1.

Introduction
1.1Back Ground of the Study
Managing the financial needs and operations of any business is very important to the
management of the company, because it has an effect on both profits and liquid assets of
the firm. Financial needs are largely classified into two types: working capital needs and
fixed capital needs. Working capital enables an enterprise to conduct its day-to-day
operation. We need to analyze short term assets and liabilities carefully in order to
manage the firm’s liquidity, and management of working capita helps managers to
control their operations of the firm through making available cash to pay for `short-term
debt and the maturity of long term debt as well as expenses resulting for daily operations.
So, an optimal level of working capital must be kept to tradeoff between return and risk
(Ranjith, 2008).

One of the integral components of the overall corporate strategy is to manage working
capital efficiency. This needs to control short term obligation as well as decrease
investment in liquid assets create shareholder value (Elijelly 2004). In practice, Narender,
Menon and Shawetha, (2009) show that a firm may lose several investment opportunities
or suffer a liquidity problem if the working capital is too low or it is improperly managed.

Working capital management is a very sensitive area in the field of financial management
also (Joshi, 1994). It involves the decision of the amount and composition of current
assets and the financing of these assets.

1.2Statement of the Problems

Sugar mills are facing severe liquidity problems. They don’t have enough cash to pay a
good price to suppliers and above all pay their suppliers on time. This problem has gone
so worst that they are not able to pay their legal liabilities. Considering the situation of
the sugar mills; banks are not willing to advance any further loans. A firm with more debt
will mean that it has less internal financing and that there could be less capital available
for daily operations. This negative relationship is confirmed by Raheman and Nasr
(2007), Zariyawati et al. (2009), Mathuva (2009), Zariyawati et al. (2010) and Erasmus
(2010) for different countries. Anticipation of high sales growth could result in firms

1
stocking up on inventory which could outweigh the effect on trade credit (Moussawi et
al. 2006). The positive effect of growth on inventory is confirmed by Blazenko and
Vandezande (2003). Appuhami (2008), Banos-Caballero et al. (2010a), Chiou et al.
(2006), Hill et al. (2010) and Nazir and Afza (2009) find a positive relationship between
working capital and sales growth. In almost all studies on the impact of working capital
on profitability, a highly significant negative relationship was found.

The researcher motivated with the following reasons to conduct the research:

 So far no empirical study in Ethiopian context regarding the impact of working

capital management on profitability of sugar factory.
 In addition, the study addresses the research question “to what extent do working
capital management affects profitability of sugar manufacturing companies in
Ethiopia.”
 More specifically, the study investigates on the relationship between working
capital management and profitability.
1.3 Objectives of the study
1.3.1 General Objective
The major objective of the proposed study will examine the impact of working capital
management on profitability of sugar factories in Ethiopia: A case study of Wonji-
Shoa sugar factory

1.3.2 Specific Objectives

The present study will be undertaken to achieve the following specific objectives with
regard to impact of working capital management on profitability of sugar factories: A
case study of Wonji-Shoa sugar factory.

 To identify relationship between Working Capital Management and Profitability

in Wonji Shoa Sugar Factory in Ethiopia.
 To assess the relationship between two objectives liquidity and profitability.
 To investigate the impact of accounts receivables days, accounts payable days and
cash conversion cycle on net operating profitability of the Wonji Shoa Sugar
Factory in Ethiopia.

2
 1.4 Research Questions
 What is the relationship between Working Capital Management and Profitability
in Wonji Shoa Sugar Factory?
 Do accounts receivables days, accounts payable days and cash conversion cycle
have impact on net operating profitability of Wonji Shoa Sugar Factory in
Ethiopia?
 What is the relationship between profitability with financial leverage and debt
ratio of factory?
1.5 Significance of the Study
The beneficiaries of this research include the sugar factory under consideration where it
can find the problems along the recommendation for better future management of its
resources to increase profitability. It also serves an input for those who are conducting
research in the future. It may also serve the government to see the problem to take
corrective action in sugar industry. It helps for the stakeholders (Out grower's farms,
Insurance companies, Banks, employees etc) of Wonji Shoa sugar factory to know the
basic determinant factor of profitability and understanding their level of significance.
Government (currently the owner of sugar factory in Ethiopia) and potential investors
needs the proposed study in order to protect their investments and directing themselves in
to the best investment alternatives respectively by forecasting expected return related to
Wonji-Shoa Sugar factory.

1.6 Delimitation of the Study

To address the problem under consideration the study delimitated due to the constraint of
methodology applied the study will be delimitated by its topic, study area and variables
that consider.
 Topic: the topic of the proposed study will be limited to the impact of working
capital, on profitability of Wonji-Shoa Sugar Factory.
 Study area: The geographical scope of the proposed study will be limited to the
boundary of Wonji Shoa Sugar Factory, Ethiopia.
 Variables: Return on the asset(ROA), Cash conversion cycle(CCC), Average
payment period(APP), Average collection period(ACP), Current ratio(CR), Debt
ratio (DR), Inventory management period(IMP), Size(S), Sales growth(SG) and
Average Collection Period(ACP).
 Methodology: the methodology is only delimitating in to quantitative method

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 with descriptive statistics, correlation and econometrics analysis tools.
1.7 Organizations of the Paper
The paper is organized under five chapters. The first chapter deals with the problem
and its approach, which includes background to the study, statement of the problem,
research objectives, scope and limitations of the study, significance of the study and
organization of the research report. The second chapter is exclusively devoted to the
review of related literature on impact of working capital management from different
countries perspective. Chapter three deals with the methods used to collect and analyze
the data. Analysis and presentation of the findings of the study is described in chapter
four. The last chapter, chapter five, presents the conclusions drawn from the findings, the
recommendations made to address the problems uncovered, and the implications of the
findings for future research, practitioners, government and other support agencies.

2. Review of the Related Literature

2.1Theoretical Review of Related Literature
2.1.1 Concept of Working Capital Management
There are two concepts of working capital viz. quantitative and qualitative. Some people
also define the two concepts as gross concept and net concept. According to quantitative
concept, the amount of working capital refers to ‘total of current assets. What we call
current assets? Smith called, ‘circulating capital’. Current assets are considered to be
gross working capital in this concept.

The qualitative concept gives an idea regarding source of financing capital. According to
qualitative concept the amount of working capital refers to “excess of current assets over
current liabilities. L.J. Guttmann defined working capital as “the portion of a firm’s
current assets which are financed from long–term funds.”

2.1.2 Importance of Working Capital Management

For smooth running an enterprise, adequate amount of working capital is very essential.
Efficiency in this area can help, to utilize fixed assets gainfully, to assure the firm’s long-
term success and to achieve the overall goal of maximization of the shareholders, fund.
Shortage or bad management of cash may result in loss of cash discount and loss of

4
reputation due to non-payment of obligation on due dates. Insufficient inventories may be
the main cause of production held up and it may compel the enterprises to purchase raw
materials at unfavorable rates.

2.1.3 Determinants of Working Capital

There are no set rules or formulas to determine the working capital requirement of a firm.
A number of factors influence the need and quantum of the working capital of a firm.
These are discussed below:

Nature of Industry: - The composition of an asset is related to the size of a business and
the industry to which it belongs. Small companies have smaller proportion of cash,
requirements and inventory than large corporations. Need of working capital is thus
determined by the nature of an enterprise.

Demand of Creditors: - Creditors are interested in the security of loans. They want their
advances to be sufficiently covered. They want the amount of security in assets which are
greater than liabilities.

Cash Requirements: - Cash is one of the current assets which are essential for the
successful operations of the production cycle. Cash should be adequate and properly
utilized. A minimum level of cash is always needed to keep the operations going.

General Nature of Business: - The general nature of a business is an important

determinant of the level of the working capital. Working capital requirements depends
upon the general nature and its activity on work. They are relatively low in public utility
concerns in which inventories and receivables are rapidly converted into cash.
Manufacturing organizations, however, face problems of slow turn-over of inventories
and receivables, and invest large amount in working capital.

Time: - The level of working capital depends upon the time required to manufacture
goods. If the time is longer, the amount of working capital required is greater and vice-
versa. Moreover, the amount of working capital depends upon inventory turnover and the
unit cost of goods that are sold. The greater this cost, the larger is the amount of working
capital.

5
Volume of Sales: - This is the most important factor affecting the size and component of
working capital. A firm maintains current assets because they are needed to support the
operational activities which results in sales.

Terms of Purchases and Sales: - If the credit terms of purchases are more favorable and
those of sales less liberal, less cash will be invested in inventory. With more favorable
credit terms, working capital requirements can be reduced as a firm gets time for payment
to creditors or suppliers.

Inventory Turnover: - If the inventory turnover is high, the working capital

requirements will be low. With good and efficient inventory control, a firm is able to
reduce its working capital requirements.

Receivables Turnover: - It is necessary to have effective control over receivables.

Prompt collection of receivables and good facilities for setting payables result into low
working capital requirements.

2.2Empirical Studies on the Impact of WCM on Profitability of

Firms
Though the impact of working capital policies on profitability is highly important, only a
few empirical studies have been carried out to examine this relationship. Working capital
management is important because of its effects on the firms‟ profitability and risk, and
consequently its value (Smith, 1980). The greater the investment in current assets, the
lower the risk, but also the lower the profitability obtained. Contrary to this, Carpenter
and Johnson (1983) provided empirical evidence that there is no linear relationship
between the level of current assets and revenue systematic risk of the US firms; however,
some indications of a possible nonlinear relationship were found, which were not highly
statistically significant.

Soenen (1993) investigated the relationship between the net trade cycle as a measure of
working capital and return on investment in the US firms. The results of chi-square test
indicated a negative relationship between the length of net trade cycle and return on
assets. Furthermore, this inverse relationship was found different across industries

6
depending on the type of industry. A significant relationship for about half of the
industries studied indicated that results might vary from industry to industry. Another
aspect of working capital management has been analyzed by Lamberson (1995) who
studied how small firms respond to changes in economic activities by changing their
working capital requirements and level of current assets and liabilities. Current ratio,
current assets to total assets ratio and inventory to total assets ratio were used as a
measure of working capital requirement, while the index of annual average coincident
economic indicator was used as a measure of economic activity. Contrary to the
expectations, the study found that there is a very small relationship between changes in
economic conditions and changes in working capital. In order to validate the results of
Soenen (1993) on a large sample and with a longer time period,

Most of the empirical studies support the traditional belief about working capital and
profitability that reducing working capital investment would positively affect the
profitability of firm (aggressive policy) by reducing proportion of current assets in total
assets. Deloof (2003) analyzed a sample of Belgian firms, and Wang (2002) analyzed a
sample of Japanese and Taiwanese firms, emphasized that the way the working capital is
managed has a significant impact on the profitability of firms and increase in profitability
by reducing number of days accounts receivable and reducing inventories. A shorter Cash
Conversion Cycle and net trade cycle is related to better performance of the firms.
Furthermore, efficient working capital management is very important to create value for
the shareholders.

Another study by Afza and Nazir (2007) investigated the relationship between aggressive
and conservative working capital policies and found a negative relationship between the
profitability measures of firms and degree of aggressiveness of working capital
investment and financing policies. Raheman and Nasr (2007) suggested that there exist a
negative relation between working capital management measures and profitability. Shah
and Sana (2006) used a very small sample of 7 oil and gas sector firms to investigate this
relationship for period 2001-2005. The results suggested that managers can generate
positive return for the shareholders by effectively managing working capital.

7
Lack of empirical evidence on the working capital management and its impact on the
firm performance in case of sugar industry in Ethiopia is main motivating force to study
the subject in more detail. Existing literature with reference to Ethiopia on the
comparison of different working capital measures on sectorial basis lacks the empirical
evidence. Therefore, the present study is an attempt to fill this gap and estimates the
relationship between working capital management and firm performance shareholders
(Wang, 2002; Deloof, 2003).

Tryfonidis and Lazaridis (2006) carried out a research for the companies listed in Athens
Stock Exchange. Tryfonidis and Lazaridis (2006) analyzed the relationship between
working capital management and profitability of the firms. The variable for the
measurement of profitably was gross operating profit in their research.

Significant relationship between the cash conversion cycle and profitability was reported.
Tryfonidis and Lazaridis (2006) stated that the profit can be maximized by taking care of
every component of working capital at individual level..

2.3 Model Developed

Person Correlation will be used to calculate the relationship between different variables
used in this research. Working capital components are cash, inventory, receivables and
payables. To find the effect of working capital management on profitability of sugar
industry regression model will be developed using empirical framework.

The researcher specifies his model as: -NOI = β0 + β1 (lnS) + β2 (SG) + β3 (CR) + β4
(GR) +β5 (NDAR) + β6 (NDI) + β7(NDAP) + εit

Variables to be studied

Dependent Variables
NOI - Net operating income is (sales –cost of goods sold)/ (total assets)
Net operating income is used as a profitability and performance measure in this research.
Shin and Soenen (1998) and Deloof (2003) also used net operating income as a
comprehensive measure of profitability in their researches. They stated that working
capital management significantly affects the profitability of the firm.

8
 Independent Variables

In this research three comprehensive components of working capital management Trade

credit policy, Inventory policy and Payment policy will be used. Many researchers which
include Shin and Soenen (1998), Deloof (2003) and Padachi (2006) used same
components for analyzing working capital management.

S - Sales are expressed in millions of Birrs

Natural log of sales is included in the research to measure the size of the firms. It is
assumed that bigger the size more the profit. Shin and Soenen (1998), Deloof (2003) and
Padachi (2006) also included sales as a measure of firm size and found positive and
highly significant relation between sales and corporate profitability.

SG - Sales growth is (current year’s sales - last year’s sales)/last year’s sales

Sales growth is added in the research to measure the investment growth opportunity in
the industry. Deloof (2003) included sales growth in his research and found positive and
highly significant relation with profitability.

CR - Current ratio is current asset/current liabilities

Current ratio is taken as the measure of liquidity in the firm. More the liquidity of the
firm less will be investment in working capital and firm will easily pay its immediate
liabilities and creditors but on other hand more liquidity means that less investment in
inventory and less sales. It is found that current ratios have direct and significant
relationship with profitability (Rehman and Afza, 2010)

GR - Gearing ratio is total fixed liability/total capital employed

Gearing ratio is used to measure the leverage of the firm. Rehman and Afza (2010) used
gearing ratio in the research and find negative relationship with profitability. It means
higher the debt less the profit.

NDAR – Number of days accounts receivable is (A/R x 365)/sales.

9
Number of day’s accounts receivable is included as a component of working capital
management. Generous credit terms can increase sales as it allows more time for
customers to check the goods from the supplier before paying the cost (Long, Malitz and
Ravid, 1993; Deloof and Jegers, 1996). Customers enjoy advantage from longer credit
terms as compare to taking a loan from financial institution (Petersen and Rajan, 1997).
Therefore, number of day’s accounts receivable significantly affects the profitability of
the firm (Deloof 2003).

NDI - Number of days inventory is (inventory x 365)/cost of goods sold

Firms have different optimal level of investing in working capital some invest more some
invest less. On one hand keeping low inventory result in high liquidity but on other hand
keeping high inventory saves firm from stock out and also result in more sales. Many
researchers have included NDI as one of the components of working capital management
as NDI has a negative relation with NOI and significantly affect the profitability. The
negative relation shows that low profit means less sales and less sales result in more
inventory (Deloof, 2003).

NDAP - Number of days accounts payable is (A/P x 365)/purchases

Number of day’s accounts payable is also an important component of working capital

management. Firm enjoys more liquidity and gets the chance to examine the quality of
goods before paying to their suppliers if they pay late but on other hand, they miss the
discount offered by the suppliers which they can avail by prompt payment. Padachi
(2006) and Deloof (2003) in their researchers found that number of days accounts
payable significantly affect the profitability of the firm.

2.4 Hypothesis
The researcher will primarily focus on the following hypothesis:

H1: Sales has a significant impact on NOI.

H2: Sales Growth has a significant impact on NOI.

H3: Current Ratio has a significant impact on NOI.

H4: Gearing Ratio has a significant impact on NOI.

10
H5: Number of Days Accounts Receivable has a significant impact on NOI.

H6: Number of Days Inventory has a significant impact on NOI.

H7: Number of Days Accounts Payable has a significant impact on NOI.

3. Research Design and Methodology

3.1Research approach and Design

Once data were found acceptable, electronically tabulation using the E-views
software programmed for data entry and analysis was made. Analysis of data was
undertaken to show important relationships of variables in the study. To this end, a
mix of both descriptive statistical and regression analysis is used.

Descriptive research will be used; it will help to describe relevant aspects of

phenomena of cash conversion cycle and provide detailed information about each
relevant variable. The results are analyzed first followed by a descriptive analysis of
the variables used in the study.

In quantitative analysis two methods are applied: First: The researcher used
correlation models, specifically Pearson correlation to measure the degree of
association between different variables under consideration. Second: Regression
analysis is used to estimate the causal relationships between profitability variable,
liquidity and other chosen variables.

3.2Population and Sampling

The main source of data is financial statements (income statements and balance sheets) of
Wonji-Shoa sugar factory. The variables used in the study, dependent, independent and
control variables, all are calculated and drawn from these financial statements of the
factory. The reason for restricting the time period to ten years was that the latest data for
the study was available for these years.
3.3 Data Collection Instrument

11
The data which will be used for the purpose of the research consisted of ten years annual
financial data of Wonji-Shoa factory. Data of all the variables belonged to a period
starting from fiscal year 2010 to fiscal year 2020

3.4 Data Collection Procedures

The Proposed undertakes the issue of identifying key variables that influence working
capital management of Ethiopian firms. Most of the variables identified in the
investigation have been taken from the existing literature on working capital
management. The study takes into account of all the variables discussed below.
Variables, which include dependent, independent, and control variables, used to
investigate the test hypothesis are described as follows:

 Net Operating Profitability (NOP) which is a measure of Profitability of the firm

is used as dependent variable. It is defined as Earnings before Interest and Tax
divided by Total Assets.
 Average Collection Period (ACP) used as proxy for the collection policy is an
independent variable. It is calculated by dividing account receivable by sales and
multiplying the result by 365 (number of days in a year).
 Average Payment Period (APP) used as proxy for the payment policy is also an
independent variable. It is calculated by dividing accounts payable by expenses
and multiplying the result by 365.
 Sales (S)
 Sales growth (SG)
 Gearing ratio (GR)

In working capital literature, various studies have used the control variables along with
the main variables of working capital in order to have an opposite analysis of working
capital management on the profitability of firms (Deelof, 2003; Eljelly, 2004; Teruel and
Solano, 2005 and Lazaridis and Tryfonidis, 2006). On the same lines, along with working
capital variables, the present study has taken into consideration some control variables
relating to firms such as the size of the firm, the current ratio and its financial leverage.

12
The size of the firm has been measured by the logarithm of its total assets, as the original
large value of total assets may disturb the analysis.

Moreover, the financial leverage was taken as the debt to equity ratio of each firm for the
whole sample period. Some studies, like Deloof (2003) in his study of large Belgian
firms, also considered the ratio of fixed financial assets to total assets as a control
variable; however, this variable cannot be included in the present study because of
unavailability of data, as most of the firms do not disclose full information in their
financial statements. Therefore Current Ratio (CR)which is a traditional measure of
liquidity is calculated by dividing current assets by current liabilities is used as a
control variable along with Size (Natural logarithm of Sales (LOS) and Debt Ratio
(DR) used as proxy for Leverage and is calculated by dividing Total Debt by Total
Assets.

All the above variables have relationships that ultimately affect working capital
management. It is expected that there is a negative relationship between net operating
profitability on the one hand and the measures of Working Capital Management (number
of day’s accounts receivable, accounts payable and cash conversion cycle) on the other
hand. This is consistent with the view that the time lag between expenditure for the
purchases of raw materials and the collection of sales of finished goods can be too long,
and that decreasing this time lag increases profitability.

Ethical Consideration
Ethical clearance and permission obtained from the institutional review board Faculty of
Business and Economics of different University, Ethiopia. Permission is also granted
from Government corporation unit through formal letter. Participation in the study was
on the voluntary basis and participants are asked for willingness before they are provided
the questionnaire. The subjects are also assured that their responses used only for the
purpose of the study. An attempt is made to first explain the objectives and significance
of the study to the respondents. Name and other identifying information are not used in
the study. The researcher safeguarded all information related to the participants. Their
privacy, identity and confidentiality are maintained by assigning them code numbers
instead of names (anonymity).

13
Time and Budget Schedule

Budget schedule

No, Item Quantity Cost per unit (birr) Total cost (birr)

1 Stationary material
paper 0.5pad 150.00 150.00
pens
flash 5 Pcs 8.00 40.00

1 Pcs 280.00 280.00

2 Telephone expense 200 minutes 0.75 9000

3 Printing 185page 6 108.00

4 Transportation 25 days 20.00 500.00

5 Other cost -- 1000 1000

Time schedule

Months in 2021G.C
No, Activities Aug Nov Dec Jan Mar Apr May Jun July

1 Title selection xxxx

2 Writing the back Xxxx Xxxx

ground

3 Literature review xxxx

4 Data collection xxxx xxxx

5 Data processing xxxx
and organize

14
 6 Data analyzing xxxx
and interpreting

7 Submitting and xxxx

presentation

8 Final xxx
presentation or x
defense

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