WORKING CAPITAL MANAGEMENT AND

PROFITABILITY: EVIDENCE FROM TOP LISTED

COMPANIES IN MALAYSIA

Sharifah Nur Asykeen El Edrus Bt Wan Habib Ismail

Bachelor of Finance with Honours

2011

UN

IVE

RS

IT

IMALAYSIA

SA

RA

WA

K

U N I M AS

Faculty of Economics and Business

WORKING CAPITAL MANAGEMENT AND PROFITABILITY:

EVIDENCE FROM TOP LISTED COMPANIES IN MALAYSIA

SHARIFAH NUR ASYKEEN EL EDRUS BT WAN HABIB ISMAIL

This project is submitted in partial fulfillment of

the requirements for degree of Bachelor of Finance with Honours

Faculty of Economics and Business

UNIVERSITI MALAYSIA SARAWAK

2011

Statement of Originality

The work described in this Final Year Project, entitled

“Working Capital Management and Profitability: Evidence from Top

Listed Companies in Malaysia”

is to the best of the author’s knowledge that of the author except

where due reference is made.

(13 MAY 2011)

(SHARIFAH NUR ASYKEEN EL

EDRUS BT WAN HABIB ISMAIL)

22274

ABSTRAK

WORKING CAPITAL MANAGEMENT AND PROFITABILITY:

EVIDENCE FROM TOP LISTED COMPANIES IN MALAYSIA

Oleh

SHARIFAH NUR AYKEEN EL EDRUS BT WAN HABIB ISMAIL

Kertas kerja ini meneliti pengaruh pengurusan modal kerja terhadap

keuntungan dari 100 syarikat utama Malaysia di papan utama Bursa Malaysia

selama tempoh 2004 -2009. Bahagian kritikal dari kertas kerja ini mengkaji 64

syarikat yang berdaftar selama tempoh 2004 -2009 dan data kewangan diambil

dari pangkalan data Thomson DataStream dan laporan tahunan syarikat.

Nisbah hutang dan saiz syarikat telah digunakan sebagai pembolehubah

kawalan. Secara keseluruhannya, penemuan menunjukkan bahawa, dengan

menggunakan analisis korelasi Pearson dan regresi, hasil ini menunjukkan

bahawa keuntungan syarikat di Malaysia secara substansial telah dipengaruhi

oleh kitaran penukaran tunai, leverage (yang digunakan hutang) dan saiz

syarikat. Pertama, bukti yang ditemui menunjukkan ada hubungan negative

yang signifikan antara keuntungan dan kitaran penukaran tunai. Ketika

kitaran penukaran tunai meningkat, keuntungan syarikat akan menurun.

Namun, bukti yang ditemui bahawa tidak ada hubungan yang signifikan sama

sekali antara keuntungan syarikat dengan nisbah lancar. Selain itu, kajian ini

juga mendapati bahawa keuntungan syarikat mempunyai hubungan negatif

yang signifikan dengan leverage (hutang yang digunakan). Terdapat juga

hubungan positif antara saiz syarikat dan keuntungan.

ABSTRACT

WORKING CAPITAL MANAGEMENT AND PROFITABILITY:

EVIDENCE FROM TOP LISTED COMPANIES IN MALAYSIA

By

SHARIFAH NUR AYKEEN EL EDRUS BT WAN HABIB ISMAIL

This research study examines the effects of working capital management

towards the firms’ profitability of 100 top Malaysian listed firms’ on the Main

Board of Bursa Malaysia over the period 2004 -2009. The empirical part of the

study investigates 64 top listed firms over the period 2004 -2009 and the

financial data are extracted from Thomson DataStream data base and

companies’ annual reports. Debt ratio and size of firms have been used as

control variables. On the overall basis, the findings show that, by using Pearson

correlation and regression analysis (general least square with cross-section

weight models), this results indicate that firms’ profitability in Malaysia have

substantially been affected by cash conversion cycle, leverage (the used of debt)

and firm size. First, the evidence found that that there is a significant negative

association between profitability and the cash conversion cycle. When the cash

conversion cycle increased, the profitability of the firm will decrease. However,

the evidence found that there is no significant relationship at all between the

firm’s profitability with current ratio. Besides, this research study also found

that the profitability of the firm has significant negative relationship with

leverage (the used of debt). There is also positive relationship between the size

of firm and its profitability.

ACKNOWLEDGEMENT

Bismillahirrahmanirrahiim. In the name of Allah s.w.t., the Most Gracious and

Most Merciful. Peace and blessing of Allah be upon Prophet Muhammad. By

Grace of Allah s.w.t. finally this final year project is accomplished,

Alhamdullilahirrabiralamin. First and foremost, I am grateful to Allah s.w.t. for

guiding me to develop and complete this final year project without much

complicatedness. Indeed, without His help and will, nothing is accomplished.

I would like to take this chance to express my special thanks and sincere

gratitude to my supervisor, Madam Josephine Yau Tan Hwang for her patience,

advice and guidance, criticism, understand and knowledge throughout the

progress of this research and in helping me completing this research. Without

her support, I would not been able to finish my works.

I also would like to put across very special thanks to my lecturers for their

assistance and encouragement which enable me to obtain valuable knowledge. I

also would like to convey my highest appreciation to beloved family for giving

me everything sincere love and prayer. I am truly thankful for their sacrifice,

patience, encouragement, and supporting in my studying and for their suffering

during my studying life. In addition, I am appreciative to my friends who had

been supporting me to completing this work either by physical helps or by

praying.

Last but not least I would like to thankfulness any person which contributes to

my final year project directly or indirectly. I would like to accept their

commentary and suggestions, which was important for the successful

achievement of this study.

iii

TABLE of CONTENTS

Table of Content iii

List of Figures vi

List of Tables vii

List of Symbols and Abbreviation viii

CHAPTER 1: INTRODUCTION

1.0 Introduction 1

1.1 Background of the Study 4

1.2 Theoretical Framework 8

1.3 Problem Statement 11

1.4 Research Objectives 12

1.5 Significance of the Study 13

1.6 Limitations of the Study 14

1.7 Scope of the Study 15

1.8 Conclusion 16

CHAPTER 2: LITERATURE REVIEW

2.1 Introduction 17

2.1.1 Term of Working Capital Management 17

2.1.2 Term of Profitability 19

iv

2.1.3 Term of Debt Ratio (Leverage) 21

2.1.4 Term of Firm Size 22

2.2 Working Capital Management and Profitability 23

2.3 Leverage (Debt Ratio) and Profitability 31

2.4 Firm Size and Profitability 34

2.5 Conclusion 36

CHAPTER 3: DATA AND METHODOLOGY

3.0 Introduction 37

3.1 Conceptual Framework 37

3.2 Research Design 40

3.3 Data Collection Source and Procedure 41

3.4 Variables 42

3.4.1 The Dependent Variable 42

3.4.2 The Independent Variables 43

3.5 Methodology 48

3.5.1 The Descriptive Statistics 48

3.5.2 The Correlation of Variables 49

3.5.3 The Regression Analysis 49

3.6 Hypothesis Statement 52

3.7 Conclusion 53

CHAPTER 4: FINDINGS AND DATA ANALYSIS

4.0 Introduction 54

v

4.1 The Descriptive Statistics 55

4.2 The Correlation Analysis 57

4.3 The Regression Analysis 58

4.4 Conclusion 62

CHAPTER 5: DISCUSSION & CONCLUSION

5.0 Introduction 63

5.1 Discussion 63

5.2 Implications 68

5.3 Conclusion 69

5.4 Recommendations 71

REFERENCES 73

APPENDICES

A List of Samples by Sector Classification 77

vi

LIST of FIGURES

Figure 1: A diagram showing the relationship between indicators 38

for working capital management and profitability

Figure 2: The Operating and Cash Conversion Cycle 45

vii

LIST of TABLES

Table 1: Measurement of profitability of the firm by various authors 20

Table 2: Sample Distributions and Descriptions for

year 2004 until 2009 41

Table 3: Measurement for the cash Conversion Cycle 45

Table 4: Proxy variables description with measurement

and predicted relationship 51

Table 5: Descriptive Statistics of Variable (Samples = 384) 55

Table 6: Correlation Coefficients Matrix 57

Table 7: Cross-Section Weights Results 59

viii

LIST of SYMBOLS & ABBREVIATION

CCC Cash conversion cycle

CR Current ratio

DR Debt ratio

EBIT Earnings before Interest and Taxes

NOP Net operating profitability

SZ Logarithm of Sales

VIF Variance Inflation Factor

1

CHAPTER 1

INTRODUCTION

1.0 Introduction

According to Appuhami (2008), Gill et al (2010) together with Raheman et al (2007),

working capital management is a major element of corporate finance in view of the

fact that it directly has an effect on the liquidity as well as profitability and the risk

of the firms. For that reason, the working capital management of a firm may have

both negative and a positive impact which is obviously affects the firms’ profitability.

Furthermore, according to Deloof (2003), the way the working capital management

is deal with also would give a significant impact towards the profitability of the firm.

In addition to that, Mathuva (2010) and Raheman et al (2007) also stated that the

working capital management is dealing with the management of current asset and

current liabilities in a short-term period of financing. Consequently, the working

capital management will face some difficulties when problems arise while

controlling the current assets and the current liabilities.

On the other hand, Dong et al (2010) conveyed that the basis aim are well-managed

the firm’s current assets and current liabilities with the intention that the working

capital can be maintained at an acceptable level. In every day transaction business,

2

working capital management deals with profitability and the risk of the company.

Hence, Raheman et al (2007) stated that planning and controlling the current asset

and current liabilities would impact in an efficient working capital management

which means that the risk of inability to meet due short-term obligations can be

eliminated.

Thus, the working capital management is well-defined by Ganesan (2007), which is

stated that working capital management is the management of short-term financing

requirements of a firm and it consist of the components of working capital

management which are accounts receivable, inventories, and accounts payable.

Whereas, according to Raheman et al (2007) and Ramachandran et al (2009), the

term of working capital refers to the flow of ready funds necessary for the working

of a concern, which are deals with current assets and current liabilities. To make

more clearly, Gill et al (2010) elucidated the working capital management as the

management of current assets and current liabilities, and financing these current asset.

Furthermore, the consequence of the working capital management toward the

operation of the companies was well-recognized. Zariyawati et al (2009) stated that

working capital is an important issue throughout financial decision-making since it is

being a component of investment in asset that requires appropriate financing

investment. The performance of the company is depends on the working capital

management which is how the company develop their needs in maintaining their

liquidity. Moreover, Ganesan (2007) also highlighted that managing the proportions

of the working capital management components is important to the operations and

financial of the business from all industries.

3

Nazir et al. (2009) stated that the objective of the working capital management is to

maintain an optimal balance between each of the working capital components. The

needed components of an organization’s working capital management, basically,

depend on the type of industry and business (Appuhami, 2008).

There is variety of variables that related to the working capital management.

According to Shin et al (1998), the standard measure for working capital

management is cash conversion cycle. According to Lazaridis et al (2006), there is

look like to be a strong connection between the cash conversion cycle of a firm and

its profitability. Therefore, Gill et al (2010) defined cash conversion cycle as the

time span between the disbursement and the collection of sales of finished goods.

There are three components of cash conversion cycle which is accounts receivable,

inventories, and accounts payable and according to Lazaridis et al (2006), these

components can be managed in different ways in order to maximize profitability of

the company.

4

1.1 Background of the Study

The links between working capital management along with profitability were

investigated in this research paper. It is an empirical analysis which is used selected

top 100 listed Malaysian companies at a particular sector level on the Main Board of

Bursa Malaysia from the year of 2004 to 2009. The analysis is reported in this

section.

The main sectors in the Main Board of Bursa Malaysia such as Construction,

Consumer Product, Industrial Product, Infrastructure, Plantation, Property, and

Trading/ Services sectors which is played an important role in development of the

Malaysian economy. 100 top listed companies in Malaysian is selected companies

from the Main Board of Bursa Malaysia because all the companies that being listed

as the top companies is companies that well-managed in their performance as well as

their profitability. For example, in Construction sector, Gamuda Bhd is one of the

most leading construction, engineering, infrastructure and property development

company in Southeast Asia’s. In addition, in Trading / Services sector, which is

being a dominated in Main Board of Bursa Malaysia market is one of sector that

played an important sector in the market. Telekom Malaysia Berhad (TM) is one of

the examples in the Trading / Services which is be a market leader in the broadband

and fixed-line businesses. UMW Holdings also one of the examples in the Trading /

Services sectors that being denominator in the industrial enterprise with diverse and

global interests in the automotive, equipment, manufacturing and engineering, and

oil and gas industries. Moreover, this companies is expanded their business globally

and mostly in Asia such as in Singapore, Indonesia, Thailand, Myanmar, Vietnam,

5

Papua New Guinea, Australia, Taiwan, China, India, the United Arab Emirates and

Turkmenistan to maintain their profitability and performance.

Most of the companies in the 100 top listed companies have shown an enormous

result in their revenues as well as their financial statement in 2004 after a crisis in

2003. By the time the Malaysian market was in the crisis time, most of the

Malaysian companies were hit by the effects of massive slump in Asian currencies as

well as the stock markets and assets values. Additionally, a company with strong

financial performance may be more willing and able to participate in longer period

and gain more profit and well-managed their assets and liabilities in the company.

Therefore, the purpose of this study is to see whether the profitability have a

relationship with working capital management and liquidity as well as leverage (the

used of debt) and the size of the firm after the financial crisis in 2003, which is in the

year of 2004 until 2009.

Many of the studies about working capital management were undertaken from

countries over the world such as Thailand, Vietnam and so on especially in Western

countries. However, there are quite a few of the studies manage working capital

management in Malaysian context especially in Malaysian top listed companies. One

of the Malaysian studies in working capital management is done by Zariyawati et al

(2009). According to Zariyawati et al (2009), the ability for the firm to operate in

long-term periods is depends on how the firms deal with the investment in working

capital management. In Western context of working capital management, Gill et al

(2010) explicate that the management of working capital might have both negative

and positive impact towards the firm profitability. However, in the study done by

6

Shin et al (1998), both of them concludes that there is statistically strong relationship

exists between the profitability of the companies with the efficiency of the working

capital management. Therefore, in this research, the working capital management

measured by using the cash conversion cycle (cash gap) and current ratio (as

measurement the liquidity) which are being used by previous study such as Deloof

(2003), Demirgunes et al (2008), Eljelly (2004), Falope et al (2009), Ganesan (2007),

Gill et al (2010), Lazaridis et al (2006), Karaduman et al (2010), Raheman et al

(2007), Sbeiti (2010), Shah et al (2006), Zariyawati et al (2009) and Zubairi (2010).

In addition, this research paper also studies on the debt ratio which is use as a proxy

for the leverage. This is because, by the time the Malaysian markets were hit by the

financial crisis, the probability of the leverage increased is high especially for the

short-term period. Generally, leverage determines the company’s financial structure

and the long-term risks for the company is measured. Above and beyond, debt ratio

refers to the proportion of overall funds that obtained from the creditors. Dong et al

(2010) and Rahemen et al (2007) characterized the debt ratio as the used of the debt

in the firm and to make sure the debt financing have a relationship on the firm

profitability. According to Obert et al (2010), debt ratio measures the proportion of

total assets financed by a firm’s creditors.

The profitability of the firm is affected by the leverage. If the leverage or the used of

the debt have increased in the firm, for that reason, the profitability in the firm also

increased and if the used of the debt have decrease in the firm, as a result, the

profitability for the firm also decreased. Kila et al (2008), states that debt is an

effective tool to decrease the agency costs, and eventually optimal capital structure

7

can be derived from the balance between the costs of debt against the benefits of

debt. However, a high percentage in the debt ratio means that the company is too

reliant on the leverage to finance its activity while low percentage represents

otherwise. In general, the higher the ratio, the riskier the company position to be in

default payment and subject to face financial distress and eventually bankruptcy.

In the study done by Rajan et al (1995), larger firms tend to be more diversified and

fail less often compared to smaller firms. He also quoted that the size of the firm can

also be a proxy for the information outside investors. In addition, it does not matter if

the company size is big or small; the size of the firm would give impact on the use of

the debt and will have an effect on the firm profitability. The size of the firm is

defined by the natural logarithm of the sales similar with the studies done by Abu-

Tapanjeh (2006), Deloof (2003) and Zubairi (2010).

Size of the firm is being used by numerous researchers include Abu-Tapanjeh (2006),

Deloof (2003), Demirgunes et al (2008), Dong et al (2010), Eljelly (2004), Falope et

al (2009), Gill et al (2010), Karaduman et al (2010), Raheman et al (2007), as well as

Zubairi (2010). In addition, size of the firm have a different consequences if the size

of the firm is vary from each other. Generally, there are quite a few of measurement

to determine the size of the firm which is can be measured by assets, sales,

employees and value added. Most of the previous studies come out with varying

consequences and conclusion. The effect of the size of the firm is important to know

in this research because the size of firm will determine if the company gain a profit

or losses for every transaction of the business especially after the financial crisis in

the year of 2003.

8

1.2 Theoretical Framework

There are a different type of theories that been using in this study to determine the

relationship between the profitability with independent variables. Those theories

have different implications for the profitability of the firms.

According to Padachi et al (2010), trade-off between liquidity and profitability

showed that there is a negative relationship between the two variables which

indicates that high level of liquidity will have a problem in profitability. In addition,

Dittmar et al. (2002) elucidated that when the firm are liquid, this means that the

profitability of the firm were increased, which is the firms gain huge amount of net

working capital. However, according to trade-off theory, when the firm have high

level of liquidity, which means that the cash are easily converted to cash, the firms

actually faced a problem in handling the high profitability. According to Padachi et

al (2010), the positive relationship between profitability and cash holdings is also an

implication of the financing hierarchy view. The cost of holding cash is the liquidity

premium, which is defined as the opportunity cost for holding liquid assets.

In a study conducted by Servaes et al (2006), they suggest that in the trade-off view,

more profitable firms should hold more cash because firms that are very profitable

usually also have good investment opportunities. In addition, according to pecking

order theory, firm will hold more cash for a longer period in the cash conversion

cycle. However, according to Deloof (2001), he stated that when the cash conversion

cycles have a longer period, the firm actually reduces the need to hold the liquidity

because when the accounts receivables and inventories is greater, it can be quickly

can be converted into cash.

9

In a study done by Niu (2008), this study elucidated that in terms of profitability,

trade-off theory predicts that more profitable firms will be expected to get higher

debt ratio. However, the company actually should borrow less to prevent the loss in

the value of financial distress.

In addition, this statement also been proved by Liu et al (2009), which is this study

states that based on the trade-off theory, firm that holding more future growth and

cash will tend to borrow less. According to Dittmar et al. (2002), when the firm tend

to borrow less, the levels uses of debt will decrease, therefore, the cash for the firm

would be increased and the firm would turn out to be more profitable and does not

required external financing to finance theor operation.

In addition, this study elucidated that based on the pecking order theory; there is an

opposite relationship between profitability with the level of debt. If the firm get

higher debt ratio, the firm would get a decreased in the profitability, whereas, if the

firm get lower debt ratio, the firm will be more profitable.

In a study done by Sheikh et al. (2010), these studies indicates the trade-off theory,

which is larger firms tend to borrow more than smaller firms. This is because larger

firms tend to be more diversified and less prone to bankruptcy. The smaller firm is

expected to get high probability to pay more on debt and should be operated with

low leverage because smaller firm will be facing the financial distress. Therefore,

Dittmar et al. (2002) stated that based on trade-off theory, larger firms should hold

lower cash and firms tend to hold more cash when they are small firms.

Above and beyond, Kaen & Baumann (2003) elucidated that firm size and

profitability may be linked through a trade-off of economies of scale, transactions

10

costs and agency costs. Based on the economies of scale, profitability for the firm is

expected to have positive relationship with the firm’s size. This is because, when the

company large, the company can obtained the economies of scale, while if the size of

the company is smaller, the company is tend to get negative relationship with the

profitability.

11

1.3 Problem Statement

As many researches carried out different empirical approach in determining the

effects of the working capital management and liquidity on firm profitability,

therefore, this research paper raised up the issue what are the main factors that affect

the firm profitability.

Therefore, this research papers want to analyze the working capital management in

top listed companies in Malaysian after the financial crisis in 2003. Accordingly,

changes of economic environment will lead to the changes of financial decision-

making. This is because, according to Zariyawati et al. (2009), working capital is a

major issue for the firm financial decision-making. In addition, Zariyawati et al.

(2009), also stated that the performance of the company is depends on the working

capital management. Therefore, it is important to know how the companies build up

their earnings and sustained their liquidity subsequent to the financial crisis in 2003

and what the impact if top listed companies did not manage it well.

In addition, there are very few of the previous research discussed the working capital

management with the firm profitability in developing countries such as Malaysia. As

stated previously, working capital management is a major element in corporate

finance. Therefore, it is valuable to know the outcomes as well as with the aims to

strengthen the previous studies on the working capital management and firm

profitability.

Thus, this study tries to answer these particular research problems, what is the

relationship between current ratio, cash conversion cycle, leverage (the used of debt)

and size on the firm profitability of the Malaysian top listed companies.

12

1.4 Research Objectives

In this study, the objectives are divided into two types which are included general

objective and specific objective.

1.4.1 General Objective

The general objective for this study is to examine the relationship between the

working capital management and liquidity on the firm profitability in the Malaysian

listed firms during the period 2004 to 2009.

1.4.2 Specific Objectives

Specifically the objectives of this research are to analyze and investigate as well as to

obtain empirical evidence on the relationship among the variables, which is current

ratio, cash conversion cycle, the leverage (use of the debt) and the size of the firm

with the firm profitability in selected top 100 listed companies in Malaysia over the

six years. In addition, this study also wants to examine the stability of the

profitability of the selected top listed companies after the financial crisis during the

period of six years. Lastly, this study specifically to determine which theory would

fit the best to explained the relationship of profitability with the working capital

management as well as leverage (the used of debt) and firm size.