literature review
TRANSCRIPT
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Literature Review
The current study contributes to the literature by examining
impact of ratio analysis on the operating performance and
growth of the company. The study also sheds light on the
relationship of ratio analysis with debt level, firm risk, and
industry. Using a sample of a manufacturing, the study finds a
significant positive association between higher levels of accounts
receivable and operating performance. The study further finds
that maintaining control (i.e. lower amounts) over levels of cash
and securities, inventory, fixed assets, and accounts payables
appears to be associated with higher operating performance, as
well. We find that the firms which are experiencing unusually
high growth tend not to perform as well as those with low to
moderate growth.
Further firms which are experiencing high growth tend to hold
higher levels of cash and securities, inventory, fixed assets, and
accounts payables. These findings tend to suggest that firms are
willing to sacrifice performance (accept low or negative
operating returns) to increase their growth levels. The higher
level of growth is also associated with higher operating and
financial risk. The findings of this study suggest that perhaps the
firms should stay more focused on their operating performance
than on maintaining high growth levels.
The following section presents a brief literature review. Next, the
research method is described, including some information about
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the annual Working Capital Management Survey published by
various reports and magazine. Findings are then presented and
conclusions are drawn.
Many researchers have studied working capital from different
views and in different environments. The following are some
useful research:
Rehman (2006) investigated the impact of working capital
management on the profitability of 94 Pakistani firms listed at
Islamabad Stock Exchange (ISE) for a period of 1999-2004. He
studied the impact of the different variables of working capital
management including Average Collection Period, Inventory
Turnover in Days, Average Payment Period and Cash
Conversion Cycle on the Net Operating Profitability of firms. He
concluded that there is a strong negative relationship between
above working capital ratios and profitability of firms.
Furthermore, managers can create a positive value for the
shareholders by reducing the cash conversion cycle up to an
optimal level. Similar studies on working capital and
profitability includes Smith and Begemann (1997), Howorth &
Westhead (2003), Ghosh & Maji (2004), Eljelly (2004), and
Lazaridis and Tryfonidis (2006).
Dr Ioannis Lazaridis, Msc Dimitrios Tryfonid( 2006) studied
the relationship of corporate profitability and working capital
management. The purpose of their
paper was to establish a relationship that is statistical significant
between profitability, the cash conversion cycle and its
components for listed firms in the ASE. The results of their
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research showed that there is statistical significance between
profitability, measured through gross operating profit, and the
cash conversion cycle. Moreover managers can create profits for
their companies by handling correctly the cash conversion cycle
and keeping each different component (accounts receivables,
accounts payables, inventory) to an optimum level.
Weinraub And Visscher (1998) had discussed the issue of
aggressive and conservative working capital management
policies by using quarterly data for a period of 1984 to 1993 of
US firms. Their study looked at ten diverse industry groups to
examine the relative relationship between their aggressive /
conservative working capital policies. The authors had
concluded that the industries had distinctive and significantly
different working capital management policies. Moreover, the
relative nature of the working capital management policies
exhibited remarkable stability over the ten-year study period.
The study also showed a high and significant negative
correlation between industry asset and liability policies and
found that when relatively aggressive working capital asset
policies are followed they are balanced by relatively
conservative working capital financial policies.
Deloof( 2003) discussed that most firms had a large amount of
cash invested in working capital. It can therefore be expected
that the way in which working capital is managed will have a
significant impact on profitability of those firms. Using
correlation and regression tests he found a significant negative
relationship between gross operating income and the number of
days accounts receivable, inventories and accounts payable of
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Belgian firms. On basis of these results he suggested that
managers could create value for their shareholders by reducing
the number of days’ accounts receivable and inventories to a
reasonable minimum. The negative relationship between
accounts payable and profitability is consistent with the view
that less profitable firms wait longer to pay their bills.
Filbeck and Krueger (2005) highlighted the importance of
efficient working capital management by analyzing the working
capital management policies of 32 non-financial industries in
USA. According to their findings significant differences exist
between industries in working capital practices over time.
Moreover, these working capital practices, themselves, change
significantly within industries over time. Similar studies are
conducted by Gombola and Ketz (1983), Soenen (1993),
Maxwell et al. (1998), and Long et al. (1993).
Abdul Raheman* and Mohamed Nasr ** 2007
Working Capital Management has its effect on liquidity as well
on profitability of the firm. In this research, they have selected a
sample of 94 Pakistani firms listed on Karachi Stock Exchange
for a period of 6 years from 1999 – 2004, they have studied the
effect of different variables of working capital management
including the Average collection period, Inventory turnover in
days, Average payment period, Cash conversion cycle and
Current ratio on the Net operating profitability of Pakistani
firms. Debt ratio, size of the firm (measured in terms of natural
logarithm of sales) and financial assets to total assets ratio have
been used as control variables. Pearson’s correlation, and
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regression analysis (Pooled least square and general least square
with cross section weight models) are used for analysis. The
results show that there is a strong negative relationship between
variables of the working capital management and profitability of
the firm. It means that as the cash conversion cycle increases it
will lead to decreasing profitability of the firm, and managers
can create a positive value for the shareholders by reducing the
cash conversion cycle to a possible minimum level. They find
that there is a significant negative relationship between liquidity
and profitability. They also find that there is a positive
relationship between size of the firm and its profitability. There
is also a significant negative relationship between debt used by
the firm and its profitability.
Lamberson (1995) studied 50 small firms for a period of 1980-
1991 and used economic indicators as independent variables and
financial ratios as dependent variables to explore the relationship
between changes in working capital position and changes in the
level of economic activity. The findings show that liquidity
increased slightly for the sampled firms during economic
expansion with no notable change in liquidity during economic
slowdowns.
Mehmet SEN, Eda ORUC 2009
Their study aimed to determine the relationship between
efficiency level of firms being traded in ISE (Istanbul Stock
Exchange) in working capital management and their return on
total assets. They tried to explain the relationship between
different indicators relating to efficiency in working capital
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management and their return on total assets through two models.
According to the results in terms of both all the firms involved in
the study and sectors there is a significance negative relationship
between cash conversion cycle, net working capital level, current
ratio, accounts receivable period, inventory period and return on
total assets.
In a regional study, Pandey and Parera (1997) provided an
empirical evidence of working capital management policies and
practices of the private sector manufacturing companies in Sri
Lanka. The information and data for the study were gathered
through questionnaires and interviews with chief financial
officers of a sample of manufacturing companies listed on the
Colombo Stock Exchange. They found that most companies in
Sri Lanka have informal working capital policy and company
size has an influence on the overall working capital policy
(formal or informal) and approach (conservative, moderate or
aggressive). Moreover, company profitability has an influence
on the methods of working capital planning and control.
Shin and Soene (1998) highlighted that efficient Working
Capital Management (WCM) was very important for creating
value for the shareholders. The way working capital was
managed had a significant impact on both profitability and
liquidity. The relationship between the length of Net Trading
Cycle, corporate profitability and risk adjusted stock return was
examined using correlation and regression analysis, by industry
and capital intensity. They found a strong negative relationship
between lengths of the firm’s net trading Cycle and its
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profitability. In addition, shorter net trade cycles were associated
with higher risk adjusted stock returns.
All the above studies provide us a solid base and give us idea
regarding working capital management and its components.
They also give us the results and conclusions of those researches
already conducted on the same area for different countries and
environment from different aspects. On basis of these researches
done in different countries, we have developed our own
methodology for research.
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BIBLIOGRAPHY
Articles
1. Afza T and MS Nazir (2007). Working Capital Management Policies of
Firms: Empirical Evidence from Pakistan. Presented at 9th South Asian
Management Forum (SAMF) on February 24-25, North South University,
Dhaka, Bangladesh.
2. Deloof, M. 2003. “Does Working Capital Management Affects Profitability
of Belgian
Firms?”, Journal of Business Finance & Accounting, Vol 30 No 3 & 4 pp.
573 – 587
3. Eljelly AMA (2004). Liquidity-Profitability Tradeoff: An Empirical
Investigation in an Emerging Market. International Journal of Commerce
and Management 14(2): 48-61.
4. Filbeck G and T Krueger (2005). Industry Related Differences in Working
Capital Management. Mid-American Journal of Business 20(2): 11-18.
5. Ghosh SK and SG Maji (2004). Working Capital Management Efficiency:
A Study on the Indian Cement Industry. The Management Accountant
39(5): 363-372.
6. Gombola MJ and JE Ketz (1983). Financial Ratio Patterns in Retail and
Manufacturing Organizations. Financial Management12 (2): 45-56.
7. Howorth C and P Westhead (2003). The Focus of Working Capital
Management in UK Small Firms. Management Accounting Research 14(2):
94-111.
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8. Lamberson M (1995). Changes in Working Capital of Small Firms in
Relation to Changes in Economic Activity. Mid-American Journal of
Business 10(2): 45-50.
9. Lazaridis I and D Tryfonidis (2006). Relationship between Working Capital
Management and Profitability of Listed Companies in the Athens Stock
Exchange. Journal of Financial Management and Analysis 19 (1): 26-35.
10. Long MS, IB Malitz, and SA Ravid (1993). Trade Credit, Quality
Guarantees, and Product Marketability. Financial Management 22: 117-
127.
11. Mehmet Sen, Eda Oruc 2009: Relationship between Efficiency Level of
Working Capital Management and Return on Total Assets in Ise
International Journal of Business and Management Vol 4, No. 10 Oct 2009
12. Pandey IM and KLW Parera (1997). Determinants of Effective Working
Capital Management - A Discriminant Analysis Approach. IIMA Working
Paper # 1349. Research and Publication Department Indian Institute of
Management Ahmedabad India.
13. Rehman A (2006). Working Capital Management and Profitability: Case of
Pakistani Firms (Unpublished Dissertation). Pakistan: COMSATS Institute
of Information Technology Islamabad.
14. Smith MB and E Begemann (1997). Measuring Association between
Working Capital and Return on Investment. South Africa Journal of
Business Management 28(1): 1-5
15. Soenen LA (1993). Cash conversion cycle & corporate profitability. Journal
of Cash Management 13(4): 53-58
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16. Shin, H.H and Soenen, L. 1998. “Efficiency of Working Capital
Management and
Corporate Profitability”, Financial Practice and Education, Vol 8 No 2, pp
37-45
Books
Chandra, P. (2006). Financial Management. Chennai: Tata McGraw Hill.
Jain, K. &. (2011). Financial Management. Noida: Tata McGraw Hill.
Kapil. (2011). Financial Management. New Delhi: Pearson.
Pandey. (2009). Financial Management. Delhi: Vikas.
Periasamy, P. (2008). Financial Management. Noida: Tata McGraw Hill.
Tulsian, C.A (2012). (ADVANCED MANAGEMENT ACCOUNTING). S. CHAND.
Website:
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