literature review

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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.

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Page 1: Literature Review

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

Page 2: Literature Review

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

Page 3: Literature Review

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

Page 4: Literature Review

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

Page 5: Literature Review

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

Page 6: Literature Review

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

Page 7: Literature Review

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.

Page 8: Literature Review

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.

Page 9: Literature Review

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

Page 10: Literature Review

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:

www.tayorolls.com

www.moneycontrol.com