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CHAPTER NO.1

I N T R O D U C T I O N

1.1 INTRODUCTION

This study examines the impact of working capital management components on the

profitability of registered companies in Pakistan. In addition, the study determines how

the impact of working capital management components changes as macroeconomic

conditions change from a boom to a recession.

This chapter is organized as follos!

It brings light on working capital management as well as on the trade-off between liquidity

preservation and profit maximiation faced by companies.

It describes the problem statement under investigation and further expounds on the trade-off

emanating from managing working capital. It chronicles the main ob!ectives of the study and

is followed by section.

It specifies the key questions to be examined by the study. It also highlights the importance of

this study and pin-points the gaps in theoretical and previous studies that this research seeks to

fill in. "t the end of this section of the chapter outlines how the entire research paper is

organied.

1." CONTE#T O$ THE %TUD&

The thesis will provide a snapshot of how public listed firms manage their working capital

during both good and bad period. This management of working capital needs to be assessed

which is done with its effect on firm#s profitability. In this concern, the better working capital

is managed to help in maximiing higher profitability of a firm. Then on the basis of this

information the best way of managing working capital is assessed for both periods. $oreover


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these periods are then compared and then find out whether companies have to change their

management concerning their working capital management during times of a crisis.

&orporate financial management primarily deals with three core areas that have a bearing on

firm#s financial goals. "s postulated by 'irer et al ()**+, these three core areas of

corporate finance are as follows

% &apital budgeting, this captures the process of planning and managing a firm#s long-

term investments.

) &apital structure, it identifies mixture of long-term debt and equity maintained by a

firm.

/orking capital management, which deals with management of a firm#s short-term

assets and liabilities0

$anufacturing industry of Pakistan mainly 1*2 of goods are produced by the large scale

industries which include cement, automobiles, sugar, textile, oil and gas and etc.

$anufacturing sector includes so many sub sectors3 therefore, in depth analysis is required for

the industry as a whole at micro level. "lthough agriculture contributes to the ma!or portion in

the economy of Pakistan but &ement sector also plays a vital role. &ement sector contributes

)2 to the overall 45P of Pakistan and %2 to manufacturing sector. Production has increased

by %) percent to 66.+ million tons in )*%*-%%. The studies on both capital structure and

working capital management is rich in as far as explaining how these two corporate finance

areas directly affect firmsprofitability and liquidity.

1.' PRO()E* %TATE*ENT

The aim of this study is to examine does working capital management affect the firm profitability

the cement industry of Pakistan.


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1.+ O(,ECTI-E% O$ THE %TUD&

&ertify short-term liquidity

"rise of the short-term requirements

'inding the financing mix.

7sed the current assets and current liabilities for satisfactory working capital

maintained.

To analye the Profitability ratio among current asset and current liabilities.

The other o/ecti0es are as follos!

(i 8ne to empirically examine if working capital management components,

namely cash conversion cycle, days sales in inventory, days payables outstanding,

current ratio, and capital structure impact on profitability of Pakistan listed firms.

(ii 9econd to build a model that gauges how working capital management, particularly

cash conversion cycle, impact on profitability when the economy moves from a

boom to a recession.

(iii Third to determine if the impact of working capital management components on

profitability of companies in the industrial sector and those in the rest of the other

sectors is different. The underpinning for this investigation of the impact in different

sectors is that, relative to the rest of the companies in the other sectors, companies

in the industrial sector (which comprise manufacturing and production led

firms have significantly higher levels of current assets on their respective

balance sheets. Thus, the ob!ective is to examine if there is a difference in the

direction and extent of the impact on profitability if working capital levels change

from significantly high levels to relatively low levels.


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1. RE%EARCH 2UE%TION%

The 3e4 56estions to e in0estigated 4 this st6d4 are as follos!

i. 5o firm#s liquidity measures impact on profitability of Pakistan companies3 i.e. are

the working capital management variables statistically significant in explaining

variation in profitability0

ii. If statistically significant, what is the direction of the impact of each variable3 i.e.

is it a negative or a positive relationship0

iii. 5oes liquidity affect profitability of companies within the industrial sector and the

rest of the sectors different0

iv. Is there any difference in how working capital management impacts on

profitability as the economy moves from a boom to a recession0

v. 5oes capital structure impact on profitability of Pakistan firms, and if so, is the

relationship between capital structure and profitability positive or negative0

1.7 %I8NI$ICANCE O$ THE %TUD&

In addition to determining if working capital management components impact on

profitability of Pakistan firms, this study has many contribution-enhancing positive

features which include the following

'irstly, this paper explores the level of the impact of working capital management on

profitability as market conditions change. 9pecifically, it separates the impact of working

capital management under both an economic downturn as well as under an economic

boom. This information will be helpful in trade credit policy formulation in that it will

give guidance to company corporate managers in implementing and adapting a suitable

trade &redit policy fitting for each market condition.


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9econdly, the study investigates the relationship between capital structure and

profitability of Pakistan#s firms where limited empirical research exists. 4iven that

capital structure is viewed by a number of researchers to be the most vital of all the

aspects of capital investment decision, the study therefore examines its relationship with

profitability so as to give guidance to management in their attempt to identifying the

optimal capital structure of the firm that maximies market value.

Thirdly, the scope of the research has been stretched to explore if the selected liquidity

measures impact on profitability of companies in the industrial sector and those in the

rest of the other sectors different. This will give guidance to corporate managers in

adopting an appropriate trade credit policy applicable in their sector.

a In a typical manufacturing firm, current assets exceed one-half of total assets.

b :xcessive levels can result in a substandard ;eturn on Investment (;8I.

c &urrent liabilities are the principal source of external financing for small firms.

d ;equires continuous, day-to-day managerial supervision.

e /orking capital management affects the company#s price, risk, return.

1.9 OUT)INE O$ THE %TUD&

"t the beginning of the research Pro!ect mainly focuses on giving basic view of the research

and provides information on the outline, problems, and purpose and basic theories on the

working capital management. "fter that their main focus on the existing work by various

researchers and past empirical studies is discus. The next chapter provided details regarding

practically carrying out of the research and described data collection and analysis procedures.

The next research work gives details regarding the results of the research. &onclusion of the

research can be explained at last.


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CHAPTER NO."

)ITERATURE RE-IE:

".1 INTRODUCTION

'irst studies on this area suggest the existence of a linear relation between working capital

management and firms# profitability. Thus, firms can maximie profitability and minimie

associated risks through an efficient management of working capital accounts. In fact,

manager#s goal is to improve financial performance through working capital policies.

/orking capital management has been a concern for all firms but small firms should give

more importance to this issue because they cannot afford to survive without cash. $any

researchers have worked on the same issue but pioneer study found that working capital

management strongly affects the corporate profitability. Therefore cement industries should

address this issue seriously. They suggested that conventional approach that is to invest high

in working capital can increase profitability. They investigated = performed the research to find

out the relationship between working capital management and firm#s profitability by taking

net trading cycle as a measure of working capital management on specific industry, the result

was not that substantial. "fter observing the nature and sie of the industry, they

recommended that forceful liquidity management increase the profitability.

/orking capital is an important tool for growth and profitability for company. /orking

&apital is being required at a certain level otherwise if the levels of working capital are

insufficient then, it could lead to shortages and problems with the day-to-day operations.


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"." DE$INITION O$ ;E& TER*% AND CONCEPT%

:OR;IN8 CAPITA)

/orking capital can be defined as the difference between the current assets and the current

liabilities. It can be helpful in measuring both a company?s efficiency and its short-term

financial health. $athematically, it can be measured as

The working capital ratio (&urrent "ssets=&urrent @iabilities indicates whether a company

has enough short term assets to cover its short term debt.

The term Aworking capitalB refers to the investment in current assets which are required to

carry on the operations of the business ('irer et al, )**+. Caveri (%D+


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. /orking &apital &oncepts

6. &ombining @iability 9tructure and &urrent "sset 5ecisions

" firm creating and implementing a policy for determining the optimal amount of account

receivables has to take in account the following steps

The first step is to create the comparison between the securing of sales and profits and the

amount of opportunity cost and administrative costs of the increasing account receivables.

The percentage and the amount of risk the firm is prepared to take when extending credit to a

customer, because this customer could default when payment is due. The third step the amount

of investment in debt collection management.

PROPERTIE% O$ :OR;IN8 CAPITA) *ANA8E*ENT ON A $IR*>%

PRO$ITA(I)IT&

The main body of the literature of working capital focuses on studying the relation between

working capital management and firm#s profitability. The detailed research plan = works

estimate working capital management, by trying to determine the effect of a firm#s working

capital management on its profitability. They argue that a working capital management

resulted in the highest profitability3 probably it must be the best way of managing working

capital that can be implemented. "ll these researches have used regression analyses using

different independent variables for profitability.

The working capital management has four different short term securities.


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). "ccounts receivables

. &ash management

6. "ccounts payable management

1. IN-ENTOR& *ANA8E*ENT

$ostly in manufacturing company#s inventory contain of raw materials, work in progress,

factory overhead and final products. "ll these levels of inventory need to be financed by the

efficient management which can increase a firm#s profitability. Ideal inventory levels depend

on sales, so sales must be the first step before target setting inventories can be made. Eesides

these errors in setting inventory levels lead to lost sales or inventory management, excessive

carrying costs plays a very important role. Therefore, firms use classy computer systems to

monitor their inventory system. Inventory management may be considered as outside the

main stream of finance, it is however necessary to highlight its importance and potential

effects to corporate profitability of manufacturing companies.

". ACCOUNT% RECEI-A()E%

In "ccounts ;eceivable $anagement 'irms wants to sell their products for cash than on

credit, but due to competitive pressure, firms prefer to sell their products on credit. Ey placing

these goods in the market and by reducing the stock an account receivable is created.

;eceivables management begins with suggestion on credit3 there main aim is to check on the

system, which is equally important. &orrect actions are mostly required, more so, the only

means of understanding if the condition is getting out of hand is with good receivable control

system.

Credit Polic4

" credit policy consists of the following four variables. &redit period is the length of time

given to buyer for payment of their purchases for example, the credit period might be one

month. &ustomers prefer longer credit periods, so delaying the period will motivate sales.

Fowever, long credit periods stretch the cash conversion cycle, hence draws more capital in


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receivables which is costly. "lso, the longer a receivable is unpaid, the higher the probability

that the customer will default and the account will end up as a bad debt.

Disco6nts

The companies offer their customers discounts for the early payment. The discounts describe

the percentage reduction and how rapidly payment must be made to be eligible for the

discount. There are two benefits regarding offering discounts. 'irst, the discount amounts to a

price reduction and lower prices encourage sales. 9econd, discounts will cause some

customers to pay earlier than they otherwise, which will shorten the cash conversion cycle.

Gevertheless, discount mean lower prices, therefore lower revenues due to the quantity sold

increases enough to offset the price reduction. The gap between benefits and costs of discounts

must be balanced if a rational decision about them is to be made.

'. CA%H *ANA8E*ENT

"ll most businesses are conducted by their own nature. Therefore an integral part of working

capital management is the effective cash management level, which contains a method of

transfer of funds from where they come in, to where they are needed, depending nowhere it is

lacking and where it is in excess. To most of us Hcash# conventionally means money, bonds

and shares which can easily convertible in to cash including deposits in the bank. The financial

experts have mentioned in their research about cash holdings, deposits demand, and securities

that are easily convertible at a predictable price and thus are converted to bank deposits. That#s

why, AcashB as reported on balance sheets generally includes short -term securities, which are

also called Acash equivalentsB.

The following levels are used to optimie demand deposits holdings. There are three motives

for a company to hold cash


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%. Transaction motive, a company needs certain level of cash to meeting their daily

transactions, such as payment for supplier, salaries and so on. &ash management ensures

company to meet their regular cash outflow.

). Precautionary motives describe the cash flow which is difficult for a company to predict

that#s why companies take steps to prevent from the unexpected cash flow in future because of

the huge gap between the firms and industries. &ash management can help to relieve the

problem of sudden cash needs, for example, raised cost of raw material and default of third

party.

. 9peculative motives business cannot predict about the future it can only speculate,

unexpected investment opportunities can increase, sufficient cash holding allows the company

to take advantage of these opportunities and grow in the future.

&ompanies can en!oy several benefits under holding sufficient cash. 9till, it cannot provide a

good business environment3 it can earn interest if they are used in the proper investment.

;esearchers have raised two questions in their investigation

(i There is an optimal cash level that can maximie firm value.

(ii 'irm value can be reduced if the cash deviates from the optimal level.

;esults describe that there is a relationship between cash holding and firm value, which

means that optimal cash level that take advantage of firm value occur. It shows that firm value

will be decreased if the cash holding is different from this optimal level. The result shows that

Trade-off theory can also explain that there is an optimal level of cash holding which can

balance the marginal benefit and cost. These results show that having optimal cash holding is

the central task of cash management.

The researcher mentions that two constraints which decide how much cash a firm should

maintain.


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(ii 9elf-imposed balance,

(i &ompensating balance

The balance which is required for the services that are rendered by banks to the firms is known

as compensating balance.

(ii 9elf-imposed balance,

The balance which is calculated by considering factors like the need for cash, the predictability

of this requirement, the interest rate on marketable securities or the borrowing rate, and the

fixed cost of affecting a transfer between marketable securities and cash or effecting a loan

transaction. It is the balance which is self-imposed for the need of certain transactions.

8utcomes confirm that cash holding enable firms to take profitable investment opportunities,

which leads to the point that cash holding level of growth firm is higher than the matured

firms. They also find that the factors of cash holding are different between growth firms and

matured firms. &ash holdings in growth companies decrease with the raise of firms#

characteristics sie, level of liquid assets and sort-term debt. Fowever, in matured firms,

cash level shows a positive relationship with firm sie and dividend pay-out and negative

relationship with firms# research and development expenses. /ith In a similar study, cash

holding level in firms from &anada is strongly affected by their market to book ratio, cash

flow, net working capital leverage, and firm sie explain the optimiation problem of meeting

demands for cash over time with cash deposit in bank or invested in stock. 9tudy shows the

solutions of optimal level of cash

'irm#s future performance in poorly corporate governance will be reduced since cash can be

dissipated very fast. 8n the opposite side, in well-governed firms, firms# future operating

performance will get a big improvement due to the negative impact of cash holding can be

cancelled out.

+. ACCOUNT% PA&A()E *ANA8E*ENT


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9uppliers offer trade in credit which create account receivable, opposite to that, customers

accept the trade in credit that will generate account payable. It arises when firms purchase

goods or services on credit3 it is the payment for salespersons for products, services

inventories and supplies. 8ne of the advantages of having trade credit from sellers is that

company can reduce some investment in working capital management and save some

resource. $aximiing the account payable and stretching the payment term could be a

competitive advantage for firms. In abroad, on average there are 1* percentage of the total

short term debt.


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(i )ong?Ter@ $inancing (enefits

a @ess worry in refinancing short-term obligations

b @ess uncertainty regarding future interest costs.

(ii )ong?Ter@ $inancing Ris3s

(i Eorrowing more thanwhat is necessary

(ii Eorrowing at a higher overall cost (usually

(iii Res6lt

It point out that manager accepts less expected profits in exchange for taking less

risk

CO*PARI%ON :ITH AN A88RE%%I-E APPROACH

(i %hort?Ter@ $inancing (enefits

a. 'inancing long-term needs with a lower interest cost than short-term debt

b. Eorrowing onlywhat is necessary

(ii %hort?Ter@ $inancing Ris3s

a. ;efinancing short-term obligations in the future

b. 7ncertain future interest costs

(iii Res6lt

a. $anager acceptsgreaterexpected profits in exchange for takinggreaterrisk.

RE)ATION (ET:EEN )IA(I)IT& %TRUCTURE AND CURRENT A%%ET

DECI%ION%

(i " conservative policy of AhighB levels of current assets allows a more aggressive method

of financing current assets.

(ii " conservative method of financing


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(iii

The level of current assets and the method of financing those assets are interdependent.

".' :OR;IN8 CAPITA) *ANA8E*ENT CO*PONENT%

In the research paper observes a sample of )< companies listed in 9tock :xchange for a

period of four years from )**6-)**D. The primary focus of their study was to establish

whether there is a relationship that is statistically significant between profitability and the

cash conversion cycle and its components. They found that lower gross operating profit is

associated with an increase in the numbers of days of accounts payables. 'urthermore, they

conclude that managers can create profits for their companies by handling correctly the cash

conversion cycle and keeping each different component of cash conversion cycle to an

optimum level.

$I8. 1! OPERATIN8 AND CA%H CON-ER%ION C&C)E%


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&apital structure measures the extent to which a company is funded through debt

relative to equity. 'or the purpose of this study, the alternative way for capital structure is the

Adebt to equityB, which was easily available on 5ebt is expressed as both current and

long term debt. /hile the definition of short-term debt used in practice may include

operating debt (accounts payable and accrued liabilities, short-term debt used in this

particular study excludes operating debt because

(% It is a function of the firm#s operations and which describe its essential business and

contractual relationship to its suppliers rather than outward creditors, and

() The operating debt such as accounts payable is already accounted for in equation 6 above

(day#s payables outstanding. It can collapse the business relationship between suppliers

and demanders. 'inally it will affect firm#s profitability (4amelan, )**1. 9ome elements of

account payable management, such as account payable policy, application of the policy and

checking result, can help manager ensure that efficiency of account payable management

reached (9aner, )*%%.

".'." E#I%TIN8 AND RE)E-ANT )ITERATURE

In the studies there have been few researches on working capital management. Their research

work based on the different sectors of the economy. 9ana and 9hah ()**> worked on oil and

gas sector. They acquired a very small sample of consisting only 1 firms and they concluded

that profitability and value of shareholders can be increased by managing the working capital

efficiently. Gair and "fa ()**1 in their research analye the relationship between

aggressive and conventional way of investing in working capital for )*< firms for %1 different

sub sectors. ;esults showed that there is an inverse relationship between aggressive approach

in working capital investment and the profitability of the firms. Gasr and ;ehman ()**1

analyed the relationship between the profitability and components of working capital

management which includes no of days accounts receivable, no of days accounts payable no of

days inventory and cash conversion cycle The result showed that there is inverse relationship


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between them. In the year Gair and "fa ()**+ analyed the working capital management

for )*6 firms.

"lthough researchers have studied the relationship between the components of working capital

management and the corporate profitability with reference to Pakistan but it#s required to be

increased. There is less relationship found between the two variables. This goal has been a

motivational force to do a research on the cement sector of Pakistan. 'or this purpose sample

of %D cement firms listed on Carachi stock exchange has been taken during %DDD-)**D.

".'.' :OR;IN8 CAPITA) *ANA8E*ENT PO)ICIE% AND $IR*

PRO$ITA(I)IT&

;esearches on the relationship between /&$ and firms# performance, started through the

analysis of a linear relation. /orking capital investment involves a trade-off between

profitability and risk, demanding the understanding that decisions which can increase

profitability.

'irstly, overproduction reflecting an intention to cut prices or extend more credit terms to

boost sales and=or overproduction to decrease cost of goods sold (&49 expense. "fter

knowing that extending credit terms results in creation of Aday#s sales in receivablesB, it is

therefore unlikely that day#s sales in receivables, in addition to other working capital

management components can be manipulated in boosting sales=earnings of a firm. 9econdly,

timing the sale of assets (both non-current assets and current assets, which form part of

working capital management to report gains. Thirdly, decreasing the discretionary selling,

general, and administrative (94" expenses to increase income. 'inally, decreasing research

and development (;5 expenses.

The above mentioned activities indicate that working capital management components may be

manipulated by firms in boosting sales=earnings. /hile this manipulation may be undertaken

by firms, the primary focus of this study is not to examine how working capital


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management components are manipulated by firms in boosting sales=earnings but to examine

the relationship between various working capital management components and profitability of

Pakistan firms listed on the C9:.

Tale 1 ? )inear Relationship eteen :or3ing Capital Acco6nts and :or3ing

Capital

Profitailit4 Ris3Acco6ntsPa4ale

In0entoriesAcco6nts

Recei0ale:C* In0est@ent

)ength

)inear Relation

Conser0ati0ePolic4

Lower Lower ShortenHigher

levelsExtend

Higher Investment/Longer

Aggressi0ePolic4

Higher Higher :xtendLowerlevels

ShortenLower

Investment/Shorter

".+ CONC)U%ION O$ )ITERATURE RE-IE:

The result of the preceding literature review on working capital management is that while

working capital management components may impact on profitability of firms, there is

uncertainty regarding both the appropriate variables that might serve as alternatives for

working capital management as well as on the direction of the impact of different components

on profitability. In his research, $athura ()*%* finds that there exists a highly significant

positive relationship between the period taken to convert inventories into sales and

profitability, which finding is contrary to that of 5eloof ()** whose study findings conclude

that there is a negative relationship between day#s sales in inventory and profitability. This

therefore shows that there is no clear-cut direction of the relationship between any of the

variables of working capital management and firms profitability. The differences in the

direction of the impact could be attributable to any one of the following factors


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() 5ifference in the nature of the industries selected in different studies, and

( 5ifferences in the economic conditions for the selected time frames.

"lso noted in literature review is that there is no clear-cut direction on the impact of capital

structure on profitability from one country to another. 'or example, findings by 9alawu ()**D

show a negative relationship in clear contrast with findings by 5e "ngelo and $asulis (%D+*

that show a positive relationship.

The other consideration noted in literature review is that working capital management

components can be manipulated by firms in boosting sales. This however is not the focal point

of this study.


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CHAPTER NO.'

RE%EARCH *ETHODO)O8&

'.1 INTRODUCTION

The data used in the study is uniquely accounting based data mainly contained in the firm#s

financial statements. The financial statements are obtained from different sources

%. Internet

). 9tock :xchange

. 5ifferent Eooks

6. Teachers 4uidance

. 5ifferent researchers

The following ratios were extracted from Internet (% days sales in inventory, () days sales

in receivables, ( days payables outstanding, and (6 current ratio. ;atios extracted from

9tate Eank of Pakistan are the debt to equity ratio and the operating profit margin. The other

variables such as cash conversion cycle and dummy variables were calculated from the

extracted data.

'." *ETHOD O$ DATA CO))ECTION

The secondary data necessarily required to perform the research was gathered from the official


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library of 9tate Eank and Carachi stock exchange. ;emaining of the data is collected from

annual reports, 9tate Eank of Pakistan analysis reports and economical surveys.

'.' %A*P)E %IBE

There are %D &ement industries listed at Carachi 9tock :xchange out of which %< are selected.

$any firms are not included whose data was not available or observations were missing for

few years. The research data research consisted of %% years annual data of the variables used in

research. ;esults of data of all the variables belonged to period starting from fiscal year %DDD

to fiscal year )**D because this is the period where many of new cement industries were

installed and many of them were shut down due to other reasons. There are total )*D

observations.

DATA CO))ECTION

The sample consists of * companies from cement factory of @ahore. The reasons that the

sample focuses on cement factory is because cement factory is very important in current

environment. /orking capital management plays an essential role in their business operation.

Therefore, their performance is highly related with their working capital management. /ith

sufficient working capital management, cement companies can maximie their financial

flexibility and increase liquidity which can bring more value for firms.

%ECONDAR& DATA

The secondary data has been obtained from the Internet. 8ther sources are as follows-

Internet

9tock :xchange

5ifferent Eooks

Teachers 4uidance

Eusiness Gewspapers

5ifferent ;esearch


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'.+ -ARIA()E% AND HO: THE& ARE *EA%URED

"s mentioned in chapter %, the explanatory variables to be used as proxies of working capital

management are

(% &ash conversion cycle,

() 5ays sales in receivables,

( 5ays sales in inventory,

(6 5ays payables outstanding

( :xplanatory variable to be explored by the study is capital structure (whose proxy in this

study is debt to equity ratio.

(1 Jariable in the study is the market condition, which is used to examine the difference

and the extent (if any of the impact of working capital, particularly cash conversion cycle,

on profitability as economic conditions change.

/hile this study explores the impact of the above-mentioned seven variables on profitability,

it is noted that this list of the selected variables is not complete as there are a number of

liquidity and capital structure measures that may impact profitability. The choice of

explanatory variables is based on the following factors

% "lternative theories related to working capital management (for example, one theory

stating that a longer cash conversion cycle increases firm profitability given that it leads to

higher sales, and the opposing theory stating that corporate profitability decreases as cash

conversion cycle elongates, particularly if the costs of higher investment in working

capital rise faster than the benefits of holding more inventory and=or granting more trade

credit to customers and

) /orking capital management variables used in previous studies conducted in other

geographic !urisdictions such as 4reece, Eelgium, 7.9., Cenya, and Turkey.

Tale "! -ariales 6sed in the st6d4

Jariable "bbreviation

&ash &onversion &ycle &&&

5ays 9ales in ;eceivables 59;


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5ays 9ales in Inventory 59I

5ays Payables 8utstanding 5P8

&urrent ;atio &;"

5ebt to :quity ;atio 5T:

8perating Profit $argin 8P$5ummy Jariable - :conomic 5K

5ummy Jariable - Industry 5KK

CASH CONVERSION CYCLE

The variable is used as a measure to gauge profitability. It measures the net time interval

between actual cash expenses on a firm#s purchase of productive resources and the ultimate

recovery of cash receipts from product sales. It is measured as follows

&&& L 59; M 59I N 5P8

In turn, the three components of cash conversion cycle are specified below.

DA&% %A)E% IN RECEI-A()E%

This component of the cash conversion cycle measures the number of days it takes to collect

cash from debtors. ;esearch state that day sales in receivables measure the effectiveness of

the firm#s credit policy. It indicates the level of investment in receivables needed to maintain

the firm#s sales level and is measured as follows

59;L (Trade ;eceivables = 9ales O >1.> 2 of the variance

remained unexplained.

The dependent variable of the research was G8I therefore3 the &oefficients table was required

to be analyed and interpreted.

'. DIA8NO%TIC TE%T%

5iagnostic tests are robust statistical tests carried out to verify if the data used have met the

assumptions underlying the ordinary least squares regression and where possible to

remove problems associated with panel time series data. 9ome of the problems of panel time

series data include heteroskedasticity, multicollinearity, and auto-correlation, among others.

The diagnostic tests carried out in the study are detailed below.

'..1 TE%T $OR HETERO%;EDA%TICIT&

8ne of the main assumptions for the ordinary least squares regression is the similarity of the

variance of the residuals. If the variance of the residuals is non-constant, then the

residual variance is heteroskedasticity making the regression estimates, namely coefficients

and standard errors, to be biased if the models are not re-specified or variables not

transformed. "s per equation %% below, heteroskedasticity means that the variance of the

error term is not constant overtime.

for all i,


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This study uses the Ereusch-Pagan test in all the two regression model specifications to

verify whether or not heteroskedasticity is present in the models. The null hypothesis is that

the variance of the residuals is homogenous. Tables 6 and < below present the Ereusch-Pagan

test results for heteroskedasticity for model specification I and II respectively. The results

show that the variance of the error term in each model specification is not constant, which if

not corrected leads to biased standard errors. The presence of heteroskedasticity was however

controlled by using the ArobustB command when performing both regressions, resulting in

generation of Arobust standard errorsB. ;esearchers state that the Arobust standard errorsB

address the problem of errors that are not independent and identically distributed and that

the use of Arobust standard errorsB does not change the coefficient estimates provided by

the ordinary least squares, but change the standard errors and significance tests.

'.." TE%T $OR *U)TICO))INEARIT&

Eoth regression models were tested for multicollinearity. The primary concern with

multicollinearity is that, as the degree of multicollinearity increases, the regression

model evaluation of the coefficients become unstable and the standard errors for the

coefficients can get inflated. The variance inflation factor (JI' is used to detect whether one

predictor has a strong linear association with the remaining predictors (the presence of

multicollinearity. @aaridis and Tryfonidis ()**> proclaim that JI' measures how

much of the variance of an estimated regression coefficient increases if predictors are

correlated. $ontgomery and Peck ()**1 suggest that when JI' is greater than 6-+, then the

regression coefficients are poorly estimated. In this study, we used the JI' command when

regressing profitability against the explanatory variables. The predictors had resultant

variance inflation factors ranging between %.6 and .1 across both model specifications as

shown in Table > below. The results indicate that there is absence of multicollinearity between

predictors in the regression models. Tolerance, defined as %=JI', is the inverse of JI'.


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Tale +! -ariance Inflation $actor

4iven that the cash conversion cycle is made up of other ratios used in the study, namely

days sales in receivables, days sales in inventory, and days payables outstanding,

to avoid multicollinearity problem, the two model specifications were developed separating

one model containing the cash conversion cycle from the other containing days sales in

receivables, days sales in inventory, and days payables outstanding.

'.F %U**AR&

This chapter described the procedural approaches followed in examining the impact of all

selected working capital management components on the profitability of C9: listed

companies. In particular, the approaches used in the study are (% descriptive statistics, ()

correlation matrix, and ( regression analysis. ;egression model specification I was

developed to examine the impact on the variable (profitability by five working capital

management variables, namely cash conversion cycle, current ratio, debt to equity, years, and

economic conditions. 8n the other hand, model specification II is used to retreats profitability

against days sales in inventory, days sales in receivables, days payables outstanding, and

*odel

-I$

Jariable JI' %=JI'

&&& .% *.%D6+++%+

&;" ).6) *.6%))%6

5T: %.6) *.1*6))


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conversion cycle is made up of day#s sales in inventory, day#s sales in receivables and

days payables outstanding.

5iagnostic tests were carried out to verify if the data used have met the assumptions

underlying the ordinary least squares regression and where possible to remove problems

associated with panel time series data. "lthough the diagnostic results show presence of

heteroskedasticity in both models, this problem was however controlled by using Arobust

standard errorsB resulting in non- spurious regression results, which are presented in &hapter 6

below.

CHAPTER NO G+

PRE%ENTATION O$ RE%U)T%

This chapter presents results obtained by the models. 'irst, descriptive statistics showing

relevant phenomena such as median and mean of variables used in the study are presented

under section 6.). It is followed by section 6. which presents the conventional

correlation matrix which measures the degree of association between different variables

under consideration.

9ection 6.6 presents the regression analysis which outlines an in-depth examination of the

causal relationship between profitability of Pakistani firms and the various explanatory

variables under consideration. The regression analysis uses pooled ordinary least squares

regression to determine the influence of the various explanatory variables under consideration

on profitability. @astly, a summary highlighting key findings of the study is presented under

the last section.

+.1 DE%CRIPTI-E %TATI%TIC%


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Table < below presents descriptive statistics of the collected variables. It shows the mean,

median and standard deviation of the variables used in the study. In addition, it shows the

minimum and maximum values of each respective variable which essentially gives an

indication of how wide ranging each respective variable can be.

TA()E ! DE%CRIPTI-E %TATI%TIC%

$ % % % % S

5ays 9ales %

% 6 + % 1

5ays 9ales %

% 6 %

% %

5ays %

% < 1 % 1

5ebt to %

- * ). * *

8perating %

- % ) - 1&ash %

- ) %

% %

&urrent %

* % )

+.1.1 INTRODUCTION

It specifies the collected variables. It shows the minimum and maximum values of each

variable.

It can be explained below

+." DE%CRIPTI-E %TATI%TIC%

'or the descriptive statistics, we begin with the correlations matrix although describing the

relationship between variables it does not identify the causes. Therefore, the estimated

correlations between explanatory variables and profitability show a higher correlation

between profitability.

'or &:8#s characteristics, presented in Table >, firms in our sample are managed mainly by men

(>+.+23 within respect to &:8#s age, %%.


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GENDER Frequency Percent

Male 73,596 68.81%

Female 33,365 31.19%

AGE Mean Frequency Percent

20 to 29 26.60 12,327 11.52%

30 to 39 34.56 41,732 39.02%

40 to 44.13 34,099 31.88%

50 to 60 54.09 18,803 17.58%

EDUCATION Frequency Percent

Very Low 16,630 15.55%

Low 45,010 42.08%

Medium 26,614 24.88%

High 18,707 17.49%

and %% observations, corresponding to 6%, firms.

TA()E 7 ? CEO>s Characteristics

+.' CORRE)ATION *ATRI#

/ith an efficient working capital management, firm value should be higher. The market value

shows a negative relationship which is consistent with the expected relationship. This

positively related to the firm value, it shows that a firm value will go up if firms can keep their

payable longer. This relationship confirms the hypothesis that if the time lag between

h i th t i l t ll ti th l f fi i h d d i h t d th fi


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value will be higher. The positive and significant relationship between current ratio and cash

conversion cycle matches the result in the investigation and verified that Amore firms with

high current ratio and longer cash conversion cycleB. That#s why with efficient working

capital management, firms# liquidity will be improved, which is shown as lower current ratio.

+.+ RE8RE%%ION ANA)&%I%

In order to have further investigation the impact of working capital management on firm

value, regression analysis is followed. The results of the impact of working capital

management on firm value including other control variables, which described in methodology

section. The Impact of /orking &apital $anagement on 'irm Jalue :vidence from &ement

factory.

In the regression

(% The relationship between firm value and 5ays 9ales 8utstanding, which is the alternative

of company#s receivable policy, is tested. The result shows a negative relationship between

them. 7nfortunately, this result is not significant from ero in the sample firms.

In regression

() 5ays Inventory 8utstanding negatively and highly significant reacts to firm value. It

implies that an increase in 5ays Inventory 8utstanding.

( " positive relationship between firm value and 5ays Payable 8utstanding is tested, and

the positive sign is consistent with the sign that I expected. Fowever, this result is not

consistent with the result in but the relationship is insignificant as the regression.

(6 The result does present that a cash conversion cycle is negatively related to firm value, and

it is highly significant. It confirms that with an efficient working capital management, shorter

cash conversion cycle, firm value will increase. In order o have a future understanding of the

impact of working capital management on firm value, especially how working capital

management affect firm value.

+. %U**AR&


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CHAPTER NO G

DI%CU%%ION AND CONC)U%ION

.1 INTRODUCTION

This chapter discusses and compares results of the study with findings by other studies

elsewhere that explored the relationship between working capital management and firm

profitability.

It highlights relations between findings of this study and those of previous studies.

'urthermore, the section provides suggestions on what could be the primary differences

between findings of this study and those of previous studies. It concludes the chapter and is

followed by framework which suggests further work to be done in comparison with this study.

." DI%CU%%ION

&ement sector which is the second biggest sector in manufacturing sector of Pakistan

contributes to the economy significantly. Ceeping in mind the importance of cement sector in


40/52

the economy of Pakistan ob!ective of this research is to analye the effect of working capital

management on firm#s profitability in the cement sector of Pakistan. To carry out the research

data from %D cement industries which are currently listed at Carachi 9tock :xchange is

analyed. The results shows that profitability of cement industries are significantly affected by

the efficient management of working capital and working capital management play a vital role

in creating a value for the shareholders.

.' CONC)U%ION

The main purpose of the study is to draw the results about the firm#s profitability in the

working capital management. This study investigates how relatively large public listed

companies in the can manage their working capital in the most profitable way, during non-

crisis periods and during a crisis period. /orking capital is studied as a whole, but its parts are

also studied individually. The non-crisis period and crisis period are then compared with each

other and differences are highlighted.

The aim of this research is to test whether firm value can negatively relate to cash conversion

cycle in the sample of cement factory, and how working capital management affects firm

value.

.+ I*P)ICATION%

$any recommendations can be drawn from the above research results. :very cement factory

should give due importance to working capital management. &ement industries should make

such collection and payment policies which are in favor of the firm and existing policies

should be thoroughly reviewed. &ement industries should decrease there payment and

receivable cycle. This can only be done when there will be professional management. The

results suggest that cement industries should keep optimum level of inventory and cash

conversion cycle. This could only be possible when cement industries will give due

importance to every component of cash conversion cycle. &ement industries should hire

professional human resource to take decisions related to finance. 9ince the sample comes from


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an important element of working capital. The application of the result from cement industry

can be limited to other industry. 9econdly, the sie of sample is rather small. The accuracy of

result can be affected. 5ue to the limitation of database, there are only )D> observation are

available, this can be the drawback of study. Thirdly, there may some outliner exist in the

sample, which may cause skewness in the result.

There are many cement industries where only one person is looking after the whole

department. In order to maximie the profit cement industries should manage there working

capital efficiently.

. $UTURE R E%EARCH

:very sector in manufacturing sector should be analyed at micro level for efficient working

capital management so it can be understand that which factors affects the working capital

management more and how working capital management can increase profitability in different

sectors of our country. The scope of future investigation can be extended to focus on the detail

of relationship between each component of working capital management and firm value or

other performance. :specially focus on 5ays 9ales 8utstanding and 5ays Payable 8utstanding

since they are not significant in this airline industry study. $ore substitutes of firm value and

working capital management can be applied into the research in order to make sure findings are

more accurate.


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RE$ERENCE%

"li "hsan, /orking &apital $anagement Policies of 'irms :mpirical :vidence from

Pakistan

"l-$walla, $., Athe impact of working capital policies on 'irm#s profitability and value the

case of QordanB,

&ampello, $., 4raham, Q.;. Farvey the impact of working capital policies on 'irm#s

profitability and value.

&onstraints in china does working capital management make a difference0

&onversion &ycles&'o!rnal of Economics and (inance& )*+,-. -6>.

'ilbeck, 4. and Crueger, A"n "nalysis of /orking &apital $anagement ;esults

ProfitabilityB, 9witerland Qournal of Eusiness,

(inancial St!dies ,* +-. >>%->D%.

Qose, $. @., &. @ancaster, Q. @. 9tevens.(%DD>. &orporate ;eturns and &ash

@aaridis, I. 5. Tryfonidis. ()**>. ;elationship between /orking &apital $anagement and

Profitability of @isted &ompanies in the "thens 9tock :xchange. 'o!rnal of (inancial

%anagement and 0nalysis& ,1 +,-. )> N


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Product $arketability.(inancial %anagement )) +5-. %%1-%)1.

Profitability.(inancial 4ractice and Ed!cation 6 +)-. 1-6. Impact of /orking &apital $anagement on the Profitability of

8il and 4as 9ector of Pakistan.E!ropean 'o!rnal of Scientific 2esearch. ,7+-. *% - *1.

9hin, F.F., @. 9oenen.(%DD+. :fficiency of /orking &apital and &orporate

8niversity of 9xford. ISS$ ,5:,;*516.

7yar, ". ()**D. The ;elationship of &ash &onversion &ycle with 'irm 9ie and Profitability

"n :mpirical Investigation in Turkey. International 2esearch 'o!rnal of (inance and

Economics, )6.

/ang, S.Q. ()**). @iquidity $anagement, 8perating Performance, and &orporate Jalue

:vidence from Qapan and Taiwan.'o!rnal of %!ltinational (inancial %anagement& ,). %D.


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APPENDICE%

Anne6re 1 ? %pecification >D

;esidual %6D)D%.>* +. D%:M*+

"oefficient standard Err t Stat 4;val!e Lower 17< 8 p p e r 17+) >. )%:- D1 *. DD11>)>6) %. %+11< *. DD11>)>

%. %+116


45/52

Anne6re " ? %pecification %

"G 8 J "

S %S S

; < %>+

*

; % >D)D%.>* +D*1)>D6. 1

" t t 4 L 8 L 8

I > % < % 6 + 6 1

& - * - * - - - -

& - ) - % - - - -

5 - % - - - - -

5 - % - % - - - -

&&&O5K %. *D)16++)%D >.)*D)>6) %. %+116


46/52

Anne6re ' ? %pecification %

"G 8 J "

S % ( S

; 1 % ); % >

To tal %6>* +D*1)>D6. 1

" S t 4 L 8 L 8

I > % < % 6 + +

& - * - * - - - -

& - ) - % - - - -

5 - % - - - - -

5 - % - % - - - -

&&&O5K %. *D)16++)%D >. )*D)>6) %. %+1161+


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Anne6re ? %pecification II regression at FG confidence le0el!

97$$";S87TP7T

2egression Statistic s

$ *

;

*

" *

9 %

8bs e rv ati ons %6>%

"G 8 J "

S % ( S

; + ) + *

; )

To tal %6>* ++D)+>)). 1

"oefficients Standard Error tStat 4;val!e Lower17< 8pper17< Lower1*&*< 8pper1*&* 6 % > > 1 > 1

5 * * * * - * - *

5 - * - - - - -

5 - * - > - - - -

&&&O5 *. %*6>66D1 *. )%D*>6%% *. 611>D%*+1 *.>)D6%1D) - *. )


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Anne6re 7 ? %pecification II regression at FF confidence le0el!

97$$";S87TP7T

2egress ion Statistics

$ *

;

*

" *

9 %

O.s e r0 ati on s 1+71

"G 8 J "

S % ( S

; + ) +

; )

To tal %6>* ++D)+>)). 1

"oefficients Standard Error tStat 4;val!e Lower17< 8pper17< Lower11&*< 8pper11&* 6 % > > 1 < +

5 * * * * - * - *

5 - * - - * - *

5 - * - > - - - -

&&&O5 *. %*6> . )%D*> *. 611> *. >)D - *.) *. >>D


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Anne6re 9 ? Correlation *atri

)7 5 4a=istan (irms listed o n th e 'S E. )** 5 ; )*,* > , .5? , (irm @ea r 9 A serv a tion s

94%meas!resoperatingprofitmargin."""cashconversion cycle."20c!rrentratio. BTEdeAttoe!ityratio.

BS2dayCssalesin

r e c e iv aA le s . BSI da y s s a le s in in v e n to ry . an d B 4 9 day s pay aA le s o! ts tand in g

9 4 % """ " 20 BTE BSI BS2

B4 9

8 %

& - %

& - * %

5 - - - %

5 *.* * * - %

5 - * * - *

5P 8 -* .D6


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