INTRODUCTION (Subramanyam and Wild, 2010). The main indicator of

INTRODUCTION

BACKGROUND:-

We Will Write a Custom Essay Specifically
For You For Only $13.90/page!


order now

Working capital management related to the management of current
assets and current liabilities. Working capital management is considered very
important in the sustainability process of production or operation activities
of the company. If the working capital cannot be fulfilled, then the production
process is in danger. Indeed, this can be overcome by borrowing capital to
banks or other financial institutions. But that would automatically increase
the liquidity risks faced by the company. Therefore working capital management
is very important to prevent this from happening in the future.

Optimal working capital levels are determined largely by management
of current assets and current liabilities. It requires continuous monitoring to
maintain proper levels in the various components of working capital. Especially
for manufacturing companies current assets amount covers more than half of
total assets. First, the management of current assets where within the post
contained the company’s assets that could be used in the operating activities
of the company. Cash account is included in current assets; where cash is used
by companies to finance the operating activities of the company include the
purchases of raw materials and maintenance supplies. Later, accounts receivable
is a tool used by the company to increase the number of sales. The company
carries out the policy of giving credit to the consumer to achieve sales
targets and ultimately to meet the profitability targets that have been set.

There are some amounts of inventories needed by company for the
sustainability of the production process in case a significant increase of
demand. Inventory is one part of the working capital (Subramanyam and Wild,
2010). Inventory is one part of current assets which have fairly large quantity
and are in need of special attention. Most companies maintain inventory levels
at a certain level. This happens because the company wanted to have enough
supplies so that the sale of the company can continue to run. If the supply is
not enough, they can lead to a decrease in sales volume below the level that
can be achieved (Subramanyam and Wild, 2010).

The main indicator of working capital management, commonly used in
studies is the cash conversion cycle (cash conversion cycle). In this study,
the cash conversion cycle and its components are used as a basis for assessing
the efficiency of working capital management to determine its relevance in
achieving the objectives of profitability.

Working capital management will indirectly affect the level of
corporate profitability. As described above, any measures taken by the company
will have an impact on the level of sales and eventually also affect the value
of companies that are affected by the amount of net profit.

The company’s ability to generate profits by using all its resources
referred to profitability. Munawir (2010) mentions the profitability as
company’s ability to generate profits within a certain time that can be
measured by the success of the company and the company’s ability to manage its
assets. It is this ability which became one of the factors that may affect
investor consideration in deciding where he should be investing. Profitability
also showed the effectiveness and efficiency of companies in utilizing its
resources. The higher the level of productivity of a company the better
performance is.

Profitability and liquidity are two important and major aspects of
corporate business life (Vataliya, 2009). The problem is that increasing
profits at the cost of liquidity can bring serious problems to the firm.
Therefore, there must be a trade-off between these two objectives (liquidity
and profitability) of firms. One objective should not be at the cost of the
other because both have their own importance. If firms do not care about
profit, they cannot survive for a longer period. In other round, if firms do
not care about liquidity, they may face the problem of insolvency or
bankruptcy.

In manufacturing companies, working capital is expected to affect
the company’s profitability. It can be seen from the operating activities of
companies started from capital investment to supplies the raw materials of its
products and their receivables and pay for the debts of the company. The
manufacturing company is a company that produces the needs of society in Pakistan
both as an industry that produces goods to satisfy basic needs also generates
additional needs. Inventory is an asset to manufacturing company, since the
inventory is a major source of income in these types of companies.
Manufacturing companies must store enough supplies to meet the needs of its
customers. Failure on this account would be bad if it was not considered
seriously, because it can result in loss of sales / revenue so as to reduce the
company’s operating profit.

In this study, the selected industries as an object of research are
the manufacturing industry. Because the industry is consider ideal in working
capital management. In manufacturing companies, it can be seen from the
operating cycle that involves investment in inventories and receivables and
make the payments on their debts. In connection with the days of outstanding
inventory (DOI), the study was conducted in industries associated with
supplies. In particular, the manufacturing industry associated with supplies.
Based on the above mentioned argumentation, this study observed the effect of
working capital to profitability of manufacturing company in Pakistan.

PROBLEM STATEMENT:-

How Working capital management affects the profitability of Manufacturing
Industry in Pakistan?

 

SIGNIFICANCE:-

This research adopts previous research conducted by Akoto,
Vitor, & Angmor (2013) who studied the effect of working capital
management on profitability in the manufacturing industry listed in Ghanaian
Stock Exchange 2005-2009 consist of the dependent variable is the return on
equity to measure profitability, independent variables; number of days accounts
receivable, number of days accounts payable, cash conversion cycle, &
current ratio. And the control variable is the size of the company and current
assets turnover. Prior research done by Falope and Ajilore (2009) found
a significant negative relationship between net operating profitability and the
average collection period, inventory turnover in days, average payment period
and cash conversion cycle for a sample of fifty Nigerian firms listed on the
Nigerian Stock Exchange. Furthermore, the study found no significant variations
in the effects of working capital management between large and small firms. An
important lesson therefore is that, prudent working capital management is
critical for the profitability of firms of all sizes.

From previous study Akoto, Vitor, & Angmor (2013)  can be seen that the research about working
capital management and its impact towards profitability and liquidity had given
an inconsistent result. Regarding these inconsistencies between previous
studies, I want to reconduct the research using different variables and object.

OBJECTIVES:-

This
research was conducted with objectives to determine the:

 

Ø 
Effect of
number of days accounts receivable towards profitability of
manufacturing company listed in Pakistan Stock Exchange 2010-2014.

 

Ø  Effect of number of days
accounts payable towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014.

Ø  Effect of the level of cash
conversion cycle towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014.

Ø  Effect of the level of current
ratio towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014.

Ø  Effect of firm size to
profitability towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014.

Ø  Effect of current assets
turnover towards profitability of manufacturing company listed in Pakistan
Stock Exchange 2010-2014.

 

RESEARCH QUESTION:-

This study wants to analyze the effect of working capital on
profitability in the manufacturing industry in Pakistan in 2010-2014.

The research questions are as follows:

1)     
What
is the effect of Number of Days Accounts Receivable towards
profitability of manufacturing company in Pakistan?

2)     
What
is the effect of Number of Days Accounts Payable towards profitability
of manufacturing company in Pakistan?

3)     
What
is effect of the level of Cash Conversion Cycle towards profitability of
manufacturing company in Pakistan?

4)     
What
is the effect of the level of Current Ratio towards profitability of
manufacturing company in Pakistan?

5)     
What
is the effect of firm Size to Profitability towards profitability of
manufacturing company in Pakistan?

6)     
What
is the effect of Current Assets Turnover towards profitability of manufacturing
company in Pakistan?

 

LITERATURE
REVIEW

VARIABLES:-

The dependent variable in this study is Return on Asset,
as a measure for firm’s profitability. Independent variable consists of Cash
Conversion Cycle, Average Collection Period, Average Payment
Period, Inventory Turnover Period, Debt Ratio and Firm
Size as a proxy for component of working capital management.

            Cash Conversion
Cycle:

Cash
conversion cycle is an efficiency ratio which measures the number of days for
which a company’s cash is tied up in inventories and accounts receivable. It is
aimed at assessing how effectively a company is managing its working capital. The calculation
measures how fast a company can convert cash on hand into inventory and
accounts payable, through sales and accounts receivable, and then back into
cash.

Conversion
Cycle = (Average Collection Period)+(Average Payable Period)+(Inventory
Turnover Period)

Average Collection Period:

The average
collection period ratio, often shortened to “average collection
period” is also referred to as the “ratio of days to sales
outstanding.” It is the average numbers of days it takes a company to
collect its accounts receivable. Usually, Calculated by dividing 365 Days into
Account Receivable Turnover Ratio.

            Average Payment Period:

The
average payment period (APP) is defined as the number of days a company takes
to pay off credit purchases. It is calculated by by
dividing 365 Days into Account Payables Turnover Ratio.

,           Inventory
Turnover Period:

The
Inventory turnover is a measure of the number of times inventory is sold or
used in a time period such as a year. The equation for inventory turnover
equals the cost of goods sold divided by the average inventory.

           

 

Debt
Ratio:

Debt
Ratio is a financial ratio that indicates the percentage of a company’s assets
that are provided via debt. It is the ratio of total debt (the sum of current
liabilities and long-term liabilities) and total assets (the sum of current
assets, fixed assets, and other assets such as ‘goodwill’).

 

 

 

THEORATICAL FRAMEWORK:-

In this study, two types of theories will be adopted, which are Trade-Off
Theory and Pecking Order Theory.

 The Trade-Off Theory implies that “firms
with high level of liquidity may potentially meet low profitability problem”.
In other word, there is a Acceptability of negative relationship between
liquidity and profitability (Jakpar S, Tinggi M, Siang TK, Johari A,
Myint KT, et al. 2017) (Filbeck and Krueger). A study conducted by
Filbeck and Krueger 4 has revealed that there is an existence of significant
inverse relationship between profitability and liquidity of companies in United
Kingdom. Dittmar et al. 5 indicate
that when the firms are liquid, the firms generate huge amount of net working
capital, follow by diminishing level of profitability. However, in a situation
of over trading, the trade-off theory will highlight the firms will, actually
be confronted with the problem of holding too little liquid once the firms
generate high level of profitability.

Second, the Pecking
Order Theory implies
that “there is an opposite relationship between the levels of debt and
profitability”. It means that, if the firms has higher debt ratio, the
firms would have low or decreasing profitability and vice versa. Myers and
Majluf found an inverse relationship between profitability and debt.
Profitable firms with higher level of retained earnings will not be over-dependant
on external financing. Thus, a pecking order theory suggests that the
firms should rather use the internal fund instead of the required external fund
or debt to finance their operation in order to overcome the problem which will
potentially affect the firm’s value. As reported in a study by Raheman and
Nasr, as the firms’ leverage increase, it will have a significant and negative
impact on its profitability.

 

 

 

 

 

 

 

 

 

 

 

MODEL DIAGRAM:-

Description   

Proxies
(Measurement)

Variable

Return on asset (ROA) 

(Net income)/(Total assets)

Dependent

Cash Conversion Cycle (CCC)

(Average Collection Period)+(Average
Payable Period)+(Inventory Turnover Period)

Independent

Average Collection Period (ACP)

365/Accounts Receivable Turnover Ratio

Independent

Average Payment Period (APP)

365/Accounts payable Turnover Ratio

 independent

Inventory Turnover Period (ITP)

(Inventory)/(Cost of Goods Sold ×
365)

Independent

Debt Ratio (DR)

(Total Liabilities)/(Total Assets)

Independent

Firm Size (SZ)

Natural Logarithm of Sales

Independent

 

HYPOTHESIS:-

H1: There is a relationship between log cash conversion cycle and
firm’s profitability

H2: There is a relationship between log Average collection period
and firm’s profitability

H3: There is a relationship between log Average Payment period and
firm’s profitability

H4: There is a relationship between log Inventory turnover and
firm’s profitability

H5: There is a relationship between debt ratio and firm’s
profitability

H6: There is a relationship between firm size and firm’s
profitability.

(Jakpar S, Tinggi M, Siang TK, Johari A, Myint KT, et al. 2017)

 

  METHODOLOGY

RESEARCH TYPE:-

 The Type of Research will be
Quantitative Research.

DATA COLLECTION & SAMPLING:-

In this study, the financial data are collected from the Annual
Reports of relevant companies listed at the Pakistan Stock Exchange (PSX) which
is Pakistan
Stock Exchange (PSX) is the stock exchange of Pakistan with trading
floors in Karachi, Islamabad and Lahore. The sample consists of 100 firms in manufacturing sector over a
period of five years spanning from 2010 to 2014. The financial data of those
companies include firm’s Net Sales, Purchases Inventory, Cost
of Goods Sold, Net Income, Total Assets, Total Liabilities
and Account Receivable.

ANALYTICAL TECHNIQUE:-

Correlation coefficient test:

Correlation coefficient will
be used to measure the strength of the relationship between two variables such
as dependent variable and independent variable. It is conducted to determine
the relationship between the five independent variables namely Average
Collection Period, Average Payment Period, Inventory Turnover Period, Cash
Conversion Cycle, Debt Ratio and Firm Size with the dependent variable of
return on assets ratio.

Panel
regression analysis:

 

The model of Pooled Ordinary Least
Square (OLS), Random Effect and Fixed Effect Model will be used in this study
in order to estimate the impact of working capital management on profitability.
The regression model as follows:

ROAit=C+?1(LCCCit)+?2(LACPit)+
?3(LAPPit)+?4 (LICPit)+?5(DRit)+?6(SZit)+?it

Where,

C = Constant term

ROA = Return on Assets

LCCC = Natural logarithm of Cash Conversion Cycle

LACP=Natural logarithm of Account Collection Period

LAPP=Natural logarithm of Account Payment Period

LICP=Natural logarithm of Inventory
Conversion Cycle

DR=Debt Ratio

SZ=Firm Size (measured by Log of Sales);   ?=Error Term

x

Hi!
I'm Eileen!

Would you like to get a custom essay? How about receiving a customized one?

Check it out