Effects of working capital management on

SME profitability
Author(s):
Pedro Juan García‐Teruel (Deptartment of Management and Finance, Faculty
of Economy and Business, University of Murcia, Murcia, Spain)

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Acknowledgements:
Financial support from Fundación CajaMurcia is gratefully acknowledged.

Abstract:
Purpose
– The object of the research presented in this paper is to provide empirical
evidence on the effects of working capital management on the profitability of
a sample of small and medium‐sized Spanish firms.

Design/methodology/approach
– The authors have collected a panel of 8,872 small to medium‐sized
enterprises (SMEs) covering the period 1996‐2002. The authors tested the
effects of working capital management on SME profitability using the panel
data methodology.

Findings
– The results, which are robust to the presence of endogeneity, demonstrate
that managers can create value by reducing their inventories and the number
of days for which their accounts are outstanding. Moreover, shortening the
cash conversion cycle also improves the firm's profitability.

Originality/value
– This work contributes to the literature in two ways. First, no previous such
evidence exists for the case of SMEs. Second, unlike previous studies, in the
current work robust test have been conducted for the possible presence of
endogeneity problems. The aim is to ensure that the relationships found in
the analysis carried out are due to the effects of the cash conversion cycle on
corporate profitability and not vice versa.

An Analysis of Working Capital

Management Results Across Industries
Author(s):
Greg Filbeck (Schweser Study Program)

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Abstract:
Firms are able to reduce financing costs and/or increase the funds available
for expansion by minimizing the amount of funds tied up in current assets.
We provide insights into the performance of surveyed firms across key
components of working capital management by using the CFO magazine’s
annual Working Capital Management Survey. We discover that significant
differences exist between industries in working capital measures across time.
In addition, we discover that these measures for working capital change
significantly within industries across time.

5. Conclusion The different analyses have identified critical management practices and are expected to
assist managers in identifying areas where they might improve the financial performance of their
operation. The results have provided owner-managers with information regarding the basic financial
management practices used by their peers and their peers attitudes toward these practices. The
working capital needs of an organization change over time as does its internal cash generation rate. As
such, the small firms should ensure a good synchronization of its assets and liabilities. This study has
shown that the paper and printing industry has been able to achieve high scores on the various
components of working capital and this has positively impact on its profitability. On this premise this
industry may be referred as the ‘hidden champions’ and could thus be used as best practice among the
SMEs. Further, this research concludes that there is a pressing need for further empirical studies to be
undertaken on small business financial management, in particular their working capital practices by
extending the sample size so that an industry-wise analysis can help to uncover the factors that explain
the better performance for some industries and how these best practices could be extended to the
other industries. This would also assist policy-makers and educators to identify the requirements of, and
specific problems faced by small firms in Mauritius, especially as more emphasis is placed on the sector
by the government. This study has come at an opportune time where the Mauritian government is
deploying resources to help the SME sector so that the latter can positively contribute to the Mauritian
economy. This analysis has been constrained by the sample size and the nature of the data, which could
have well affected the results. Further studies will aim at increasing the sample size for still better and
consistent panel estimates.

References: Anand, M. 2001. “Working Capital performance of corporate India: An empirical survey”,
Management & Accounting Research, Vol. 4(4), pp. 35-65 Berryman, J. 1983. “Small Business Failure and
Bankruptcy: A survey of the Literature”, European Small Business Journal, 1(4), pp47-59 Bhattacharya, H.
2001. Working Capital Management: Strategies and Techniques, Prentice Hall
Impact of Aggressive Working Capital
Management Policy on Firms’
Profitability

Introduction:

The corporate finance literature has traditionally focused on the study of long-term financial decisions,
particularly investments, capital structure, dividends or company valuation decisions. However, short-
term assets and liabilities are important components of total assets and need to be carefully analyzed.
Management of these short-term assets and liabilities warrants a careful investigation since the working
capital management plays an important role in a firm’s profitability and risk as well as its value (Smith,
1980). Efficient management of working capital is a fundamental part of the overall corporate strategy
in creating the shareholders’ value. Firms try to keep an optimal level of working capital that maximizes
their value (Deloof, 2003; Howorth and Westhead, 2003 and Afza and Nazir, 2007).

Literature Review :

Many studies have analyzed the financial ratios as a part of working capital management; however, very
few of them have discussed the working capital policies in specific. Gupta (1969) and Gupta and Huefner
(1972) examined the differences in financial ratio averages among industries. The conclusion of both the
studies was that differences do exist in mean profitability, activity, leverage and liquidity ratios among
industry groups. Johnson (1970) extended this work by finding cross-sectional stability of ratio groupings
for both retailers and primary manufacturers. Pinches et al. (1973) used factor analysis to develop seven
classifications of ratios and found that the classifications were stable over the 1951-1969 time period.

Conclusion:

The present study investigates the relationship between the aggressive/conservative working capital
asset management and financing polices and its impact on profitability of 204 Pakistani firms divided
into 16 industrial groups by KSE for the period 1998-2005. The impact of aggressive/conservative
working capital investment and the financing policies has been examined using panel data regression
models between working capital policies and profitability. The study finds a negative relationship
between the profitability measures of firms and degree of aggressiveness of working capital investment
and financing policies. The firms report negative returns if they follow an aggressive working capital
policy. These results were further validated by examining the impact of aggressive working capital
policies on market measures of profitability, which was not tested before. The results of Tobin’s q were
in line of the accounting measures of profitability and produced almost similar results for working
capital investment policy. However, investors were found giving more value to those firms that are more
aggressive in managing their current liabilities.

Working capital management and firms’

performance in emerging markets: the
case of Jordan
Author(s):
Bana Abuzayed (Talal Abu‐Ghazaleh College of Business, The German
Jordanian University, Amman, Jordan)

Abstract:
Purpose
– The purpose of this paper is to examine the effect of working capital
management on firms’ performance for a sample of firms listed on a small
emerging market, namely Amman Stock Exchange.

Design/methodology/approach
– The paper includes a conceptual as well as empirical analysis, in which
data from a sample of listed firms for the period from 2000 to 2008 are
analyzed to examine if more efficient working capital management improves
firms’ accounting profitability and firms’ value. Cash conversion cycles as well
as its components are used as measures of working capital management
skills. In this study, two performance measures are used: one accounting and
one market measure, believing that wealth maximization is shareholders’
main concern. To bring up more robust results, this study used more than one
estimation technique, including panel data analysis, fixed and random effects,
and generalized methods of moments.

Findings
 – Using robust estimation techniques this study found that profitability is
affected positively with the cash conversion cycle. This indicates that more
profitable firms are less motivated to manage their working capital. In
addition, financial markets failed to penalize managers for inefficient working
capital management in emerging markets.

Analysis of Effects of Working Capital

Management on Corporate Profitability of
Indian Manufacturing Firms.
 Source: International Journal of Business Insights & Transformation . Oct2011-
Mar2012, Vol. 5 Issue 1, p71-77. 7p. 1 Color Photograph, 6 Charts.
 Author(s): Arunkumar, O. N.; Radharamanan, T.

 Abstract: This paper analyzes the effect of working capital management on

the profitability of manufacturing firms. The study considers different
variables affecting working capital management and their effect on the
profitability of manufacturing firms. The variables considered are as debtor's
days, inventory days, creditor's days, and cash velocity, working capital policy,
net working capital leverage, size of the firm, and current ratio. The authors
apply correlation and regression analysis to identify the effects of the above
variables on profitability. The results of correlation analysis show that there is
negative relation between profitability and debtor's days, inventory days, and
creditor's days. Regression analysis uses two different methods, the fixed
effects model and ordinary least squares model. The regression analysis
reveals that the cash velocity, size of the firm, and net working capital
leverage are significant in two methods. The study shows a positive
relationship for number of days of inventory and number of days of accounts
payable with the profitability. The study also finds that profitability improves
when a shorter cash conversion cycle exists and, when the current assets and
current liabilities are equal. The results further show that cash velocity and
firm size are significant in both the models.
Liquidity management efficiency of
Indian Steel Companies (a Case Study)
Author: Islam Uddin Khan Assistant Professor in Commerce Kaliyaganj College under University of Gour
Banga Uttar Dinajpur, West Bengal, India

ABSTRACT :

Liquidity management is of crucial importance in financial management decision. The optimal of

liquidity management is could be achieve by company that manage the trade-off between profitability
and liquidity management. The paper analyses the association between the liquidity management and
profitability of 230 Indian private sector steel companies obtained from CMIE database. Liquidity
management indicators and profitability indicator over the period from 2002 to 2010 are modeled as a
linear regression system in multiple correlation and regression analysis. Evidence of petite association
between those variables is found. A descriptive statistics discloses that liquidity and solvency position is
very satisfactory and relatively efficient liquidity management is found. Multiple regression tests confirm
a lower degree of association between the liquidity management and profitability. Keywords: Secondary
data, multiple regression analysis, financial management, India, steel Paper Type: Research Paper

INTRODUCTION :

Working capital is an important issue during financial decision making since its being a part of
investment in asset that requires appropriate financing investment. However, working capital always
being ignored in financial decision making since it involve investment and financing in short term period.

CONCLUSIONS:

Liquidity management is of crucial importance in financial management decision. The optimal of

liquidity management is could be achieve by company that manage the trade off between profitability
and liquidity management. The purpose of this study is to investigate the liquidity management
efficiency and profitability relationship. A descriptive statistics discloses that liquidity and solvency
position in terms of debt is very satisfactory and relatively efficient liquidity management is found but
liquidity position has no impact on profitability. Multiple regression tests confirm a lower degree of
association between the working capital management and profitability. Thus, company manger should
concern on liquidity management, especially unexplained variables in purpose of creation shareholder
wealth.

Working Capital Management: The Effect of Market

Valuation and Profitability in Malaysia
Author : Nor Edi Azhar Binti Mohamad Department of Finance & Economic, University Tenaga
Nasional Sultan Haji Ahmad Shah Campus, 26700 Muadzam Shah, Pahang, Malaysia

Abstract:

The paper is made with an attempt to bridge the gap in the literature by offering empirical evidence
about working capital management and its effect to the performance of Malaysian listed companies
from the perspective of market valuation and profitability. The secondary data for analysis is retrieved
from Bloomberg’s Database of 172 listed companies randomly selected from Bursa Malaysia main board
for five year period from 2003 to 2007. The study aims to explore the effects of working capital
component i.e cash conversion cycles (CCC), current ratio (CR), current asset to total asset ratio (CATAR),
current liabilities to total asset ratio (CLTAR), and debt to asset ratio (DTAR) to the firm’s performance
by looking at firm’s value i.e Tobin Q (TQ) and profitability i.e. return on asset (ROA) and return on
invested capital (ROIC). Applying correlations and multiple regression analysis, the result shows that
there are significant negative associations between working capital variables with firm’s performance.
Thus it highlights the importance of managing working capital requirements to ensure an improvement
in firm’s market value and profitability and this aspect must form part of the company's strategic and
operational thinking in order to operate effectively and efficiently.

Conclusion:

In this paper we make an empirical research on the associations between working capital management
with firm’s performance. The study employed three model specifications in order to test the postulated
hypotheses, using market value measure of TobinQ and profitability measured by return on invested
capital (ROIC) and return on asset (ROA) along with other independent variables for 172 selected listed
companies in Bursa Malaysian for the period of 2003 until 2007. On the basis of findings of the research,
it can be conclude that there are significant relations between WCM with firm’s performance as findings
suggested that, working capital components and performance in Malaysia disclose both positive and
negative association. The study revels that out of five components selected for the study, CATAR shows
positive significant relationships with TobinQ, ROA and ROIC .Whereas, three components (CCC, CACLR
and CLTAR) illustrate negative significant relations with TobinQ, ROA and ROIC, whilst, DR is negatively
significant with ROA only but insignificant with ROIC, while positively significant with TobinQ. The
regression results support hypotheses 1, hypotheses 2 and hypotheses 3 as depicted by table 3, the F
statistics is substantiated at the 1% significant level for TobinQ(F=11.761) ROA(F=53.606) and
ROIC(F=41.089) implying the null hypotheses that the regressions coefficients are all zeros can be
rejected at 1% level of significant. Though, the R squared (TobinQ=0.254; ROA=0.489 and ROIC=0.440)
and adjusted R square (TobinQ=0.064; ROA=0.239 and ROIC=0.194) statistically shows weak
relationships for the three hypotheses tested, however, the estimated regressions is efficient for
predictions and the hypotheses 1, hypotheses 2 and hypothesis 3 can be accepted implying that there
are an associations between working capital variables with the market value and profitability of listed
companies in Malaysia. In conclusions, applying correlations and multiple regression analysis, the result
shows that there are significant negative associations between working capital variables with firm’s
market value and profitability. Thus it highlights the importance of managing working capital
requirements to ensure an improvement in firm’s market value and profitability and this aspect must
form part of the company's strategic and operational thinking in order to operate effectively and
efficiently. Although all the alternate hypotheses are support by the analysis, however the results of
present study are in contradiction to some earlier studies on the issues. Nevertheless, we hope that the
result can contribute to the body of knowledge by identifying how market value and profitability of
Malaysian companies effected by their working capital. It was recommended that the study is further
improved with more sample size, different variables for working capital practices and also other external
variable which might provide a strong relationship between the variables and help to uncover the better
firm’s performance in Malaysia perspectives. Thus this study is left for future to be further explored.