IMPACT OF WORKING CAPITAL ON PROFITABILITY

PERFORMANCE

Objectives of the study

To establish a relationship between working capital management and profitability.

To examine the combine effect of the working capital ratios on profitability.

To determine the working capital leverage for examining the sensitivity of ROI to changes in the level of gross working capital of the company

Hypothesis of the study

1. H0: there is no relationship between working capital and profitability

2. H0: there is no effect of working capital components on profitability

Data base and methodology

The ratios relating to working capital management which have been selected and computed for the study are (i) Working Capital Ratio (WCR) (ii) Acid Test Ratio (ATR) (iii) Working Capital Turnover Ratio (WTR) (iv) Current Assets to Sales Ratio (CTSR) (v) Current Assets to Total Assets Ratio (CTTR) (vi) Inventory Turnover Ratio (ITR) (vii) Debtors Turnover Ratio (DTR) (viii) Cash Turnover Ratio (CTR). For determining the sensitivity of ROI to change in the level of working capital, the working capital leverage has been computed. All statistical calculations have been done through SPSS (17.version).

Analysis and Implications

Table 1

Simple Correlation Analysis between Selected Rations Relating to Working Capital Management and Return on Investment

Year CR ATR CTTR CTSR WTR ITR DTR CTR ROI (%)

2000-2001 0.78 0.49 0.28 0.62 -5.71 4.24 4.36 18.18 -5.01

2001-2002 0.77 0.47 0.30 0.46 -7.12 5.54 5.96 27.96 5.52

2002-2003 0.98 0.71 0.27 0.36 -128.57 10.21 6.27 31.65 5.322003-2004 1.46 1.27 0.50 0.97 3.25 7.74 6.14 30.65 -3.392004-2005 1.18 1.04 0.54 0.83 7.86 10.57 8.06 30.87 -6.462005-2006 0.96 0.87 0.65 0.67 -40.98 14.55 9.86 57.43 -4.562006-2007 1.20 1.05 0.74 1.07 5.62 7.83 9.45 17.09 -14.312007-2008 3.68 2.98 0.85 0.71 1.92 7.34 19.97 47.86 24.062008-2009 2.37 1.94 0.45 0.58 2.97 9.47 19.76 70.22 24.292009-2010 1.80 1.52 0.31 0.63 3.56 10.35 34.37 516.80 -1.78

correlation co.(r) .749* .690* .093 -.477 -.o34 -.086 .362 -.037*Significant at 0.05 level of significant **Significant at 0. 5 level of significant

Table value of with (n-2) i.e., 8 degree of freedom at 0.05 and 0.5 levels of significance are 2.31 and 0.71 respectively.

Source: compiled from annual reports of Andhra cement Ltd

Table 2- correlation matrix

Particulars CR ATR CTTR CTSR WTR ITR DTR CTR ROI

CR 1ATR .992** 1

CTTR .548 .601* 1CTSR .091 .175 .632* 1WTR .305 .332 .331 .594* 1ITR -.023 .061 .220 -.022 -.326 1DTR .608* .627* .075 -.072 .287 .257 1CTR .167 .191 -.277 -.126 .159 .249 .856** 1ROI .749** .690* .093 -.477 -.034 -.086 .362 -.037 1

** Correlation significant at the 0.01 level (2-tailed) * correlation significant at the 0.05 level (2-tailed)

Note: CR=Current Ratio, ATR=Acid Test Ratio, CTTR=Current Assets to Total Assets Ratio, CTSR=Current Assets to Sales Ratio, WTR=Working Capital Turnover Ratio, ITR=Inventory Turnover Ratio, DTR=Debtor Turnover Ratio, CTR=Cash Turnover Ratio, ROI=Return On Investment.

Table3- Multiple correlations and multiple regression analysis

Variables in the equation ROI= β0+ β1 CR+ β2 CTTR+ β3CTSR+ β4WTR+ β5ITR+ β6DTR+ β7CTR,Where as,

(i) Working Capital Ratio (WCR)

(ii) Acid Test Ratio (ATR)

(iii) Working Capital Turnover Ratio (WTR)

(iv) Current Assets to Sales Ratio (CTSR)

(v) Current Assets to Total Assets Ratio (CTTR)

(vi) Inventory Turnover Ratio (ITR)

(vii) Debtors Turnover Ratio (DTR)

(viii) Cash Turnover Ratio (CTR).

Variable Regression Coefficient

Standard Error of Regression Coefficient “t” Value Sig.t

CR 11.401 4.702 2.424 .136CTTR -27.422 17.103 -1.603 .250CTSR -25.432 13.330 -1.908 .197WTR .047 .059 .806 .505ITR .653 .780 .838 .490DTR .719 .863 .833 .492CTR -.073 .042 -1.734 .225

constant 8.270 8.599 8.599 .438multiple R=.988 R2=.976 adj.R2=.891 S.E.of R=4.23042

*significant at 0.05 level of significance ** significant at 0.5 level of significance

Table value of with ( n-k-1) i.e.,2 degree of freedom at 0.05 and 0.5 levels of significance 4.30 and 2.92 respectively

Table 4: Working capital leverage Ratio

Year Sales(Rs.in corer) Working capital Working capital leverage ratio2001 90.93 -15.90 -5.722002 123.58 -17.35 -7.122003 144.00 -1.12 -128.572004 109.43 33.68 3.252005 119.49 15.20 7.862006 151.62 -3.70 -40.982007 101.21 18.01 5.622008 442.27 230.18 1.922009 369.36 124.37 2.972010 294.58 82.75 3.56

(Source: Annual report of Andhra cements Ltd)

Table1 shows that co-efficient of correlation between selected rations relating to working capital management and ROI from the table1 it is inferred that co-efficient of correlation between ROI and CR is (+.749) which indicate that there is a higher degree of positive association between ROI and CR. The value of co-efficient correlation is found to be significant at 5 percent level. Similarly, from the table1 it is observed that co-efficient correlation between ROI and ATR is (+.690) which indicate that there is a higher degree of positive relation between ROI and ATR which is significant at 5 percent. The relationship between ROI and CTTR (+.093), DTR (+.362).which is found that lower degree of relationship between ROI, CTTR and DTR and which is significant at 0.05 levels. The rest of working capital ratio such as CTSR (-.477), WTR (-.034), ITR (-.086) and CTR (-.037) are negatively correlated with ROI and which is insignificant at 0.05 levels.

In order to understand influence on profitability, a liner multiple regression models were used in Table2 and Table3 represent the multiple correlation matrix and multiple regression technique have been used to study the impact on working capital ratios on profitability performance of the firm. In this study CR, ATR, CTTR, CTSR, WTR, ITR, DTR and CTR have been used as the explanatory variables and ROI has been used as dependent variable. In this analysis, the correlation matrix representing correlation co-efficient between the explanatory variables have been constructed in table2. The table reveals that there is a very high degree of correlation between CR and ATR (.992), CR and DTR (.608), ATR and CTTR (.632), CTSR and WTR (.594), DTR and CTR (.856).due to this cause CR,ATR,DTR.CTTR,CTSR,WTR,DTR and CTR have been used for analysis. The regression model used in this analysis is hereunder. ROI= β0+ β1 CR+ β2 CTTR+ β3CTSR+ β4WTR+ β5ITR+ β6DTR+ β7CTR,where β0, β1, β2, β3,

β4 and β5,are the parameters of the ROI line to be estimated.

The pooled regression results of the model exhibiting the impact of working capital on profitability of the firm are depicted in the Table3. The model for the working capital management and firm’s profitability is selected on the basis of strong diagnostics and high value for the R-squared the result is represented in table3. Table3 exhibiting the relationship between the dependent variable ROI,and all the independent variables taken together and the impact of these independent variables on the profitability of the company. When CR increased by 11.401 units which was statistically significant at 0.5.when DTR increased by one unit, profitability of the company increased by 0.719 units which was statistically significant at 0.5 levels. When ITR increased by one unit, the ROI of the company increased by 0.653 which is statistically significant at 0.5 levels, the remaining working capital ratios such as CTTR (-27.422),CTSR(-25.432),CTR(-.073) are negatively influence the profitability of the firm, which is statistically significant at 0.5 levels and insignificant at 0.05 levels. The multiple correlations co-efficient of ROI on CR, CTTR, CTSR, WTR, ITR, DTR and CTR is 0.988. it reveals that the profitability of the company was highly influenced by CR,CTTR,CTSR,WTR,ITR,DTR and CTR. it is also endorsed that from the R2 value that the independent variables CR,CTTR,CTSR,WTR,ITR,DTR and CTR contributed 97.6 percent of the variation in the profitability of the company.

In table 4 it has been attempted to measure the sensitivity of ROI due to variability in the level of working capital with the assistance of calculation of the Working Capital Leverage of the company. Table 4 shows that in the year 2005 the WCL of the company was the highest among all the years under the study was 7.86 representing maximum sensitivity of ROI due to changes in the level of working capital investment. In the year 2003 the WCL was -128.57 which is the lowest among the all years which shows that least sensitivity of ROI due to variability in the working capital investment maximum helpful in the

2005 in increasing the profitability of the company under study. The table 4 reveals that during 2004(3.25), 2007 (5.62), 2008 (2.97), 2009 (2.97) and 2010 (3.56) WCL of the company is greater than one and during the periods 2001 (-5.72,) 2002 (-7.12), 2003 (-128.57) and 2006 (-40.98) the WCL of the company is negative. It represent that in all the years of the study period increases in the rate of return on investment was less than proportionate to decrease n working capital.

Conclusion

Working capital management and profitability disclosed both negative and positive association. Out of nine rations selected for the study three ratios namely, CTSR, WTR and CTR registered negatively correlation with profitability. The slope of the ROI equation depicted that positive and negative influence of variations in the independent variables on the profitability of the company. Out of seven regression coefficient of the ROI line, three coefficient which are CTTR (-27.422), CTSR (-25.432), CTR (-.073) are negatively influence on the profitability. The

coefficient of multiple determinations (R2) makes it clear that 97.6 percent of the total variation in the profitability of the firm.WCL of the company concluded, the increase in the profitability of the company was less than the proportion to decrease in working capital.

(ix) Working Capital Ratio (WCR)

(x) Acid Test Ratio (ATR)

(xi) Working Capital Turnover Ratio (WTR)

(xii) Current Assets to Sales Ratio (CTSR)

(xiii) Current Assets to Total Assets Ratio (CTTR)

(xiv) Inventory Turnover Ratio (ITR)

(xv) Debtors Turnover Ratio (DTR)

(xvi) Cash Turnover Ratio (CTR).