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International Journal of Accounting & Business Management
www.ftms.edu.my/journals/index.php/journals/ijabm
Vol. 4 (No.2), November, 2016
ISSN: 2289-4519 DOI: 10.24924/ijabm/2016.11/v4.iss2/227.241
This work is licensed under a Creative Commons Attribution 4.0 International License.
Research Paper
Impact of working capital management on firm's profitability
Sherry Bulin School of Accounting and Business Management
FTMS College, Malaysia [email protected]
Abdul Basit
School of Accounting and Business Management FTMS College, Malaysia
Sahibzada Muhammad Hamza
School of Accounting and Business Management FTMS College, Malaysia
ABSTRACT
This research seeks to establish the impact of Working Capital Management (WCM) towards the
profitability of Malaysia’s consumer product firms. This research was done on 50 companies
registered in Bursa Malaysia, which covered the period of 2011 – 2015 with a total observation
of 250 firms/years. The dependent variable to measure the profitability is Return on Asset (ROA).
The independent variable used in this research is Inventory Turnover Ratio (ITR), Cash
Conversion Cycle (CCC), Collection Period (CP) and Working Capital Turnover Ratio (WCTR). Also,
this study adopted explanatory research design. Moreover, convenience sampling technique is
used to select companies. The collected data was analyzed using descriptive means, Pearson
correlation and multiple linear regressions via E-Views. Regression analysis was used in this
research to examine the effect of working capital management on the profitability of the firms.
Thus, the findings show insignificant relationship between Inventory Turnover Ratio (ITR),
Working Capital Turnover Ratio (WCTR) and Collection Period (CP) on Return on Asset (ROA).
However, the only significant relationship was found between Cash Conversion Cycle (CCC) and
Return on Asset (ROA). While this study are inserted only as 50 companies, for future researches
should include a larger sample of organizations and sectors that might reconsider a better result
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of significant relationship between Inventory Turnover Ratio, Working Capital Turnover Ratio
(WCTR) and Collection Period (CP) on Return on Asset (ROA).
Key Terms: Working Capital Management, Profitability, Cash Conversion Cycle, Inventory Turnover Ratio,
Working Capital Turnover Ratio, Collection Period, Return on Asset, Consumer Product Firms, Malaysia
1. INTRODUCTION
The purpose of this research is to review the impact of Working Capital Management (WCM) on
firm’s profitability from 50 industries of consumer product listed in Bursa Malaysia. WCM is an
extremely important part in corporate finance which is directly impacts the profits of the
company. A significant number of studies had been done in developed and developing countries
(Hailu, 2016; Lu, 2013; Solano & Pedro, 2007; Richard et al, 2013). As we seeing the past studies
by researchers mainly concentrated of manufacturing sectors (Hailu, 2016; Richard et.al, 2013;
Lawal, 2015; Samiloglu and Demirgunes, 2008 and Makori, 2013; Farrah, Nasruddin, 2006 and
Azhar, 2010).
It clearly shows that due to the global financial crisis which presses the firms, WCM studies from
the past years has been facing problems in conducting it in an even manner (Forbes, 2014).
Thereby, the possibilities of a high number of business failures have risen up because of the
mismanagement of a WC. Therefore, it is essential for WCM to be managed in an effective way for
a proper maintenance to stabilize profitability in the long run (Ozbayrak and Akgun, 2006). Over-
trading of the SMEs and the rapid expansion of the businesses has been decided upon being one
of the key issues has been causing the process of firm becoming progressively worse. Beside the
fact that over-trading brings negative impact on a company, business’ reputation falls when there
is a decline in the quality in production or business cannot fulfill agreements (Goyal, A.M, 2013).
For instance, the Seylan Bank Plc (2010) has suffered through 29 times shot up of gearing ratio
(GR) of the bank’s funding within 5 years.
On a different note, another issue that should be taken in account is that the banks shortened
their credit facility in global financial crises of 2008. This has led the creditor and debtor to
squeeze in and end up with a pressing issue of Working capital. Ralf and Daniel (2008)
mentioned that it is reported that due to the situation of the country’s bank withdrawing or
shortening their credit terms, car manufacturers in Germany happened to be pushed into the
verge of bankruptcy.
Research Objectives
To analyze the consequences of Inventory Turnover Ratio on ROA.
To analyze the consequences of Cash Conversion Cycle on ROA.
To analyze the consequences of Average Collection Period on ROA.
To analyze of Working Capital Turnover Ratio on ROA.
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2. LITERATURE REVIEW
According to Deloof (2003), Working Capital Management (WCM) is to sustain the optimum
balance among the components working capital, which are cash, receivable, inventories and
payable are fundamental part of comprehensive corporate strategies on creating values and an
important source of competitive advantage in business. According to Harris (2005), WCM is an
uncomplicated concept and easy to ensure the firm's ability to finance differences between short-
term assets and short-term liabilities. However, working capital may describe as surplus current
assets compared to the current liabilities. Despite WCM possibly reached in a number of ways
(Robert Alan Hill, 2013).
In addition theoretically, Miller and Orr (1966) came up with another new model of cash
management. As Miller and Orr model, the cash management companies had let their cash
balance moved in two, upper and lower limits. Companies buy and sell securities market only if
the cash balance is at the lower limit or above. Theory of Transaction cost is used to describe a
number of different behaviors. Many times this involves accounted transactions not only in
apparent cases of sale but also to purchase in spite of day to day emotional interactions and
informal exchange of gifts (Williamson, 1975). Further, the Economic Order Quantity (EOQ) is
order quantity by minimizing the number of holdings and ordering costs for the year. EOQ
considers that the annual demand evenly throughout the year, fixed order costs regardless of the
number of units ordered, set a lead time, prices continuous, and only applies to the case of the
product (Brigham, ET al.1999). The cash conversion cycle (CCC) has provided a determining
theoretical background of working capital management. Thus, working capital comes to mean
that funds used to be operating in the short period. Apart from that, Nimarathasan (2010),
argued that the relationship between working capital management affecting on the profits as
most companies have huge amount of cash invested in working capital and even the large
numbers of short term payable as a financing options.
The research conducted by Mathuva (2009) reviewed the effect of working capital management
components on corporate profits using a sample of 30 listed companies on Nairobi Stock
Exchange (NSE) for the years 1993 to 2008. The study found a significant negative relationship
between when it takes companies to collect the cash from the customer and their profits, there is
a positive correlation significantly between the time taken to convert inventory into sales and
profitability, and positive correlation exists between the time taken for firm for paying creditors
and profits. Apart from that, Mohamod and Soad (2010) attempted a study on empirical evidence
offered on working capital management and it impacts on performance of the listed companies
in Malaysia from a perspective of market assessment and profitability. The results show a
negative significant association between working capital variables to firm performance. However,
Alipour (2011), indicate a correlation between working capital management and profitability in
Iran. Another researcher Ray (2012)provides a review of the correlation between working
capital management and profitability components for Indian manufacturing firms and found a
strong negative correlation between the size of working capital management including the
number of days’ accounts receivable and the conversion cycle cash, financial debt ratio of
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corporate profits. Lastly, Zubair and Muhammad (2013) conducted a research to examine the
effect of working capital management to profitability and found significant negative correlation
between WCM firms to profitability.
Conceptual Framework
Figure1: Conceptual Framework
According to Riyanto (2001) Return on Assets also used to measure the efficiency of the firm to
maximize profits by the exploitation of its assets. Return on assets often used as a technique to
determine the rate of return on total assets after deducting expenses and taxes and considered to
be a potential measure to gauge firm’s profitability (Heikal et al, 2001). The inventory turnover
days measuring the average period in which inventories held prior to sale or applied in the
operation of the companies and found to be strongly positive correlated with Return on Assets.
H1: There is a positive significant impact of Inventory Turnover Ratio on Return on Asset.
Gitman (2009) explained that the cash budget was estimated future cash entry and come out
from the company and how the money is used for operating business activities. However, the
cash conversion cycle is period of time the money invested in accounts receivable and inventories.
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In fact, the Cash Conversion Cycle (CCC) is applicable with the number of resources tied firm and
found to be strongly correlated with the profitability of the firm.
H2: There is a positive significant impact of Cash Conversion Cycle on Return on Asset.
According to Madishetti and Kibona (2013), the average collection period is referring how long it
should take on average by the business to receive due accounts receivable from clients and
customers. The average collection period is the average number of days taken in the past to
collect payment after credit sales. According to the type of business, the average collection period
was calculated each year or for a given time period (Ntui Ponsian, Kiemi Chrispina, Gwatako Tago
and Halim Mkiibi, 2014).
H3: There is a positive significant impact of Collection Period on Return on Asset.
According to Samiloglu, F., & Demirgunes, K. (2008), working capital turnover ratio describes
how many times the results of working capital turns into revenue. Furthermore, working capital
turnover ratio could be compared with records before or with the competitors to find out
whether the working capital is irregular or not. Ratio indicates the speed of the company's net
working capital. This ratio showing that company's efficiency in the use of working capital.
H4: There is a positive significant impact of Working Capital Turnover Ratio on ROA.
3. Methodology and Design
The research design for this study is descriptive explanatory as established by (Harwell, 2010)
who institute that descriptive and explanatory research require suggestions and the research
questions for this study demands to be interpreted into recommendations. Quantitative methods
used for this research since it help theory and hypothesis testing, gathering a large number of
data, which is more suitable to respond the questions, whether this method is more objective and
reliable but is not affected by personal opinion researchers in the phenomenon (Parkinson and
Drislane, 2011).
Data Collection Methods: In the present study, researcher is using secondary data collection
for all numerical data variables and data able to be obtained from annual reports. Nonetheless,
since the data for this study were collected from the published annual reports of the companies
of the sample, it will become the only source needed for this research.
Population and Sample Size: Research had been done on Kuala Lumpur Stock Exchange (KLSE)
Consumer Product Companies in the Bursa Malaysia; the total population for this study is 98
companies which were publicly listed by Bursa Malaysia. Hence the sample size chose for this
study is 50 companies which will be studied within the time span of 2011-2015 and will be
selected by convenience sampling technique.
Accessibility: The research would extract data from the published annual reports of the sample
companies which are conveniently available from the official websites. This study is fully to act as
a secondary data compilation which proves that it will not be linked with human behavior. The
only problem that lies is the access to the published data should be made through legal means
(Pearson, 2010).
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Data Analysis Methods: According to John Tukey (1961), data analysis is the procedure for
analyzing the data, the technique for interpreting the results of such procedures, methods of data
collection plan to make the analysis easier, more accurately or more precisely, and all the
equipment and the results of (mathematical) statistics were used to analyze the data. Three
methods of data analysis involved in this research are regression, correlation and descriptive
statistics. Econometric Views (Eviews) software was used in this study to analyze the data
collected. Eviews, is a statistical analysis software package was used for analysis of time series
econometrics, forecasting models, and test the correlation between variables (Gora, 2012)
4. Data Analysis
Descriptive Statistics
Table 1: Descriptive Statistics
N Min Max Mean Standard
Deviation Skewness Kurtosis
Statistics Statistics Statistics Statistics Statistics Statistics Statistics
% % % % % % %
ROA 250 -14.613 36.383 6.154 6.299 1.273 7.302
ITO 250 0.149 121.269 6.454 14.048 6.715 49.437
CCC 250 -26.617 4131.916 174.032 338.234 9.576 103.695
CP 250 0.000 217.045 74.415 36.510 0.701 4.196
WCTOR 250 -524.430 1186.296 125.402 189.675 1.840 10.161
According to table 1, the mean value of return on asset is 6.154. For ROA, the standard deviation
is 6.299. Therefore, the sample companies experiences 6% of return on their assets within the
considered time span. The average period of the inventory turnover as a proxy for basic
inventory is 6.454 days. This means that the firms in the sample require an average of 6.454 days
to convert their inventory into cash. Moreover, the company takes 174.03 days on average to
convert cash into inventory and accounts payable through sales and accounts receivables and
convert them again into cash. Further, the sample companies take 74 days for receiving the debts
from the trade debtors of the sample companies selected for this research. Finally, the working
capital turnover ratio is evaluated and the mean at 125.40 which indicates that the sample
companies were found to generate 125% of sales on their employed working capital.
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Table 2: Correlation Analysis
Correlation Probability
ROA ITO CCC WCTOR CP
ROA 1
-----
ITO -0.010546 1
0.8682 -----
CCC -0.064213 -0.100914 1
0.3119 0.1115 -----
WCTOR 0.02735 -0.044358 -0.012663 1
0.6669 0.4851 0.8421 -----
CP -0.08943 0.23025 0.005869 -0.182139 1
0.1586 0.0002 0.9264 0.0039 -----
*Correlation is significant at the 0.05 level
In accordance to Table 2, shows the inventory turnover ratio is negatively correlated with return
on assets and the relationship strength between these two variables is weak with a value of -
0.010. Further, inventory turnover ratio is not significantly correlated with a probability value
0.868 which is higher than 0.05. Hence, this shows that consumer product sector in Malaysia is
no efficiently managing inventory and because of this sales are getting effect. Moreover, cash
conversion cycle and return on assets has a correlation coefficient of -0.064 with a probability
value of 0.311 which indicates a weak negative insignificant relationship. Furthermore, working
capital turnover shows a insignificant positive relationship with return on assets with a
correlation coefficient of 0.02735 and a significant value of 0.667. Lastly, the relationship
between collection period and return on assets has a negative insignificant correlation with a
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correlation co-efficient of -0.089 and a probability value of 0.1586.
Regression Analysis
The purpose of regression analysis in this study is to test the impact of inventory turnover ratio,
cash conversion cycle, working capital turnover ratio and collection period on return on asset.
Table 3: Model 1- Determinants of Profitability
Model R-squared Adj. R-squared F-statistic Durbin-Watson
Statistics
1 0.702 0.614 7.938 2.236
Dependent Variable ROA
Seeing to Table 2 indicates that the R-squared is 0.702 which shows that 70% of the dependable
variable is described with the independent variables, while the remaining percent 30% is
described by other factors which are not considered in this analysis. In addition, the R-adjusted
Square is 0.614 which means 61% variation of independent are allot to return on assets.
Therefore, in this case a model is a good fit with a value of 0.61. F-value indicates that there is a
relationship between independent variables and return on assets with a value of 7.938.
Probability (F-statistics) value is 0 which means the model is significant. The Durbin Watson
Static Test is 2.236 which shows that there is no auto correlation amongst the selected samples
chosen for this research.
Table 4: Model 1- Beta Coefficient of Working Capital
Variable β Std. Error t-Statistic Prob.
CONSTANT 7.431 1.196 6.211 0
ITO 0.028 0.079 0.351 0.726
CCC 0.003 0.001 -2.727 0.007
WCTOR -0.001 0.002 0.556 0.579
CP 0.015 0.013 -1.148 0.252
Dependent Variable ROA
The equation of Multiple Linear Regression was generated by β-coefficient that predicts
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dependent variable return on asset and independent variables, inventory turnover ratio, cash
conversion cycle, working capital turnover ratio and collection period.
ROA= CONSTANT + β1ITO + β2CCC + β3WCTOR + β4CP
ROA = 7.431 + 0.028ITO + 0.003CCC - 0.001WCTOR + 0.015CP
The table above shows that cash conversion cycle variable is only significant with return on asset
with a value of 0.007. However, inventory turnover ratio, working capital turnover ratio and
collection period is not significant with a value of 0.05. Based on the above result cash conversion
cycle have a influential impact on return on assets as inventory turnover ratio, working capital
turnover ratio and collection period does not place any significant impact on return on assets.
The highest beta (β) coefficient value is for inventory turnover ratio of 0.028 with an insignificant
value of 0.726. Followed by cash conversion cycle beta (β) coefficient value 0.003 with a
significant value of 0.007, working capital turnover ratio beta (β) coefficient value is 0.001 with
insignificant P-value of 0.579. Lastly, collection period beta (β) coefficient value is 0.015 with P-
value of 0.252.
HYPOTHESIS SIGNIFICANT
LEVEL RESULT EFFECT
H1 : There is a positive significant impact of Inventory Turnover Ratio on Return on Asset.
0.726 Rejected The P-value is 0.726 which is more than 0.05. This shows that Inventory Turnover Ratio is not significant impact on Return on Asset.
H2 : There is a positive significant impact of Cash Conversion Cycle on Return on Asset
0.007 Accepted The P-value is 0.007 which is less than 0.05 significant levels. This shows that Cash Conversion Cycle is significant impact on Return on Asset.
H3 : There is a positive significant impact of Collection Period on Return on Asset.
0.579 Rejected The P-value is 0.579 which is more than 0.05. This shows that Collection Period is not significant impact on Return on Asset.
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Table 5: Summary of Hypothesi
5.0. Conclusion and Recommendation
The result concluded that inventory turnover ratio, collection period and working capital
turnover ratio does not place a significant impact on firm profitability which shows that quick
dispatched of inventory stock does not places influence impact on the profitability of the sample
consumer product companies registered in Bursa Malaysia. While flipping the other side of coin,
The cash conversion cycle has significant positive impact on return on asset, which indicates that
the quick conversion of cash places a significant influential impact on the profitability of the
consumer product company registered in Bursa Malaysia.
Recommendations
The further researchers are recommended to make an inquiry with a broader approach through
addressing other sectors and different countries to check the similarity in the results found.
Further, a more diverse framework could be engaged which includes other working capital and
profitability measures to portray a more visible picture. Lastly, a comparative study can also be
made to check the different of working capital management on profitability based on industry
natures.
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