INTRODUCTIONBACKGROUND:-Working capital management related to the management of currentassets and current liabilities. Working capital management is considered veryimportant in the sustainability process of production or operation activitiesof the company. If the working capital cannot be fulfilled, then the productionprocess is in danger. Indeed, this can be overcome by borrowing capital tobanks or other financial institutions. But that would automatically increasethe liquidity risks faced by the company. Therefore working capital managementis very important to prevent this from happening in the future.
Optimal working capital levels are determined largely by managementof current assets and current liabilities. It requires continuous monitoring tomaintain proper levels in the various components of working capital. Especiallyfor manufacturing companies current assets amount covers more than half oftotal assets. First, the management of current assets where within the postcontained the company’s assets that could be used in the operating activitiesof the company. Cash account is included in current assets; where cash is usedby companies to finance the operating activities of the company include thepurchases of raw materials and maintenance supplies. Later, accounts receivableis a tool used by the company to increase the number of sales. The companycarries out the policy of giving credit to the consumer to achieve salestargets and ultimately to meet the profitability targets that have been set.
- Thesis Statement
- Structure and Outline
- Voice and Grammar
There are some amounts of inventories needed by company for thesustainability of the production process in case a significant increase ofdemand. Inventory is one part of the working capital (Subramanyam and Wild,2010). Inventory is one part of current assets which have fairly large quantityand are in need of special attention. Most companies maintain inventory levelsat a certain level. This happens because the company wanted to have enoughsupplies so that the sale of the company can continue to run. If the supply isnot enough, they can lead to a decrease in sales volume below the level thatcan be achieved (Subramanyam and Wild, 2010).The main indicator of working capital management, commonly used instudies is the cash conversion cycle (cash conversion cycle). In this study,the cash conversion cycle and its components are used as a basis for assessingthe efficiency of working capital management to determine its relevance inachieving the objectives of profitability.
Working capital management will indirectly affect the level ofcorporate profitability. As described above, any measures taken by the companywill have an impact on the level of sales and eventually also affect the valueof companies that are affected by the amount of net profit.The company’s ability to generate profits by using all its resourcesreferred to profitability.
Munawir (2010) mentions the profitability ascompany’s ability to generate profits within a certain time that can bemeasured by the success of the company and the company’s ability to manage itsassets. It is this ability which became one of the factors that may affectinvestor consideration in deciding where he should be investing. Profitabilityalso showed the effectiveness and efficiency of companies in utilizing itsresources.
The higher the level of productivity of a company the betterperformance is.Profitability and liquidity are two important and major aspects ofcorporate business life (Vataliya, 2009). The problem is that increasingprofits at the cost of liquidity can bring serious problems to the firm.Therefore, there must be a trade-off between these two objectives (liquidityand profitability) of firms.
One objective should not be at the cost of theother because both have their own importance. If firms do not care aboutprofit, they cannot survive for a longer period. In other round, if firms donot care about liquidity, they may face the problem of insolvency orbankruptcy. In manufacturing companies, working capital is expected to affectthe company’s profitability. It can be seen from the operating activities ofcompanies started from capital investment to supplies the raw materials of itsproducts and their receivables and pay for the debts of the company.
Themanufacturing company is a company that produces the needs of society in Pakistanboth as an industry that produces goods to satisfy basic needs also generatesadditional needs. Inventory is an asset to manufacturing company, since theinventory is a major source of income in these types of companies.Manufacturing companies must store enough supplies to meet the needs of itscustomers. Failure on this account would be bad if it was not consideredseriously, because it can result in loss of sales / revenue so as to reduce thecompany’s operating profit.In this study, the selected industries as an object of research arethe manufacturing industry. Because the industry is consider ideal in workingcapital management. In manufacturing companies, it can be seen from theoperating cycle that involves investment in inventories and receivables andmake the payments on their debts. In connection with the days of outstandinginventory (DOI), the study was conducted in industries associated withsupplies.
In particular, the manufacturing industry associated with supplies.Based on the above mentioned argumentation, this study observed the effect ofworking capital to profitability of manufacturing company in Pakistan.PROBLEM STATEMENT:- How Working capital management affects the profitability of ManufacturingIndustry in Pakistan? SIGNIFICANCE:-This research adopts previous research conducted by Akoto,Vitor, & Angmor (2013) who studied the effect of working capitalmanagement on profitability in the manufacturing industry listed in GhanaianStock Exchange 2005-2009 consist of the dependent variable is the return onequity to measure profitability, independent variables; number of days accountsreceivable, number of days accounts payable, cash conversion cycle, ¤t ratio. And the control variable is the size of the company and currentassets turnover. Prior research done by Falope and Ajilore (2009) founda significant negative relationship between net operating profitability and theaverage collection period, inventory turnover in days, average payment periodand cash conversion cycle for a sample of fifty Nigerian firms listed on theNigerian Stock Exchange. Furthermore, the study found no significant variationsin the effects of working capital management between large and small firms. Animportant lesson therefore is that, prudent working capital management iscritical for the profitability of firms of all sizes.
From previous study Akoto, Vitor, & Angmor (2013) can be seen that the research about workingcapital management and its impact towards profitability and liquidity had givenan inconsistent result. Regarding these inconsistencies between previousstudies, I want to reconduct the research using different variables and object.OBJECTIVES:-Thisresearch was conducted with objectives to determine the: Ø Effect ofnumber of days accounts receivable towards profitability ofmanufacturing company listed in Pakistan Stock Exchange 2010-2014.
Ø Effect of number of daysaccounts payable towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014.Ø Effect of the level of cashconversion cycle towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014. Ø Effect of the level of currentratio towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014. Ø Effect of firm size toprofitability towards profitability of manufacturing company listed in Pakistan Stock Exchange 2010-2014. Ø Effect of current assetsturnover towards profitability of manufacturing company listed in PakistanStock Exchange 2010-2014.
RESEARCH QUESTION:-This study wants to analyze the effect of working capital onprofitability in the manufacturing industry in Pakistan in 2010-2014.The research questions are as follows:1) Whatis the effect of Number of Days Accounts Receivable towardsprofitability of manufacturing company in Pakistan?2) Whatis the effect of Number of Days Accounts Payable towards profitabilityof manufacturing company in Pakistan?3) Whatis effect of the level of Cash Conversion Cycle towards profitability ofmanufacturing company in Pakistan?4) Whatis the effect of the level of Current Ratio towards profitability ofmanufacturing company in Pakistan?5) Whatis the effect of firm Size to Profitability towards profitability ofmanufacturing company in Pakistan?6) Whatis the effect of Current Assets Turnover towards profitability of manufacturingcompany in Pakistan? LITERATUREREVIEWVARIABLES:-The dependent variable in this study is Return on Asset,as a measure for firm’s profitability. Independent variable consists of CashConversion Cycle, Average Collection Period, Average PaymentPeriod, Inventory Turnover Period, Debt Ratio and FirmSize as a proxy for component of working capital management. Cash ConversionCycle:Cashconversion cycle is an efficiency ratio which measures the number of days forwhich a company’s cash is tied up in inventories and accounts receivable. It isaimed at assessing how effectively a company is managing its working capital. The calculationmeasures how fast a company can convert cash on hand into inventory andaccounts payable, through sales and accounts receivable, and then back intocash.ConversionCycle = (Average Collection Period)+(Average Payable Period)+(InventoryTurnover Period)Average Collection Period:The averagecollection period ratio, often shortened to “average collectionperiod” is also referred to as the “ratio of days to salesoutstanding.” It is the average numbers of days it takes a company tocollect its accounts receivable.
Usually, Calculated by dividing 365 Days intoAccount Receivable Turnover Ratio. Average Payment Period:Theaverage payment period (APP) is defined as the number of days a company takesto pay off credit purchases. It is calculated by bydividing 365 Days into Account Payables Turnover Ratio., InventoryTurnover Period:TheInventory turnover is a measure of the number of times inventory is sold orused in a time period such as a year. The equation for inventory turnoverequals the cost of goods sold divided by the average inventory.
DebtRatio:DebtRatio is a financial ratio that indicates the percentage of a company’s assetsthat are provided via debt. It is the ratio of total debt (the sum of currentliabilities and long-term liabilities) and total assets (the sum of currentassets, fixed assets, and other assets such as ‘goodwill’). THEORATICAL FRAMEWORK:-In this study, two types of theories will be adopted, which are Trade-OffTheory and Pecking Order Theory. The Trade-Off Theory implies that “firmswith high level of liquidity may potentially meet low profitability problem”.In other word, there is a Acceptability of negative relationship betweenliquidity and profitability (Jakpar S, Tinggi M, Siang TK, Johari A,Myint KT, et al. 2017) (Filbeck and Krueger). A study conducted byFilbeck and Krueger 4 has revealed that there is an existence of significantinverse relationship between profitability and liquidity of companies in UnitedKingdom. Dittmar et al.
5 indicatethat when the firms are liquid, the firms generate huge amount of net workingcapital, follow by diminishing level of profitability. However, in a situationof over trading, the trade-off theory will highlight the firms will, actuallybe confronted with the problem of holding too little liquid once the firmsgenerate high level of profitability.Second, the PeckingOrder Theory impliesthat “there is an opposite relationship between the levels of debt andprofitability”. It means that, if the firms has higher debt ratio, thefirms would have low or decreasing profitability and vice versa. Myers andMajluf found an inverse relationship between profitability and debt.Profitable firms with higher level of retained earnings will not be over-dependanton external financing. Thus, a pecking order theory suggests that thefirms should rather use the internal fund instead of the required external fundor debt to finance their operation in order to overcome the problem which willpotentially affect the firm’s value.
As reported in a study by Raheman andNasr, as the firms’ leverage increase, it will have a significant and negativeimpact 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 andfirm’s profitabilityH2: There is a relationship between log Average collection periodand firm’s profitabilityH3: There is a relationship between log Average Payment period andfirm’s profitabilityH4: There is a relationship between log Inventory turnover andfirm’s profitabilityH5: There is a relationship between debt ratio and firm’sprofitabilityH6: There is a relationship between firm size and firm’sprofitability. (Jakpar S, Tinggi M, Siang TK, Johari A, Myint KT, et al.
2017) METHODOLOGYRESEARCH TYPE:- The Type of Research will beQuantitative Research.DATA COLLECTION & SAMPLING:-In this study, the financial data are collected from the AnnualReports of relevant companies listed at the Pakistan Stock Exchange (PSX) whichis PakistanStock Exchange (PSX) is the stock exchange of Pakistan with tradingfloors in Karachi, Islamabad and Lahore. The sample consists of 100 firms in manufacturing sector over aperiod of five years spanning from 2010 to 2014.
The financial data of thosecompanies include firm’s Net Sales, Purchases Inventory, Costof Goods Sold, Net Income, Total Assets, Total Liabilitiesand Account Receivable.ANALYTICAL TECHNIQUE:-Correlation coefficient test: Correlation coefficient willbe used to measure the strength of the relationship between two variables suchas dependent variable and independent variable. It is conducted to determinethe relationship between the five independent variables namely AverageCollection Period, Average Payment Period, Inventory Turnover Period, CashConversion Cycle, Debt Ratio and Firm Size with the dependent variable ofreturn on assets ratio.Panelregression analysis: The model of Pooled Ordinary LeastSquare (OLS), Random Effect and Fixed Effect Model will be used in this studyin 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)+?itWhere,C = Constant termROA = Return on AssetsLCCC = Natural logarithm of Cash Conversion CycleLACP=Natural logarithm of Account Collection PeriodLAPP=Natural logarithm of Account Payment PeriodLICP=Natural logarithm of InventoryConversion CycleDR=Debt RatioSZ=Firm Size (measured by Log of Sales); ?=Error Term