Management and Administrative Sciences Review www.absronline.

org/masr
ISSN: 2308-1368
Volume: 2, Issue: 6, Pages: 715-720 (November 2013)
2013 Academy of Business & Scientific Research
*Corresponding author: Hamid Bashir,
Asst. Company Secretary, Sialkot International Airport, Sialkot-Pakistan.
E-Mail: hamiddhillo@gmail.com
715

Research Paper
Does Efficient Working Capital Management Enhance Profitability of
Pakistani Firms?
Hamid Bashir
1*
and Waqar Ahmad
2
1. Asst. Company Secretary, Sialkot International Airport, Sialkot-Pakistan.
2. Faculty of Management Sciences, University of Central Punjab, Lahore-Pakistan.

The current paper aspires to explore further the impact of working capital management on
profitability by considering recent statistics. For the stated purpose, a sample of 100 non-
financial firms listed on Karachi Stock Exchange (KSE) for the period of 2005-2009 is
considered. Inventory turnover in days (ITID), Average Collection period (ACP) and
Average Payment period (APP) are used as components of working capital. Having used
net profit after tax as a measure of profitability, study results show that managers can
enhance profits of the firms by mounting ITID and APP to an optimal level. The
improved ITID increases sales of the firm while distended APP makes available the
opportunity of short term investment.

Key words: working capital, profitability, VIF Test, Panel data techniques,
Pakistan

INTRODUCTION
Two types of debates prevail in the academic field
regarding the impact of working capital on
profitability. According to the first group of
thought only fixed capital is responsible for profit
generation whereas, working capital may have
negative relationship with profitability. Second
group argues that unless and until a minimum
level of investment is not made in working capital
a firm cannot achieve its prime objective of
profitability. They support their argument with the
fact that working capital comprises of current
assets and current liabilities of the firm and
without sustaining an optimal level of working
capital smooth functioning of a firm cannot be
possible.
Working capital plays a vital role as it affects
directly to the profitability and liquidity of the
firm. Horne and Wachowicz (2004) reported that
excess of current assets in a firm reduces the
profitability whereas shortage of current assets
enhances the probability of insolvency. Eljelly
(2004) suggested that through efficient working
capital management firm can make best possible
investment in current assets and pay off its
obligations timely.
Profit maximization is the prime objective of any
business but the importance of liquidity cannot be
ignored. If a firm increases its current assets it
increases its liquidity but at the same time

Does Efficient Working Capital Management enhance Profitability? Research Paper

716

decreases the profitability. Both these objectives of
profitability and liquidity are important so one
objective cannot not be achieved at the cost of
other. If the importance of profit is ignored firm
cannot run for a longer period and if we try to
overlook the importance of liquidity it may
enhance the probability of insolvency and
bankruptcy. Both the objectives are crucial and
can be achieved through efficient management of
working capital. Shin and Soenen (1998) stated
that objectives of profitability and liquidity can be
achieved through efficient management of
working capital.
Mangers should analyze the optimal level of
working capital to maximize the objective of
profitability. Long et al (1993) and Deloof and
Jegers (1996) documented that the problem of
stock-out can be prevented through adequate
inventory stock and sales of the firm can be
enhanced through efficient credit trade policy.
They concluded that credit policy allows the
customers to analyze the quality of the product
before making payment whereas late payment to
supplier allows the firms to invest for short time
and provides the opportunity to analyze the
quality of bought products. Cash conversion cycle
is used as the most popular measure of working
capital. Conversion cycle is the difference between
the payment of purchases and collection of sales.
Profitability might be increased through long cash
conversion cycle as it increases the sales of the
firm. Profitability may be reduced when cost of
investment crosses the benefits of investment in
working capital.
The above discussion prescribing the importance
and impacts of working capital management leads
us towards the question of whether efficient
management of working capital enhances the
profitability of Pakistani non-financial firms? In
order to empirically investigate the impact of
working capital and its components on
profitability, a sample of 100 non-financial firms
for the period of 2005-2009 is taken under
consideration.
The current study will validate the results of
previous studies as well as the current study will
contribute in following ways. First, it will validate
the results of previous studies on same topic
especially to the results of Rehman and Nasr
(2007), a well known research in Pakistan on the
topic of working capital. Secondly, advanced Panel
data techniques are used to analyze the impacts of
working capital on profitability.
Section two provides brief literature from previous
studies. Third section of the study describes
methodology used for investigating the
relationship between working capital and
profitability. Section four comprises of the
empirically results and discussion. Fifth section
concludes the whole study.
LITERATURE REVIEW
Topic of working capital has been analyzed by
many researchers in different environments and
countries. The previous studies show mix results
regarding the impact of working capital on
profitability as discussed above that there are two
groups of thoughts. According to first group there
is a negative relationship between working capital
and profitability while second group argues that
without making investment in working capital a
firm cannot achieve its prime objective of
profitability.
Deloof (2003) studied a sample of 1009 non-
financial Belgium firms for the period of 1992-1996
to investigate the impacts of working capital on
profitability. His results showed negative
relationship among profitability, Average
Collection Period (ACP), Average Payment Period
(APP) and Inventory Turnover in Days (ITID). He
suggested that managers can enhance
shareholders value by reducing ACP while long
APP will provide an opportunity to invest for
short time. Ghosh and Maji (2003) investigated a
sample of Indian cement firms for the period of
1992-93 to 2001-02 to check the efficiency of
working capital management. Instead of
traditional working capital ratios they used special
indices such as performance, utilization and
overall efficiency indices. Study results showed
that some of the observed firms showed healthier
efficiency during that period.
Eljelly (2004) examined a sample of 929 Saudi
Arabian firms to check the impacts of working
capital on profitability. His results showed
Manag.Adm. Sci. Rev.
ISSN: 2308-1368
Volume: 2, Issue: 6, Pages: 715-720

Bashir and Ahmad
negative relationship between working capital and
profitability.
Mangers should manage current assets and
liabilities in a way that make enable to pay off the
liabilities on time and mitigate the chances of over
and under investment. Filbeck and Krueger (2005)
reported that financial managers can bring value to
firms by organizing well its receivables, payables
and inventories. Their results showed positive and
significant relationship between ACP and
profitability.
Lazaridis and Tryfonidis (2006) documented that
managers can enhance the profits of firm by
keeping each component of working capital on an
optimal level and appropriate handling of CCC.
They used a sample of 131 listed firms on Athens
Stock Exchange (ASE) for the period of 2001-2004
and their results showed significant relationship
between operating profit and CCC and its
components. Falope and Ajilore (2009)
investigated a sample of 50 Nigerian firms for the
period of 1996-2005. Their results showed strong
negative relationship between profitability and
ACP, APP, ITID and CCC. Mathuva (2009) used a
sample of 30 listed firms of Nairobi for the period
of 1993-2008 to check the impact of components of
working capital on profitability of firm. His results
showed significant negative relationship between
ACP and profitability while a strong positive
relationship was observed between APP, ITID and
profitability.
Rehman and Nasr (2007) took a sample of 94 non-
financial firms of Pakistan for the period of 1999-
2004 to investigate the effects of working capital
and its components on profitability. Their results
showed that profitability decreases with the
increase in CCC and they suggested managers can
enhance shareholders value by reducing CCC to
minimum level.
The above literature presents different types of
impacts of working capital management on
profitability for different countries. The current
study investigates the impact of working capital
and its components on profitability for Pakistani
firms.

RESEARCH METHOD
Data and Sampling
Current study aims to investigate the impact of
working capital management on profitability. In
doing so, a balanced panel data of 100 non
financial firms for the period of 2005-2009 is
considered. Data of the variables used in this study
is collected from annual reports of the firms.
Variables of the Study
Mainly the focus of current study is on
profitability, working capital and liquidity but
some control variables are also included to control
the impact of other factors. Profitability and
liquidity are measured through net profit after tax
and current ratio respectively. Whereas, Inventory
turnover in days (ITID), Average collection period
(ACP) and Average payment Period (APP) are
used as a components of working capital.

Profitability (PRO) = (Profit before tax / total assets)
Inventory turnover in days (ITID) = (inventory *
365 / Cost of goods sold)
Average collection period (ACP) = (Ac/ Receivables *
Number of days in a year (365) / Sales )
Average Payment Period (APP) = (Ac/ payable * 365 /
credit purchases)
Current Ratio (CR) = (Current assets/current
liabilities)
Size (SZ) = (Natural Logarithm of sales)
Leverage (LEV) = (Total debts / total assets)
RESULTS AND DISCUSSIONS
Descriptive Statistics
Table 1 presents the descriptive statistics for 100
non-financial Pakistani listed firms. It shows mean,
median, standard deviation, maximum and
minimum values for variables of interest.
Table: 1 Descriptive Statistics: See Appendix
Mean value of profitability is 8.3% which shows
that on average firms are profitable. The mean
value of 74.230 of ITID shows that on average
firms take 74 days to convert their inventory into
sales. On average, firms take 93 days to collect
Does Efficient Working Capital Management enhance Profitability? Research Paper

718

their receivables and pay their liabilities on
average in 545 days. The considerable difference
between ACP and APP shows that firms of the
sample collect their receivables far before the
payment of their liabilities which means that firms
have an opportunity of short term investment. On
average, liquidity measure with mean value of 1.52
shows favorable results. Average size (logged) of
the firms is 8.3 while on average firms usage of
leverage is 1.71.
Correlation Analysis
Table 2 presents coefficients of correlation between
profitability and independent variables. Starting
from ITID, the negative coefficients of ITID (-0.125)
and ACP (-0.183) show that ITID and ACP are
negatively correlated with profitability.
Table 2: Correlation Analysis: See Appendix
Whereas, positive coefficient (0.087) of APP shows
positive relationship between APP and
profitability. Current ratio (liquidity) and size are
positively correlated with positive coefficients of
0.081 and 0.307 respectively. The negative
coefficient of leverage (-0.213) shows that leverage
has negative relationship with profitability of firms
of the sample.
Further, the Variance Inflation Factor (VIF) is used
to check the problem of multicolinearity. Test
results show that values of all variables lies
between 1.02 to 3.62 which are lesser than 10. It
means that there is no problem of co-linearity.
REGRESSION ANALYSIS
Model used for the study
To empirically investigate the impact of working
capital management on profitability, following
model is used:-
Eq. 1
Where, PRO is dependant variable, is the
constant coefficient and is the coefficient of
components of working capital. denotes to
coefficient of control variables and is the error
term.
Econometric Methodology
Sample of current study is comprised of panel data
in which element of heterogeneity is must Baltagi
(2009). Hence, simple OLS regression is not
suitable for panel data as it does not take into
account the element of heterogeneity. Lagrange
Multiplier (LM) test is applied to test the
assumption of Baltagi (2009). Test results reject the
null hypothesis of zero variances across entities
and suggested that simple OLS model is not
suitable for the current study. Further, Hausman
Specification Test is used to choose between
Random effect and Fixed effect models. Results of
Hausman Specification test rejects the hypothesis
of no correlation between individual effect and
other regressors of the study. Results of Hausman
Specification test are presented in Regression table.
Test shows that Fixed effect model is more
appropriate and reliable technique for the current
sample.
Results of Regression analysis
Table 4 presents the results of regression analysis
for the impacts of working capital management on
profitability. All the coefficients of components of
working capital show positive relationship with
profitability but this relationship is only significant
for APP and ITID. The positive coefficient of ITID
(0.00020) shows that profitability increases along
with increase in ITID. This relationship is in
accordance to theory and earlier studies as
profitability of firm is directly related to sales.
Further, positive and significant coefficient of APP
(0.00007) shows that profitability of a firms
increases as its the payment period of firm
increases. This relationship is also in accordance to
the prior studies. The enlarged payment period of
a firm allows the firm to earn profits by making
short term investments.
Table 3: Regression Analysis: See Appendix
The positive coefficient of CR shows positive
relationship with profitability but this relationship
carries no significance. Size with positive and
significant coefficient (0.053) shows that size of the
firms is positively correlated with profitability
Manag.Adm. Sci. Rev.
ISSN: 2308-1368
Volume: 2, Issue: 6, Pages: 715-720

Bashir and Ahmad
while leverage has significant negative impact on
profitability of firms.
SUMMARY AND CONCLUSION
Current study investigates the impact of working
capital management on profitability of Pakistani
non-financial firms for the period of 2005-2009.
Average collection period, Average payment
period and Inventory turnover in days are used as
components of working capital while current ratio
is taken as a measure of liquidity.
Results of the current study are in supportive to
the prior literature of positive relationship between
profitability and working capital management.
Almost all the components of working capital
shows positive and statistically significant
relationship with profitability. It means that
efficient working capital management plays an
imperative role for the enhancement of
profitability of the firms.

REFERENCES
Baltagi, B. H. (2009). A companion to
Econometric analysis of panel data. John
Wiley & Sons.
Deloof, M. and Jegers, M. (1996). Trade credit,
product Quality, and Intra Group Trade:
Some European Evidence. Financial
Management, 25 (3), 33-43.
Deloof, M. (2003). Does Working Capital
Management Affects Profitability of
Belgian Firms?. Journal of Business Finance
& Accounting,30 (3 & 4), 573 587.
Eljelly, A. (2004). Liquidity-Profitability
Tradeoff: An empirical Investigation in an
Emerging Market. International Journal of
Commerce & Management,14 (2), 48 61.
Falope O. and Ajilore O. (2009). Working
capital management and corporate
profitability: Evidence from panel data
analysis of selected quoted companies in
Nigeria. Research Journal of Business
Management, 3, 73-84.

Ghosh, S. K. and Maji, S. G. (2003). Working
Capital Management Efficiency: A study
on the Indian Cement Industry. The
Institute of Cost and Works Accountants of
India.
Lazaridis I. and Tryfonidis D. (2006).
Relationship between working capital
management and profitability of listed
companies in the Athens stock exchange.
Journal of Financial Management and
Analysis, 19, 26-25.
Long, Michael. S, Malitz. Lleen. B, and Ravid,
S. Abraham, (1993). Trade Credit, Quality
Guarantees, and Product Marketability.
Financial Management,117 127.
Mathuva D. (2009). The influence of working
capital management components on
corporate profitability: A survey on
Kenyan listed firms. Research Journal of
Business Management, 3, 1-11.
Raheman A. and Nasr M. (2007). Working
Capital Management And Profitability
Case Of Pakistani Firms. International
Review of Business Research Papers, 3 (1), 279-
300.
Shin, H.H. and Soenen, L. (1998). Efficiency of
Working Capital Management and
Corporate Profitability. Financial Practice
and Education, 8 (2), 37-45.







Does Efficient Working Capital Management enhance Profitability? Research Paper

720


APPENDIX

TABLES
Table: 1 Descriptive Statistics
Variables No. Mean Std. Dev Median Min Max
PRO 500 0.083 0.166 0.059 -0.588 1.143
ITID 500 74.230 99.564 49.718 0.136 992.984
ACP 500 93.885 100.941 65.826 3.539 828.492
APP 500 545.084 276.524 510.306 45.790 1807.728
C.R 500 1.521 2.361 1.104 0.010 42.790
SZ 500 8.366 2.056 8.479 1.335 13.326
LEV 500 1.719 2.922 1.109 -0.104 43.756


Table 2: Correlation Analysis

PRO ITID ACP APP C.R SZ LEV VIF
ITID -0.125 1

1.25
ACP -0.183 0.149 1

1.13
APP 0.087 -0.017 -0.052 1

1.30
C.R 0.081 0.118 0.160 0.044 1

3.62
SZ 0.307 -0.377 -0.281 0.043 -0.064 1

2.25
LEV -0.213 0.024 -0.049 0.114 -0.086 0.030 1 1.02

Table 3: Regression Analysis
Variable Coefficient t-Statistic Prob.
C -0.41329 -3.48098 0.00060
ITID 0.00020 2.71094 0.00700
ACP 0.00001 0.11904 0.90530
APP 0.00007 2.89393 0.00400
CR 0.00317 1.25636 0.20970
SZ 0.05311 4.01901 0.00010
LEV -0.00498 -2.52465 0.01200
R-squared 0.69901

Adjusted R-squared 0.61489

Hausman Specification test

Chi Sq. Statistics-d.f. 15.69-6

Prob. 0.015