Working Capital ManagementDissertation PDF

ASIA PACIFIC INSTITUTE OF
INFORMATION TECHNOLOGY
Masters in Business Administration
(Finance)
By
FATHIMATH SHAMSIYYA
[CB No.005302]
[Intake : MP13A1MF]
Date of Submission: 11th August 2015
Supervisor: Professor Kennedy Gunawardana
Assessor: MR.S.C. Kaluarachchi
Word count: 9676

TITLE
An impact of aggressive working capital policy on corporate
profitability in the selected listed companies of Colombo Stock
Exchange
Supervisors Declaration
Student Name: Fathimath Shamsiyya (Cb005302)
Supervisors Name: Professor Kennedy Gunawardana
I, Professor Kennedy Gunawardana, have certified that above student work entitled as An
impact of aggressive working capital policy on corporate profitability in the selected listed
companies of Colombo Stock Exchange was undertaken and submitted to the APIIT (Asia
Pacific Institute of Information Technology) as partial fulfilment of Masters in Business
Administration Degree in Finance. I believe presentation of this research work may equally
precise and complete up to the required standard of degree awarding body Staffordshire
University.
Sign:
Professor Kennedy Gunawarudena
11th August 2015

Stundents Declarion
This research work is submitted as the partial fulfillment requirement of Masters in Business
Administration (Finance). I assure that this work is not previously accepted in any substance in
any degree. Further it is not being concurrently submitted this particular topic in candidature of
any degree. All the information taken from different sources are duly referenced as per
Staffordshire Reference Guidelines.
Sign:
Fathimath Shamsiyya
11th August 2015

Acknowledgement
This research proposal on working capital management in listed companies in Sri Lanka is
possible due to the help, support, and blessings from various parties. Firstly, I would like to
thank my lecturer Professor Kennedy Gunawardana for his immense advice. As a lecturer and
guide, Professor gave me new insights and ideal opinions regarding this research topic that lead
to go ahead further with this entire research work. I am overwhelmed and much appreciated to
Professor Kennedy Gunawardana for his kindness and valuable time to complete this proposal
successfully. I would also like to appreciate the help given from Assessor Mr . Kaluarachchi.
Secondly, I would like to thanks, APIIT administration for their help and support. APIIT
Librarians help me to get the required and necessary materials to do the research.
Finally, I sincerely thank to my parents, and my dear friends, who give continuous support and
advices to finish this research proposal.
Abstract
This study has investigated the impacts of aggressive working capital policies on firms
profitability at Colombo Stock Exchange. Out of 292 companies listed at the Colombo Stock
Exchange, 162 companies select as a target population by excluding service sector and new
companies listed less than five years. The study comprises a sample size of 114 companies,
which includes 12 sectors out of 20 sectors in Colombo Stock Exchange. Due to the negative
figures in ratio data, those companies data eliminated and sample size further reduces to 68
companies consisting 09 sectors. An aggressive working capital policy measures through
aggressive investment and financing policy. Corporate profitability measures through return on
assets of the companies. The main purpose of this study is to find out the impacts of aggressive
working capital policy on corporate profitability in the selected listed companies in the Colombo
Stock Exchange. Statistical software package Gretl version gretlw32.exe will be used for data
analysis. Hausman test, Breusch-Pagan Lagrangian Multiplier (LM) test and Chow test run to
select appropriate model for the final data analysis. Pooled OLS regression uses as an inferential
analysis while statistical analysis such as descriptive and correlation matrix uses to evaluate the
data before running regression analysis. The results of the study revealed a positive relationship
between aggressive working capital policy and corporate profitability for the selected listed
companies in Colombo Stock Exchange. The result also indicated that debt used by the
companies does not have significant impact on corporate profitability but there is a positive
relationship between them. It further indicated that high aggressive working capital policy raises
the financial distress level of the company. Based on study results, financial managers in these
selected listed companies in Colombo Stock Exchange can improve and enhance profitability
further if they adopt more aggressive working capital policy.
Key words: Corporate Profitability, Aggressive Investment Policy, Aggressive Financing

Policy, Debt Ratio, Return on Assets
vi
TABLEOF CONTENTS
Acknowledgement .................................................................................................................................. x
Abstract................................................................................................................................................. vi
CHAPTER ONE .................................................................................................................................... 1
1.0 Introduction ...................................................................................................................................... 1
1.1 Introduction ............................................................................................................................ 1
1.2 Background of the study ............................................................................................................. 1
1.3 Research Question ...................................................................................................................... 2
1.4 Problem Statement ...................................................................................................................... 2
1.5 Problem Justification................................................................................................................... 3
1.6 Objectives of the study ................................................................................................................ 3
1.7 Significance of the study ......................................................................................................... 4
1.8 Scope of the study ......................................................................................................................... 4
1.9 Conclusion.................................................................................................................................... 5
CHAPTER TWO ................................................................................................................................... 6
2.0 Literature Review ............................................................................................................................. 6
2.1 Introduction ...................................................................................................................................... 6
2.2 Working Capital Management Reviews ............................................................................................ 6
2.2.1 Working Capital Management- International Context ................................................................. 6
2.2.2 Working Capital Management- Sri Lankan Context ................................................................ 8
2.3 Working Capital Policies Reviews ................................................................................................ 9
2.3.1 Working capital policy-International context .......................................................................... 9
2.3.2 Working Capital Policies-Sri Lankan Context ...................................................................... 13

vii
2.4 Critical Reviews and Conclusion and Variables Selection ........................................................... 15
2.4.1 Researchers Critical Review................................................................................................ 15
2.4.2 Variables Selection .............................................................................................................. 16
2.4.3 Conclusion of Literature Reviews ......................................................................................... 17
CHAPTER THREE .............................................................................................................................. 19
3.0 Research Methodology ................................................................................................................... 19
3.1 Introduction ................................................................................................................................ 19
3.2 Conceptual Framework ............................................................................................................... 19
3.2.1 Illustration of Conceptual Framework .................................................................................. 20
3.3 List of Hypotheses ...................................................................................................................... 21
Table 1 List of Hypotheses ............................................................................................................... 21
3.4 Population and target population ................................................................................................. 22
3.5 Sample size................................................................................................................................. 22
3.5.1 Research design ....................................................................................................................... 22
3.5.2 Data collection method ............................................................................................................ 22
3.5.3 Sampling method ..................................................................................................................... 23
3.5.4 Illustration of the sample .......................................................................................................... 24
3.6 Proposed statistical method ......................................................................................................... 26
3.6. 1 Statistical method used by previous research studies ............................................................ 26
3.7 Conclusion of Research Methodology ......................................................................................... 27
CHAPTER FOUR ................................................................................................................................ 28
4.0 Data Analysis ................................................................................................................................. 28
4.1 Introduction ................................................................................................................................ 28
4.2 Basic Assumption Tests .............................................................................................................. 29
4.3 Descriptive Statistics ................................................................................................................... 29
4.4 Correlation Matrix .................................................................................................................. 31
viii
4.5 Panel Diagnostics........................................................................................................................ 31
4.5.1 Hausman test ........................................................................................................................ 32
4.5.2 Breusch - Pagan Lagrangian Multiplier Test ............................................................................. 32
4.6.3 Chow Test or F Test ............................................................................................................. 33
4.7 Panel Data Model Selection ........................................................................................................ 34
4.8 Pooled OLS Regression analysis ................................................................................................. 34
Model 1: Pooled OLS, using 340 observations .................................................................................. 35
4.9 conclusion of data analysis .......................................................................................................... 36
CHAPTER FIVE .......................................................................................................................... 37
5.0 Discussion of Findings ............................................................................................................ 37
5.4 Overall Summary of Pooled OLS regression model ................................................................. 40
5.5 Summary of findings ............................................................................................................... 40
CHAPTER SIX .................................................................................................................................... 42
6.0 Recommendation and Conclusion ................................................................................................... 42
6.1 Conclusion.................................................................................................................................. 42
6.2 Limitation and recommendation for future research ..................................................................... 43
References............................................................................................................................................ 45
Bibliography ........................................................................................................................................ 49
Appendices........................................................................................................................................... 50
Appendix A ...................................................................................................................................... 50
Appendix B ...................................................................................................................................... 51
ix
LIST OF TABLES
TABLE 1 LIST OF HYPOTHESES ............................................................................................................................. 21

TABLE 2 FINAL SAMPLE SIZE ................................................................................................................................ 25
TABLE 3 STATISTICAL METHOD USED BY PREVIOUS RESEARCHERS ......................................................................... 26
TABLE 4 EXPLANATORY VARIABLES- DUMMY ...................................................................................................... 28
TABLE 5 DESCRIPTIVE STATISTICS ........................................................................................................................ 29
TABLE 6 CORRELATION MATRIX .......................................................................................................................... 31
TABLE 7 HAUSMAN TEST STATISTIC ..................................................................................................................... 32
TABLE 8 BREUSCH-PAGAN LAGRANGE MULTIPLIER TEST ...................................................................................... 33
TABLE 9 CHOW TEST ........................................................................................................................................... 33
TABLE 10 TESTS APPLIED TO PANEL DATA ............................................................................................................ 34
TABLE 11 POOLED OLS REGRESSION ANALYSIS ................................................................................................... 35
TABLE 12 OVERALL MODEL SUMMARY ................................................................................................................ 40
TABLE 13 SUMMARY OF RESULTS ......................................................................................................................... 41
TABLE 14 DIFFERENT TEST OF NORMALITY ........................................................................................................... 50
TABLE 15 VARIANCE INFLATION FACTORS............................................................................................................ 50
TABLE 16 LM TEST (WHITE'S TEST) ....................................................................................................................... 51
LIST OF FIGURES
FIGURE 1: CONCEPTUAL FRAMEWORK .................................................................................................................. 20

FIGURE 2 SAMPLE OF COMPANIES IN THE CSE ....................................................................................................... 24
FIGURE 3 STATISTICS SUMMARY .......................................................................................................................... 30
x
CHAPTER ONE
1.0 Introduction
1.1 Introduction
Maintaining consistent high financial performance is a target for each company doing business.
Financial managers involve daily operation to maximize its corporate profitability by managing
all its existing resources in an efficient and effective manner. Various academics, professional
and researchers argued that profit could maximize only by minimizing risks associated with
working capital management components and its policies. Past millennia, there are thousands of
researches undertaken in working capital management and corporate performance field.
Presently, majority researchers in accounting and finance major, show interested to observe the
relationship between aggressive working capital policy and corporate profitability.
1.2 Background of the study
In corporate finance, working capital management is a crucial component and companies need
to have an adequate level working capital to run business smoothly. Working capital
management is a significant aspect for a successful business.
Working capital management means a company ability to finance its short-term current assets
and current liabilities. It has an important role in a business. Several researches conduct on the
working capital management and named some base papers such as Deloof, (2003), Raheman &
Nasr, (2007), Afza & Nazir, (2009) and so on. Mostly, all these studies examine the relationship
between working capital management and profitability. Various research findings revealed that
working capital management and corporate profitability have a positive relationship while others
1
argued it has a negative relationship. Some studies results showed no significant relationship
exist between them.
An aggressive working capital policy influences corporate profitability evident from the
previous research studies conducted in the other countries such as Pakistan, Nigeria, Kenya and
Iran. The degree of aggressiveness of working capital in an investment policy depends on firms
plan to heavy investment on long-term fixed assets rather than short-term current assets. The
requirement of current assets is an essential to maintain at certain level, especially liquid assets
that can easily converted into cash, to pay off its short-term obligation. An early payment
prevents and reduces the possible risk of financial distress. Thus, different working capital
policies have an influence on corporate profitability and liquidity too.
On the other hand, there are few researches conducted in the Sri Lankan so far regarding
aggressive working capital policy. Recently, Perera&Wickremasinghe,(2010),
Bei&Wijewardana,(2012), Pirashanthini et al.,(2013), Bandara&Weerakoon,(2011), and
Lingesiya & Nalini,(2011) did research on the working capital policies. However, except two,
other studies just narrow down their study area into randomly selected one sector in Colombo
Stock Exchange. Listed companies in Colombo Stock Exchange contribute sufficient inputs for
the development of Sri Lankan economy, thus, it is extremely useful to investigate impacts of
using aggressive working capital policy on corporate profitability.
1.3 Research Question
How does working capital policy affect corporate profitability in the listed companies of
Colombo Stock Exchange?
1.4 Problem Statement
Does an aggressive working capital policy affect the corporate profitability? How does this
policy affected to the financial distress?
2
1.5 Problem Justification
Working capital management is a serious problem and issue that companies facing in daily
operation. An effective working capital policy plays a vital part in a business irrespective of a
firm size. Whether company is small-medium enterprise or listed company or, private sole
enterprise, having adequate level of working capital is essential to run business efficiently.
If a company able to make a profit and compete with other rivals in the competitive market
referred as operationally efficient firms. Nevertheless, in a certain situation if firms have less
current assets and stills adopting aggressive working capital policy, it may be possible chances
to face liquidity issues. Hence, this significant phenomenon looks forward into firms possible
future. Hence, it is essential to evaluate the effectiveness of aggressive working capital policy on
corporate profitability.
Heavy investment on current assets rather than fixed assets may create some consequences.
Potential benefits that a firm could earn from fixed assets and creating more shareholders wealth
becomes an opportunity cost for some companies. On the other hand, if a firm invest more on
fixed assets by ignoring its short-term capital requirements, it may face possible bankruptcy or
financial distress issues due to lack of funds needed to operating business. Consequently,
working capital policies have trade-off between profitability and risks. Thus, an effective
working capital policy is useful for a successful business.
1.6 Objectives of the study
The purpose of the study is to examine an aggressive working capital policy impact on corporate
profitability for listed companies in the Colombo Stock Exchange for the period of 2009-2013.
The specific of objectives of the study are as follows:
To determine the impact of aggressive working capital policies on corporate profitability

of listed companies in Colombo Stock Exchange,
3
To predict the organizational financial distress by using aggressive working capital
policies and,
To find out, effectiveness of aggressive working capital policy
1.7 Significance of the study
Managers: Managers involve in day-to-day operation of business that involved working capital.
Hence, managers can evaluate required firms optimal level of working capital and impacts on
firms performance if this required level reduces or increases. They can also identify the best
working capital policy for a business to maximize its profits. Particularly this study helps them
to know driving forces of working capital management and its policies. In addition, they may
also able to recognize its influence on corporate profitability.
Financial institutions: These parties can acquire companys financial stand easily and may able
to identify healthy companies to invest. This study gives an indication to these that if companies
adopting particular working capital policies they may be to earn profit better or not.
Shareholders: Moreover, before investing in a company, it is important to know whether

company will be profitable in the future or not. This study facilitates them to understand how
profitability and firm value affected due to the working capital policy. A recent study of working
capital management revealed that working capital policy is significant to maximize the
shareholders wealth. In addition, some studies have stressed that investors give more weight to
buy shares of those companies who create more value for them. Lastly, this study adds further
knowledge to the existence empirical researching finding on the working capital management
and its policies in the Sri Lankan context.
1.8 Scope of the study
The sample data obtained for this research covers only listed companies in the Colombo Stock
Exchange over five years, during 2009-2013. Therefore, it may not reflect the companys entire
4
performance in managing their working capital policies. The research data collects for five years
period as a result this study may be indicative but not conclusive. New infant companies and
service sectors firms excluded from the target population. However, the sample size is
representative and can give an idea of generalization for the population. This study uses
secondary data available on published financial statements, so credibility criteria duly enforced.
Credibility of this research outlines in the Appendix B. However, this research does not reflect
any qualitative aspect such as skills of managers and CEO to improve the company performance
and solving working capital problems.
1.9 Conclusion
This chapter one highlights the study background and the research questions, problem statement,
objectives, scope and significance of the study. The next chapter, literature reviews evaluate
critically reviews of previous research studies conducted on the working capital management
and its policies.
5
CHAPTER TWO
2.0 Literature Review
2.1 Introduction
Working capital management, as part of financial and corporate management, shows a critical
part of a firms development and growth. It plays an important role in a financial performance
(Deloof, 2003). Due to this, several researchers and academics find interested to study the
impacts of working capital policy on profitability.
This literature reviews chapter split into major three sections. First section represents the
reviews of previous research studies on working capital management. Second section presents
the reviews of working capital policies. These reviews again divide into two sub-sections as
international context and local context. Lastly, in the third section pointed out the critical review
of researcher and conclude the chapter by selecting variables for the development of hypothesis
testing for present study based on the previous studies.
2.2 Working Capital Management Reviews
This section outlines working capital management literature reviews from both globally and
locally conducted researches. In International context section, outlines few that mostly cited base
papers in the working capital management whereas for local Sri Lankan context all the available
studies reviewed as this present current study focuses on the Sri Lankan companies. Thus, it is
important to outlines details of all previous working capital research conducted in Sri Lanka.
2.2.1 Working Capital Management- International Context
Deloof, (2003) carried out a sample of 1009 non-financial Belgium firms for a period of 1992-
1996 to study the impacts of working capital management on firms profitability. The study
6
found out a strong negative relationship between gross operating income and working capital
management. They discussed most of the firms in their sample size have a large amount of cash
and the way of financing this cash may have an impact on their profitability. Furthermore, the
study noted that managers in less profitable firms could create firm value if they reduce the
number of days in account receivable and minimize the number of days in inventory conversion
period to sales. In addition, study also reported that less profitable firm waits longer to settle
their due payment to creditors.
Raheman & Nasr, (2007) in their research study regarding working capital management and
profitability of 94 selected listed firms in Karachi Stock Exchange, Pakistan showed a negative
relationship between working capital management and its profitability. Further, the study
explained that by reducing days in cash conversion cycle, increases profitability and creates
more positive value for firms and its shareholders.
Mathuva, (2010) examined working capital management and corporate profitability for 30 listed
firms on the Nairobi Stock Exchange, Kenya. The study found that most profitable firms took
less time to collect cash from its customers. Moreover, study commented that if firms delayed
payment to its creditors, the more profitable firm becomes. This study finding is also in line with
Raheman & Nasr, (2007).
Banos-Caballero et al., (2014) had an attempt to examine working capital management through
the net trade cycle with net operating profit using descriptive statistics. Finding of the study
explained that an optimal level of working capital ensured higher profitability due to higher
sales and discount given on early payments and it has a positive effect on firms performance.
However, if required level of working capital exceeds the optimum level, firms opportunity cost
and financing constraints starts. This study also revealed that firm can increase its performance
by reducing the number of days in its account receivable.
Gill et al.,( 2010) had empirically examined the relationship between cash conversion cycle and
profitability on 88 listed companies in New York Stock Exchange from 2005 to 2007. Research
7
findings showed positive relationship existed between cash conversion cycle and profitability. It
means by increasing the days in cash conversion cycle firms can increase profitability.
Therefore, the study confirmed a positive relationship between the working capital management
components and profitability of listed firms in New York Stock Exchange.
2.2.2 Working Capital Management- Sri Lankan Context
Perera & Wickremasinghe, (2010) focused to investigate working capital practice management
of manufacturing sector firms listed and unlisted in Sri Lanka. Research sample comprises of
thirty listed companies and ten unlisted companies for five years from 2008-2012. The sample
data gathered through a survey questionnaire and interviews among chief financial officers and
managing directors. The study discovered that majority firms in the manufacturing sector used
an informal working capital management. Finance managers are responsible to manage working
capital components while managing directors formulate working capital policies on ad-hoc
basis. The results showed that normally firms used cash budgets and current ratio as technique to
manage working capital. Furthermore, chi-square result confirmed no significance relationship
between specific working capital policy and its profitability.
Ajanthan, (2013) examined working capital management and profitability of firms in three
sectors in Colombo Stock Exchange (manufacturing, beverage, food and tobacco and chemicals
and pharmaceutical companies) for five years from 2007-2011. The study disclosed no
significant relationship between working capital management and profitability.
Niresh, (2012) investigated working capital management and financial performance of 30

selected manufacturing companies in Colombo Stock Exchange from 2008-2011. This study
findings also found no significant relationship exist between working capital management and
its policies on profitability. This study results are similar with study finding of Ajanthan, (2013).
Ramesh & Balaputhiran, (2013) studied the relationship between working capital management
and profitability for 17 manufacturing companies listed in Colombo Stock Exchange from 2006-
8
2010. Pearson correlation analysis result found a statistically significant moderate positive
relationship between inventory turnover in days and cash conversion cycle with net profit.
Nevertheless, it also indicated a weak negative relationship between current ratio, creditors
payment period and debtors payment period with net profit. Furthermore, the study discussed
improper management of working capital and allocating cash more than enough cash makes
firms inefficient and reduces benefits of short-term investment.
Yogendrarajah & Thanabalasingam, (2014) examined selected nine listed trading firms in
Colombo Stock Exchange using SPSS software for five years from 2004 to 2009 to find out
working capital management influence on financial performance. The study findings proved a
negative relationship between return on assets and inventory turnover and cash conversion cycle.
2.3 Working Capital Policies Reviews
This section focus on literature reviews of aggressive working capital policies on corporate
profitability. There are various literatures on working capital policy globally conducted but few
research studies conducted on this area in the Sri Lankan.
2.3.1 Working capital policy-International context
Weinraub & Sue Visscher, (1998) had empirically investigated to find out industry differences
in working capital investment and financing practices on ten different cross-section over ten
years period. The regression analysis used to examine the relationship between working capital
policies and industries financial performances showed different no statistical significance but
there is a positive relationship between theses working capital practices across industries and its
performance.
Oloo & Mwangi, (2014) analysed information related to the aggressive financing working
capital policy for 38 listed companies in Nairobi Securities Exchange in Kenya. In this study,
study used both primary and secondary data by using statistical software SPSS version 2.1 and
9
showed a positive effect on profitability. Therefore, study recommended companies should
further enhance their aggressive financing policy to improve their profitability.
Khaksarian,( 2014) investigated working capital policies with profitability measured through
return on assets and tobins q. This study results showed that aggressive working capital policy
has a negative relationship with profitability. The study also confirmed that an increase in
aggressive investment policy resulting a decrease in return on assets.
Valahzaghard et al., (2013) had empirically investigated working capital policies in different
view by take into account the industry along with firm financial performance. However, the
study results concluded aggressive investment policy and tobins q has no statistical significant
relationship.
Usman et al., (2014) have randomly selected a sample of 32 listed firms in manufacturing
industry in Karachi Stock Exchange, Pakistan for five years from 2006-2010 to study the
impacts of working capital management and its policies on corporate profitability. By running
panel data regression model showed a negative relationship between working capital
management (cash conversion cycle) and profitability (return on assets) for all except for the
chemical firms. This result contradicts with Gill et al., (2010) who found a positive relationship
between working capital management and profitability.
Reddy, (2013) evaluated aggressive working capital policys impact on profitability of Indian
companies during 2007-2011. Panel regression result found a negative impact on profitability.
Further, study highlighted firms can improve profitability by adopting more conservative
working capital policies and noted that if companies follows more aggressive working capital
policy there is a greater chance of financial distress occurrence and may lead to bankruptcy if the
managers couldnt manage its current assets and liabilities properly.
Afza & Nazir, (2007) have also studied the relationship between working capital policies and
profitability. This study tested aggressive investment and financing policy for 17 industrial
10
groups of public limited companies listed on Karachi Stock Exchange from 1998-2003. The
findings showed a negative relationship between return on assets and aggressive investment and
financing policy. However, this result indicated that industries that follow an aggressive
investment policy also follow an aggressive financing policy.
Nazir & Afza, (2009) once again did the research on impact of aggressive working capital
management policies on firms profitability with additional market measures of profitability as
tobins q. In this study, sample data included only the non-financial listed companies in Karachi
Stock Exchange during 1998-2005. The sample data included consistent companies in the
business and eliminated all the negative equity firms, and new firms and any firms delisted
during this period. This research study comprises 204 non-financial companies over 17
industrial sectors. The panel data regression showed that there is a negative relationship between
aggressive investment policy and return on assets and tobins q. However, study findings found
a positive relationship between tobins q and aggressive financing policy. Thus, this study
concluded that investors give more weight to those companies who follow aggressive financing
approach to manage its current liabilities (Nazir & Afza, 2009, p.19).
Al-Shubiri, (2010) also investigated relationship between aggressive investment and financing
policy for 59 industrial listed companies in Aman Stock Exchange during the period of 2004-
2007. An impact of working capital policies on firms profitability measured through cross-
sectional regression model. The result showed a negative relationship between working capital
policies and profitability. The study noted that firm makes a negative return if they follow
aggressive investment policy and aggressive financing policy to manage its working capital.
Nyabuti & Alala, (2014) have investigated aggressive investment and financing working capital
policys influence on return on assets of listed companies in Nairobi Securities Exchange in
Kenya. The study finding shows a negative relationship between aggressive investment and
financing working capital policy and return on assets.
11
Javid & Marie Zita,( 2014) investigated the working capital policies and corporate performance
for 20 companies in cement sector in Pakistan. Their study result showed when increasing
aggressive investment policy ratio, the aggressiveness decreases, and return on assets, net profit
margin and return on equity and tobins q reduces. This research study stressed that adopting
aggressive working capital policy; firms cannot make more profit and creates firm value.
Furthermore, the study revealed that managers could not increase return on assets based on
book-value performance if they follow aggressive working capital policy. This study result is
similar with previous studies conducted by Afza & Nazir, (2007), Padachi, (2006) and Raheman
& Nasr, (2007)
Palani & Mohideen, (2012) has studied aggressive working capital policys impact on firm
profitability of 204 Indian firms listed in Bombay Stock Exchange during 2002-2010 for 16
different industrial groups. The study tested its relationship with take into economic condition
represented as gross domestic per capita as a control variable. Panel data regression analysed
using E-view software and results showed a negative relationship between aggressive
investment and financing policy and return on assets.
Amiri (2014) also reported relationship between working capital policies and profitability for 93
firms for five years through applying systematic elimination of companies not related to
financial sector. The study used E-view software to do data analysis and showed no significant
relationship between aggressive investment and financing policy and return on assets.
Hassani & Tavosi, (2014) surveyed the effects of working capital policies on liquidity for
companies listed in Tehran Stock Exchange for a period of 2006-2012. However, the study
noted that companies used aggressive working capital policies, risk level of firms increases.
Therefore, the study concluded an aggressive investment and financing policy had a negative
relationship with liquidity.
12
2.3.2 Working Capital Policies-Sri Lankan Context
Pandey and Perera (1977), empirically investigated working capital policies effect on corporate
profitability. The study focused on the private manufacturing companies listed in Colombo
Stock Exchange and found that most of the companies in Sri Lanka follow informal working
capital policies (cited in Pirashanthini et al., 2013).
Bei & Wijewardana, (2012) conducted an empirical research to investigate working capital
policies impact on firm performance of listed companies in Colombo Stock Exchange, Sri Lanka
during 2002-2009. This study identified main three working capital policies as aggressive,
conservative, matching, and used multiple-regression analysis to test factors that influence on
working capital policies and profitability. The study proved that different types of working
capital policies affects differently for firm efficiency, liquidity and profitability of a company.
Pirashanthini et al., (2013) analyzed the relationship between aggressive working capital policies
on profitability for twenty randomly selected companies in manufacturing sector listed in
Colombo Stock Exchange from 2008-2012. The study used secondary data for correlation and
regression analysis to measure the impacts of working capital policies on firms profitability.
From the study, results showed a R2 of 0.132. However, no variables are statistically significant
at significant level 5% and study concluded no significant relationship exist between aggressive
investment and financing policy with return on assets.
Bandara & Weerakoon, (2011) empirically studied impacts of working capital management
practices on firm value for seven different sectors of companies listed in Colombo Stock
Exchange consisting 74 companies for a 5 years period from 2005-2009. The study identified
working capital practices into three different types as aggressive, moderate and conservative
approach and used as independent variables and firm value measured through market value
added and economic value added used as a dependent variables. The panel data regression
employed to test the relationship and result showed mix results for different working capital
approaches. The study conclude that firms following moderate working capital approach may
13
able to improve firms value by resulting higher economic value added and market value added
of firms in Sri Lanka.
Lingesiya & Nalini, (2011) had an attempt to study the relationship working capital management
and its policies with profitability for 30 manufacturing firms listed in Colombo Stock Exchange
for a period of 2006-2010. Their study result reported a negative relationship between working
capital management and its policies and profitability. The study used pooled OLS regression
analysis and showed significant p-value for aggressive investment and financing policy and debt
ratio, as 0.0020, 0.0603 and 0.0260 respectively. In addition, study stressed that companies can
further enhanced its profitability if they manage working capital policies properly.
Subramaniam & Anandasayanan, (2011) studied aggressive working capital policies and
conservative working capital policy impact on profitability for 70 listed firms from 16 sectors in
Colombo Stock Exchange during 2003-2009. This study used aggressive investment and
financing policy as explanatory variables to measure the aggressive working capital policies.
While, profitability measured through return on equity, return on assets, and size of the firms,
sales growth and firm leverage as control variables. Using STATA Software, run regression
model and result found a negative relationship between working capital policies and
profitability. Addition, study pointed out that investors believe firms with less equity and long-
term debt may able to create value for them and earn high profit.
Murugesu, (2013) indicated aggressive investment working capital policy has a negative impact
on manufacturing companys profitability in Colombo Stock Exchange. The study selected 20
manufacturing firms using random sampling method for over five years from 2008-2012. The
study used three dependent variables (return on equity, return on assets and tobins q) to
measure profitability. An aggressive investment and financing policies are taken to measure the
aggressiveness of working capital policies. Correlation matrix and regression analysis used to
investigate the existing relationship between aggressive working capital policies and
profitability. The findings of the study showed no significant impact on aggressive investment
policy.
14
2.4 Critical Reviews and Conclusion and Variables Selection
2.4.1 Researchers Critical Review
Based on the above literatures, most of the studies found a negative relationship between
working capital policies and financial performance. All above studies confirmed for an existing
relationship between working capital policies and financial performance. Some studies findings
showed working capital policies have strong impacts on profitability. However, all these
researches prove the degree of aggressiveness varies from one study to another. This variation
arisen may be due to several reasons such as resource constraints, variation in data sample and
so on. Several studies confirmed that if a firm follow an aggressive investment policy also
follows an aggressive financing policy.
Working capital policy and business itself have some characteristics related. Researcher
observes few studies mentioned the reasons behind the selected samples and reason for
systematic elimination of companys nature of business. Further, it is very evident that different
researchers used different financial performance measurement to calculate profitability. Some
literatures used return on assets, return on equity, net profit margin, gross profit margin and net
operating income. However, more than 80% of the above research studies used return on assets
as profitability measures as it shows actual firms return in relation to all its resources employed.
Based on research studies carried out in Sri Lanka, especially for the same sector anylsis, some
researchers have found no significant relationship between working capital management and
profitability. Likewise, Ajanthan, (2013) Niresh, (2012) Pirashanthini et al., (2013) and Ramesh
& Balaputhiran, (2013), conduct research on manufacturing sector companies listed in Colombo
Stock Exchange. However, except later all other studies found no significant relationship
between working capital management and profitability. The later study results found a negative
relationship exists between working capital management and profitability of the manufacturing
companies in Colombo Stock Exchange. This may be possible due to the different statistical
15
analysis of data, however it contradicts with credibility criteria for mentioned by (Saunders et
al., 2009).
2.4.2 Variables Selection
Based on above literature reviews, majority studies use aggressive working capital policies and
take into account two variables as independent variables to measure aggressiveness working
capital polices. They are total current to total assets (AIP) and total current liabilities to total
assets (AFP). There are various ratios to measure profitability. Nevertheless, most studies use
return on assets (ROA), return on equity (ROE), and tobins q and therefore for this study
researcher choose return on assets (ROA) to measure corporate profitability. Following are the
formulae to calculate the variables as used in previous studies and current study followed same
method to calculate the ratios.
Total Current Assets(TCA)

AIP = 100%
Total Assets (TA)
If AIP ratio is high, means company following a conservative investing policy and if it is low
means, company is adopting aggressive investing policy. It interprets to mean that company has
fewer liquid assets compared to long-term fixed assets. Whereas in conservative investment
policy company have, more liquid assets compared to fixed assets. The positive beta coefficient
of this ratio means aggressive investment policy and it will have negative impact on the
corporate profitability. The negative beta-coefficient of this ratio shows conservative investment
policy and it will positively affect corporate profitability.
Total Current Liabilities

AFP = (TCL) 100%
Total Assets (TA)
If AFP ratio is higher, it means company is following an aggressive financing policy. This
means company is maintaining high current liabilities than long-term debt. Whereas, low ratio
indicates that company is adopting a conservative financing policy. Therefore, positive beta -
16
coefficient indicates aggressive financing policy have positive impact on profitability while
negative beta-coefficient specifies conservative policy and have negative impact on profitability.
Operating Profit before

ROA = income & tax 100%
Total Assets (TA)
In all previous research, researchers have put the same assumption based on the beta coefficient
of these variables.
2.4.3 Conclusion of Literature Reviews
It is necessary to point out that above-mentioned reviews taken from various sources such as
research paper developed around the world. Source of information mainly includes published
sources such as journals. In over all, numerous working capital management and its policies
research studies carried out for the developing regions in South Asian compared to the other
regions in the World. Still fewer studies conducted to show a practical approach of working
capital policies in a qualitative research aspect. Kieschnick & LaPlante, (2012) had an attempt
to study the working capital management and shareholders wealth in United States of American
companies in a practical approach. Mostly, all the studies reviewed in the above are based on the
secondary data.
From the reviews of previous studies are evident that there is clear link between working capital
policies and profitability. From the previous studies it is obvious that majority of the research
studies found similar results. Majority researchers identified that there is a negative relationship
between aggressive working capital policies and firms profitability. It means most of the
profitable firm do not follow aggressive working capital policy rather they follow a conservative
or moderate working capital policy to manage its-short-term liabilities and assets. Further, total
debt ratio is also affecting profitability of the company. However, there are also studies found
positive relationship exist between working capital policy and profitability like Weinraub & Sue
Visscher, (1998), Gill et al., (2010) and Yogendrarajah & Thanabalasingam, (2014).
17
The above-mentioned studies carried out with different size of samples data size, time-periods,
in different countries for different sectors or industries and they are distinctively varied from to
one another. In addition, researcher would like to note that very few researches conducted so far,
for the Sri Lankan context covering companies from all the sectors in Colombo Stock Exchange
and all above studies conducted are outdated to represent current financial performance analysis
in Sri Lankan companies.
Hence, this study focuses on the recent data published covering five years period from 2009-
2013 and it will give more current situation to show impact of aggressive working capital
policies on corporate profitability. Therefore, this study will investigate impact of working
capital policies on profitability for listed companies in Colombo Stock Exchange. Research
Methodology is outlined in the next chapter three.
18
CHAPTER THREE
3.0 Research Methodology
3.1 Introduction
This chapter explains the framework of the research study. It includes the research design, total
population and sample size taken and statistical method plan to use for data analysis.
3.2 Conceptual Framework
Conceptual framework show overall picture of research under taken in this study as a guide, to
test the relationship between independent and dependent variables. Based on previous,
literatures this conceptualization is formulated. Dependent variable is corporate profitability
measured through return on assets ratio as this ratio indicates how well company used its total
assets to generate profit. Independent variables are aggressive investment and financing working
capital policies. These two policies indicated degree of aggressiveness of working capital
policies measured through ratios total current assets to total assets and total current liabilities to
the total assets respectively.
19
3.2.1 Illustration of Conceptual Framework
Independent Variables Dependent Variables
Working capital policies Corporate Profitability
AIP (TCA/TA) ROA (EBIT/TA)
AFP (TCL/TA)
Aggressive financing policy
(AFP)
Control Variable
Debt ratio
DR (TL/TA)
Figure 1: Conceptual framework
Source: Authors own work, (2015)
20
3.3 List of Hypotheses
Table 1 List of Hypotheses
H01: There is no relationship between aggressive investment

policy and return on assets of the selected listed companies in
Colombo Stock Exchange
Hypothesis 01
Ha1:There is a relationship between aggressive investment policy

and return on assets of the selected listed companies in Colombo
Stock Exchange
H02:There is no relationship between aggressive financing policy

Stock Exchange
Hypothesis 02
Ha2:There is a relationship between aggressive financing policy

Stock Exchange
H03: There is no impact between debt used by the listed

companies in Colombo Stock Exchange and its profitability
Hypothesis 03
Ha3: There is a impact between debt used by the listed companies

in Colombo Stock Exchange and its profitability
21
3.4 Population and target population
The population of the study is listed companies in Colombo Stock Exchange. According to
Colombo Stock Exchange Web site, (2015) there are 292 listed companies since year 1990 to
2014 which covers 20 sectors. However, excluding service sector companies and other
inappropriate companies with unavailable data and new companies, target population becomes
162 listed companies that cover 12 sectors.
3.5 Sample size
The target population of 162 listed companies, taken sample size is 114 companies, which
covers 12 business sectors by Anderson sampling table at 95% significant level. However, due
to the negative ratio figures data, further some companies eliminated from the sample data
sample and final sample size is 68 companies consisting nine sectors for five years period from
2009-2013.
3.5.1 Research design
This study is a quantitative research by using deductive approach. Hypothesis testing of this
study investigates through regression analysis study with minimal interference for selected listed
companies. A cross-sectional study may undertake, as it is easy and less time consuming. In
such study, data gathers just once to answer the research questions (Sekaran & Bougie, 2010).
3.5.2 Data collection method
The secondary data is collected using financial statements of companies and other available
sources in Colombo Stock Exchange Web site.
22
3.5.3 Sampling method
The probability distribution of stratified sampling technique will use for this study to avoid
biasness. Furthermore, Saunders et al., (2009) analyze a decision tree to decide sampling
method. Therefore, sample size covers 41% of the target population; sample data representation
may help to give unbiased generalisation.
23
Trading (7/162)*114= 5
3.5.4 Illustration of the sample
Manufacturing (33/162)*114=24
Stores and supplies (4/162)*114= 3
Population 292
Motors (6/162)*114= 4
Target
population
Plantations (18/162)*114=13
162
Sample
Land & property (19/162)*114= 13
114
Hotels& Travels (30/162)*114= 21
Chemicals & Pharmaceuticals (9/162)*114= 6
Beverage food & Tobacco (19/162)*114= 13
Footwear& Textile (3/162)*114= 2
Figure 2 Sample of companies in the CSE

Construction & Engineering (3/162)*114= 2
Source: Colombo Stock Exchange, CSE, (2015)
Diversified Holdings (11/162)*114= 8
24
As seen above figure 2, sample size is 114 companies from 12 sectors in Colombo Stock
Exchange. Nevertheless, due to the negative ratio figures, the sample data reduced further. In
previous studies, researchers also eliminated negative data before the actual process of data
analysis. Therefore, in this study, after careful elimination of negative ratio figures, sample size
reduces to total 68 companies consisting nine sectors of Colombo Stock Exchange. The
following table shows details frequency of recent sample size taken for final data analysis. In
addition, researcher would like to mention that after reduction of negative ratio figures three
sectors (food and textile, construction, engineering and chemical, and pharmaceuticals) left just
one company to represent the sector. Therefore, due to small size for entire sector representation,
these three sectors eliminated from sample to avoid replication error of data with other sectors.
Table 2 Final sample size
# Sectors Five years observation # companies

1 Manufacturing 75 15
2 Beverage Food and Tobacco 50 10
3 Diversified Holding 30 6
4 Hotels and Travels 45 9
5 Land and Property 30 6
6 Plantations 55 11
7 Trading 20 4
8 Motors 20 4
9 Stores and Supplies 15 3
Total observations 340 68
Source: Authors own work (2015)
25
3.6 Proposed statistical method
3.6. 1 Statistical method used by previous research studies
Table 3 Statistical method used by previous researchers
Authors Title Variables Method
Oloo& Effect of Aggressive Financing Independent Variable: descriptive

Mwangi, Policy on Profitability of listed Aggressive Financing statistics,
(2014) Companies at the Nairobi Policy regression
Securities Exchange, Kenya analysis
Dependent Variable:
Gross Operating Profit

Regression and
Pirashanthini Working Capital Approaches and Independent variables: correlation
et al., ( 2013) Firms Profitability of
manufacturing companies in Sri Aggressive Investment
Lanka Policy and Aggressive
Financing Policy
Dependent variables:
Return on assets, Return on
Equity
Nazir & Impact of Aggressive Working Independent Variables: regression
Afza, (2009) Capital Management Policy on Aggressive Investment analysis
Firms Profitability Policy and Aggressive
Financing Policy
Dependent Variables:
Return on Assets and
Tobins Q
Control Variables: Size,
Growth and Debt
ratio(Leverage)
26
Al-Shubiri,
(2010) Analysis of the relationship Independent Variables: AIP regression
between working capital policy and AFP analysis
and operating risk: an empirical
study on Jordanian industrial Dependent Variables:
companies
ROA, ROE and Tobins Q
T. Afza and Is it better to be aggressive or Independent Variables: cross-sectional

M. S. Nazir conservative in managing working Aggressive financing regression
(2009) capital? policy, aggressive model
investment policy
Dependent Variables:
Return on assets, return on
equity
Khaksarian, A study on the effect of working Independent variables: regression
(2014) capital management on AIP and AFP model
profitability on Cement and Dependent Variables:
Petrochemical industries: Evidence Return on Assets and
from Tehran Stock Exchange Tobins Q
Growth and Debt ratio
(Leverage)
Javid & Impact of Working Capital Policy Independent Variable: panel data
Marie Zita, on Firms Profitability: AIP regression
(2014) A Case of Pakistan Cement Dependent Variables: ROA, analysis
Industry ROE, NPM, and Tobins Q
Growth and Leverage(Debt
Ratio)
Source: Authors own work based on the previous research studies evaluated in the report,(2015)
3.7 Conclusion of Research Methodology
In reference to above table 3, shows main base papers of previous research studies directly
related to the variables selected in the conceptual framework. Consequently, present study
mainly focuses regression analysis to test their hypothesis. Therefore, author intends to use
regression model to test hypothesis using Gretl version gretlw32.exe. In the next chapter four,
outlines the data analysis.
27
CHAPTER FOUR
4.0 Data Analysis
4.1 Introduction
The study data analysis consists of five years data for 68 companies. Therefore, researcher used
panel data that includes data from year 2009 to 2013 covering of nine different sectors of
Colombo Stock Exchange. Hence, multiple panel regression analysis conducted using Gretl
version gretlw32.exe, to find out the impact of aggressive working capital policy on firms
corporate profitability. This study used dummy variables to distinguish between the aggressive
and conservative working capital policies. D11 used for Aggressive working capital while D22
represents the conservative working capital policies. It is as follows:
Table 4 Explanatory Variables- Dummy
Dummy Variables for aggressive working capital policies

Explanatory Variables D1 D2
AIP 0 1
AFP 1 0
DR 1 0
1
D1: TCA/TA is less than 50 % means aggressive investment policy, TCL/TA is higher than 50% means aggrieve
financing policy. Debt ratio (DR) also categorized as high and low leverage. As most previous research stated that
AFP policy associated with high leverage ratio (Deloof, 2003) D1 follows higher DR ratio which is higher than
50%.
2
D2: represent conservative working policy. AIP is more than 50%, AFP less than 50% and DR is less than 50%.
28
4.2 Basic Assumption Tests
According to Berry, (1993) it is necessary to perform essential assumption tests before running a
regression analysis. This basic assumption tests run to check research data is good for the
model. The results of normality, multicollinearity, and heteroskedasticity tests are shown in
Appendix A.
In this study, normality test (table 14) confirms using three different, Jarque-Bera, Doornik-
Hansen and Shapiro-Wilk test. The significance level of these tests (p-values) is very small. This
indicates that residuals are not normally distributed. Although referring to the large number of
observations and central limit theorem, this assumption can ignore normality of the residuals
(Hassani & Tavosi, 2014, p.34). In referring to Appendix A, table 15 showed there is no
multicollinearity in the variation inflation factor. In addition, Durbin-Watson shows 1.558067;
means there is no auto-correlation problem of residuals in the model. Whites test (LM test) for
heteroskedasticity (Appendix A table16,) shows residuals are homogenous as p-value (0.0709) is
more than 0.05.
4.3 Descriptive Statistics
Table 5 Descriptive Statistics
Variable Mean Median Minimum Maximum
ROA 13.8899 10.2000 0.0700000 125.020

AIP 0.691176 1.00000 0.000000 1.00000
AFP 0.135294 0.000000 0.000000 1.00000
DR 28.5816 24.0000 0.110000 87.2700
Variable Std. Dev. C.V. Skewness Ex. kurtosis
ROA 15.1977 1.09416 3.39227 14.7372
AIP 0.462689 0.669423 -0.827589 -1.31510
AFP 0.342542 2.53183 2.13255 2.54777
DR 20.3282 0.711234 0.469779 -0.751689
29
140
120
100
80 ROA
AIP
60
AFP
40 DR
20
0
Mean Median Minimum Maximum
Figure 3 Statistics Summary
Descriptive statistics use to analyze the data to categorize the main characteristics outlining their
variability i.e. mean, standard deviation, minimum and maximum. Above table 5 presents
descriptive statistics of all variables used in data analysis for all 68 firms in Colombo Stock
Exchange. Return on assets, aggressive investment and financing policy and debt ratio all have
a positive mean value, which ranges from a low of 13.8899 to 28.5816. Standard deviation for
the variables of return on assets, aggressive investment policy, aggressive financing policy, and
debt ratio are 15.1977, 0.4626, 0.3425, and 0.20.33 respectively. The maximum standard
deviation is for debt ratio, the lowest standard deviation is for return on assets. The maximum
value is 125.020 for return on assets and lowest 87.2700 for debt ratio. The minimum value for
return on assets and lowest value for debt ratio are 0.0700000, and 0.110000 respectively.
30
4.4 Correlation Matrix
Correlation matrix is an important test to check auto-correlation of the variables in the models.
Table 6 Correlation Matrix
Correlation coefficients, using the observations 1:1 - 68:5 5% critical value (two-tailed) =
0.1064 for n = 340
ROA AIP AFP DR

1.0000 -0.2127 0.2946 0.2425 ROA
1.0000 -0.2940 -0.4115 AIP
1.0000 0.2984 AFP
1.0000 DR
Table 6 indicates the correlation matrix of dependent and independent variables for the selected
companies in Colombo Stock Exchange 5 years from 2009 to 2012. Dependent variable return
on assets has a positive correlation with aggressive investment policy and debt ratio. However, it
has a negative correlation with aggressive financing policy. The result also indicates is no
problem of auto-correlation among selected variables. Most researchers considered presence of
auto-correlation if correlation is 0.70 or above (Sekaran & Bougie, 2010, p.352).
4.5 Panel Diagnostics

Panel diagnostics involve main three tests primarily run for panel data to suitable model
regression. It includes Hausman test, Bresuch-Pagan LM test and Chow test. Following are
results of these tests using Gretl version gretlw32.exe.
31
4.5.1 Hausman test
Hausman test involves main two tests; they are fixed effects and random effects. Fixed effect
model assumed firm specific intercept across sectors, which captures the effects of those
variable particular to that specific firm, and eliminate anything that is time invariant. Whereas,
random effect model just as opposite to it assumed that individual firm intercepts which varies
within the sectors and omitted variables effects are not fixed (Clark & Linzer, 2012). If p-value
is more than 0.05, random effect is desirable. If it is less than 0.05, than choice will be fixed
effect model. To test hypothesis to select which model is suitable as follows:
H0: Random effect is appropriate. H1: Fixed effect is appropriate

Table 7 Hausman Test Statistic
Hausman test statistic:

H = 7.30884 with p-value = prob(chi-square(3) > 7.30884) = 0.062679
(A low p-value counts against the null hypothesis that the random effects model is consistent, in
favor of the fixed effects model.)
Table 8 explains the results of the Hausman specification test. The p-value is 0.062679 which is
higher than 0.05. Based on Hausman Specification test rejected null hypothesis and accept
alternative. Therefore, it indicates that fixed effect is suitable for our data analysis.
4.5.2 Breusch - Pagan Lagrangian Multiplier Test
The Breusch-Pagan Lagrange multiplier (LM) test decides between random effect model and
pooled OLS regression. It gives details of major existing variation among units. In case of no
variation across sectors, pooled OLS regression is desirable than random effect model. (Clark &
Linzer, 2012).
32
Table 8 Breusch-Pagan Lagrange multiplier Test
H0 : The pooled OLS model is desirable, H1: random effects model is desirable
Breusch-Pagan test statistic:

LM = 0.00582474 with p-value = prob (chi-square(1) > 0.00582474) = 0.939165
(A low p-value counts against the null hypothesis that the pooled OLS model
is adequate, in favor of the random effects alternative.)
Table 9 shows the probability value of LM test is greater than 0.05 (P-value0.939165). Based on
p-value accept null hypothesis that indicates that pooled OLS model is better than random
effects model. It conclude that Pooled OLS regression model is suitable. This interprets to mean
that there are no differences of aggressive working capital policies adopted by different firms
among the sectors in Colombo Stock Exchange.
4.6.3 Chow Test or F Test
Chow test applies for the selection of fixed effect model and Pooled OLS Model. This gives
details of the model according to its nature of data. The hypothesis of the chow test is:
H0: The pooled OLS model is adequate H1: Fixed effect model is adequate.
Table 9 Chow Test
Augmented regression for Chow test

OLS, using 340 observations
Dependent variable: ROA
coefficient std. error t-ratio p-value
const 15.7021 3.32488 4.723 3.44e-06 ***
AIP -5.17719 2.56675 -2.017 0.0445 **
AFP 6.35117 3.28688 1.932 0.0542 *
DR 1.21019 3.58636 0.3374 0.736
33
splitdum 0.212154 4.76562 0.04452 0.9645
sd_AIP 1.95116 3.72599 0.5237 0.6009
sd_AFP 10.1288 5.00081 2.025 0.0436 **
sd_DR -3.75414 -3.75414 -0.7723 0.4405
Mean dependent var 13.88985 S.D. dependent var 15.19768
Sum squared resid 68809.61 S.E. of regression 14.39645
R-squared 0.12119 Adjusted R-squared 0.102661
F(7, 332) 6.54053 P-value(F) 3.04E-07
Log-likelihood -1385.165 Akaike criterion 2786.33
Schwarz criterion 2816.962 Hannan-Quinn 2798.536
Chow test for structural break at observation 34:5,F(4, 332) = 1.52626 with p-value 0.1941
The result of p-value in chow test (table 9) is 0.1941 that is greater than 0.05. Therefore, null
hypothesis of chow test accepted and reject the alternative. Thus, chow test suggest that Pooled
OLS model regression is suitable for our data set.
4.7 Panel Data Model Selection
Table 10 Tests applied to Panel data
Test Applied P-Value Model Selection
Hausman test 0.0958466 Random Effect

LM Test 0.939165 Pooled OLS
Chow Test 0.1938 Pooled OLS
Based on above table 10 concludes that majority test results showed that Pooled OLS regression
model is suitable for panel data analysis.
4.8 Pooled OLS Regression analysis
According to table 10, majority tests are in favour of Pooled OLS regression, therefore study
select Pooled OLS regression for all companies. The regression equation is as follows:
34
ROAit = 0 + 1 (AIP)it + 2 (AFP)it + 3 (DR)it + +eit
Where ROA is return on assets, AIP is aggressive investment policy, AFP is aggressive
financing policy, DR is debt ratio, e is error term.
Model 1: Pooled OLS, using 340 observations
Table 11 Pooled OLS Regression Analysis
Included 68 cross-sectional units

Time-series length = 5
Dependent variable: ROA
Coefficient Std. Error t-ratio p-value

const 16.4761 2.35887 6.9848 <0.00001 ***
AIP -4.24322 1.84893 -2.2950 0.02235 **
AFP 10.9187 2.47898 4.4045 0.00001 ***
DR -1.33485 2.4063 -0.5547 0.57945

F(3, 336) 13.14387 P-value(F) 3.90e-08
rho 0.044598 Durbin-Watson 1.558067
* Significant at 10% level, ** Significant at 5% level, *** Significant at 1% level
The results of pooled OLS Model revealed in the above table 11, showed aggressive investment
and financing policy were statistically significant at level 5% and 1% respectively. The p-value
of return on assets, aggressive investment policy, and aggressive financing policy are 0.00001,
35
0.02235, and 0.00001 respectively. The p-values of all variables show that are highly significant
except debt ratio (p-value=0.57945). The beta-coefficients of Pooled OLS regression indicate
that an aggressive investment and financing policy have positive impacts on corporate
profitability (return on assets) of selected listed companies in Colombo Stock Exchange.
4.9 conclusion of data analysis
Based on the basic assumption tests our study sample data set is fit to the ordinary linear model.
The residuals are not normally distributed. On the other hand, there is no problem of
hetereoskedasticity and multicollinearity (auto-correlation) in our data set. Based on panel
diagnostic, which includes Hausman, Breusch-Pagan and Chow test, majority test agreed that
pooled OLS regression method is suitable. The result of pooled OLS regression in table 11
showed a significance p-value with aggressive investment and financing policy and return on
assets. While, it shows that debt ratio is not statistically significant. The next chapter evaluate
the detailed discussion of these findings.
36
CHAPTER FIVE
5.0 Discussion of Findings
5.1 The first hypothesis:
There is a relationship between aggressive investment policies on return on assets
The results of Pooled OLS model in table 11 shows that aggressive investment policy has a
significant (P-value=02235) impacts on corporate profitability of selected listed companies in
Colombo Stock Exchange (=0.05). This can interpret as that when a company adopt more
aggressive investment policies, higher the chances of enhancing its profitability. Similarly
reducing aggressive investment policy may lower firms profitability. The negative beta-
coefficient (= -4.24322) of aggressive investment policy indicate a positive relationship existed
between aggressiveness working capital investment policies and return on assets (profitability).
This means as total current assets to total assets (AIP) decreases the level of aggressiveness
increase and firm return on assets decreases. Whereas, total current assets to total assets ratio
increases the aggressiveness decreases and increase the return on assets. Therefore, there is a
positive relationship between aggressive investment policy and return on assets of the selected
listed companies in Colombo Stock Exchange. It also means most of the Sri Lankan companies
listed in Colombo Stock Exchange improve its profitability by maintaining high liquid assets
compared to total assets.
This finding led to reject first null hypothesis and accept first alternative hypothesis. (Ha1: There
is a relationship between aggressive investment policy and return on assets of the selected listed
companies in Colombo Stock Exchange).
37
5.2 The Second Hypothesis:
There is a relationship between aggressive financing policies and return on assets
According to Pooled OLS regression results in the above table 11, aggressive financing policy
are significant (P-value= 0.00001) on corporate profitability of selected listed companies in
Colombo Stock Exchange (=0.01). The positive coefficient (=10.9187) indicates a positive
relationship between the aggressiveness financing policy and corporate profitability. This
indicates that when company adopt high level of aggressive financing policy, the level of
aggressiveness goes down and yields a negative return. This suggests that listed Sri Lankan
companies enhance it profitability by having low ratio of total current liabilities to total assets
(AFP). Further, this is an indication that profitable companies take longer days to pay the bills as
mentioned in the previous studies (Afza & Nazir, 2007). Conversely, some previously
researchers argued that taking too many days to settle the payment to creditors may deteriorate
the relationship between them and it brings a bad brand image to the company.
This finding led to reject second null hypothesis and accept second alternative hypothesis. (Ha2:
There is a relationship between aggressive financing policy and return on assets of the selected
listed companies in Colombo Stock Exchange).
5.3 The Third Hypothesis:
There is an impact between debt used by the listed companies in Colombo Stock Exchange and
its profitability
Based on results of pooled OLS regression model in table 11, control variable, debt ratio is not
significant at 5 % of significant level (p-value=0.57945). Even though it is not significant,
results indicates there is a positive relationship between debt ratio and return on assets. It is
consistent with the traditional risk theory of high risk and high return.
38
In previous empirical studies evaluated that financial distress increased when company follows
aggressive financing policy. Therefore, companies in Colombo Stock Exchange need careful
management on aggressive financing policy to reduce the level of financial distresses caused due
to increasing debt ratio along with high profitability. Managers need to understand the sufficient
and adequate level working capital requirement needed to run their day-to-day operation.
Previous researchers such as Deloof, (2003) noted this issue trade-off risk and return in their
study to avoid liquidity and bankruptcy problems.
This finding led to reject third alternative hypothesis and accept third null hypothesis. (Ho3:
There is no impact between debt used by the listed companies in Colombo Stock Exchange and
its profitability).
The present study results above discussed are similar and consistent with previous studies of of
Weinraub & Sue Visscher, (1998); Murugesu, (2013); Yogendrarajah & Thanabalasingam,
(2014); Ramachandran & Janakiraman, (2009) (Gill et al., 2010) findings that there is a positive
relationship between aggressive working capital policy and corporate profitability.
However, this study results contradicts with Usman et al., (2014); Subramaniam &
Anandasayanan, (2011); Lingesiya & Nalini,(2011); Afza & Nazir, (2007); Afza & Nazir,
(2009); Oloo & Mwangi,(2014); Khaksarian, (2014) and Al-Shubiri, (2010) who found a
negative relationship between aggressive working capital policy and firms profitability.
Moreover, this result are not consistent with study findings of Ajanthan, (2013); Bei &
Wijewardana, (2012); Pirashanthini et al., (2013); and Niresh, (2012) who found no significant
relationship between working capital policies and firm profitability of listed companies in Sri
Lanka.
39
5.4 Overall Summary of Pooled OLS regression model
Table 12 Overall Model Summary

F(3, 336) 13.14387 P-value(F) 3.90e-08
rho 0.044598 Durbin-Watson 1.558067
From the table 12, overall model summary, the value of R-squared of Pooled OLS regression is
0.105030. This means that 10.50 % variation in independent variables (AIP, AFP and DR) can
be accounted in the dependent variable return on assets. The standard error of estimated
regression is 89.5% and adjusted R-Squared is 0.097039. The overall model is fit, as F-statistics
is significant (3.90e-08) but very small. Durbin-Watson value is 1.558067, which indicated no
problem of auto correlation in the data set. This means that 10.50% of changes in dependent
variable (ROA) can be explained by explanatory variables (AIP,AFP and DR) and remaining
89.5% variation are error term due to other factors that are not identified in this research that
may impact on the profitability of selected companies of Colombo Stock Exchange.
5.5 Summary of findings
The following table 13 summarised the data findings results for the aggressive working capital
policy impacts on corporate profitability of listed companies Colombo Stock Exchange. The
sample data of 68 companies comprise of nine different sectors for total five years and these data
collected from the respective companies annual reports .Using Gretl version gretlw32.exe run
the Pooled OLS regression in order to find out the relationship between aggressive working
capital policy and corporate profitability.
40
Table 13 summary of Results
No Hypothesis Results Sign Tool

1 H01:There is no relationship between aggressive H0 rejected
investment policy and return on assets of the
selected listed companies in Colombo Stock
Exchange
Ha1:There is a relationship between aggressive Ha accepted positive
investment policy and return on assets of the
Exchange
2 Ho2:There is no relationship between aggressive H0 rejected
financing policy and return on assets of the
Regression
Exchange
Ha2:There is a relationship between aggressive Ha accepted positive
financing policy and return on assets of the
Exchange
3 Ho3:There is no impact between debt used by the H0 accepted no
listed companies in Colombo Stock Exchange and significant
its profitability but
positive
Ha3:There is an impact between debt used by the Ha rejected
listed companies in Colombo Stock Exchange and
its profitability
41
CHAPTER SIX
6.0 Recommendation and Conclusion
6.1 Conclusion
In corporate finance literature, still there are few research studies carried in working capital
policy, especially, regarding the capital structures of short-term finance and different types of
policies to manage this working capital. In this study, researcher presented an empirical study in
Sri Lankan companies working capital policies and profitability including different sectors of
companies in Colombo Stock Exchange. The sample data includes 68 companies from 09
different sectors listed in Colombo Stock Exchange for five years from 2009-2013.
The main purpose of this study is to find out the impact of aggressive working capital policy on
corporate profitability of selected listed companies in Colombo Stock Exchange during 2009-
2013. The specific research objectives are to find out the relationship between the aggressive
working capital policies (investing and financing) and corporate profitability and to find out the
financial distress and effectiveness of working capital policies.
The pooled OLS regression model shows a positive relationship between aggressive investment
and financing policy and corporate profitability of the selected companies in Colombo Stock
Exchange. Debt ratio and return on assets have a positive impact but it is not statistically
significant at 5%.
This finding is similar with previous study of Weinraub & Sue Visscher, (1998); Murugesu,
(2013); Yogendrarajah & Thanabalasingam, (2014); Ramachandran & Janakiraman, (2009) and
add knowledge to the existing working capital policies literatures that showed a positive
relationship between aggressive working capital policies and profitability. On the other hand,
study findings are contradicts with previous studies of Lingesiya & Nalini, (2011),Afza & Nazir,
(2007), Afza & Nazir, (2009), Oloo & Mwangi, (2014), Khaksarian, (2014) and Al-Shubiri,
42
(2010) who found a negative relationship between aggressive working capital policies and
profitability. This may be due to several factors such different measurement of the variables and
different characteristics of different industries and the different type of data and data analysis
tool used in the study. Pointing out these factors, in the next section researcher recommends
some future research areas can apply to this research study.
In addition, the research objectives of the study are achieved as the study findings revealed that
there is a relationship between aggressive working capital policies and profitability. The study
showed a positive relationship between aggressive working capital policy and corporate
profitability of companies listed in Colombo Stock Exchange. The results showed no statistical
significance between debt ratio and return on assets but there is a positive relationship between
them.
6.2 Limitation and recommendation for future research
The study sample data limited to random selected 09 industrial sectors in Colombo Stock
Exchange comprising 68 companies and research period of research is limited to only five years.
Therefore, the results may be indicative. Researcher recommends to future research to be
conduct in the following areas to get more accurate and appropriate findings.
Future research can conduct with additional explanatory variables along with aggressive
working capital policies to find the effects of more appropriate results. Previous
researchers Afza & Nazir,( 2009); Deloof, (2003), include control variables like real
Gross Domestic Product, sales growth and firm size in their research study
Further, future research can investigate aggressive working capital policies with more
additional measurement of corporate profitability such as tobins q and return on equity
Study can conduct to find out different industrial factor impact with aggressive working
capital policies along with profitability like previously (Afza & Nazir, 2009) conducted
study for listed companies in Karachi Stock Exchange ,Pakistan
43
In addition, future researchers can also conduct study of aggressive working capital
policy with liquidity, risks and firm value. previously Bandara & Weerakoon, (2011)
investigated seven different sectors in Colombo Stock Exchange consisted 74 companies
to test firm value and risks impact on working capital policies with economic value
added and Market value added.
In addition, a research study can also focus to companies operating in the financial sector
only.
Lastly, future researchers may also conduct empirical investigation on financial
performance and working capital policies with CEO characteristics. Gomes, (2013) has
empirically investigated the characteristics of CEO age and education qualification level
has any impact on the working capital management and profitability of Portugal firms.
This study results showed a positive relationship between CEO characteristics with
profitability. Further, they noted that older Male Portugal CEO with high qualification
level as CEO behind almost all the profitable firms in Portugal.
44
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Appendices
Appendix A
Normal Distribution different tests
Table 14 Different test of normality
Test for normality of SECTORS:

Tests D_H Signif S_W signif J-B signif
Doornik-Hansen
test 48.3059 3.24E-11
Shapiro-Wilk W 0.91355 4.60E-13
Jarque-Bera test 21.6366 2.00E-05
Multicollinearity- VIF factor
Variance Inflation Factors: Minimum possible value = 1.0, Values > 10.0 may indicate a
multicollinearity problem.
Table 15 Variance Inflation Factors
AIP 1.190
AFP 1.172
DR 1.223
VIF (j) = 1/(1 - R(j)^2), where R(j) is the multiple correlation coefficient
between variable j and the other independent variables
Properties of matrix X'X:
1-norm = 909
Determinant = 32296701
Reciprocal condition number = 0.016396562
50
Heteroskedasticity
Table 16 LM test (white's test)
Unadjusted R-squared = 0.034184

Test statistic: TR^2 = 11.622529,
with p-value = P(Chi-square(6) > 11.622529) = 0.070939
Appendix B
Research creditability: Creditability aspect of this research is judged in main three ways. This
as follows:
Reliability:-Reliability explains that the results of the study should be if another research is
conduct on the same way in different circumstance. (Saunders et al., 2009) stated that is should
not be subject bias, observer bias and subject error.
Validity:-This research finding is real. The relationship of the two variables show same
relationship in reality and do not exist any fictitious numbers or values to make the findings
attractive (Saunders et al., 2009).
Generalization: Generalization is also known as external validity. This explains the extents of
our research results are applicable to other research setting in the same field.
In this research, data collected from financial statements of the respective companies in the
Colombo Stock Exchange Web site. This data are belongs to real World companies of different
Accounts. The values of ratios return on assets (EBIT/TA), aggressive investment policy
(TCA/TA), aggressive financing policy (TCL/TA) and debt ratio (TL/TA) calculated from the
financial statements of the companies.
51
To meet the research development, aggressive investment and financing policy and debt ratio
categorise into two major sub- groups, which used to for data analysis. As in this research is
focused on aggressive working capital policies only so all the aggressive ratio in dummy
variable D1 (i.e AIP less than 50 % while AFP and DR if it is more than 50%).and conservative
approach ratios in dummy variable D2. (i.e aggressive investment policy ratio is more than 50 %
while aggressive financing policy and debt ratio is less than 50%).
Therefore, the findings of this research meet all three criteria of reliability, validity and
generalization.
52

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ASIA PACIFIC INSTITUTE OF

Masters in Business Administration

Date of Submission: 11th August 2015

Supervisor: Professor Kennedy Gunawardana

Assessor: MR.S.C. Kaluarachchi

Word count: 9676

An impact of aggressive working capital policy on corporate

profitability in the selected listed companies of Colombo Stock

Student Name: Fathimath Shamsiyya (Cb005302)

Supervisors Name: Professor Kennedy Gunawardana

Professor Kennedy Gunawarudena

11th August 2015

Staffordshire Reference Guidelines.

11th August 2015

Key words: Corporate Profitability, Aggressive Investment Policy, Aggressive Financing

CHAPTER ONE .................................................................................................................................... 1

1.0 Introduction ...................................................................................................................................... 1

1.1 Introduction ............................................................................................................................ 1

1.2 Background of the study ............................................................................................................. 1

1.3 Research Question ...................................................................................................................... 2

1.4 Problem Statement ...................................................................................................................... 2

1.5 Problem Justification................................................................................................................... 3

1.6 Objectives of the study ................................................................................................................ 3

1.7 Significance of the study ......................................................................................................... 4

1.8 Scope of the study ......................................................................................................................... 4

CHAPTER TWO ................................................................................................................................... 6

2.0 Literature Review ............................................................................................................................. 6

2.1 Introduction ...................................................................................................................................... 6

2.2 Working Capital Management Reviews ............................................................................................ 6

2.2.1 Working Capital Management- International Context ................................................................. 6

2.2.2 Working Capital Management- Sri Lankan Context ................................................................ 8

2.3 Working Capital Policies Reviews ................................................................................................ 9

2.3.1 Working capital policy-International context .......................................................................... 9

2.3.2 Working Capital Policies-Sri Lankan Context ...................................................................... 13

2.4.1 Researchers Critical Review................................................................................................ 15

2.4.2 Variables Selection .............................................................................................................. 16

2.4.3 Conclusion of Literature Reviews ......................................................................................... 17

CHAPTER THREE .............................................................................................................................. 19

3.0 Research Methodology ................................................................................................................... 19

3.1 Introduction ................................................................................................................................ 19

3.2 Conceptual Framework ............................................................................................................... 19

3.2.1 Illustration of Conceptual Framework .................................................................................. 20

3.3 List of Hypotheses ...................................................................................................................... 21

Table 1 List of Hypotheses ............................................................................................................... 21

3.4 Population and target population ................................................................................................. 22

3.5 Sample size................................................................................................................................. 22

3.5.1 Research design ....................................................................................................................... 22

3.5.2 Data collection method ............................................................................................................ 22

3.5.3 Sampling method ..................................................................................................................... 23

3.5.4 Illustration of the sample .......................................................................................................... 24

3.6 Proposed statistical method ......................................................................................................... 26

3.6. 1 Statistical method used by previous research studies ............................................................ 26

3.7 Conclusion of Research Methodology ......................................................................................... 27

CHAPTER FOUR ................................................................................................................................ 28

4.0 Data Analysis ................................................................................................................................. 28

4.1 Introduction ................................................................................................................................ 28

4.2 Basic Assumption Tests .............................................................................................................. 29

4.3 Descriptive Statistics ................................................................................................................... 29

4.4 Correlation Matrix .................................................................................................................. 31

4.5.1 Hausman test ........................................................................................................................ 32

4.5.2 Breusch - Pagan Lagrangian Multiplier Test ............................................................................. 32

4.6.3 Chow Test or F Test ............................................................................................................. 33