THE EFFECT OF WORKING CAPITAL MANAGEMENT ON
FIRMS ‘PROFITABILITY:
A CASE OF SELECTED MANUFACTURING COMPANIES IN
DAR ES SALAAM
THE EFFECT OF WORKING CAPITAL MANAGEMENT ON
FIRMS ‘PROFITABILITY:
A CASE OF SELECTED MANUFACTURING COMPANIES IN
DAR ES SALAAM
By
Emmanuel Fredrick
A Research Dissertation Submitted in Partial Fulfillment of the Requirements for theAward of the Degree of Master of Science in Accounting and Finance (MSc-A&F)of Mzumbe University Dar es Salaam Campus College
2013
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CERTIFICATION
The undersigned certifies that he has read and hereby recommends for acceptance by
the Mzumbe University a dissertation entitled:“The effect of Working Capital
Management on Firms' Profitability: A Case of Selected Manufacturing
Companies in Dar es Salaam, in partial fulfillment of the requirements for award of
the degree of Masters of Science in Accounting and Finance of Mzumbe University.
……………………………………..
Major Supervisor
………………………………….
Internal Examiner
………………………………
External Examiner
Accepted for the Board of MUDCC
…………………………………………………………
CHAIRPERSON, FACULTY/DIRECTORATE BOARD
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DECLARATION
I, Emmanuel Fredrick, declare that this thesis is my own original work and that it
has not been presented and will not be presented to any other University for a similar
or any other degree award.
Signature……………………………….
Date……………………………………..
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COPYRIGHT
© 2013
This dissertation is a copyright material protected under the Berne Convention, the
Copyright Act 1999 and other international and national enactments, in that behalf,
on intellectual property. It may not be reproduced by any means in full or in part,
except for short extracts in fair dealings, for research or private study, critical
scholarly review or discourse with an acknowledgement, without the written
permission of Mzumbe University, on behalf of the author.
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ACKNOWLEDGMENTS
First of all I am thankful to GOD the most beneficial and merciful who gave me the
courage to finish my dissertation.
Secondly, I wish to express my gratitude to my supervisor Dr. D.M.L. Kasilo for his
constructive advice, directions, comments, support and professional guidance.
Finally, I wish to thank Mr&MrsF. N.Olotu, and all sister and brothers for their
prayers which played an important role in the completion of my dissertation. Without
their moral and financial support it would have been impossible for me to write this
dissertation report.
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ABBREVIATIONS AND ACRONYMS
CCC - Cash conversion cycle
EBIT - Earnings before interest and taxes
NSE - Nairobi stock exchange
NTC - Net-trade cycle
OLS - Ordinary least square
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ABSTRACT
This research has examined the effect of working capital management on
profitability of manufacturing companies
Working capital management is a very important component of corporate finance
because it directly affects the liquidity and profitability of the company. It’s not
enough with high profitability to be a successful company but an effective managed
working capital is also important to success. Neglecting working capital management
can in the worst case lead to the downfall of a company even if it has profitability.
In this study, the Researcher selected a sample of 4 Tanzania manufacturing
companies listed on Dar es Salaam Stock Exchange and collected data for a period of
4 years from 2008 to 2011. The Researcher studied the effect of different variables of
working capital management including accounts receivable days, accounts payable
days, inventories days and cash conversion cycle on the net operating profit of
Tanzania manufacturing firms. Financial data were extracted from companies
audited annual reports from respective company’s websites. Pooled ordinary least
square (OLS) regression analysis has been used to analyse financial data.
The results show that accounts receivable days and cash conversion cycle have a
positive relation with profitability but with no significance. Accounts payable days
and inventories days have a positive relation with profitability and are highly
significant.
Working capital management directly affects the firm’s profitability. Managers
responsible for value creation and wealth maximization can achieve their objective,
by managing working capital effectively. The policy implication of this study is that
accounts payable days need more consideration. Also this research indicates that
companies should have proper inventory management system to avoid overstocking.
Accounts receivable days and cash conversion cycle also need to be taken into
consideration as they have been ignored.
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TABLE OF CONTENTS
Pages
CERTIFICATION ...................................................................................................... iDECLARATION........................................................................................................ iiCOPYRIGHT ............................................................................................................ iiiACKNOWLEDGMENTS ........................................................................................ ivABBREVIATIONS AND ACRONYMS.................................................................. vABSTRACT............................................................................................................... viTABLE OF CONTENTS......................................................................................... viiLIST OF TABLES ..................................................................................................... xLIST OF FIGURES .................................................................................................. xi
CHAPTER ONE: INTRODUCTION STATEMENT OF THE PROBLEM ANDOBJECTIVES ............................................................................................................ 1
1.1 Introduction ............................................................................................... 11.2 Background ............................................................................................... 11.3 Statement of the problem .......................................................................... 41.4 Research objectives ................................................................................... 51.4.1 Main Objective.......................................................................................... 51.4.2 Specific Objectives.................................................................................... 61.5 Research Questions ................................................................................... 61.5.1 Main Question ........................................................................................... 61.5.2 Specific Questions..................................................................................... 61.6 Significance of the Study .......................................................................... 61.7 Limitations ................................................................................................ 7
CHAPTER TWO: LITERATURE REVIEW......................................................... 82.1 Introduction ............................................................................................... 82.2 There are two concepts of working capital namely, Gross working capital
concept and Net working capital concept. ................................................ 92.2.1 Gross Working Capital Concept ............................................................... 92.2.2 Net Working Capital Concept ................................................................. 102.3 Working Capital Management Concepts ................................................ 102.4 Accounts Receivable Days and Profitability........................................... 112.4.1 Accounts Receivable ............................................................................... 112.4.2 The Effect of Accounts Receivable Days on Profitability ...................... 122.5 Accounts Payable Days and Profitability................................................ 132.5.1 Accounts payable .................................................................................... 132.5.2 The Effect of Accounts Payable Days on Profitability ........................... 142.6 Inventories Days and Profitability........................................................... 162.6.1 Inventories............................................................................................... 162.6.2 The Effect of Inventories Days on Profitability ...................................... 172.7 Cash conversion Cycle and Profitability................................................. 182.7.1 Cash conversion cycle............................................................................. 182.7.2 The effect of Cash Conversion Cycle on Profitability ............................ 20
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2.8 Liquidity Ratios....................................................................................... 232.9 Factor leading to Corporate Performance ............................................... 24
CHAPTER THREE: ANALYTICAL FRAMEWORK ....................................... 273.1 Framework: Variables / Concept............................................................. 273.2 Analytical Framework............................................................................. 293.3 Hypothesis ............................................................................................... 333.4 Effective of Working Capital Management ............................................ 333.5 Operational Definition............................................................................. 333.6 Financial Strength ................................................................................... 343.7 Effective Corporate Performance............................................................ 34
CHAPTER FOUR: THE RESEARCH DESIGN ................................................. 354.1 Introduction ............................................................................................. 354.2 Type of Research..................................................................................... 354.3 Research Design...................................................................................... 364.4 Study Area............................................................................................... 374.5 Population................................................................................................ 374.6 Sample..................................................................................................... 374.6.1 Meaning of Sample ................................................................................. 374.6.2 Sample Size ............................................................................................. 374.7 Sampling Techniques .............................................................................. 384.7.1 Sample Procedures .................................................................................. 384.8 Data Sources and Data Collection Methods............................................ 394.8.1 Data Analysis .......................................................................................... 394.9 Data Analyses Strategy and Decision Criteria ........................................ 424.9.1 Variables and Measurement .................................................................... 424.9.2 Validity.................................................................................................... 434.10 Conclusion............................................................................................... 44
CHAPTER FIVE: DATA ANALYSE AND DISCUSSIONS ON THEFINDINGS ................................................................................................................ 45
5.1 Introduction ............................................................................................. 455.2 The Effect of Accounts Receivable Days on Profitability of
Manufacturing Companies ...................................................................... 475.3 The Effect of Accounts Payable Days on Profitability of Manufacturing
Companies............................................................................................... 475.4 The Effect of Inventories Days on Profitability of Manufacturing
Companies............................................................................................... 485.5 The Effect of Cash Conversion cycle on profitability of Manufacturing
Companies............................................................................................... 505.6 Findings and Discussion.......................................................................... 515.6.1 Profitability of the selected Manufacturing companies........................... 515.6.2 Gross Profit Margin................................................................................. 515.6.3 Net Profit Margin .................................................................................... 515.6.4 Operating Profit Ratio ............................................................................. 51
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CHAPTER SIX: CONCLUSION AND RECOMENDATION............................ 526.1 Introduction ............................................................................................. 526.2 Conclusions ............................................................................................. 526.2.1 The Effect of Accounts Receivable Days on Profitability of
Manufacturing Companies. ..................................................................... 536.2.2 The Effect of Accounts Payable Days on Profitability of Manufacturing
Companies............................................................................................... 546.2.3 The Effect of Inventories Days on Profitability of Manufacturing
Companies............................................................................................... 546.2.4 The Effect of Cash Conversion Cycle on Profitability of Manufacturing
Companies............................................................................................... 556.3 Limitations of the Study.......................................................................... 556.4 Areas for Further Research ..................................................................... 566.5 Recommendation..................................................................................... 57
REFERENCES......................................................................................................... 58
APPENDICES .......................................................................................................... 61Appendix 1: Questionnaire ................................................................................ 61Appendix 2: Financial data of manufacturing companies from 2008 to 2011 .. 65Appendix 3: Regression summary output.......................................................... 66
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LIST OF TABLES
Pages
Table 5.1: Regression output: Accounts receivable days and profitability ......... 47
Table 5.2: Regression output: Accounts payable days and profitability ............ 47
Table 5.3: Regression output: Inventories days and profitability........................ 48
Table 5.4: Regression output: Cash conversion cycle and profitability ............. 50
xi
LIST OF FIGURES
Figure 2.1: Operating and cash conversion cycle ................................................. 19
Figure 3.1: Presents the diagrammatically the conceptual framework for this
research............................................................................................... 32
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CHAPTER ONE
INTRODUCTION STATEMENT OF THE PROBLEM AND OBJECTIVES
1.1 Introduction
Capital structure and working capital management are two very widely revisited
areas by academicians. This area of finance has been approached in various ways by
many academicians in many countries over the world. Some has focused mainly on
optimizing accounts receivable so that firms can maximize profit.
The impact of working capital management on the profitability of manufacturing
Firms has attracted the attention of researchers in different countries of the world in
recent times. This research expands the horizon of knowledge in this area by
Shedding more light on working capital management as measured by the cash
conversion cycle (CCC), and how the individual components of the CCC influence
the profitability of world leading beer brewery firms. Multiple regression equations
were applied to a cross sectional time series data of five world leading beer brewery
firms after ensuring that the data are stationary and co-integrated. The outcome of the
analysis clearly pinpoint that working capital management as represented by the cash
conversion cycle, sales growth and lesser debtors’ collection period impacts on beer
brewery firms’ profitability.
In this chapter, researcher gives an introduction to the chosen subject and presents
the statement of the problem, which leads to research objectives and research
questions. Researcher also presents the significance of the study.
1.2 Background
Working capital management is important part in firm financial management
decision. Working capital refers to a company’s Current assets. Current assets are
cash and equivalents, accounts receivable, and inventory. Working Capital
Management is applying Investment and Financing decisions to current assets.
Working capital management is a very important component of corporate finance
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because it directly affects the liquidity and profitability of the firm (Raheman& Nasr,
2007).
An optimal working capital management is expected to contribute positively to the
creation of firm value. To reach optimal working capital management firm manager
should control the tradeoff between Liquidity (ability to pay bills, keep sales coming
in, keep customers happy, play it safe ) and Profitability (size of earnings after taxes)
accurately. Working capital management is the lifeblood of business, every
manager’s primary task is to help keep it flowing, and to use the cash flow to
generate profits. Working capital in business is considered as lifeblood in human
body.
Firms may have an optimal level of working capital that maximizes their value.
Large inventory which indicates longer inventories days and generous trade credit
policy may lead to high sales. The larger inventory also reduces the risk of a stock-
out. Trade credit which leads to longer accounts receivable days may stimulate sales
because it allows a firm to access product quality before paying (Raheman& Nasr,
2007). Another component of working capital is accounts payable days. Raheman
and Nasr (2007) state that delaying payment of accounts payable to suppliers allows
firms to access the quality of bough products and can be inexpensive and flexible
source of financing. On the other hand, delaying of such payables can be expensive if
a firm is offered a discount for the early payment. By the same token, uncollected
accounts receivables can lead to cash inflow problems for the firm.
In traditional view of relationship between cash conversion cycle (as measure of
working capital management) and profitability is ceteris paribus. The shorter firm
cash conversion cycle, the better a firm profitability. This shows that less of time
money tied up in current asset and less external financing. While, the longer cash
conversion cycle will hurt firm’s probability. The reason is that firm having low
liquidity that would affect firm is risk. However, if firm has higher level of account
receivable due to the generous trade credit policy it would result to longer cash
3
conversion cycle? In this case, the longer cash conversion cycle will increase
profitability. Thus, the traditional view cannot be applied to all circumstances.
For many manufacturing firms the current assets account for over half of their total
assets (Raheman& Nasr, 2007 p. 279). The management of working capital may
have both negative and positive impact of the firm’s profitability, which in turn, has
negative and positive impact on the shareholders’ wealth. The present study seeks to
examine the effects of accounts receivable days, accounts payable days, inventories
days and cash conversion cycle on profitability of manufacturing firms.
A variety of variables related to working capital management that might potentially
be associated or ‘responsible’ for the profitability of manufacturing firms can be
found in the literature. In this study, the choice of explanatory variables is consistent
with those of Deloof (2003) and other empirical literature related to working capital
management and profitability. As a result, the final set includes five proxy variables:
accounts receivable days, accounts payable days, inventories days, cash conversion
cycle and net operating profit.
The corporate finance literature has traditionally focused on the study of long-term
financial decisions, particularly investments, capital structure, dividends or company
valuation decisions. However, short-term assets and liabilities are important
components of total assets and needs to be carefully analyzed. The current study
examine the effects of accounts receivable days, accounts payable days, inventories
days and cash conversion cycle on profitability of manufacturing firms by taking a
sample of 4 manufacturing firms for the period of four years from 2008 to 2011.
Using single regression analysis, researcher's results answered the research specific
questions. Specifically, results indicate that the cash conversion cycle and all its
major components, namely, accounts receivable days, accounts payable days,
inventories days, are associated with firm’s profitability.
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The remainder of the study is organized as follows: Chapter one provides statement
of the problem, research objectives and research question. In chapter, two is literature
review both theoretically and empirically. Chapter three is methodology. Research
findings are discussed in chapter four and conclusions and policy implication are
presented in the last chapter.
1.3 Statement of the problem
Working capital management is a very important component of corporate finance
because it directly affects the liquidity and profitability of the company. It deals with
current assets and current liabilities. Working capital management is important due
to many reasons. First, the current assets of a typical manufacturing firm accounts for
over half of its total assets. For a distribution company, they account for even more
(Horne &Wachowicz, 2000). Efficient working capital management involves
planning and controlling current assets and current liabilities in a manner that
eliminates the risk of inability to meet due short term obligations on the one hand and
avoid excessive investment in these assets on the other hand (Eljelly 2004, p. 48).
Working Capital Management is a very sensitive area in the field of financial
management (Joshi, 1994). It involves the decision of the amount and composition of
current assets and the financing of these assets. Current assets include all those assets
that in the normal course of business return to the form of cash within a short period,
ordinarily within a year and such temporary investment as may be readily converted
into cash upon need. The Working Capital Management of a firm in part affects its
profitability. The ultimate objective of any firm is to maximize the profit. However,
preserving liquidity of the firm is an important objective too. The problem is that
increasing profits at the cost of liquidity can bring serious problems to the firm.
Therefore, there must be a tradeoff between these two objectives of the companies.
One objective should not be at cost of the other because both have their importance.
If we do not care about profit, we cannot survive for a longer period. On the other
hand, if we do not care about liquidity, we may face the problem of insolvency or
bankruptcy. For these reasons, working capital management should be given proper
consideration and will ultimately affect the profitability of the firm.
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Pass and Hike (2007) elucidated that it is not enough with high profitability to be a
successful company but an effective managed working capital is also important to
success. A neglected managed working capital management can, in worst-case lead
to the downfall of a company even if it has a high profitability.
In spite of the importance of working capital management and its effects on the
profitability of firms, this area has been neglected for research for a long time.
Although abundant researches and theoretical development have been done in the
area of investment and long-term finance but this gray area of short-term finance, in
particular working capital management has been neglected for a very long time. Such
neglect might have been acceptable, if working capital had a relatively little
importance to the firm, but effective working capital management has a crucial role
to play in enhancing the profitability and growth of the firm.
Keeping this in view and the wider recognition of the potential contribution of
manufacturing sector to the economies of developing countries, this research intends
to analyze the relevance of working capital management on the profitability of
manufacturing companies. The researcher work would contribute by providing
empirical evidence regarding the management of working capital and is relevance to
the profitability of manufacturing firms in Tanzania.
1.4 Research objectives
1.4.1 Main Objective
The main objective of this research is to analyze the effect of working capital
management on firm profitability. In accordance with this aim, to consider
statistically significant relationships between firm profitability and the components
of cash conversion cycle at length, a sample consisting of Dar es Salaam Stock
Exchange (DSE) listed manufacturing firms for the period of 1998-2007 has been
analyzed under a multiple regression model. Empirical findings show that accounts
receivables period, inventory period and leverage affect firm profitability negatively;
while growth (in sales) affects firm profitability positively
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1.4.2 Specific Objectives
The specific objectives of this study are:
(i) To find out the effect of accounts receivable days on profitability of
manufacturing companies.
(ii) To find out the effect of accounts payable days on profitability of
manufacturing companies.
(iii) To find out the effect of inventories days on profitability of manufacturing
companies.
(iv) To find out the effect of cash conversion cycle on profitability of
manufacturing companies.
1.5 Research Questions
1.5.1 Main Question
The main question guiding this research reads:
Does working capital management affect the profitability of manufacturing
companies?
1.5.2 Specific Questions
(i) What is the effect of accounts receivable days on profitability of
manufacturing companies?
(ii) What is the effect of accounts payable days on profitability of
manufacturing companies?
(iii) What is the effect of inventories days on profitability of
manufacturing companies?
(iv) What is the effect of cash conversion cycle on profitability of
manufacturing companies?
1.6 Significance of the Study
The effect of working capital management on firms’ profitability has been studied in
Tanzania.(Kasilo,1997) Muzumbe Library Therefore, this research contributes to
negatively the gap in knowledge. By their numbers alone manufacturing companies
7
are the key driver for Tanzania economy. Understanding how manufacturing
companies achieve high performance has significant implications for companies
owners/managers, employees, and the national economy. High level of performance
can facilitate a firmsgrowth and subsequent profit performance, which in turn can
yield employment gains and contribute to the general economic health of Tanzania.
Conversely, low performance may lead to firm stagnation or failure, and the negative
economic ramifications commensurate with these outcomes. Therefore,
understanding the effect of working capital management on firm's profitability is
vitally important to the manufacturing sector .This research has also be submitted in
partial fulfillment of the requirements for the award of degree of Masters of Science
in Accounting and Finance at Mzumbe University.
1.7 Limitations
Every study conducted has to experience limitations, some limitations have occurred
and still the researcher will tend to experience in the process of conduction the study.
Limitations do cover mainly in collection of data processing and analysis of data.
Some of the main limitations of the study are:
Cost of the study, in that the researcher will Incur high cost of printing, as well as
photocopying to maintain the hard copy of the study. Because the research involves
Internet applications hence costs to use internet in observing trading activities has to
be taken into consideration.
Time limit has been also a limitation on the completion to the proposal. Time is not
in our side for us to complete the study in the time provided.
This has been caused mainly by the limited availability of resources to work on the
research such as computers and employment activities where by most of time
spending in the office.
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
Literature review researcher presents theoretical and empirical literature review of
related studies highlighting the theories and findings of different researchers as well
as conceptual framework regarding working capital management.
Profit maximization is the ultimate objective of firm`s as well as protecting liquidity
is an important objective too. The difficult of working capital management is to
achieve the two objectives optimally within an operating period if profit increases at
the cost of liquidity and this may create serious problem to firms. Therefore, to solve
such problems, there must be some compromise between these two objectives of
firms. One objective will not achieve at the cost of other as both objectives have their
own importance to firms. If firms do not care about profitability, they may not
survive for a longer longer period. On the other hand, if firms do not care about
liquidity, they may face problem of insolvency or bankruptcy.
Working Capital Concepts
Working capital refers to firm's investment in short-term assets, such as cash,
accounts receivable and inventories of raw materials, work-in-process and finished
goods. It can also be regarded as that portion of the firm's total capital, which is
employed in short-term operations. It refers to all aspects of current assets and
current liabilities. In simple words, we can say that working capital is the investment
needed for carrying out day-to-day operations of the business smoothly. The
management of working capital is no less important than the management of long-
term financial investment (Kuchhal, 1985).
All companies produce an annual set of accounts consisting of a balance sheet, profit
and loss accounts and Cash flow statement. Most of these companies also produce
interim set of accounts during the year, usually on a monthly or quarterly basis.
9
These interim accounts are called management accounts and are not available to
people outside the company, they are for the company managers only enabling them
to monitor progress on a regular basis. To do this ratio analysis can be used.
Managers need to know how well they are performing now to enable them to make
business perform better in the future. They need to know the baseline from which
their performance as a manager will be measured. An awareness of the current
business performance and position will help them to focus their efforts.
According to Deloof
(2003) the way that working capital is managed has a significant impact on
profitability of firms. It has also been proved that by minimizing the amount of funds
tied up in current assets; firms can reduce financing costs and/or increase the funds
available for expansion. Cote and Latham (1999, p. 261) argued the management of
receivables, inventory and accounts payable have tremendous impact on cash flows,
which in turn affect the profitability of firms. As found by Lazaridis and Tryfonidis
(2006), companies enjoy better pricing when they hold enough cash to purchase from
own suppliers and thus they may enhance their profit. So having enough liquidity
also affects the profitability of the firm.
2.2 There are two concepts of working capital namely, Gross working capital
concept and Net working capital concept.
2.2.1 Gross Working Capital Concept
Gross working capital refers to firm’s investment in current assets. Current assets are
the assets which can be converted into cash within an accounting year include trade
receivables, cash and inventories. According to this concept, working capital means
Gross working capital which is the total of all current assets of a business; it can be
represented by the following equation (Mead, 1993):
Gross working capital = Total current assets
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2.2.2 Net Working Capital Concept
Net working capital refers to the difference between current assets and current
liabilities. Current liabilities are those claims of outsiders that are expected to mature
for payment within an accounting year and include trade payables and outstanding
expenses. Net working capital can be positive or negative. A positive net working
capital will arise when current assets exceed current liabilities. A negative net
working capital occurs when current liabilities are in excess of current assets, it can
be represented by the following equation (Gitman, 1997);
Net working capital = Current assets – current liabilities.
It is hardly to find a running business firm, which does not require some amount of
working capital. Even fully equipped manufacturing firms are sure to collapse
without (a) an adequate supply of raw materials to process, (b) cash to meet the wage
bill, (c) the capacity to wait for the market for its finished products, and (d) the
ability to grant credit to its customers. Working capital, thus, is the life-blood of a
business. Actually, any organization, whether profit-oriented or otherwise, will not
be able to carry on day-to-day activities without adequate working capital (Kuchhal,
1985).
2.3 Working Capital Management Concepts
The working capital meets the short-term financial requirements of a business
enterprise. It is the investment required for running day-to-day business. It is the
result of the time lag between the expenditure for the purchase of raw materials and
the collection for the sales of finished products. The components of working capital
are inventories, accounts to be paid to suppliers, and payments to be received from
customers after sales. Financing is needed for receivables and inventories net of
payables. The proportions of these components in the working capital change from
time to time during the trade cycle. The working capital requirements decide the
liquidity and profitability of a firm and hence affect the financing and investing
decisions. Lesser requirement of working capital leads to less need for financing and
less cost of capital and hence availability of more cash for shareholders. However,the
11
lesser working capital may lead to lost sales and thus may affect the profitability. The
management of working capital by managing the proportions of the working capital
management components is important to the financial health of businesses from all
industries. To reduce accounts receivable, a firm may have strict collections policies
and limited sales credits to its customers. This would increase cash inflow. However,
the strict collection policies and lesser sales credits would lead to lost sales thus
reducing the profits. Maximizing account payables by having longer credits from the
suppliers also has the chance of getting poor quality materials from supplier that
would ultimately affect the profitability. Minimizing inventory may lead to lost sales
by stock-outs. The working capital management should aim at having
balanced;optimal proportions of the working capital management components to
achieve maximum profit and cash flow (Vedavinayagam, 2007).
Working capital concepts give an idea of what working capital is all about and
working capital management concepts explain the management of components of
working capital and how they may affect profit of the firms. Hereunder researcher
shows what literature says both theoretically and empirically about the components
of working capital management and its effect on profitability.
2.4 Accounts Receivable Days and Profitability
2.4.1 Accounts Receivable
All the businesses have either products or services to sell to the customers, they also
want to maximize their sales so, in order to increase the level of their sales they use
different policies to attract customers and one of them is offering a trade credit. It
means a company sells its product now to receive the payment at specify date in the
future and this is when accounts receivable arise. Hill &Sartoris (2005) found that
one sixth of total assets for manufacturing corporations consist of accounts
receivable and because of its huge proportion in the total assets, it can become a
problem for the organization in a way that it requires more financing for the period
for which payment is due from the customers. Accounts receivable also have
opportunity cost associated with them because company cannot invest this money
12
elsewhere until and unless it collects its receivables. More accounts receivable can
raise the profit by increasing the sale but it is also possible that because of high
opportunity cost of invested money in accounts receivable and bad debts the effect of
this change might turn difficult to realize. On the other hand if a company adopts a
policy to have a low level of accounts receivable then it can reduce the profitability
by reducing the sales but it can contribute to the profit by reducing the risk of bad
debts and by reducing investment in the receivable (Andrew & Gallagher 1999,
ph.465).
2.4.2 The Effect of Accounts Receivable Days on Profitability
The time between the sale and the receipt of payment is known as trade credit period
or accounts receivable days. It is believed that longer period of collection of accounts
receivable or longer credit period offered by the company results into higher sales,
and more sales bring more profit in the business. Therefore, there could be an
existing relationship between the number of day’s accounts receivable and
profitability of the firm. On the other hand large time span between the sale and
receipt of accounts receivable result in decline of cash flows and may result in bad
debts, which in turn may reduce the profit of the firm (Brealey& Myers 2006, p.
814).
Theoretically, accounts receivable days may lead either to an increase or to decrease
of the firms’ profitability, and which period of collection is preferable, having long
accounts receivable days or short accounts receivable days? This question will be
answered by empirical results of the related study of the following researchers.
To test the relationship between working capital management and corporate
profitability, Deloof (2003, p. 573) used a sample of 1,009 large Belgian non-
financial firms for a period of 1992-1996. By using correlation and regression tests,
he found significant negative relationship between gross operating income and the
number of day’s accounts receivable of Belgian firms. Based on the study results, he
suggests that managers can increase corporate profitability by reducing the number
of day’s accounts receivable.
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Other researchers Nobanee and AlHajjar (2009b) who studied the relationship
between working capital management and corporate profitability of Japanese firms
analyzed a sample of 2,123 Tanzania non-financial companies listed in the Dar es
salaam Stock Exchange for the period 1990-2004 and they concluded that company
managers can increase profitability by shortening the receivables collection period.
On the other hand Ramachandran and Janakirama (2006 p. 61) studied the firm’s
efficiency in working capital management in the paper industry in India. They
analyzed the relationship between working capital management efficiency and
Earnings before interest and taxes (EBIT). Using regression analysis it was found
that there is a positive relationship between collection period and EBIT. This means
credit facility increases sales of firm, which ultimately increases profitability.
The study results of Deloof (2003, p.573) and Nobanee and AlHajjar (2009b) are the
same as they suggest that managers can only increase corporate profitability by
reducing the number of days accounts receivable however their results contradict
with Ramachandran and Janakirama (2006, p.61) as they found that corporate
profitability can only be increased by increasing accounts receivable days. The
mixed results may be due to different period and selection of companies of their
researches.
2.5 Accounts Payable Days and Profitability
2.5.1 Accounts payable
Accounts payable are generated when company purchases some products for which
payment has to be made no later than a specified date in the future. Accounts payable
are a part of all the businesses and have some advantages associated with it e.g. it is
available to all the companies regardless of the size of the company and earlier
payment can bring cash discount with it (Arnold 2008, p.479). Companies should try
prolonging the time of payment as long as possible as they can use the advantage of
their suppliers financing their investments until payment has been made. Another
argument for prolonging the time for payment is that the producing companies, for
14
example, need some time to convert their purchased raw materials into products they
can get sold and get cash in return (Maness &Zietlow 2005, 235). Some suppliers
offer their customers discount rates as an attempt to get them to pay their receivables
before maturity date, which may sound tempting, but this is not always the most
profitable option. To avoid being misled by these discounts offers, companies should
carefully consider every discount offer they get to see that it is beneficial in terms of
their conditions. For a discount to be beneficial for the buyer the discount rate should
be higher than the interest rate the company would have to pay for a loan over the
same period as the discount period (Maness &Zietlow 2005, p. 235). If there is no
discount offer given companies should use the whole credit period and pay their
payables on due date. Paying after due date should always be avoided unless the
company has fallen in financial difficulties and there is no other choice. The reason
for this is that delayed payments can result in unnecessary costs as late fees
(Dolfe&Koritz 2000, p. 49).
2.5.2 The Effect of Accounts Payable Days on Profitability
An accounts payable day is a time between the purchase of goods and its payment. If
the firm is unable to pay its accounts payable on time then it signals to the market
that firm have some financial problem and it might go bankrupt resultantly its
goodwill will be spoiled and the value of its shares will go down. Therefore, it is
necessary for the firm to manage the day’s accounts payable in a way that it does not
create any trouble for it. Shorter duration of day’s accounts payable can be beneficial
for an organization as it has some discount associated with it but at the same time, it
will force a company to reduce the collection period, which might cause the
reduction of sale.
Therefore, companies have to be very careful while deciding on the duration of day’s
accounts payable. For us it is better for a company to have larger duration of day’s
accounts payable (Arnold, 2008, p.531).
15
Longer accounts payable days are preferable theoretically delaying payment of
accounts payable to suppliers allows firms to access the quality of bought products
and can be inexpensive and flexible source of financing. On the other hand, delaying
of such payables can be expensive if a firm is offered a discount for the early
payment or is being charged for late payment. The following researchers give us
empirical evidence on effect of accounts payable days on firms profitability, and
these are as follows,
Ghosh and Maji (2003) studied the firm’s efficiency in working capital management
in the cement industry in India. They analysed the relationship between working
capital management efficiency and EBIT. Using regression analysis it was found that
there is a positive relation between payable period and EBIT, which means profitable
firms delay their payables.
Falope and Ajilore (2009, p. 73) used a sample Tanzania quoted non-financial firms
for the period 2008 -2011. Their study utilized panel data econometrics in a pooled
regression, where time-series and cross-sectional observations were combined and
estimated. They found a significant negative relationship between net operating
profitability and average payment period for a sample of Tanzania firms listed on
Dar es Salaam Stock Exchange. As the firm’s corporate profitability can only be
increased by reducing payment period.
According to Garcia-Teruel and Martinez-Solano (2007, p 164) who studied the
effects of working capital management on the profitability of a sample of 8,872 small
and medium-sized enterprises (SMEs) from Tanzania covering the period 2008 -
2011. They found that managers can create value by reducing their number of days
for which their accounts are outstanding as this will improve the firm’s profitability.
From empirical results we get mixed results as Ghosh and Maji (2003) claim that
profitable firms delay their payables means they have longer duration of days
accounts payable as Arnold (2008, p.531) suggested. But Garcia-Teruel and
Martinez-Solano (2007, p 164) and Falope and Ajilore (2009, p. 73) found that
16
managers can only increase profit by reducing numbers of accounts payable as firms
benefit discount for the early payment and avoid being charged for late payment.
2.6 Inventories Days and Profitability
2.6.1 Inventories
Inventories comprise raw material, finished goods and work in process. It is not
necessary for a firm to hold high level of raw materials inventory, in fact, a firm can
order raw material on the daily basis but the high ordering cost is associated with
such a policy. Moreover, the delay in supply might stop the production. Similarly,
firm can reduce its finished goods inventory by reducing the production and by
producing the goods only to meet, the current demand but such a strategy can also
create trouble for the company if the demand for the product rises suddenly. Such a
situation might cause the customer dissatisfaction and even a loyal customer can
switch to the competitors brand. Therefore, the firm should have enough inventories
to meet the unexpected rise in demand but the cost of holding this inventory should
not exceed its benefit (Brealey& Myers 2006, p.821).
Companies should keep inventory at a level, which maximizes the profit, and this
level is known as optimal level. There are costs associated with inventory i.e.
carrying cost and ordering cost. Carrying cost involves all the expenses, which firm
has to bear for on handling inventory and this involve insurance, warehouse
expenses, security expenses etc. Ordering cost is a cost that is associated with one
order. It includes telephone expenses, management time, and clerical expenses etc.
Ordering cost is a fixed cost and its effect can be reduced by ordering a big lot but
big lot will increase the carrying cost. On the other hand, if a finance manager saves
the carrying cost by ordering twice or thrice rather than one big lot then ordering cost
will increase. In both cases, profitability is directly affected. Therefore, in order to
find an optimal level managers have to find a balance between cost and benefit
associated with different inventory levels (Andrew & Gallagher 1999, p.472).
17
2.6.2 The Effect of Inventories Days on Profitability
Inventories days can be defined as the time between the receipt of raw material and
delivery of finished goods. The effect of inventories days on profitability depends on
the policy which a company adopts towards working capital. A company with
aggressive working capital policy holds minimal inventory and has few days for
which they held inventory. This policy tends to enhance the profitability of the firm,
as carrying costs associated with inventory tends to be low.
While a company with defensive, policy has higher level of inventory and has longer
inventories days. Hence, this policy might reduce the profitability because of the
funds tied up in inventory and due to higher carrying costs associated with higher
level of inventory (Andrew & Gallagher, 1999).
In theory the policy of the company will determine the inventory conversion period
and this will have an effect on profitability accordingly. The study results of the
different researchers on the effect of inventories days on firms’ profitability are as
follow;
Mathuva (2009, p. 1) examined the influence of working capital management
components on corporate profitability by using a sample of 30 firms listed on tDar es
Salaam Stock Exchange (DSE) for the periods 2008 to 2011. He used Pearson and
Spearman’s correlations, the pooled ordinary least square (OLS), and the fixed
effects regression models to conduct data analysis. The key findings of his study
were that there exists a highly significant positive relationship between the period
taken to convert inventories into sales (the inventory conversion period) and
profitability.
The research conducted by Lazaridis and Tryfonidis (2006, p. 26) who studied 131
companies listed on Dar es Salaam Stock Exchange for 2008 to 2011 to investigate
the impact of profitability and managing working capital. By using regression and
correlation analysis it was found that there is significant relation between
18
profitability and components of working capital. They found a significant positive
relationship between profit margins and inventory.
On the other hand Samiloglu and Demirgunes (2008, p. 44) conducted the study to
examine the effect of working capital management on company profitability of listed
manufacturing companies in Dar es Salaam Stock Exchange for the period from
2008 to 2011 inventory period used to measure the effect of working capital
management, return on assets is used as a profitability measure. Results from
regression analysis show that profitability has a significant negative relation with
inventory period.
Mathuva (2009, p. 1) and Lazaridis and Tryfonidis (2006, p. 26) suggested that there
is positive relationship between profitability and inventory conversion period as
managers can increase corporate profitability by having longer inventory conversion
period. However Samiloglu and Demirgunes (2008, p. 44) their results show that
profitability has a significant negative relation with inventory period so managers can
increase corporate profitability by reducing the number of inventories period. This is
obvious that companies used for their studies had different inventories policies.
2.7 Cash conversion Cycle and Profitability
2.7.1 Cash conversion cycle
It is a time span between the payment for raw material and the receipt from the sale
of goods. For a manufacturing company we can define it more precisely, it is a time
for which raw material is kept for the processing plus the time taken by the
production process plus the time for which finished goods are kept and sold and the
time taken by the debtors to pay their liability, minus the maturity period of account
payable. By this definition it is quite clear that longer cash conversion cycle require
more investment in the current assets (Arnold 2008, p. 530). Cash conversion cycle
is likely to be negative as well as positive. A positive result indicates the number of
days a company must borrow or tie up capital while awaiting payment from a
19
customer. A negative result indicates the number of days a company has received
cash from sales before it pay its suppliers (Hutchison et al 2007, p. 42).
Inventories days
+
Cash conversion cycle = Accounts receivable days
–
Accounts payable days
As can be seen in figure 2.1, the cash conversion cycle period is determined by the
inventory and accounts receivable period minus the accounts receivable period
(Uyar, 2009)
Figure 2.1: Operating and cash conversion cycle
Source: Uyar (2009 p. 188). The relationship of cash conversion cycle with firm size
and profitability: An empirical investigation in Turkey.
20
2.7.2 The effect of Cash Conversion Cycle on Profitability
As cash conversion cycle is the time span between the expenditure for the purchases
of raw materials and the collection of sales of finished goods. The longer the time
lag, the larger the investment in working capital. A longer cash conversion cycle
might increase profitability because it leads to higher sales.
However, corporate profitability might also decrease with the cash conversion cycle,
if the costs of higher investment in working capital rise faster than the benefits of
holding more inventories and/or granting more trade credit to customers (Deloof
2003, p 573).
Therefore, the ultimate goal is having shorter cash conversion cycle. Cash conversion
cycle can be shortened by reducing the inventory conversion period via processing
and selling goods more quickly; or by decreasing the receivables collection period
via speeding up collections; or by lengthening the payables deferral period through
slowing down payments to suppliers. This increases companies’ efficiency of
internal operations and results on higher profitability (Nobanee, 2009).
The above literature supports shorter cash conversion cycle as it will lead to an
increase in firms’ profitability. Various researchers who studied the effect of cash
conversion cycle on profitability came up with the following results as follows;
Shin and Soenen (1998, p 37) researched the relationship between working capital
management and value creation for shareholders. The standard measure for working
capital management is the cash conversion cycle (CCC).
In their study, Shin and Soenen (1998, p 37) used net-trade cycle (NTC) as a measure
of working capital management. NTC is basically equal to the CCC where all three
components are expressed as a percentage of sales. They examined this relationship
by using correlation and regression analysis, by industry, and working capital
intensity. Using a COMPUSTAT sample of 58,985 firm years covering the period
1975-1994, they found a strong negative relationship between the length of the firm's
21
net-trade cycle and its profitability. Based on the findings, they suggest that one
possible way to create shareholder value is to reduce firm’s NTC.
In a study conducted by Raheman and Nasr (2007, p. 279) who studied the effect of
different variables of working capital management including cash conversion cycle
on the net operating profitability of Pakistani firms. They selected a sample of 94
Pakistani firms listed on Karachi Stock Exchange for a period of six years from 1999
- 2004 and found a strong negative relationship between variables of working capital
management and profitability of the firm. They found that as the cash conversion
cycle increases, it leads to decreasing profitability of the firm and managers can
create a positive value for the shareholders by reducing the cash conversion cycle to
a possible minimum level.
On the other hand, other researchers support that investing more in cash conversion
cycle may lead to increased profitability since maintaining high inventory levels is
expected to increase sales, reduce supply costs, reduce cost of possible interruption
in production and protect against price fluctuations (Blinder &Maccini, 1991, p. 291)
Once again there are mixed results as Shin and Soenen (1998, p. 37) and Raheman
and Nasr (2007, p. 279) suggest that only possible way to create shareholders value
means increasing profitability is by reducing the firm’s cash conversion cycle.
However, Blinder and Maccini (1991, p. 291) support for higher cash conversion
cycle as it leads to higher profitability. Different results may be due to different
policies these companies might have been used in controlling elements of cash
conversion cycle
Working capital management has identified as independent variable while
profitability of the manufacturing sector as dependent variable. Inventory days,
accounts receivable days, accounts payable days and cash conversion cycle has
identified as indicators of working capital management and net operating profit as
indicator of profitability. When there are a less number of inventory days, and a less
number of accounts receivable days and higher number of accounts payable days, it
22
says that there is a good cash conversion cycle. A good cash conversion cycle
indicates proper working capital management. According to literature since there is a
negative relation between proper working capital management and profitability, a
shorter cash conversion cycle finally leads to higher performance in firms.
In summary, the literature review indicates that working capital management affects
profitability of the firm. From different researches we get different results and
conclusions which help the researcher to come up with specific research questions
and developing research methodology as follows:
Specific research questions:
(i) What is the effect of accounts receivable days on profitability of
manufacturing companies?
(ii) What is the effect of accounts payable days on profitability of manufacturing
companies?
(iii) What is the effect of inventories days on profitability of manufacturing
companies?
(iv) What is the effect of cash conversion cycle on profitability of manufacturing
companies?
In spite of the impact working capital management may have on firms’ profitability,
not much has been done in the area of the provision of empirical evidence in support
of the claims of working capital management on profitability performance of
Tanzania firms. Given this rareness of empirical studies, it is hoped that this study
will fill a gap and provide useful support for understanding the effect of working
capital management on firms’ profitability in Tanzania.
23
2.8 Liquidity Ratios
Liquidity ratios provide information about a firm’s ability to meet its short-term
financial obligations they are of particular interest to those extending short term
credit to the firm. There are many types of liquidity ratios as follows.
a) Current Ratio,
Current assets divided by Current Liabilities. These assesses whether you have
sufficient assets to cover your liabilities. A ratio of 2 shows you have twice as many
current assets as current liabilities. This ratio is also known as working Capital ratio
because it is about the excess of current assets over current liabilities. It is calculated
using the following formula.
Current Ratio= Current Assets
Current liabilities
b) Quick or Acid Ratio,
Current Assets (excluding stock) divided by current liabilities. A ratio of 1 shows
liquidity levels are high- an indication of solid financial health. Mathematically it is
expressed as
Acid test Ratio= Current Assets- stock
Current liability
Current Liabilities are those liabilities which must be paid shortly such as creditors
and bank overdrafts. A bank overdraft is considered to be a current liability because
it can be recalled without notice. The ideal ratio should be around 1:1.
c) Defensive Interval,
Liquid assets divided by daily operating expenses. This measures how long your
business could survive without cash coming in. This should be between 30 and 90
days. It is calculated by using the following formula.
Defensive Interval= Current assets- stock
Daily operating expenses
d) Cash Ratio,
It is the most conservative liquidity ratio. It excludes all current assets except the
most liquid. Cash and cash equivalents. The cash ratio is defined as follows;
24
Cash ratio= cash marketable securities.
Current liabilities
The cash ratio is an indication of the firm’s ability to pay off its current liabilities if
for some reason immediate payment were demanded.
2.9 Factor leading to Corporate Performance
a) Technology Forces
Technology refers to the means chosen to do useful work. Technological forces
include not only the glamorous invention that revolutionizes our lives but also the
gradual improvements in methods, in materials, in design, in application, in diffusion
into new industries and in efficiency.
For centuries the simple process of handling business correspondence has involved
dictation, made the process more efficient, include the creation of standardized
shorthand writing system, the invention of type writer, the use of voice recording
machines for dictation and the use of microcomputer for transcription and editing.
All four represent technological change even though only the typing recording and
word processing activities involve machines. So this technology has many effects on
corporate performance since it lead to new product, alternative product and change in
complementary product or services.
b) Social Forces
Social forces include factors that relate to the values, and demographic
characteristics of an organization’s customers. Dynamic social forces can
significantly influence the demand of an organization products or services and can
alter its strategic decision.
The behavior patterns of individuals and groups reflect their attitudes, beliefs, and
values. The social environment includes the altitudes and values of society as well as
behavior which are motivated by those values. The impact of the social factor is felt
in changing needs, taste, and preference of consumers in relation with employees and
in expectations of society about how the organization should fulfill its citizenship
25
role. Expectation concerning responsible use of the physical environment has greatly
increased in business organizations. The attitudes of employee and consequently, the
relationship of employees to the firm are also changing. The willingness to put effort
to earn more money is less evident that it was in the past, a employees opt for more
leisure and depend less on work to meet their needs for esteem and fulfillment so this
led to ineffective corporate performance.
c) Market share.
Market share is the percentage of a market [defined in terms of either units or
revenue] accounted for by a specific entity in a server.
Market need to be able to translate sales targets into market share because the will
demonstrate weather forecasts are to be attained by growing with the market or by
capturing share from competitors.
The latter will almost be more difficult to achieve. Market share is closely monitored
for signs of change in the competitive landscape. And it frequently drives strategic or
tactical action. Increasing market share is one of the most important objectives of
business.
The main advantage of using market share as a measure of business performance is
that it is less dependent upon micro environmental variables such as the state of the
economy or change in tax policy. However increasing market share may be
dangerous of market of fungible hazardous productizes.
Market share is a key indicator of market competitiveness that’s how well a firm is
doing against its competitors. This metric supplemented by changes in salaries
revenue helps managers evaluate both primary and selective demand in their market.
That is enables them to judge not only total market growth or decline but also trends
in customers selections among competitors.
26
Generally sales growth resulting from primary demand (total market growth) is less
costly and more profitable than that achieved by capturing share from competitors.
Conversely loses in market share can signal serious long term problems that require
strategic adjustment firms with market shares below a certain level may not be
viable. Similar within a firms products line market shares trends for individual
product are considered early indicators of future opportunity or problem.
d) Quality of staff is another factor led to effective corporate performance since
employee and other workers of the company are the one who can effluence
the effective corporate performance or ineffective. The quality of staff can be
build by good system of providing employment through required
specification. Equal and good reward and punishment system.
e) Company policy Implementation.
27
CHAPTER THREE
ANALYTICAL FRAMEWORK
3.1 Framework: Variables / Concept.
Variable is the operational zed way in which the attribute is presented for further data
processing. In data processing data are often represented by a combination of items.
Researcher use an experiment to search cause and affect relationships, they design
experiment so that changes to one independent variable led to change of dependent
variables.
In order to analyze the effects of working capital management on the firm’s
Profitability, we used the return on assets (ROA) as the dependent variable.
We defined
This variable as the ratio of earnings before interest and tax to assets. With regards to
the independent variables, we measured working capital Management by using the
number of days accounts receivable, number of days of Inventory and number of
day’s accounts payable. In this respect, number of days
Accounts receivable (AR) is calculated as 365 × [accounts receivable/sales]. This
Variable represents the average number of days that the firm takes to collect
payments from its customers
The higher the value, the higher its investment in accounts receivable.
We calculated the number of days of inventory (INV) as 365 ×
[Inventories/purchases].
This variable reflects the average number of days of stock held by the firm. Longer
storage times represent a greater investment in inventory for a Particular level of
operations.
6
29
The number of days accounts payable (AP) reflects the average time it takes firms to
pay their suppliers. We calculated this as 365 × [accounts payable/purchases].
The higher the value, the longer firms take to settle their payment commitments to
their suppliers
Considering these three periods jointly, we estimated the cash conversion cycle
(CCC). this variable is calculated as the number of days accounts receivable plus the
Number of days of inventory minus the number of days accounts payable. The longer
the cash conversion cycle, the greater the net investment in current assets, and hence
the greater the need for financing of current assets.
Together with these variables, we introduced as control variables the size of the firm,
the growth in its sales, and its leverage. We measured the size (SIZE) as the
logarithm of assets, the sales growth (SGROW) as (Sales1 – Sales0)/Sales0, the
leverage (DEBT) as the ratio of debt to liabilities.
3.2 Analytical Framework
Dependent variable is what you measure in the experiment and what is affected
during the experiment. The dependent variable responds to the independent variable
is called dependent because it depends on the independent variable. In this research
the dependent variable is Corporate Performance.
Independent Variables are the variables you have control over what you choose and
manipulate. It is usually what you think will affect the dependent variable. In some
cases you may not able to manipulate the independent variable. It may be something
that is already there and is fixed, something you would like to evaluate with respect
to how it affects something els
Working capital management has identified as independent variable while
profitability of the manufacturing sector as dependent variable. Inventory days,
accounts receivable days, accounts payable days and cash conversion cycle has
identified as indicators of working capital management and net operating profit as
30
indicator of profitability. When there are a less number of inventory days, and a less
number of accounts receivable days and higher number of accounts payable days, it
says that there is a good cash conversion cycle. A good cash conversion cycle
indicates proper working capital management. According to literature since there is a
negative relation between proper working capital management and profitability, a
shorter cash conversion cycle finally leads to higher performance in firms.
The measure of working capital management is cash conversion cycle. And it is
described by the following equation: Cash conversion cycle=Receivables collection
period + Inventory turnover period –Payable deferral period
For the purpose of analysis, the ultimate measurement of profitability has been
chosen to be return on asset (ROA). The method of calculating cash conversion cycle
(CCC) has been shown earlier as well. The variables are calculated as shown in the
table following. Only the CCC and its components have a unit of days, except for
these, all other variables are expressed in terms of proportion or ratio. The variables
that have been used are as follows: No Variables Method used for Calculation
(i) Return On Asset (ROA) Net Profit / Total Asset
(ii) Net Profit Margin (NPM) Net Profit / Sales
(iii) Interest Coverage Ratio (ICR) Earnings Before Interest and Taxes/Interest
Expense 4 Quick Ratio (QR) (Current Asset - Inventory)/Current Liability
(iv) Cash Conversion Cycle (CCC) RCP + PDP – ITP
(v) Receivables Collection Period (RCP) 360 / (Sales/ Accounts Receivables)
(vi) Payable Deferral Period (PDP) 360 / (COGS/Accounts Payable)
(vii) Inventory Turnover Period (ITP) 360 / (COGS/Inventory)
(viii) Cash to Current Liability ( CTCL) Cash/Current Liability
(ix) Cash to Sales (CTS) Cash/Sales
The ratio of cash to sales has been taken to have an idea if the companies are
enjoying any benefit out of holding cash which reflects in the company’s
profitability. As it has been explained as a probable reason by Lazaridis and
Tryfonidis (2006) that companies enjoy better pricing when they hold enough cash to
31
purchase from own suppliers. Cash to current liability has been taken to observe if
the companies are cautious enough to keep up with their maturing dues or obligations
and if they are benefitting out of this performance as well. Many other variables
have also been considered for the purpose of this study, but those have been excluded
later as they do not show statistically significant relationship with the dependent
variables. Finally the dependent variables used for the research are mainly the
profitability ratios and debt coverage ratio or ROA, NPM and ICR respectively. But
NPM and ICR has also been used as independent variable to assess their impact on
ROA. All other variables are considered to disclose the working capital condition or
cash position of the firm and are used as independent variable against the earlier said
dependent variables.
32
Figure 3.1: Presents the diagrammatically the conceptual framework for this
research
Firms/corporate
performance
Working
Capital
Proper
management of
receivable
(Account
receivable days)
Proper
management of
stock (inventories
days)
Social
factor
Quality of
staffs
Proper
management
payable
(Accounts
payable days)
Financial Indicators
Profitability
(i) The gross profit margin
(ii) Net profit Margin to asset
(iii) Return on capital employed
(iv) Return on investment
Financial indicators
Liquidity
(i) Current and quick ratios
(ii) Debt to equity and debt
(iii) > Cash flow ratios
33
3.3 Hypothesis
The hypotheses developed based on relationship involved between dependent
variable and the Independent variables.
Ho: Firms or Corporate Performance is influenced by inventorydays, accounts
receivable day, account payables day and cash conversion cycle.
Ha: Firms or Corporate Performance is not influenced by inventorydays, accounts
receivable day, account payables day and cash conversion cycle.
3.4 Effective of Working Capital Management
Effective Firms Corporate Performance is encompasses Strategic planning,
budgeting, forecasting workflow, reporting, modeling, scenario planning, and
profitability analysis.
According to key performance indicator such as revenue, return on Investment
(ROI), Overhead, and Operational cost. Indicators of Effective Performance can be
measured by looking profitability ratio as The Gross Margin ratio, Net Profit Margin,
Return on Capital Employed (ROCE) and Return on Investment (ROI), The type of
data required to be collected for analysis will be Income, Cash and Capital and
Carriers of data will be Statement of Financial Position and Cash flow Statement.
3.5 Operational Definition
Financial statement is measured by using financial ratio. Financial ratios are useful
indicators of a firm performance and financial situation. Most ratio’s can be
calculated from information provided by the financial statement’s financial ratio can
be used to analyze trends and to compare the firm’s financial to those of other firms.
In some cases, ratio analysis’ can predict future bankruptcy. Ratio analysis is a good
way to evaluate the financial results of your business in order to gauge its
performance. Ratio allows you to compare your business against different standards
using the figures on your balance sheet.
34
Accounting ratios can offer an invaluable insight into a business performance.
Ensure that the information used for comparison is accurate otherwise the results will
be misleading. The financial ratio is about five types which are activity ratio,
profitability ratio, liquidity ratios, leverage ratios, and stock market ratios
3.6 Financial Strength
Financial Strength ratios go by many names (liquidity, Solvency, Financial
Leverage) but they all point to the same thing. What is the business’s financial
strength and position? A balance sheet oriented value investor looks closely to make
sure that the company will be around tomorrow.
Value investors first look at financial strength for obvious danger. The Indicator of
Financial Strength is as Current and Quick ratios, Debt to Equity and Debt to Assets
and Cash flow ratios The type of data required to be collected for analysis will be
company assets for five years conservative, Company capital, Company Liability and
company Cash and Cash equivalent for five conservative years. And carriers of data
will be Statement of Financial Position and Cash flow Statement.
3.7 Effective Corporate Performance
Effective Corporate Performance is encompasses Strategic planning, budgeting,
forecasting workflow, reporting, modeling, scenario planning, profitability analysis.
According to key performance indicator such as revenue, return on Investment
(ROI), Overhead, and Operational cost. Indicators of Effective Performance can be
measured by looking profitability ratio as The Gross Margin ratio, Net Profit Margin,
Return on Capital Employed (ROCE) and Return on Investment (ROI), The type of
data required to be collected for analysis will be Income, Cash and Capital and
Carriers of data will be Statement of Financial Position and Cash flow Statement.
35
CHAPTER FOUR
THE RESEARCH DESIGN
4.1 Introduction
This chapter covers type of research, research design used, study area, population,
sample size and sampling techniques. Data sources/data collection methods, data
analysis/statistical approaches used including units of analysis, variables and their
measurements, and issues related with internal and external validity.
A good research design is essential for a successful research process. In research
process you have to plan in advance the study areas, the type of research to be
carried out, method of obtain required data, A sample from which data is to be
collected, method to use in collecting and analyzing data, and duration and fund
required to complete the study. A research design will indicate a plan of how you are
going to approach the research question to provide the required answers.
Aaker et all (2002) defined a research design as the detailed blue print used to guide
a research study towards its objectives.
4.2 Type of Research
When it comes to the collections of data it is important to choose data that is suitable
for the study. Two approaches to choose amongst when doing a study within social
science are the qualitative method and the quantitative method (Halvorsen, 1992, p.
78).
The qualitative method is relevant for studies whose objective is to enter more deeply
into a special topic by using a minor population and several variables. The focus with
a qualitative study is directed towards discovering the specific and extraordinary
within a special area in order to obtain an enhanced understanding as a result. To
facilitate such particular result, a closer relation between the researcher and its
36
information objects is often required in difference to the quantitative method
(Halvorsen, 1992, p. 82-83).
As regards to the quantitative method, this methods’ features are focusing more on
the present time and the research is carried out in a more structured and standardize
way in contrast to the qualitative method. The collected data used are more empirical
and quantified and with the help of statistics, researchers use this data to verify or
falsify hypothesises or replicate earlier studies to see if their results agree and can be
generalized (Olsson &Sörensen, 2007).
Researcher has chosen to apply the quantitative approach for her study with the
motivation that she intends to collect data from the companies’ annual reports and
use statistics to determine the statistical relationship between two or more variables.
Since researcher intends to use numerical data to answer research questions she finds
the quantitative method more suitable for this study. Researcher’s intention is not to
interpret her findings but to test and see how well her results agree with earlier
studies.
4.3 Research Design
Research design is a plan for collecting and utilizing data so that desired information
can be obtained with sufficient precision in to test a hypothesis properly or to answer
research questions.
The research is to be conducted in Dar es Salaam city, all manufacturing companies
in Dar es Salaam are referred to as Population of study. From the population a
sample will be selected using judgment sampling technique. The data will be
collected from respective company’s websites.
The analysis of data will be primarily guided by previous empirical studies, namely
Deloof (2003). Pooled ordinary least square regression analysis will be used to
examine the effect of accounts receivable days, accounts payable days, inventories
days and cash conversion cycle on profitability of manufacturing companies. Once
37
research questions have been answered the conclusion will be drawn from the
findings and comparing with the previous researchers’ findings.
4.4 Study Area
The researcher will confine herself in Dar es Salaam city. All Dar es Salaam
municipalities will be taken into consideration and these are Kinondoni, Ilala and
Temeke. Researcher has selected this city because most of the listed manufacturing
companies at stock exchange are in Dar es Salaam. However the chosen area of study
represents the other areas in Tanzania.
4.5 Population
Population is a group of individual’s persons, objects, or items from which samples
are taken for measurement. The entire manufacturing companies in Dar es Salaam
city form the population of the study.
4.6 Sample
4.6.1 Meaning of Sample
A sample is a finite part of a statistical population whose properties are studied to
gain information about the whole (Webster, 1985).
It is difficult and often impossible to study the whole population due to constraints
such as time frame, financial and material resources, etc. It is in this regards that in
this study researcher choose to use sample as her study unit and then after the results
she gets from the sample will be inferred to the whole population.
4.6.2 Sample Size
Kothari (2004 p. 56) defines sample size as the number of items to be selected from
the universe to constitute a sample. The samples have been drawn from the listed
manufacturing companies of Dar es Salaam stock exchange (DSE). The justification
of taking DSE listed companies is that companies listed in the stock markets are
likely to go through a formal regulated audit process and have an incentive to attract
38
new investors and make an impression by presenting profits if those exist in order to
make their shares more attractive. But firms not listed with the stock exchange have
less of an incentive to present true operational results and hide true profit in order to
avoid corporate tax, as according to Lazaridis and Tryfonidis (2006).
The sample size of 4 firms was obtained from 4 industries. And the duration covered
in this study is from year 2008 - 2011. In this study researcher excluded finance
companies such as banks and insurance, service companies like airlines because of
their different nature of operations.
4.7 Sampling Techniques
In line with the objective the researcher’s study, the judgment sampling technique
was be used in the selection of samples. At first the industries were selected. The
sample industries were drawn on the basis of judgmental sampling in order to ensure
diversification in the nature of business. Initially 6 industries were selected from
which 4 industries were finalized.
The selected industries are cement Industry, food processing Industry, tobacco
Industry and beverage Industry. The firms selected from each industry were also
based on judgmental sampling method. From the cement Industry 1company has
been taken, 1 company from food processing Industry, another 1 company from
tobacco Industry, and 1 company from beverage Industry. So the sample size of
firms is 4 (n = 4) of the four industries. And the duration covered in this study is
from year 2008 to year 2011. These specific firms are Tanzania Breweries Ltd, East
African Breweries Ltd, Tanzania Portland Cement Company Ltd and Simba Cement
Company Ltd.
4.7.1 Sample Procedures
The method of sampling will be non probability under judgmental or purposive
sampling that the decision to which element to be included or excluded in the sample
rests on the researcher judgment.
39
Measurements have to be taken into consideration when data is collected. The
method involved will be quantitative approach. Data type will be secondary data
collected by using written sources from the field concerned. Secondary data is the
data that have been already collected by and readily available from other sources.
Such data are cheaper and more quickly obtainable than the primary data and also
may be available when primary data cannot be obtained at all. The information
collected will be critically analyzed to indicate the effective working capital
management.
4.8 Data Sources and Data Collection Methods
The data used in this study have been collected from secondary sources, that is, the
company’s audited annual reports. Data for this study were collected from respective
company’s websites.
4.8.1 Data Analysis
Data analysis is intended to derive descriptive statistics by classifying, organizing
and summarizing the data into tables and graphs based on research conducted. In
addition data analysis will lead to the development of inferential statistics to test the
hypothesis and to allow room for decision making in the improvement of financial
statement analysis in making financial decision within the country.
The statistical tools will also be used in the inferential analysis to reach conclusions
and interpretation on the study. The research will be analyzed based on the objectives
and goals to be achieved in the study and coming up with proper decision.
The analysis of data was primarily guided by previous empirical studies, namely
Deloof (2003). The quantitative data analysis has been adopted by using pooled
Ordinary Least Square (OLS) regression analysis in order to examine the effect of
accounts receivable days, accounts payable days, inventories days and cash
conversion cycle on profitability of manufacturing companies.
40
There are two types of analysis under quantitative analysis which are correlation
analysis and regression analysis. Correlation analysis used to measure the direction
of the linear relationship between two variables as well as to measure the strength of
association between variables (Kothari 2004, p.139).
While Regression analysis determines the statistical relationship between two or
more variables (Kothari 2004, p.141).
As a researcher tends to study the effect of accounts receivable days, accounts
payable days, inventories days and cash conversion cycle on profitability of
manufacturing companies, regression analysis has been used. Due to type of data
available, quantitative data and for the purpose of identifying each variables
influence separately single regression has been chosen.
The limitation of this data analysis is that the technique is demanding because it
requires quantitative data relating to several years. And also Regression analysis is
likely to reach the conclusion that there is a strong link between two variables,
whereas the influence of other, more important, variables may not have been
estimated (this error is called data snooping).
The tool should therefore be used with care. The regression analysis considered net
operating profit as dependent variable and accounts receivable days, accounts
payable days, inventories days and cash conversion cycle as independent variables.
The dependent variable has been regressed against each Independent variable. And
the results have been expressed in the form of regression equation as follows:
γi = αi+ βiXit + εit
Where;
γi = dependent variable of firm i at time t
αi = the intercept of the equation
Xit = different independent variables of firm i at time t
βi = co-efficient of Xit variables
41
εit= the error term
t= time 1, 2….n, where n is the total number of years, n = 4
i= 1…… n, where n is the total number of firms, n = 4
Operational models:
From the general equation various regression models have been formulated as
follows:
Model 1
This model is used to find out the effect of accounts receivable days on net operating
profit
N.O.Pit = αi+ βi (ARDit) + εit
Model 2
This model is used to find out the effect of accounts payable days on net operating
profit
N.O.Pit = αi+ βi (APDit) + εit
Model 3
This model is used to find out the effect of inventories days on net operating profit
N.O.Pit = αi+ βi (IDit) + εit
Model 4
This model is used to find out the effect of cash conversion cycle on net operating
profit
N.O.Pit = αi+ βi (CCCit) + εit
Where;
N.O.Pit = net operating profit for firm i in year t
ARDit = accounts receivable days for firm i in year t
APDit = accounts payable days for firm i in year t
IDit = inventories days for firm i in year t
42
CCCit = cash conversion cycle for firm i in year t
4.9 Data Analyses Strategy and Decision Criteria
After collection, data editing and cleaning will be done to ensure data consistency,
uniformity and completeness. The researcher will employ the use of computer
software such as Ms Excel for analysis and presentation. This is due simplicity and
ability to draw graphs and tables and hypotheses testing.
Data analysis is intended to derive descriptive statistics by classifying, organizing
and summarizing the data into tables and graphs based on research conducted. In
addition data analysis will lead to the development of inferential statistics to test the
hypothesis and to allow room for decision making in the improvement of financial
statement analysis in making financial decision within the country.
The statistical tools will also be used in the inferential analysis to reach conclusions
and interpretation on the study. The research will be analyzed based on the objectives
and goals to be achieved in the study and coming up with proper decision
4.9.1 Variables and Measurement
The choice of variables was also guided by previous empirical studies and by the
availability of data. Thus, the variables are defined to be consistent with those of
Deloof (2003) and other empirical literature cited above.
Net operating profit that is a measure of profitability of firm is used as dependent
variable. It is defined as:
Net operating profit = Sales - Cost of sales
Total assets - Financial assets.
Accounts receivable are customers who have not yet made their payment for goods
or services, which company has already provided. The number of day’s accounts
receivable reflects the time between the sale and the receipt of payment. In this
43
respect, number of days accounts receivable used as proxy for the collection policy
and is an independent variable. It is calculated as
Accounts receivable days = Accounts receivable x 365
Sales
Inventories are lists of stocks of raw materials, plus work in progress or finished
goods waiting to be consumed in production or to be sold. The number of days
inventories reflects the number of days of stock held by a firm. It was used as a
proxy for the inventory policy also is an independent variable, and is calculated as
Inventories days = Inventories x 365
Cost of goods sold
Accounts payable are suppliers whose invoices for goods or services have been
processed but who have not yet been paid. The number of days accounts payable,
reflects the time it takes companies to pay their suppliers. It was used as a proxy for
the payment policy and is also an independent variable. It is calculated as
Accounts payable days = Accounts payable x 365
Cost of goods sold
The cash conversion cycle used as a comprehensive measure of working capital
management is another independent variable. It is calculated as
Cash conversion cycle = Accounts receivable days + Inventories days – Accounts
payable days
4.9.2 Validity
Bryman and Bell (2005, p. 597) refers to validity as “a measure of how well a
specific measurement of a concept, really gives an accurate picture of the concept”.
In this study researcher aims to examine the effect of accounts receivable days,
44
accounts payable days, inventories days and cash conversion cycle on profitability of
manufacturing companies. The data consist of figures collected from companies’
annual reports so there is no risk for misinterpretation of the numbers. The figures
are converted into number of days according to the cash conversion cycle equation
which is a well-known concept which strengthen the validity that the components
give an accurate picture of the concept.
4.10 Conclusion
The conclusion will be drawn by interpreted those financial ratio calculated from
financial statement of Twiga Cement over five conservative years to evaluate the
effective Corporate Performance.
45
CHAPTER FIVE
DATA ANALYSE AND DISCUSSIONS ON THE FINDINGS
5.1 Introduction
Data were obtained from a sample of four Manufacturing companies, availability of
information, and year of establishment were also considered for selecting the sample
Industries. The study covered a period of four years from 2008 to 2011. This study
was based on both primary and secondary data. The primary data were collected
through questionnaire survey with an object to know the real practices of working
capital management in Industries
The Questionnaire was divided into four parts in accordance with the major
dimension of working with the major dimension of working capital management.
Working Capital Management, Cash Management, Inventory Management,
Accounts Receivable Management and others. Secondary time series data were
taken to see the profitability and the link between profitability and working capital
management.
For the purpose of examining and providing empirical evidence on the effects of
accounts receivable days, accounts payable days, inventories days and cash
conversion cycle on profitability of the manufacturing companies, researcher has
used single pooled OLS regression analysis. Ordinal least square is the method for
estimating the unknown parameter in a linear regression model.
Findings have been categorized according to specific research questions and
objectives, and these are as follows
47
5.2 The Effect of Accounts Receivable Days on Profitability of
Manufacturing Companies
Table 5.1: Regression output: Accounts receivable days and profitability
Variable Accounts receivable days
Coefficient 0.000104771
P – value 0.960911843
R square 0.000165537
Table 5.2. Presents the regression output on the effects of accounts receivable days
on profitability of manufacturing companies. The results indicate that the coefficient
of accounts receivable days is positive (Coefficient: 0.0001) but the relationship is
not statistically significant because its p-value which is 0.96 is definitely larger than
0.05. R-square is 0.00016; means that only 0.016% variation in profitability is caused
by changes in accounts receivable days this makes the results to be insignificant.
The findings are different from the study results of Deloof (2003, p.573) and
Nobanee and AlHajjar (2009b) who found significant negative relationship between
gross operating income and the number of days accounts receivable. However the
findings are the same with Ramachandran and Janakirama (2006, p.61) as through
regression analysis it was found that there is a positive relationship between
collection period and EBIT though the above findings are not statistically significant.
5.3 The Effect of Accounts Payable Days on Profitability of Manufacturing
Companies.
Table 5.2: Regression output: Accounts payable days and profitability
Variable Accounts payable days
Coefficient 0.001087677
P – value 0.046696781
R square 0.238505872
48
Table 5.3.1 presents the results of the effect of accounts payable days on profitability
of manufacturing companies. The accounts payable days positively impacting the
profitability (Coefficient: 0.0011) though is too low.
The relationship is significant as p-value is 0.05. R-square is 0.238, indicating that all
things being equal, 23.8% of the variations in profitability is caused by changes in
accounts payable days. Even though the results are not highly significant but do
make economic sense, since the longer a firm delays its payments the higher level of
working capital levels it reserves and uses in order to increase profitability. Thus, the
more profitable firms wait longer time to pay their bills.
The results are the same as Ghosh and Maji (2003) findings who through regression
analysis they found that there is a positive relation between accounts payable period
and EBIT, which means profitable firms delay their payables. However findings
differ from Falope and Ajilore (2009, p. 73) who used a sample of 50 Nigerian
quoted non-financial firms for the period 1996 -2005 and Garcia-Teruel and
Martinez-Solano (2007, p 164) who studied the effects of working capital
management on the profitability of a sample of 8,872 small and medium-sized
enterprises (SMEs) from Spain covering the period 1996 - 2002 as they found a
significant negative relationship between net operating profitability and average
payment period.
5.4 The Effect of Inventories Days on Profitability of Manufacturing
Companies.
Table 5.3: Regression output: Inventories days and profitability
Variable Inventories days
Coefficient 0.001792273
P – value 0.000213248
R square 0.610339671
49
Table 5.4.1 presents the results of the effect of inventories days on profitability of
manufacturing companies. Inventories days affect profitability positively
(Coefficient: 0.002). The relationship between inventories days and profitability is
statistically significant at 1 per cent significance level as p - value is 0.0002. R-
square is 0.6103, indicating that all things being equal 61.03 per cent of the
variations in profitability has been caused by changes in inventories days.
This means that maintaining high inventory levels reduces the cost of possible
interruptions in the production process and the loss of business due to scarcity of
products. Maintaining high levels of inventories also helps in reducing the cost of
supplying the products and protects the firm against price fluctuations.
This is consistent with Mathuva (2009, p. 1) who examined the influence of working
capital management components on corporate profitability by using a sample of 30
firms listed on the Nairobi Stock Exchange (NSE) for the periods 1993 to 2008 and
Lazaridis and Tryfonidis (2006, p.26) who studied 131 companies listed on Athens
Stock Exchange for the period of 2001 to 2004 to investigate the impact of
profitability and managing working capital as they found a significant positive
relationship between profit margins and inventory and they suggested that managers
can increase corporate profitability by having longer inventory conversion period.
However the findings are contrary to Samiloglu and Demirgunes (2008, p. 44) who
conducted the study to examine the effect of working capital management on
company profitability of listed manufacturing companies in Istanbul Stock Exchange
for the period from 1998 to 2007 as the results from regression analysis show that
profitability has a significant negative relation with inventory period.
50
5.5 The Effect of Cash Conversion cycle on profitability of Manufacturing
Companies.
Table 5.4: Regression output: Cash conversion cycle and profitability
Variable Cash conversion cycle
Coefficient 0.000780167
P – value 0.226600907
R square 0.095835213
Table 5.5.1 shows the results of the effect of cash conversion cycle on profitability of
manufacturing companies. With the positive coefficient of 0.0008 means that the
relationship is positive but not statistically significant as p-value of 0.22 being larger
than 0.05. R-square is 0.096, means that all other things remain constant only 9.6%
variations in profitability is caused by changes in cash conversion cycle hence makes
the whole results to be insignificant.
The findings are contrary to Shin and Soenen (1998, p 37) who researched the
relationship between working capital management and value creation for
shareholders and Raheman and Nasr (2007, p. 279) who studied the effect of
different variables of working capital management including cash conversion cycle
on the net operating profitability of Pakistani firms.
Their results show a strong negative relationship between the cash conversion cycle
and its profitability as managers can create a positive value for the shareholders by
reducing the cash conversion cycle to a possible minimum level.
The research objectives has been achieved as researcher has been able to produce the
findings of the effect of accounts receivable days, accounts payable days, inventories
days and cash conversion cycle on profitability of the manufacturing companies in
Tanzania.
51
5.6 Findings and Discussion
There are four parts in this section. The first part shows the profitability position of
the manufacturing companies.
In the second part the position of working capital is analyzed. The third part focuses
on correlation between profitability and working capital management and the last
part showed the impact of working capital management on profitability
5.6.1 Profitability of the selected Manufacturing companies
Profitability of the Firm`s can be assessed by gross profit margin ratio, net profit
ratio, return on investment, operating profit ratio, return on capital employed and
return on total assets
5.6.2 Gross Profit Margin
The earnings in terms of sales can be accessed through the profit margin. The gross
profit margin reflects the effectiveness of pricing policy and of production efficiency.
Some authors consider that a profit margin ratio ranging from 20% to 30% may be
considered as the standard norm for any industrial enterprise.
5.6.3 Net Profit Margin
The ratio of net profit margin reveals the overall profitability of the concern, that’s
why it is very useful to the shareholders and the prospective investors. It also
indicates management efficiency.
5.6.4 Operating Profit Ratio
It represents the overall earnings of an enterprise and one can get a clear idea about
the efficiency of an enterprise from its operating profit ratio. The higher the ratio, the
better is the overall efficiency of the enterprise. Operating profit ratio ranging from
4% to 6% is considered the norm for the purpose of comparison and control by some
authors
52
CHAPTER SIX
CONCLUSION AND RECOMENDATION
6.1 Introduction
This study shows the effect of accounts receivable days, accounts payable days,
inventories days and cash conversion cycle on profitability of Tanzania
manufacturing firms. After analyzing the data for the period of 4 years from 2008-
2011 by using pooled ordinary least square regression analysis, conclusion has been
drawn based on specific research objectives as follows;
6.2 Conclusions
This study finds a negative relationship between cash conversion cycle and
profitability of the Firm. This study extends the earlier said studies in the sense that
this study shows a strong positive relationship of profitability with the firms’ cash
holding position along with other indicators. And it also recommends that the firms
should forecast their sales and hold cash enough as according to their projected sales
level, so that they are able to take advantage of the bargaining position while making
purchases and thus reduce cost.
It is very clear that the efficient management of working capital and liquidity has a
positive effect on the firms’ profitability. So this study clearly asserts that, firms in
the manufacturing companies in Tanzania have enough scope to enhance their
profitability by handling their working capital in more efficient ways. Especially, the
inventory turnover if handled efficiently can produce a significant positive impact on
profitability of the firm. Thus this study finds enough evidences that a firm is likely
to enjoy better profitability if the firm manages its working capital with better
efficiency and focuses on cash position with more care.
This study aimed to examine the effect of working capital management on firm`s
profitability
53
6.2.1 The Effect of Accounts Receivable Days on Profitability of
Manufacturing Companies.
The research objective was to find out the effect of accounts receivable days on
profitability of manufacturing companies. Previous researchers found negative
relationship between accounts receivable days and corporate profitability (Deloof
(2003, p.573) and Nobanee and AlHajjar (2009b)).
But Ramachandran and Janakirama (2006, p.61) found a positive relationship
between accounts receivable days and net operating profitability.
However from the findings I found a positive relationship between accounts
receivable days and profitability of manufacturing companies in Tanzania but with
no significance. This may be due to sample size being too small to warrant
meaningful interpretation as OLS regression analysis requires quantitative data
relating to several years.
The policy implication of this study is that accounts receivable days need more
consideration. Accounts receivable have opportunity cost associated with them
because company cannot invest this money elsewhere until and unless it collects its
receivables.
More accounts receivable can raise the profit by increasing the sale but it is also
possible that because of high opportunity cost of invested money in accounts
receivable and bad debts the effect of this change might turn difficult to realize. On
the other hand if a company adopts a policy to have a low level of accounts
receivable then it can reduce the profitability by reducing the sales but it can
contribute to the profit by reducing the risk of bad debts and by reducing investment
in the receivable (Andrew & Gallagher 1999, p.465).
54
6.2.2 The Effect of Accounts Payable Days on Profitability of Manufacturing
Companies.
Another specific research objective was to find out the effect of accounts payable
days on profitability of manufacturing companies. Researcher found a positive
significant relationship between accounts payable days and net operating
profitability. This means the longer the accounts payable days the higher the
profitability of manufacturing companies in Tanzania.
Researcher’s findings are consistency with Ghosh and Maji (2003) as they reported a
positive relation between payable period and Earnings before interest and tax.
However the policy implication of this is that even though the companies should try
to prolong the time of payment as long as possible as they can use the advantage of
their suppliers financing their investments until payment has been made, but on the
other hand, delaying of such payables can be expensive if a firm is offered a discount
for the early payment or is being charged for late payment so manufacturing
companies need to take into consideration about the accounts payable days.
6.2.3 The Effect of Inventories Days on Profitability of Manufacturing
Companies.
To find out the effect of inventories days on profitability of manufacturing
companies was another specific research objective. As a result researcher found that
there is significant positive relationship between inventories days and net operating
profit. Her findings are in line with Mathuva (2009, p. 1) and Lazaridis and
Tryfonidis (2006, p. 26) findings as they suggested that managers can increase
corporate profitability by having longer inventory conversion period.
The policy implication of this result is that there should be a proper inventory
management system to avoid over stock of inventory resulting efficient outcome of
investment.
55
6.2.4 The Effect of Cash Conversion Cycle on Profitability of Manufacturing
Companies.
Finding the effect of cash conversion cycle on profitability of manufacturing
companies was one of the specific research objectives. From the findings I found a
positive relationship between cash conversion cycle and net operating profitability
but with no significance. Again this may be due to sample size being too small to
warrant meaningful interpretation as OLS regression analysis requires quantitative
data relating to several years.
The policy implication here is that manufacturing companies need to pay attention on
cash conversion cycle as longer cash conversion cycle might increase profitability
because it leads to higher sales.
However, corporate profitability might also decrease with the cash conversion cycle,
if the costs of higher investment in working capital rise faster than the benefits of
holding more inventories and/or granting more trade credit to customers (Deloof
2003, p 573).
6.3 Limitations of the Study
This study is limited to the sample of Dar es Salaam manufacturing firms which are
listed on Dar es Salaam stock exchange. The findings of this study could only be
generalized to manufacturing firms similar to those that were included in this
research.
The study conducted to examine the effect of working capital management on firms’
profitability, there are lots of measures one can choose to measure the profitability of
the firm like gross operating profit, net operating profit, return on assets, return on
capital etc. However is not possible for researcher to conduct a research by
considering all the measures of the profitability. So, net operating profit was chosen
by researcher as a measure of profitability.
56
Lastly, the study was conducted over the period of four years from 2008 to 2011
which is shorter compare to other researchers of different countries. Researcher also
was unable to get some of the financial data of some companies for some years
which lead her not to produce meaningful interpretation for some of the specific
research objectives. Those objectives are to find out the effect of accounts receivable
days and cash conversion cycle on profitability of manufacturing companies
Throughout this study the researcher face some limitation in carrying out the study,
common limitation where disclosure of some of the information, interviewee to
reveal their education level, failure to return questionnaires on time and cooperation
from the subject of the study, these are discussed below
(i) Information disclosure: This is the one of the limitation researcher face when
carrying out the study, Interview where having time hard time to give
sensitive information on what they have done so far, the reasons observed
was fear of being seen as if they have done not too much to society.
(ii) Education: The researcher also getting hard time to know interview profile,
the one with high level of education were cooperative in giving their
education profile.
(iii) Corporation: Research received little corporation from some of the
interviewe,the reasons behind is that they are too busy to get time to be
interviewed or even to fill questionnaires and give detailed information
6.4 Areas for Further Research
Further empirical studies to be undertaken on the same topic with different sectors
and extending the years of the sample in order to warrant meaningful interpretation
as regression analysis requires quantitative data relating to several years. The scope
of further research may be extended to the working capital management components
including cash, marketable securities etc.
57
6.5 Recommendation
However, in view of the concluding remarks, the following suggestions are given for
increasing efficiency in working capital management as well as profitability on the
basis of the analysis as well as information gathered through questionnaire:
(i) Monthly performance evaluation should be done as maximum textiles under
the study evaluate the same.
(ii) Inventory should be turned out quickly.
(iii) Fund flow statement should be prepared periodically.
(iv) Cost audit should be done continuously.
(v) For cash management, cash budget, cash flow statement, cost minimizing
model like Baumol Model, Miller-Orr, etc. Model should be used.
(vi) Lead time should be reduced.
(vii) Account Receivable turnover in days should be reduced.
(viii) Inventory turnover in days should be reduced.
(ix) Cash Conversion Cycle is said to be the heart of working capital
management. The study reveals that the cash conversion cycle should be
reduced.
(x) Investment in Current Assets should be increased.
(xi) Current Liabilities should be reduced.
(xii) For most of the selected textiles the net working capital is negative. It should
be improved. m. Liquidity management should be more organized.
58
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61
APPENDICES
Appendix 1: Questionnaire
This questionnaire is part of the research study on the Effect of working capital
management on Firm` profitability a case of selected manufacturing companies in
Dar es Salaam in Tanzania. The research is in partial fulfillment of Finance for
Emmanuel Fredrick a student of Mzumbe University.
The information communicated in this form is strictly confidential and will not, in
any circumstances, be divulged to third parties. You are therefore kindly requested to
answer the questions herein as honestly, objectively and accurately as possible. The
results of this survey will be used solely for the purpose of the research investigation
and no direct mention or allusion to respondents or the organization they represent
will be made.
Please answer all the following questions according to the instruction given. You are
therefore kindly asked to complete this work within a week from the date of
submission.
You name will not appear anywhere in this questionnaire.
I thank you for taking time to complete this survey questionnaire.
62
Please answer the questions according to the instruction:
SECTION A: (MANAGEMENT AND EMPLOYEES).
Fill the blanks or Tick the appropriate answer
1. Gender
Male………………. Female…………..
2. What your Position in these companies?
(i) Director
(ii) Manager
(iii) Supervisor
(iv) Others specify……………….
3. What is your experience (years) concerning your position?........................
4. Do you have ability and competencies to lead these companies?
(i) Yes
(ii) No
5. If the answer above is yes mention at least four reasons you able and
competent to lead
(i) ………………………………………….
(ii) …………………………………………
(iii) ………………………………………..
6. Referring to the question above, of being able and competent to lead, how do
you perform your leadership role in these companies?
7. Does working capital management affect the profitability of manufacturing
companies?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
63
If yes how working capital management affect on firm's profitability Tanzania
………………………
8. Does an Account receivable day on profitability affect manufacturing
companies?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
9. Does an Account payable day on profitability affect manufacturing
companies?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
10. Does Inventories days on profitability affect manufacturing companies?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
11. Does Cash conversion cycle on profitability affect manufacturing companies?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
12. Are there any challenges/problems on profitability manufacturing companies?
Yes [ ]
No [ ]
I don’t know [ ]
64
13. Is it true that working capital management on firm's profitability affect
manafacturing Companies in Tanzania?
(i) Yes [ ]
(ii) No [ ]
(iii) I don’t know [ ]
14. Below are factors which are affect working capital management on Firms'
profitability manucturing companies, choose only four factor only
(i) Accounts receivable days [ ]
(ii) Accounts payable days [ ]
(iii) Inventories days [ ]
(iv) Cash conversion cycles on profitability [ ]
(v) Economic factor [ ]
15. Please state five reasons why you think there is a the effect of working capital
management on firm profitability
(i) …………………………………………………………………………
(ii) …………………………………………………………………………
(iii) …………………………………………………………………………
(iv) …………………………………………………………………………
(v) …………………………………………………………………………
THE RESEARCHER THANKS YOU AND APPRECIATES YOUR
COOPERATION.
65
Appendix 2: Financial data of manufacturing companies from 2008 to 2011
COMPANY
NAME CODE YEAR
DEPENDENT
VARIABLE
INDEPENDENT
VARIABLES
Tanzania
Breweries
Ltd
Net Operating
Profit
Accounts
receivable
days
Accounts payable
days
Inventories
days
Cash
conversion
cycle
1 2008 0.62361648 24.55535497 128.577632 86.63997039 -17.38230662
1 2009 0.521048317 25.53057977 99.70129226 98.30953839 24.13882591
1 2010 0.497274897 20.08631679 114.0602447 110.9373867 16.96345882
1 2011 0.539787817 11.56692504 115.5131498 113.7201702 9.773945417
East African
Breweries
Ltd
2 2008 0.522498058 46.20309069 198.1157638 143.3196293 -8.593043816
2 2009 0.483599796 44.13848493 193.0837885 148.4509475 -0.494356028
2 2010 0.499496583 52.78316398 185.3712685 64.73612274 -67.85198181
2 2011 0.444707481 57.44770062 217.1240676 70.33259659 -89.3437704
Tanzania
Portland
Cement
Company
Ltd
3 2008 0.407082911 6.331637697 111.7686557 103.9231692 -1.513848777
3 2009 0.480642457 9.420909891 108.4814782 124.5340944 25.4735261
3 2010 0.468882132 9.696048409 72.62557157 150.5165746 87.58705145
Simba
Cement
Company
Ltd
4 2008 0.590762422 13.83866042 76.43666692 112.0298375 49.43183095
4 2009 0.482755703 11.59462426 60.7696256 98.22622292 49.05122159
4 2010 0.418504879 17.42300022 50.00286327 102.9833084 70.40344537
4 2011 0.333367985 19.05567363 61.30167297 108.4240467 66.17804732
66
Appendix 3: Regression summary output
• Accounts receivable days as independent variable
Regression Statistics
Multiple R 0.012866137
R Square 0.000165537
Adjusted R Square -0.066490093
Standard Error 0.136513573
Observations 17
ANOVA
Df SS MS F Significance F
Regression 1 4.62819E-05 4.62819E-05 0.002483473 0.960911843
Residual 15 0.279539335 0.018635956
Total 16 0.279585617
Coefficients Standard
Error
t Stat P-value Lower 95% Upper 95%
Intercept 0.52531367 0.061140936 3.53694E-07 0.394994849 0.65563249
Accounts
receivable
days
0.000104771 0.002102371 0.049834458 0.960911843 0.004376328 0.004585869
• Accounts payable days as independent variable
Regression Statistics
Multiple R 0.48837063
R Square 0.238505872
Adjusted R Square 0.187739597
Standard Error 0.119136562
Observations 17
67
ANOVA
Df SS MS F Significance F
Regression 1 0.066682811 0.066682811 4.6981164 0.046696781
Residual 15 0.212902806 0.01419352
Total 16 0.279585617
Coefficients Standard
Error
t Stat P-value Lower 95% Upper 95%
Intercept 0.387478134 0.070925975 5.46313437 6.543E-05 0.236302996 0.538653271
Accounts
payable
days
0.001087677 0.000501808 2.167513884 0.0466968 1.80974E-05 0.002157256
• Inventories days as independent variable
Regression Statistics
Multiple R 0.78124239
R Square 0.610339671
Adjusted R Square 0.584362316
Standard Error 0.08522262
Observations 17
ANOVA
Df SS MS F Significance F
Regression 1 0.170642194 0.170642194 23.49506581 0.000213248
Residual 15 0.108943424 0.007262895
Total 16 0.279585617
Coefficients Standard
Error
t Stat P-value Lower 95% Upper 95%
Intercept 0.298999271 0.051544264 5.800825272 3.49549E-05 0.189135273 0.408863269
Inventories
days
0.001792273 0.000369756 4.847170908 0.000213248 0.001004156 0.00258039
68
• Cash conversion cycle as independent variable
Regression Statistics
Multiple R 0.309572629
R Square 0.095835213
Adjusted R Square 0.03555756
Standard Error 0.129818199
Observations 17
ANOVA
Df SS MS F Significance F
Regression 1 0.026794147 0.026794147 1.589896234 0.226600907
Residual 15 0.25279147 0.016852765
Total 16 0.279585617
Coefficients Standard
Error
t Stat P-value Lower 95% Upper 95%
Intercept 0.5098764 0.034570192 14.74901858 2.46285E-10 0.436191781 0.583561019
Cash
conversion
cycle
0.000780167 0.000618733 1.260910875 0.226600907 -0.000538631 0.002098965