Literature on Working Capital Management and Profitability

Literature on working Capital Management and positivityRegarding the explore of running(a) neat wariness and make headwayableness. This chapter exists of literature review of divers(prenominal) inquiryers and their studies findings in accordance to the region their studies ar based on. I testament start with the region of United States of Ameri raft and followed by the European countries. Studies from separate countries not included in the aforementioned regions go forth be draw in the following topic. This chapter ends with a table summarizing the findings of different authors from this literature review.Variables interpretationAverage exhibition Period on favourablenessIn an bind wrote by Milling (1991, p. 48), he mentioned thatAverage intoxicateion beat halt dance steps the dot that a firms middling sales dollar remains outstanding as an account delinquent.Average collection period is formulated by dividing accounts receivable by salesand multiplying b y the number of age in a course of study (365). It is the average number of days which a firm manages to collect its outstanding debts from customers (Garcia-Teruel Martinez-Solano, 2007). According to Lazaridis and Tryfonidis (2006), acerage collection period is one of the components to meter the hard currency renewal troll which is manageable to increase the profitableness and im shew firms increment. In Raheman and Nasr (2007) research adaptation, the correlativity compend amidst average collection period and net operating lucrativeness shows a negative coefficient. This means that if the average collection period increases, it will lower the profits in return. However, the Pearsons cor analogy proved thither is a soaked positive family among average collection period and interchange transformation turns/second. Most moneymaking firms argon observed to be possessed of a shorter period of collection period (Deloof, 2003). These same firms a re also larger in size, have higher sales growth and lower debt funding.Further research do by Garcia-Teruel and Martinez-Solano (2007) had itsresult consistent with Deloof (2003) finding. They had agreed that elongate the deadlines for customers to re get their payments may project greater payment facilities, further would negatively affect the profitability of a firm. Sales may also be change magnitude receivable to the leniency of firms collection policy.To increase corporate value, a high feature accounts receivable portfolio couldbe relieve oneselfd, safeguarded and realized through effective quotation oversight. This is repayable to heavy investments in accounts receivable by larger corporations. Hence, Pike and Cheng (2001) mat up it is important to control the mention watchfulness policy and practices choices in rate to maximize value. The lower the investments placed on accounts receivable, the more reduction in interest be, hence, a respectable increase in earnings (Milling , 1991). in like manner that, there is a close kind betwixt sales growth and the take of authentic assets (Kim, Rowland Kim, 1992). The example given was that the increment in credit sales will make it to higher inventories and accounts receivable. It is unavoidable to invest in current assets in that matter.According to Deloof (2003, p.584)An alternative explanation for the negative relation between accounts receivable and profitability could be that customers want more era to assess the quality of products they buy from firms with declining profitability.Schwartz (1974) debated that firms that be able to obtain gold at lower cost would offer trade credit to firms set about higher financing cost through finance-based models. Emery (1984) was able to conclude that investments in trade credit are a much better pickax for short-term investment than market securities. The advantage of trade credit fag be spontaneous and exist without formalities, but the limitation is that it is purchasable for goods and work only (Hossain Akon, 1997). line of descent Turnover on ProfitabilityZero stock and Just-in-time manufacturing had been a popular scroll heed practices (Reynolds, 1999). In much simpler terminology, inventory employee turnover means the cycle of using and replenishing goods. According to Reynolds (1999), inventory turnover psychoanalysis has major importance because inventory management directly wedge operations profitability. This analysis serves as a measure of firms efficiency and profitability. Inventory turnover analysis can assist fiscal managers in recognizing problems and can help reduce associated costs.Average Payment Period on ProfitabilityCompanies of different sizes (small, medium and large) are now taking longertime period to repay their debts (Anonymous, 2005). The same author also mentioned that was affected due to larger companies imposing longer payment terms on their suppliers, who are usually not in a position to choos e. Companies in a lower part of the chain would face specie flow problems as companies on the upper chain wait for payment before they pay their suppliers.Cash Conversion Cycle on ProfitabilityThe notes conversion cycle is able to capture the impact of an effective on the job(p) crown management policy, which are due to the effects from turnover of receivables, inventories and payables. The function of interchange conversion cycle is defined by Jose, Lancaster and Stevens (1996, p.34)The CCC measures the time between cash outlays for resources and cash receipts from product sales. The CCC is dynamic in the sense it combines both balance sheet and income statement selective information to create a measure with a time dimension.Richards and Laughlin (1980) consequently operated this concept by measuring the number of days currency are committed to receivables and inventories and little the number of days payments are deferred to suppliers. Shin and Soenan (1998) are able to pro ve a strong correlation between cash conversion cycle and profitability. Even so, they apply a substitute of cash conversion cycle called the net work cycle.Using this cash conversion cycle, also cognise as cash-to-cash (C2C), companies could testify a point of reference for inter-firm comparisons. Besides ameliorate profits earned, companies could obtain overall efficiencies and balance supply chain operations (Hutchison, Farris II Anders, 2007).Regional United States of AmericaAccording to a research done by Kim, Rowland and Kim (1992), it was aboutthe implications of running(a) neat management practices by Nipponese manufacturers in the US. This study is to determine the clinicals of functional jacket management by Japanese manufacturers in US and to identify options for funding. As Japans opposed direct investment in the business expansion of US has increased rapidly, therefore, it is important to manage the firms working great well. International working pileu s management has significant importance as total assets and liabilities of multinational corporations consist of current assets and short-term liabilities. There are few differences in financial structure between the US companies and Japanese manufacturersJapanese firms rely more on banks short-term debt.Japanese firms project a lower level of net working capital.Japanese firms operate with about half as much equity as US firms.Japanese firms hold twice as much in long-term investments as US firms.Japanese firms reported lower inventory level more accounts receivables and twice as much cash as US firms.Questionnaires were sent out to Japanese manufacturing companies operating in US. Executives from these Japanese-owned firms perform this survey to determine the companys working capital policies and practices. The data reverted back to researchers show that Japanese firms rated the virtually important objective of working capital management is to be providing current assets and lia bilities in second of pass judgment sales, while minimizing investments in current assets being the least important. Moreover, most of their short-term financing were sources from Japanese banks.In 1996, Jose, Lancaster and Stevens performed a research on the kin ofcorporate returns and cash conversion cycle. This study examined the long-run balance wheel relationship between a measure of ongoing liquidity postulate (cash conversion cycle) and measures of profitability. Data collected were from the annual Compustat tapes, which covers the twenty- grade period starting from social class 1974 to 1993. There are altogether 2,718 firms which have complete data required. The variable quantitys were tried using nonparametric and multiple regression analysis, with the industry and size variable controlled. Richards and Laughlin (1980) and Emery (1984) had noted the constraints of using traditional financial ratios and believed in the liquidity management measures to reflect the abi lity of firms meeting their short-term financial obligations. feed on assets (ROA) and return on equity (ROE) measures are also included in this study to separate asset management and financing influence. Jose, Lancaster and Stevens concluded that there are key findings for ROA and ROE. These asset management returns and levered returns revealed an increase in mathematical process and benefits.Shin and Soenan (1998) did a study to test the efficiency of working capitalmanagement to create profitability. They apply a Compustat sample of 58,985 firms covering the period 1975 1994. The relationship between the length of net trading cycle, corporate profitability and risk-adjusted stock return was examined. scratch trading cycle could be computed as belowNet Trading Cycle = (Inventory Turnover + Average Collection Period Average Payment Period) x (365 / Sales)The outcome of the study shows strong negative relation between the length of firms net trade cycle and profitability. They also considered that working capital efficiency increases profitability there will be a negative relationship between net trading cycle and stock return. The examination of this relationship is done using the correlation and regression analysis, by industry and working capital intensity. In their study, it is mentioned that working capital is a result of the cash conversion cycle. Gentry, Vaidyanathan and Lee (1990) actual the weighted cash conversion cycle, which masters the timing by the meat of funds in each step of the cycle. On the other hand, Deloof (2003) said that this system could not be used due to incompleteness of information available for count. Liquidity ratios, such as current ratio and acid-test ratio, could not measure the working capital management efficiently due to reasons that these ratios include calculation of assets which are not readily available to be converted into cash and the ratios ignored the timing of cash conversion (Shin Soenan, 1998). In all , maximum working capital efficiency is an essential factor of total corporate outline to create shareholders value.A research was done on the international working capital of multinationalcorporations by Dr. Hadley Leavell from Sam Houston State University. His journal was make in 2006. To enhance profitability of multinational corporations, Ricci and Di Vito (2000) suggested reducing the floating costs of time value, ventes on outstanding accounts receivables, transaction costs and orthogonal exchange conversion costs when moving cash between countries. However, the impediment to overcome regulatory and geographical barriers may lead to a loss of control and payment regulations placed on cross-border cash concentration to maximize profitability.Regional EuropeIn year 2003, Deloof investigated the relation between working capitalmanagement and profitability of a sample 1,009 large Belgian non-financial firms between old age 1992 1996. The cash conversion cycle was considere d as the statewide measure for working capital, whereas gross operating income is the measurement for profits. There is the weighted cash conversion cycle modified by Gentry, Vaidyanathan and Lee in 1990, but was not applied by Deloof because of the limited information availability. Deloof relate the correlation and regression analysis to his research to prove that there is a relationship between working capital management and profitability.Another research done in Europe is by Lazaridis and Tryfonidis in year 2006.They investigated the relationship between working capital management and corporate profitability of a sample of 131 companies listed in the Athens Stock Exchange. Data was collected from year 2001 2004. In this research, profitability was measured through gross operating profit and cash conversion cycle. Lazaridis and Tryfonidiss research also established that larger companies are cash-management-focused with more credit sales, which led to cash flow problems. Smaller scale firms are more focused on stock management and credit management. Similar to Deloofs (2003) research, the cash conversion cycle is used to describe the effectivity of working capital management in this study. Regression analysis used in this research showed a negative relationship between cash conversion cycle and profitability.Garcia-Teruel and Martinez-Solano (2007) were involved in a research to offer up evidence about the effects of working capital management towards to profitability of Spanish small and medium-sized (SME) enterprises. Many previous researches are focused on larger form of firms. They collected a sample of over 8, 800 SMEs which covers the year 1996 2002 from the AMADEUS database. The selection was done in accordance to the requirements by Europeans Commissions recommendation on the definition of SMEs. In fact, the current assets and current liabilities of their sample of SMEs proportion is the mass of total assets and liabilities available to the firm s. They used the cash conversion cycle to measure the profitability of the firms on their research sample. Their study was supported by Deloof (2003), affirm that firms can improve profitability by lowering outstanding accounts receivables and payables and inventories. A univariate analysis was conducted to determine differences in variables, followed by a multivariate analysis to determine working capital management on corporate profitability. Return on Assets ratio was set as the dependent variable to establish profitability. In the correlation matrix used, they found a negative relationship between their dependent variable (return on assets) with the number of days accounts receivables, days of inventory and days accounts payable. They confirmed that by shortening the cash conversion cycle, firms could improve profitability.Regional OthersHossain and Akon (1997) did a case study on financing working capital ofBangladesh textile mill about corporations. This case study covers 4 0 public sector textile units under the ownership and administration of Bangladesh cloth Mills Corporations. The study covered a period of twelve years from 1982 1993. According to Hossain and Akon, well-known economists believed that current assets should be considered as working capital as the whole of it helps to generate profits. In their study, it shows that a vast amount of short-term finance was used in financing fixed and current assets to the extent of 100 percent. This caused a lower capability to earn profits, but increases the risk of insolvency. The aggressive working capital financing (using short-term funds to finance fixed assets) should be tamed in Bangladesh textile mills corporations to maximize profits, by resorting to long-term funds which are less costly. Methods used to test their hypothesis are through regression analysis and compare the calculation of financial ratios.Raheman and Nasr (2007) had done a research to prove the relationship betweenworking cap ital management and profitability of Pakistani firms. A sample of 94 firms listed on Karachi Stock Exchange was selected. Firms are listed for a period of 6 years from 1999 2004. It was mentioned that an excess of current assets could lead to a firm realizing its return on investment. However, it was proven otherwise if firms have a shortage of current assets (Horne Wachowicz, 2000). The measurement of profitability used by Raheman and Nasr is the Net Operating Profitability. They used the regression analysis to assess their hypothesis. Their study includes data of regression analysis of cross-sectional and time-series data. The pooled-regression (constant coefficient models) type of panel data analysis was applied. They believe that increase in the cash conversion cycle would lead to lower profit generation (Shin Soenan, 1998 Deloof, 2003 Lazaridis Tryfonidis, 2006 Garcia-Teruel Martinez-Solano, 2007).Summary of Literature Review author (Year)Market (Region)Evidence of Finding sKim, Rowland and Kim (1992)Japanese Manufacturers in US (USA)Objective of working capital management is to be providing current assets and liabilities in support of anticipated sales.Jose, Lancaster and Stevens (1996)Compustat (USA)Key findings in asset management returns and levered returns.Shin and Soenan (1998)Compustat (USA)Relationship between the length of net trading cycle, corporate profitability and risk-adjusted stock return.Leavell (2006)transnational corporations (USA)International working capital and multinational corporations.Deloof (2003)Belgian non-financial firms (Europe)Application of cash conversion cycle.Lazaridis and Tryfonidis (2006)Companies listed on Athens Stock Exchange (Europe)Larger companies are cash-management-focused, Smaller firms are more focused on stock management and credit management.Garcia-Teruel and Martinez-Solano (2007)Spanish SMEs (Europe)Effects of SMEs working capital management towards its profitability.Hossain and Akon (1997)Bangladesh (Asia) finance Bangladesh textile mills corporations.Raheman and Nasr (2007)Karachi Stock Exchange (Asia)Working capital management of Pakistani firms and its profitability.Table 2.1 Summary of Literature ReviewConclusionWorking capital is about establishing optimum liquidity position by effectivelymanaging resources invested in day-to-day operations of the business. After studying the journals and researches done, it can be concluded that liquidity and profitability of firms was affected by the components and working capital management measures (accounts receivable, inventory and accounts payable).