Cash Conversion Cycle And Profitability Of A Firm
Cash Conversion Cycle and Profitability of a Firm in Food Sector
of PakistanA THESIS SUBMITTED TO THE PUNJAB COLLEGE OF
COMMERECE
(UNIVERSITY OF CENTRAL PUNJAB)
IN FULFILLMENT OF THE REQUIREMENT
FOR THE DEGREE
MASTERS IN COMMERCE (ACCOUNTING & FINANCE)
BYMuhammad Tayyab
Supervisor: Faisal Baloch
PUNJAB COLLEGE OF COMMERECEUniversity of Central Punjab2014
RESEARCH COMPLETION CERTIFICATECertified that the research work
contained in this thesis Cash Conversion Cycle and Profitability of
a Firm in Food Sector of Pakistan has been carried out and
completed by Muhammad Tayyab Reg # S4F12MCOM0054 under my
supervision during his masters of commerce.
_______________
Principal Date:__________________
Punjab College of Commerce
University of Central Punjab Research
Supervisor:______________________
Lahore, Pakistan
Certificate of ExaminationCertified that quantum and quality of
the research work contained in the thesis Cash Conversion Cycle and
Profitability of a Firm in Food Sector of Pakistan adequate for the
award of degree of Masters of Commerce.
Internal Examiner External Examiner
Signature: ______________ Signature: ______________
Name: _________________ Name: _________________Date:
__________________ Date: __________________Principal:Signature:
______________
Name: _________________
Date: __________________
Declaration:
I, Muhammad Tayyab Reg No S4F12MCOM0054, Student of masters of
commerce during the session of 2012-2014, hereby declare that the
matter printed in the dissertation titled Cash Conversion Cycle and
Profitability of a Firm in Food Sector of Pakistan is my own work
and has not been printed, published and submitted as research work
in any form in any university, research institute etc in Pakistan
or Abroad.Dedication:
I would like to dedicate this report to my dear parents and
respected teachers who guided me through my studying carrier and
still doing their best for me. To be here in this institution at
this level I am just because of my parents, especially their
training, guidance, love, affection and motivation. I pray that I
can serve my parents as best as I can.
ACKNOWLEGEMENT
First of all I am very thankful to Almighty ALLAH who gave me
courage and confidence to making this dissertation. I am also
thankful to respected Sir Faisal Baloch & Sir Waqar Ahmed in
the UCP campus sargodha, who gave me chance and opportunity to make
such a professional project, in which I analyze the entire scenario
regarding food industry. They have been a steady source of track
throughout the course of this whole internship. Their innumerable
ideas were precious and gave me with an insight to the path, which
was off the beaten track otherwise. I have yet to see the limits of
their sympathetic, stamina and altruistic concerns for me. I am
especially thankful to my parents and friends for giving me the
silent support in terms of courage and strength that I needed to
accomplish my goals. Words might not be adequate to express my
feelings towards them.
Abstract:
CCC is very important for every manufacturing firm because it
helps the manager to maintain inventory keeping time properly. CCC
tells us how a manufacturing firm is able to manage its inventory
properly. There must be a balance between assets and liabilities in
order to maintain working capital properly. The data which is used
in this article is obtained from financial statements of companies
registered in Karachi stock for the year 2006 to 2011. The sample
consists of 54 firms in food sector. Regression analysis is used to
examine the relationship of CCC with profitability of firms in food
sector of Pakistan. In regression analysis we used Return on Assets
and Gross profit to total asset as dependent variable. The study
evaluated that there is Positive relationship between CCC and
profitability of food sector of Pakistan from 2006 to 2011
KEY WORDS:Cash conversion cycle, profitability, food sector,
Karachi stock exchange, CCCContents:
Chapter#1: Page# 1.1. Introduction.111.2. Food Industry of
Pakistan.12-161.3. Cash conversion cycle....17-191.4. Purpose of
study...201.5. Period of study..201.6. Problem Statement...211.7.
Objectives..........................................................................................................................211.8.
Research Question211.9. Research model221.10. Research
hypothesis.231.11. Importance24Chapter#2:
2.1. LITERATURE REVIEW...24-29Chapter#3:
Research Design and Methodology
3.1. Population..303.2. Research Approach/Design..303.3. Data
Collection..303.4. Analysis..303.5. Regression analysis...303.6.
Cash Conversion Cycle Operationalization313.7. Profitability
Operationalization.32-33Chapter#4:
Analysis4.1. Regression Equation: 1 & Results..34-364.2.
Regression Equation: 2 & Results...36-37Chapter#5:
Recommendations and Conclusion5.1. Recommendation385.2.
Conclusion39 References..40-43Table of contents:Table #TitlePage
#
1Production pattern of sugarcane in the world12
2Pakistan Sugarcane Area and Yield13
3Province wise sugar production14
4Food processing units in Pakistan16
5Regression equation 1st results 35
6Regression equation 2nd results 37
Figures
Figure #TitlePage #
1Urban population trend in food sector across Asian
countries15
2Cash flow cycle17
3Cash conversion cycle20
4Research model22
List of Abbreviations:Sr#AcronymsAbbreviation
1CCCCash conversion cycle
2GPtoTAGross profit to total assets
3CRCurrent ratio
4WCMWorking capital management
5ROAReturn on assets
6ROEReturn on equity
7NPMNet profit margin
8TATRTotal assets turnover ratio
9WCtoTAWorking capital to total assets
Chapter#1:
1.1. Introduction The size of global processed food industry is
estimated to be valued around US $3.5 trillion and accounts for
threefourth of the global food sales following countries are
subject of growth in food sector in developing countries in Asia,
Europe, and AsiaPacific, which are suffering of high population
There is still potential in ASEAN countries that can be covered
with respect to food sector, having population more than 550
million people. Despite its large size, only 6% of processed foods
are traded across borders compared to 16% of major bulk
agricultural commodities
From past five years there is a growth in food sector about 15.9
% annually. The main food processing industries in the world are
America and Europe. Convenience products such as dried instant
soups, reconstituted fruits and juices, shelf cooking meals are
becoming popular throughout the worldEmployment ratio in this
sector in different major countries is as follows.
US: 12 million
Europe: 2.5 million
After India and china the largest food market in Asian countries
is Japan. The most technologically strong food industry is in
Australia; the reason is that the cost of production in this
country is very low.
There are four steps in food industry that are; production,
process, transportation and distribution. We can see that this
chain involves all the stakeholders of this sector from small
farmer to a retail distributor. There should be alignment in all of
these steps so that it will produce significant effects and can
work effectively around the whole cycle. In order to maintain
competitive edge we should focus on food beverages and Tobacco
other then the agricultural inputs like wheat, maize, cotton and
sugarcane, fruits, vegetables and dairy these also play a
significant role in food sector of Pakistan.Production pattern of
sugarcane in the world
Country
Cane Yield (T/ha)
Sugar Recovery (%)
Sugar Yield (t/ha)
Australia Egypt Brazil USAColombia Mexico India PakistanWorld
Avg.
100.4110.8 68.4 80.2 80.5 79.5 66.9 49.0 64.4
13.811.514.511.711.511.6 9.9 9.210.6
13.8512.74 9.91 9.38 9.26 9.22 6.64 3.54 6.82
Table#11.2. Food Industry of PakistanThe total production ratio
of food sector in Pakistan is 27% and the total employment ratio is
16% which belongs to manufacturing sector. Pakistan having huge
consumer base and Pakistan is at eighth number in the world that
covers approximately 169 million consumers, having more than 1000
large scale food processing units. As effect of globalization food
style of consumers is totally changed in Pakistan. The average
individual consumer spending is about 42% of his income on food
items.There are many fast food chains in Pakistan that are changing
the life style of individuals .The efficiency of food industries
depends upon availability of the raw materials and Pakistan is a
bigger producer of many crops (such as wheat, rice, sugarcane and
oilseeds)
There are many problems in the food industry of Pakistan. But
still there is increasing trend In our food industry due to the
changing demands of the customers as result of globalization. Some
of the major problems include:
* Political instability* Monopolistic trend* Lack of resources*
lack of skilled workers* rough infrastructural facilities*
ineffective utilization of factors of production* Transportation
issues* High cost of production.Pakistan is at fifth number in the
world with respect to farming of sugar cane, in production Pakistan
is at eleventh number and in yield of sugar Pakistan is at 60Th
number in the world. Sugarcane is major raw material for this
industry production. After the Indo-Pak separation there is an
increase in the total cultivated area of sugar cane. The sugarcane
is cultivated over the area covering more than 1 million
hectares.In Pakistan there are more than 81 firms which are engaged
in production of sugar and their annual production is more than 6.1
million tons. This sector contribute large amount in GDP of the
country by exporting sugar to other countries and earn foreign
reserves.Pakistan Sugarcane Area and YieldYearArea (000 Ha)Produced
000 TonesYield per HectareUtilization % by Sugar Mills
2000-01
960.0
43,620
45.4
67.47
2001-02
999.7
48,041
48.1
76.33
2002-03
1,099.7
52,049
47.3
80.28
2003-04
1,074.8
53,800
50.1
81.15
2004-05
966.4
43,533
45.0
73.74
Table#2Mostly sugar is produced in province of Punjab and Sindh.
Very small amount is produced in NWFP in past Punjab was partly
dependent on supply of sugar from Sindh. But now Punjab is self
sufficient in production of sugar due to development in sugar
industry in Punjab .Sugar production is seasonal activity. The
mills works approximately 150 day s throughout the year Province
wise sugar production (In Tones)
Province2005-062004-052003-042002-032001-02
Punjab 1,832,2282,182,330
2,599,490
2,351,102
2,152,175
Sindh1,038,122801,063
1,221,268
1,158,674
940,959
NWFP128,157
132,407
176,252
166,983
104,611
Total2,998,507
3,115,801
3,997,010
3,676,759
3,197,745
Table# 3A variety of imported food (given below) can be easily
seen on shelves of modern retail stores. The products are as
follows soft drinks and fruit juices, Jams and jellies, dry milk,
cheese, Ice creams, almonds, pistachios, Biscuits and wafers,
vegetables, medicines, Chocolates ,cereals, Honey, Tea and coffee,
noodles and Baby items.Growth trend in urban population is as
follows in figure #1.
Figure # 1
The soft drink industry in Pakistan has become major sector in
the economy of Pakistan from several years. As per the latest
survey byAAJ TV, almost 170 firms are working in the Pakistan in
this industry. The beverage industry covering Juices, drinks,
drinking water, milk, energy drinks tea and coffee as well. In
Pakistan different firms are leading in different products in
beverages based upon their specialization and product
Recently a survey is conducted in 2013 was conducted in October
2013 byDynamic Research Consultants The survey results based upon a
comparative study between two types of gender first one is young
adult age from 16 to 22 years and second one is matured having age
more than 22 years results survey are given below.
The survey findings explain the different consumption patter
between the genders having different age limit. Overall, the
results of survey concluded that the females are more probable to
consume different drinks then males. Tea is the more preferred
drinks in the mature adults (having age more than 22 years). While
the energy drinks are more consumed by young adults then the mature
adults Drinks that are consider as healthy drinks like mil and
fruit juices are consumed greater in mature the soft drinks are
consumed in a huge amount among both of genders
Now the tea has become a part of Pakistani culture, Pakistan is
at first number in tea consumption in the world. In Pakistan per
capita tea consumption is 1 kg and average tea consumption in the
world is in the world 0.75 kg .
Table#2In soft drink classification, there are two major
competitors all over the world which are PepsiCo and Coca Cola, and
locally in Pakistan gourmet cola is emerging and giving tough
competition to Pepsi and just because of their low cost then both
brands. There is also significant growth in juice industry in
Pakistan just because of healthy vitamins qualities in juices. The
solid growth in particular industry is just because multiple fruits
are cultivated in Pakistan. The government of Pakistan has removed
custom duty on export of locally manufactured juice. There are 38
units which are engaged in production of juices and the vital firms
in this industry are nestle Pakistan Limited, Benz industries and
Mitchell
Energy drinks are scored as less consumed beverage then others
as the least consumed beverage. The significant company in this
industry is Red Bull, which is a multinational brand with
aggressive strategies covering 63% share in 2012 .recently Sting
was introduced by PepsiCo in Pakistan and becoming major cold drink
and consumed at huge number in adults.
The beverage industry in Pakistan has many opportunities and
gaps which are too be filled. Beverage industry is one of the
fewest industries in Pakistan which shows significantly growth from
past years and probably to grow faster in future due to increasing
consumption pattern among both of genders. According to recently
report Pakistan beverage industry in facing two major threats which
are, politically instability and increasing inflation rate in the
country .1.3. Cash conversion cycle Liquidity management is one of
the most important financial management techniques. It measures the
time in which the inventory is converted into cash again and the
account receivables are recovered. Figure#2In accordance with
(Siddiquee and Khan, 2009) effective capital management policies
may become firms competitive edge. And the firm will not need to
get loan from outside sourcesAccording to Gardner et al. 1986 there
is much importance of Working capital management in firms
operations because it has a direct relationship with the financial
performance of a firm.
Companies can increase their profitability by Decreasing the
period of cash conversion cycle by decreasing the accounts
receivables collection time period, and increasing the time period
of cash payments or credit payments. The basic objective of every
company is to increase the profitability of the company so the
company focuses on all the factors which affect the profitability
of firm. Filbeck and Krueger (2005) focus on the performance of
working capital management and find that there are variations in
working capital tools from time to time .WCM theory presented by
Richards and Laughlin (1980) explain that cash conversion cycle is
a great measure to check the efficiency of organizational working
capital management. It is a great measure to know that how fine a
corporation is organizing its working capital (Nobanee et al.
2011). According to Gitman (1974) cash conversion cycle is a good
evidence of working capital management efficiency, Cash conversion
cycle guide managers regarding investment and credit decisions,
inventory and suppliers management. Padachi, 2006 tells us that
Cash conversion cycle and collection cycle are good indicators for
analyzing firms performance. According to Weinraub and Visscher
aggressive working capital management policies has higher number of
risk and also higher volume of payoff and conservative working
capital management policies has lower risk, and lower risk lead
towards lower returns. According to Jose et al. (1996) aggressive
working capital management will tends towards shorter cash
conversion cycle which will leads towards higher profitability of a
firm.In the opinion of Shin and Soenen (1998) in order to get
higher returns we have to invest fewer amounts in current assets,
the purpose is to reap the higher risk which will lead towards
higher profits.
Smith (1980) suggested that in order to lower the risk the firm
will have to invest in their current assets heavily but due to
lower risk the returns will fall down. According to the old concept
of firms profitability and cash conversions there is inverse
relationship between both of them. But there is a disadvantage that
this may harm the working of an organization and also impact the
profitability.(AlHajja, 2009) suggested that the firm can increase
their profitability by reducing the conversion cycle and cash
conversion cycle is reduced by increasing the payment period to
creditors and increasing the time of payment to debtors and
inventory days period cycle, the receivable collection period and
the inventory conversion period. (Malitz and Ravid, 1993) open
credit terms increases the sale volume of the firm but it effects
the short term financial operations of a firm but narrow credit
terms will reduce the sale volume of firm which lead towards lower
profitability.
In contradiction with other studies (Lyroudi and Lazaridis)
argue the relationship between profitability and CCC of a firm and
concluded that there is a direct relationship between profitability
of a firm and cash conversion cycle. There are many reasons of this
harmful impact one of them is that when reducing inventory
conversion period there may be a problem of reduction in the
collection period, another reason is that firm may loses its good
customers due to demanding of early payment of their debts. And
when the firm increases its firms payable period the reputation of
the firm may be on stake, there should be a proper management
between receivables and payables.
Capitalism works through a complex and sometimes confusing
process. The basic principle however is fairly simple. It is
basically and free enterprise system that rewards hard work.
We have to identify a proper match between amount receivables
and payables. In order to work more smartly the firms have to boost
up their cash receivings and slower their cash payments. The
principal behind this tactic there is the technique of operating
cycle and cash conversion cycle.We can reduce the cash conversion
cycle by minimizing the working capital flow. It can be done
through reducing the time of receivables of debtors and increasing
the time of payables of creditors.
Figure#3Cash conversion cycle is considered as important tool to
measure working capital and profitability of a firm. In accordance
with (Lyroudi & Lazaridis, 2000) cash conversion cycle directly
affects the liquidity position of a firm. Richards & Laughlin
(1980) gives the thought of cash conversion cycle in important for
calculating the effectiveness of liquidity management of a firm. It
represents the gap between cash collections and cash payments .the
equation for CCC is given below:Cash conversion cycle = operating
cycle average payment period
And
Operating cycle = inventory days period + average collection
period 1.4. Purpose of studyThe basic objective of our study is to
examine the relationship between the cash conversion cycle and
profitability of a firm
1.5. Period of studyWe analyze the financial statements of
companies listed under Karachi stock exchange from the period of
2006 to 20111.6. Problem StatementCash conversion cycle is one of
the most important techniques in working capital management and
which affects the firms all financial operations. It directly
affects the profitability of firm. The manager must consider cash
conversion cycle while managing cash issues; how the firm will
collect money from debtors and pay this cash to creditors. There
are many researches on cash conversion cycle and financial
performance of a firm but there is very little work on cash
conversion cycle and profitability in food sector of Pakistan, this
was our research problem to overcome this gap.To identify the
impact of cash conversion cycle on a firms profitability1.7.
Objectives
Following are our research objectives.
To determine the impact of cash conversion cycle on
profitability.
To determine the impact of average payment period on return on
asset and Gross Profit to total assets
To determine the impact of length of average collection period
on return on asset and Gross Profit to total assets
To determine the impact of inventory days period on return on
asset and Gross Profit To total Assets 1.8. Research Question:What
is the nature of the relationship among Cash Conversion Cycle and
Profitability of food sector of Pakistan?1.9. Research Model:
Figure#4INDEPENDENT VARIABLE Cash conversion cycle
DEPENDENT VARIABLE ProfitabilityCash conversion cycle
includes
Account receivable period
Inventory days period
Accounts payable period
Profitability includes Return on assets
Return on equity
Net profit margin Gross profit to total assetsControl
variables:Total asset turnover ratio
Natural log of sales
Cash ratio
Dividend coverage ratio Working capital to total assets 1.10.
Research hypothesis: H1: There is a strong negative relation
between profitability and cash conversion cycle
Ho: There is a strong positive relationship between
profitability and cash conversion cycle
1.11. ImportanceOur study will contribute to the previous
researches in the following ways. Firstly the good management of
working capital is very valuable for shareholders of a firm.
Secondly, the shareholders are more aware about all the operations
of a firm related to working capital management due to
digitalization.This research will contribute significantly towards
the food sector of Pakistan and will provide base paper to future
researchers in food sector.Chapter#22.1. LITERATURE REVIEW(SALEEM,
2012) conducted a research on cash conversion cycle and
profitability of 32 companies from manufacturing sector of Pakistan
, and they used regression and correlation analysis to find out the
relationship between cash conversion cycle and profitability of
firms and she conclude that there is a negative relationship
between cash conversion cycle and profitability of firms (Bhutto,
2011) conducted a research on Relationship of Cash Conversion Cycle
with Firm Size, Working Capital Approaches and Firms Profitability
and they selected 157 companies from oil and gas sector of Pakistan
registered at Karachi stock exchange to examine the relationship
between cash conversion cycle and performance of a firm and they
conclude that there is a strong negative relationship between cash
conversion cycle and firms sales revenues, return on equity and
return on assets (A) conducted a research on profitiability and
working capital management of firms of Siri lanka and he chosed
manufacturing sector , beverages sector of Siri lanka and he used
pearsons correlation analysis he finds that shoter the cash
conversion cycle greater will be the profitability of firm.(Nasr,
2007) work on Working Capital Management And Profitability they
choose a sample 94 firms registered at Karachi stock exchange for
the period of six years and uses Pearsons correlation and
regression analysis in their model and suggested that there is a
strong negative relationship between CCC and performance of a firm
.(Zawaira, 2014) works on the association between working capital
management and profitability of non-financial companies listed on
the Zimbabwe stock exchange find out the relationship between
working capital management variables and profitability of firms of
Zimbabwe and they selected a sample of 32 non financial firm
registered at Zimbabwe stock exchange , they used regression
analysis in their model and finds that there is a inverse
relationship between payable period and profitability.(Afza, 2008)
concluded about is it better to be aggressive or conservative
in
Managing working capital? they selected a sample of 208 public
limited companies listed at Karachi stock exchange for the duration
of 1998 to 2005 to find out the impact of aggressive as well as
conservative working capital management policies on profitability
of firms and finds out that there is a strong inverse relationship
between working capital policy and performance of firm. (Bieniasz,
2011) conducted a research on The Influence of Working Capital
Management on the Food Industry Enterprises Profitability they
selected a sample from food sector of Poland to analyze the CCC and
turnover cycle with the help of debtor, current liabilities,
creditor, sales and finds out that the firms having shorter working
capital cycle as compare to larger one have higher profitability
ratio.(Attari, 2012) works on The Optimal Relationship of Cash
Conversion Cycle with Firm Size and Profitability he choose
manufacturing sector of Pakistan and selected 31 firms and
collected the data for the period of 2006 to 2010 and used one way
ANOVA and Pearson correlation method and find that there is a
opposite relationship between CCC and profitability (Mehmet, 2009)
have worked on Relationship between Efficiency Level of Working
Capital Management and Return on Total Assets in ISE they collected
the data from Istanbul Stock Exchange and concluded that there is
inverse relationship between CCC and profitability (return on total
assets) of any firm.(Sabri, 2012) conducted a research on Different
Working Capital Polices and the Profitability of a Firm they
collected the data of 45 industries from Amman Stock Exchange
(ASE). From the period from 2000 to 2007.they analyzed the data
with the help of T-Tests and Mann-Whitney-U Tests. They concluded
that companies are different from each other on the basis of high
and low cash conversion cycle because of their different
profitability ratios.(QUAYYUM, 2011) have worked on the topic
Effects of Working Capital Management and Liquidity: Evidence from
the Cement Industry of Bangladesh they collected the data for 2005
to 2009 from the Dhaka Stock Exchange. The result of this research
shows that there is a relative higher level of relationship between
the profitability ratios and various liquidity ratios and working
capital variables of the firm.(Chhapra, 2010) worked on textile
sector of Pakistan to determine the impact of working capital
management on profitability and he finds out a significant negative
relationship between debt used and profitability of firm
(Malik, 2013) in Pakistan they conducted a study about working
capital management and profitability of a firm they have very
strong view that there negative relationship between net operating
profitability and average collection time,
(DELOOF, 2003) examined that there is inverse relationship
between profitability and number of collection days. He conducted
this research in Belgian(Terrell, 2007) concluded that there is
inverse relationship between accounts receivables and profitability
(Uyar, 2009) studied the relationship between c ash conversion
cycle and firm size. And he concluded that there is a strong
inverse relationship between cash conversion cycle and the firm
performance.
(Nobanee) examined that there is a strong inverse relationship
between the cash conversion cycle and Return on asset in all the
sectors of economy but not in FMCG and in service sector. (Anser,
2013) find out that there always an inverse relationship between a
firm cash conversion cycle and return on investment of the firm. (
ZUBAIRI ,2010) conducted a research and find a relationship between
cash conversion cycle and firm size .he focus on automobile sector
of Pakistan and predict that larger firms work more efficiently for
collecting there receivables. (Stine, 1993) conducted that there is
a strong need in small businesses for managing properly their cash
conversion cycle because in small businesses there is lack of cash.
And he found out that cash conversion cycle increases profitability
because there is less need of cash and also no need of external
borrowing.
(NOBANEE, 2006) conducted a study in United States and he find
that cash conversion cycle is related with working capital
management. They both work hand by hand in contributing in the
profitability of the firm. (VIJAYAKUMAR, 2011) examined that the
relationship between cash flow and profitability of the firm. And
he found that there is strong negative relationship between both of
them.
(Garcia, 2007) concluded that there is a positive relationship
between accounts payable payment cycle and profitability of a firm.
The firms that pay their bills after a reasonable delay enjoy more
profitability.
(ELJELLY, 2004) concluded in his research that there is inverse
relationship between cash collection cycle and profit ratio of a
firm.
(SEN, 2009) he conducted a study on 220 public limited firms and
calculated that there is a negative relationship between longer
cash conversion cycle and profitability. Longer CCC will lower the
profits of a firm.
(HIJAZI, 2006) they conducted a research study on listed
companies in Karachi stock exchange of Pakistan and conclude that
there is inverse relationship between arrears inventory and profits
of a firm.
(Sana, 2006) examined a study in oil and gas sector of Pakistan
and resulted that there is a very strong inverse relationship
between profitability and cash conversion cycle of a firm, And also
examined that there is also a link between working capital and
profitability of firms working in Pakistan.
(VISSCHER, 1998) done a research work on ten different sectors
for the period of ten years. And find that small firms require a
shorter cash conversion cycle as compared to larger firms. And in
response the profitability of small firms increases.Filbeck and
Krueger (2005) give focus on the performance of working capital
management and worked on 32 industries in USA and find that there
is variations in working capital tools from time to time.
Pandey and Parera (1997) provides a base on working capital
management policies, they gather data from different manufacturing
firms listed in Sri Lankan Stock exchange. They use questionnaire
as their data gathering tool, and find that there is a unofficial
link between working capital management policy and the size of a
firm. And also finds that the profitability of a firm also great
impact on the working capital management policies. They worked on
the official data of Colombo stock exchange. Weinraub and Visscher
worked on aggressive working capital management and finds out a
relationship between risk and working capital policies and suggest
that aggressive working capital management policies has higher
number of risk and also higher volume of payoff and conservative
working capital management policies has lower risk, and lower risk
lead towards lower returns.
Gardner et al. 1986, Weinraub and Visscher (1998) there is much
importance of Working capital management in firms operations
because it has a direct relationship with the financial performance
of a firm.
(Smith, 1980) Suggested that in order to lower the risk the firm
will have to invest in their current assets heavily but due to
lower risk the returns will fall down. (SOENEN, 1993) worked on
working capital management and profitability of US firms and by
using chi-square test and concluded that that there is strong
inverse relationship between net cash conversion cycle and return
on assets.
(Jose, 1996) worked on the working capital management and
profitability and collected the data of US firms and find that
aggressive working capital management will tends towards shorter
cash conversion cycle. And by his findings there is a perfect
negative relationship between profitability and cash conversion
cycle of US firms. Shin and Soenen (1998) suggested that to get
higher returns we have to invest fewer amounts in current assets;
the purpose is to reap the higher risk which will lead towards
higher profits.
(AlHajja, 2009) finds that the firm can increase their
profitability by reducing the conversion cycle and cash conversion
cycle is reduced by increasing the payment period to creditors and
increasing the time of payment to debtors and inventory days period
cycle, the receivable collection period and the inventory
conversion period.
In contradiction with other studies (Lyroudi, 2000) finds out
that there is a direct relationship between profitability of a firm
and cash conversion cycle. and profitability is calculated by
Return on assets (ROA) and net profit margin (Smith, et.al, 1997)
used Chi-square test for analyzing the relationship between CCC and
profitability and also finds out that there is a strong positive
relationship between both of them and profitability is calculated
by Return on investment (ROI)
Malitz and Ravid (1993) used open credit terms increases the
sale volume of the firm but it effects the short term financial
operations of a firm but narrow credit terms will reduce the sale
volume of firm which lead towards lower profitability. Siddiquee
and Khan (2009), concluded that the effective capital management
policies may become firms competitive edge. And the firm will not
need to get loan from outside sources. And find that there is a
positive relationship between working capital management and
performance of firm in term of profitability.
Richards & Laughlin (1980) gives the thought of cash
conversion cycle in important for calculating the effectiveness of
liquidity management of a firm.
Lyroudi & Lazaridis (2000) gives the idea that there is
greater impact of working capital management and profitability and
also concluded that cash conversion cycle directly affect the
liquidity position of a firm.
Filbeck & Krueger (2003) said that there are many other
factors that affects the working capital management for example
interest rate, and increase in interest rate will also show
increase in cash conversion cycle
Chapter#3:Research Design and Methodology
3.1. Population
Our population is Food Sector of Pakistan.3.2. Research
Approach/Design
Our research is quantitative in nature as we quantify our
variables with the help of different questions. We use different
dimensions of each variable, and then use different questions for
each dimension. There is accurate evidence of reliability and
validity about the scales is available that we used in our
research.
3.3. Data Collection
Our population is Karachi stock for the year 2006 to 2011.The
data which is used in this article is obtained from financial
statements of companies registered in Karachi stock for the year
2006 to 2011. The sample consists of 54 firms in food sector.3.4.
Analysis
We use Regression analysis for analyzing the results of our
model.3.5. Regression analysisIs a statistical tool for finding the
relationship between independent and dependant variable .There are
many techniques in regression analysis by which we can check the
relationship between variables. Regression analysis shows us that
how much change accrued in dependant variable due to change in
independent variable while other variables remain constant.3.6.
Cash Conversion Cycle Operationalization Average receivables
periodAverage receivables period provides information about
liquidity of business; it also helps managers to develop their
companys credit policy which is beneficial for company as well as
for the customers. The time taken by firms to collect its accounts
receivables from its debtors or customers is known as account
receivable period. Following is the formula. The outcome of
seasonal sales will be affected by this formula. Where:Days = Total
no of days in yearAR = Average amount of debtorsCredit Sales =
Total credit sales throughout the year
It is important for a firm to analyze the average receivable
period , in how many days the company will collect its receivables
to meet its long and short terms obligations.
Average payment periodTime required by a firm to pay its debts
to the companys creditors is known as Average payment period. We
can calculate the average payment period by It is a time between
the purchase of goods and its payment (Arnold, 2008, p.531). We can
calculate the average payment period by(AverageAccountpayable/Net
CreditPurchase)*365
If the payment period of company is lengthy then the firm cannot
take the advantage of trade discounts and other benefits. Companies
always try to shorten their payment period for getting these
benefits.APP helps firm to get a better judgment of the cash
outflows for future planning. Judgment of cash outflows has
significant role in successful business Average payment period
determines past trends in the payment of the trade credit. Average
payment period brings managements awareness to variables that must
be explore to ensure that the business operations are working
successfully Days Sales of InventoryA performance measurement tool
which tells us about the in how many days the firm will able to
convert its inventory (including raw material inventory, work in
process & finished goods) into sales. Normally less days in
sales inventory is good for company.
It is also an important tool to measure cash conversion cycle.
Following is the formula of inventory in days period.
Inventory days = 365*(average inventory/cost of goods sales)
If a firm is unable to convert its inventory into sales quickly
then its a danger sign for firms growth and it may create problems
for firms survival. 3.7. Profitability OperationalizationNet Profit
Margin
This ratio tells us how much rupee of profit is being generated
by one rupee sales Net profit margin is commonly represented as a
percentage. (Abdul Raheman, 2007) finds that the relationship
between Net profit margin and CCC and concluded that there is a
strong inverse relationship between both of them. Net profit margin
is calculated by this formula
(Net Profit Margin = Net profit /Net sales)Return on assetReturn
on asset is a tool which tells us about how much earnings are
generating by company by usage of its assets. Greater the return on
asset the greater will be the profitability. (Bhutto, 2011)
concluded greater the cash conversion cycle of a firm greater will
be the total assets and return on assets. This variable is also
used by (SALEEM, 2012), (Afza, 2008), (Zawaira, 2014) and
(Bieniasz, 2011)
The formula of return on asset is as follows. Return on equityWe
can explain return on equity is the amount earned by firm by using
shareholder equity. This ratio is an important tool for evaluating
either the firm is working in the favor of shareholders or not,
utilizing their investment effectively we can enhance the firms
profitability. Bhutto, 2011) find that the length of cash
conversion cycle has inverse relationship between return on equity
and sales income . To measure the profitability of a firm this
variable also used by (M.S Nazir), and (Zawaira, 2014) . The
formula of return on equity is as follows. Return on Equity = Net
Income/Shareholder's EquityGross Profit to Total AssetsThis ratio
tells us how much dollars of GP is earned by each dollar of total
assets. With the help of this ratio we can check that either the
firm is using assets effectively for production of gross profit and
net profit or not. To measure the profitability of a firm this
variable is not being used by any other researcher. We calculated
the firms profitability by this ratio
The formula of this ratio is as follows
Gross profit to Total Assets = (Gross profit /Total Assets)
Chapter#4Analysis4.1. Regression Equation: 1In 1st equation Return
on assets has been taken as dependent variable, whereas Natural log
of sales, Cash conversion cycle, working capital to total assets
and dividend coverage ratio has been taken as independent variable
Y= +1(NLofS) + 2(Cash cycle) +3(WCtoTA) + 4(dividend CR ) + =
return on assets
1 = Natural log of sales
2 = cash conversion cycle
3 = working capital to total assets
4 =dividend carried ratio Analysis of variance R-SQUAREADJUSTED
R-SQUAREPROB>F
0.23930.22970.0000
R-square shows 23.93% of variation in ROA which is explained
with the help of four independent variables .The adjusted R-square
is slightly lower than R-square which is 22.97%
F-statistics showing the normal validity of model as its value
25.08 which is significant and the probability of f is 0.0000
ROA
Coef.Std. Err.TP>|t|[95% Conf.Interval]
NLofSales.0115076.00323213.660.000.0051487.0178665
CCC.0000428.00013530.320.752-.00002234.000309
WCtoTA.00159.00028515.580.000.0010292.0021508
DividendCR.0095852.00289783.310.001.0038841.0152864
_cons-.1139518.0449506-2.540.012-.202389-.0255147
Results:
The above schedule shows the estimated coefficients of the
variables. The Return on assets is positively related to cash
conversion cycle, Natural log of sale, working capital to total
assets and dividend coverage ratio .Natural log of sales is
positively related with return on assets and the results are
significant with respect to probability of t which is lower than 10
% which shows that our variable is significant. Cash conversion
cycle is also directly related with return on assets but as compare
to probability of t the results shows that the variable is
insignificant. While the working capital to total assets also
positively co-related with return assets which means that greater
that ratio greater will be the profitability of a firm .Similarly
dividend coverage ratio also positively linked with return on
assets. Greater the dividend coverage ratio greater will be the
profitability o a firm
Normally the f value more than 15 in considered as significant
and shows good fit of regress model, here the value of f is 25.08
which is significant .Regress results indicates that slope
coefficient is -.1139518 and Beta coefficient for natural log of
sales is .0115076, Beta coefficient for CCC is .0000428, Beta
coefficient for working capital to total assets .00159 and the beta
coefficient for dividend coverage ratio is .0095852. Normally,
prob. >T does not exceed 0.10 for statistical significance of
parameter. Therefore, it can be concluded that the variables are
significant below then at 10 percent. P>|t| natural log of sales
0.000, for CCC is 0.752, for Working capital to total assets is
0.000 and for dividend coverage ratio is 0.001. Normally the t
value more than 3 shows that the parameter is significant, here the
t value for natural log of sales is 3.66, for CCC .032, for Working
capital to total assets is 5.58 and for dividend coverage ratio is
3.31 which means that the Natural log of sales, working capital to
total assets, and dividend coverage ratio is statistically
significant while the CCC is statistically insignificant 4.2.
Regression Equation: 2
Y= +1(GrowtS)+ 2(CCC ) +3(CR) + 4(TATR) In 2nd equation profit
to total assets has been taken as dependent variable, whereas
growth (sales), Cash conversion cycle, current ratio and total
assets turnover has been taken as independent variable Here is
Gross profit to total assets = Gross profit to total assets 1 =
growth (sales)
2 = cash conversion cycle
3 = current ratio
4 = Total assets turnover ratio R-SQUAREADJUSTED
R-SQUAREPROB>F
0.45510.44820.0000
R-square shows 45.51% of variation in gross profit to total
assets which is explained with the help of four independent
variables which means that the dependent variable will change
45.51% with respect to independent variables .The adjusted R-square
is slightly lower than R-square which is 44.82%
GPtoTACoef.Std. Err.TP>|t|[95% Conf.Interval]
GrowthS-.0030989 .0044947 -0.69 0.491 -.0119418 .0057441
CCC.0003937 .0001351 2.91 0.004 0001278 .0006596
CR.0030443.0032717 0.93 0.353 -.0033926 .0094811
TARA.1746662 .0107789 16.20 0.000 .1534595 .1958729
_cons-.0519178 .019891 -2.610.009 -.0910518 -.0127837
Results From the regression results it is concluded that Growth
is negatively related with gross profit to total assets which means
that lower the growth (sales) greater the profitability of a firm.
But the cash conversion cycle is positively related with the
dependent variable which means that longer the length of cash
conversion cycle greater will be the profitability of a firm. While
current ratio is positively related with the gross profit to total
assets which means that greater the investment in current assets
will leads towards higher corporate profits. And Total assets
turnover ratio is also positively related with gross profit to
total assets Normally the f value more than 15 in considered as
significant and shows good fit of regress model, here the value of
f is 66.60 which is significant. Normally the t value more than 3
shows that the parameter is significant, in accordance with our
regression analysis results the parameters growth (Sales) , CCC and
Current ratio are insignificant but total assets turnover ratio is
highly significant . Normally, prob. >T does not exceed 0.10 for
statistical significance of parameter. Therefore, it can be
concluded that the variables are significant below then at 10
percent. P>|t|. From our results growth (Sales) and current
ratio are insignificant but the CCC and total assets turnover ratio
are perfectly significant.
Chapter#5Limitations, Recommendations & Conclusion5.1.
Recommendation & limitations For managing working capital
effectively there must be a proper match between account
receivables period and accounts payment period. The main objective
of every firm is to increase their profitability, and companies
decrease their cash conversion period by decreasing there
receivables period and increasing their payment period. We can
apply more than one statistical test on this study for increasing
its significance
We can also use cross sectional data and can increase our
research work validity.
We can collect data from more than one stock exchange like
Islamabad and Lahore stock exchange.
In this study we collect date from our country we can increase
importance of our study by collecting data from another country.
The total time available for this research was too short.
This research includes data only from Pakistan food sector; we
can take data from other countries as well.5.2. Conclusion
There is much importance of Cash conversion cycle in every
business because it assists managers for decision making regarding
collection of receivables from debtors and payment to creditors, it
provide direction regarding how many days a company should hold its
inventory. The greater the inventory holding period there will be
more problems like storage, damages etc. Cash conversion cycle is
very important for a company to analyze its efficiency in working
capital management.According to Gardner et al. 1986 there is much
importance of Working capital management in firms operations
because it has a direct relationship with the financial performance
of a firm.
Companies can increase their profitability by Decreasing the
period of cash conversion cycle by decreasing the accounts
receivables collection time period, and increasing the time period
of cash payments or credit payments. The basic objective of every
company is to increase the profitability of the company so the
company focuses on all the factors which affect the profitability
of firm. (AlHajja, 2009) concluded that the firm can increase their
profitability by reducing the conversion cycle and cash conversion
cycle is reduced by increasing the payment period to creditors and
increasing the time of payment to debtors and inventory days period
cycle, the receivable collection period and the inventory
conversion period. There should be balance between current assets
and current liabilities so that the company can work efficiently
with its finances. If the cash will be managed efficiently then
there will be less chances of shortage of cash and insolvency.
(Smith, 1980) Suggested that in order to lower the risk the firm
will have to invest in their current assets heavily but due to
lower risk the returns will fall down. (SOENEN, 1993) worked on
working capital management and profitability of US firms and by
using chi-square test and concluded that that there is strong
inverse relationship between net cash conversion cycle and return
on assets.In our research we concluded that there is strong
positive relationship between cash conversion cycle and
profitability of a firm. In our results Gross profit to total
assets and return on assets is significantly affected by cash
conversion cycle. Greater the length of CCC greater will be the
profitability of food sector of Pakistan. our results are in
accordance with Katerina Lyroudi they concluded that The cash
conversion cycle is directly related with return on assets and the
net profit margin . References1. DELOO, M. (2003). Does Working
Capital ManagementAffect Profitability. journal of Business Finance
.
2. Goa, A. B. (2011). The Influence of Working Capital
Management on the Food Industry Enterprises Profitability.
3. Malik, R. A. (2013). Cash Conversion Cycle and Firms
Profitability A Study of Listed Manufacturing Companies of
Pakistan. IOSR Journal of Business and Management (IOSR-JBM) .
4. Mutenheri, T. Z. (2014). THE ASSOCIATION BETWEEN WORKING
CAPITAL MANAGEMENT AND PROFITABILITY OF NON-FINANCIAL COMPANIES
LISTED ON THE ZIMBABWE STOCK EXCHANGE. International Journal of
Research In Social Sciences .
5. Nasr, A. R. (2007). Working Capital Management And
Profitability Case Of Pakistani Firms. International Review of
Business Research Papers , 279-300.
6. Nazir, T. A. (n.d.). IS IT BETTER TO BE AGGRESSIVE OR
CONSERVATIVE IN MANAGING WORKING CAPITAL? Journal of Quality and
Technology Management .
7. Niaz Ahmed Bhutto, G. A.-u.-R. (2011). Relationship of Cash
Conversion Cycle with Firm Size, Working Capital Approaches and
Firms Profitability: A Case of Pakistani Industries. Pak. j. eng.
technol. sci. , 45-64.
8. ORU, M. . (2009). Relationship between Efficiency Level of
Working Capital Management and Return on Total Assets in Ise.
international journal of business and management .
9. QUAYYUM, S. T. (2011). Effects of Working Capital Management
and Liquidity: Evidence from theCement Industry of Bangladesh.
10. Raza, M. A. (2012). The Optimal Relationship of Cash
Conversion Cycle with Firm Size and Profitability. International
Journal of Academic Research in Business and Social Sciences .
11. Sabri, T. B. (2012). Different Working Capital Polices and
the Profitability of a Firm. International Journal of Business and
Management .
12. Saleem, S. A. (2012). The Relationship Of Cash Conversion
Cycle And Firms Profitability: An Empirical Investigation Of
Pakistani Firms. International Journal of Financial management
.
13. soenen, L.A. (1993). Cash conversion cycle & corporate
profitability. Journal of Cash Management.
14. Nobanee, H 2009, 'Working Capital Management and Firm's
Profitability: An Optimal CashConversion Cycle',
15. Uyar, A. (2009). The Relationship of Cash Conversion Cycle
with Firm Size andProfitability: An Empirical Investigation in
Turkey. Journal of Finance and Economics .16. Demirgunes, K. and
Samiloglu, F. (2008). The effect of working capital management on
firm profitability: Evidence from Turkey.International Journal of
applied economics and finance
17. Dong, H.P., Su, J., (2010). The Relationship between Working
Capital Management and Profitability: A Vietnam Case. International
Research Journal of Finance and Economics
18. Ebaid, I. E. (2011). Accruals and the prediction of future
cash flows Empirical evidence from an emerging market, Management
Research Review, 34(7), 838-853.
19. Eljelly, A. (2004). Liquidity-Profitability Tradeoff: An
empirical Investigation in an Emerging Market. International
Journal ofCommerce and Management, Vol 14 No 2 pp. 48 61
20. Enqvist, J., Graham, M. and Nikkinen, J. (2008). The impact
of working capital management on firms frofitability in different
business cycles: Evidence from Finland. Retrieved from
http://ssrn.com/abstract=1794802.
21. Farris II, M. T. and Hutchison, P. D., (2002). Cash-to-cash:
the new supply chain management metric. International Journal of
Physical Distribution and Logistics Management, Vol. 32 No. 4,pp.
288-298
22. Filbeck, G. and Krueger, T.M. (2003). An Analysis of Working
Capital Management Results across Industries, Mid American Journal
of business, 20(2).23. Gentry, J.A., Vaidyanathan, Lee, R., and
Wai, H., (1990), A Weighted Cash Conversion Cycle, Financial
Management, Vol. 19 (No. 1, Spring),, pp. 90-99.24. Lyroudi, K.;
McCarty, D.; Lazaridis, J. and Chatzigagios, T., "An Empirical
Investigation of Liquidity: The Case of UK Firms", presented at the
Annual Financial Management Association Meeting in Orlando, October
1999.
25. Miller, Jeffrey W., "Working Capital Theory Revisited," The
Journal of Commercial Bank Lending, May 1979, pp. 15-31.
26. Moss, D.J. and B. Stine, "Cash Conversion Cycle and Firm
Size: A Study of Retail Firms", Managerial Finance, Vol. 19, Issue
8, 1993, pp. 25-34.
Profitability
Cash conversion cycle
Account receivable period
Return on assets
Inventory days period
Return on equity
Accounts payable period
Gross profit to total assets
H1 (Negative relationship)
Profitability
Cash conversion cycle
Ho (Positive relationship)
Profitability
Cash conversion cycle
Table#4
43 | Page