WORKING CAPITAL

RELATIONSHIP WITH
CORPORATE PROFITABILITY
SUBMITTED BY TARUN KUMAR

MBA(FINANCE)
ROLL NO: 28
SECTION: A

MARCH 1, 2019
AMITY BUSINESS SCHOOL
NOIDA 125
 LITERATURE REVIEW’S
1. MY FIRST RESEARCH PAPER IS FROM MIAN SAJID NAZIR AND TALENT
AFZA AND THE TOPIC WHICH THEY TOOK INTO CONSIDERATION IS
“impact of aggressive working capital management policy on firm’s profitability”.
THEY HAVE USED THIS PANEL DATA REGRESSION MODEL FROM 1998-
2005 WHICH IS DONE 204 PAKISTAN FIRM’S WHICH WAS AGAIN
DIVIDED INTO 16 INDUSTRIAL GROUPS BY KSE. THE STUDY FINDS A
NEGATIVE RELATION BETWEEN THE BOTH SO IF A FIRM FOLLOW
AGGRESSIVE WORKING CAPITAL THEN THEY WILL FACE A NEGATIVE
RETURNS BUT AFTER THAT THEY CONDUCTED A TEST WHICH WAS NOT
DONE BEFORE FOR FURTHER VALIDATING THE RESULTS WHICH THEY
GOT “the relation between aggressive working capital polices on market measure of
profitability”. SO IN SHORT THIS STUDY ONLY TELLS YOU THAT A FIRM
CANNOT GENERATE MORE PROFIT WITH THIS AGGRESSIVE WORKING
CAPITAL POLICY AND AS FAR AS BV (BOOK VALUE) IS CONCERNED EVEN
THEN NO EXTRA RETURNS ON ASSETS TOWARS SHORT TERM ASSETS
AND LIABILITIES. THE MARKET VALUE WAS MORE AS COMPARED TO
BOOK VALUE, EVEN IF THE FIRM USES HIGH LEVEL OF CL (CURRENT
LIABILIITIES) IN THEIR FINANCING. THE INVESTER BELIEVED THAT, IF A
FIRM WANTS TO OUTRUN OTHER FIRM IN THE MARKET THEY NEED TO
HAVE LESS EQUITY AND LESS LONG TERM LIABILITIES OR LOANS BUT
SOME FACTORS LIKE AGENCY PROBLEM MIGHT PLAY AN VITAL ROLE IN
SUCH TYPE OF CASES AND MAY BE DISCOVERED IN FUTURE.

https://www.researchgate.net/profile/Talat_Afza/publication/228320063_Impact_of_Aggressive_W
orking_Capital_Management_Policy_on_Firms'_Profitability/links/0912f50c06d20688c6000000.pdf.
2. MY SECOND RESEARCH PAPER IS FROM US AND IT IS WRITTEN BY –

AMARJIT GILL, NAHUM BIGER AND NEIL MATHUR ON RELATIOSHIP

BETWEEN WORKING CAPITAL MANAGEMENT AND PROFITABILITY. THEY
WERE ENTIRELY ON DIFFERENT TRACK, THEY SAID THAT THERE IS NO
STATISTICAL SIGNIFICANT RELATIONSHIP BETWEEN THE VARIABLES. THE
VARIABLES THEY TOOK INTO CONSIDERATION WAS ACCOUNT RECEIVABLES
AND CORPORATE PROFITABILITY. THEY ALSO FOUND THAT THERE IS POSITIVE
RELATIONSHIP BETWEEN CASH CONVERSION CYCLE AND GROSS OPERATING
PROFIT AND EVEN BETWEEN THE FIRM’S SIZE AND GROSS OPERATING PROFIT
RATIO. Therefore, IT LOOKS LIKE OPERATIONAL PROFITABILITY TELLS HOW
MANAGERS ACT IN TERMS OF MANAGING ACCOUNT RECEIVABLES. FURTHER
THE NEGATIVE RELATIONS SHOWS THAT LESS PROFIT MAKING FIRMS WILL
FOLLOW UP DECREASE IN THEIR ACCOUNT RECEIVABLES WHILE THEY
ATTEMP TO REDUCE THEIR CASH GAP IN THE CONVERSION CYCLE. THEIR
FINAL CONCLUSION WAS THEY NEED TO MANAGE THEIR WORKING CAPITAL
IN A MORE EFFICIENT WAY IN ORDER ENHACE THE PROFITABILITY.

https://pdfs.semanticscholar.org/4fba/a2174386ee0cc6e90de5d098b9e36962f2de.pdf

3. WHEN WE TALK ABOUT SMEs, WORKING CAPITAL PLAYS A VITAL ROLE AS

MOST THE ASSETS ARE CURRENT AND THEIR MAIN SOURCE FOR EXTERNAL
FINANCE IS CURRENT LIABILITIES. KEEPING THESE TWO THINGS IN MIND, THIS
THIRD RESEARCH FOCUS ON PROVIDING THE EMPERICAL EVIDENCE ON
THE IMPACT OF WORKING CAPITAL MANAGEMENT OF SPANISH’S SMEs. For
this purpose, they collected 8872 SMEs(panel) from 1996-2002. THEY FIGURED IT OUT
THERE IS SIGNIFICANT NEGATIVE RELATION BETWEEN AN SME’S
PROFITABILITY AND DAYS OF INVENTORY AND NUMBER OF DAYS ACCOUNT
RECEIVABLE. HOWEVER, THEY CANNOT CONFIRM THAT THE NUMBER OF
DAYS FOR ACCOUNT PAYABLE AFFECTS THE RETURN ON ASSETS IN SMEs DUE
TO LOST SIGNIFICANCE IN THIS RELATION WHEN THEY TRIED TO CONTROL
FOR POSSIBLE ENDOGENEITY PROBLEMS.
Finally, SMEs have to be concerned with working capital management(wkm) as VALUE CAN
BE CREATED IN THESE TYPE OF FIRM BY REDUCING THEIR CASH CONVERSION
CYCLE TO A MINIMUM LEVEL AS FAR AS WHICH IS REASONABLE. THIS
RESEARCH PAPER IS WRITTEN BY “Pedro Juan Garcia Teruel and pedro Martinez-
Solano”.

https://pdfs.semanticscholar.org/00bd/dc1faf6eb1113b4d01a7ca46cf8a8bdcd662.pdf

4. NOW, BY THIS 4TH POINT YOU MUST HAVE GET MAIN THEME OF MY PROJECT
TO COMPARE WORKING CAPITAL VARIABLES WITH THE FIRM’S
PROFITABILITY but this research paper will take into consideration the Turkish
manufacturing firm from 1998-2007 and it is written by “F.Samiloglu and K.Demirgunes”.

REGRESSION MODEL IS USED IN THIS RESEARCH AND THEY FOUND OUT A/C
RECEIVABLES PERIOD AND INVENTORY PERIOD THEY ARE DIRECTLY
RELATED WITH WORKING CAPITAL AS COMPARED TO OTHER VARIABLES
HAVE SIGNIFICANTLY NEGATIVE IMPACT OF FIRMS PROFIT. This means both of
these variable lengthens profitability decrease and vice-versa. The other variables apart from
these two that affect firm’s profitability are growth and leverage affecting it positively and
negatively respectively which concludes that rise in sales make the profit to grow while debt
have opposite affect if you do any changes in it.

THE RESULTS OF THIS STUDY TELLS US THAT IF A FIRM WANTS TO INCREASE

THEIR PROFIT THEY CAN DO SO BUT FOR THAT THEY NEED TO REDUCE
ACCOUNT RECEIVABLES AND INVENTORY PERIODS. AND THIS NEGATIVE
RESULT BETWEEN THE VARIABLE CAN BE DUE TO CUSTOMER WANT TO MORE
TIME TO ASSESS QUALITY OF PRODUCTS AS THEY PURCHASE IT FROM FIRM
WITH DECLINING PROBABILITY as per deloof,2003 the research paper they took into
consideration.

https://scialert.net/fulltextmobile/?doi=ijaef.2008.44.50
5. WORKING CAPITAL V/S PROFITABILITY BY “dr. loannis lazaridis and msc. dimitrios
tryfonidis” ON THE SAME RELATION TALKED ABOVE BUT IN THE COMPANIES LISTED
IN ATHENS STOCK EXCHANGE. THEY OBSERVES THAT THERE IS NEGATIVE
RELATIONSHIP BETWEEN CASH CONVERSTION CYCLY AND PROFITABILITY. So
it looks like operational profitability how working capital will be managed by the firm’s owner or
manager. Researcher observed lower the operational profit is linked with the increase account payable
days.

So, the above could lead us to a conclusion that the firm which do not make much profit actually wait
for longer period of time to pay their bill taking advantage of credit period granted by suppliers. This
negative relation between the profit and a/c receivables tells you that less profitable firm in order to
reduce the cash gap in the cash conversion cycle will try follow a decrease in their a/c receivables.
Likewise, the negative relation between the corporate profitability and inventory period that is case
of sudden fall in sales due to mismanagement of the inventory will lead to trying up for more than
required capital in the expense of profitable operations. SO, IF YOU AS MANGER WANTS TO CREATE
PROFIT FOR YOUR COMPANY, YOU NEED TO HANDLE THE CASH CONVERTION CYCLE CORRECTLY AND
KEEPING EACH DIFFERENT COMPONENT OF WORKING CAPITAL AT OPTIMAL LEVEL.

https://s3.amazonaws.com/academia.edu.documents/37259440/The_relationship_between_w
orking_capital_management_and_profitability_of_listed_companies_in_the_Athens_Stock_E
xchange.pdf?AWSAccessKeyId=AKIAIWOWYYGZ2Y53UL3A&Expires=1552751251&Si
gnature=wsNNlQpOXsuulRcseXpeF4FDC%2BQ%3D&response-content-
disposition=inline%3B%20filename%3DThe_relationship_between_working_capita.pdf

## Final conclusion ALMOST EVERY PAPER IS TALKING THE SAME THING IF

YOU OBSERVE SO THERE IS CLEAR EVIDENCE OF NEGATIVE RELATION OF
WORKING CAPITAL VARIABLES AND PROFITABILITY OF FIRMS SPECIALLY
SMEs.