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Navena Nesa Kumari et al., International Journal of Research in Management, Economics and Commerce,

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A Study on the Impact of the Working

Capital Management on the Profitability of

the Leading Listed Manufacturing

Companies of Chennai (2006-2012)

Navena Nesa Kumari1 and Victor Louis Anthuvan

2

1(Research Associate, Loyola Institute of Business Administration, Loyola College, Nungambakkam, Chennai, India)

2(Dean – Research, Professor of Finance, Loyola Institute of Business Administration, Loyola College,

Nungambakkam, Chennai, India)

I. WORKING CAPITAL MANAGEMENT – AN OVERVIEW Introduction and its Background

India is well on its own way to become the premier manufacturing location for companies around the

world (Manpreet and Ravi, 2008)1. India‟s share of industrial sector in GDP is 26 per cent (FICCI survey, 2012-

2013)2. Among which manufacturing sector is considered to be the most important sector in the overall

economic growth, so the sector needs to have a deep analysis at industry level as well as firm level.

There are a number of factors that affect the profitability of an enterprise. Their influence differs with

the aspects of both short term, and long term. Understanding these factors will be very helpful in managing a

business entity. In one hand the performance can be determined using the micro level and macro level factors.

On the other hand, there will be some internal as well as external factors too, which decides the effectiveness of the organisational profitability. At the same time an important role falls with the manager of the enterprise, who

should take all efforts to improve the financial performance of the company. Working capital is the major source

of Financing that a manufacturing firm needs to deal with (Kim and Hyun, 2013)3. According to Horne and

Wachowitz (2000)4

Working capital management efficiency is crucial especially for manufacturing firms; hence a major

part of assets is composed of current assets. Working capital is identified as one of the life giving forces for any

economic unit and its management is considered to be the most important function of corporate management.

All corporate entities irrespective of size and nature of business whether profit oriented or not, requires

necessary amount of working capital for their survival. Working capital management is the most decisive factor

for maintaining liquidity, solvency and profitability of business (Mukhopadhyay, 2004)5. The firms may likely

to face insolvency; if there is no any trade-off between liquidity and profitability with reference to working capital management (Kargar and Blumenthal, 1994)6. Working capital management plays distinctive role for

making the liquidity and profitability comparisons among various firms which includes the decision making

composition of current assets financing. The proportion of the liquid assets should be high, so that lesser will be

the risk of running out of Current asset and Liquid assets, being all other things equal. The components of

working capital such as marketable securities, receivables, inventory and cash management play a critical role in

the performance of any firm. (Eljelly, 2004)7.

Operational Definition and meaning of working capital

According to Guthmann and Doughall (1955)8 working capital is the excess of current assets over

current liabilities. Similarly, Gerstenberg (1959)9 stated “Any comprehensive discussion on the working capital

includes the excess of current assets over current liabilities”. This view is completely endorsed by (Accountants

Hand Book). Working capital typically means the firms holding of current or short – term assets such as cash,

receivables, inventory and marketable securities (V. K. Bhalla. 2004)10.

The Importance of working capital management

Working capital management is a significant feature of financial management. Its importance stems

from two reasons. Current Assets Investments represent a substantial portion of total Investment. Management

of working capital refers to the management of current Assets and current liabilities. The foremost drive of

course, is on the management of current Assets. Working Capital involves the proportion of the assets of a

business, that are used, in current operation, which includes receivables, inventories (raw materials, work-in-

progress and finished goods) merchandise, bill receivable and cash. The goal of working capital management is

to manage, current asset in such a manner so that the satisfactory level would be maintained.





Working capital management is an important function of financial management. Its function in an

organization is similar to that of heart in a human body. The financial manager must determine the satisfactory

level of working capital funds and also the optimum mix of current assets and current liabilities. The

management should ensure sources of funds which is used to finance working capital and should also see

whether short term obligation of the business is met well in time. Whereas, liquidity is a precondition to ensure

the firm‟s ability to meet its short-term obligations and its continued flow can be guaranteed from a profitable undertaking.

Strategies of working capital management

While discussing the working capital management strategies, it is necessary to note that which

definition of working capital is used. If the narrower definition is used, then working capital management means

inventory management, receivables management and payables management. With broader net working capital

definition current asset and current liability are managed.

In context of working capital management the inventory management means primarily deciding the

size of inventory. Firms should have an optimum level of inventories and large inventory reduces the risk of a

stock-out but it needs more working capital. In managing working capital delay in payments to suppliers can be

used for flexible and inexpensive source of business financing. But late payments are also very costly if the firm

is offered discount for early payment.(Deloof,2003)11. Accounts receivables are the third area where providing

time to the customer‟s in order to pay (trade credit) may stimulate sales as customers can evaluate product quality before paying it. Trade credit can also be a source of credit to firms that cannot get credit granted from

financial institutions cheaply (Ibid). Trade credit is a widely studied area (Petersen and Rajan,199712; Deloof

and Jegers, 199613 Ng et al., 199914). There exist many theories about trade credit, and many researchers have

been made to show if theories are right. Petersen and Rajan (1997)15found that firms use trade credit more when

credit from financial institutions is not available.

Research Questions

1. The present study is attempted to answer the question whether working capital management at

manufacturing sectors in India has a significant impact on the profitability or not?

2. To examine the components of working capital (cash, debtors, inventory) on profitability in the sample

units.

3. To access the effectiveness of liquidity management on profitability in the selected 15 sectors. 4. To investigate to what extent working capital management impact profitability of the sectors in the

study.

5. At the same time, what are the metrics should the Industrial sector focus on while investing in working

capital?

Research problem

Realizing the importance of working capital management in the growth and development of the

manufacturing Industries in India the current research intends to reveal relationship between working capital

management and its effect on profitability of top 162 S&P CNX 500 manufacturing firms listed in NSE from

CMIE prowess Database for a period of 2006 – 2012. In light of the above facts, “A Study on the Impact of the

Working Capital Management on Profitability of the Leading Listed Manufacturing Companies of Chennai

(2006-2012)” has been undertaken.

Objective for the study

Broad Objective

To study the sector-wise relationship between Working Capital Management and Profitability of

Leading Listed Manufacturing Sectors in Chennai (2006-2012).

Specific Objective

To analyze the sector-wise relationship between Debtors conversion period and Net Operating

Profitability.

To study the sector-wise relationship between Inventory turnover period and Net Operating

Profitability.

To enquire into the sector-wise relationship between Average payment period and Net Operating

Profitability.

To analyze the sector-wise relationship between Cash conversion cycle and Net Operating Profitability.

To examine the sector-wise relationship between Current Ratio and Net Operating profitability of the

firm.

To look into the sector-wise relationship between Quick Ratio and Net Operating profitability of the

firm.

To study to what extent the working capital management impacts the Net Operating profitability of the

selected 15 sectors.

Hypothesis for the study – (Individual Test of hypothesis for selected 15 sectors)





H1: There is no relationship between Debtors conversion period and Net Operating profitability.

H2: There is no relationship between Inventory turnover period and Net Operating profitability.

H3: There is no relationship between Average payment period and Net Operating profitability.

H4: There is no relationship between Cash conversion period and Net Operating profitability.

H5: There is no relationship between Current Ratio and Net Operating profitability.

H6: There is no relationship between Quick Ratio and Net Operating profitability.

Limitations

The present study has been framed to study only the impact of working capital management on

profitability.

The secondary data was drawn for a period of 6 years from (2006-2012), for analysing the selected

manufacturing units listed in NSE India.

Further the study is limited to 15 sectors alone. There are more than 20 sectors listed under S&P CNX

500 companies but consistent data were available only for these 15 sectors. The 15 sectors consist of

162 companies.

Due to the time constrain the primary study was restricted to manufacturing units in Chennai city only.

From 162 selected samples of India, only 42 companies were available in Chennai out of which the

researcher could cover only 34 companies.

Scheme of Chapterization

The entire study has been organized into six chapters. The first chapter deals with an introduction of

working capital management and its background, concepts, importance, need, scope, strategies of working

capital management with research questions, problem statement, objective and hypothesis of the study also been

discussed. The second chapter includes research and conceptual studies made in the field of working capital

management and profitability, reports from planning commission to manufacturing sector, components of

working capital management etc., which helps in finding out the operational performance of manufacturing and

the effect of changing working capital requirements, approaches and policies. The third chapter contains

methods and materials, which deal with population, sample selection process, data collection process (primary

and secondary), statistical tools used etc. The fourth chapter deals with a results and discussion of secondary

data. The fifth chapter deals with the results and discussion of primary data. The Sixth chapter summarizes the findings, recommendations and conclusion of the study.

II. REVIEW OF LITERATURE Introduction

The economic recession of 2007 once again started an increased interest on short-term financial

management (Economic Survey 2007-2008)16. Managing working capital is a significant part of short-term

financial management. Working capital management is an important function of financial management which

helps in maintaining an optimal balance between each of the working capital components. Industries can reduce

their financing costs or increase the funds available for expansion of projects by minimizing the amount of investment tied up in current assets. In a broad-spectrum, the current assets are considered as one of the

important component of total assets of a firm. A business entity may be able to reduce the investment in fixed

assets by renting or leasing plant and machinery. But, the same strategy cannot be followed for the components

of working capital. Since, the high level of current assets may diminish the risk of liquidity associated with the

opportunity cost of funds that may have been invested for long-term assets. India‟s strategic objective of the

manufacturing sector for the next 15 years should be brought to develop the quantitative and qualitative changes

through a set of policies and plans (Manufacturing Industry survey 2008)17. Therefore, the cost associated with

the strategy of doing business is as much as high in India. Hence to overcome the difficulty and meet the

challenges of manufacturing sector in India the Industries are encouraged to attract more investments into the

stream in order to minimize the risk of liquidity and to maximize profitability. The liquidity and profitability

trade off can be tackled efficiently by improving and adopting effective working capital management strategies

with in the manufacturing sector.

Definition, Theories and Determinants of WCM

The Importance of working capital management is reflected in the fact that it includes both current

assets and current liabilities. Organizing short-term funds, assigning favourable credit terms, regulating the, cash

movement, administering accounts receivable, and investing short-term surplus funds consume a great deal of

time of financial managers (Pandey I.M. 2007)18. This section will elaborate the definition, theories and

determinants of working capital management in detail.

Definition of working capital management

Working capital is defined in Annual survey of Industries (1964)19to include “stocks of materials,

stores, fuels, semi-finished goods and by-products, cash in hand and at bank and the algebraic sum of sundry

creditors represented by outstanding factor payments e.g. rent, wages, interest and dividend. Working capital





management is to manage the firm‟s current assets and current liabilities in such a way that a satisfactory level

of working capital is maintained (Gitman, L.J. 1976)20. “The efficiency of a business enterprise to earn profits

depends largely on its ability to manage working capital. Working capital management has acquired paramount

importance in the recent past, especially in view of tight money conditions prevailing in the economy”

(Agarwal, H.L. 1987)21

. Management is required to be vigilant in maintaining appropriate levels in the various

working capital accounts (Donaldson, 1957)22.

Theories of WCM and Profitability in various sectors

Working capital management is mainly concerned with two factors, namely the first level of current

assets to be held in the types of assets that are to be financed. Modern financial management aims at reducing

the level of current assets without ignoring the risk of stock outs. This occupies much of the finance manager's

time in taking operational decisions. The economic activities of a company are best judged by the value that is

created by such performance which is benefitted by the value. Sen and Oruc (2009)23 investigated the efficiency

of working capital management and its relationship with profitability in Istanbul Stock Exchange (ISE). They

used three-month table data issued by 49 production corporations for the period from 1993 - 2007 over five

production sectors, including white goods, electronic, Cement, food, chemical and textile. Their results showed

that aggressive working capital management is represented by shorter Cash Conversion Cycle and the current

ratio which results in increased profitability. This sector-wise investigation reveals that there is a significant

similarity among sectors with regard to the relationship between working capital management and profitability except for the chemical sector.

Similarly, in India, Vijay Kumar (2011)24 examined the relationship between working capital

management and firm‟s profitability in automobile industries. The study includes a sample consisted of 20 firms

for the period of 13 years from 1996-2009. The result of this study has shown that there is a negative

relationship between the length of cash conversion cycle and the firm profitability. His findings are consistent

with the recent literature in the area of working capital management and profitability.

Strategies / Measurements of Working capital management and profitability

Vunyale et al. (2007)25 investigated the determinants of working capital management in cement

industry in India. Authors used net liquidity balance and the working capital requirements as measure of

investing the working capital management of the industry. The data consists of companies in cement industry

for a period of 10 years from 1995 – 2006, compiled with CMIE Prowess database for a sample of 50 companies. It is clear from the survey that companies with the better firm performance had better working

capital performance efficiency and will keep their working capital requirements relatively in a low level.

Similarly, to the above study Appuhami (2008)26investigate the impact of firms‟ capital expenditure on

their working capital management. The study was drawn using the data collected from listed companies in the

Thailand Stock Exchange of 1613 firm-year observations for a period of 2000 - 2005. The study used the Net

liquidity balance and working Capital Requirement as a proxy for working capital measurement and established

multiple regression analysis. The research found that firms‟ capital expenditure, and operating cash flow had a

significant impact on working capital management. The findings of the study can be concluded that the listed

companies in Thailand change their working capital management policies based on many factors, such as

working capital investment, capital expenditure and cash flow etc. Especially, the findings suggest that

companies manage working capital efficiently when companies have the growth opportunities so that they can

meet their required capital expenditure to expand their business.

Determinants of Working Capital Management

The corporate finance literature has traditionally focused on the study of long-term financial decisions

that is particularly long-term investments, capital structure, dividends or company valuation decisions.

However, the short-term assets and liabilities are important components of total assets that needs to be analyzed

carefully. The present study is expected to contribute for the better understanding of firm related factors that

shape up the working capital requirements of firms especially in the emerging markets like India.

Working capital management efficiency is vital especially for manufacturing firms, where major part

of assets is composed of current assets (Horne and Wachowitz, 2000)27. It directly affects the profitability and

the liquidity of firms (Raheman and Nasr, 2007)28. The profitability and liquidity trade-off is vital to meet the

capital expenditure and also to measure the firm‟s solvency, hence illiquidity firms may even have pushed to

bankruptcy (Kargar and Bluementhal, 1994)29. Shin and Soenen(1998)30 argued that efficient working capital management is very important to create value for the shareholders. While Smith et al. (1997)31 emphasized that

profitability and liquidity are the salient goals of working capital management. The significance of working

capital management efficiency is irrefutable (Filbeck and Krueger, 2005)32. The Working capital is known as

life giving force for any economic unit and its management is considered among the most important function of

corporate in general.

Theoretical Foundations of Working capital components and Profitability

This section of the review states the importance of working capital management on profitability.

Accounts payable includes trade credit and accrued expenses which together provide finance to the operations of





an on-going business (Bhattacharya, 2003)33. Inventory, accounts receivable and cash management reflects the

current assets. But creditors‟ period represents the current liabilities. Credit period of account payable shows

how many days are taken to pay for their suppliers. If payment period is increased, it may result in loss of goods

supplied. Hence, the firms would build better relations with their supplies and try to retain optimal level of

working capital resources. Results of literature revealed that there are variations in the performance of sectors

under certain economic environment and conditions. Hina Agha (2012)34 tested the impact of working capital management on profitability in Pharmaceutical

companies. The secondary data was collected from Karachi stock exchange for the period of 1996-2011. The

results indicate that through proper working capital management the company can increase its profitability.

Therefore, the managers can improve the profitability of their firms by minimizing the inventory turnover period

and account receivables period by decreasing creditor‟s turnover periods.

Mohammad Fawzi (2011)35 study investigated empirical evidence about working capital management

and its effect on the profitability of Industrial Jordanian companies listed in ASE.The sample entails of 39

companies for the 8 years period from 2004-2011. The results of correlations and multiple regression analysis,

shows that there are significant negative associations between working capital variables with firm's profitability

therefore it highlights the importance of managing working capital to improve firm's profitability.

Studies and importance of Cash and Cash equivalents on profitability

Management of cash is one of the key areas of working capital management. Cash enables a firm to pay current obligations as and when they fall in due since it forms the most liquid asset. In the words of Gitman

(1976)36 liquid assets provide a pool of funds to cover unexpected outlays, thereby reducing the risk of „liquidity

crises‟. Apart from the fact it is most liquid current asset; cash is the common denominator to which all current

assets can be reduced because the other major current assets, (i.e) receivables and inventory get eventually

converted into cash. Cash the most liquid asset, is vital for the daily operations of business firms. While the

proportion of corporate assets held in the form of cash is very small, often between 1 to 3 percent. Its efficient

management is crucial to t2he solvency of business in a very important sense. Cash is the focal point of fund

flows in a business (Pandey, I. M. 2007)37.

The study states that cash cycle allows in deducting the payable period from operating cycle. Richard

and Laughlin‟s (1980)38was the first to introduce the cash conversion cycle concept for determining the net

amount of cash investment required for varying sales levels. This approach includes the length of time that the investment funds are tied up in the working capital as well as the amount of fund required. By covering a period

of 1975-1978 the study includes the calculation of Liquidity ratios and cash conversion cycle. The study stated

that management should ensure low cash conversion cycle period compared with that of competitors and

industry average. The analysis provides more than explicit insights for managing a firm's working capital

position which will assure the proper amount and the timing of funds available to meet a firm's liquidity needs.

Nazir et al. (2009)39 have identified cash management as the process of ensuring cash available to meet

the running expenses. Studies which considered cash conversion cycle as the best measure of working capital

has been discussed in this section.

Studies and Importance of Inventory on Profitability

Inventory constitutes the second largest asset category for manufacturing companies, next to plant and

equipment. The proportion of investment in inventories to total assets generally varies between 15 – 30 percent.

The most important objective of inventory management in India is to avoid loss of production/Sales. Generally, the inventories are the largest asset in a manufacturing firm. There are three types of inventories they are the raw

materials, work-in process, and the finished goods. Inventory may lead to a several costs like storage cost,

obsolescence, and insurance cost. If the firm does not maintain a proper investment level with inventories, a

disruption of the production and decrease in the sales can occur (Pandey. I. M. 2007)40.

Importance of Inventory management

In an Organization, Inventories are maintained to widen the latitude in planning and scheduling

successive operations. Raw Material enables a firm to decouple its purchasing and production activities to

certain extent. Inventory delivers flexibility in purchasing and production schedule. Likewise, the production

schedule needs to be influenced by immediate purchasing activity. An enterprise which conducts its business

operations at higher level with proportionately lower volume of raw material inventory is considered to be an

efficiently managed concern (Mohan Reddy. 1991)41.

Monitoring and control of Inventories

The success of an inventory programme by and large depends upon the practices and procedures

followed by the purchasing department in a business enterprise (Mishra R.K. 1975)42. This section discusses the

tools and the techniques used to maintain and control inventories. The popular control techniques adopted in

industries are ABC, JIT, and FSN.

In most Inventories, a small proportion of items accounts for a very substantial usage and a large

proportion of items count for a very small usage. ABC analysis is a selective approach to inventory control

which calls for a greater concentration of effort on inventory. In this category A represents most important





items, B represents moderate importance, and C represents items of least importance. The Just-in-time inventory

control system, originally developed by Taichi Okno of Japan, simply implies that the firm should maintain a

minimal level of inventory and rely on suppliers to provide spare parts and components „just-in-time‟ to meet its

assembly requirements. FSN is used to find out the fast moving, slow moving, and non-moving items in a store

department (Vaisakh et al., 2013)43

.

Theories on Inventory management and Profitability While measuring the inventory as a component of working capital which impacts profitability the

metric used is the Inventory turnover period (ITP). This period is compared with competitors who‟re widely

used to assess the performance of Inventory which is a major component of working capital. Inventory, in most

industries, accounts for largest proportion of gross working capital. Therefore, a number of studies have been

conducted to find the determinants of working capital investment in inventories. The subsequent discussion

provides a brief review of studies dealing with investments on inventory in India.

The first a small but fine piece of work is the study conducted by National Council of Applied

Economic Research (NCAER, 1966)44 with reference to working capital management in three industries viz.

cement, fertilizer and sugar. This was the first empirical study on working capital management in countries with

„scarcity of investible resources‟. This study was mainly dedicated to the ratio analysis of structure, utilization

and financing of working capital for the period 1959 to 1963. This study classified these industries into private

and public sector for comparing their performance with reference to the working capital management. This study stated that inventory constituted a major portion of working capital i.e. (74.06 %) in the sugar industry

followed by cement industry (63.1%) and fertilizer industry (59.58 %). The study observed that the control of

inventory had not received any proper attention. The inventory control was mainly confirmed to materials

management leading to the neglect of stores and spares. The utilization of working capital concerned with

cement and fertilizer industry had a more efficient utilization of working capital resources. The sugar industry

had an inefficient utilization of working capital largely due to the accumulation of stock with the factories. As

regards financing of working capital the study showed that inventory had contributed huge towards the

financing of working capital.

Studies and Importance of Receivables and Trade Credit on profitability

The term receivable is defined by Joy (1977)45 as debt owed to the firm by customers arising from sale

of goods or services in the ordinary course of business”. Improving working capital has become a focus for every chief financial officer (CFO) and is a crucial to business growth and profitability. So far, current strategies

often fail to recognize the role accounts receivable plays in reducing the cost of working capital, which also

have a positive impact on customer relationships and even the wider economy. A firm‟s investment in accounts

receivable depends on how much it sells on credit and how long it takes to collect receivables. Accounts

receivable constitute the third most important asset category for business firms, after plant, equipment and

inventories. Hence it behoves a firm to manage its credit as well.

Bieniasz, Golas (2011)46 defined the term receivables as the number of days from the moment of sale

until receiving the payment. Credit sales create account receivable allowing a reasonable credit period for their

customers. Credit sales increase the sales volume of the company. However, this may lead to increase in the bad

debts (Bhattacharya, 2003)47. Therefore, it is essential for the firms to implement a suitable collection policy.

Increased average collection period generally reflects the poor collection efforts delay in the customer payments

and financial distress (Bernstein and Wild, 1998)48.

Models of Working Capital Management

This section includes the models used in the literature, from 80‟s till date. A detailed explanation about

the models has been drawn.

Agarwal’s Goal Programming Model

Several studies have stressed the importance of effective working capital management. Agarwal

(1988)49 had formulated a goal programming model for the working capital decision. The proposed model is a

static, aggregate-level, a dynamic/multi-stage micro-model; with an appropriate inter linkages between the

different variables, incorporating the working capital cycle concept and the time value of money. According to

this model the relationship between different components of working capital, fixed assets, sales, and profits

needs to be examined in greater depth and modelled accordingly. The results of the model suggest that working

capital, and inventory in particular, should be streamlined to profitability. This approach is thus in conformance with the studies of (Rafuse, 199650; Cote et al., 199951; Garcia-Teruel and Martinez-Solano, 200752; Filbeck and

Krueger, 200553; Singh, 200854; Singh and Pandey, 200855). In particular, the proposed model has serious

limitations, which may not have taken some other relevant parameters into consideration. It assumes stable

turnover ratios, which may limit its applicability in practice. The proposed model is a linear programming

model, and thus deals only with the linear behaviour of working capital.

Dynamic Model

Carmine Binachi56 sketched a dynamic model which is useful to measure the effectiveness of net

working capital management. This subject is commonly studied through the use of accounting models based on





general ledger data, which is used to evaluate the financial structure of the firm through balance sheet analysis,

ratios and fund flows. This model is useful in supporting the budgeting process, and also in monitoring accounts

receivables, Inventories, and current debts effect on profits. This model utilizes variance analysis, thereby

supporting the performance evaluation. The model suggests that Net Working Capital management particularly

from financial perspective often assume that a linear and nonlinear relation exists between working capital

components and other variables of Net working Capital. This approach also takes into consideration the way how the internal variables such as the sales price extensions, the

customer service levels may be affected by the external market variables relating to customer preference and

competitor‟s policies. The dynamic model concludes that it may give a strong support to the corporate growth,

strategic control, and better comprehension feedback to the current operations.

Traditional Approach / Ratio Analysis/ Conventional Model

Conventional model of working capital management is based on the observation of the net working

capital behaviour, components (i.e) within the current assets and liabilities, in liquidity ratios or metrics

(working capital, current ratio, cash ratio, and acid test or quick ratio) on firm‟s operating and financial cycles.

In general, a firm with a sound liquidity situation has a positive net working capital and liquidity ratios equal or

superior to certain benchmarks, which may be established on an industry basis or on firms of similar type or

size. It is also recommended to observe the evolution of those ratios through time, so as to determine the trends.

The determination of each of the working capital components is done by disaggregating these components and treating them separately.

This study aims at adopting the financial ratio analysis methods for analysing the study.

Fleuriet’s model

Fleurietet al. (1980, 2003)57 intended to bring a new method for working capital management. Initially,

the model proposes a new managerial classification for current asset and liability accounts, according to their

financial or operating nature, with this segregation being essential to the process of assessing firms‟ working

capital requirements. However, this is exactly what is done in the conventional analysis of working capital. In

other words, the refusal of Fleuriet‟s model naturally leads to the conventional model. However, the proposed

model demonstrates the dangers of model building based on intuitive ideas that were not proven empirically.

Even though Fleuriet‟s model had diverse criticism, it has been taught in Brazilian undergraduate and post

graduate university courses since 80‟s as a modern and sophisticated tool for working capital analysis and management.

Altman Z Score – Model

The Z - score formula for predicting bankruptcy was published in 1968 by Edward I. Altman (1968)58.

The formula is used to predict the probability that a firm will go into bankruptcy within two years. The

corporate defaults are predicted using Z - scores, which is considered as a good control measure for the financial

distress status of companies in academic studies. The Z-score comprises of multiple corporate income and

balance sheet values to measure the financial health of a company. The original Z-score formula was T1 =

Working Capital / Total Assets, T2 = Retained Earnings / Total Assets, T3 = Earnings before Interest and Taxes

/ Total Assets, T4 = Market Value of Equity / Total Liabilities, T5 = Sales/ Total Assets.

Theoretical underpinnings of Liquidity

Definition of Liquidity In accounting, liquidity is a measure of the ability of a debtor to pay their debts as and when they fall

due. It is typically expressed as a ratio or a percentage of current assets and current liabilities. Liquidity is the

capacity to pay short-term obligations. It is safer to invest in liquid assets than illiquid ones because it is easier

for an enterprise to realize quick profits out of investments.

Measures of Liquidity

The liquidity of a business entity can be measured using various ratios with a published balancesheet.

The current ratio is the simplest measure calculated by dividing the total current assets by the total current

liabilities. The quick ratio is measured by deducting inventories and prepayments from current assets and then

dividing by current liabilities. This ratio predicts a measure of the ability to meet current liabilities from assets

that can be readily sold. The operating cash flow ratio can be calculated by dividing the operating cash flow by

current liabilities. This measure is the ability to service current debt from current income, rather than through asset sales.

Liquidity and Profitability Trade-off

The Net working capital has a bearing on liquidity, profitability and risk of becoming technically

insolvent. In general, the greater the working capital the higher is the liquidity, the lower is the

risk and profitability vice versa. The trade - off between profitability and risk is an important element in

evaluation of the level of net working capital of a firm.

Working capital is the most crucial factor for maintaining liquidity, survival, solvency and profitability

of the business (Mukhopadhyay, 2004)59. Working capital management is one of the most important areas while

http://en.wikipedia.org/wiki/Edward_I._Altman

http://en.wikipedia.org/wiki/Bankruptcy

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http://en.wikipedia.org/wiki/Accounting

http://en.wikipedia.org/wiki/Debtor

http://en.wikipedia.org/wiki/Ratio

http://en.wikipedia.org/wiki/Percentage

http://en.wikipedia.org/wiki/Liability_(accounting)

http://en.wikipedia.org/wiki/Balance_sheet




http://en.wikipedia.org/wiki/Current_ratio

http://en.wikipedia.org/wiki/Quick_ratio

http://en.wikipedia.org/w/index.php?title=Operating_cash_flow_ratio&action=edit&redlink=1

http://en.wikipedia.org/wiki/Operating_cash_flow

http://en.wikipedia.org/wiki/Current_liabilities

http://en.wikipedia.org/wiki/Current_liabilities





making the liquidity and profitability comparisons among firms, involving the decision of the amount and

composition of the current assets and the financing of these assets. The greater the proportion of liquid assets,

lower will be risk of running out of cash, all other things being equal. The components of working capital

including cash, marketable securities, account receivables and inventory management play a vital role in the

performance of any firm (Eljelly, A. 2004)60

.

Importance of the working capital management in other areas The role of working capital is significant not only in top performing firms but also for small and

medium sized firms, its impact on corporate governance and the electronic transfer system to meet the

requirements of working capital in time, were some of the policies drawn by the firms which influences the

working capital management are discussed in this section.

Role of the Working capital management in the small and medium sized firms

The working capital management is particularly important in the case of the small and medium sized

companies. Most of these companies‟ assets are in the form of the current assets. The current liabilities seem to

be one of their main sources of the external finance.

The objective of the (Teruel. P.J.G and Solano .P.M. 2007)61 research was to provide empirical

evidence about the effects of the working capital management on the profitability using return on assets. The

Effect of Working Capital Management on ROA for a sample of 8,872 covering the period 1996–2002stated

that there exists a significant relationship between working capital and profitability. Anubha Srivastava (2000)62 has done a case study on the various facts of the working capital

management at RIL at its Engineering Procurement and Construction (EPC) division, which mainly deals in

power projects. The financial analysis of the company has also been carried out to know its credit worthiness.

The working capital management involves not only managing the different components of the current assets, but

also the current liabilities, or to be more precise in financing the current assets. There are three main areas in the

working capital management one is the study focuses on receivables management, second is on cash

management, and the third one is on the inventory management. The study concludes that the company manages

its receivable accounts through ageing analysis and manages its cashthrough the management information

system. The inventory management is made easier through the process of a high sales and sale in transit. The

analysis with respect to the company‟s competitors is done to further understand its position in the market.

Research Gap This study takes into consideration the top 162 S&P CNX 500 manufacturing firms within the

geographical area of India. Some Previous research might have studied the relation between the working capital

management and the profitability, but those research failed to address the Sector-wise issues of the working

capital management. This study aims at fulfilling such gaps by considering the industry specific nature of

working capital by dividing the sample into 15 sectors. This thesis will introduce the reader about diverse

techniques used to measure the working capital management.

Purpose of the Research

The purpose of this research is to analyze whether the working capital management affect the company

profitability of 15 manufacturing sector in India or not. The study about Industry effect are interesting because

the shares of Indian manufacturing, which is the most dominant sector within the industries, remained in 15.5

percent during this period (FICCI manufacturing Sector Survey 2012)63. The share is the modest when compared to that of the China (above 40 per cent) and some of the East Asian countries (above 30 per cent). The

need to focus on manufacturing industries needs added advantage. The purpose of the thesis is to point out

which of the working capital management drivers and metrics affect the profitability and to address and verify

the industries that are affected the most among the selected sectors.

Summary of Highlights

The strength of a company's balance sheet can be evaluated by examining three broad categories of

investment quality, Adequacy in the Working capital, the asset performance and the capitalization structure.

This study started with a comprehensive look at evaluating the quality of a company‟s in the working capital

position. However, this study entails in measuring the liquidity and the managerial efficiency related to the

companies Competency. The cash conversion cycle (also referred to as CCC or the operating cycle) is the

analytical tool of choice for determining the investment quality of two critical assets - inventory and accounts receivable. Literature states that Inventory Turnover period and Receivables Turnover period is a good indicator

of the management's ability to handle the important inventory and receivable assets.

A quick ratio and current ratio is what creates real liquidity, is a positive indication of the quality and

the efficient management of liquidity. The need to sharply change the growth of Indian Manufacturing sector

requires a holistic appraisal of what needs to be done to improve their competitiveness.

The concept of management of the Working capital refers to the managers‟ skills in handling the short

term investments and the aim of capital management is to increase the liquidity, the profitability and the value of

shareholders (Nilsson et al., 2010)64. Recent studies of manufacturing strengths of the country reveal that

http://www.investopedia.com/terms/b/balancesheet.asp

http://www.investopedia.com/terms/w/workingcapital.asp





industries focused on the policies they adopted were differed. The literature review found some significant

positive and negative relationships between working capital management, liquidity and solvency factors. The

literature states that there is a lack of the sector – wise study in India. Hence, the present study has been aimed

to focus on the relevant factors of liquidity, profitability and solvency on profitability of 15 selected

manufacturing sectors in detail.

All the successful countries had one thing in common is that they had very good process of consultation between the producers and the policy makers. The streamlining of this requires action by the

government agencies in the state and the centre thereby attracting more investments into the manufacturing

sector. The major concern of the manufacturing sector has to focus more in controlling and managing the short –

term obligation such as the working capital. A review of literature is an essential to place the study in proper

perspectives so that to identify the gaps and not to duplicate the same work. After reviewing the literature, it can

be concluded that there are certain research gaps in the earlier studies that the present study aims at fulfilling

those gaps.

MATERIALS AND METHODS Introduction

Managing the working capital is an important part of short-term financial management. The long-term

financial management often receives more attention although many researchers, Jose et al. (1996)65, Deloof

(2003)66 have shown that short-term financial management also has a clear effect on the profitability of a firm.

Mulins (2004)67 noted that the working capital management can be used to gain competitive advantage. In India

the corporate sector seems to have an adequate and satisfactory level of working capital as reflected in their

liquidity ratios. The foreign based companies are placed in a better relative to domestic companies. There is a

wide inter-industry variation in liquidity ratios and performance of working capital of the corporate enterprises.

Concepts and Its Importance

The management of working capital is essential for a company to remain liquid, and to meet its short-

term obligations. This thesis aims to concentrate on the different metrics and process around the working capital

management in various selected sectors and to find out how companies can manage the working capital in a better way. The method used in this study will be quantitative in nature of how the working capital management

affects the profitability of manufacturing firms in selected industrial sectors in India. Industry effects with

reference to the working capital management will also be addressed.

Conceptual Framework for the Study





Methods of Data Collection

The purpose of this research is to contribute towards a very important aspect of financial management

known as the working capital management with reference to India. The research intends to reveal relationship

between the working capital management and its effects on the profitability of 162 manufacturing firms from

CMIE prowess Database.

The Secondary Sources To achieve the above noted objectives, extensive use of libraries was done. This study is based on both

the primary and the secondary data. The secondary data were collected through the Government reports, official

records, Journals, Books, websites of Internet and financial statements, such as income statements, balance

sheets of S&P CNX 500 companies. For the purpose of arriving at meaningful inferences a six-year period

beginning with 2006-2012 was derived from CMIE Prowess Database listed in NSE. From the top S&P CNX

500 companies 240 units has been shortlisted which had similar business module and the financial information

pertaining to income statements, balance sheets, and cash flow statements etc. and also supports the study

variables. There are more than 20 sectors which is includes this 240 companies. But all the 20 sectors do not

have data for a continuous period of 6 years. Consistency of the data is desirable for the accurate result. Only

162 companies have data for 6 years‟ period. These companies constitute of 15 sectors. Hence only top 162 out

of S&P CNX 500 companies from CMIE Prowess database were considered for the study. The other non-

financial firms which lack in data were eliminated from this study.

The List of Sectors selected for the study from 162 S&P CNX 500 companies listed in NSE

S.NO Selected 15 Sector Total Units

1 Automobile 10

2 Electrical Equipment 10

3 Steel and Aluminum 17

4 Pharmaceutical 13

5 Cements 13

6 Consumer Durables 6

7 Engineering 7

8 Textiles 14

9 Chemicals 12

10 Tyres 5

11 Pumps 5

12 Food 8

13 Sugar 5

14 Trading 3

15 Construction 34

TOTAL 162

The Primary Sources

The primary data was collected from CFO‟s of thirty-four manufacturing units located in Chennai.

These 34 samples of primary data have been derived from the shortlisted companies of S&P CNX 162

companies from the CMIE prowess database. This sample was drawn under the criteria of covering the

geographical area of Chennai city. The present study is an empirical investigation of analytical nature including

field study. The questionnaire schedule method was adopted to obtain information from CFO‟s of selected

manufacturing units in Chennai.

The Methods of Analysis

The present study adopts Systematic Random Sampling method. The reliability and validity test has been performed for the primary data (i.e) Questionnaire survey. The tools such as Descriptive statistics, Ratio

analysis, Correlation, Chi-square has been used to analyse the secondary data.

The Reliability Test

For conducting the reliability test 15 samples were selected for factors like, general identification, the

working capital performance and key components of manufacturing units, reminder procedures of

manufacturing units, turnover periods, the working capital financing, standards and ethics of manufacturing

units with profitability were undertaken. The reliability and validity is checked by Cronbach‟s Alpha test. The

results of the test are 0.73.

Statistical Tools Used





To analyze the impact of the variables selected for this study, the following tools are used:

Accounting Tools (Ratio Analysis)

Correlation

Chi-Square

Software Application Used

The software applications used to analyze the data are, SPSS (Statistical Package for Social Science) version - 19.0.

FINDINGS FOR SECONDARY DATA On the whole the study identifies the issues related to the working capital management undertaken by

manufacturing industries through the various questionnaire survey and secondary data analysis. The findings of

the sector – wise study based on the secondary data have been discussed below.

Findings for Pearson correlation of working capital component and liquidity on Net operating

profitability for Automobile sector for a period of 2006-2012

From the study it has been found that among the working capital components, inventory turnover period is affecting the Net operating profitability of automobile sector. It has been found that there is a

negative relationship exists (i.e) reduction in the inventory days will increase the company‟s

profitability. So, the automobile firms should concentrate more on reducing the Inventory turnover

days. Hence from the study it is evident that inventory plays a major role in automobile sector.

Findings of Pearson correlation co-efficient of working capital components and liquidity with Net

Operating Profitability for Electrical Equipment sector for a period of 2006-2012

From the study it has been found that there is a negative relationship exists (i.e) the decrease in the

period of working capital components such as debtor‟s collection period, Inventory turnover period,

and Average payment period will increase the profitability of the Electrical Equipment sector. It is also

found that increase in the period of cash conversion cycle will increase the Net operating profitability.

Findings of Pearson correlation co-efficient of the variables of working capital components and

liquidity with Net operating profitability for Steel and Aluminium sector for a period of 2006-

2012


period of working capital components such as Inventory turnover period, and Average payment period

will increase the profitability of the Steel & Aluminium sector. The study also found that current ratio

and quick ratio had a positive relationship which states increase in the investments of current assets and

liquid assets will increase the Net operating profitability.


Liquidity with Net Operating Profitability for Pharmaceutical Sector for a period of 2006-2012


period of working capital components such as Debtors conversion period, Inventory turnover period, Average payment period, and Cash conversion cycle period will increase the Net Operating

profitability of the Pharmaceutical sector. The study also found that current ratio and quick ratio had a

positive relationship which states increase in the investments of current assets and liquid assets will

increase the Net operating profitability.


Liquidity with Net Operating Profitability for Cement sector for a period of 2006-2012


period of working capital components such as Debtors conversion period, Average payment period,

and Cash conversion cycle period will increase the Net Operating profitability of the Pharmaceutical

sector.

Findings of Pearson correlation co-efficient of all, variables of working capital components and

Liquidity with Net Operating Profitability for Consumer Durables sector for a period of 2006-

2012



and Cash conversion cycle period will increase the Net Operating profitability of the Consumer

Durables sector. The study also found that current ratio and quick ratio had a positive relationship

which states increase in the investments of current assets and liquid assets will increase the Net

operating profitability.


Liquidity with Net Operating Profitability for Engineering sector for a period of 2006-2012







and Cash conversion cycle period will increase the Net Operating profitability of the Engineering

sector. The study also found that quick ratio had a negative relationship which states increase in the

investments of liquid assets will decrease the Net operating profitability or vice versa.


Liquidity with Net Operating Profitability for Textile sector for a period of 2006-2012



and Cash conversion cycle period will increase the Net Operating profitability of the Textile sector.


Liquidity with Net Operating Profitability for Chemical sector for a period of 2006-2012


period of working capital components such as Debtors conversion period, and Average payment period

will increase the Net Operating profitability of the Chemical sector. The study also found that current

ratio and quick ratio had a positive relationship which states increase in the investments of current

assets and liquid assets will increase the Net operating profitability.


Liquidity with Net Operating Profitability for Tyre sector 10 for a period of 2006-2012


period of working capital components such as Debtors conversion period, Inventory turnover period

will increase the Net Operating profitability of the tyre sector. The study also found that quick ratio had

a positive relationship which states increase in the investments of liquid assets will increase the Net

operating profitability.


Liquidity with Net Operating Profitability for Pump sector for a period of 2006-2012


period of working capital components such as Debtors conversion period, Inventory turnover period,

Average payment period, and Cash conversion cycle period will increase the Net Operating profitability of the Pump sector.


Liquidity with Net Operating Profitability for Food sector for a period of 2006-2012



and Cash conversion cycle period will increase the Net Operating profitability of the Food sector.


Liquidity with Net Operating Profitability for Sugar sector for a period of 2006-2012

The study states that the working capital components and liquidity is not related to Net operating

profitability of the Sugar sector. It is found that in the sugar sector profitability is not affected by

working capital variables for the study period.


Liquidity with Net Operating Profitability for trading sector for a period of 2006-2012

The study found that current ratio and quick ratio had a positive relationship which states increase in

the investments of current assets and liquid assets will increase the Net operating profitability of the

trading sector. In trading sector liquidity plays a major role in maximizing the profitability.


Liquidity with Net Operating Profitability for construction sector for a period of 2006-2012


period of working capital components such as Debtors conversion period, and Inventory Turnover

period then the same will increase the Net Operating profitability of the Construction sector.

Summary of Findings Based on Variables Independent Variables (Debtors Collection Period, Inventory Turnover period, Average Payment

period, cash conversion cycle, Current Ratio, Quick ratio, Firm Size, Fixed Assets to Total Assets, Debt Ratio)

WITH Dependent Variable (Net Operating Profitability)

Findings for the Debtors Collection Period and the Net Operating profitability for all the selected

sectors for a period of 2006 to 2012

From the analysis it has been found that there is negative correlation exists between debtor‟s collection

period and Net operating profitability. This result has been consistent for the sectors such as Electrical

and Equipment, Pharmaceutical, Cement, Consumer Durable, Engineering, Textile, Tyre, Pump, and





Food. The inference stated when the debtor‟s collection period increased by one day, the net operating

profit of the firm tends to decrease or vice versa. Thus this finding are consistent and in line with

Kaddumi and Ramaan (2012), Bieniasz and Golas (2011). But the theoretically, if the day‟s collection

period is increased customers have good opportunity for acquiring more goods for longer credit period.

As a consequence, the sales of the company tend to increase, which results in increased profitability.

Findings for the Inventory Turnover Period and the Net Operating Profitability for all the

selected sectors for a period of 2006 to 2012

From the analysis it has been found that there is negative correlation exists between Inventory

Turnover Period and Net Operating Profitability. This result has been consistent for the sectors such as

Automobile, Electrical and Equipment, Steel and Aluminium, Pharmaceutical, Cement, Tyre, Pump,

and Construction. The Inference stated that an increase in the number of Inventory turnover days (i.e) if

inventory takes more days to sell then it results in decrease in profitability or vice versa. Thus the

storage and insurance cost can be increased and as a result the profitability may decrease. Highly

expensive Inventories‟ tied up in the firm may cause severe lose in the business. So the study states that

decrease in the inventory days will increase the profitability. The results for the Inventory turnover

period are consistent with the studies of Kaddumi and Ramadan (2012), Ganesan (2007), Khamrui

(2012), Bieniasz & Golas (2011).

Findings for the Average Payment Period and the Net Operating Profitability for all the selected

sectors for a period of 2006 to 2012

From the analysis it has been found that there is negative correlation exists between Average Payment

Period and Net Operating Profitability. This result has been consistent for the sectors such as Electrical

and Equipment, Steel and Aluminium, Pharmaceutical, Cement, Consumer Durable, Engineering,

Textile, Chemical, Pump, Food and Construction. The study implies that lengthening the average

payment period may negatively impact profitability. One the other side shortening average payment

period, will increase the profitability. The cause for negative relationship would be that more profitable

firms are shortening their payment period s in order to sustain the good suppliers. Further the firms

should keep better relations with their suppliers and try to maintain optimal Working capital

management.

Findings for the Cash conversion cycle Period and the Net Operating Profitability for all the

selected sectors for a period of 2006 to 2012

From the analysis it has been found that there is negative correlation exists between the combined

effect of all the three variables is analyzed by estimating the relationship of Cash conversion cycle

Period and Net Operating Profitability. This result has been consistent for the sectors such as

Pharmaceutical, Cement, Consumer Durable, Engineering, Textile, Pump, Food. It implies that if the

cash conversion cycle increases profitability will be decreased. However, increase in the days of cash

conversion cycle means that delay in money inflows. Therefore, it leads to unbalancing in cash

holdings and tie up of liquidity. This will have a negative impact on profits. Thus the results are in line

with Nilson (2010), Shin and Sonen (1998), Ogundipe (2012).

On the other hand, the cash conversion cycle is having a significant and positive relationship

with profitability for Electrical Equipment sector alone. The relationship is consistent with the view that increase in cash conversion cycle positively impacts the profitability while a decrease in cash

conversion cycle will have an negative effect on profitability. Also it indicates that firms earning high

profits are less motivated to manage their cash conversion cycle. Relaxed credit terms resulting in

greater level of receivables, longer cash conversion cycle and operating cycle results in increased

profits (Sharma &Kumar, 2011). Moreover, more profitable firms are less motivated to manage cash

conversion cycle (Abuzayed, 2012), (Gill, Biger & Mathur, 2010).

Findings for the Effect of the Liquidity (Current Ratio) on the Net Operating Profitability

Working capital management has traditionally used the current ratio and quick ratio to measure the

liquidity position of a company. In this analysis the current ratio has a significant positive relationship

with net operating profitability. The relationship states that increase in current assets positively impacts

the profitability while a decrease in current ratio will have a negatively effect on profitability. It

indicates that the two objectives of liquidity and profitability have been achieved by Steel and Aluminium, Pharmaceutical, Consumer durables, Chemical, Trading sectors as well.

And, from the analysis it has been inferred that the remaining sectors such as Automobile,

electrical, Cement, Engineering, Textile, Tyre, Pump food and construction sectors has to maintain a

balance or trade-off between these two measures, since the study states that there is no relationship

exists between them.

Effect of Liquidity (Quick Ratio) on Net Operating Profitability

In this analysis the Quick ratio has a significant positive relationship with net operating profitability.

The relationship states that increase in Quick assets positively impacts the profitability while a decrease in





Quick ratio will have a negatively effect on profitability. It indicates that the two objectives of liquidity and

profitability have been achieved by Steel and Aluminium, Pharmaceutical, Consumer durables, Engineering,

Chemical, Tyre, Trading sectors as well. And, from the analysis it has been inferred that the remaining sectors

such as Automobile, electrical, Cement, Textile, Pump, food and construction sectors has to maintain a balance

or trade-off between these two measures, since the study states that there is no relationship exists between them.

ANALYSIS OF QUESTIONNAIRE SURVEY The Present chapter deals with the chi-squared analysis (i.e) cross tabulation of the questionnaire

survey for which the data has been drawn through a field investigation. The analysis and interpretation for the

study according to the nature of data collected in 34 manufacturing concern in Chennai seems to have some

significant relationship between various components of working capital, liquidity measures, solvency, ability to

drive the working capital, organisation priority and utilisation of working capital resources, financing strategies,

working capital cycle periods, standard terms of payment, Invoice payments etc. have been discussed in this

chapter.

Summary of Findings, for Primary Data This section explains the findings of the questionnaire survey carried out in the various industrial units

at Chennai. The discussed findings reveal the factors which are considered to be important in increasing the

organisational performance (i.e) of the selected industrial units at Chennai.

26% of the industrial units selected for the study were established from the year 1971-1980.

85% of the industries drawn for the study are private Ltd.

29% of the respondents were from Automobile sector, whereas 22% are from pharmaceutical sector.

It has been found that the primary Data covers 29% of Automobile firms in Chennai.

It is clear from the questionnaire survey that most of the firms about 68% of them had a turnover of

about 21 to 30 million.

From the survey it has been found that 19 units had training programs, which implies a fair

improvement in the working capital performance.

The study found that 41 percentage of industries place a highest level of importance on working capital, which helps in maintaining their profits.

It has been found that 50% percentage of surveyed industries, utilize their working capital resources

effectively which earns them more profit, hence they are best in class among their peer groups.

The surveyed industrial units allow about 15-45 days for collecting their accounts receivables. But the

industries take more than 45-90 days to pay for its creditors.

Thus it is found that the surveyed firms take more time to pay for their creditors, and allows less time

to collect their receivables. This policy helps in meeting the operational expenses, and also helps in

increasing the profit.

The study found that 44% of the surveyed firms take about 45-90 days for their inventory conversion

period

It has been observed that 50% of the surveyed firms take more than 90days to convert their stock into cash cycle.

The study identified that a balanced trading cycle adopted by surveyed firms, which enhance their

profits.

It has been analysed that 79% of the surveyed firms follow a bills discounting procedure, which

increases the effectiveness of profits in the organisation.

The survey attempted to study the practice of remainder procedure, and it has been found that 29% of

companies are sending the remainders 1 week before the due date.

It has also been observed 30-40% of the payments were received only after sending the remainders,

which means the organisation should follow an effective remainder procedure in order to increase the

percentage of payments which results in increased profits.

It has been found that 19 industrial firms have adopted specific inventory model. Among the various

inventory models JIT, EOQ and FSN found to be more frequently used inventory models in the surveyed firms.

From the four inventory models adopted in the various industries. EOQ seems to be more reliable

model used by the surveyed firms.

It has been found from the study that to ensure sufficient cash flow cash management practices,

budgeting of cash and determination of cash balances were considered to be the most important

practices to meet the cash requirements in the surveyed industrial units.

From the questionnaire survey it is found that receivables management practices such as setting up of

credit guidelines, selling products on credit and review of levels of receivables to be the most important

and useful strategies in order to increase the organisational performance.





It is found that frequent assessment of review of inventory levels will help in increasing the

profitability.

It is found from the survey that most of the companies will go for stock replacement orders once in 3

months frequently.

It has been found that the surveyed organisations were tremendously increasing their profits and

growth by their sales and assets performance which is increases the organizations efficiency year by year.

In order to meet the working capital financing the surveyed firms adopted working capital term loans

and credit/overdraft facilities as their basic activity to facilitate the operational requirements which

results in the increased efficiency.

44% (15) of industries take working capital term loans as their major source of external financing for

working capital requirements.

The study found some issues with reference to the importance on training and education on use of

computer spread sheets, were lacking to maintain an appropriate credit control and collection policies.

The study identified the lack of qualified accounting staff and suitable accounting software as the

motivation for effective working capital management practices.

The study revealed that the operation of the firms possesses limited formal education, weak managerial

and financial management skills within the firm. Owners/Directors were found to act as barriers for efficient usage of working capital management practices. Hence operational level officers could not

adopt policies to meet the standards expected by industries.

RECOMMENDATIONS Recommendations to the Company (At Operational Level)

The industrial sectors are suggested to take up the electronic money system in order to speed up the

cash inflows and outflow.

If the delays in payments are taking place for the first time, a direct contact with the customer is

required to know the reasons behind the unusual delay or a remainder letteror mail is suggested. If the days past due is more than 60 days, the situation is serious. Hence the top management should be

contacted and future processes should be stopped. The credit manager should have patience and try to

find out the causes for the delay.

If the payment is due for more than 90 days, all deliveries should be stopped. The account may be on

the brink of becoming bad debt. It has to be closely monitored with a view of collecting as much

payment as possible.

The goal must be that all priority outflows be met fully out of operating cash flows while all

discretionary outflows are met with the balance in conjunction with the financial flow

A Mismatch between the current receipts and current payments should be reduced as much as possible.

Managers should take special care with regard to the lengthening of payable deferral since it might

harm the corporation‟s credit reputation and as a result it will decrease the profitability in long-run horizon.

Companies must set a trade-off between profitability and liquidity so that neither the liquidity nor

profitability suffers, managing working capital in more efficient ways, enhances and develops models

that detect liquidity problem.

This study indicates that firms must have adequate current assets in order to keep daily business

operations in work, which does not affect profits.

Recommendations to the Company (At Management Level)

From the questionnaire survey it is analysed that it‟s not the responsibility of the finance department

alone. Companies should implement a proper cash-focused management system.

The cash-focused management system should be reviewed using the key performance indicators (KPIs)

on working capital in order to meet the operational level successfully in the surveyed firms.

The surveyed firms should provide “Awareness training Program at management level” and “Activity training Program on new processes” at operational level.

Most of the surveyed firms in Chennai consider loans and overdrafts as their only source of working

capital financing. Funds should be raised by turning to asset-based finance such as invoice discounting,

and harnessing the power of the web to raise finance etc.

The surveyed firms should avoid holding unnecessary levels of stock. This can be one of the biggest

benefits on working capital. Often stock problems result in a lack of communication among different

departments, so it should be reviewed properly. Hence it is recommended to adopt JIT model of

inventory management to avoid overstock





The study suggests that the organization should adopt accurate invoices as a key performance measure

for receivables to avoid unnecessary delays and to maintain effective payment process within their

customer.

The study suggests that both companies and policymakers should devise strategies to promote and train

the managers to take decisions regarding the working capital.

Even in certain period Adequate working capital can be used by the surveyed firms to enhance their profitability and international competitiveness

The study states proper record keeping system can be adopted to monitor the proper flow of their

working capital which also facilitates the customer management system.

In general, the aim of the business should be to educate staff to consider the trade-offs between various

working capital assets when negotiating with customers and suppliers.

The survey indicates the sample firms have to maintain formal terms with suppliers and customers and

document carefully.

SECTOR-WISE SUMMARY AND CONCLUSION Efficient management of working capital has been recognized as one of the basic function of finance

for successful conduct of business operation. This strategy not only influences profit earning capacity of

business undertakings, but also includes the content of operation. The management of working capital is

concerned with the management of current assets and current liabilities. The present study pertaining to working

capital management is an attempt to examine the structure of working capital in such a way to assess the

performance of inventory management, investigate the credit periods, to examine the utilization of cash

resources, to verify the liquidity position and to identify to what extent working capital management impacts the

profitability of selected industrial sectors at India (Chennai).

The sample consists of top 162 S&P CNX 500 firms which come under 15 sectors such as Automobile, Electrical Equipment, Steel and Aluminium. Pharmaceutical, Cement, Consumer Durables, Engineering,

Textile, Chemical, Tyre, Pump, Food, Trading, Sugar and Construction to determine the objectives for the

present study. The data collected for the study includes both primary and secondary sources. The collected data

were analysed using various financial tools and techniques with application of certain statistical methods such as

SPSS. The study brought to light certain facts and facets about the working capital management in India

(Chennai). This chapter will state the sector-wise conclusions based on the empirical analysis made and has

been briefly summarized.

Automobile sector

The present study states that inventory plays a major role in the automobile sector. From the analysis it

has been found that among the working capital components, inventory turnover period has got a significant

impact on Net operating profitability. So, the automobile firms should focus more on managing and reducing the

Inventory turnover days in order to maximize profitability and to withstand the competitive environment.

Electrical Equipment

The study on the electrical equipment sector stated that working capital management components

(Inventory, debtors, payments and cash) plays a major role in increasing the organizational performance. So

investment in working capital components should be devised properly. The study stated effective utilization of

working capital resources will increase the profitability of the electrical equipment sector.

Steel and Aluminium sector

Steel sector in India is one of the fastest growing and it ranked fifth among the steel production units in

the world. The study on steel and aluminium sector stated that working capital components such as Inventory

turnover period, and Average payment period should be kept in minimum hence to realize the increased

profitability of the Steel and Aluminium sector. The study also found that current ratio and quick ratio should be

maximized (i.e) which states increase in the investments of current assets and liquid assets will increase the profitability of the sector.

Pharmaceutical Sector

The study on the electrical equipment sector stated that working capital management components such

as (Inventory, debtors, payments and cash) plays a crucial role in increasing the organizational performance. It is

evident that working capital management affects the pharmaceutical companies in India. Thus the sector needs

close co-ordination between these working capital components. The study also states that increase in the

investments of current assets and liquid assets will increase the Net operating profitability.

Cement sector

From the study it has been evident that the working capital component affects the Net operating

profitability of Cement sector. The study stated that decrease in the period of working capital components such

as Debtors conversion period, Average payment period, and Cash conversion cycle period will increase the Net

operating profitability of the sector. So, the cements sector should collect the debts as soon as possible, early conversion cash cycle and payment periods should be decreased in order to increase the profits.





Consumer Durables sector

The study on consumer durables sector initiated that maintaining the minimum period of working

capital components such as Debtors conversion period, Average payment period, and Cash conversion cycle

period will increase the Net operating profitability of the sector. At the same time the study insist current ratio

and quick ratio should be maximized, which states increase in the investments of current assets and liquid assets

will increase the Net operating profitability. Thus the study states that profitability of consumer durables sector is affected by the working capital management and liquidity factors.

Engineering sector

From the study it has been found that there is a significant negative relationship exists between

working capital components and profitability of engineering sector. The study states that the decrease in the

period of working capital components such as Debtors conversion period, Average payment period, and Cash

conversion cycle period will increase the Net operating profitability of the Engineering sector. The study also

found that quick ratio had a negative relationship which states decrease in the investments of liquid assets will

decrease the Net operating profitability or vice versa.

Textile sector

It has been evident from the analysis that the Net operating profitability is affected by working capital

components of textile sector. The study reveals that decrease in the period of working capital components such

as Debtors conversion period, Average payment period, and Cash conversion cycle period will increase the Net operating profitability of the Textile sector. Hence the period of working capital components should be

minimized in textile sector. Furthermore, the study stated working capital management plays a vital role in

textile sector too.

Chemical sector

The study stated that Net operating profitability of chemical sector is affected by working capital

components of chemical sector. It reveals that the decrease in the period of working capital components such as

Debtors conversion period, and Average payment period will increase the Net Operating profitability of the

Chemical sector. It is found that in chemical sector receivables and payments periods should be minimized in

order to increase the profits. So, proper co-ordination in debtors and payments periods are required. The study

also found that current ratio and quick ratio had a positive relationship which states increase in the investments

of current assets and liquid assets will increase the Net operating profitability.

Tyre sector

The study on tyre sector revealed that debtors and inventory plays a major role. The analysis stated that

decrease in the period of working capital components such as Debtors conversion period, Inventory turnover

period will increase the Net operating profitability of the tyre sector. The study also found that increase in the

investments of liquid assets will increase the Net operating profitability. So it is evident from the above

statement that tyre sector had a significant impact on Net operating profitability by working capital components.

Pump sector

It is clear from the study that there is a significant relationship exists between working capital

components and Net operating profitability of pump sector. The analysis stated that the decrease in the period of

working capital components such as Debtors conversion period, Inventory turnover period, Average payment

period, and Cash conversion cycle period will increase the Net operating profitability of the Pump sector. Hence

it is evident that the pump sector also had significant impact on profitability by working capital components.

Food sector

From the study it has been found that there is a significant relationship exists between working capital

components and profitability of food sector. It is evident that decrease in the period of working capital

components such as Debtors conversion period, Average payment period, and Cash conversion cycle period will

increase the Net Operating profitability of the Food sector. So, it is clear that profitability of food sector also

affected by the working capital management.

Sugar sector

The study states that there is no relationship exists between working capital components and Net

operating profitability of the Sugar sector. Even the liquidity factors were not impacting the profitability. This

may be because of government undertaking in selling the products at public distribution system. Thus the sector

does not impact the working capital components on profitability. It is found that in the sugar sector profitability is not affected by working capital variables but there may be some other factors which impact the profits in the

sugar sector.

Trading sector

The study stated that there is no relationship exists between working capital components and

profitability of trading sector. But the analysis found that current ratio and quick ratio had a significant impact

which means the increase in the investments of current assets and liquid assets will increase the Net operating

profitability of the trading sector. Hence, in trading sector liquidity plays a major role in maximizing the

profitability.





Construction sector

From the study it has been found that there is a significant relationship exists between working capital

components and profitability of construction sector. The study stated that decrease in the period of working

capital components such as Debtors conversion period, and Inventory Turnover period will increase the Net

operating profitability of the Construction sector. The sector should concentrate more on receivables and

Inventory. This may be due to volatility in the prices of the products connected to construction sector. The sectors are advised to have an effective inventory model, so as to maximize the efficiency of the organization

performance. Further, the study states that working capital management had a significant impact on profitability.

Whereas liquidity does not have a significant impact on profits during the study period in construction sector.

CONCLUSION Working capital is an important source of fund for the company in the absence of which, the company

may not fulfil its obligations on time. Therefore, it should be given due importance and treated as an integral

part of overall corporate management functions. It is also very important to evaluate the cause and effect

relationship of every activity of the management to assess its impact on working capital. During the course of study, the impact of various causes has been observed. The questionnaire survey indicates the external factors

such as the Inventory, cash, receivables, payables, policies, remainder procedures, and effectiveness of

administrative strategies, operational cycle periods etc, that affect the working capital of a company. Some

organizations are not following the policies and practices but consider the policies to be an important factor.

Management can control the cost to some extent to support additional sales growth and investments by

negotiating with their vendors and to attain effective working capital management. The managers of selected

industrial units should avail themselves with the various training program organized by government and other

bodies like government- sponsored business support services such as the Chamber of Commerce, and to polish

their knowledge in financial management and other managerial topics. This will help to improve their trading

activities as well as to decrease the poor managerial skills. The Industries will have to venture into many

projects of the government, which will increase the goodwill of the company. The study identified most of the

company is following a conservative policy in maintaining its current assets and it can be said that the overall performance of the company is satisfactory with an effective working capital management being an integral part

of its system.

On reflecting on the research work it can be said the aim and objectives have been achieved. Thus the

study has tried to investigate into the working capital management components, liquidity, solvency and

determinants of the sample S&P CNX 162 top companies and came out with some convincing findings to

identify some factors which could be contributed to the efficient usage of working capital resources. The study

found some positive and negative relationships which reflect on profitability. Suggestions have also been drawn

based on the findings to various industries. Among the 15 selected sectors, the study found that the sugar and

trading sectors were not affected by working capital components. Where the other 13 sectors such as

Automobile, Electrical Equipment, Steel and Aluminium, Pharmaceutical, Cement, consumer durables,

Engineering, Textile, Chemicals, Tyre, Pumps, Food, and Construction firms seems to have significant and strongly related with working capital components, liquidity and profitability. As stated in earlier part of the

study, this is an empirical study, the prime objective of which is to reflect on components, liquidity and solvency

factors which have an impact on profitability.

Scope for Future Research

The Present study investigated the impact of working capital management on profitability considering

the various parameters such as working capital components, Liquidity, solvency and profitability. The research

was undertaken in 15 sectors, and the industries considered for the study falls under S&P CNX 500 companies

alone. The area working capital is Vibrant and has its significance not only in top performing firms, but also in

Small and medium sized firms. The idea or the framework adopted for the study can be applied to SME‟s as

well as Distressed firms, to find out their performance in working capital management and also to test their

significance. This framework will be helpful for future researchers to find out the issues relating to profitability

associated with management of working capital and liquidity in detail and also by exploring more variables in various sectors.

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Documents

A Study on the Impact of the Working Capital Management on ...indusedu.org/pdfs/IJRMEC/IJRMEC_1304_57925.pdf · Scheme of Chapterization The entire study has been organized into six