WORKING CAPITAL MANAGEMENT AMONG LISTED COMPANIES OF PAKISTAN

Study aims to investigate the strength of working capital management for measuring financial performance of listed stocks. Study incorporates descriptive statistics, Pearson correlation and multiple regression models for interpretation and execution of data. Five years (2006-11) panel data of 125 listed companies of Pakistan stock exchange (PSX) is selected in accordance to sample selection criterion. Results of regression analysis supported inverse relationship between firm`s profitability and working capital management. Return on asset and Gross operation income are taken as indicators of profitability. Inventory turnover in days, Average age of A/R, Average payable period and Cash conversion cycle are considered as independent variables to measure firm’s profitability. Firm size, Sales growth and financial debt ratio are favoured as control variables. Overall Return on asset models indicated poor values of R-square`s and Gross operating income models showed robustness.


Introduction
Corporate finance generally relies on the empirical analysis or investigation of long-term monetary settlements. Academicians and institutional analysts have especially proposed theories for capital structure, investment considerations, organizational valuation in terms of dividend policies and market earnings. Short-term investments normally have the life of one year and symbolize the most important portion of balance sheet analysis and require sensible attention because of their meaningful and valuable contribution toward firm`s profitability (Smith, 1980). Http://www.granthaalayah.com ©International Journal of Research -GRANTHAALAYAH [81] Working capital management is all about allocation and monitoring of short-term corporate financial decisions (Gitman, 2005). Management arms should always strive to maintain perfect level of working capital, to perform business operation more efficiently (Howorth &Westhead 2003).
An investment concerning working capital develops a linkage between risk and return. Firm's decision to make a contribution for higher returns will also expand risk factors and the attempts to minimize risk will also leads toward lower returns. Raheman and Nasr, (2007) stated that efficacy in short-term financial decisions is the most important component because major portion of firm's assets consists of fixed assets. Samiloglu and Dermigunes, (2008) discussed working capital management in relation to the financial health of corporations. They also suggest that an improper proceeding of working capital management may lead towards bankruptcy. Likewise, ignoring liquidity for generating greater profits can cause harmful results. Therefore, it is important for a firm to create a balance among profitability and liquidity. Furthermore, Gitman, Working capital management is required to attain optimal level of organization`s profitability and liquidity. Higher current asset ratio lowers the inadequacy of cash, implying that all key participants of working capital including inventories, securities, cash and receivables have strong influence on firm`s management, which may add value for shareholder's attraction and retention (Eljelly, 2004

2.1.Working Capital Management Concept
Working capital management is declared as the most important tool for firm`s financial management. Proper concentration on working capital may help organization`s to stay healthy, in financial terms (Shin & Soenen, 1998). It is the responsibility of firm's management to gauge trade-off among proposed earnings and risk, prior to make decision against amount of current asset investment. There are two basic ways for managing working capital i.e. either by reducing working capital investment or by designing strategies for boosting sales volume. Adopting aggressive policies (reducing working capital investment) generally positively affect firm`s profitability. According to Wang, (2002) handsome reduction in corporate inventory and customer credit requirements may lower down sales volume, on the other hand expanding suppliers financing may decline discount percentage. Opportunity cost exceeds up to 20 percent, depending on the granted period and discounted percentage Wilner, (2000). Contrary to conventional theories, adopting conservative policies (healthier investments) towards firm`s working capital may also result in firm`s financial benefits. Maintaining huge volume of inventory minimizes the possible intrusion cost during production process and business loss caused by products deficiencies, minimizes cost of supply, and product price fluctuations (Blinder & Maccini, 1991).
Awarding trade credits may support organization`s in multiple ways. Petersen & Rajan, (1997); Brennan et al. (1988) stated that trade credit is an effective tool for price cut, to provide monetary benefits to customers for collecting products at low demand times (Emery, 1987), to confess customers in order to investigate and ensure that delivered products meet the agreed quantity and quality (Smith, 1987), which advice organization`s to establish long-term relationships with customers (Ng et al., 1999). Though, these advantages required proper attention for preventing decline in profitability due to increase in short-term investments.
Empirical researches regarding working capital management and firm`s profitability encourages aggressive working capital policies for strengthening financial viability. Jose et al. (1996) support the role of aggressive working capital approaches for enhancing firm`s profitability by providing empirical evidence from listed companies of United States. Shin and Soenen (1998) proved strong positive impact of trade credit reduction on firm`s profitability by taking sample from US capital market for the period ranges from 1974 to 1994, though this relationship seems to be poor while conducting analysis at industry level (Soenen, 1993).
Deloof, (2003) studied Belgian firm`s for the period of 1992 to 1996, for the purpose of investigating relationship between average age of accounts receivable and firm`s financial performance, study indicated that reduction in average age of accounts receivable improves firm`s profitability, additionally it was stated that low profitable firm`s require long time durations to settle down their outstanding claims. However, Wang, (2002) took sample of Taiwanese and Japanese firm`s for the period ranges from 1985-1996, results of the study supported short cash conversion cycle is relatively better for firm`s operational achievements.
Theoretical findings defined the fact that designing working capital strategies requires to follow some industry specific benchmarks which organizations have to maintain (Hawawini et al., 1986). Hence, firm`s speed up their amount of profitability by reducing inventories and accounts receivables to a minimal level, as per their given benchmarks. Moreover, Soenen, (1993) stated that management should struggle to collect cash inflows as soon as possible, on the other hand delay the cash outflows as longer as possible. This strategy will shorten the age of cash conversion cycle, which will ultimately lead towards organizational long-term financial benefits.

2.2.Earlier Studies on Working Capital Management
Although numerous studies have already been conducted to evaluate the impact of working capital management on firm`s financial viability, some of empirical findings are discussed here to design research gaps and objectives.  Textile sector of Pakistan was studied in order to analyse the impact of working capital management on firm`s profitability. Average time duration required to convert stock into cash, average days for working capital and operating cycle were selected as independent variables to study the efficacy of firm`s working capital system, while return on equity, return on asset, profit margins and economic value additions were favoured as firm`s profitability indicators. Six years data of 160 textile firm`s for the period of 2000 to 2005 was selected as sample to reach empirical findings. Ordinary least square and fixed effect regression equations were applied for analyzation and interpretation of collected data sets. Results highlighted significant and inverse relationship among average age of accounts receivables, average payable period and return on assets, while positive significant association exist between return on asset and average age of inventory. Furthermore, positive association was found among return on asset and cash conversion cycle of textile sector of Pakistan (Ali, 2011 H1: Average collection period is negatively related to profitability. H2: Average age of inventory is negatively related to profitability. H3: Average payment period is negatively related to profitability. H4: Cash conversion cycle is negatively related to profitability.

2.5.Objectives of The Study
Present study aims to explore the impact of specific components of working capital management including; average age of accounts payable, average age of accounts receivable, average age of inventory and cash conversion cycle on financial performance of the listed companies of Pakistan. In order to present a comprehensive analysis, firm size, annualized sales growth and financial debt-ratio have been taken to control un-wanted effects of other variables in the regression equation.

3.1.Sample Selection
Study gathered five years' panel data  of 125 textile firms. Textile is amongst one of the largest sector of Pakistan`s economy, as it contributes about 60% to total national exports and 9.5% to GDP (Pakistan bureau of Statistics, 2012). Sample of 125 textile firms is selected from total of 155 listed textile firms at KSE, study based data availability and listing criteria for selection of sampled firms, in order to avoid missing values.

Dependent Variable
Return on asset (ROA) and Gross operating income (GOI) are taken as measures of firm's profitability (dependent variable). ROA is defined as net profit divided by total assets; while GOI is measured as sales minus cost of goods sold, whole divided by total assets minus financial assets.

Independent Variables
DSI act as a tool for firm`s inventory management. It measures the average number of days from delivery of raw materials to the sale of finished goods. It is calculated as inventory divided by cost of goods sold, multiplied by annual number of days. DSO indicates the average collection period, it measures average number of days a firm required to collect its bills. It is computed by dividing accounts receivable to sales and multiplied with annual number of days. DPO shows the average payment period. It is measured as accounts payable to cost of goods sold, and multiplied by annual number of days.
CCC is an indicator of working capital management that quantify the average time period between cash outflow for inventories or resources and cash inflow from sales. CCC is measured as DSO plus DSI minus DPO. Firm size, sales growth and financial debt ratio are taken as control variables.

5.2.Analysis and Discussion
In this study, the researchers have conducted tests with five regression panel equations to determine the strength of working capital management elements, for measuring firm`s profitability by taking ROA and GOI as indicators of profitability.   (1), (2), (3) and (4) respectively. DPO is omitted in equation (5), while DSI, DSO and CCC remained significant and negative for measuring dependent variable.

Conclusion
Efficient management of working capital is an important tool for achieving organizational profitability. Purpose of present study was to test the performance of working capital management for measuring firm`s profitability. Findings of present study support the work of prior researches. This study indicated that ROA as is a poor indicator of firm`s profitability, moreover GOI is a better explanatory measure for organizational performance. Results of current study will help organizations to improve their effectiveness by managing their working capital.