Research Article
Open Access
Relationship between Working Capital and
Corporate Performance in the Textile Sector of
Pakistan
Shahzad Atta1, Haris Javed1, Muhammad Jawad Khalil1, Imtiaz Ahmad2 and
Muhammad Nadeem3*
1MS Scholar, National University of Modern Languages Islamabad, Pakistan
2PHD Scholar, North China University of Water Resources and Electric Power
3Faculty of Management Sciences, National University of Modern Languages Multan
*Corresponding author: Muhammad Nadeem, Faculty of Management Sciences, National University of Modern Languages Multan. E-mail:-
@
Received: October 21, 2017; Accepted: November 01, 2017; Published: November 09, 2017
Citation: Nadeem MD, Shahzad A, Javed H, et al. (2017) Relationship between Working Capital and Corporate Performance in the Textile Sector of Pakistan. Int J Fam Busi Manag 1(1): 1-5.
Abstract
This research study has tried to examine the association between
the working capital and corporate performance in the textile sector
of Pakistan. Textile sector is one of the major sectors in Pakistan
which have crucial contribution in the economy. Secondary data was
gathered and used for the evaluation of the relationship between
the working capital and corporate performance in the textile sector
of Pakistan. Data was collected from the annual reports of the
companies published during 2008-2012. Regression Model is used
for the analysis of the gathered data. Results revealed that average
collection period and operating cycle are positively associated with
the corporate performance of the organizations in Pakistan. Corporate
performance is measured through return on equity and firm size is
positively associated with the return on equity. Leverage is negatively
linked to the return on equity in the textile sector of Pakistan. Overall
it has been observed that working capital and corporate performance
are linked and have significant impact on the textile sector of Pakistan.
Keywords: Textile Sector, Working Capital, Corporate
Performance, Profitability, Pakistan
Introduction
Working capital is related with managing and financing
short term investment decisions and management of current
assets as well as fixed assets at the same time. Managing theses
short term investment decisions is known as working capital
management. All the organizations manage their current assets
efficiently due to their importance in the measurement of overall
performance of the organizations. Productions organizations
manage their current assets with great care due the dependence
of their liquidity and profitability on the working capital. It is
evident from the past researches that organizations have faced
critical situations due to their mismanagement of working capital.
All those organizations operating in developed or developing
countries, which have given less importance to their working
capital have suffered in managing ideal performance [1].
Liquidity of the organizations is as crucial as the profitability of
the organizations. Balance between the liquidity and profitability
is crucial to be managed due to their critical impact on the
organizations. Literature has provided the risk of insolvency
for those organizations which are failed to manage the balance
between the liquidity and profitability of the organizations.
Organizations with too much short term assets and the
organizations with less than the required short term investment
have faced serious risk of insolvency in the past therefore the
balance between the current assets and long term assets is very
crucial for the organizations [10].
Capital Budgeting, Capital Structure and Working Capital
Management are the main roofs of finance which are crucial to
be handled[4].Working capital management is related to the
current asset management which directly affect the liquidity of
the organizations. Capital Budgeting and Capital Structure are
associated with the handling of long term assets which have more
impact in the long run and return of the assets. Mostly studies
have focused on the developed countries to measure the impact of
working capital on the performance of the organization whereas
less work has been done in the under developed countries. This
research study has focused to evaluate the effect of working
capital on the performance of the organization in the textile
sector of Pakistan which is not focused in the past.
Literature Review
The significance of working capital management efficiency is
undeniable. It is known as life giving force for any organization
and its management is considered among the most essential
functions of corporate management. Every organization whether,
profit oriented or not, regardless of their size and nature of
business, requires necessary and sufficient amount of working
capital and its management. It is the most fundamental factor
for maintaining liquidity, survival, solvency and profitability of
business.
Considering the importance of working capital management
the researchers focused on evaluating the working capital
management and profitability relationship among others.
However, there are a few studies with reference to Pakistan like
[2]. Working Capital Management is vital as it directly affects the
profitability and liquidity of firms. Working capital management
is one of the most essential areas while making the liquidity and
profitability comparisons among firms involving the decision of
the amount and composition of current assets and the financing
of these assets. The greater the relative proportion of liquid
assets, the smaller the risk of running out of cash, all other
things being equal. All components of working capital including
cash, marketable securities, account receivables and inventory
management play a vital role in the performance of any firm.
Efficient working capital management is very important to create
value for the shareholders.
Corporate Performance is simply the performance of
the corporation or company and Corporate Performance
Management is the effective and efficient management of the
corporation that leads them towards the achievement of their
goals [5]. Here performance is considered and measured with the
help of different indicators that include profitability and firm size
etc. Budgeting, Forecasting and Planning are some components
of corporate performance management that help corporations to
observe and plan about the performance of the corporations from
time to time.
Padachi observed the trends in Working Capital Management
and its impact on the performance of firms [9]. Panel data
analysis and regression analysis was used on a sample of 58 small
manufacturing Mauritian firms for the period of 1998-2003.
The dependent variable, return on total assets was used as a
measure of profitability and the relation between working capital
management and corporate profitability. The study revealed
that paper and printing industry were having best practices due
to efficient management of components of working capital and
its positive impacts on profitability, thus they were considered
industry champions.
Mathuva DM tested the influence of working capital
management components on corporate profitability in Kenya [7].
A sample of 30 firms listed on the Nairobi stock exchange from
1993 to 2008 was used. Pooled OLS and fixed effect regression
models were used. The study concluded that there exists a highly
significant negative relationship between the time it take for
firms to collect cash from their customers and profitability.
Determinants of Profitability
Determinants of Profitability are explored below to examine
the relationship between the working capital and corporate
performance in the textile sector of Pakistan.
Average Collection Period
Average collection period is the time period in which
organizations collect their receivables from the customers.
Organizations with the strict collection policy cannot survive in
long time period but too much leniency in the collection duration
may also affect the profitability of the organizations badly [6].
Some studies have found positive association of average collection
period with profitability but according to some researches there
is negative association between the average collection period and
profitability of the organizations.
Operating Cycle
Operating cycle is a complete cycle in which organizations
procure and convert the raw material into finished goods
and receive the cash against the sold items. Normally it takes
more time to receive the cash which affects negatively to the
profitability but it can be improved through reducing no of days
in receivables [8].
Cash Conversion Cycle
Cash conversion cycle is a time period in which organizations
convert their resources into cash flows. Cash inflow and cash
outflow are two have much importance in measuring the
performance of the organizations [3]. Organizations expect a
negative relationship between the cash conversion cycle and
profitability of the organizations but some studies also found a
positive relationship of cash conversion cycle with profitability.
On the basis of the above facts following hypothesis can be
developed.
H1: There is positive and significant relationship between average
collection period and ROE.
H2: There is positive and significant relationship between
operating cycle and ROE.
H3: There is positive and significant relationship between cash
conversion cycle and ROE.
Research Methodology
This study explores the determinants of corporate
performance in context of textile firms of Pakistan. It is based
on secondary data that is collected form annual reports of firms.
These firms are listed on Karachi Stock exchange. The sample size
is the data of 38 firms listed on Karachi stock exchange of Pakistan.
The analysis is restricted to period of 5 years (2008-2012). Only
those firms have been selected whose data was available for all
these years. The appropriate sampling technique has been used
as the data of as much firms was easily available that included in
the sample. Regression analysis has been done in this study. Using
regression model, each variable is being added to the model in
view of its estimation power over the dependent variable. Each
time as the variable enters into the model, all the other variables
are reexamined and some variables restricted out in analysis
due to negative values. Data for this research was collected from
the concerned firm’s websites, from company offices and from
the website of Karachi stock exchange. Panel data is used for
the purpose of evaluating the samples and to cater the dynamic
situations. Return on equity is the dependent variable measured
to evaluate the profitability of the organizations whereas the
Average collection period, Cash conversion cycle and Operating
cycle are the explanatory variables. This model was used before
by Abuzayed [8].
i stands for the ith cross-sectional unit and t for the tth time period.
is performance measure
(ROEit ) for the ith firm at time t, and
is the intercept.
is a 1 x K vector of observations on K explanatory
variables for the ith firm in the tth period β is a K x 1 vector of
parameters, it
is a disturbance term and is defined as
Where
denotes the unobservable individual effects and
denotes the remainder disturbance. The descriptions of three
estimation models (i.e., pooled OLS, fixed effects and random
effects) can be written for each component of working capital as
below.
Where is the return on equity for the ith firm at the time t, is
the average collection period of ith firm at time t, is the operating
cycle of the ith firm at time t, is the cash conversion cycle of i
th
firm at time t.
Findings
[Table 1] It is obvious from the above results that average
median and the return on equity are positive which 0.1354 is.
Average median of the average collection period is positive with
the return on equity which is 10.1649. Average median of the
operating cycle is positive with the return on equity which is
64.2921. Average median of the cash conversion cycle is negative
with the return on equity which is -29.1482. It is pertinent to
mention that return on equity is measured as profit before
taxation/ total shareholder equity. Average collection period
calculated as trade debts/ (sales/360). Cash conversion cycle
(measured as [average age of inventory + average collection
period)-average payment period]. Operating cycle (measured as
average age of inventory + average collection period).
Table 1: Descriptive Statistics
Variables |
Observations |
Mean |
Std. Dev |
Median |
Maximum |
Minimum |
ROEit |
185 |
0.1528 |
0.2644 |
0.1354 |
1.2984 |
-0.5149 |
ACPit |
185 |
17.4681 |
18.2482 |
10.1649 |
85.4827 |
0 |
OCit |
185 |
81.4683 |
62.8746 |
64.2921 |
370.4917 |
0.1171 |
CCCit |
185 |
-121.4627 |
213.8462 |
-29.1482 |
279.1548 |
-934.5419 |
SIZEit |
185 |
14.7129 |
1.4789 |
14.1872 |
16.4731 |
8.4771 |
LEVit |
185 |
0.364 |
0.1721 |
0.4978 |
0.8179 |
0.0049 |
[Table 2] According to results of the above results it is clear
that return on equity has positive link and correlated with
average collection period, firm size and cash conversion cycle
while it is negatively linked and correlated with leverage and
operating cycle. Average collection period has positive link and
correlated with return on equity, leverage, cash conversion cycle
and operating cycle while it is negatively linked with size of the
firm.
[Table 3] It is clear from the results of above table that the
average collection period is positively associated with the return
on equity but it is not significantly linked with the return on
equity. It means average collection period crucial and has an
impact on the performance of the organizations.
[Table 4] Results of the above mentioned table have shown
a positive but insignificant link between the operating cycle and
return on equity which shows its importance in the measurement
of the organizational performance.
[Table 5] Results of the above table explores that cash
conversion cycle has a positive and significant linkage with the
return on equity in the textile sector of Pakistan.
Table 2: Correlation of Variables
Variables |
ROEit |
ACPit |
SIZEit |
LEVit |
CCCit |
OCit |
ROEit |
1 |
0.0069 |
0.0752 |
-0.1254 |
0.1684 |
-0.0245 |
ACPit |
0.0069 |
1 |
-0.4484 |
0.1174 |
0.2729 |
0.4134 |
SIZEit |
0.0752 |
-0.4484 |
1 |
0.0293 |
-0.4124 |
-0.3342 |
LEVit |
-0.1254 |
0.1174 |
0.0293 |
1 |
-0.2154 |
-0.0602 |
CCCit |
0.1684 |
0.2729 |
-0.4124 |
-0.2154 |
1 |
-0.5241 |
OCit |
-0.0245 |
0.4134 |
-0.3342 |
-0.0602 |
0.5241 |
1 |
Table 3: Average Collection Period on Profitability (ROE)
Variable |
Coefficient |
Std. Error |
t-Statistics |
Prob. |
C |
-0.0754 |
0.2153 |
-0.3652 |
0.6784 |
ACPit |
0.001 |
0.001 |
1.0039 |
0.2982 |
SIZEit |
0.0221 |
0.0129 |
1.4983 |
0.1049 |
LEVit |
-0.2043 |
0.1147 |
-1.9648 |
0.0471 |
R2 |
0.0314 |
|
|
|
Adjusted R2 |
0.0149 |
Mean dependent var. |
|
0.1651 |
S.E regression |
0.2641 |
S.D. dependent var. |
|
0.2642 |
F-statistics |
1.9754 |
Probability (F-statistic) |
|
0.1071 |
Table 4: Operating Cycle and Profitability (ROE)
Variable |
Coefficient |
Std. Error |
t-Statistics |
Prob. |
C |
0.0078 |
0.2284 |
0.0354 |
0.9604 |
OCit |
6.02E-05 |
0.0002 |
2.7465 |
0.8541 |
SIZEit |
0.0149 |
0.0125 |
1.2342 |
0.2058 |
LEVit |
-0.2009 |
0.1154 |
-1.8472 |
0.0569 |
R2 |
0.0257 |
|
|
|
Adjusted R2 |
0.0112 |
Mean dependent var. |
|
0.1547 |
S.E regression |
0.2542 |
S.D. dependent var. |
|
0.2623 |
F-statistics |
1.4872 |
Probability (F-statistic) |
|
0.171 |
Table 5: Cash Conversion Cycle on Profitability (ROE)
Variable |
Coefficient |
Std. Error |
t-Statistics |
Prob. |
C |
-0.2296 |
0.2184 |
-1.0821 |
0.2644 |
CCCit |
1.00E-04 |
9.86E-05 |
2.7841 |
0.0041 |
SIZEit |
0.0289 |
0.0115 |
2.3954 |
0.0164 |
LEVit |
-0.1148 |
0.1184 |
-1.1199 |
0.2508 |
R2 |
0.0597 |
|
|
|
Adjusted R2 |
0.0529 |
Mean dependent var. |
|
0.1628 |
S.E regression |
0.2549 |
S.D. dependent var. |
|
0.2778 |
F-statistics |
4.4687 |
Probability (F-statistic) |
|
0.0043 |
Control Variables on Profitability (ROE):
Leverage and size of the organizations are the controlled
variables of the data and it is obvious that leverages are the
borrowings and debts of the organizations therefore they are
negatively associated with the return on equity in the textile
sector of Pakistan. Organizations should work to reduce their
leverages to reduce their negative impact on the profitability
of the organization. Size of the organizations are positively
associated with the organizational performance.
Conclusion
Findings of the research explored that working capital of the
organizations have a significant impact on the performance of the
organizations in the textile sector of Pakistan. Average collection
period, cash conversion cycle and operating cycle are positively
associated with the performance of the organizations which
means that they are affecting the profitability of the organizations
significantly.
Management of the organizations should realize the
importance of the working capital and they must manage their
working capital efficiently and effectively. Size of the organizations
also impact the performance of the organizations therefore
management should take great care while making strategies and
developing policies regarding management of the working capital
of the organizations. This research study has focused on the
textile sector of Pakistan whereas other sectors can be handed in
future. The results are based on the five year data (2008-2012)
available in the annual reports and websites whereas in future
data of more years can be utilized for better understanding.