LONDON SOUTH BANK UNIVERSITY

FACULTY OF BUSINESS

Impact of working Capital Management

on Profitability in UK Manufacturing
Industry
BY
SENTHILMANI THUVARAKAN

DISSERTATION
MSc. Accounting with Finance

Electronic copy available at: http://ssrn.com/abstract=2345804

TABLE OF CONTENTS
Page Number
1.0

Chapter 1 Background, Aim and Objective..4

1.1 introduction....4
1.2 Problem definition.....6
1.3 Objective of the research.........6
1.4 Hypothesis......6
1.5 Delimitations..........7
1.6 Usefulness of the research..........8
1.7 Structure of the dissertation .....8

2.0

Chapter 2 - Literature review..9

2.1 Introduction...9
2.2 Theoretical background of the working capital management........9
2.2.1

Factors determining working capital requirements..............9

2.2.1.1

Internal factors...9

2.2.1.2

External factors....12

2.3 Working capital components.........12

2.3.1

Accounts receivable12

2.3.2

Inventory management...13

2.3.3

Cash management and short term securities...13

2.3.4

Accounts payable management.....13

2.3.5

Short term borrowing.14

2.3.6

Cash conversion cycle.14

2.4 Working capital policy.....16

2.4.1

Defensive policy.....16

2.4.2

Aggressive policy.....16

2.4.3

Conservative policy......17

2.5 Critical review of previous studies.17

Electronic copy available at: http://ssrn.com/abstract=2345804

2.6 Summary of the empirical studies...21

2.7 Conclusion .22

3.0

Chapter 3 Research methodology23

3.1 Research design.23

3.2 Statistical method...23
3.2.1 Descriptive statistics...23
3.2.2 Quantitative analysis..23
3.3 Variables .23
3.3.1 Dependent variable 24
3.3.1.1

Gross operating income.24

3.3.2 Independent variable..24

3.3.2.1

Receivable days.....24

3.3.2.2

Payable days...24

3.3.2.3

Inventory days.24

3.3.2.4

Debt ..24

3.3.2.5

Size of the firm ...25

3.4 Null hypothesis ..25

3.5 Hypothesis testings...26
3.5.1 The t-test..26
3.5.2 Test of association 26
3.5.2.1

Correlation analysis26

3.5.2.2

Multiple regression analysis..26

3.6 Data sources..27

3.7 Determining the sample size27
3.8 Transforming data in to information27
3.8.1 Scatter diagram..27
3.8.2 Frequencies 28

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3.9 Ethical consideration .28

4.0 Chapter 4 Data analysis and discussion...28
4.1 Descriptive statistics28
4.1.1 Manufacturing industry...28
4.1.2 Telecommunication industry..30
4.1.3 Construction industry...31
4.2 Correlation analysis ...32
4.2.1 Manufacturing industry32
4.2.2 Telecommunication industry..34
4.2.3 Construction industry..35
4.3 Multiple regression analysis .37
4.3.1 Manufacturing industry37
4.3.2 Telecommunication industry 39
4.3.3 Construction industry ....40
5.0 Chapter 5 Conclusion and further research....42
5.1 Conclusion .....42
5.2 Further research and recommendation ....43
6.0 Appendix .44
6.1 Hypothesis developments.44
6.1.1 Null hypothesis44
6.1.2 Alternative hypothesis...44
6.2 T test manufacturing industry...45
6.3 T test construction industry..51
6.4 T test telecommunication industry57
7.0 References

1. Introduction
Current uncertainties in the global economy and back drop of the euro crisis is putting
extreme amount of pressure on chief executives across Europe to maximise share holders
return and manage the earning effectively and efficiently. With investors more concerned
about the volatility of the economic climate, it is very important to maximise the liquidity
of the company and free cash flow.
At the economic meltdown cash has become a very expensive resource to borrow.
Therefore each and every company should not forget the fact that most of the cash are
tied in the working capital components. So it is very important to bring in a new strategy
to manage the cash flow effectively without affecting key suppliers relationship. Hence
working capital management is given higher priority by the managers.
Although overall European working capital levels are decreasing, the differences in
performance are very significant. The study of PWC shows that the difference between
the good and bad performers is getting more pronounced and this indicates that there is
huge improvement potential for those that are not in the upper quartile (top 25%
performers). Overall, the study shows that 2,307 of the largest listed European companies
had over 900bn (700bn) unnecessarily tied up in working capital in 2011, which could
have been released if all companies included in the study were to match the performance
of the upper quartile. By comparison, UK companies had over 59bn (49bn) tied up in
2011, which could have been released if they had better managed their working capital.
Comparing the cash-to-cash conversion cycle across sectors highlights the differences in
underlying business models and reveals those that operate in a cash culture. In the study,
retail was the most efficient sector in the UK in 2011, with an average of 19 days cashto-cash conversion cycle. Service companies were the second most efficient (23 days),
followed by telecommunications (26 days). At the other end of the scale, manufacturing
companies were the least efficient (104 days), followed by oil & gas (88 days) and
pharmaceuticals (85 days). (PWC 2012a)
According to Rafuse (1996) majority of the business failures are due to poor management
of working capital components and the firms success heavily depends on how frequent
they are able to generate more cash. Guthmann and Dougall (1948) defined working
capital as current assets minus current liabilities. The current refers to a time period of
one year or less than one year. (Emery and Finnerty, 1997).
The components of working capitals are inventories, trade receivables and trade
payables. Trade receivable days can be calculated as [accounts receivable*365] /sales.
Inventory days are [inventories*365] /cost of sales. Trade payable days are [accounts
payable*365]/purchases.
The proportion of the working capital components can change from time to time during
the trade cycle (Lamberson 1995). According to Van & Wachowicz (2000), the working

capital components will be based on the objective of the firm and maximisation of
profits.
Working capital can be calculated using cash conversion cycle (CCC). This is also
known as Net trade cycle (NTC) or Days of working capital (DWC). CCC simply
calculates the time difference between the cash collection and cash payments.
The shorter CCC means the less time capital is tied up in the business operation and it is
always good for the companys day to day operation (Hutchison et al., 2007). On the
other hand operating cycle (OC) captures the time from the purchase of inventories to
collection of cash from customers (Lawrence and Chad 2012).
Working capital can generate significant amount of cash within a short period of time for
firms. Therefore effective management of working capital is very important for every
organization. Shin and Soenen (1998a) emphasized that working capital management is a
key part of corporate strategy and the way it is managed can have a significant impact on
the liquidity and the profitability of the company.
According to Deloof (2003a) majority of the firms invested significant amount of cash in
working capital and using trade payable as a key source of financing. So the way its
handled can have a significant impact on the profitability of the firm. Lazaridis and
Tryfonidis (2006a) in their research concluded that operating profitability will indicate
how the management will respond in terms of managing the working capital components.
This is because they identified a negative relationship between the working capital
components and the profitability.
The profitability of the firms can be increased through efficient management of working
capital Ganeshan (2007a). Raheman and Nasr (2007a) suggested that managers can
increase the shareholders value by reducing the receivable days and inventories days to a
minimum level. Efficient working capital management is all about managing the
working capital components effectively to meet the short term obligation (Eljelly 2004a).
Vishnani (2007a) emphasized that each and every company has to be careful when
investing huge amount of funds in working capital, this is because it can reduce the
profitability of the company significantly. On the other hand Ching et al. (2011a)
identified that working capital management is equally important for both the working
capital intensive and fixed capital intensive companies.
From the above studies its very clear working capital is playing an important role in
enhancing the shareholders wealth and it is given higher priority by the finance
managers. Further it should be noted that, for listed manufacturing firms,
telecommunication firms and construction firms there are only few researches carried out
in the UK covering recent periods. Our study covering the recent periods of 2006-2011
on UK listed manufacturing firms, telecommunication firms and construction firms will
be very useful to maximise the return to the shareholders.

1.1 Problem definition

The problem statement we are going to analyse in our research is impact of working
capital management on profitability. Further we will evaluate whether the debt and size
of the firm are affecting the profitability of the firm.

1.2 Objective of the research

To analyze our problem statement in more detail we have developed objectives for our
research. Our research key focus is to identify the impact of working capital components
on profitability in different industries. The main objectives of our research is to establish
a relationship between the working capital management, debt and size of the firm and
profitability covering a period of 5 years for 60 UK manufacturing firms, 20 construction
firms and 17 telecommunication firms listed in the London stock exchange.

1.3 Hypothesis
In order to achieve our objectives we have developed the hypothesis for our research.
According to Ryan and et.al (2002, p.130), when we are evaluating the relationships
between the dependant variable and independent variables, the null hypothesis Ho will
indicate that there is no relationship between the variables and the alternative hypothesis
H1 will indicate that there is a relationship between the variables. For our study the
hypothesis is given below,
Hypothesis 1 (H1): The debtors collection period is negatively related to the
profitability. The credit policy gives the customers more flexibility to buy the goods and
services on credit terms. Further customers can assess the quality of the product and
services. However increase in the debtors days can have negative impact on companys
performance as they will find it very difficult to generate cash to manage the other
expenses. Further debtors outstanding for long period may needs to be written off. So
speeding up in the debtors collection is very vital for every organization. The collected
cash can be invested in day to day operations to expand business operation and increase
profitability.
Hypothesis 2 (H2): The inventory days are negatively related to the profitability. When a
company maintains a high level of inventory with generous trade credit policy the sales
are likely to increase, hence improving the profitability of the company. However the
increases in inventory days mean the cost for storing the inventories will increase.
Further if there arent any more demand for the products the stock needs to be written off
which can increase the obsolescence stocks. So all of these can increase the cost for the
company and reduces the profit.
Hypothesis 3 (H3): The payable days are negatively related to the profitability. Suppliers
are another key part of business success, when a supplier gives trade credit periods to the
firms it gives the flexibility to assess the quality of the material purchased. Further it
should be noted that credit period can be used as a source of finance. When a company is
7

running on loss it will fully utilize the credits periods given to them. That means increase
in loss will delay the payment to supplier. That is the logic behind this hypothesis.
Hypothesis 4 (H4): Cash conversion cycle (CCC) is negatively related to the firms
profitability. Cash conversion cycle measures the time difference between the purchases
of inventory to payment received from customers for the finished goods sold. The higher
the times it takes more investment time is invested in working capital management. A
longer cash conversion cycle can increase the profitability. On the other hand the
profitability can also decrease if the cost of working capital management increases than
the benefit of holding more inventories and allowing generous trade credit policies.
Hypothesis 5 (H5): There is a negative relationship between the debt and the
profitability. Debt is the key source of finance for majority of the firms. But higher
gearing is not always good for the companys health. Higher gearing means increases in
the interest payments, so this can affect the profitability of the firm. Normally high
geared companies are considered to be more risky. So the suppliers will be more
considered to offer credit periods to customers. This can affect the cash flow
management and the profitability of the firms.
Hypothesis 6 (H6): There is a positive relationship between the size of the firm and the
profitability. Size of the firms can be measured in terms of sales growth. So normally an
increase in the sales can increase the profitability. This is because when the sales
volumes are increasing firms can benefit from economies of scale. An economies of scale
means the ability of the firms to exploit benefits by spreading the fixed cost over the
increased units. Further increase in the production can improve the efficiency in the
production process hence reducing the labour and materials cost. All of these can lead to
increase in the profitability.

1.4 Delimitations
Our research only focuses on 60 listed UK manufacturing firms, 20 construction firms
and 17 telecommunication firms. Our sample is limited to the manufacturing sector,
telecommunication sector and construction sector. The banking, insurance, finance and
rental businesses are omitted in this study due to its nature of business. Comparison will
be made with financial information obtained for the year ended 2006 to 2011. The
relationship between the return on equity, return on investment and return on sales and
working capital components are not being evaluated in our research.

1.5 Usefulness of the research

Our study will be useful in many ways. Firstly this will add to the existing knowledge in
terms of working capital management and profitability. Further if we can identify, how
the components of working capital are affecting the profitability, the management can
strike a balance between those components to maximise the share holders wealth. Finally
the current economic situation is not in a healthy position. The findings of our research

can be used not only by manufacturing organizations but also by other organizations to
improve their financial performance and financial crisis of the country.

Literature review
2.1 Introduction
Working capital measures the financial strength of the company and it is playing an
important role in maximising shareholders wealth. Every day finance managers spend
significant amount of time to strike a balance between the working capital components,
this is to meet the companys short term obligation. The purpose of this research is to
investigate the relationship between the working capital components inventories, trade
receivable and trade payable and firms profitability. In addition, we will evaluate
whether the financial debt, size of the firm and sales growth affects the profitability of
the firms.

2.2Theoretical background of the working capital management

Many companies have a good portion of the finance staff handling the day-to-day issues
that involve working capital decision-making. Current assets are constantly being
transformed to other current assets, for example: Inventory into sales and sales into credit
sales (Debtors). Current Liabilities are supposedly and better being paid with within a
period given by external parties. Liquidity is not determined by the forced-sell
(liquidation value), but on operating cash flows of those assets. (Shin and Soenen 1998b)
Working capital investments and related short-term finances originate from three main
business operations - purchasing, producing and selling. This happens as a result of the
business operations. Although, the operations dictate balances of working capital
investments and finances, the working capital balances also dictates the cost (for
example, cost of a third party to collect debtors payments) and flexibility (the long time
duration to convert the stock into sales). Better management of working capital and debts
within 1 year can make purchasing, producing and selling functions cost efficient and
flexible. At the end, working capital items are studied and solutions brought forward to
better manage the business operations. Carefully, managing working capital can reduce
cost and could accrue benefits to the organization (Brealey et al, 2006 pp 815-827).
Good management of working capital is vital as an organization unable to settle its
creditors is technically insolvent. The portfolio of current assets is large when compared
to total assets for trading and manufacturing organizations, so its crucial that working
capital is managed in a optimal way, balancing liquidity and profitability. Although a
firm is profitable and if substantial amounts are tied up in receivables the firm will have
to borrow more or take more credit to finance inventory. Therefore this could lead to a
scenario where the firm is in need of cash to buy stock for sales and they will be having
to incur a cost (interest) if an overdraft is taken to finance stocks. For this reason,
9

profitability and liquidity should be carefully managed if the firm is to ensure its goingconcern. Investment in inventory is inevitable and necessary for sales to happen. Proper
buying of inventory, which is goods that have a reasonable chance for good sales to take
place will improve profitability and liquidity. Goods that are fast-moving will have a
shorter cash operating cycle. (Padachi, 2006a).
According to Rafuse (1996) a large portion off businesses fail due to not managing
working capital items well, this maybe due to high inventory days and debtors days and,
hence a long cash operating cycle. Generating cash, quickly will ensure that the company
can buy more stocks for re-sale and give credit to customers. Therefore, making the
company more successful. Guthmann and Dougall (1948) defined working capital as
current assets minus current liabilities. This is the capital that is used for day to day
operation of a business. Current is known as less than one year. . (Emery and Finnerty,
1997).
Having optimal amounts of working capital at the needful times is crucial for successful
and efficient operation of a business. Using working capital uncontrollably or lavishly on
stocks during an economic recession is not advisable, as credit will not be easily
obtainable in the event current assets have to be financed by loans. A countrys tight
monetary policy will discourage banks generally to loan in a recessionary period. One
can say that during a recessionary period the firm products will not be demanded as
earlier. However, if it the demand is inelastic for the product, demand will not wane.
The successful generation of internally funds are highly related to the working capital
management. Working Capital results from the difference between Current Assets and
Current Liabilities of the company, and is then associated to the short term financial
management. The main concern of the short term financial management is the firms
short-run operating and financing activities. Firms are eager to utilise internal generated
funds because they do not have to pay interest on these funds and there is no maturing
period. However, managers can get complacent. Also obtaining debt will increase the
debt to equity ratio and make the share price unattractive if the firm is not making profits.
There is greater flexibility for firms to utilize their own funds for investment. The same
cannot be said when firm secures a loan from a financial institution, financial institutions
provides a loan disbursement readily and cheaply only when there is a need to improve a
companys productive capacity. Therefore, internally generated funds offer flexibility for
a firm. (Brealey et al, 2006 pp 813-832)
Research findings, have shown that one of ripple effects of the of the current financial
crisis is companies unable to obtain cash credit due to stringent and unavailability of
credit. So, as a result companies have to manage their working capital more carefully as
they do not have cash readily available. UKs largest companies have failed to free up
125bn of cash in total over the last five years due to inefficient working capital
management, compared to 400bn across Europe, new PwC research shows. That very
little has been done to significantly increase working capital efficiency between 2004 and

10

2008, which includes the onset of the current financial crisis (PwC 2012b). This shows
that working capital management should be taken seriously.

2.2.1 Factors determining working capital requirements

There are several factors determining the working capital requirement of the company.
However it should be noted it is subject to different circumstances. Primarily the
determining factors can be classified in to two types they are internal factors and external
factors. The factors represent each category is presented below.

2.2.1.1 Internal factors

The following factors will be considered by a company when determining the working
capital requirement for a particular period. Each variable are explained in details.
Nature of the business- The working capital requirement depends on the type of
business the firm undertakes. Manufacturing and trading organizations will hold more
stocks and will have many trade debtors and in turn these maybe funded by trade
payables and short-term debt. Therefore, the working capital requirement is a lot. On the
other hand, service organizations like a hotel or a restaurant will have cash sales and
hence a small debtor amount. As a result, the working capital for a restaurant might be
far less than a manufacturing firm, but, the restaurant will also carry food and drink
stocks to enable them to do their business smoothly.
Size of the business Small companies, especially the ones which are just established
will not have adequate funds to finance their working capital, creditors will not lend to
people who they do not trust on their creditworthiness. As a result, small firms will tend
to have low levels of working capital. However, large firms with a massive turnover and
profits will look to build on the growth momentum and will have substantial stocks and
debtors. Therefore, the large firms working capital requirements are generally huge.
Firms production policy Firms working capital requirement maybe influenced by the
firms production policy. Generally, there are two extreme production policies: steady
policy, where here will be a steady working capital need during the period. The other is
seasonal policy, where the firms will increase their production in the peak sales period; as
a result, the working capital requirement will be more during this period.
Firms credit policy - Some companies may allow only 15 days credit, while another
may allow 60 days credit to its customers. When the credit period is longer, the firm will
have to call on more working capital to finance the debtors. When a company has a credit
policy for a shorter period, cash comes in and the firm will not be so cash-starved, hence,
the working capital requirement is less.
Growth and expansion of business When the directors of a company decide to
expand the business or when the business is growing organically, there will be a greater
11

need to fund fixed assets and current assets. In these two scenarios, the need for working
capital is at the most. Stocks are bought in the intention of selling and trade credit is
given on generous terms. Therefore, there will be a growing need for working capital to
sustain the business in the long-run. There is also a risk of over-trading.

2.2.1.2 External factors

These are the external factors against which managers doesnt have any control. These
factors are mainly determined by the environment a company which operates.
Economic and business seasonal cycle: Most firms experience fluctuations in demand,
maybe due to seasonality, for their products and services. These irregularities in the
business operations affect the working capital requirements. When there is a boom in the
economy, generally demand for the products will increase and hence sales will increase,
as a result, it invariably will lead to the firms investment in inventories, debtors and
short-term debts will also increase. In this scenario, additional investment in productive
fixed assets may be undertaken.. The firms will usually take long-term debt or retained
earnings, if there is a cash balance, to finance these fixed asset investments. Whereas, a
slowing down of the economy, sales will reduce and as a result, , the firm will try to
reduce their short-term borrowings as stocks and debtors will not be much.
Changes in the technology: Better technology, if it is a manufacturing firm might fasten
the production process and hence reduce the cash operating cycle, as finished goods
could be put to the market soon. However, the initial investment for this technology
investment will require a large cash outlay
Taxation policy: Taxation systems of a country will determine how much tax has to be
paid. If the countrys, business climate is investment-friendly, there might be lower
taxation rates and will not put a strain on the firms ability to pay taxes. In most times,
this is not the case. Some taxation regimes require tax to be paid up-front, like quarterly
of a firms financial period. As a result, the firm may have to borrow a part of the sum to
be paid for taxation if the cash is tied up in debtors. Taxes have a bearing in the
management of working capital.
In conclusion, firms financial manager should be aware of the internal and external
factors that can influence the firms working capital needs. He/she should prepare
strategies to address these factors to manage the working capital.

2.3 Working capital components

2.3.1 Accounts receivable
When a company sells goods or services on credit, it records this as a receivable in the
ledgers and the balance sheet. Companies gets it cash within a given period that it gives
the customer, this is called the credit period. Companies manage the receivables by
intimating the credit period to the buyer so that the buyer will know when to pay.
12

Companies usually carry out a credit analysis to gauge who are paying on time and who
are not. By receiving cash early, it could improve the companies life-blood that is the
working capital.. Collecting the cash too early and not providing generous credit terms
might hamper business sales in the long run as customers might turn to competitors to get
the goods. Another option to improve working capital and to get cash early is to sell and
handover the trade receivables to a factoring company. The factoring company will
discount the trade receivables to make a profit and return rest of the money to the
company. There might be slight risk when obtaining the factoring facility, as the
factoring company might treat the credit customers harshly when they dont pay-up on
time. Thereby, harming trade relations with the company that gave on credit. (Brealey et
al, 2006 pp 814-819).

2.3.2 Inventory management

Inventory or stocks are a crucial make-up of current assets. Manufacturing firms usually
contain in their inventory: raw materials, works in progress or finished goods. Whereas, a
consultancy company would have no inventory. In most cases, it is a balancing to keep
inventory for sales and having less inventory to improve working capital. When there are
less stock when a customer demand has to be met immediately, the company will lose
out on revenue if customer demand is not met. On the other side of things, holding too
much inventory will have a opportunity cost and may give rise to obsolescence The trend
has been to lower inventory levels over the past decades. For example, 30 years ago U.S
companies had approximately 12% of total assets tied up in inventory, whereas today the
percentage is around six. A concept that has originated from Japan for managing
inventory is just-in-time. The just in time keep suppliers ready to supply goods or stocks
when the need arises for organisation to satisfy customer demand. By this way,
inventories are held at zero or in low levels. (Brealey et al, 2006 pp 821)

2.3.3 Cash management and short-term securities

Cash in the current assets section can have multiple uses. It can be used to buy stock, pay
salaries and purchase fixed assets etc. It is safe for organizations to hold big amounts of
cash for companies cash needs as they do not have to raise an overdraft, call on
shareholders to put in additional capital or raise debt. Large amounts cash which is not
used for buying stocks, to fund the expansion of business or to pay dividends gives the
company a lost opportunity to earn a return. This cash can be invested in a savings
account, fixed deposit or government bonds for example, to earn an interest.. The
company should prepare a forecast cash-flow and see whether they are not in need of
cash, otherwise, after investing cash in securities it may be called on to buy stock or pay
creditors This will lead to costs to the company in investing cash in securities, such as
administrative time taken to inform the bank and get the money to the company and in
some cases there might be a penalty. Some large organization, at the end of the day when
they have a cash balance, they invest it in a overnight money market deposit accounts
(MMDAs) which pays a interest rate Other short-term securities that companies can
invest their liquid funds in are Government treasury bills, commercial papers, bonds,
13

mutual funds, corporate notes and mortgage-backed securities. (Brealey et al,, 2006 pp
821-822)

2.3.4 Accounts payables management

Account payable is the liability that comes from credit sales and is posted as a sum
receivable by the seller and account payable from the buyer. Most companies, specially
retail and manufacturing buy goods on credit and record it as a liability that has to be
paid. A company can extend its credit policy based on the relationship between the
suppliers. However it should be noted that it is a form of short term debt, effective
management of trade credit is important and company should make sure suppliers are
receiving the payment on time to make them satisfied.
Arnold (2008 pp.479-482) says that buying good on credit and then selling them on
credit to customers is a cheaper form of finance than an organization taking a bank
overdraft to finance credit sales. Goods purchased on credit usually will be paid at a
future date, this credit period is given by the seller. Businesses obtaining trade credit is
regular norm. Obtaining trade credit has benefits, such as debtors does not have to
financed by short term debt, if the creditor period is long the cash could be used to buy
inventory for sales. t. Companies need to manage their forecasted cash-flow and pay the
creditors when the amount fall Paying the creditors on time will enable a company to
obtain more credit from suppliers and other supplier too will given on credit as the
companys reputation in the market-place is good. Paying the debt on time will improve
the companys image and hence will prevent any legal action taken by creditors A
method to identify when the payables are due, is to analyze past instances where how
much time was taken to pay creditors. Another method would be to take trade payable
outstanding as at now divide it by credit sales and multiply in by the number of days.
This will provide an indicator roughly how long it takes to pay the creditors.

2.3.5 Short term borrowings

There are many options for a company to take for short term borrowings, they are: bank
overdraft or line of credit, promissory notes, commercial papers, bill of exchange, and
loan from finance companies. These short term borrowings have to be settled within a
year, except for a revolving line of credit, however, this type credit is reviewed by the
bank periodically (Arnold, 2008 pp.474-79). With regard to short term borrowings, this
form of financing is expensive as it carries a high rate of interest and it is not cheap as
goods bought on credit. Careful planning of working capital is necessary to avoid a
situation where the company goes insolvent or in that matter in the short-term. If there is
an inability to pay the short term-borrowings when they fall due, it can lead, to the worst,
the wind-up or liquidation of a business. The reputation of credit-worthiness will come
into question. Therefore, many stakeholders, especially the creditors and lends will avoid
any transactions.
14

2.3.6 Cash conversion cycle (CCC)

Cash conversion cycle is a time span between the payment for raw material and the
receipt from the sale of goods. The cash operating cycle is the amount of time between
the companys purchasing raw materials, converting to a finished goods and the receiving
of cash from the sale of the goods. (Arnold, 2008 pp.454)mentioned that companies take
a cycle in which companies purchase inventory, sell goods on credit, and then collect the
amounts due. For a typical manufacturing company, the cash operating cycle takes in the
form as; raw materials holding period minus payables payment period plus WIP (Work in
progress) holding period plus finished goods holding period plus Receivables collection
period. This shows that the longer the cash conversion period, the more investment
needed to finance current assets. Faster the cash conversion cycle the better prepared the
company will be to pay their liabilities when they are due. Whereas, a longer cash
conversion cycle will put the company in difficulty in paying up liabilities when they fall
due, in a situation like this it will harm the companys reputation.
To calculate the CCC, it is raw materials holding period minus payables payment period
plus WIP (Work in progress) holding period plus finished goods holding period plus
receivables collection period.
Profitability means the ability of the business to make profit and to be sustainable. It
indicates and measures the success of the business. The profitability measure is gross
operating income. It can be calculated as sales minus cost of goods sold excluding
depreciation and amortization. Then this will be divided by total assets minus financial
assets. This is because for a firm which is listed on the stock exchange the majority of the
financial assets will be in the form of shares. By removing it the link is now between
working capital and profitability. In addition financial debt can be calculated as financial
debt/total assets. The equation for size is natural logarithm of sales and for sales growth,
this years sales minus previous years sales. (Deloof 2003b)
Cash conversion cycle can (CCC) be calculated as follows,
CCC = trade receivable days + inventory days trade payable days
Cash conversion cycle is described in the figure 2.

15

Figure 2 Cash conversion cycle

Inventory purchased

inventory sold

Inventory period

accounts receivable period

Accounts payable period

cash conversion cycle

Time

Cash received
Operating cycle

(Source Jordan 2003 p 643)

Profitability means the ability of the business to make profit. It measures the success of
the business. The profitability measure is gross operating income. It can be calculated as
sales minus cost of goods sold excluding depreciation and amortization. Then this will be
divided by total assets minus financial assets. This is because for a firm which is listed on
the stock exchange the majority of the financial assets will be in the form of shares. By
removing it the link is now between working capital and profitability. In addition
financial debt can be calculated as financial debt/total assets. The equation for size is
natural logarithm of sales and for sales growth, this years sales minus previous years
sales. (Deloof 2003b)

2.4 Working capital policy

In simple terms working capital can be defined as current assets minus current liabilities.
When a company unable manages it current liability through its current assets liquidity
problem arises. This can threaten the future existence of the company. On the other hand
when there are excess cash in the cash, a company should invest in short term securities
to enhance the wealth of the shareholders. Working capital policy can be mainly
classified in three categories. They are defensive policy, aggressive policy and
conservative policy.

2.4.1 Defensive policy

A defensive policy is where a company funds fixed assets and large part of its current
assets from long-term debt and equity. The financial accountant can plan with precision,
for example, financing huge sum of inventory from a debenture loan (1 year). The
company can have a large stock to meet customer demand as they fall due. Customers
will not be disappointed or go to competitors for goods in this scenario as they can get
the goods from companys vast stocks. Inventory planned to be sold for in 60 days could
be funded by a trade creditor who offers the company to pay he/she in 60 days time. A
delivery van could be financed by taking a debenture loan for 3 years. The defensive
policy keeps the company in a comfortable zone as they would not push for stock to be
16

made into sales or debtors to pay up earlier as already this has been financed by long
term funds. Therefore, profitability is reduced. Debt carries a interest cost and further
reduces profitability. Firms who do not know the demand for their goods and
merchandise would want to be shielded under the defensive policy. Under defensive
policy high level of stock and trade debtors would be present.
This policy would have a long cash conversion cycle. However, there would hardly be a
case where stocks and debtors would be funded by a bank overdraft. The company will
have to pay interest to the lender on the amount loaned. By holding large stocks, the
company runs the risk of obsolescence and incurring holding costs. This policy reduces
the need to handle working capital proactively as the current assets are already funded
with long term funding sources. The downside to this policy is that there are many cost
involved which will reduce profitability. (Arnold, 2008 p.530).

2.4.2 Aggressive policy

The aggressive working capital policy is companys intention to fund its working capital
through short term debt. This policy is thought to be cheap because funds such as
overdraft can be called upon when needed and the interest will be paid only when an
overdraft is taken unlike long-term debt where interest has to be paid for the entire loaned
amount for the year. Short-term debt has to be settled within one year so there is less
flexibility for a company. In an aggressive working capital policy the whole amount of
current assets are financed by short-term debt. Some part of the non-current assets also
will be finance by short-term debt. This policy will push the finance department to be
proactive in the management of working capital always, as they need to sell stocks fast
and collect receivables on a timely manner. In order to, settle the short term debts on
time. As a result this policy is very risky
If the business is in an expansion drive, boosting sales and profitability will be difficult
under an aggressive policy as the short-term debt will be insufficient to finance the
increased stocks and receivables. Therefore, such a policy is risky. This policy is suited
to firms which operate in a stable economic environment. The product has to be
established and give steady cash-flow which will make cash forecasting easier and hence
improve working capital management.
Generally a company which follows aggressive working capital policy doesnt offer long
credit period. It is normally around one month credit period. On the other hand the
inventory level will be to minimum; this will be based on the demand made by the
customers. Just in time production will be in place for these types of company. But it
should be noted that it is high risk strategy which offers high return to the company.
(Arnold, 2008 p.536).

2.9.3 Conservative policy

Some companies would want to adopt a mixture of the conservative working capital
policy and the aggressive working capital policy. If they see a good reason that debtors
17

will pay on time to settle trade creditors then they will try to fit in the aggressive working
capital policy element. On the other hand, if a particular expensive type of stock has not
shown interest by customers yet but hold promise in the future, then the company would
try the conservative approach by taking a long term loan to buy and stock this item and
hope that the promise materializes. It is important that some items of current assets and
sub-categories are studied properly to see which policy will suit which item and category.
By understanding and managing the current assets, the company could maximize its
profitability and improve the liquidity. This policy will have the elements of the two
policies described above and as a result will balance the firms profitability and risk.
Generally aggressive working capital suites a company which has high sales or growth,
this is because they will be able to manage the cash flow issues funded by the sales
growth. Whereas a company with an unstable environment and with fickle sales will
have to adopt the conservative policy because it cannot be certain about the cash
materializing soon to pay the liabilities. An aggressive policy will cause the company
financial anguish. Hence, understanding the current assets and liabilities will inform the
firm the best choice of working capital policy. (Arnold, 2008 p.538).

2.5 Critical review of previous studies

Many researchers have studied the impact of working capital management on
profitability. Below we have presented the researches relevant to our topic:
Smith (1980) carried out a research to identify the relationship between the profitability
and liquidity. He concluded that there is a positive relationship between the profitability
and liquidity. So it can be considered that effective management of liquidity can increase
the financial strength of the firm. Lamberson (1995) selected 50 US firms covering the
period of 1980-1991 to identify the relationship between the economic activity and
working capital policy. They found that there is no significant relationship between the
economic activity and working capital components.
Shin and Soenen (1998b) selected 58,985 American firms, covering the period 19751994 to investigate if there is any relationship between firms Net Trade Cycle (NTC)
and its profitability. They used regression and correlation analysis in their study. Their
findings suggested a negative relationship between firms profitability and NTC. Lyroudi
and et.al (1999) selected companies listed on the London Stock Exchange, covering a
period of 4 years revealing that, cash conversion cycle (CCC), are negatively related with
net profitability, return on assets and return on equity.
Cote and Latham (1999) emphasized that effective management of receivable days,
inventory days and payable days can positively influence the cash flow of the company.
Finally the cash flow is playing a vital role in determining the survival of the company.
Moyer et al. (2003) found that Working Capital consists of a large portion of a firms
total investment in assets, 40% in manufacturing and 50-60% in retailing and wholesale
industries respectively. The firms could reduce its financing cost and increase the funds
18

available for expansion if they minimise the funds tied up in current assets. They found
that cash helps to keep the firm liquid. It enables the firm to pay its obligations and also
protects the firm from becoming bankrupt.
Deloof (2003c) selected a sample of 1009 Belgian non financial firms covering a period
of 1992-1996. They used correlation analysis and regression analysis in their research.
They concluded gross operating profit and working capital components are negatively
correlated.
Jose at al. (2003) in their research selected 2178 firms covering the period of 1974 to
1993 to evaluate the relationship between the return on investment and cash conversion
cycle. They used multiple regression analysis in their study. They concluded that there
exists a negative relationship between the cash conversion cycle and the profitability of
the firms. This is evident in several industries such as manufacturing, retail services,
professional services and etc.
Eljelly (2004) in his study found that there is a negative relationship between the
profitability and the liquidity indicators such as current ratio and CCC. Lazaridis and
Tryfonidis (2006b) selected 131 companies listed in the Athens Stock Exchange for the
period covering 2001-2004.They observed cash conversion cycle and payable days are
negatively related. Padachi (2006b) identified negative relationship between profitability
and working capital components.
Shah and Sana (2006) in their research used receivable days, payable days, inventory
days, current ratio, and quick ratio as the independent variable and gross operating
income as the dependant variable. They used correlation analysis and ordinary least
square method to evaluate their data. They concluded that there is a negative relationship
between the gross operating income and working capital components.
Ganeshan (2007b) used Days of Working Capital (DWC) to measure the efficiency of
working capital. They concluded that, the relationship between profitability and DWC is
not significant. Raheman and Nasr (2007b) concluded that there is a strong negative
relationship between the working capital components, debt and the profitability. Further
the relationship between the size of the firm and profitability is positively correlated.
Garcia and et.al (2007) used 8872 Spanish firms for the period covering 1996-2002. They
concluded that profitability firms take less time to collect their receivable, pay their due
early and convert the inventories into finished goods within a short period. Afza and
Nazir (2007) identified a negative relationship between the firms performance and
working capital investment policies. Samiloglo and Demirgunes (2008) examined the
relationship between working capital components and profitability. They concluded
accounts collection periods and inventory conversion periods are negatively related with
the profitability.

19

Vishnani (2007b) selected electronic industry to carry out their research. They identified
that industry as a whole there is no significant relationship between the liquidity and
profitability.
Zariyawati et al. (2009) concluded that the relationship between Cash conversion cycle
and profitability is negative. Sen and Eda (2009) studies revealed that shorter Cash
conversion cycle leads to increase in the profitability. Falope and Ajilore (2009) in their
study found a significant negative relationship between the working capital components
and net operating profitability for a sample of 50 Nigerian firms. Uyar (2009) in his study
concluded that there is a significant negative relationship between Cash conversion cycle
and return on assets. According to Rezazadeh and Heidarian (2010) companys
profitability can be improved by reducing CCC.
Mohamad and Saad (2010) studied Bloombergs database of 172 listed firms from
Malaysia for the period covering 2003-2007. They concluded that working capital
components are negatively related with firms performance. Gill et al. (2010) in his study
revealed, there is a significant relationship between the working capital components and
profitability. Mathuva (2010), in his study concluded that payable days and inventory
days are positively related with the profitability whilst receivable days negatively
associated with the profitability
Danuletiu (2010) selected 20 Alba companies to establish a relationship between the
working capital components and profitability. The selected period covers 2004 to 2008.
This gives a 80 firm years. They used net working capital as their independent variable.
On the other hand return on assets, return on sales and return on equity has been used as
the dependant variable. Pearson analysis is used to measure the relationship and they
concluded that there exists a negative relationship between the profitability of the firm
and working capital components.
Gill, Biger, and Mathur (2010) in their research selected 88 companies from Newyork.
They carried out their research on selected periods between 2005-2007. The dependant
variables are receivable days, payable days, inventory days, natural logarithm of sales,
gearing. The independent variable is gross operating income. This measured by
deducting cost of sales from sales. They used regression analysis to evaluate the
variables. They concluded that there is a negative relationship between the profitability
and receivable days. Therefore firms need to develop effective strategy to collect their
receivable on time. Further they also concluded that the relationship between the cash
conversion cycle and profitability is positive.
Dong (2010) concluded that the relationship between the profitability and the working
capital management is negative. For this research companies listed on the Vietnam stock
exchange are selected covering the period of 2006 to 2008. He mainly analysed the
relationship between the working capital components and cash conversion cycle. He
concluded that the relationship between the cash conversion cycle and profitability is

20

negative. This leads to the fact in order to increase the profitability a company needs to
reduce the receivable days and inventory days to the minimum.
Ikram ul Haq, Sohail, Zaman, and Alam (2011) selected 14 firms from cement industry
in Pakistan. The period covered for the study was 2004 to 2009. They used receivable
days, payable days, inventory days, current ratio, liquid ratio and current assets to total
assets ratio to predict the behaviour of the return on investment. Regression analysis and
correlation analysis are used to measure the relationship between the variables. Finally it
is concluded that the relationship between these variables and return on investment is
moderate.
Nobanee et.al, (2011) used 2,123 Japanese non-financial firms in their study. They
concluded managers can increase the profitability by reducing the CCC. According to
Kieschnick et al. (2011) increase in investment in working capital will decrease the value
of the firms. Ching et al. (2011b) investigated the relationship between the profitability
and working capital management. They used return on sales, return on assets and return
on equity to measure the profitability in different ways. They concluded that cash
conversion cycle and debt ratio is negatively related with the profitability.
Mobeen et.al (2011) used 65 listed companies of Karachi Stock Exchange for the period
covering 2005-2009 and revealed that there exists a strong correlation between the
working capital components with the firms profitability. Vijayakumar (2011) in his
research identified that there is a negative relationship between the CCC and the
profitability. Sharma and Satish (2011) emphasised that the relationship between the
profitability and working capital components are positive.
Mohammad Morshedur Rahman (2011) selected Textiles industry to carry out their
research. They found out that there is no significant relationship between the working
capital management and profitability. Sayeda Tahmina Quayyum (2012) selected several
industries to carry out their research. Their research main objective is to find out which
industry is significantly influenced by the working capital components. They concluded
that except for the food industry there exists a significant relationship between the
working capital components and profitability.
Sebastian Ofumbia (2012) selected Nigerian firms to identify the impact of working
capital components on profitability. They identified that the relationship between cash
conversion cycle and profitability is significant compared to other variables. Secondly
the inventory conversion period and creditors payment play a vital role. They
recommended that companies should collect the cash from the debtors on time, the
collected cash should be reinvested in short term securities, the government of Nigeria
should encourage Foreign direct investment in the country to boost the economy and
company performance as well.
Bagchi and Khamrui (2012 b), selected 10 fast moving consumer goods (FMCG)
companies covering the period from 2000 to 2010. Return on assets has been used to
measure the profitability. On the other hand CCC, interest coverage ratio, inventory days,
21

payable days, receivable days, gearing ratio has been used as independent variables. They
concluded that the working capital components are negatively related with the
profitability of the firm.
Maryam Garajafary (2012) found that the relationship between the working capital
components and profitability is negative. This means the increase in receivable days,
payable days; inventory days and cash conversion cycle can decrease the profitability of
the company. They suggest that in order to maximise the wealth of the shareholders
managers needs to focus on the effective management of working capital components.

2.6Summary of empirical studies

From the above studies it is evident that the majority of the researchers found similar
results. These researchers identified a negative relationship between the trade payables
and profitability, this supports with the fact that less profitable firms fully utilising the
credit period granted by the suppliers. The negative relationship between the trade
receivables and firms profitability means profitable firms take less time to collect trade
receivable. Likewise the negative relationship between the inventories and profitability
indicates, profitability firms converting the inventory in to finished goods within a short
period.
Further it is very evident that the term profitability is calculated in different ways by the
researchers. They are of return on sales, return on assets, return on equity, return on
assets and return on invested capital, gross operating profit and net operating income.
Although the conclusion is similar for the majority of the authors, the conclusion of Shin
and Soenen (1998) Deloof (2003),Garcia and et.al (2007) and Nobanee et.al, (2011) is
more reliable as they have used large amount of sample covering a significant periods in
their research. However the only concern here is; the research data of Shin and Soenen
(1998) and Deloof (2003) is outdated at present context.
According to Raheman and Nasr (2007), Ching (2011), Alam et.al (2011), Bagchi and
Khamrui (2012), there is a negative relationship between the firms debt and profitability.
Further they also identified a positive relationship between the firms size, logarithm of
sale and the profitability.
On the other hand, for Ganeshan (2007) and Mathuva (2010) the finding is different.
Ganeshan (2007) emphasized that the relationship is not significant between days of
working capital and the profitability. They carried out the research in Telecommunication
industry, this industry nature is quite different compared to manufacturing industry.
Izadima and Taki (2010) examined the effects of working capital management on
capability of profitability for listed companies on Tehran Stock Exchange for the period
of 2001-2008 In this study return on total assets is considered as a measure for capability
of profitability. The results indicate that there is a negative significant relationship

22

between cash conversion cycle and return on assets and also a lot of investment in
inventories and accounts receivable leads to declining of profitability.
Since its more related with technologies, the way of doing business and the management
style will vary according to the rapid changes in the technologies. Frequently changing
environment might have led to insignificant relationship between days of working capital
and profitability. According to Mathuva (2010) the relationship between the payable
days, inventory days and profitability is positive; this is conflicting with other
researchers findings. Mathuva (2010) in his research only used 30 samples which are
listed in Nairobi stock exchange, further the market in Nairobi is not developed
compared with the western market. These could be the possible reasons for the different
conclusion by Mathuva (2010).

2.7Conclusion
The review of the previous studies gives us a clear link between the working capital
components and the profitability. Further it is evidenced that the total debt and size of the
firm also affecting the profitability of the firm. The above studies have been carried out
for different size of sample, time periods, countries and industries. The industries include
manufacturing, non financial firms, fast moving consumer goods and telecommunication.
All these give us a clear indication that the working capital components are given higher
priorities by the corporate world. Further it should be noted that there are only few
researches carried out for manufacturing companies listed in the UK.
In our research we will be evaluating whether the working capital components trade
receivable, inventories and trade payable are affecting the gross operating income of
manufacturing firms listed in UK. Further we will use cash conversion cycle as a
comprehensive measure of working capital management. Our study will focus on recent
periods, 2006-2011. At present financial crisis majority of the managers are finding it
very difficult to maximise the shareholder wealth, so our study covering the recent
periods will be very useful for managers to increase the wealth of the shareholders.

23

Research methodology
Research methodology chapter explains how our research will be undertaken to achieve
the objective of our research. This includes the type of our research, sample size,
variables used, data and statistical model which will be used to identify the relationship
between the profitability and the working capital management.

3.1 Research design

Our research is ex post facto research. This approach evaluates the relationship between
variables which have been already occurred. Here we will be using our variables to test
the relationship between the working capital management and the profitability. Further
our research methodology will use both the descriptive statistics and quantitative
analysis. We are using quantitative methods as we will be using financial data collected
from the database to evaluate our problem statement.
Our study will use pooled ordinary least square and generalize least square methods for
the analysis. We will use panel data in pooled regression analysis. The time series and
cross sections will be combined to do the research. This is because we are going to use
five year timer periods and observe the behaviours of working capital components, debt
and size of the firm throughout those five years.

3.2 Statistical methods

We can divide this part in to two main areas they are descriptive analysis and quantitative
analysis.

3.2.1 Descriptive analysis

This is the first analysis we will do in our research. Descriptive analysis normally helps
us to obtain the summary details about the collected data .This includes minimum,
maximum, mean and standard deviation of the collected data. If we dont use the
descriptive analysis it will be very difficult to get a clear understanding about the data
collected and its pattern over the years. In order to calculate descriptive summaries we
will use the SPSS software to analyse the collected data for our variables.

3.2.2 Quantitative analysis

Quantitative analysis means the statistical analysis used to study the pattern of the
collected data. Quantitative tests can be used to estimate the data and test the hypothesis
of the research. Here we will use two types of methods. They are Pearson correlation
analysis, regression analysis and t- test. The explanation for these three analyses is
explained briefly under chapter 3.5 hypothesis testing.

24

3.3 Variables
Variables for the research have been selected based on the previous studies and it is
presented below,

3.3.1 Dependant variable

3.3.1.1 Gross operating income
The main purpose of running the business is to enhance shareholders wealth. Whether a
company is running successfully or not can be calculated using the profitability. The
profitability simply measures how much income a company is able to generate apart from
the cost of selling that item. Generally a high profit margin means the ability of the
company to keep its cost to a minimum level is high. Gross operating profit margin can
be calculated as follows,
Gross operating income = sales - cost of goods sold

3.3.2 Independent variables

3.3.2.1 Receivable days
Trade receivable is the amount a company needs to collect from their customers. The
main purpose of granting customers credit is to increase the sales. The effectiveness and
efficiency of the debt collection can be measured through receivable days. Higher
receivable days means the debt collection policy is not effective and there are
possibilities for writing off more debt. Receivable days can be calculated as follows,
Receivable days = [accounts receivable*365] /sales.
3.3.2.2 Payable days
The amounts payable to the suppliers for the goods and services purchased is represented
as trade payable. When the suppliers offer credit periods to the firm it gives the flexibility
to manage the finance with other expenses. Further the credit period also allows the firm
to measure the quality of the supplied product and services. The payable days can be
calculated as follows,
Payable days = [accounts payable*365]/purchases.
3.3.2.3 Inventory days
The inventories in the form of raw materials, work in progress, and finished goods. This
is one of the major parts of assets for manufacturing firms. However higher level of
inventory days is not always good sign for the company as it can increase the storage cost
and obsolescence stock. It can be calculated as follows,
Inventory days = [inventories*365] /cost of sales.

25

3.3.2.4 Debt
Debt is the obligation owed by one company to another company. Debt can be short term
as well as long term. The short term debt means the debt which needs to be paid within 1
year. On the other hand long term debt means the debt which needs to be paid after one
year. Higher gearing is not a good indication for company financial health. Higher
gearing can delay the potential loan opportunities for the future. So it can act as a barrier
for the potential growth opportunities of the company. Gearing can be calculated as
follows,
Gearing = (financial debt/total assets) * 100.
3.3.2.5 Size of the firm
Size of the firm can influence the firms performance in several ways. Firstly if a firm is
large player in the market it gives the bargaining power to strike good deals with
supplier. Further the lenders will be happier to provide the loans. The firm will have
strong distribution channel so they can easily reach the end customers very quickly. Size
of the firms can be calculated as logarithm of sales and the formula is given below,
Size of the firm = logarithm of sales

3.4 Null hypothesis and alternative hypothesis

Hypothesis 1
H0: There is no relationship between the debtors collection period and the profitability.
H1: The debtors collection period is negatively related to the profitability higher the
debtors collection period lower the profitability and vice versa.
Hypothesis 2
H0: There is no relationship between the inventories days and the profitability.
H2: The inventory days are negatively related to the profitability higher the inventories
day lower the profitability.
Hypothesis 3
H0: There is no relationship between the payable days and the profitability.
H3: The payable days are negatively related to the profitability higher the payable days
lower the profitability.

Hypothesis 4
26

H0: There is no relationship between the cash conversion cycle and the profitability.
H4: Cash conversion cycle (CCC) is negatively related to the firms profitability - higher
the CCC lowers the profitability.
Hypothesis 5
H0: There is no relationship between the debt and the profitability.
H5: There is a negative relationship between the debt equity ratio and the profitability.
Hypothesis 6
H0: There is no relationship between the size of the firm and the profitability.
H6: There is a positive relationship between the size of the firm and the profitability.

3.5 Hypothesis testing

The hypothesis test can be done in several ways the one we are going use is represented
below,
3.5.1 The t test
The t test takes two sets of data and then examines whether the average of the two
group are statistically different from each other. For example this can be used to analyze,
the increase in profitability is mainly caused by working capital components or size of
the firm. The test will be carried out at 5% significance level. The result will be
significant if the P value is 5% or less than that.
3.5.2 Test of association
This approach will evaluate the relationship between the two variables for example
relationship between the profitability and the debt. The relationship between these two
variables means, changes in one variable can affect other variable. Two methods will be
used in testing the association and they are given below
3.5.2.1 Correlation analysis
This study measures the strength of the relationship between the profitability and the
working capital components. The coefficient lies between the -1 to +1. If the coefficient
is 0, means there is no association between the two variables. The positive sign indicates
increase in one variable will increase the other variable. On the other hand a negative
sign means increases in one variable will reduce the other variable.

27

3.5.2.2 Multiple regression analysis

Multiple regression analysis technique will be used to study the linear relationship
between the dependent variable and independent variable by calculating the coefficients
for a straight line. (Hair et al., 2000) The formula for regression analysis is given below
Yi = a + b1X1 + b2X2
Yi = dependent variable.
a = intercept (value of y when x is zero)
b1 = Slope coefficient for independent variable X1.
X1 = Independent variable 1
So our formula for the research is as follows,
Gross profitability = a + b1Xreceivable days + b2Xpayable days + b3Xinventory days+
b4Xcash conversion cycle + b5Xlogarithm of sales + b6Xgearing
Regression analysis will analyse the linear relationship between the profitability and
independent variables such as receivable days, payable days, inventories days, cash
conversion cycle, debt and size of the firm.

3.6 Data sources

Data collection can be primary or secondary. For our study we are going to use
secondary data. Secondary data means the data is collected from the existing research.
Several articles from the journal will also be used in our literature study. For other
variables like trade receivable days, payable days and so on, the data will be obtained
from the financial analysis made easy (FAME) database. This database includes 2.8
million companies in UK and Ireland for several years. This database can be accessed
through London South Bank University library.

3.7 Determining the sample size

The criteria used to select the sample in manufacturing industry, construction industry
and telecommunication industry is as follows,
1.
2.
3.
4.

Listed on the stock exchange

UK companies
Manufacturing industry/Construction industry/Telecommunication industry
Years 2007-2011 (5 years)

Companies without the financial information for the 5 years have been eliminated from
the sample. The key ratios for our research has been obtained from thee FAME data base.
28

This includes receivable days, payable days, inventory days, gearing. Based on the
collected ratios cash conversion cycle and logarithm of sales is calculated.
The amount of manufacturing companies initially selected for the 5 years were 240. This
gives a 1200 company years in total. Due to the time constraint only 60 companies were
selected based on their highest turnover. This gives a 300 company years for
manufacturing firms. In similar to this 20 construction firms were selected which gives
100 company years in total. At last 17 telecommunication firms also selected based their
highest sales. This gives 85 company years for telecommunication industry.

3.8 Transforming data in to information

In this part we will use both the Minitab and Microsoft excel 2007 to transform our data
in to information. The structure of the presentation is as follows.
3.8.1 Scatter diagram
We will use this diagram in the beginning stage of our research. This approach at the
beginning stage will help us to identify any relationship between the dependant variable
profitability and independent variable trade receivable, trade payable and etc. The
identified behavior will be very useful to take our research forward.
3.8.2 Frequencies
Here we will use pie chart, bar chart, and tables to represent information like number of
listed manufacturing firms in the London stock exchange. The charts will always give a
clear picture about the collected data.

3.9 Ethical Consideration

We have taken every aspect of ethical issues in to consideration. So we can give the
assurance that our research doesnt have any ethical implications.

29

Chapter 4: Data analysis and discussion

We have carried out two types of test in this research. They are descriptive statistics and
quantitative analysis. The results of the analysis are discussed below.

4.1 Descriptive statistics

Descriptive statistics shows the mean value and standard deviation of the 60
manufacturing firms, 20 construction firms and 17 telecommunication firms observed in
the London stock exchange. In addition to this it also provides the minimum and
maximum value of the variables.

4.1.1 Manufacturing industry

Variables

Minimum Maximum Mean

Standard
deviation

Gross profit

60

0.02

1.43

0.35

0.2869

Receivable days

60

0.58

116.14

53.10

22.58

Payable days

60

0.00

136.89

31.59

21.15

Inventory days

60

3.84

132.51

9.31

22.49

Cash conversion cycle

60

-18.93

138.45

29.81

28.06

Logarithm of sales

60

200

27387

836

5513

Gearing

60

0.00

776.6

78.0

120.30

The mean value of the gross profit is 35% and the standard deviation is 28.69%. This
means the gross profit can vary from mean to the both sides by 28.69%. The average
value of the cash conversion cycle is 29.81 days. The firms receive payment from the
customers at an average of 53.1.the standard deviation of the receivable day is 22.58
days.
The maximum value is 116.14 days, which is very significant. Manufacturing firms
making payment to the suppliers after 32 days on a average basis. It indicates one month
credit period is agreed between suppliers and firms. However the maximum value is
136.89 days. Which quite significant considering the nature of the current economic
situation. The mean value of the inventory is just 9.31 days which is more unlikely. But
the days can vary to 32 days. The gearing average is 78% which is very high; it can
squeeze the profitability of the firms through interest payments.

30

4.1.2 Telecommunication industry

Variable

Minimum Maximum Mean

Standard
deviation

Gross profit

17

0.00

0.61

0.26

0.20

Receivable days

17

12.70

201.20

67.10

43.20

Payable days

17

4.81

126.05

45.80

30.39

Inventory days

17

0.00

871.60

92.20

214.50

Cash conversion cycle

17

-41.7

397.60

88.40

97.70

Logarithm of sales

17

8.22

1061.10

219.20

269

Gearing

17

0.00

295.0

86.20

100.1

The mean value of the gross profit is 26% and the standard deviation is 20%. This means
the gross profit can vary from mean to the both sides by 20%. On the other hand the
minimum value of the gross profit is nil value. The maximum value is 61%.
The firms receive payment from the customers at an average of 67.10; the standard
deviation of the receivable day is 43.2 days. The maximum value is 201.20 days, which
is very significant.
Telecommunication firms making payment to the suppliers after 45.80 days on an
average basis. However it can vary by 30.39 days by the both the sides. The maximum
value of the credit term is 126.05 days.
The mean value of the inventory is 92.2 days; the standard deviation is 214.50 days. The
maximum values of inventory days are 871.60 days which is very significant. This could
be due to the production in progress. The inventory days are very low in the
manufacturing compared to telecommunication firms. This could be due to the nature of
the business.
The average value of the cash conversion cycle is 88.41 days which is very significant
compare with the manufacturing industry cash conversion cycle 39.81 days. The
minimum value is 41.7 days which is 30 days higher than the manufacturing days. On the
other hand it can vary by 97.7 days by the both the sides.
The gearing average is 86.20% which is very high; it can squeeze the profitability of the
firms through interest payments. It can deviate by 100% from the both the side. The
maximum value of the gearing is 295%.

31

4.1.3 Construction industry

Variable

Minimum Maximum Mean

Standard deviation

Gross profit

20

0.00

0.26

0.09

0.07

Receivable days

20

3.31

106.45

39.45

30.02

Payable days

20

4.40

181.39

58.71

44.36

Inventory days

20

0.00

907.10

54.0

201.40

Cash conversion cycle

20

-105.0

138.80

20.20

72.60

Logarithm of sales

20

244

4153

1175

1068

Gearing

20

7.73

464.10

87.00

126.40

The mean value of the gross profit is only 9% which is the lowest percentage compared
with the other two industries. The standard deviation is 7%. So it means the maximum it
can go up to is 7%. The average value of the cash conversion cycle is 20.20 days which
is very low compared with the telecommunication industry.
The firms receive payment from the customers at an average of 39.45 .The standard
deviation of the receivable day is 30.02 days. So it can deviate to 70 days or 10 days. The
maximum value is 106.45 days.
Firms making payment to the suppliers after 58.71 days on an average basis. This means
the industry is taking two months credit period on a average basis. However it can
deviate by 44.36 days by the both the side. The maximum value of the payable day is
181.39 which is very significant.
The mean value of the inventory is 54days; the standard deviation is 201.40 days. The
maximum value of inventory days are 907.10 days which very significant. This could be
due to the nature of the business.
The gearing average is 87% which is very high; it can squeeze the profitability of the
firms through interest payments. It can deviate by 126.4% from the both the side. The
maximum value of the gearing is 464% which very significant. This is almost 200%
higher than the manufacturing industry.
To summarise the findings of the telecommunication, it can be said there are variances
between the manufacturing industry and telecommunication industry. The main reason
for this could be due to the difference in sample selected and nature of business
operations.
32

4.2 Correlation analysis

In this section we have used correlation study to measure the relationship between the variables
used in this study. The result of the study is discussed below.

4.2.1 Manufacturing industry

Details
Receivable
days
Payable days
Inventory days
Cash
conversion
cycle

Gross
profit
0.157
0.229

Receivable Payable
days
days

Inventory
days

-0.123
0.351
-0.229
0.078
0.036
0.787

0.298
0.021
-0.234
0.072
0.393
0.002

0.162
0.216
-0.385
0.002

0.491
0.000

-0.172
0.190
0.426
0.001

-0.070
0.597
0.354
0.006

0.117
0.018
0.375
0.889
-0.246
-0.014
Gearing
0.058
0.916
Cell Contents: Pearson correlation
Sales

CCC

Sales

0.088
0.502
-0.049
0.709

0.169
0.196

P-Value
Figure 3 - Scatter plot gross profit vs. independent variables

Scatterplot of Gross profit vs Receivable d, Payable days, ...

Receiv able day s

Pay able day s

Inv entory day s

1.6
1.2
0.8

Gross profit

0.4
0.0
0

50

100

CCC

1.6

50

100

Sales

50

100

Gearing

1.2
0.8
0.4
0.0
0

50

100

10000

20000

400

800

33

The results of the Pearson correlation show that there is a positive coefficient of 0.157
with the p-value of 0.229. This indicates the relationship between the receivable days and
profitability is not significant. The correlation result between the payable days and
profitability also indicates the similar result with the negative coefficient of -0.123 and
0.351 p-value, so this also indicates that there is no significant relationship between the
payable days and profitability.
The coefficient result for the inventory day is -0.229 with the p-value of 0.078, so this is
also indicates that there is no significant relationship between the profitability and
inventory days. Cash conversion cycle also indicates that there is no significant
relationship between the profitability as the p-value of the cash conversion cycle is
significant than the determined p-value level of 0.05.
The results are not in line with the previous studies. It can be argued that the inventory
build up in the warehouse can encourage the smooth flow the production, so it leads to
increase of sales and profitability. But inventory build up also has negative consequences
on the profitability of the firms, for example increase in storing cost. There is a positive
relationship between the sales and profitability. The relationship between the gearing and
profitability is negative which is also in line with the view that interest payments can
reduce the profitability of the firm. But the p-value indicates the relationship is not
significant.
4.2.2 Telecommunication industry

Details

Gross
profit
0.187
0.471

Receivable Payable
days
days

Payable days

-0.149
0.567

-0.225
0.386

Inventory days

-0.098
0.707
0.212
0.414

0.642
0.005
0.953
0.000

-0.345
0.175
-0.509
0.037

0.674
0.003

-0.088
0.737
-0.476
0.054

-0.062
0.813
-0.378
0.134

-0.173
0.508
0.722
0.001

-0.129
0.621
-0.208
0.422

Receivable
days

Cash
conversion
cycle
Sales
Gearing

Inventory
days

CCC

Sales

-0.001
0.996
-0.559
0.020

-0.017
0.949

Cell Contents: Pearson correlation

34

P-Value
Figure 4 - Scatter plot gross profit vs. independent variables

Scatterplot of Gross profit vs receivable, payable, inventory, ...

receiv able

pay able

inv entory
60
45
30

Gross profit

15
0
0

100
ccc

200 0

50

100

500
gearing

150

Sales

1000

60
45
30
15
0
0

200

400 0

500

1000

300

The results of the Pearson correlation show that there is a positive coefficient of 0.187
with the p-value of 0.471. This indicates the relationship between the receivable days and
profitability is not significant. The correlation result between the payable days and
profitability indicates negative coefficient of -0.149 and 0.567 p-value, so this also
indicates that there is no significant relationship between the payable days and
profitability.
The coefficient result for the inventory day is 0.098 with the p-value of 0.707, so this also
indicates that there is no significant relationship between the profitability and inventory
days. Cash conversion cycle also indicates that there is no significant relationship
between the profitability as the p-value 0.414 is higher than the determined p-value of
0.05.
There is negative relationship between the sales and profitability. The coefficient level is
-0.088. The p-value is 0.737 which is higher than the determined p-value of 0.05. The
relationship between the gearing and profitability is negative with the p-value of 0.05, so
this indicates there is a significant negative relationship between the profitability and
gearing. This is also in line with the view that interest payments can reduce the
profitability of the firm. The similarity with the manufacturing firm study is the
relationship between payable days and profitability is negative. In addition the
relationship between the cash conversion cycle and profitability is positive. However the
relationship is not significant.

35

4.2.3 Construction industry

Details
Receivable
days
Payable days
Inventory days
Cash
conversion
cycle

Gross
profit
0.027
0.910

Receivable Payable
days
days

Inventory
days

-0.327
0.160
-0.135
0.571
-0.177
0.455

0.055
0.816
0.282
0.228
0.793
0.000

-0.052
0.829
-0.565
0.009

0.265
0.259

0.033
0.891
-0.415
0.069

0.041
0.863
-0.121
0.613

0.377
0.037
0.102
0.878
-0.157
-0.264
Gearing
0.509
0.260
Cell Contents: Pearson correlation
Sales

CCC

Sales

0.010
0.966
0.035
0.885

-0.247
0.293

P-Value
Figure 5- Scatter plot gross profit vs. independent variables

Scatterplot of profit vs receivable, payable, inventory, ccc, ...

receiv able

pay able

inv entory

30

20

10

profit

0
0

50

100

ccc

30

100

200 0

turnov er

500

1000

gearing

20

10

0
-100

100

2000

4000 0

200

400

36

The results of the Pearson correlation show that there is a positive coefficient of 0.027
with the p-value of 0.910. This indicates the relationship between the receivable days and
profitability is not significant. The correlation result between the payable days and
profitability indicates negative coefficient of -0.327 and 0.160 p-value, so this also
indicates that there is no significant relationship between the payable days and
profitability.
The coefficient result for the inventory day is -0.135 with the p-value of 0.571, so this
also indicates that there is no significant relationship between the profitability and
inventory days. Cash conversion cycle also indicates that there is no significant
relationship between the profitability as the p-value is higher than the 0.05 level..
The result of the construction firms study is also not as expected. There is positive
relationship between the sales and profitability.. The similarity with the
telecommunication industry study is the relationship between payable days and
profitability is negative. In addition the relationship between the cash conversion cycle,
receivable days and profitability is positive. However the relationship not significant.

4.3 Multiple Regression Analysis

4.3.1 Manufacturing industry
The regression equation is
Gross profit = 0.342 + 0.00051 Receivable days + 0.0013 Payable days - 0.00308
Inventory days + 0.00173 cash conversion cycle + 0.000007 Sales - 0.00052 Gearing
S = 0.28
R-Sq = 11.90%
R-Sq (adj) = 3.80%
Summary of the Results
Predictor

Coefficient

SE Coefficient

Constant

0.3418

0.1112

3.08

0.003

Receivable days

0.0005

0.0021

0.23

0.817

Payable days

0.0013

0.0022

0.60

0.554

Inventory days

-0.0030

0.0022

-1.39

0.170

Cash conversion cycle

0.0017

0.0017

0.96

0.340

Sales

0.000007

0.000007

1.01

0.315

37

Gearing

-0.00052

0.000374

-1.39

0.170

Multiple Regression Model Interpretation

Multiple regression analysis like regression analysis evaluates the relationship between
the multiple variables in this research. For example how combined variables like
receivable days, payable days and other variables affecting the profitability of the firm. R
square means how much percentage is explained by the benchmark index. R square can
vary from 100 to 0. An R square of 100 means the entire index is explained by the
variable
In this context R-square is 11.90%, so this means the proportion of gross profitability
(dependent variable) is explained by the independent variables are 11.90%. Adjusted R
square is used to compensate for the additional variable in the model. In this context Rsquare is 3.80%. It is assumed that if the p value is lower than the 0.05, there is a
significant relationship between the independent variables and dependent variable. When
the p value is higher than the 0.05, then it is considered that there is no significant
relationship between the variables.
The relationship between the receivable days and the gross operating income is positive.
The p-value here is 0.817 which very higher than the determined p-value 0.05, so it can
be concluded that the relationship between these variable are not statistically significant.
There exists a positive relationship between the payable days and gross operating
income. But it has to be noted that the calculated p-value of 0.554 is higher than the
determined p-value 0.05. So it can be concluded that the relationship between the payable
days and gross operating income are not statistically significant.
The relationship between the inventory days and gross operating income is negative. The
p-value here is 0.170 which is higher than the determined p-value 0.05. So it can be
concluded that the relationship between these variables are not statistically significant.
There is a positive relationship between the gross operating income and sales. The pvalue in this context is 0.315 which is higher than the determined p-value of 0.05. So it
cannot be considered the relationship between the sales and gross operating income is
significant.
There exists a negative relationship between the gearing and the gross operating income.
The p-value in this context is 0.170 which is higher than the determined p-value of 0.05.
so it can be concluded that the relationship Is not significant.
Conclusion
There is no significant relationship between the independent variable and gross operating
income in the manufacturing industry.
38

4.3.2 Telecommunication industry

The regression equation is
Gross profit = 28.50 0.073 Receivable days + 0.172 Payable days - 0.0241 Inventory
days + 0.0365 Cash conversion cycle + 0.0058 Sales - 0.133 Gearing
S = 19.79
R-Sq = 33.60%
R-Sq (adj) = 3.40%
Summary of the Results
Predictor

Coefficient

SE Coefficient

Constant

28.51

14.60

1.95

0.07

Receivable days

0.073

0.1695

0.43

0.675

Payable days

0.1722

0.2749

0.63

0.544

Inventory days

-0.02411

0.0343

-0.70

0.498

Cash conversion cycle

0.0365

0.084

0.43

0.675

Sales

-0.00582

0.01952

-0.30

0.771

Gearing

-0.13260

0.08244

-1.61

0.136

Multiple Regression Model Interpretation

R-square is 33.60%, so this means the proportion of gross profitability (dependent
variable) is explained by the independent variables are 33.60%. In this context R-square
is 3.40%. It is assumed that if the p value is lower than the 0.05, there is a significant
relationship between the independent variables and dependent variable. When the p value
is higher than the 0.05, then it is considered that there is no significant relationship
between the variables.
The relationship between the receivable days and the gross operating income is positive.
The p-value here is 0.675 which very higher than the determined p-value 0.05, so it can
be concluded that the relationship between these variable are not statistically significant.
There exists a positive relationship between the payable days and gross operating
income. But it has to be noted that the calculated p-value of 0.544 is higher than the
determined p-value 0.05. So it can be concluded that the relationship between the payable
days and gross operating income are not statistically significant.
39

The relationship between the inventory days and gross operating income is negative. The
p-value here is 0.498 which is higher than the determined p-value 0.05. So it can be
concluded that the relationship between these variables are not statistically significant.
There is a negative relationship between the gross operating income and sales. The pvalue in this context is 0.771 which is higher than the determined p-value of 0.05. So it
cannot be considered the relationship between the sales and gross operating income is
significant.
There exists a negative relationship between the gearing and the gross operating income.
The p-value in this context is 0.136 which is higher than the determined p-value of 0.05.
so it can be concluded that the relationship between the gearing and profitability is not
significant.
Conclusion
There is no significant relationship between the independent variable and gross operating
income in the telecommunication industry.

4.3.3 Construction industry

The regression equation is
Gross profit = 2.72 + 0.0131 Receivable days + 0.0556 Payable days - 0.0051 Inventory
days + 0.0065 cash conversion cycle + 0.0026 Sales + 0.0004 Gearing
S = 7.36
R-Sq = 26.40%
R-Sq (adj) = 0.1%

Summary of the Results

Predictor

Coefficient

SE Coefficient

Constant

2.72

5.24

0.52

0.612

Receivable days

0.013

0.0605

0.22

0.832

Payable days

0.0556

0.0422

1.32

0.209

Inventory days

-0.0051

0.0087

-0.58

0.571

40

Cash conversion cycle

0.062

0.052

1.18

0.259

Sales

0.0026

0.0016

1.63

0.125

Gearing

0.0043

0.0158

0.28

0.786

Multiple Regression Model Interpretation

In this context R-square is 26.1%, so this means the proportion of gross profitability
(dependent variable) is explained by the independent variables are 26.1%. Adjusted R
square is used to compensate for the additional variable in the model. In this context Rsquare is 0.1%. It is assumed that if the p value is lower than the 0.05, there is a
significant relationship between the independent variables and dependent variable. When
the p value is higher than the 0.05, then it is considered that there is no significant
relationship between the variables.
The relationship between the receivable days and the gross operating income is positive.
The p-value here is 0.832 which very higher than the determined p-value 0.05, so it can
be concluded that the relationship between these variable are not statistically significant.
There exists a positive relationship between the payable days and gross operating
income. But it has to be noted that the calculated p-value of 0.209 is higher than the
determined p-value 0.05. So it can be concluded that the relationship between the payable
days and gross operating income are not statistically significant.
The relationship between the inventory days and gross operating income is negative. The
p-value here is 0.571 which is higher than the determined p-value 0.05. So it can be
concluded that the relationship between these variables are not statistically significant.
There is a positive relationship between the gross operating income and sales. The pvalue in this context is 0.125 which is higher than the determined p-value of 0.05. So it
cannot be considered the relationship between the sales and gross operating income is
significant.
There exists a negative relationship between the gearing and the gross operating income.
The p-value in this context is 0.786 which is higher than the determined p-value of 0.05.
so it is also indicating the relationship between these variable also not significant.

Conclusion
There is no significant relationship between the independent variable and gross operating
income in the construction industry.

41

Chapter 5 Conclusion and further research

5.1 Conclusion
The purpose of this study is to find out, how working capital components are influencing
the profitability of the manufacturing industry, telecommunication industry and
construction industry. This is because over the last few years many UK companies have
failed to free up the cash due to inefficient management of working capital. When a
company is able free up the cash flow, it can be invested in other potential business
opportunities
In order to maximise the cash flow and working capital, a company needs prepare the
budgeting and benchmarking system. This will enable them to create a perfect system to
effectively use the working capital components. To ensure the quality of the budgeting,
managers needs to make sure the forecasting of short term and medium term cash flow is
accurate.
Reducing the amount of tax paid and identifying the areas where cash outflow is
significant will helps to retain more cash for investment. Identifying the areas where tax
relief can be made is one possible option. Further it is also very important to monitor the
cost incurred for the fixed asset, because the cost for fixed asset maintenance or
improvements can be very significant and can affect the entire business operations.
However it should be noted due to the nature of business some companies will find it
very difficult to optimise the working capital, so best strategy that can be implemented to
enhance performance is to identify the key drivers in working capital management.
It is expected that there is a negative relationship between the profitability of the firms
and working capital components. However based on the findings of our research there is
no significant relationship between the working capital components receivable days,
payable days, inventory days, cash conversion cycle and profitability of the firm. These
results suggest that the manager needs to focus on core business principle to maximise
shareholders wealth, for example innovative products.
Regarding our hypothesis we reject alternative hypothesis (H1) that there is a negative
relationship between the receivable days and profitability. In the same way we reject our
hypothesis H2 (there is a negative relationship between the inventory days and
profitability), H3 (there is a negative relationship between the payable days and
profitability), H4 (there is a negative relationship between the cash conversion cycle and
profitability), H6 (there is a positive relationship between the sales and profitability of
the firm), indicating that there is no significant relationship between the working capital
components and profitability. However there is a negative relationship between the
gearing and profitability in the telecommunication firms, but for construction firms and
manufacturing firms there is no significant relationship.

42

When we critically study the previous journals it is very clear that the result is not in line
with the studies of (shin and soenan 1998, Deloof 2003, Eljelly 2004, and Raheman, A;
Nasr, M (2007)), found negative relationship between the working capital components
receivable days, payable days, inventory days, cash conversion cycle and profitability.
These authors also emphasised that by improving the cash conversion cycle a company
can increase its profitability and maximise shareholders wealth.
The rejection of hypothesis could be due to the following reasons, although we have tried
to evaluate many variables as possible, our research is limited to public firms listed on
the stock exchange. Public companies will develop strategy to meet the expectation of
their shareholders. Further listed companies will be having more media pressure, so these
companies always need to demonstrate fair trade policy. On the other hand the strategy of
unlisted companies may be different due to its nature of ownership and risk taking
ability.
Gross profit is the dependant variable in our research, it is very important to consider that
it is just a one form of measuring the performance of the company. The main reason we
used gross profit in our research is to measure the operating success or failure of the firm
before any financial activity have an impact on the profitability. The profitability can
measured in terms of net profitability, return on investment, return on capital employed
and return on equity.
Even though the selected firms represent a similar industry its nature of operation could
be different. For example if we take Glaxosmithkline PLC which has a turnover of 27387
million for 2011 and Fuller Smith & Turner PLC which has a turnover of 241.9
million for 2011. The Glaxosmithkline PLC is having a strong bargaining power
compared with the Fuller Smith & Turner PLC. As result it can extend its credit period,
this will gives them the flexibility to manage other expense. They can also force the
customers to pay immediately. The source of finance available to them is also vast, for
example bank loans or right issue. So when comparing these companies to establish a
relationship between the working capital components and profitability can give
misleading result. So it may be a good idea to select these companies data for ten years
and then calculate the relationship for each company individually can give accurate
results.
Further the profitability of the firm is mainly determined by how it is able to add value to
its customer through its innovative idea. The more innovative a company is higher its
profit margin. To elaborate more we can take Apple iphone and Nokia lumia. Since apple
is able to innovate more new concepts its profit margin is high and the customers also
ready to pay premium price for their price. So it is very important for companies to add
value through its value chain. This focus will enable them to increase the profit margin
and enhance shareholders wealth.
Over last few years entire world is affected by the recession, especially European
countries. So it is also very important to identify whether the recent developments
43

amongst these nations are playing a vital role in affecting the result of our research. Since
the economy is more volatile it is very difficult to establish a pattern through our
collected data for the research.
Whatever the circumstances it can be concluded that working capital management is very
important for each and every companies as it can be used as a source of finance. The
issue here is, to what extent the important should be given to the working capital
management is a big question. Focusing on core business is very important as it will
determine how much price customers are will to pay for the goods and services.

Further research
There are several research areas identified during the progress of our study. One is to
focus on how a company can use optimal working capital policy to improve its liquidity
position. Effective and efficient management of working capital can reduce the short
term borrowing required by a company, hence saving interest payments and improving
the profitability.
However the question arises here is to what extent a company can rely on working capital
to improve its profitability. So it may be good idea to select other variables like quality,
labour, innovation and etc to carry out a research and find out how it having an impact on
profitability. Based on the findings of the relationship it can be then determined, what are
the important factors a company should give high preference when its come to
determining the profitability.
This is because there are other several factors which determine the profit margin of the
company. Throughout the value chain, this includes quality of the raw material, labour
hours, brand awareness and etc. so it is also very important for each and every company
to focus on core business principles. In the mean time these companies needs to develop
strategy to maximise the use of working capital components.
Other potential research opportunity is to select large amount of sample (for example 500
to 1000) covering a period of 10 years and doing a research on country basis. This can
include comparing western countries and Asian countries; this can bring in new
understandings. The management style in each part of the world is different so the result
will be very interesting.
The dependent variable profitability can be measured in different terms includes net
profit margin, return on asset, return on capital employed and etc. So taking each and
every profitability measures to find out which profitability measure is significantly
influenced by the working capital components can be very useful for the managers in
corporate world.
Additionally research can also be carried out to find the factors determining the working
capital policy of the company. For example sales, economic situation, political stability
of the country and etc. Assume country x is having high level of inflation, in that case the
44

interest rate will be very high. So the companies will be under pressure to use its working
capital components to finance its short term requirements.
Further research can also be carried out amongst unlisted companies to identify how the
working capital component is playing the role. This is because family business is not
facing the pressure faced by listed companies, so there may be several opportunities to
increase the profitability of the company or to identify how the private companies
utilising the working capital components. Compared with the listed companies, the
capital available to private companies are limited so better uses of working capital can
increase the profitability.

45

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