Economics and Finance Review Vol. 3(11) pp.

01 14, September, 2014

Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

Effect of Working Capital Management on performance of Firms Listed at the Nairobi

Securities Exchange
Cyprian Nyarige Nyamweno
Department of Economics, Finance and Accounts,
School of Business,
Jomo Kenyatta University of Agriculture and Technology,
Nairobi Kenya
E-mail: cyprian.nyarige@yahoo.com
Tobias Olweny
Lecturer, School of Business,
Jomo Kenyatta University of Agriculture and Technology
E-mail: toolweny@yahoo.com

ABSTRACT
This study sought to determine the effect of working capital management on performance of firms listed at the
Nairobi Securities Exchange in Kenya. A sample of 27 listed firms was used for the period 2003 to 2012. The
study employed a Robust GMM applied to Arellano-Bover/Blundell-Bond linear dynamic panel-data estimation
analysis. The results revealed that days of accounts receivables and cash conversion cycle have an indirect
effect on performance measured by gross operating profit. Days of accounts payables and days in inventory
have a significant and direct effect on performance. Inflation and size were found to have indirect and direct
effect on performance respectively. Although not significant, they cannot be ignored by finance managers who
wish to boost performance. ANOVA results confirm that various sectors have varying and somewhat same
averages of working capital. Therefore industry averages should not ignored when setting working capital
management policies in Kenya.
Keywords: Working Capital Management (WCM), Gross Operating Profit (GOP), days in accounts receivables
(AR), days in accounts payables (AP), days in inventory (INV), Nairobi Securities Exchange (NSE),
1. INTRODUCTION
Working capital performance provides critical insight into the state of a companys financial position. As an
important indicator of financial fitness, the availability of a companys working capital is one of the first items a
lender or investor will examine on a balance sheet (Financial Executives International Canada, 2013).
Globally 1000 companies lose about $2 billion per year due to poor working capital management. The recent
financial and economic crisis has shown how important it is for firms to maintain a healthy cash position. The
risk of becoming illiquid always increases in times of credit constraints and economic downturn. However,
companies are still unable to properly assess their cash needs (Frankfurt Business Media, 2012).
Long term financing and short term are two ways of financing a business enterprise. Long term financing is
requirement means a firm needs for capital expenditure while short term financing is requirement for certain
expenditure like procurement of raw materials, payment of wages, day-to-day expenditures. Working capital
management is the short-term finance of the business which is a closely related to trade between profitability
and liquidity. Efficient working capital management seeks to improve the operating performance of a business
concern and it helps to meet the short term liquidity. Hence, the study of working capital management is not
only an important part of financial management but also an overall management of a business concern
(Paramasivan C; Subramanian T, 2009).
The stock market and financial sector also plays an important role in the development of any economy. The
depth of the financial sector has generally been found to promote economic growth. It is confirmed that a wellfunctioning capital market increase economic efficiency, investment and growth (Ngugi, Amanja, & Maana,
2010). This means that the performance of the listed firms in any economy is vital to the performance of the
stock market and of that economy at large.

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Inflation on the other hand affects working capital management and policy. It plays out on both the balance
sheet and the income statement of all businesses and households. Anticipating the future effects of inflation can
work to the advantage of the savvy financial manager. The fundamental principle to be followed in inflationary
times is that cash is guaranteed to lose value over time while the physical assets will gain in value. Incorporating
this principle into all financial transactions becomes critical for success (Carl S; Dan L; Ellisabeth D, 2011).
Shareholders, economies and lenders have invested heavily in the listed firms financially and providing a
healthy environment for conducting business. Therefore these stakeholders expect such companies to perform to
the expected standards. Some companies have so far performed well while others have suffered declined
performance. Some companies have been delisted from the NSE due to financial reasons (Chebii, Kipchumba,
& Wasike, 2011).
Working capital presents a huge opportunity for companies to release cash from their balance sheets and operate
more effectively. Actually well-managed cash provides firms with growth without the need for additional
funding (Frankfurt Business Media, 2012).
From companies annual reports from Nairobi Securities Exchange (2013), it is evident that many companies
quoted at NSE do not pay dividends consistently, and when they pay, the level of payout is very low contrary to
shareholders expectations. Further with corporate failures witnessed in Kenya like Uchumi Supermarkets and
Kenya Cooperative Creameries, with some undergoing through receivership Maina & Sakwa (2010), there was
need and motivation to undertake this study.
1.2 Research Objectives
1.2.1 General Objective
The main objective of this is study was to determine the effect of working capital management on performance
of firms listed at the Nairobi Securities Exchange.
1.2.2 Specific objectives
1. To determine the effect of cash conversion cycle on profitability of firms listed at the NSE.
2. To determine the effect of days of accounts payables on profitability of firms listed at the NSE.
3. To determine the effect of days of accounts receivables on profitability of firms listed at the NSE.
4. To determine the effect of days in inventories on profitability of firms listed at the NSE.
1.3 Significance of the study
This study is useful in the following ways; first, it identifies how the components of working capital affect
performance of listed firms. Thus, a firm management can strike a balance between those components to
maximize the shareholders wealth as well meet the shareholders expectations. Its findings will also validate
some of the outcomes of previous studies.
1.4 Scope of the study
The study considers the listed non-financial firms at the NSE. Such firms define their working capital differently
as compared to financial, insurance and investment firms. In its nature, Nairobi Securities Exchange is an
international market open to foreign investors and hence the firms listed have an international image. Any
dismal performance will make investors lose interest in investing in them and the market. This study utilized the
working capital components as reported in the financial statements and annual reports of the listed firms. The
findings of this study are generalized for all companies making them very useful not only to the firms listed but
also for the firms in Kenya, the stock market and economy at large.
1.5 Limitations of the study
While care is taken to collect the accurate data, there is chance that the financial statements may lack accurate
information as they are subject to manipulation by firms so as to meet industry specific requirements. There is
risk that the financial information displayed might have been modified to omit or include some information as
part of working capital to meet company requirements or other regulatory requirements for listed companies.
This may pose a challenge for generalization especially for the private and family owned companies.
1.6 Delimitations of the study
Financial Institutions have been excluded from the study sample because their working capital includes deposits
and loans which make part of their main business as well as the financial regulatory requirements as opposed to
other firms. Therefore working capital may affect their performance differently from non-financial firms.

Economics and Finance Review Vol. 3(11) pp. 01 14, September, 2014
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The exclusion of financial firms may cast doubt on the generalizations of the results of the study. The firms
listed have well developed financial structures with the oversight of the Capital Market Authority hence they
have the ability to comply with stringent financial regulatory requirements. The analysis of such firms therefore
provides an important insight into the management of working capital policies and their effects in performance
of all firms in Kenya.
2. LITERATURE REVIEW
The main theme of the theory of working capital management is the interaction between current assets and
current liabilities and it involves managing the balance between a firms short-term assets and short-term
liabilities with an aim of ensuring to continuity of operations (Pandey, 2011).
2.1 Trade Credit theories
Trade credit can either be given by a supplier in the form of accounts receivables, or can be received by a
customer in the form of accounts payables. The authors of this body of literature have studied why firms decide
to receive or to grant trade credit based on the advantages of either the supplier or customer, from the
operational, commercial and financial perspective;
2.1.1 Financing advantage theory
According to Joana, Vitorino, and Moreira(2011), a supplier may have an advantage over traditional lenders in
investigating the credit worthiness of his clients, as well as a better ability to monitor and force repayment of the
credit. This may give a number of cost advantages over financial institutions in offering credit to a buyer as
elaborated below: (a) information acquisition - a supplier may visit the buyers premises more often than
financial institutions would. The size and timing of the buyers orders also give an idea of the condition of the
buyers business. The buyers inability to take advantage of early payment discounts may serve as a tripwire to
alert the supplier of deterioration in the buyers creditworthiness (Biais, Bruno, Gollier, & Viala, 1993).While
financial institutions may also collect similar information, the supplier may be able to get it faster and at lower
cost because it is obtained in the normal course of business, (b) controlling the buyer - the supplier can threaten
to cut off future supplies in the event default or delayed repayment. This threat may especially be credible if the
buyer accounts for a small portion of the suppliers sales. By contrast, a financial institution may have more
limited powers; the threat to withdraw future finance may have little immediate effect on the borrowers
operations (Garcia-Teruel & Martinez-Solano, 2007), and (c) salvaging value from existing assets - if the buyer
defaults, the supplier can seize the goods supplied. The more durable the goods supplied the better collateral
they provide and the greater the credit the supplier can provide. Financial institutions can also reclaim the firms
assets to pay off the firms loan but if the supplier already has a network for selling its goods, its costs of
repossessing and resale will be lower than that of an institution (Mian & Smith, 1992).
2.1.2 Price discrimination theory
Market power of firms can be enhanced considerably by practicing price discrimination through trade credit as
buyers are heterogonous. Mostly, firms enjoying high price-cost margin are found to resort to price
discrimination (The National Bureau of Economic Research, 1996).
Trade credit follows industry practice hence the application of this strategy is limited and can be used selectively.
Customers who have low default risk and can obtain institutional finance at better terms may not be willing to
accept trade credit because its implicit cost is higher than that of institutional finance. This makes the offer only
attractive to high-risk marginal customers whose access to institutional finance is prohibitively costly raising the
incidence of bad debts (Bhattacharya, 2009).
2.1.3 Transactions costs theory
Trade credit may reduce the transactions costs of paying bills. Rather than paying bills every time goods are
delivered, a buyer might want to cumulate obligations and pay them only monthly or quarterly. This will enables
an organization to separate the payment cycle from the delivery schedule (Ferris, 1981).
2.2 Risk-return trade-off theory
The management of working capital involves risk and return trade-off. It is not possible to accurately estimate
the working capital needs and so a firm must decide about levels of current production to be carried out. Given a
firms technology and production policy, sales and demand conditions and operating efficiency, its current
assets holdings will depend upon its working capital policy which may follow conservative or aggressive policy
and these policies involve risk and return trade-offs (Pandey, 2011).

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2.3 The Cost trade-off theory

Cost of liquidity and illiquidity are involved in maintaining a particular level of current assets. Very high level
of current assets means excessive liquidity hence return on assets will be low as funds are tied up in idle cash
and stocks earn nothing while high levels of debtors reduce profitability. Therefore cost of liquidity through low
rates of return increases with the level of current assets. Conversely, cost of illiquidity means holding
insufficient current assets whereby a firm will be unable to honor its obligations forcing it to borrow on shortterm at high interest rates. This adversely affects a firms creditworthiness and may limit future access to funds
and possible insolvency. A firm should balance the cost of liquidity and cost of illiquidity at equilibrium as
shown in figure 1(Pandey, 2011).
Figure 1: Cost Trade-off

Source:(Pandey, 2011)
2.4 Empirical Review
Firms management can create value by reducing the number of days accounts receivables (AR), increasing
their inventories (INV) to a reasonable level, take long to pay their creditors in as far as they do not strain their
relationships with these creditors and careful reduction of the cash conversion cycle to its minimum. In a study
by Mogaka & Jagongo (2013) on the effects of working capital management on firms profitability (measured
by ROA) using panel data, they found out a significant negative relationship between profitability and number
of AR and CCC, but an insignificant positive relationship with INV and AP(significant). Financial leverage,
sales growth, current ratio and firm size were used as control variables and were found to have significant effect
on the firms profitability.
A study by Kulkanya (2012) on the relationship between working capital and profitability (measured by
GOP)using a panel regression revealed a significant negative relationship between profits and inventory
conversion period, receivables conversion period and cash conversion cycle. Therefore managers can improve
profitability by reducing the cash conversion cycle, inventory conversion period, and receivables conversion
period. Accounts payables have an insignificant negative relationship with profitability and managers cannot
increase profitability by lengthening the payables deferral period. However he noted that industry characteristics
have an impact on the GOP.
A study on working capital management in Turkish clothing Industry by Karabay and Glseren(2013),
concluded that clothing companies should reduce debt collection period, cash conversion cycle and establish a
balance between liquidity and profitability in order to survive and to increase their profits. Size was found to
have a significant positive relationship with days of accounts payables and current ratio. Big size companies do
not have liquidity problems as they have capacity to increase their liquidity without borrowing.
Muchina and Kiano (2011), while studying the influence of working capital management on firms profitability,
a case study of SMEs in Kenya, found out that average debtors days, stock turnover period and cash conversion
cycle significantly affect firm profitability. Financial leverage, ratio of current ratio and firm size had a
significant impact on the profitability. This study however did not find out the direction of the relationship
between cash conversion cycle and profitability.
Anandasayanan (2014), who studied the effects of working capital management on profitability of Sri Lankan
listed firms for the period 2003-2009, found a significant negative relationship between net operating
profitability and the average collection period, inventory turnover in days and average cash conversion cycle.
This was interpreted to mean that managers can create value by reducing the number of days of accounts
receivable and inventories to a reasonable minimum. The control variable natural logarithm of sales was

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significantly positively related with profitability. Debt ratio was insignificantly positively related to profitability
meaning that managers do not have to bother very much on the debt ratio when determining the strategy to
increase their profits.
A study by Vural, Sokmen, and etenak (2012) on the effects of working capital management (measured by
GOP) on firms performance: evidence from 75 manufacturing firms listed on Istanbul Stock Exchange using
dynamic panel data analysis, revealed that firms can increase profitability by shortening accounts receivables
collection period and cash conversion cycle. The control variable leverage revealed a significant negative
relationship with firm value measured by Tobin Q and profitability.
A consistent result was further obtained from a study by J. Garcia (2011) on the impact of working capital
management upon companies profitability: evidence from European Companies that used cash conversion
cycle to represent working capital and GOP to measure of profitability, revealed a significant negative
relationship between RCP, ICP, Payables Deferral Period, CCC, and profitability. These findings suggest that
firms can improve their profitability by reducing the time span during which working capital is tied within the
company.
2.5 Conceptual Framework
The conceptual framework shows the effect of working capital on firm performance.
Figure 2: Schematic Conceptual Framework
Cash conversion cycle
Size

Days in Inventory

Performance (GOP)
Days of accounts payables
Inflation
Days of accounts receivables
Source: Author (2014)
To remain consistent with previous studies, measures pertaining to working capital management and
profitability were taken from Vural, Sokmen, and etenak (2012). Variables have been measured as shown in
Table 1: Variable Abbreviation and Measurement
Abbreviation

Variable in full

Measurement

GOP

Gross Operating Profit

sales-cost of goods sold / total assets-financial assets

GOPt-1

Previous
Profit

AR

Days in accounts receivables

(average of accounts receivable / sales* 365)

AP

Days in accounts payables

(average of accounts payable/cost of goods sold *365)

INV

Days in inventory

(Inventory / cost of goods sold)*365

CCC

Cash Conversion Cycle

AR+ INV- AP

LNSALES

Size

natural logarithm of total sales

INFL

Inflation

Annual inflation rates

error term of the model

intercept

year

Gross

Operating

salest-1-cost of goods soldt-1/ total assetst-1-financial

assetst-1

2.6 Research Gaps

The study used a Robust Generalized Method of Moment (GMM) System Estimation applied to ArellanoBover/Blundell-Bond linear dynamic panel-data which is a system estimator that uses additional moment
conditions based on the work of (Manuel Arellano and Stephen Bond, 1991). Studies so far undertaken in Kenya
in this area on thought, have not employed this method of analysis, a gap that this study bridges therefore adding
to the existing literature. Use of lags of the dependent variable is crucial to control for dynamics of the process

Economics and Finance Review Vol. 3(11) pp. 01 14, September, 2014
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therefore enabling a researcher to discover new or different relationships between dependent and independent
variables especially over a long period Braas-Garza, Bucheli, and Garca-Muoz (2011), like in this study 10
years. The firms listed at the securities exchange are assumed to be financially prudent and healthy which
potential attracts investors. If such companies do not maximize the shareholder returns, no matter the financial
and operating environment, the public including international investors will lose interest in investing in NSE and
which will negatively affect the economy.
3. RESEARCH METHODOLOGY
To remain consistent with other studies (Vural, Sokmen, & etenak, 2012), the study used a system generalized
method of moments employed to dynamic panel data for the analysis. A purposive sample of 27 firms was
studied from a population of 57 listed firms, Nairobi Securities Exchange (2013) andexposed to 270 total
observations for the year 2003 to 2012.The following sectors considered (Nairobi Securities Exchange, 2013);
Agriculture (6), Automobile and Accessories (4), Construction and allied (5), Commercial and Services (4),
Energy and Petroleum (2), Manufacturing and Allied (6).
3.1 Data Analysis and Presentation
Data of accounts payables, accounts receivables, inventories, sales turnover, total assets, and cost of goods sold
was extracted from individual company published annual reports and financial statements was collected. The
country annual inflation rates were obtained from published reports by Kenya National Bureau of Statistics for
the study period.
The study used a Robust GMM applied to dynamic panel data by employing Roodman, D (2006) xtabond2
command which is not an inbuilt Stata to analyze data. This estimation technique was used because, among
difference GMM, ordinary least squares and within group estimators, GMM estimators exhibit the smallest bias
and variance for dynamic panel data (Braas-Garza, Bucheli, and Garca-Muoz (2011).Once the system
estimators were obtained, the validity of the model was checked. Manuel Arellano and Stephen Bond (1991),
propose a test to detect serial correlation in the disturbances in the first-differenced errors for second order
autocorrelation (AR (2)). To find out the difference between the effects of the working capital management on
performance of firms in different sectors, a one-way ANOVA was carried for each variable.
The following regression equations were estimated;
Model I:

GOP = 0+ 1GOPit-1+ 2 ARit + 3LNSALESit + 4 INFLit + it

Model II:

GOP = 0 + 1GOPit-1+ 2INVit + 3LNSALESit + 4INFLit + it

Model III:

GOP = 0 + 1GOPit-1+ 2APit + 3LNSALESit + 4INFLit + it

Model IV:

GOP = 0 + 1GOPit-1+ 2CCCit + 3LNSALESit+ 4INFLit + it

Model V:

GOP = 0 + 1GOPit-1+ 2ARit+ 2APit + 2INVit+ 2CCCit+3 LNSALESit+ 4INFLit + it

Equation 5 was estimated as a control model to establish the relationship and significance of the individual
working capital components to the overall model as done by (Mathuva, 2010).
4. RESEARCH RESULTS AND DISCUSSION
4.1 Descriptive Statistics
Table2: Descriptive Data Analysis
Variables
Obs
Mean

Std. Dev.

Min

Max

GOP

270

0.603778

0.901789

11.72

AR

270

73.83917

45.68519

9.596

336.681

AP

270

123.9285

98.27132

15.45

495.364

INV

270

102.7382

71.05691

355.252

CCC

270

52.89482

95.80095

-271.28

311.488

LNSALES

270

8.057499

1.525012

3.61092

11.8095

INFL

270

9.488737

3.570342

4.08

15.1

Source: Survey of 2003-2012, Stata output

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Table 2 shows that the credit period granted by firms to their clients ranged averagely at 73.84 days while
creditors were paid after 123.93 days. Inventory took an average of 103.02 days to be sold while the average
CCC ranged at 52.65 days. Therefore NSE listed firms issue a shorter credit period while they hold cash due to
creditors longer as a delay tactic to reinvest. The firms exhibit a conservative working capital policy to cushion
them from unexpected fluctuations in the market. These findings somewhat match those obtained by; Mogaka
and Jagongo (2013) with ACP of 56.54 days, ICP of 93.85 days, APP of 96.50 days and CCC of 53.88 days and
Safda and Chaudhry(2012) who used ROA to proxy profitability found out average accounts receivable of 89.36
days, days in inventory of 94.65 days, days in accounts payable of 154.79 days, with CCC of 30.35 days.
Also a study in Istanbul in Turkey by Vural, Sokmen, and etenak (2012) found days of accounts receivables
was 94.3 days, days in inventory was 94.56 days, but days of accounts payables of 64.48 days and cash
collection cycle of 128 were different. This means that the firms paid their debts as soon as possible faster that
they could receive the debt owed to them by their customers. This may be attributed to the fact that firms main
intention was to grow sales by issuing longer credit period while the market may suppliers may be sensitive to
debt owed to them by such firms a fact that firms may not want to spoil their credibility. The difference in these
results to the ones of this study can be attributed to the nature of the market and economy in which they have
been carried out. In advanced economies, the suppliers may be more sensitive than those in developing
economies hence the reaction by firms.
4.2 Correlation Results
Table 3: Pearson Correlation matrix between variables
Variables
GOP
AR
AP
INV
GOP

1.000

AR

-0.159*

AP

0.309

INV

0.079

CCC

0.218

INFL

0.014

INFL

1.000
0.486*

-0.055
*

LNSALES

1.000
0.059

-0.334

LNSALES
*

CCC

0.383

-0.503
0.056

1.000

-0.639

0.134
0.032

0.213*
0.199

0.055

1.000
-0.236*

1.000

0.0340

-0.011

1.000

Significant at 0.05 and 0.01significance level. Source: Stata output

The results as shown in Table 3 reveal that satisfactory performance of managers would increase profitability
by reducing CCC. AR and CCC are negatively correlated with GOP indicating that if the both duration of both
increase, it will have a negative impact on the profitability. AP and INV are both positively related with GOP
meaning that an increase in AP and INV leads to increase in GOP. Also the results reveal that LNSALES and
INFL are directly correlated with GOP indicating that profitability increase with increase in both size of the
firms and inflation. Consistent results have been obtained by Joana, Vitorino, & Moreira (2011), Vural, Sokmen,
& etenak (2012), Baveld (2012) and Nzioki, Kimeli, Abudho, and Nthiwa (2013). Mogaka & Jagongo (2013)
further found out that ACP and CCC are indirectly related to ROA and the trio of ICP, LNSALES and APP
being directly related. The direct relation between profitability and APP means that lagging payments to
suppliers ensures that firms have enough to purchase more inventories for resale thus increasing its sales levels
and boosting their profits. Firm size was also found to be positively related to ROA meaning that larger firms
report higher profits compared to smaller firms. Similar result for inflation was obtained by Awan (2014) where
the study obtained a direct but insignificant relationship with ROE but a significant one with ROA.
However, shortcoming of Pearson correlations is that they are not able to identify the causes from consequences
hence the regression analyses will be held in this study Baveld (2012).
4.3 Regression results
The validity of instruments was done using Sargan test which is based on the observation that residuals should
be uncorrelated with instruments as a null hypothesis. The results in Table 4, Table 5, Table 6, Table 7, and
Table 8, reveal that the null hypothesis that the over-identifying restrictions are valid cannot be rejected
(p>0.05). To test serial correlation of order 1 in levels, the study checked for correlation of order 2 in differences.
The instruments are uncorrelated with the errors or that they are not omitted variables in the model (p>0.05).
The wald test for joint significance of coefficients revealed that the coefficients in the model are statistically
jointly significant in determining the variations in GOP despite some of them individually not significant
(p=0.0000, wald chi2 (4) = 28.03 in Table 4, (p=0.0000) and wald chi2(4) = 21.78 in Table 5, (p=0.0000) and

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wald chi2(4) = 24.10 in Table 6, (p=0.0000) and Wald chi2(4) = 37.10 in Table 7 and (p=0.000) and Wald
chi2(4) = 368.53 in Table 8 respectively).
4.3.1 Effect of accounts receivables on firm profitability
The results on Table 4 reveal that AR is not an important determinant of GOP (p=0.618>0.05), but has a
negative effect on GOP meaning an increase in the AR leads to a decline in GOP. A one day increase in AR is
associated with a 0.0913281% decrease in profitability. This negative relationship is consistent with the cost
trade-off theory. Similar findings were reported by Baveld (2012), Joana, Vitorino, & Moreira (2011), Mogaka
& Jagongo (2013), and Nzioki, Kimeli, Abudho, & Nthiwa (2013). A study by Safda & Chaudhry(2012)
reported an indirect but significant relationship of profitability. This therefore means that a more restrictive
credit policy will improve performance of a firm. The results further reveal the control variable LNSALES has a
direct relationship with a firms performance meaning that a 1% increase in sales leads to 7.941621% increase
in GOP. This is true because firms with more sales turnover are more likely to get more credit from banks for
expansion and increase in profits because of the effects of sales revenue on profits. Such firms also enjoy
economies of scale which adds to their profits. Also there is a positive effect of inflation on performance, a
result that also obtained by Rasheed(2014).Last years GOP was found to directly determine this years GOP
which mean that a 1% increase in last years GOP leads to a 15.582% increase in this years GOP. Although not
significant, it has a high effect on GOP as compared to other variables. The intercept is negative at -0.0919019
meaning that when, last years GOP, AR, LNSALES and inflation are held at zero, firms will make losses at
9.190%. This implies that working capital has a big effect firms profitability.
Model I: GOP=-0.09190+0.15582GOPt-1- 0.000913ARit+0.079416LNSALESit+0.0002122INFLit+ it
4.3.2 Effect of accounts payables on firm profitability
AP is an important determinant GOP (p=0.068<0.10)at 10% confidence interval as revealed in Table 5with a
direct effect on GOP meaning that a one days increase in the days of accounts payables is associated with
increase in GOP by 0.1672%. This is consistent with findings by (Mathuva, 2010). Last years GOP is found to
directly determine this years GOP as revealed by the positive coefficient (0.1124015) which is interpreted to
mean that a 1% increase in last years GOP leads to an 11.24015% increase in this years GOP. Despite the fact
that the effect is not significant, it has a high effect on GOP as compared to other variables. LNSALES has a
direct but insignificant effect on GOP with a coefficient of 0.0874989 meaning that a 1% increase in sales leads
to an8.7499% increase in GOP. Further it means that under high sales level, a firm will make more profits by
delaying in paying off their creditors. Firms will utilize the cash due to the creditors so to increase their
production thereby influencing their profitability. Inflation (-0.002491) is indirectly related to the GOP meaning
that a 1% increase in inflation, leads to a 0.249% decrease in profitability. During high inflation, firms will
delay their payments to creditors which they reinvest to increase their profitability. This is because firms find it
hard to access credit from the banks as interest for such loans will increase in tandem with inflation. Therefore
the control variables affect the choice of working capital policy by firms listed at the NSE.
Model II: GOP=-0.3780+0.1124GOPt-1+0.001672APit+0.087499LNSALESit- 0.002491NFLit+ it
4.3.3 Effect of days in inventory on firm profitability
The results in Table 6reveal that, the days in inventory is found to have a direct and significant (0.0044289)
effect on GOP (p= 0.019<0.05). This is means that one day stay in inventory leads to a 0.4429% increase in
GOP. Therefore an adequate and timely flow of inventory is imperative for the success and growth of any
company.
This is consistent with a conservative working capital management policy. This means maintaining high levels
of inventory will in turn reduce the cost of possible interruptions in the production process and possible loss of
business due to shortages. This result is consistent with that of Mathuva (2010). However, this result is
somewhat different from that of Baveld (2012), Stephanou (2010), Kulkanya (2012), Panigrahi(2013), and
Garcia-Teruel & Martinez-Solano, (2007), who found an indirect relationship of days in inventory and
profitability. The differences may be attributed to the regression analysis methodology that was employed by
this study. Last years GOP is found to directly determine this years GOP as revealed by the positive coefficient
(0.1714255) which is interpreted as; a 1% increase in last years GOP leads to a 17.14255% increase in this
years GOP. Despite the fact that the effect is not significant, it has a high effect on GOP as compared to other
variables. LNSALES (0.0573022) and inflation (-0.0050861) are both not significantly affecting GOP.
LNSALES is interpreted to mean that a 1% increase in sales leads to a 5.73% increase in GOP. This is also from
the theoretical relationship between sales revenue and GOP. Also a 1% increase in inflation leads to a 0.05086%

Economics and Finance Review Vol. 3(11) pp. 01 14, September, 2014
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ISSN: 2047 - 0401

decrease in GOP. This happens because during inflationary times disposable income of consumers is eroded by
inflation hence they cannot afford to buy more thereby reducing firms sales revenue.
Model III: GOP=-0.39374+0.17143GOPt-1+0.004429NVit+0.05730LNSALESit-0.005086INFLit+ it
4.3.4 Effect of cash conversion cycle on firm profitability
Table 7 shows that CCC has an indirect but not a significant (p=0.135>0.10) effect on GOP. That is interpreted
to mean that a one day increase in cash conversion period, leads to decreases in profitability of 0.1772% hence
for managers to increase profitability, they should reduce the CCC. This is also consistent with cost trade-off
theory and the findings of Mathuva(2010), Baveld(2012), Stephanou(2010), and Amarjit, Nahum, and
Neil(2010). Last years GOP is found to directly determine this years GOP as revealed by the positive
coefficient (0.1674274) which is interpreted to mean that a 1% increase in last years GOP leads to a 16.74274%
increase in this years GOP. Despite the fact that the effect is not significant, it has a high effect on GOP as
compared to other variables. LNSALES (0.067031) and inflation (0.00063) are both have direct but not
significant effect on gross operating profit. The results further mean that at high inflationary times, firms will try
as much as possible to shorten the CCC to protect the sales gains from being eroded by inflation and take
advantage of delaying the cash to creditors and making the most out of it. The findings of LNSALES were
consistent with those of consistent with Mathuva(2010).
Model IV: GOP=2.552+0.1674GOPt-1-0.1772CCC it+6.703LNSALES it+0.0630INFLit+ it
4.3.5 Effect of working capital management on firm profitability
The model V as reported in Table 8 serve a control model for the variables under study to provide an indicator
as to the most significant variable affecting the study. All the variables are significant (p<0.05) with the
exception of control variables LNSALES, INFL and lagged form of the GOP. The results confirm that AR (0.1263628) and INV (-0.1228277) have an indirect effect on GOP but CCC has a wrong sign (0.1235656) that is
positively related to GOP with the AP also directly related to GOP (0.125545). LNSALES (0.0834587) has a
direct effect on GOP while inflation (-0.000577) has a negative effect on GOP. Last years GOP is found to
directly (0.1531341) determine this years GOP.
Model V: GOP=-0.32832+0.1531GOPt-1-0.126363ARit+0.125545APit0.1235656CCCit+0.08345868LNSALESit-0.000577INFLit+ it
4.4 Analysis of Variance (ANOVA)
The study carried a one-way ANOVA on all the four components of working capital management namely AR,
AP, INV and CCC to find if their means for the selected sectors are significantly different.
For all the variables under consideration, the F-values were significant (p<0.10) as shown by results in Table 9,
Table 11, Table 13 and Table 15, meaning that least one of the means differ from zero in all the six sectors, but
it does not tell us where the differences or similarities are in the averages of those variables. This necessitated
application of a bonferroni correction on each of the variables as reported in Table 10, Table 12, Table 14 and
Table 16. The results that show significant p values (P=0.0000<0.10) and are said to have different averages of
AR. While those that reveal are insignificant (P>0.10) have same averages of AR meaning that the sectors have
somewhat same policy towards treatment of days of accounts receivable. It indicates that the application of
working capital policies on the four components (AR, AP, INV and CCC) do not differ significantly across
those sectors. While those with unequal means imply that approaches used by firms in such sectors do
significantly vary.
5. SUMMARY OF THE FINDINGS, CONCLUSION AND RECOMMENDATIONS
The results show that the AR and CCC have indirect effect on firms profitability but which is not significant
hence by shortening collection period and CCC firms may increase their profitability. Also AP and INV have a
significant and direct effect on firms GOP. Control variables LNSALES and INFL were found to have different
effects on the choice firms working capital policy. In overall measure, the control variables affect how firms
choose their working capital policies. Working capital management is viewed as an effective lever to increase
cash flow and preserve, or even to enhance company value. But more importantly, for many companies in
Kenya today, it may be the necessary key to survival.
Based on the key findings, the following conclusions have been reached: The management of a firm can create
more value for their shareholders by reducing the CCC and AR. AP and INV were found to have a significant
direct effect on firm performance. Firms management can therefore create value for their shareholders by

Economics and Finance Review Vol. 3(11) pp. 01 14, September, 2014
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ISSN: 2047 - 0401

lagging payments to their creditors taking care not to ruin their credibility which may prevent future credit
facilities and possible litigation from creditors. By reducing the days in accounts receivable, firms will have
ready cash to reinvest and can prevent the cash from getting eroded by effects of inflation as well as benefit
from cheap source of financing owing to the fact that the cost of borrowing in Kenya is on the upward trend.
Also firms can create value by increasing their inventory levels but only to an optimum level that can maximize
returns and minimize the costs of keeping it considering the effects of inflation and the size of their firms. By
doing so the finance managers should keep the cash conversion cycle short while watching their various
industry averages and practices as shown from the ANOVA test results.
5.1 Recommended areas for further research
Further study should be conducted using quarterly data as this way the various components of working capital
like will be subjected to a more robust regression with increased number of observations.
Also future study should consider economic cycles for the same sample. This will give a better insight into
working capital management in tandem with changing economic cycles for example the global financial crisis of
2007 to 2008.
Further research can also focus on carrying out an analysis at different business cycle. This can be done as a
case study of selected companies because at different stages of business growth, businesses are expected to
manage working capital differently while trying to maximize profits. It is expected that a business that is starting
might want to allow more days in accounts receivable than normal so as to attract more sales while at the same
time it may want to reduce the same at it studies the customers. All these actions can be verified by conducting a
study in that area.
Finally further study should be also consider using a different measure of firm performance other than GOP but
employing robust GMM applied to dynamic panel data. This may include market share, ROA, EPS, DPS among
others. The listed companies have to worry about the reaction of the shareholders whose main interest may be in
DPS and EPS.
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ISSN: 2047 - 0401

APPENDIX 1: REGRESSION RESULTS

Table 4: Effect of days of accounts receivables on firm profitability
Prob> chi2 = 0.000, Wald chi2(4) = 28.03
GOP
Coef.
Std. Err. (Robust)
z
P>|z|
[95% Conf.
GOPt-1
0.15582
0.1466553
1.06
0.288
-0.1316192
AR
-0.0009133
0.0018294
-0.50
0.618
-0.0044988
LNSALES
0.0794162
0.0676618
1.17
0.241
-0.0531986
INFL
0.0002122
0.0035277
0.06
0.952
-0.0067019
INTERCEPT -0.0919019
0.5736794
-0.16
0.873
-1.216293
Arellano-Bond test for AR(1) in first differences: z = -1.99 Pr> z = 0.046
Arellano-Bond test for AR(2) in first differences: z = -0.55 Pr> z = 0.584
Sargan test of overriding restrictions: chi2(26) = 22.22 Probability > chi2 = 0.676
Table 5: Effect of days of account payables on firm profitability
Prob> chi2 = 0.000 Wald chi2(4) = 21.78
GOP
Coef.
Std. Err. (Robust) z
p>|z|
[95% Conf.
GOPt-1
0.1124015
0.1070196
1.05 0.294
-0.0973531
AP
0.0016722
0.000916
1.83 0.068
-0.0001232
LNSALES
0.0874989
0.0576461
1.52 0.129
-0.0254855
INFL
-0.002491
0.0044302
-0.56 0.574
-0.011174
INTERCEPT
-0.377997
0.4149732
-0.91 0.362
-1.191329
Arellano-Bond test for AR(1) in first differences: z = -1.75 Pr> z = 0.081
Arellano-Bond test for AR(2) in first differences: z = 0.05 Pr> z = 0.960
Sargan test of overriding restrictions: chi2(26) = 21.07 Prob> chi2 = 0.739

Interval]
0.4432592
0.0026722
0.212031
0.0071264
1.032489

Interval]
0.3221561
0.0034675
0.2004833
0.0061919
0.4353355

Table 6: Effect of days in inventory on firm profitability

Prob> chi2 = 0.000, Wald chi2(4) = 24.10
GOP
GOPt-1
INV
LNSALES
INFL
INTERCEPT

Coef.
0.1714255
0.0044289
0.0573022
-0.005086
-0.393741

Std. Err. (Robust)

0.1372014
0.001891
0.0747448
0.0051625
0.5440556

z
1.25
2.34
0.77
-0.99
-0.72

p>|z|
0.212
0.019
0.443
0.325
0.469

[95% Conf.
-0.0974843
0.0007226
-0.0891949
-0.0152044
-1.46007

Interval]
0.4403352
0.0081351
0.2037992
0.0050322
0.6725885

Arellano-Bond test for AR(1) in first differences: z = -2.37 Pr> z = 0.018

Arellano-Bond test for AR(2) in first differences: z = 0.23 Pr> z = 0.817
Sargan test of overriding restrictions: chi2(26) = 19.99 Probability> chi2 = 0.792
Table 7: Effect of cash conversion cycle on firm profitability
Prob> chi2 = 0.000, Wald chi2(4) = 37.90
GOP
Coef.
Std. Err. (Robust)
z
p>|z|
GOPt-1
0.1674274
0.15636
1.07
0.284
CCC
-0.0017719
0.0011856
-1.49
0.135
LNSALES
0.067031
0.0592343
1.13
0.258
INFL
0.00063
0.0038416
0.16
0.870
INTERCEPT
0.0255214
0.4532583
0.06
0.955
Arellano-Bond test for AR(1) in first differences: z = -2.11 Pr> z = 0.035
Arellano-Bond test for AR(2) in first differences: z = -0.27 Pr> z = 0.787
Sargan test of overriding restrictions: chi2(26) = 19.64 Prob> chi2 = 0.808

[95% Conf.
-0.1390325
-0.0040957
-0.0490661
-0.0068995
-0.8628486

Interval]
0.4738873
0.0005519
0.183128
0.0081594
0.9138914

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Economics and Finance Review Vol. 3(11) pp. 01 14, September, 2014
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Table 8: Effect of working capital management on firm profitability
Prob> chi2 = 0.000, Wald chi2(7) = 368.53
GOP
Coef.
Std. Err. (Robust)
z
p>|z|
GOPt-1
0.1531341
0.1269879
1.21
0.228
AR
-0.126363
0.0364225
-3.47
0.001
AP
0.12555
0.035491
3.54
0.000
INV
-0.122828
0.0348552
-3.52
0.000
CCC
0.123566
0.0356369
3.47
0.001
LNSALES
0.0834587
0.0592553
1.41
0.159
INFL
-0.000577
0.0033513
-0.17
0.863
INTERCEPT
-0.32832
0.5222939
-0.63
0.530
Arellano-Bond test for AR(1) in first differences: z = -2.52 Pr> z = 0.012
Arellano-Bond test for AR(2) in first differences: z = -0.43 Pr> z = 0.670
Sargan test of overriding. restrictions: chi2(58) = 38.54 Prob> chi2 = 0.977

ISSN: 2047 - 0401

[95% Conf.
-0.095758
-0.197750
0.0559839
-0.191143
0.0537186
-0.032680
-0.007146
-1.351997

Interval]
0.4020259
-0.054976
0.195106
-0.0545129
0.1934127
0.199597
0.0059914
0.6953573

APPENDIX 2: ANOVA RESULTS

Table 9: ANOVA of days of accounts receivables
Source

SS

df

MS

Prob> F

Between groups
Within groups

59683.704
501755.94

5
264

11936.74
1900.59

6.28

0.0000

Total

561439.65

269

2087.136

Table 10: ANOVA of days of accounts receivables by sector (bonferroni correction)

Row MeanAGR
AUTO_ACC
COMMERCI CONSTRU
ENERGY
Col Mean
C
AUTO_ACC
-1.46(1.000)
COMMERCI
-12.80(1.000)
-11.34(1.000)
CONSTRUC
-34.04(0.001*) -32.58(0.008*) -21.24(0.336)
ENERGY
-21.23(0.905)
-19.77(1.000)
-8.43(1.000)
12.81(1.000)
MANUFACT -33.92(0.000*) -32.46(0.005*) -21.11(0.276)
0.13(1.000)
-12.68(1.000)
* **
Significant at 0.05 and 0.10 significance levels.
Table 11: ANOVA of days of accounts payables
SS
df
MS
F
Prob> F
Between groups
985523.252
5
197104.65
32.27
0.0000
Within groups
1612277.81
264
6107.112
Total
2597801.06
269
9657.253
Total
2597801.06
Table 12: ANOVA of days of accounts payables by sector (bonferroni correction)
Row MeanAGR
AUTO_ACC
COMMERCI
CONSTRUC
Col Mean
AUTO_ACC
57.24 (0.006*)
COMMERCI
177.53(0.000*) 120.28(0.000*)
CONSTRUC
10.55(1.000)
-46.69(0.078**)
-166.98(0.000*)
ENERGY
1.84(1.000)
-55.40(0.153)
-175.69(0.000*)
-8.71(1.000)
*
MANUFACT 83.30(1.000)
26.06(0.000 )
-94.23(0.000*)
72.75(0.001*)
***
Significant at level of 0.05 and 0.10 respectively.
Table 13: ANOVA of number of days in inventory
Source
SS
df
Between groups
447709.961
5
Within groups
789456.145
253
Total
1237166.11
258

MS
89541.992
3120.380
4795.217

F
28.70

ENERGY

81.46(0.000*)

Prob> F
0.0000

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ISSN: 2047 - 0401

Table 14: ANOVA of number of days in Inventory by sector (bonferroni correction)

Row MeanCol Mean

AGR

AUTO_ACC

117.98(0.000*)

COMMERCI

13.93(1.000)

-104.06(0.000*)

CONSTRUC

31.36(0.078**)

-86.63(0.000*)

17.43(1.000)

ENERGY

-32.20(0.448)

-150.18(0.000*)

-46.12(0.046*)

-63.55(0.000*)

MANUFACT

41.53(0.002*)

-76.46(0.000*)

27.60(0.269)

10.17(1.000)

* **

AUTO_ACC

COMMERCI

CONSTRUC

ENERGY

73.72(0.000*)

Significant at 0.05 and 0.10 significance levels respectively.

Table 15: ANOVA of cash conversion cycle

Source

SS

df

MS

Prob> F

64.66

0.0000

Between groups

1350267.87

270053.575

Within groups

1102572.35

264

4176.41041

Total

2452840.22

269

9118.36514

Table 16: ANOVA of cash conversion cycle by sector (bonferroni correction)

Row Mean-|
Col Mean

AGR

AUTO_ACC

70.33(0.000*)

COMMERCI

-169.73(0.000*)

-240.06(0.000*)

CONSTRUC

-2.19(1.000)

-72.52(0.000*)

167.54(0.000*)

ENERGY

-44.22(0.128)

-114.55(0.000*)

125.51(0.000*)

-42.03(0.219)

MANUFACT

-64.64(0.000*)

-134.97(0.000*)

105.09(0.000*)

-62.45(0.000*)

AUTO_ACC

COMMERCI

CONSTRUC

ENERGY

-20.42(1.000)

Significant at 0.05 significance level.

14