Article

Military-Madrasa-Mullah
A Global Threat
Complex

Effect of Working Capital

Management on Firm Profitability:
Empirical Evidence from India

159
159
Global Business Review
12(1) 159173
2011 IMI
SAGE Publications
Los Angeles, London,
New Delhi, Singapore,
Washington DC
DOI: 10.1177/097215091001200110
http://gbr.sagepub.com

A.K. Sharma
Satish Kumar
Abstract
The main aim of this article is to examine the effect of working capital on profitability of Indian firms.
We collected data about a sample of 263 non-financial BSE 500 firms listed at the Bombay Stock (BSE)
from 2000 to 2008 and evaluated the data using OLS multiple regression. The findings of our study
significantly depart from the various international studies conducted in different markets. The results
reveal that working capital management and profitability is positively correlated in Indian companies.
The study further reveals that inventory of number of days and number of days accounts payable are
negatively correlated with a firms profitability, whereas number of days accounts receivables and cash
conversion period exhibit a positive relationship with corporate profitability. The present study contributes to the existing literature by examining the effect of working capital management on profitability in the context of an emerging capital market such as India.
Keywords
Working capital management, OLS regression, return on assets, accounts payable, current ratio,
leverage

Introduction
Corporate finance theory can be discussed under three main areas: capital budgeting, capital structure
and working capital management. Capital budgeting and capital structure decisions are related to financing and managing long-term investments and their returns. Working capital management is a very important component of corporate finance theory and deals with managing short-term financing and
investment decisions of the firm. The corporate finance literature in the past has focused extensively on
the study of long-term financial decisions, particularly investments, capital structure or company valuation decisions. However, working capital management also directly affects the liquidity of the company
as it deals with the management of current assets and current liabilities that are essential for the smooth
running of a business unit. Efficiency in working capital management is vital, especially for production
A.K. Sharma is Associate Professor at the Department of Management Studies, Indian Institute of Technology
Roorkee, Roorkee (Uttrakhand), India. E-mail: anilfdm@iitr.ernet.in
Satish Kumar (Corresponding Author) is a Research Scholar at the Department of Management Studies, Indian
Institute of Technology Roorkee, Roorkee (Uttrakhand), India. E-mail: India
satisddm@iitr.ernet.in
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A.K. Sharma and Satish Kumar

firms as it accounts for over half of its total assets. For a trading or distribution company, they constitute
even more than half of their total assets and thereby directly affect the profitability and liquidity of the
company (Raheman and Nasr, 2007). Sometimes, inaccurate working capital management procedures
may also lead to bankruptcy, even though their profitability may constantly be positive (Samiloglu and
Demirgunes, 2008). Excessive levels of current assets can easily result in a firms realizing a substandard
return on investment (Raheman and Nasr, 2007).
On the other hand, firms with lower levels of current assets may incur a shortage of funds and face
difficulty in maintaining smooth business operations (Horne and Wachowicz, 2000). Efficient management of working capital is a fundamental part of overall business strategy in creating shareholders value.
Therefore, firms try to keep an optimal level of working capital that maximizes their value (Afza and
Nazir, 2007; Deloof, 2003). More specifically, working capital investments involve a trade-off between
profitability and risk as it affects the firm value. Corporate decisions that tend to increase profitability
lead to increased risk and conversely, decisions that focus on risk reduction will lead to reduced potential
profitability.
An important part of managing working capital is maintaining the liquidity in day-to-day operations
to ensure smooth running and meeting its obligations (Eljelly, 2004). This is not a simple task since
managers must make sure that business operation is both efficient as well as profitable. There are chances
of mismatch in current assets and current liability during this process, which could affect the growth and
profitability of the business. A popular measure of working capital management (WCM) is the cash conversion cycle, that is, the time lag between the expenditure for purchase of raw materials and the collection
from sales of finished goods. The longer this time lag, the larger the investment in working capital. A
longer cash conversion cycle might increase profitability because it leads to higher sales. On the other
hand, corporate profitability might also decrease with the cash conversion cycle, if the costs of higher
investment in working capital rise faster than the benefits of holding inventory or granting more trade
credit to customers. Many researchers like Shin and Soenen (1998) have highlighted the importance of
shortening the cash conversion cycle (CCC), as managers can create value for their shareholders by reducing the cycle to a reasonable minimum.
A firm may adopt an aggressive working capital management policy with a low level of current assets
or it may use working capital to finance decisions of the firm in the form of high level of current liabilities as a percentage of total liabilities. Wang (2002) points out that if a firm follows aggressive policies
and the inventory levels are reduced too much, the firm risks losing any increases in sales. Also, a significant reduction in trade credit granted may provoke a reduction in sales from customers requiring
credit. In fact, the opportunity cost may exceed 20 per cent, depending on the discount percentage and
discount period granted (Ng et al., 1999; Wilner, 2000). On the other hand, investing heavily in working
capital or using conservative policies may also result in higher profitability. Maintaining high inventory
levels reduces the cost of possible interruptions and loss of business due to scarcity of products, reduced
supply costs and can protect against price fluctuations (Garcia-Teruel and Martinez-Solano, 2007). However, such benefits have to offset the reduction in profitability due to the increase of investment in current
assets.
Most empirical studies relating to working capital management and profitability support the fact that
aggressive working capital policies enhance a firms profitability. Researchers like Jose et al. (1996),
Shin and Soenen (1998), Deloof (2003) and Wang (2002) supported the fact that reducing net credit
period may enhance the profitability of firms, allowing managers to create value for shareholders by
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Effect of Working Capital Management on Firm Profitability

161

reducing the investment in current assets to an optimal level. There is, however, no empirical evidence
available regarding the relationship of working capital management and profitability of Indian companies.
In this context, the objective of the current study is to provide empirical evidences about the effect of
working capital management on profitability for a sample of 263 non-financial Indian companies during
the period 200008. This study is believed to be among the first few to trace the relationship between
WCM and profitability of Indian companies. The results of the study reveal that working capital management and profitability is positively correlated in Indian companies. The study further reveals that
number of days inventory and number of days accounts payable are negatively correlated with a firms
profitability, whereas number of days accounts receivables and cash conversion period are positively
related with corporate profitability.
The study is structured as follows; the second section deals with brief review of important studies on
the working capital management and firm profitability; the third section describes the sample and variables definitions used in the study; in the fourth section the methodology employed is explained, the fifth
section deals with analysis and findings of the study; and finally, the main conclusions are discussed in
last section.

Literature Review
Various studies have analyzed the relationship of working capital management and firm profitability in
various markets. The results are quite mixed, but a majority of studies conclude a negative relationship
between WCM and firm profitability. The studies reviewed have used various variables to analyze the
relationship, with different methodology such as linear regression and panel data regression. In this section, we have presented the chronology of major studies related to our study in order to assess and identify the research gap.
Soenen (1993) investigated the relationship between the net trade cycle as a measure of working capital and return on investment in US firms. The results of the study indicated a negative relationship
between the duration of net trade cycle and return on assets (ROA). Furthermore, this relationship between net trade cycle and return on assets was found to be differ across industries, depending on the type
of industry. A significance relationship for about half of the industries studied indicated that results might
vary from industry to industry. To support the results of Soenen (1993) on a large sample and with a long
time period, Jose et al. (1996) examined the relationship between profitability measures and management
of ongoing liquidity needs for a large cross section of firms over a 20-year period. They tested the long
run equilibrium relationship between the cash conversion cycle and alternative measures of profitability,
using both non-parametric and regression analysis. The study concluded with strong evidence that
aggressive working capital policies enhance profitability. The authors found no evidence of a positive
cross sectional relationship for the CCC-profitability in any of the industries studied.
In order to examine the relationship between efficient working capital management and a firms profitability Shin and Soenen (1998) used net-trade cycle (NTC) as a measure of working capital management.
The relationship was examined using correlation and regression analysis, by industry and working capital
intensity. Using a sample of 58,985 firm years covering the period 197594, in all cases, authors found
a strong negative relation between the length of the firms net-trade cycle and its profitability. Also,
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A.K. Sharma and Satish Kumar

shorter NTC were associated with higher risk-adjusted stock returns. Shin and Soenen highlighted the
importance of reducing NTC to create shareholder value.
Lyroudi and Lazaridis (2000) used the Greek food industry to examine the cash conversion cycle as a
liquidity indicator of the firms and tried to determine its relationship with the current and the quick
ratios, with its component variables. They investigated the implications of the CCC in terms of profitability, indebtness and firm size. The results of their study indicated that there is a significant positive
relationship between the cash conversion cycle and the traditional liquidity measures of current and
quick ratios.
Wang (2002) examined the relationship between liquidity management and operating performance,
and that between liquidity management and corporate value for firms in Japan and Taiwan. The empirical
findings for both Japan and Taiwan show negative CCCROA and CCCROE relationships which are
sensitive to industry factors. The study supported the results of Jose et al. (1996) and Shin and Soenen
(1998) that a lower CCC corresponds with better operating performance. The study further revealed that
aggressive liquidity management is associated with higher corporate value for both countries in spite of
differences in structural characteristics or in the financial system of a firm.
Deloof (2003) investigated the relationship between working capital management and corporate profitability for a sample of 1,009 large Belgian non-financial firms for the period 199296. He used trade
credit policy and inventory policy as measured by number of days accounts receivable, accounts payable
and inventories, and the cash conversion cycle as a comprehensive measure of working capital management. The results of the study were as consistent as of Shin and Soenen (1998). Deloof found a significant
negative relation between gross operating income and the number of days accounts receivable, inventories
and accounts payable. Thus, he suggests that managers can create value for their shareholders by reducing
the number of days accounts receivable and inventories to a reasonable minimum.
Eljelly (2004) empirically examined the relation between profitability and liquidity, as measured by
current ratio and cash gap (cash conversion cycle) on a sample of companies in Saudi Arabia. Using correlation and regression analysis the study found significant negative relation between the firms profitability and its liquidity level, as measured by current ratio. The negative relationship was more evident
in firms with high current ratios and longer cash conversion cycles. At the industry level, however, the
study found that the cash conversion cycle or the cash gap is of more importance as a measure of liquidity than the current ratio that affects profitability. The size variable was also found to have a significant
effect on profitability at the industry level.
Lazaridis and Tryfonidis (2006) investigated the relationship of corporate profitability and working
capital management of 131 companies listed in the Athens Stock Exchange (ASE) for the period 2001
04. The purpose of this study was to establish a relationship that was statistically significant, between
profitability, the cash conversion cycle and its components for listed firms in the ASE. The results of the
research showed that there is a statistical significance between profitability, measured through gross
operating profit and the cash conversion cycle. They observed that lower gross operating profit is associated with an increase in the number of days accounts payables. Moreover, managers can create profits
for their companies by correctly handling the cash conversion cycle and keeping each of the different
component (accounts receivables, accounts payables and inventory) to an optimum level.
Padachi (2006) analyzed the working capital management practices through a sample of 58 small
manufacturing companies in Mauritius. The basic purpose of this study was to examine the trends in

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working capital management and its impact on firms performance. The regression results show that high
investment in inventories and receivables is associated with lower profitability. This study has also
shown that the paper and printing industry has been able to achieve high scores on the various components
of working capital and this has had a positive impact on its profitability. The findings also reveal an
increasing trend in the short-term component of working capital financing.
Raheman and Nasr (2007) provide further evidence about the relationship of working capital
management and profitability. Using variable and methodology as used by Deloof (2003) on a sample of
94 companies listed on the Karachi Stock Exchange (KSE) for the period 19992004, the results show
that there is strong negative relationship between variables of WCM and profitability of the firms. It
means that as the cash conversion cycle increases, it leads to decreasing profitability of the firm. Thus,
managers can make the shareholders value positive by reducing CCC to the minimum possible level. The
authors also found a positive relationship between the size of the firm and its profitability, and a significant
negative relationship between debt and profitability.
In a related study Afza and Nazir (2007) investigated the relationship between the aggressive/conservative working capital policies of various industrial groups and a large sample of 263 companies
listed at Karachi Stock Exchange for a period of 19982003. Using ANOVA and LSD test, the study
found significant differences among the working capital investment and financing policies across different industries. Using ordinary least regression analysis, the authors concluded a negative relationship
between the profitability measures of firms and degree of aggressiveness of working capital investment
and financing policies.
Garcia-Teruel and Martinez-Solano (2007) for the first time examined the effect of working capital
management on profitability of small and medium sized Spanish firms. Using panel data regression
methodology, the authors revealed that managers can create value by reducing their inventories and the
number of days for which their accounts are outstanding. The results of the study are similar to those
found in previous studies that focused on large firms (Deloof, 2003; Jose et al., 1996; Shin and Soenen,
1998; Wang, 2002). The authors further concluded that SMEs have to be concerned with working capital
management because they can also create value by reducing their cash conversion cycle to a minimum,
as far as that is reasonable.
Samiloglu and Demirgunes (2008) in their study examined the effect of working capital management
on firm profitability about companies listed at the Istanbul Stock exchange (ISE). Using the multiple
regression model, the study examined the effect of working capital on firm profitability for the period of
19982007. The findings of the study show that accounts receivables period, inventory period and leverage affect firm profitability negatively; while growth (in sales) affects firm profitability positively.
Zariyawati et al. (2009) used panel data of 1,628 firm years for the period between 19962006 that
consisted of six different economic sectors, in order to examine the relationship between working capital
management and firm profitability of the firms listed in Malaysia. Results of this study found that the
CCC is significantly negatively associated with the firm profitability. They further emphasized that
managers should focus on reduction of the cash conversion period in order to create shareholder wealth.
The results of the study are consistent with that of other studies conducted in different markets. Luo et
al. (2009) find that the efficiency of a firms working capital management has a lasting impact on the
firms performance. Improvement in working capital efficiency leads to increase in future earnings, as
the market responds positively to the improvement of working capital efficiency. Firm value increases
when cash conversion cycle decreases.

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Closer examination of literature on the relationship of working capital management and profitability
in general supports the fact that aggressive working capital policies enhance firm profitability (Jose
et al., 1996; Shin and Soenen, 1998 for US companies; Deloof, 2003 for Belgian firms; Wang, 2002 for
Japanese and Taiwanese firms; Raheman and Nasr, 2007 for Pakistan firms; Lazaridis and Tryfonidis,
2006 for Greek firms). This implies that reducing working capital investment is likely to lead to higher
profits. Another point that emerges from the literature review is that the relationship has been tested in
various markets but no empirical evidence is available for the emerging economy of India. This motivates
us to explore the nature of relationship between working capital management and profitability of Indian
firms, which forms the basis of the study.

Data and Variables

Sample and Data
Our sample consists of 263 companies, all from BSE 500, broad market indices of the Indian capital
market. The BSE 500 index represents nearly 93 per cent of the total market capitalization on BSE. The
Index covers 20 major industries of the economy and was launched on 9 August 1999. The sample companies consist of 15 industries with full annual data of eight variables during the period 200008. The
sample was constructed as follows. Firms must be available during the study period of year 2000 to year
2008. Because of the specific nature of their activities, firms related to banking and financial and Information Technology (IT) sectors were excluded from the sample. Some firms with missing data were also
removed from the sample. Thus a balanced panel dataset of 2,367 firm year observation was obtained,
with observation of 263 firms between 2000 and 2008. The data required for the purpose of this study
has been taken from the Capitaline and CMIE- Prowess databases. Table 1 describes the data selection
procedure and Table 2 shows the sample distribution by type of industry classification of the index.
Table 1. Sample Selection Procedure
Firms listed in the BSE 500
Less: financial and IT services firms
Remaining non-financial firms
Less: firms with incomplete data
Firms included in the final sample

500
(163)
337
(74)
263

Variables
In order to analyze the effects of working capital management on the profitability of Indian companies, profitability is measured by Return on Assets (ROA), which is defined as the ratio of earnings
before interest and tax to total assets. ROA is used as a dependent variable. ROA has been used by
Samiloglu and Demirgunes (2008), Garcia-Teruel and Martinez-Solano (2007), Nazir and Afza (2009),
Talat and Sajid (2008) and Uyar (2009) in their studies. The return on assets is a better measure since it
relates the profitability of the company to the asset base (Padachi, 2006).
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Table 2. Industry Wise Sample Distribution for the Year 200008

Industry Classification
Agriculture Equipments
Capital Goods
Chemical & Petro Chemical
Consumer Durables
Diversified
FMCG
Health Care
Housing Related
Media & Publishing
Metal, Metal Products & Mining
Miscellaneous
Oil and Gas
Telecom
Textile
Transport Equipments
Total

No. of Firms
16
40
15
6
12
20
27
28
7
27
10
17
6
6
26
263

Number of days accounts receivable (AR), number of days of inventory (INV) and number of days
accounts payable (AP) was used as the independent variable or explanatory and was considered for
measuring working capital. In this respect, number of days accounts receivables (AR) is calculated as
365 [account receivable/sales]. This denotes the number of days that the firm takes to collect payments from its debtors. The higher the value, the more its investment in accounts receivables. The number
of days accounts payable (AP) indicates the average time taken by the firm to pay their creditors. The
higher the value, the longer the firm takes to settle the payment commitments to creditors and this is
calculated as 365 [account payable/purchase]. Finally, the number of days of inventory (INV) was
calculated as 365 [inventories/purchase]. This variable shows the average number of days of inventory
held by the firm, where longer values indicate greater investment in inventory for a particular level of
business activity. Taking together these three aspects, the cash conversion cycle (CCC) was estimated.
CCC is used as a comprehensive measure of working capital as it shows the time-lag between payment
for the purchase of raw material and the collection of sales of finished goods. A lower value of CCC is
better as it indicates less investment in current assets and also signifies high liquidity, which easily converts its short term investment in current assets to cash. A higher value of CCC signifies greater investment
in current assets, and therefore shows the greater need for financing of current assets. The CCC is calculated as the number of days account receivables (AR) plus the number of days of inventory (INV)
minus the number of days accounts payable (AP).
Apart from these variables, the size of the firm, the growth in its sales, firm leverage and current ratio
were introduced as control variables. Firms size (SIZE) was measured as the natural logarithm of
assets(Intotal assets), for sales growth (GROW) as (Sales1Sales0)/Sales0, the firm leverage (LEV) as the
ratio of total debt to total asset and current ratio (CR) measured as the ratio of current assets to current
liabilities (CA/CL). The reason for choosing these variables is that most of researchers (Deloof, 2003;
Garcia-Teruel and Martinez-Solano, 2007; Jose et al., 1996; Nazir and Afza, 2009; Raheman and Nasr,
2007; Shin and Soenen, 1998; Wang, 2002; Zariyawati et al., 2009) have used these to calculate the
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A.K. Sharma and Satish Kumar

relationship between WCM and profitability in various markets. Some researchers like Deloof (2003),
Raheman & Nasr (2007) and Lazaridis and Tryfonidis (2006) in their studies also considered the ratio
of fixed financial assets to total assets as a control variable; however due to unavailability of
such data regarding Indian firms in their financial disclosure, we have not included the same in our
study.

Descriptive Statistics
Table 3 shows descriptive statistics about the variables used in the study. The mean value of return on
assets is around 197 per cent with a standard deviation of 128 per cent; the number of accounts receivables
are 471 days and number of accounts payable are 683 days. The table further shows that mean value of
cash conversion cycle of all the firms taken together is 450 days. Together with this, the firms have seen
their sales growth by almost 248 per cent annually on an average, while the mean value of current ratio
is 14.53 during the study period (200008).
Table 3. Descriptive Statistics
Variable

Obs.

Mean

SD

Median

Maximum

Minimum

ROA
AR
INV
AP
CCC
SIZE
GROWTH
LEV
CR

263
263
263
263
263
263
263
263
263

197.6065
471.7452
660.3573
683.0038
449.0988
57.9015
2.4789
2.6646
14.5354

127.9268
492.9124
973.2349
1877.761
1830.095
11.96735
3.121791
12.39536
7.884705

171.97
366
460.2942
428
454.5967
57.01709
1.816482
3.575471
12.58

26.83
3
2.125802
22
20,420.7
27.40183
0.87779
194.978
4.4

1,029.96
5,318
10,175.65
27,244
10,184.65
98.0267
40
12.87057
94.86

Source: SPSS output.

Notes: ROA-return on assets; AR-number of days accounts receivables; INV-number of days inventory; AP-number of
days accounts payable; CCC-cash conversion cycle; SIZE-natural logarithm of assets; GROWTH-sales growth; LEVLeverage; CR-current ratio.

Table 4 offers the correlation matrix of the variables. There is a negative correlation between return
on assets and the number of days of accounts payable as well as days of inventory, but a positive correlation with cash conversion cycle and number of days of accounts receivable. Further, ROA is negatively
correlated with GROWTH, SIZE and LEV but positively correlated with current ratio, which measures
the short-term liquidity position analysis of the company. With regard to correlations between the
independent or control variables, maximum values are found only between the number of days accounts
payable (AP) and account receivables (0.39) and number of days of inventory (0.24). There is also
positive correlation between cash conversion cycle and number of days of inventory (0.35). Since there
is no high value of correlation coefficient among the variables used in the study, there is less chance of
potential multicollinearity problem, which was further analyzed with variance inflation factor (VIF)
values.

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Table 4. Correlation Matrix

ROA
AR
INV
AP
CCC
SIZE
GROWTH
LEV
CR

ROA

AR

INV

AP

CCC

SIZE

1
0.143
0.022
0.073
0.101
0.121
0.033
0.056
0.031

1
0.233
0.390
0.007
0.144
0.223
0.029
0.280

1
0.238
0.351
0.085
0.183
0.011
0.124

1
0.795
0.044
0.158
0.004
0.015

1
0.129
0.004
0.018
0.157

1
0.216
0.076
0.172

GROWTH

LEV

1
0.047
1
0.305 0.068

CR

Source: SPSS output.

Notes: Significant at 95 per cent level of significance; Significant at 90 per cent level of significance; ROA-measure return on
assets; AR-number of days accounts receivables; INV-number of days inventory; AP-number of days accounts payable;
CCC-cash conversion cycle; SIZE-natural logarithm of assets; GROWTH-sales growth; LEV-Leverage; CR-current
ratio.

Methodology
The primary aim of this study is to investigate the impact of WCM on corporate profitability of Indian
firms. This is achieved by developing a methodology and empirical framework as used by Nazir and
Afza (2009), Zariyawati et al. (2008), Samiloglu and Demirgunes (2008) and Garcia-Teruel and MartinezSolano (2007). The following OLS regression equations were used to obtain the estimates:
ROAit = 0 + 1 GROWTHit + 2 LEVit + 3 CRit + 4 SIZEit + 5 INVit + it

(1)

ROAit = 0 + 1 GROWTHit + 2 LEVit + 3 CRit + 4 SIZEit + 5 ARit + it

(2)

ROAit = 0 + 1 GROWTHit + 2 LEVit + 3 CRit + 4 SIZEit + 5 APit + it

(3)

ROAit = 0 + 1GROWTHit + 2 LEVit + 3 CRit + 4 SIZEit + 5 CCCit + it

(4)

Where ROA measures the return on assets, GROWTH, the sales growth, LEV, the leverage, SIZE, the
company size as measured by natural logarithm of sales, INV, the number of days inventories, AR, the
number of days accounts receivables, AP, the number of days account payables, CR, the current ratio and
CCC measures the cash conversion cycle. The subscript i denotes firms (cross section dimensions)
ranging from 1263 and t denoting years (time-series dimension) ranging from 200008.

Result and Analysis

Tables 5 to 8 present the results obtained after regressing equation (1), (2), (3) and (4). In order to check
the presence of autocorrelation and multicollinearity in the data, Durbin Watson (D-W) and Variance
Inflation factor (VIF) statistics was analyzed and it was found that the statistics are within the limit,
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A.K. Sharma and Satish Kumar

Table 5. Summary of Polled OLS Regression Result of Equation (1) for the Period 200008
Parameters
Coefficient
t-value
Significance
VIF
Adj. R2
F-value
F-Significance
D-W Stats.

CR

SIZE

LEV

GROWTH

INV

0.439
0.413
0.680
1.127
0.005
1.277
0.274
1.656

1.480
2.168
0.031
1.074

0.731
1.103
0.271
1.015

2.869
1.046
0.296
1.164

0.003
0.398
0.691
1.042

Source: SPSS output.

Table 6. Summary of Polled OLS Regression Result of Equation (2) for the Period 200008
Parameters
Coefficient
t-value
Significance
VIF
Adj. R2
F-value
F-Significance
D-W Stats.

CR

SIZE

LEV

GROWTH

AR

0.118
0.110
0.912
1.178
0.024
2.287
0.047
1.627

1.350
1.991
0.048
1.079

0.711
1.082
0.280
1.015

3.850
1.420
0.157
1.161

0.038
2.257
0.025
1.117

Source: SPSS output.

Table 7. Summary of Polled OLS Regression Result of Equation (3) for the Period 200008
Parameters
Coefficient
t-value
p-value
VIF
Adj. R2
F-value
F-Significance
D-W Stats.

CR

SIZE

LEV

0.356
336
(0.737)
1.13
0.008
1.410
0.221
1.66

1.423
2.083
(0.038)
1.08

0.721
1.090
(0.277)
1.02

GROWTH
2.577
0.935
(0.351)
1.18

AP
0.004
0.901
(0.369)
1.04

Source: SPSS output.

Table 8. Summary of Pooled Regression Result of Equation (4) for the Period 200008
Parameters
Coefficient
t-value
p-value
VIF
Adj. R2
F-value
F-Significance
D-W Stats.

CR

SIZE

LEV

GROWTH

CCC

0.200
0.187
(0.851)
1.15
0.012
1.590
0.163
1.66

1.364
1.992
(0.047)
1.09

0.713
1.078
(0.282)
1.02

2.758
1.016
(0.310)
1.15

0.006
1.300
(0.195)
1.04

Source: SPSS output.

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leading to the conclusion that there is no presence of autocorrelation and multicollinearity in the data.
The highest value of VIF statistics obtained was 1.18 whereas a commonly given rule of thumb is that
VIFs of 10 or higher may be a reason for concern (Gujarati and Sangeetha, 2008). D-W statistics value
was found to be 1.66 in equation (1), which was highest in all four equations. Durbin-Watson statistic
ranges in value from 0 to 4 with an ideal value of 2 indicating that errors are not correlated, although
values from 1.75 to 2.25 may be considered acceptable. Further some authors (Makridakis and
Wheelwright, 1978) consider D-W value between 1.5 and 2.5 as acceptable level indicating no presence
of collinearity.

Firm Profitability and Number of Days Inventory

Table 5 reveals the summary statistics of regression equation (1). Regression results reveal that there is
a negative relationship between Size, Leverage, Growth and Inventory with dependent variable, that is,
returns on assets. Size and growth which are considered important indicators of firm performance are
generally found to be positively correlated with profitability. Therefore, higher the growth, more will be
the profitability and greater the size of company, greater will be the profitability of a concern. Table 5
shows that in Indian companies, both these indicators are negatively correlated with profitability, which
is contrary to many international findings on such variables and also to the theory of corporate finance.
Only ROA and current ratio (CR) have a positive relationship. The regression coefficient of number of
days of inventory (INV) was found to be negative (0.003) which implies that an increase in the number
of days inventory by one day is associated with a decrease in profitability (measured by return on assets)
by 0.003 per cent. As per corporate finance theory, lesser the number of days of inventory holding, higher
will be profitability of the company. This implies that the firms profitability can be increased by reducing
the number of days of inventory held in the firm. The regression results reveal that in Indian companies,
reduction in number of days of inventory will contribute to the profitability of the companies. The results
of our study are consistent with the results of the studies conducted by Padachi (2006), Garcia-Teruel and
Martinez-Solano (2007), Deloof (2003) and Raheman and Nasr (2007) in their respective analysis of the
relationship between profitability and number of days of inventory. Another important observation that
can be made from Table 5 is that the conventional measure of liquidity, i.e., current ratio, is positively
related with the return on assets, which is a positive situation for Indian companies, and the results are
consistent with earlier studies of Zariyawati et al. (2009). However, this is contrary to the studies of Shin
and Soenen (1998). Further coefficients about Size and Growth are negatively correlated with profitability
of the firm which is a very strange situation and against the basic paradigm of the theory of corporate
finance. It is also contrary to other studies such as that of Padachi (2006), Zariyawati et al. (2009) Deloof
(2003), Nazir and Afza (2009) and Raheman and Nasr (2007).

Firm Profitability and Number of Days Accounts Receivables

Table 6 presents the result of regression equation (2) for the period 200008. A positive relationship is
found between profitability and number of days of accounts receivables. In corporate finance theory,
lesser the number of days of accounts receivables, more it will add to the profitability of the company.
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But looking at the coefficient value of number of days of accounts receivables (AR) by Indian companies
shows that an increase in the number of days of accounts receivables by one day is associated with an
increase in return on assets (ROA) by 0.038 per cent. This contradicts the theory of efficient management
of working capital. The results of our study significantly differ from those conducted by Deloof (2003),
Lazaridis and Tryfonidis (2006), Raheman and Nasr (2007) and Garcia-Teruel and Martinez-Solano
(2007). This reveals that in Indian companies, managers can improve profitability by increasing the
credit period granted to their customers. In fact, after liberalization of the Indian economy in the 1990s,
the consequent influx of MNCs has put forward multiple challenges to their Indian counterparts. Their
products and services being superior to those of Indian companies, it has become necessary for Indian
companies to grant longer credit to sustain in their market and respond to the competition. Leverage
shows a significant negative relationship with the dependent variable (ROA), which means that when
leverage of the firm increases, it will adversely affect the profitability of the company, which is contrary
to the theoretical framework. Size and growth variables exhibit the same result as in equation (1).
Further, the table reveals a negative relationship between current ratio and profitability of the firms.
The lower current ratio of the company will add to its profitability. This is consistent with theory that
lesser the money blocked in current assets more will be profitability of the firm. Value of adjusted R2
(also called the coefficient of multiple determinations) is very low (0.024), which implies that variation
in the profitability of the firm due to independent variables selected for the present study is very low.

Firm Profitability and Number of Days Accounts Payables

Table 7 reveals results of regression equation (3) after replacing number of days of accounts receivables
with number of days of accounts payables. The number of days a firm takes to pay its suppliers (creditors)
depends upon its profitability. More profitable firms pay their creditors early as compared to less profitable ones, which in turn affects the profitability of the firm. The regression results show a negative relationship between number of days of accounts payables (AP) and firm profitability as measured by return
on assets. The coefficient for days of accounts payables is negative and confirms the negative correlation
between profitability and number of days of accounts payable. Deloof (2003) justifies similar results by
arguing that less profitable firms tend to delay payments. This is actually happening in the Indian market
with regard to the domestic firms operating in the manufacturing sector. Companies like Onida and
Videocon that had stakes of more than 20 per cent in the consumer durable sector before the liberalization
of the Indian economy are now fighting for survival due to influx of MNCs in this sector. For instance,
Onida average payable period is about 700 days, which is an alarming situation that has come up as a
result of reduced profitability of the company due to loss in market shares in favour of MNCs. This
implies that less profitable firms take longer to settle payments to creditors due to their inability to pay
dues on time. Descriptive statistics as presented in Table 3 confirm the same results indicating that Indian
companies on an average take a longer time (683 days) to pay their suppliers. When profitability
decreases, less cash is generated from operations and companies are able to survive by delaying payment
to creditors (Padachi, 2006). The results make economic sense since the longer the payment period used
by the firm, more amounts of fund can be reserved and used for other operations in order to carry on its
operations and earn reasonable profits.

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Firm Profitability and Cash Conversion Cycle

The combined effect of all the three variables used in equations (1), (2) and (3) was analyzed using the
relationship between profitability and cash conversion cycle. The coefficient value of CCC was found to
be positive (0.006). This implies that a decrease in the cash conversion cycle will generate lesser profits
for a company, which is in contrast with the theory that states a lower CCC will generate more profits for
a company. In theory, shortening of cash conversion cycle adds to the profitability of the company
whereas longer cash conversion cycle negatively affects the profitability of the company. But in case of
Indian firms, regression result exhibit contrary revealing that longer the duration of CCC, more profitable
the firms will be. The results are not significant at given level of significance with p-value (0.195). Moreover the regression results show that size, leverage and growth have negative correlation coefficient
values. These results depart from the earlier studies by Deloof (2003) which conclude that there is negative relationship between cash conversion cycle and profitability of the firm. Further negative relationship
is proved by Samiloglu and Demirgunes (2008), Lazaridis and Tryfonidis (2006), Zariyawati et al. (2009)
and Raheman and Nasr (2007), concluding that the increase or decrease in the cash conversion period,
significantly affects profitability of the firm. But like in our study, positive relationship between CCC
and profitability is concluded by Padachi (2006) with correlation coefficient value of 0.002. Further, the
regression model, like in all other equations is not significant with a very low adjusted R2 value of 0.012.
The overall results imply that in Indian companies shortening of cash conversion period negatively
affects the profitability of the companies but statistically these values are not significant (Table 8). One
possible explanation of such results about Indian companies may be that if a firm has higher level of
accounts receivables due to generous trade credit policy it would result in longer cash conversion cycle.
In this case, the longer cash conversion cycle will increase profitability (Zariyawati et al., 2009).

Conclusion
Working capital management is an important part of financial management decisions in all firms. The
ability of the firm to operate for longer durations depends on a proper trade-off between management of
investment in long-term and short-term funds (working capital). Firms can achieve optimal management
of working capital by making the trade-off between profitability and liquidity. The present study investigates the relationship between the working capital management and profitability of 263 Indian firms
divided into 15 industrial groups by BSE 500 index for the period 200008. The impact of working capital management has been analyzed using OLS multiple regression models between WCM and profitability. The study finds a negative relationship between profitability and number of days accounts
payables and number of days of inventory, but a positive relationship between profitability and number
of days accounts receivables. With regard to integrated analysis of the number of days accounts receivables, days of inventory and days of accounts payable as measured by cash conversion period, our study
conveys different results as compared to many studies conducted in different countries in the past. The
WCM and profitability show a positive relationship [as measured by cash conversion cycle, a comprehensive measure of working capital] as against the theoretical foundation. The present study reveals that
shortening of the cash conversion cycle negatively affects the profitability of Indian companies. Our
results related to relationship between a firms profitability and number of days of accounts payables and

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A.K. Sharma and Satish Kumar

number of days of inventory are similar to those found in previous studies (Deloof, 2003; Jose et al.,1996;
Lazaridis and Tryfonidis, 2006; Raheman and Nasr, 2007; Samiloglu and Demirgunes, 2008; Zariyawati
et al., 2009). However, analysis related to relationship between CCC and profitability significantly depart
from the studies of Shin and Soenen (1998), Deloof (2003), Padachi (2006), Zariyawati et al. (2006),
Samiloglu and Demirgunes (2008) and Nazir and Afza (2009). Hence, an unusual and strange relationship in certain cases has been observed in Indian companies which may be very useful for users/decision
makers who are engaged in the management of short term funds in the corporate world. Further, the
study prompts the researchers to investigate the relationship between working capital management and
the firms profitability with a broader set of companies operating in India.
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