Working Capital Management and Firms Performance:

An Analysis of Sri Lankan Manufacturing Companies

Lingesiya Y.
Department of Financial Management,
University of Jaffna, Sri Lanka
lingesiya@yahoo.com

Nalini S.
Northern Provincial Office,
Central Bank of Sri Lanka, Sri Lanka
nalinisivalingam@gmail.com

Abstract
Management of working capital refers to management of current assets and of current
liabilities. Firms may have an optimal level of working capital that maximizes their value.
Prior evidence has determined the relationship between working capital and performance.
This study extends the literature. The working capital was determined by the cash conversion
cycle and position of working capital, indicated by the current ratio, quick ratio, and stock to
current assets. The performance was measured in terms of profitability by return on total
assets, and relationship between working capital management and profitability was
investigated by using panel data analysis for a sample of 30 listed manufacturing companies
for the period of 2006 2010. Estimated equation by the panel data method to obtain the
estimates of the parameters of pooled model was applied for explanatory variables to
measure their effect on firm performance. Results indicate that high investment in inventories
and receivables lead to lower profitability and current assets to total assets lead to higher
profitability. The results conclude that a strong relationship between working capital
management and performance.

Key words: Performance, Working Capital Management

1.0 introduction
Capital structure and working capital management are two areas widely revisited by
academia in order to postulate firms profitability. The working capital meets the short-term

financial requirements of a business enterprise. It is the investment required for running dayto-day business. It is the result of the time lag between the expenditure for the purchase of
raw materials and the collection for the sales of finished products. The main components of
working capital are inventories, accounts to be paid to suppliers, and payments to be received
from customers after sales. Financing is needed for receivables and inventories net of
payables. The proportions of these components in the working capital change from time to
time during the trade cycle. The working capital requirements decide the liquidity and
profitability of a firm and hence affect the financing and investing decisions. Lesser
requirement of working capital leads to less need for financing and less cost of capital and
hence availability of more cash for shareholders. However the lesser working capital may
lead to lost sales and thus may affect the profitability. The management of working capital by
managing the proportions of the working capital components is important to the financial
health of businesses from all industries.

Working capital management has been approached in numerous ways. Working capital is
known as life giving force for any economic unit and its management is considered among
the most important function of corporate management. Every organization whether, profit
oriented or not, irrespective of size and nature of business, requires necessary amount of
working capital. Working capital is the most crucial factor for maintaining liquidity, survival,
solvency and profitability of business (Mukhopadhyay, 2004). Working capital management
is one of the most important areas while making the liquidity and profitability comparisons
among firms (Eljelly, 2004), involving the decision of the amount and composition of current
assets and the financing of these assets. The greater the relative proportion of liquid assets,
the lesser the risk of running out of cash, all other things being equal. All individual
components of working capital including cash, marketable securities, account receivables and
inventory management play a vital role in the performance of any firm. Shin and Soenen,
(1998) argued that efficient working capital management is very important to create value for
the shareholders while Smith et. al., (1997) emphasized that profitability and liquidity are the
salient goals of working capital management. Therefore, many organizations that are
profitable on which are forced to cease their operations due to an inability to meet their shortterm debt obligations. In order to sustain the business, it is essential for any organization to
successfully manage its working capital. Keeping in view the realistic importance of working
capital management as a youthful area of corporate finance function, an attempt has been
made to examine working capital management in manufacturing companies of Sri Lanka.

The level of working capital in a business has a direct effect on the amount of growth of the
company which can sustain organically from its own internal resources. Growth of sales
requires that the business takes on additional stocks and incurs additional debtors. These
currents assets of manufacturing firms accounts for over half of its total assets. Excessive
levels of current assets can easily result in a firms realizing a substandard return on
investment. However, firms with too few current assets may incur shortage and difficulties in
maintaining smooth operations (Horne and Wachowicz, 2000). Companies inventory
management policy, debtors management policy and creditors management policy have an
important role in its profitability performance (Vishanani and Shah, 2007).

In this paper researchers investigate the relationship between working capital management
and firms performance for 30 listed manufacturing companies in the Colombo Stock
Exchange (CSE) for the period 2006-2010. The purpose of this paper is to establish a
relationship that is statistical significant between profitability, the cash conversion cycle and
its components for listed firms in the CSE. The outlook for Sri Lankas economy has
improved with the ending of the conflict in May 2009, there re-integration of the Northern
and Eastern Provinces with the rest of provinces, and renewed investor confidence following
the favorable post conflict developments. The manufacturers have taken timely measures to
safeguard and promote the industry in the current global economic condition. Manufacturing,
the largest sub-sector of the industry sector recorded a significant growth to economy
(Central Bank Report, 2009). Therefore, in this study, specially manufacturing companies
were taken into consideration since those are playing very important role in the Sri Lankan
economy in order to enhance the economic growth.

This study has following objectives:

To identify the influences of liquidity management on profitability over a period of 5 years.
To measure the relationship between working capital cycle and performance.
To find out the effect of current assets component of stock on profitability.
The paper is structured as follows. In the next section researchers present the variables used
as well as the chosen sample of firms. Results of the descriptive statistics accompanied with
regression modeling relating profitability (the dependent variable) against other independent
variables including components of the cash conversion cycle, in order to test statistical
significance. Finally the last section discusses the findings of this paper and comes up with
conclusions related with working capital management policies and profitability.

2.0 Literature Review

Many researchers have studied working capital from different views and in different
environments.
Vijaykumar and Venkatachalam (1995) in their study on Tamilnadu sugar industry with
regard to relationship between working management and profitability concluded that liquidity
was negatively associated with profitability.
Smith and Begemann (1997) emphasized that profitability and liquidity comprised the salient
goals of working capital management. The problem arose because maximization of the firms
return could seriously threaten its liquidity. Pursuit of liquidity had a tendency to dilute
returns. They evaluate traditional and alternatives working capital measures and the return on
investment (ROI). The problem under investigation was to establish whether the more
recently developed alternative working capital concepts show improve association with the
return on investment to that of traditional working capital ratio or not. The result shows that a
traditional working capital leverage ratio, current liability divided by funds flow, displayed
the greatest association with return on investment. Current assets quick ratios registered
insignificant association whilst one of the never working capital concepts, the comprehensive
liquidity index, indicated significant association with return on investment.
Shin and Soeven (1998) measured the relationship between the lengths of net trading cycle;
corporative profitability and risk adjusted stock return was examined using correlation and
regression by industry and capital intensity. The results showed that strong negative
relationship between the length of the firms net trading cycle and its profitability. In
addition, shorter net trading cycles were associated with high-risk adjusted stock returns.
Govind Rao and Rao (1999) studied the impact of working capital on profitability in Indian
cement industry and found both positive as well as negative correlations between working
capital related ratios and profitability. Sur, Biswas and Ganguly (2001) revealed in their study
of Indian aluminium producing industry, a very significant positive association between
liquidity and profitability.
Mukhopadhyay (2004) conducted a case study on working capital management in heavy
engineering firms and indicated that loans and advances, and other current assets hardly had
only role to contribute in sales / business generation of the firm during the period of, 1993-94
to 2002-03. Bardia (2004) in his study on steel giant SAIL for the period from 1991-92 to
2001-02 concluded that there is a positive relationship between liquidity and profitability.
Ghosh and Maji (2004) concluded a study on working capital management efficiency from
the view point of Indian cement industries and indicated that there is a relationship between

effective utilization of current assets and profitability of the companies under study, although
there seemed to be a wide range in the degrees of such relationship between company to
company
Amit, Sur and Rakshit (2005) studied the relationship between working capital and
profitability in the context of Indian pharmaceutical industries and concluded that no definite
relationship can be established between liquidity and profitability. Further, Narware (2004)
conducted a study of working capital management and profitability by using Fertilizer
Company, which disclosed both negative and positive association.
Additionally Padachi (2006) analyzed working capital management and performance and
trend of the working capital management in different sectors in small manufacturing firms by
using key variables of inventory days, account receivable days, account payable days and
cash conversion cycle. He concluded that different industries operational efficiency shows
significant changes and the paper and printing industry has been able to achieve high scores
on the various components of working capital and this has positively influenced its
profitability.
Vishmani at el., (2007) explained that the companys inventory management policy, debtors
management policy and creditors management policy play an important role in its
profitability performance.
In the study of Uyar (2009) he examined industry benchmarks for cash conversion cycle
(CCC) of merchandising and manufacturing companies and found that merchandising
industry has shorter CCC than manufacturing industries. He further examined the relationship
between the length of the CCC and the size of the firms and the findings indicated a
significant negative correlation between the length of CCC and the firm size, in terms of both
net sales and total assets. The study further showed significant negative correlation between
the length of CCC and the profitability.
Koperunthevi (2010) studied Working Capital Management and Firms Performance: An
Analysis of Sri Lankan Manufacturing Companies by panel data analysis. Her study
concluded that the working capital management very much influences on profitability of
manufacturing companies and increase of the cash conversion cycle leads to less profitability.
Current ratio and Quick ratio are positively related to the profitability.
All the above studies provide us a solid base and give us idea regarding working capital
management and its components. They also give us the results and conclusions of those
researches already conducted on the same area for different countries and environment from

different aspects. On basis of these researches done in different countries, we have developed
our own methodology for research.

3.0 Methodology
This paper analyses the impact of working capital management on firms performance with
special reference to Sri Lankan manufacturing companies with the period of 2006 to 2010.

3.1. Population and Sample

The data collected were from listed firms in the Colombo Stock Exchange Market. The
reason we chose this market is primarily due to the reliability of the financial statements .The
population consisted of 242 listed companies those are including manufacturing companies.
30 sample companies were selected from manufacturing companies according to the data
availability. From each sample firm the working capital data and other information is
gathered.

3.2. Variables

Working capital managements effect on performance is calculated by using explanatory

variables and control variables. Explanatory variables are liquidity ratios, working capital
cycle and components of current assets.
Profitability is measured by Return on Total Assets (ROTA), which is defined as profit
before interest and tax divided by total assets.

3.3 Explanatory Variables

Liquidity ratio of current ratio (cr) is defined as current assets divided by current liabilities
and quick ratio (qr) defined as current assets other than inventories divided by current
liabilities. Working capital cycle is the cash conversion cycle (CCC), which is used as a
comprehensive measure of working capital as it shows the time lag between expenditure for
the purchase of raw materials and the collection of sales of finished goods.
CCC = INP_days + AR_daya AP_days
Where:
IN_days = Number of inventory days is (Stock *365)/cost of sales
AR_days = Number of days account receivables is (Account receivable *365)/ Sales
AP_days = Number of days account payable is (Account payable *365)/ cost of sales
Working capital component of inventory is defined as inventory to total current assets (skca).

3.4 Control Variables

Control variables include assets management system and financial policies. In order to
include the firm size as a control variable sales, a proxy for size (The natural logarithm of
sales (lnsales)), the gearing ratio (financial debt to total assets (gear)), the gross working
capital turnover (sales to current assets (ca_turn)), current assets to total assets (ca_ta) and
current liability to total assets (cl_ta) are included as control variables.
3.5 Hypotheses

The working capital management have great importance in financial management system. To
maximize the profit and smooth run of the business, working capital management is a vital
factor. Increasing profits need more liquidity and it can bring liquidity cost to the firms.
Therefore, there must be a trade- off between these two objectives of the firms. For this
reason working capital management should be given proper consideration and will ultimately
affect the profitability of the firm. In this concept the hypotheses are:
H1: There is no relation between cash conversion cycle (CCC) and profitability of
manufacturing companies.
H2: There is no relation between liquidity (current ratio and quick ratio) and profitability of
manufacturing companies.
H3: There is no relation between current assets component of stock and profitability of
manufacturing companies.

3.6 Model Specification and Data Analysis

The analyses include panel data analysis and the models estimate using the regression based
framework (pooled ordinary least square). The relationship between working capital
management and performance is examined by regressing by Return on Total Assets against
Cash Conversion Cycle (Model 1), current ratio (Model 2), quick ratio (Model 3), and stock
to current assets (Model 4) .The coefficient on the Return on Total Assets reflects the
relationship between working capital management and performance.
Model(1):ROTA=0+1lnsalesit+2gearit+3catait+4cltait+5ca_turnit+6cccit
Model(2):ROTA=0+1lnsalesit+2gearit+3catait+4cltait+5ca_turnit+6crit
Model(3):ROTA=0+1lnsalesit+2gearit+3catait+4cltait+5ca_turnit+6qrit
Model(4):ROTA=0+1lnsalesit+2gearit+3catait+4cltait+5ca_turnit+6skcait

4.0 Results and Discussion

4.1 Descriptive Statistics

The following table gives the descriptive statistics of the collected variables. The firms
included in our sample had an average of 13.1 % return on total assets. On average 15.39 %
of total assets were current liabilities. Mean value of explanatory variables of cash conversion
cycle was 51.13 days, current ratio was 1.5139, quick ratio was 0.9938 and stock to current
assets was 42.51%. This means 42.51% of currents assets were stocks. This could be the
reason for difference between current ratio and quick ratio.

Table 1: Descriptive statistics of variables

Variables Statistics

N = 150

ROTA

0.131415

Mean
SD
Lnsales

Mean 7.367352
SD

Gearing

0.130708

1.571753

Mean 0.153906
SD

0.195168

CATA
Mean

0.552439
SD

0.571332

CLTA
Mean

0.363544
SD

CA_TURN

0.198327

Mean 3.204175
SD

2.172437

CCC
Mean

51.13404
SD

CR

Mean 1.513967
SD

QAR

33.11672

1.023874

Mean 0.997876

SD
SKCA

0.813326

Mean 0.425134
SD

0.412632

Source: Survey data

4.2 Regression Analysis

This analysis was done to estimate the casual relationship between profitability variable
(ROTA), other working capital variables (ccc, cr, qr, and skca). The Pooled ordinary least
square is used for the regression analysis.
Table 2: Results of Model(1):ROTA=0+1lnsalesit+2 gearit+3catait+4cltait+5ca_turnit+6cccit

Variable

Coefficient

Std. Error

t-Statistic

Prob.

0.026518

0.047219

0.561595

0.5749

LNSALES

0.010177

0.005367

1.896118

0.0502

GEARING

-0.100795

0.044982

-2.240795

0.0260

CATA

0.045059

0.01438

3.133325

0.0020

CLTA

0.084008

0.044509

1.887438

0.0603

CA_TURN

0.005971

0.004163

1.434372

0.1528

CCC

-0.00057

0.000274

-2.079674

0.0386

R-squared

0.152163

F-statistic

6.969479

Prob(FAdjusted R-squared

0.13033

S.E. of regression

0.121893

statistic)

0.000001

Source: Survey data

Table 2 presents the regression results of model 1. The result of the Model 1 is expressed by
regression analysis. The results of the regression indicated that coefficient of cash conversion
cycle was negatively related and significant at 5% level. It implied that the increase of cash
conversion cycle will significantly affect the ROTA of the firms. The size of the firm had
positive effect on dependent variable. The gearing of the firm had negative effect on
dependent variable. It showed that size of the firm had positive influence on ROTA and
financial debt had negative influence on ROTA. The current assets to total assets showed
positive relations with ROTA at 5 % significant level. The current liability to total assets
showed positive relation with ROTA in the pooled regression method.

The adjusted R also called as the coefficient of multiple determinations, is the percent of the
variance in the dependent. It explained uniquely or jointly by the independent variables was
0.1303. The F statistics was used to test the significance of R. Overall; the model represented
by regression F value and significant (F = 6.9694, p = 0.0000). The results indicated that null
hypothesis was rejected and there was a negative relationship between cash conversion cycle
and Return on Total Assets. This findings consisted with the study of Koperunthevi
(2010),Uyar (2009), and Shin and Soeven (1998).
Table 3: Results of Model(2):ROTA=0+1lnsalesit+2 gearit+3catait+4cltait+5ca_turnit+6crit

Variable

Coefficient

Std. Error

t-Statistic

Prob.

-0.09272

0.05141

-1.80353

0.07260

SIZE

0.00971

0.00518

1.87595

0.06190

GEARING

-0.07632

0.04443

-1.71786

0.08720

CATA

0.03787

0.01428

2.65299

0.00850

CLTA

0.16819

0.04688

3.58803

0.00040

CA_TURN

0.01135

0.00387

2.93361

0.00370

CR

0.03033

0.00857

3.53892

0.00050

R-squared

0.18048

F-statistic

8.55184

Adjusted R-squared

0.15937

Prob(F-statistic)

0.00000

S.E. of regression

0.11984

Source: Survey data

Based on the table 3 of the model 2, the regression result of the current ratio was positively
related with ROTA and size of the firm had positive relations with ROTA but it was not a
statistically significant level and gear negatively related with ROTA but it was also not a
statistically significant level. Current assets to total assets positively related and significant at
5% level. Current liability to total assets and gross working capital turnover also positively
2

impact the ROTA. The adjusted R of the regression was 0.1593 and the F value of regression
was 8.5518 with significance level (p=0.000). This finding is consisted with the study of
Koperunthevi (2010) and Bardia (2004) and Padachi (2006).

Table 4: Results of Model(3):ROTA=0+1lnsalesit+2 gearit+3catait+4cltait+5ca_turnit+6qarit

Variable

Coefficient

Std. Error

t-Statistic

Prob.

-0.055025

0.05129

-1.072821

0.2845

SIZE

0.009077

0.005264

1.724435

0.0860

GEARING

-0.080497

0.045283

-1.777629

0.0768

CATA

0.03643

0.014863

2.451131

0.0150

CLTA

0.146882

0.048197

3.047554

0.0026

CA_TURN

0.010473

0.003927

2.666747

0.0082

QAR

0.024927

0.011299

2.206125

0.0284

R-squared

0.154094

F-statistic

7.074072

Prob(FAdjusted R-squared

0.132311

S.E. of regression

0.121754

statistic)

0.000001

Source: Survey data

Based on table 4, Model(3) identified the relation with quick ratio to ROTA and control
variables. Size of the firm had positive relations with ROTA but it was not a statistically
significant and gear negatively related with ROTA but it was also not a statistically
significant. Current liability to total assets, gross working capital turnover and quick ratios
2

also positively determined the ROTA. Adjusted R of regression is 0.1323, and the F value
was 7.0740. The results of this regression also confirm that there is a well-built relation
between ROTA and quick ratio. This finding is consisted with the study of Koperunthevi
(2010) and Bardia (2004) and Padachi (2006).
Table 5: Results of Model(4):ROTA=0+1lnsalesit+2 gearit+3catait+4cltait+5ca_turnit+6skcait

Variable

Coefficient

Std. Error

t-Statistic

Prob.

0.011516

0.047139

0.244299

0.8072

SIZE

0.007667

0.005267

1.455689

0.1468

GEARING

-0.100128

0.045478

-2.201709

0.0287

CATA

0.043636

0.014521

3.005026

0.0029

CLTA

0.093418

0.044652

2.092151

0.0375

CA_TURN

0.009288

0.003912

2.37414

0.0184

SKCA

-0.021175

0.01965

-1.07757

0.2823

R-squared

0.140707

F-statistic

6.358861

squared

0.118579

Prob(F-statistic)

0.000003

S.E. of regression

0.122713

Adjusted

R-

Source: Survey data

The Model 4 stated by regression of above table 5. This regression was not recognized the
relation with ROTA and stock to current assets. The size of the firm was also not significant
this result provide the evidence that there was no significant relation with these two variables
and ROTA. Current assets to total assets, current liabilities to total assets and gross working
capital turnover as well prove the strong positive relation with depended variable and are
significant at 5% level. But there was no significant relationship between stock of current
2

assets and ROTA. The adjusted R of the regression was 0.1407. The F values of the model
was 6.358861 (p = 0.000) , this F value supported to prove this model was suitable to this
analysis. And these result accept the null hypothesis of H03 and that there was no relation
between ROTA and stocks to current assets.

5.0 Conclusion
The study set out to provide empirical evidence about the effects of working capital
management on profitability for a panel made up of a sample of 30 listed manufacturing
companies for the period 2006-2010. This paper adds to existing literature such as Shin and
Soenen (1998) and Koperunthevi (2010) who found a strong negative relationship between
the cash conversion cycle and corporate profitability for listed Sri Lankan manufacturing
firms for the 2006- 2010 period.
So far researchers observed a negative relationship between profitability (measured through
ROTA) and the cash conversion cycle which was used as a measure of working capital
management efficacy. Therefore it seems that operational profitability dictates how managers
or owners will act in terms of managing the working capital of the firm. The study concluded
that the working capital management very much influences on profitability of manufacturing
companies and increase of the cash conversion cycle leads to less profitability. Current ratio
and Quick ratio were positively related to the profitability. Having the more current assets to
total assets was the good decision to get the more profit.

On basis of the above analysis researchers may further conclude that these results can be
further strengthened if the firms manage their working capital in more efficient ways.
Management of working capital means management of current assets, current liabilities and
financing these current assets. If these firms properly manage their cash conversion period
and inventories in a proper way this will ultimately increase profitability of these companies.

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