WORKING CAPITAL - OVERALL VIEW

Working Capital management is the management of assets that are current in nature.
Current assets, by accounting definition are the assets normally converted in to cash in a
period of one year. Hence, working capital management can be considered as the
management of cash, market securities receivable, inventories, and current liabilities. In
fact, the management of current assets is similar to that of fixed assets, the sense that is
both in cases the firm analyses their effect on its profitability and risk factors, and hence
they differ on three major aspects:
1. In managing fixed assets, time is an important factor discounting and
compounding aspects of time play an important role in capital budgeting and a
minor part in the management of current assets.
2. The large holdings of current assets, especially cash, may strengthen the firm’s
liquidity position, but is bound to reduce profitability of the firm as ideal car yield
nothing.
3. The level of fixed assets as well as current assets depends upon the expected
sales, but it is only current assets that add fluctuation in the short run to a
business.
To understand working capital better we should have basic knowledge about the various
aspects of working capital. To start with, there are two concepts of working capital:
 Gross Working Capital
 Net working Capital

Gross Working Capital: Gross working capital, which is also simply known as working
capital, refers to the firm’s investment in current assets: Another aspect of gross working
capital points out the need of arranging funds to finance the current assets. The gross
working capital concept focuses attention on two aspects of current assets management,
firstly optimum investment in current assets and secondly in financing the current assets.
These two aspects will help in remaining away from the two danger points of excessive
or inadequate investment in current assets. Whenever a need of working capital funds
arises due to increase in level of business activity or for any other reason the arrangement
should be made quickly, and similarly if some surpluses are available, they should not be
allowed to lie ideal but should be put to some effective use.

Net Working Capital: The term net working capital refers to the difference between the
current assets and current liabilities. Net working capital can be positive as well as
negative. Positive working capital refers to the situation where current assets exceed
current liabilities and negative working capital refers to the situation where current
liabilities exceed current assets. The net working capital helps in comparing the liquidity
of the same firm over time. For purposes of the working capital management, therefore
Working Capital can be said to measure the liquidity of the firm. In other words, the goal
of working capital management is to manage the current assets and liabilities in such a
way that an acceptable level of net working capital is maintained.
 Title

Effect of Working Capital Management on Profitability: An Empirical Study

Objectives

 To assess the joint effect of the different ratios upon the profitability with the help
of multiple correlation coefficient and multiple regression equation.

 To ascertain the working capital leverage.

 To examine the impact of working capital on profitability of Banking,

Information Technology, Insurance and Telecommunications sector.
  Literature Review

http://www.cyberessays.com/Term-Paper-on-Alternate-Working-Capital-
Policy/4656/

Many researchers have studied working capital from different views and in different
environments. The following ones were very interesting and useful for our research:

Eljelly, 2009 elucidated that efficient liquidity management involves planning and
controlling current assets and current liabilities in such a manner that eliminates the risk
of inability to meet due short-term obligations and avoids excessive investment in these
assets. The relation between profitability and liquidity was examined, as measured by
current ratio and cash gap (cash conversion cycle) on a sample of joint stock companies
in Saudi Arabia using correlation and regression analysis. The study found that the cash
conversion cycle was of more importance as a measure of liquidity than the current ratio
that affects profitability. The size variable was found to have significant effect on
profitability at the industry level. The results were stable and had important implications
for liquidity management in various Saudi companies. First, it was clear that there was a
negative relationship between profitability and liquidity indicators such as current ratio
and cash gap in the Saudi sample examined. Second, the study also revealed that there
was great variation among industries with respect to the significant measure of liquidity.

Deloof, 2008 discussed that most firms had a large amount of cash invested in working
capital. It can therefore be expected that the way in which working capital is managed
will have a significant impact on profitability of those firms. Using correlation and
regression tests he found a significant negative relationship between gross operating
income and the number of days accounts receivable, inventories and accounts payable of
Belgian firms. On basis of these results, he suggested that managers could create value
for their shareholders by reducing the number of days’ accounts receivable and
inventories to a reasonable minimum. The negative relationship between accounts
payable and profitability is consistent with the view that less profitable firms wait longer
to pay their bills.
Ghosh and Maji, 2008 in this paper attempted to examine the efficiency of working
capital management of the Indian cement companies during 1992 – 1993 to 2001 – 2002.
For measuring the efficiency of working capital management, performance, Utilization,
and overall efficiency indices were calculated instead of using some common working
capital management ratios. Setting industry norms as target-efficiency levels of the
individual firms, this paper also tested the speed of achieving that target level of
efficiency by an individual firm during the period of study. Findings of the study
indicated that the Indian Cement Industry as a whole did not perform remarkably well
during this period.

Shin and Soenen, 2006 highlighted that efficient Working Capital Management (WCM)
was very important for creating value for the shareholders. The way working capital was
managed had a significant impact on both profitability and liquidity. The relationship
between the length of Net Trading Cycle, corporate profitability and risk adjusted stock
return was examined using correlation and regression analysis, by industry and capital
intensity. They found a strong negative relationship between lengths of the firm’s net
trading Cycle and its profitability. In addition, shorter net trade cycles were associated
with higher risk adjusted stock returns.

Smith and Begemann 2005 emphasized that those who promoted working capital theory
shared that profitability and liquidity comprised the salient goals of working capital
management. The problem arose because the maximization of the firm's returns could
seriously threaten its liquidity, and the pursuit of liquidity had a tendency to dilute
returns. This article evaluated the association between traditional and alternative working
capital measures and return on investment (ROI), specifically in industrial firms listed on
the Johannesburg Stock Exchange (JSE). The problem under investigation was to
establish whether the more recently developed alternative working capital concepts
showed improved association with return on investment to that of traditional working
capital ratios or not. Results indicated that there were no significant differences amongst
the years with respect to the independent variables. The results of their stepwise egression
corroborated that total current liabilities divided by funds flow accounted for most of the
variability in Return on Investment (ROI). The statistical test results showed that
aditional working capital leverage ratio, current liabilities divided by funds flow,
displayed the greatest associations with return on investment. Well known liquidity
concepts such as the current and quick ratios registered insignificant associations whilst
only one of the newer working capital concepts, the comprehensive liquidity index,
indicated significant associations with return on investment.
 RESEARCH METHODOLOGY

Each research study has its own specific purpose. It is like to discover to Question
through the application of scientific procedure. But the main aim of our research to find
out the truth that is hidden and which has not been discovered as yet.

Basically, project study is usually based on a research, which gives a concrete answer to a
problem. This research may be Problem Solving or Problem Oriented. Both types of
research are usually known as Applied Research.

In order to achieve the objectives of the study, the Research Methodology includes the
following:

Research Design: Descriptive Research Design

Sampling Technique: Convenience Sampling

Universe: All business and service sectors operating worldwide

Population: All business and service sectors operating in India

Sample Size: 4 sectors i.e. Banking, Information Technology, Insurance,

Telecommunications operating in India

Sampling Unit: Any single company operational under 4 sectors i.e. Banking,

Information Technology, Insurance, Telecommunications operating in India

Data Collection: Secondary Data