Vol. 4, No.

Working Capital Management and Its Impact on

the Profitability of Pukar International Co.Ltd.
Puspa Raj Ojha
Lecturer
Faculty of Management, T.U.

Abstract
This paper aims to report the results of an investigation of the relative importance
of working capital management, measured by the Return on Assets (ROA), and
its components (Current ratio, average collection period and average payment
period) to the profitability of Pukar International Trading. This paper analyzes
the effect of working capital Management on firm’s profitability in Nepal for
the period 2071 to 2072. For this Purpose, financial data of four year is used.
Pearson’s correlation and Descriptive analysis were used to establish the
relationship between working capital management and firm’s profitability and
components of working capital like Average collection period, Average payment
period and Current ratio. The study finds a negative relationship between
profitability and average collection period and average payment period, but a
positive relationship between profitability and current ratio. Moreover, current
ratio and firm size also have significant effects on the firm’s profitability. Based
on the key findings from this study it had been concluded that the management of
a firm could create value for their shareholders by reducing the number of day’s
accounts collection. Firms could also take long to pay their creditors in as far as
they did not worry their relationships with these creditors.
Keywords: Working Capital Management, Profitability, Average Collection
Period, Average Payment Period, Current Ratio, Return on Assets

Introduction
Working capital management is a very important component of corporate finance because it has
direct impact on liquidity and profitability of the company. Deloof (2003) had used the sample of 1009
large Belgian non-financial firms for a period of 1992-1996, used correlation and regression analysis and
found a significant negative relation between gross operating income and the collection period of accounts
receivable, average days in inventories and accounts payable of Belgian firms. The shorter the period is
required to convert into cash the stronger the liquidity position of the company. Working capital of the
company is the relationship between current assets and current liability items. Current assets items can be
classified into cash and other asset items which can be converted into cash quickly. The nearer the asset
to cash, the lower is the riskiness and the expected return. So it is expected a negative relation between
profitability and the length of period over which goods of company are held in non-cash current assets.
Current assets of a typical manufacturing firm accounts for over half of its total assets and for distribution
company, it account for more. Excessive current assets result in a firm’s realizing a substandard return on
investment. However firms with few current assets might incur shortages and difficulties in maintaining
smooth operations (Horne and Wachowicz, 2000).With regards to current liabilities, the firm was responsible
for paying these obligations on timely. Liquidity for the ongoing firm was not reliant on the liquidation
value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 1998).
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The ultimate aim of any company is to maximize the profit. But maintaining liquidity of the firm is
also an important objective. Increasing profits at the cost of liquidity can bring serious problems to firms
so there must be a tradeoff between liquidity and profitability objectives. If profit is not care we won’t be
able to survive for longer period. On the other hand, if we do not care liquidity, firm may face the problem
of insolvency. For this working capital management should be given proper consideration which affect the
profitability of the company. Management of short term assets and liabilities deserved the careful analysis
since the working capital management had important effect on the firm’s profitability as well as its risk
(Smith, 1980).
It is necessary to understand the meaning of current assets and current liabilities for learning the
meaning of working capital. The current assets had the short life span. These types of assets were engaged
in current operation of the business and normally used for short term operations of the firm during the
accounting period The financial structure of companies had changed because of the crisis, and companies
had been forced to prepare for costly external financing. Financial institutions had improved their conditions,
and inflexible companies were struggling to survive (Kargar, & Blumenthal, 1994). Financial flexibility
had become crucial for all companies regardless of their size and company structure. Denis (2011) had
explained financial flexibility as the ability to react to unexpected changes in cash flow or investment
opportunities with the value-maximizing approach. These were all important to a company adjusting to the
new business environment caused by the economic downturn.
The concept of working capital management addresses companies managing of their short term
capital and the goal of the management of working capital to promote the satisfying liquidity, profitability
and shareholders value. Working capital management was important because of its effects on the firm’s
profitability and risk, and consequently its value (Smith, 1980). On the one hand, maintaining high
inventory levels reduced the cost of possible interruptions in the production process, or of loss of business
due to the scarcity of products, reduces supply costs, and protects against price fluctuations, among other
advantages (Blinder and Manccini, 1991). On the other, providing on credit favored the firm’s sales in
various ways. Trade credit could act as an effective price cut (Brennan, Maksimovic and Zechner, 1988;
Petersen and Rajan, 1997) incentivizes customers to acquire merchandise at times of low demand (Emery,
1987), allows customers to check that the merchandise they received was as agreed (quantity and quality)
and to ensure that the services contracted were carried out (Smith, 1987), and helped firms to strengthen
long-term relationships with their customers (Smith and Smith, 1999). However, firms that invest heavily
in inventory and trade credit could suffer reduced profitability. Efficient working capital management
involved excessive planning and controlling. There must be the balance between current assets and current
liabilities in order to eliminate the risk of inability to meet short term obligation on one hand and avoid
excessive investment in these assets on the other hand (Eljelly, 2004).
An optimal level of working capital management would be reached by achieving a balance between
liquidity and profitability. In fact, if the company adopts a working capital management policy with an
excessive level of current assets, the risk of liquidity may be reduced. Working Capital have a greater
importance in the profitability and sustainability of any firms. Firms with lower working capital would
post a higher return on capital so shareholder will benefit from a higher return. Adequate working capital
management will allow a business to pay on time its short term obligations which include raw materials,
salaries and other operating expenses. The management of account payables and receivables is an important
driver of small firm’s profitability. Firms with more efficient working capital management will generate
more free cash flows which would result in a higher business valuation. A firm with a good relation with
its trade partners and paying its suppliers on time would benefits from favorable financing terms such as
discount payments from its suppliers and banking partners. A firm paying its suppliers on time will also
benefit from a regular flow of raw materials, ensuring that the production remains uninterrupted and clients
receive their goods on time. An efficient working capital management will help a firm to survive through a
crisis in case of an unexpectedly large order. Firm with an efficient supply chain will often be able to sell

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their products at a discount versus similar firms with inefficient sourcing.

Objectives
The major objective is to examine the effect of working capital management on firm’s profitability
of Pukar international trading company in Nepal. The other objectives are;
• To determine the relationship between average payment period (APP) and profitability of
the firm.
• To determine the relationship between average collection period (ACP) and profitability of
the firm.
• To examine relationship between current ratio (CR) and profitability of the firm.
Hypothesis
Ho1: There is no significant relationship between Average Payment Period (App) and profitability
of the firm.
Ho2: There is no significant relationship between Average Collection Period (ACP) and profitability
of the firm.
Ho3: There is no significant relationship between Current ratio (CR) and profitability of the firm.

Review of literature
Many previous researches have indicated the relations between working capital management and
profitability of a company in different environments. In literature, Preve and Sarria-Allende, (2010)
explained that traditional definition of working capital was current assets minus current liabilities. Working
capital management was the management of company’s short term assets and short term liabilities explained
by Deloof, (2003).It intended to guarantee the sufficient ability of the company to continue its activity and
to face operational expenses. More explicitly, the working capital is the investment required from the
time lag between the purchase cost of raw materials and the sale of finished products. Its management
involves accounts receivable and payable, inventories and cash. The literature for the relevant theoretical
and empirical research on working capital components (inventories, accounts payable and receivable) and
their effects on corporate profitability is first exposed. Then, existing literature on the influence of the
liquidity on corporate profitability was presented. In the sphere of inventory managing, the company aimed
to hold a minimal acceptable level of inventory with regard to its costs discussed by Toomey, (2000),
Guariglia and Mateut (2006).
Zariyawati, et., al. (2009) also examined the relationship between working capital management and
corporate profitability. Cash Conversion Cycle was used as a measured for working capital management
and the study was based on panel data for 1,628 company-years for the period 1996-2006 from six different
economic sectors listed in Bursa Malaysia. The coefficient results of Pooled OLS regression analysis
provided the strong negative significant relationship between Cash Conversion Cycle and corporate
profitability. This revealed that reducing cash conversion period results in increased profitability. Thus,
company managers should work on shortening cash conversion cycle till optimal level is achieved.
The way in which WC was managed would have the significant impact on the profitability of
companies. The significant negative relation between gross operating income and the number of days of
accounts receivable, inventories and accounts payables were found. The negative relation between account
payables and profitability was consistent with the view that less profitable companies wait longer to pay
their bills (Deloof 2003). The chief executives properly recognized the role of efficient use of WC in
liquidity and profitability, but in practice they could not achieve it due to suboptimum utilization of WC
(Prasad 2001). The Public Sector Enterprises could improve the WCM by reducing their dependence on
outside funds (Jain, 1988).
With the aggressive WCM strategy the negative relationship was expected between overall WCM
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(measured by CR), accounts receivable (AR) and profitability, while the positive relationship between
accounts payable (AP) and profitability was expected. With the conservative strategy, the positive
relationship should exist between CR, AR and profitability and the negative relationship between AP and
profitability. Empirical evidence of the relationship between CR and its components (INV, AR and AP)
and profitability was, however, mixed. For example, the relationship between WCM measured by the CCC
and profitability was found to be negative and significant by Raheman et al. (2010), Hayajneh and Yassine
(2011) and Karaduman et al. (2011). A positive and significant relationship was reported by Raheman and
Nasr (2007), Mathuva (2010), Nobanee and Alhajjar (2009) and Stephen and Elvis (2011), which supported
the conservative strategy of WCM. Afza and Nazir (2009) investigated the traditional relationship between
working capital management policies and a firm’s profitability found the significantly negative relationship
between the profitability of firms and working capital investment and financing policies.
Smith and Begemann (1997) concluded that the profitability and liquidity comprised the salient goals
of working capital management. The problem was aroused because the maximization of the firm's returns
could seriously threaten its liquidity, and the pursuit of liquidity had a tendency to dilute returns. The
statistical test results showed that a traditional 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.

Conceptual Framework

Figure 1: Conceptual framework

ACP, APP and CR are the independent variables which affect the dependent variable ROA which
shows the profitability of the firm. ACP is the average number of days between the dates that a credit is
made to the date that money is received from customer. APP is a period in which business or firm typically
takes in paying off its purchase that have been made by credit. CR is a liquidity ratio that measures a
company’s ability to pay short term and long term obligations. The current ratio is also known as the
working capital ratio.

Research Methodology
In view of the objective of the study listed above a descriptive and analytical research design have
been adopted. A quantitative research design is used to examine the relationship between variables by using
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numbers and statistics to explain and analyze its findings. Researcher has followed scientific approach
to design the research methodology for investigation. For this study secondary data is used as a source
of information for the period of four year from 2071 to 2074 B.S. The tools used for the study is SPSS
program. The researcher picks up the techniques to suit their requirement and also basis to data available
to them. The descriptive analysis and correlation analysis technique have been used for the analysis. This
study was concerned with the relationship of working capital management on profitability. It aimed at
identifying the relationship of working capital components such as Average collection period, average
payment period and current ratio on profitability. These variables have been selected as independent variable
to analyze relationship between WCM and profitability. For this, ROA is chosen as the dependent variable.
Measurement of the variables can be calculated by the following formula

ROA=Net Income/Average Total assets

APP=Accounts payable/Cost of sales * 365
ACP=Accounts Receivable/Net sales * 365
CR=Current assets/Current Liabilities

Data presentation and analysis

The results are presented from descriptive and quantitative data analysis using SPSS. Descriptive
analysis is presented first followed by correlation analysis. It shows the mean and standard deviation of
different variables in this study. It also gives minimum and maximum values of the variables.

Table 1 Descriptive Statistics

N Minimum Maximum Mean Std. Deviation
APP 4 7.06 56.51 32.7675 20.98338
ACP 4 7.27 141.05 65.1700 55.60261
CR 4 4.74 20.59 11.7100 8.00658
ROA 4 2.44 4.10 0.32700 0.08622

Table 1 shows the summary of the variables used in the study for the annual financial data of four
year. The mean value of return on assets is 32.7% with standard deviation of 8.62%.The average payment
period is 32.7675 days with a standard deviation of 20.9833 days. Average collection period shown by the
study is 65.17 days with standard deviation of 55.60 days. The firm in the study has a current ratio of 11.71.

Correlation analysis
Table 2 shows the correlation among the observed variables in the study. A correlation coefficient
is a statistical measure of the degree to which changes to the value of one variable predict change to the
value of another variable. A positive correlation indicates the extent to which those variables increase or
decrease in parallel and a negative correlation indicates the extent to which one variable increases as the
other decreases.

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Table 2 Correlations
APP ACP CR ROA
Pearson Correlation 1
APP Sig. (2-tailed)
N 4
Pearson Correlation 0.539 1
ACP Sig. (2-tailed) 0.000
N 4 4
Pearson Correlation 0.938 0.732 1
CR Sig. (2-tailed) 0.042 0.000
N 4 4 4
Pearson Correlation 0.131 0.669 0.162 1
ROA Sig. (2-tailed) 0.000 0.000 0.000
N 4 4 4 4
*Correlation is significant at the 0.05 level (2-tailed)

The results of the Pearson correlation coefficients are presented in Table 2 for all variables included,
to assess the association between the ROA and its components CR, ACP and APP. Based on the Correlation
coefficient it is evident that ACP has a more significant relationship to Profitability measured by ROA.
Table 2 shows that correlation between ROA is low correlation with APP and moderate correlation with
ACP. The components of working capital management like ACP, APP, CR are taken in the study and
observed the relationship between them.

H1: There is significant relationship between Average Payment Period (App) and profitabil-
ity of the firm (r= 0.000<0.05).
H2: There is significant relationship between Average Collection Period (ACP) and profit-
ability of the firm (r= 0.000<0.05).
H3: There is significant relationship between Current ratio (CR) and profitability of the firm
(r= 0.000<0.05).

Conclusion
The objective of the study was to investigate the relative importance of WCM, measured by return
on assets (ROA) and its components (CR, ACP, APP) to the profitability Pukar international trading .In
descriptive analysis, the mean of APP is 32.76 days, mean of ACP is 65.10 days. Similarly mean of CR is
11.71 and ROA is 32.70%.From correlation analysis, relation between ROA and APP is low correlation
with 0.131, moderate correlation between ROA and ACP with 0.669 and finally low correlation between
ROA and CR with the value 0.162.Hence from the above correlation analysis table we found that there is
significant relationship between APP and profitability of the firm. significant relationship between ACP and
profitability of the firm was observed. Finally there is significant relationship between CR and profitability
of the firm was observed.

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