21-06-2013, 04:55 PM
The Effect Of Working Capital Management On Firm’s Profitability: Empirical Evidence From An Emerging Market
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ABSTRACT
In this study, we empirically investigate the effect of working capital management on firm’s
financial performance in an emerging market. We hypothesize that working capital management
leads to improved profitability. Our data set consists of firms listed in the Cyprus Stock Exchange
for the period 1998-2007. Using multivariate regression analysis, our results support our
hypothesis. Specifically, results indicate that the cash conversion cycle and all its major
components; namely, days in inventory, days sales outstanding and creditors payment period - are
associated with the firm’s profitability. The results of this study should be of great importance to
managers and major stakeholders, such as investors, creditors, and financial analysts, especially
after the recent global financial crisis and the latest collapses of giant organizations worldwide.
INTRODUCTION
he recent global financial crisis and the collapses of colossal organizations such as General Motors,
Lehman Brothers, Bear Stearns, among others, brought to the forefront of capital markets research
the importance of management of organizational resources, and especially working capital
management. Working capital is described as the capital available to meet the day-to-day operations, and depending
on the industry, it could be a relatively high percentage of the total assets of the organization. Executives have been
emphasizing the efficient utilization of firm’s resources since there is a belief that it has an effect on the firm’s
financial performance, but there has been little empirical evidence on this specific issue (Ricci and N. DiVito, 1998;
Garcia-Teruel and Martinez Sonano, 2007; Hill et al., 2010).
LITERATURE REVIEW
Prior studies reported that working capital management may have an important effect on the firm’s
profitability. Shin and Soenen (1998), Lazaridis and Tryfonidis (2006), Raheman and Nasr (2007), among others,
measured working capital with cash conversion cycle, which consists of stockholding period, debtors’ collection
period and creditors’ payment period. These researchers supported that greater investment in working capital (the
longer cash conversion cycle) leads to reduction in the firm’s profitability (Banos-Caballero et al, 2010, and Nazir
and Afza, 2003, 2009).
Deloof (2003) used a sample of Belgian firms and found that firms can increase their profitability by
reducing the debtors collection period and the days-in-inventory period. He also found that less profitable firms wait
longer to pay their bills. Wang (2002) used a sample of Japanese and Taiwanese firms and found that a shorter cash
conversion cycle would lead to a better firm’s operating performance. Teruel and Solano (2007) took samples of
small to medium-sized Spanish firms for the 1996-2002 period and found that the firms can create value by reducing
the days-in-inventory period and the debtors collection period, thus leading to the reduction in the cash conversion
cycle.
CONCLUSIONS
The recent global financial crisis brought to the forefront of research the efficient utilization of firm’s
resources. Better utilization of resources leads to value creation. In this study, we empirically investigated the effect
of working capital management on firm’s financial performance in an emerging market. We hypothesized that
working capital management leads to improved profitability. Using a sample of 43 firms listed on the Cyprus Stock
Exchange for the period 1998-2007, our multivariate regression analysis results indicated that the cash conversion
cycle and all its major components; namely, days in inventory, days sales outstanding and creditors payment period,
are associated with firm’s profitability.