Working Capital Management and Profitability: A Study on Textiles Industry

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1 ASA University Review, Vol. 5 No. 1, January June, 2011 Working Capital Management and Profitability: A Study on Textiles Mohammad Morshedur Rahman * Abstract Textiles plays a vital role in the socio-economic development of Bangladesh. But the profitability of this industry is not satisfactory. This study is designed to show the Profitability and Working Capital position of Textiles Industries, correlation between them and whether the profitability is affected by Working Capital Management. Ratio Analysis, Correlation Matrix and Regression Analysis have been used to show Profitability, Working Capital position, correlation between them and the impact of Working Capital on Profitability respectively. For the source of data the author mainly relied on Annual Reports and official records as well as primary data collected through questionnaire. It is observed from the study that profitability and Working Capital Management position of the Textiles are not satisfactory. The study reveals that correlation exists between Working Capital Management and Profitability. The study also brings to fore that Working Capital Management has a positive impact on Profitability. Key Words: Profitability, Working Capital Management, Textile, Efficiency. Introduction A financial manager in any organization has to play three functions. These functions are (i) the management of long-term assets, (ii) the management of long-term capital and (iii) the management of short-term assets and liabilities. The management of short term assets and liabilities refers to management of Working Capital (Khan, 2002). To produce the best possible returns, the firm should keep no unproductive assets and should finance with the cheapest available sources of funds. In general, it is often advantageous for the firm to invest in short-term assets and to finance with short-term liabilities (Scherr, 2007). The Management of Working Capital plays an important role in maintaining the financial health of the firm during the normal course of business. A firm is required to maintain a balance between liquidity and profitability while conducting its day to day operations. Liquidity is a precondition to ensure that firms are able to meet their shortterm obligations and their continued flow can be guaranteed for a profitable venture (Padachi, 2006). Working Capital Management includes maintaining optimum balance of working capital components receivable, inventory and payables and using the cash efficiently for day-to-day operations. Optimization of working capital balance means minimizing the working capital * Lecturer, Dept. of Accounting Information Systems, Chittagong University

2 116 ASA University Review, Vol. 5 No. 1, January June, 2011 requirement and realizing maximum possible revenues (Ganesan, 2007). There is a strong relationship between the firm s profitability and its working capital efficiency (Shin, 1998). The term profitability refers to the ability of a firm to earn profit. Profit is determined by matching revenue against cost associated with it (Salauddin, 2001). Profit of an enterprise in absolute figure gives an idea about the result of its operation. Profitability is a widely used financial measure of performance. The concept of profitability may be used in two senses: commercial/private profitability and public profitability. Although the use of public profitability which is based on economist s notion of cost and benefits, i.e., the true opportunity cost and the benefits for the society as a whole, appears to be a more appropriate measure of performance of public enterprises, the measure of commercial profitability has been used in this study. This is because of the fact that commercial profitability is widely used to measure the performance of public enterprises in Bangladesh and even in other countries of the world like India, the UK, France etc. and also for its general acceptance and ready understandability. Two major types of profitability ratios are computed: (i) Profitability in relation to sales and (ii) Profitability in relation to investment. Gross Profit Margins (GPM), Net Operating Margin (NOM), Return on Total Assets (ROTA), Return on Equity (ROE), and Return on Investment (ROI) are the main measures of profitability. Therefore, profit is an absolute measure and profitability is a relative measure of efficiency of the operations of an enterprise. Publicly traded companies are the economic pulse of a nation. Their birth, prosperity and demise generally reflects the financial condition of the country. A fairly reliable index of an economy in its process of growth and development is the rate of growth and decline of publicly traded companies. With the rapid growth of trade, commerce and industries, the number of publicly traded companies is considerably increasing in Bangladesh. These companies play a vital role on the economy of the country. Textile is an important adjunct of industrialization in the country. Now a days textile industry is the economic pulse of Bangladesh. Its growth reflects the financial health of the country. The contribution of Textiles companies to Bangladesh economy is encouraging. The investment in this sector is increasing which indicates the potentiality of this sector. There are 39 listed Textile Companies in Dhaka Stock Exchange ( and 33 listed in Chittagong Stock Exchange ( Analyzing the Industrial Life Cycle, it is found that all of the listed companies just have reached the middle stage. No company could yet reach the maturity stage. In a word, textile industry of the country is just improving. This sector satisfies the demand of the local market and also exports to international market. Recent evidences show that the performance of this sector is not satisfactory as compared to the performance of other manufacturing sectors. Against this backdrop an attempt has been made to examine the reasons of poor performance of textiles sector and to explore whether the poor performance is the result of poor Working Capital Management. The researcher has used correlation matrix and regression analysis to examine the relationship between profitability and working capital management. Some statistical tools like mean, standard deviation and co-efficient of variance were used to evaluate the performance.

3 Working Capital Management and Profitability 117 Objectives of the study The major objective of the present study is to examine and evaluate the correlation between Working Capital Management and Profitability in textile industry over a period of three years from 2006 to The specific objectives of the study are as follows i. To examine the profitability position of the selected textiles industries. ii. To examine the management of cash, inventory and accounts receivable of selected textiles industries iii. To assess the current liability positions and the efficiency with which the overall working capital is being managed. iv. To assess the relationship between working capital management and profitability. v. To suggest some measures for improvement in working capital management. Literature review Extensive research works on working capital management have been done in both public and private sectors including multinational companies in Bangladesh. Sayaduzzaman (2006) in his article on Working Capital Management: A study on British American Tobacco Bangladesh Company Limited mentions that the efficiency of working capital management of British American Tobacco Bangladesh Company Ltd. is highly satisfactory due to the positive cash inflows and planned approach in managing the major elements of working capital. He found that working capital management helps to maintain all around efficiency in operations. In the article Liquidity-Profitability Tradeoff: An Empirical Investigation in an Emerging Market, Eljelly (2004) examined the relation between profitability and liquidity by using correlation and regression analyses and found that the cash conversion cycle was of more importance as a measure of liquidity than the current ratio that affects profitability. Raheman (2007) studied the effect of different variables of working capital management including the Collection Period, Inventory Turnover in Days, Payable Period, Cash Conversion Cycle and Current Ratio on the Net Operating Profitability of Pakistani Firms. By using Pearson s correlation and regression analysis he found that there was a strong negative relationship between variables of Working Capital Management and Profitability. He also finds that as the cash conversion cycle increases, it leads to decrease in profitability of the firm and managers can create a positive value for the shareholders by reducing the cash conversion cycle to a possible minimum level. Islam & Rahman (1994) conducted a study on working capital trends of enterprises in Bangladesh. They find that optimum working capital enables a business to have its credit standing and permits the debts payments on maturity date and helps to keep itself fairly in liquid position which enables the business to attract borrowing from the banks. Deloof (2003) surveyed on Belgian Firms to find out whether the working capital management affects profitability. He found that most firms had a large amount of cash invested in working capital. It can be expected that the way in which working capital is managed, will have a significant impact on the profitability of those firms. Using correlation and regression tests he found a significant negative relationship between corporate profitability and number of days

4 118 ASA University Review, Vol. 5 No. 1, January June, 2011 accounts receivable, inventories and accounts payable of Belgian firms. On the basis of these he suggested that manager could increase corporate profitability 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. Padachi (2006) find in his research study that a firm is required to maintain a balance between liquidity and profitability while conducting its day to day operations. The manager of a business entity is in a dilemma of achieving desired trade-off between liquidity and profitability in order to maximize the value of a firm. Lazaridis and Tryfonidis (2006) investigated relationship between working capital management and corporate profitability of listed companies in the Athens Stock Exchange. The results of the article showed that there was a statistically significant relationship between profitability and cash conversion cycle. Moreover managers could create profits for their companies by handling correctly the cash conversion cycle and keeping each different components (accounts receivables, accounts payables, inventory) to an optimum level. Ganesand (2007) suggest that efficient working capital management increases firms free cash flow, which in turn increases the firms growth opportunities and return to shareholders. Chowdhury and Amin (2007) have written an article on Working Capital Management Practices in Pharmaceutical Companies Listed in DSE. Among all the problems of financial management, the problems of working capital management have probably been recognized as the most crucial one. It is because of the fact that working capital always helps a business concern to gain vitality and life strength and to maximize profit. Shin and Soenen (1998) suggested that efficient working capital management was very important for creating value for the shareholders. The way working capital was managed had a significant impact on both profitability and liquidity. Using correlation and regression analysis they justified the relationship between the length of net trading cycle, corporate profitability and risk adjusted stock return. They found a strong negative relationship between lengths of the firm s net trading cycle and its profitability. In addition, they also found that shorter net trade cycles were associated with higher risk adjusted stock returns. Methodology of the study Data were obtained from a sample of 9 Textiles in Bangladesh. For the study only A and B Category Textiles were considered. Moreover, the size of the Textiles, availability of information, and year of establishment were also considered for selecting the sample Textiles. The study covered a period of three years from to This study was based on both primary and secondary data. The primary data were collected through questionnaire survey with an object to know the real practices of working capital management in Textiles of Bangladesh. The questionnaire was divided into four parts in accordance with the major dimension of working capital management: Working Capital Management, Cash Management, Inventory Management, Accounts Receivable Management and others. The questionnaire had 41 questions, which were open and close ended in nature. Secondary time series data were taken to see the profitability and the link between profitability and working capital management. For that the published annual

5 Working Capital Management and Profitability 119 reports of the selected Textiles Mills Limited for the study period were considered. Moreover extensive literature survey was done by searching different libraries. The collected data were analyzed and interpreted with the help of different financial ratios, statistical tools like, Standard Deviation (S.D.), Correlation Coefficient etc. With the help of SPSS, Correlation Matrix and Regression analysis were also forced out for analysis. Findings and Discussions There are four parts in this section. The first part shows the profitability position of the Textiles. In the second part the position of working capital is analyzed. The third part focuses on correlation between profitability and working capital management and the last part showed the impact of working capital management on profitability. Profitability of the selected textiles Profitability of the textiles can be assessed by gross profit margin ratio, net profit ratio, return on investment, operating profit ratio, return on capital employed and return on total assets. The table- 01depicts various profitability ratios of the selected textiles for the period under study. Gross Profit Margin The earnings in terms of sales can be assessed through the profit margin. The gross profit margin reflects the effectiveness of pricing policy and of production efficiency. Some authors consider that a profit margin ratio ranging from 20% to 30% may be considered as the standard norm for any industrial enterprise. The table-01 shows that the average gross profit ratios range from highest 34.43% in BL to lowest 9.42% in DGL. From the study it is found that the industry average gross profit ratio is % and the average gross profit ratio of all but five samples is below industry average. Variation of gross profit over the years is negligible except in two sample companies (STL and BL), which speaks about the stability of gross profit earning of this sector. Net Profit Margin The ratio of net profit margin reveals the overall profitability of the concern, that s why it is very useful to the shareholders and the prospective investors. It also indicates management efficiency in manufacturing, administrating and selling of the products. The table-01 shows that the net profit ratios range from highest 10.75% in STL to lowest %( negative) in BL. STL earned the highest average net profit margin (10.75%) and industry average is 1.35%. The calculated net profit margin ratios in table-01 are all very low except STL, STML, PTSML and HRTML. Lower profitability position refers to the company s failure to achieve satisfactory return on owner equity. It also indicates that the level of efficiency of the samples is low. The position of BL is negative. The co-efficient of variation of net profit ratios of the samples reveals that the variation of net profit over the years is negligible except two sample companies (STL and BL) which speaks about the stability of net profit earning of this sector.

6 120 ASA University Review, Vol. 5 No. 1, January June, 2011 Table: 01 Profitability Ratios of Selected Textiles Industries Ratios MDSPL STL STML BL PTSML DGL MSL HRTML AIL Year Gross Profit Margin Net Profit Margin Return on Investment Operating Profit Ratio Return on Capital Employed Return on 1.61 Total Assets (4.010) (23.30) (12.79) (13.36) (1.39) (6.74) (3.19) (3.77) (2.32) (14.9) (5.35) (7.52) (1.39) (6.74) (3.19) S. D.C. V. S. D.C. V. S. D.C. V S. D.C. V S. D.C. V (3.77) S. D.C. V Source: Annual Report and Official Records of the selected Textiles Enterprises ( to )

7 Working Capital Management and Profitability 121 Return on Investment (ROI) This ratio measures the profitability of enterprise on total investment. The Planning Commission, the Government of Bangladesh, has declared that the entire existing project in the public sector would have to guarantee a fixed return of 7.5% of the investment. The table-01 shows that the return on investment on an average for the period under study varies from maximum 19.48% in STL to minimum 0.70% in AIL and the industry average is 6.67% which is lower than the standard norm of 7.5%. The ratio for BL is negative. It is seen from the table that MDSPL, BL, PTSML, DGL, HRTML and AIL have a low ratio as compared to the industry average and standard norm, which is indicative of poor earning in terms of investment, the return on investment for STL (24.38%), STML (14.39%) and MSL (11.16%) being considered as extremely satisfactory as compared with industry average ratio as well as the standard norm. The co-efficient of variation of return on investment ratios of the samples reveals that the variation of return on investment over the years is negligible except in two sample companies (STL and MSL) which speaks about the stability of return on investment in this sector. Operating Profit Ratio It represents the overall earnings of an enterprise and one can get a clear idea about the efficiency of an enterprise from its operating profit ratio. The higher the ratio, the better is the overall efficiency of the enterprise. Operating profit ratio ranging from 4% to 6% is considered the norm for the purpose of comparison and control by some authors. The table-01 shows that the average operating profit ratio of the sample textiles ranges from the highest 29.02% in BL to the lowest 0.41% in DGL. The industry average operating profit ratio is 10.72% and most of the companies (5 out of 9) failed to attain the average but most of the companies (4 out of 9) operating profit ratio is more than standard. As to variation of operating profit over the years, it is revealed by the coefficient of variance that the variation ranges from 0.033% in DGL to % in BL. The coefficient of variance of % and % indicates inconsistency in the overall earnings of STL and BL. The negligible variation of 0.631% in MDSPL, 2.126% in STML, 1.659% in PTSML, 0.033% in DGL, 3.553% in MSL, 0.130% in HRTML and 0.520% in AIL, indicate extremely desirable stability position. Return on Capital Employed It reflects the overall efficiency with which capital is used. A rate of return ranging from 11% to 12% on Capital employed may be considered as reasonable for a selected enterprise. The table-01 shows that the average returns on capital employed ranges from 1.46% in AIL to 13.79% in STL and the average ratio is negative for BL (-7.52%). It appears from the table that the industry average return on capital employed is 3.59% which is not satisfactory in terms of the standard norm. It is seen from the table that only STL has a high ratio as compared with standard norm, STML, DGL, MSL and HRTML have a high ratio as compared to industry average. MDSPL, BL, PTSML and AIL have a ratio lower than industry average, which is indicative of poor earning in terms of capital employed. It appears from the table that BL has the highest variation (43.107%)

8 122 ASA University Review, Vol. 5 No. 1, January June, 2011 and MSL has the second highest variation (27.971%) as indicated by the coefficient of variation which indicates extreme instability in their earnings. The variation of this ratio for MDSPL (0.046%), STL (7.491%), STML (0.946%), PTSML (4.113%), DGL (2.369%), HRTML (0.575%) and AIL (0.033%) should be considered satisfactory. The lower ratios dictate that management should be more efficient in using the long term fund of owners and creditors. Return on Total Assets This ratio is calculated to measure the profit after the tax against the amount invested in total assets to ascertain whether assets are being utilized properly or not. Some authors consider 10% to 12% rate of return on total assets as reasonable norm for profitable firms and this may be considered as reasonable norm for the selected enterprises. Table -01 shows that the average return on total assets ranges from 0.59% in AIL to 7.42% in STL and the average return on total assets for BL is negative (-3.77%). It is seen from the table that the average return on total assets is % which is far away from standard norm. The average returns on total assets of all textiles are below the standard norm which cannot be considered as satisfactory and desirable. The average return on total assets of DGL (0.70%), BL (-3.77%), MSL (1.28%) and AIL (0.59%) are below the industry average. The calculated ratios show a decreasing trend for most of the textiles during the period of study and the lower ratios indicate the assets were not being utilized properly during the period. In the context of variation of this ratio over the years, it is found that the variation is almost stable. From the profitability ratios it is clear that the performance of the sample Textiles Enterprises is not satisfactory. Working Capital Management position of the selected textiles industries Working Capital position of textiles can be assessed by current ratio, quick ratio, net working capital to total assets, net working capital turnover, inventory turnover, debtors turnover and current assets turnover. Table-02 shows the working capital position of the selected textiles. Current Ratio This ratio is a measure of the firm s short term solvency. It indicates the ability of the company to meet its current obligations. Some authors consider 2:1 as standard norm for current ratio. Table- 02 shows that the industry average current ratio is 0.94:1 which indicates that the industry is not able to meet its current obligations from its current assets. The average current ratio ranges from in MSL to 1.12:1 in STL. The average current ratios of DGL (0.61:1), MSL () and AIL (0.85:1) are below the industry average as well as below the standard norm. The average current ratios of MDSPL (1.08:1), STL (1.12:1), STML (1.10:1), BL (1.06:1), PTSML (1.08:1) and HRTML (0.98:1) are above the industry average but below the standard norm. It is seen from the table that all these ratios are far from standard norm. Therefore it can be said that the liquidity in terms of current ratio had been quite inadequate in all the years under study for all the textiles. From the coefficient of variation it is clear that the variation of current ratio over time is negligible.

9 Working Capital Management and Profitability 123 Liquid (Quick or Acid Test) Ratio It measures the firm s ability to meet short term obligations from its most liquid assets. Table-02 shows that the industry average of liquid ratio is which is very lower than the standard (1:1) ratio. The table reveals that the average liquid ratio ranges from 0.29:1 in STML and in DGL to 1.28:1 in MDSPL. The average liquid ratios of STML (0.29:1), PTSML (0.55:1), DGL (0.29:1), MSL (0.38:1) and AIL (0.43:1) are below the industry average as well as far away from the standard norm. The average ratios of STL (0.64:1), BL (0.59:1), HRTML (0.70:1) are above the industry average but below the standard norm. It indicates that all Textiles Enterprises except MDSPL are financially very weak and have no ability to pay its most immediate liabilities. It is also observed that this position is declining for most of the Textile Enterprises and it is a dangerous signal for the companies. In the context of variation of this ratio over the years, it is found that the variation is almost stable. Table: 02 Working Capital Position of Selected Textiles Ratios MDSPL STL STML BL PTSML DGL MSL HRTML AIL Year Current Ratio 1.26:1 1.51:1 1.05:1 1.09:1 0.98:1 1.13:1 1.27:1 0.98:1 1.09:1 1.08:1 0.70:1 0.60:1 0.58:1 0.56:1 0.98:1 0.97:1 0.98:1 0.90:1 Quick Ratio Net Working Capital to Total Assets (in time) Net Working Capital Turnover 1.74:1 1.08:1 0.94: :1 1.31:1 1.47:1 1.28: (0.005) (0.0099) (178.1) (49.71) (254.9) :1 1.12:1 0.94: :1 0.66:1 0.69:1 0.64: (0.0099) (254.9) :1 1.10:1 0.94: :1 0.34:1 0.18:1 0.29: (0.007) (0.0099) (100.2) (25.79) (254.9) :1 1.06:1 0.94: :1 0.52:1 0.59: (0.012) (0.035) (0.0099) (24.17) (7.14) (3.96) (254.9) :1 1.08:1 0.94: :1 0.66:1 0.49:1 0.55: (0.0099) (254.9) :1 0.61:1 0.94: :1 0.23:1 0.33:1 0.29: (0.233) (0.307) (0.348) (0.296) (0.0099) (8.54) (6.94) (5.75) (7.08) (254.9) :1 0.94: :1 0.37:1 0.34:1 0.34: (0.0003) (0.0004) (0.0004) (0.0004) (0.0099) (2400) (2100) (1850) (2116) (254.9) :1 0.98:1 0.94: :1 0.76:1 0.74:1 0.70: (0.008) (0.014) (0.012) (0.012) (0.0099) (112.5) (62.14) (100.82) (91.82) (254.9) :1 0.85:1 0.94: :1 0.50:1 0.32:1 0.43: (0.008) (0.05) (0.18) (0.079) (0.0099) (112.5) (28.0) 7.06 (44.48) (254.9) S. D.C. V. S.D.C.V. S.D.C.V. S.D.C.V.

10 124 ASA University Review, Vol. 5 No. 1, January June, 2011 Inventory Turnover Debtors Turnover Current Assets Turnover Source: Annual Report and Official Records of the selected Textiles Enterprises ( to ) S.D.C.V. S.D.C.V. S.D.C.V. Net Working Capital to Total Assets It is seen from the table-02 that the industry average of net working capital to total assets ratio is :1. The table reveals that the average net working capital to total assets ratios of MDSPL (0.0383), STL (0.0543), STML (0.0403), BL (0.0247), PTSML (0.0247) and AIL (0.0407) are higher than industry average and the average ratios of DGL ( ), MSL ( ), HRTML ( ), are lower than industry average and the figures are negative. From the calculated ratios it is clearly seen that the net working capital to total assets ratios is very small and for three sample Textiles the ratio is negative. Such state of affairs indicates the inability and inadequacy of net working capital to the total assets of the selected enterprises for the period under review. Inventory Turnover Ratio A low inventory turnover may indicate an excessive investment in inventories, a high ratio often means that the firm is running short of stock, resulting in poor service to customers. Higher the ratio the better it is because it shows that the stock is rapidly turned over. The table-02 shows that the industry average inventory turnover is 6.45 times. It is seen from the table that the average inventory turnover ratio ranges from 1.47 times in BL to times in MDSPL. Some authors consider 8 to 9 times of inventory turnover ratio as the reasonable norm for an efficient concern. From the study it is seen that the average inventory turnover for all selected textiles except three textiles, MDSPL(19.99 times), DGL (9.52), HRTML (8.13), is lower than the industry average as well as standard norm which implies excessive inventory levels or a slow moving or obsolete inventories. This will adversely affect the working capital and the liquidity position of the firm. The calculated ratios indicate that the sale management of the selected Textiles is not efficient enough to sell its products.

11 Working Capital Management and Profitability 125 Debtors Turnover Accounts receivable turnover ratio or debtors turnover ratio indicates the number of times the debtors are turned over in a year. The higher the value of debtors turnover the more efficient is the management of debtors or more liquid the debtors are. Similarly, low debtors turnover ratio implies inefficient management of debtors or less liquid debtors. Table-02 shows that the average debtors turnover ratio ranges from 1.34 times in BL to times in DGL. The lower ratio for STL, BL, PTMSL, MSL and HRTML reveals that the management of debtors is inefficient and the situation is good for MDSPL, STML, DGL and AIL. From the coefficient of variance it is observed that the variance is negligible for all the textiles. Current Assets Turnover The average Current Assets Turnover ratio varied between 0.63 times in BL and 2.92 times in MDSPL during the study period. This ratio indicates that, on an average, the firm has generated sales of taka 2.24 with the current assets worth taka 1.00 and this is indeed a very low ratio in comparison with the standard norms of the industry. Moreover current assets worth taka 1.00 has been able to generate only taka 0.63 for BL. This is obviously a frustrating picture of inefficient utilization of current assets of the firm. Correlation Analysis The correlation between Working Capital Management and Profitability of the selected textiles can be assessed through Pearson s Correlation Coefficient. Table: 03: Pearson Correlation Coefficient on Efficiency in Working Capital and Profitability 9 Textiles, Current Ratio Quick Ratio 2008: 27 Firm Year Observations Gross Net Profit Return on Profit Margin Investment Margin Operating Profit Ratio Return on Capital Employed Return on Total Assets Current Ratio Quick Ratio Gross Profit Margin ** Net Profit Margin * ** 0.964** Return on Investment ** 0.845** Operating Profit Ratio Return on Capital Employed Return on Total Assets 1 *Correlation is significant at the 0.05 level (2-tailed). **Correlation is significant at the 0.01 level (2-tailed) ** Table 03 shows the relationship between the efficiency of working capital and profitability of selected textiles for the study period. The efficiency of working capital has been shown through the current and quick ratios of the textiles. It has been found that the current ratio of the selected textiles was negatively related with return on capital employed, but positively related with other profitability variables considered in this analysis. On the other hand, quick ratio of the selected textiles was negatively related with gross profit margin, return on investment, operating profit

12 126 ASA University Review, Vol. 5 No. 1, January June, 2011 ratio and return on capital employed, but positively related with the rest of the profitability variables. Though there are relationship existing within the efficiency of working capital and the profitability, yet these relationships are not statistically significant. Table 04: Pearson Correlation Coefficient on Earnings and Activity Level 9 Textiles, : 27 Firm Year Observations Gross Profit Net Profit Return Debtors Current Turnov- Assets Margin Margin er Return on Investment Operating Profit Ratio on Capital Employed Return on Total Assets Net working capital to total assets Net Working Capital Turnover Inventory Turnover Turnover Gross Profit Margin * Net Profit Margin Return on Investment Operating Profit Ratio Return on Capital ** Employed Return on Total Assets Net working capital to total assets Net Working Capital Turnover Inventory Turnover Debtors Turnover Current Assets 1 Turnover *Correlation is significant at the 0.05 level (2-tailed). **Correlation is significant at the 0.01 level (2-tailed) Table 04 shows the relationship between the efficiency ratio and the profitability ratio of the selected textiles for the study period. Current Assets Turnover is negatively related with Gross Profit Margin, Net Profit Margin and Return on Total Assets but positively related with return on Investment, Operating Profit Ratio and Return on Capital Employed. These relationships are not statistically significant. Debtors Turnover ratio is positively related with Gross Profit Margin, Net Profit Margin, Operating Profit Ratio and Return on Total Assets but negatively related with Return on Investment and Return on Capital Employed and these relationships are not statistically significant. Inventory Turnover is positively related with Return on Investment and Return on Capital Employed but negatively related with all other profitability variables. The relationship between Inventory Turnover and Gross profit Margin is statistically significant and the rest are not statistically significant. Net Working Capital Turnover is positively related with Return on Investment and Operating Profit but negatively related with the rest profitability variables and these relationships are not statistically significant. Net Working Capital to Total Assets ratio is positively related with Return on Investment and Return on Capital Employed but negatively related with the rest profitability variables and these relationships are not statistically significant. Econometric Modeling In this section the researcher has constructed a model that indicates the impact of working capital policy on the overall profitability (Return on Total Assets) of the textiles. For this purpose the secondary time series data have been used. In this model an attempt has been made to trace out

13 Working Capital Management and Profitability 127 the impact of overall working capital policy on the textiles ROA. The researcher has selected a number of variables to construct the model and finally settled with the following best variables on the basis of their partial correlation coefficient. Thus the model is: ROA=f (ARD, APD, INVD, CCCD, CASA, CLTA) ROA it =β 0 +β 1 ARD it +β 2 CASA it +β 3 CLTA it +є it ROA it =β 0 +β 1 INVD it +β 2 CASA it +β 3 CLTA it +є it ROA it =β 0 +β 1 APD it +β 2 CASA it +β 3 CLTA it +є it ROA it =β 0 +β 1 CCCD it +β 2 CASA it +β 3 CLTA it +є it Here the subscript i denotes textiles ranging from 1 to 27 and t denotes years (time series dimension) ranging from 1 to 3. The variables are ROA= Return on Total Assets, ARD= Accounts Receivable Turnover in Days, APD= Accounts Payable Turnover in Days, INVD= Inventory Turnover in Days, CCCD= Cash Conversion Cycle in Days, CASA= Current Assets to Sales, CLTA= Current Liabilities to Total Assets. After applying partial correlation coefficient the model is: ROA it = ARD it -0.04CASA it -0.04CLTA it +є it ROA it = INVD it +0.02CASA it -0.05CLTA it +є it ROA it = APD it -0.05CASA it -0.02CLTA it +є it ROA it = CCCD it +0.04CASA it -0.02CLTA it +є it Table: 05 Model Summary b Std. Error Change Statistics Model R R Square Adjusted R Square of the Estimate R Square Change F Change df1 df2 Sig.F Change Durbin- Watson a a. Predictors: (Constant), INVD, CLTA, CASA b. Dependent Variable: ROTA The adjusted R-square of the model indicates 33.5% variation in ROA of textiles industry that can be explained by the regression model. The unexplained part of the model is the error term. The Durbin-Watson test indicates that there exists no auto-correlation in the model in which the value of D-W statistic is Model 1 (Constant) CASA CLTA INVD Table:06 Coefficients a Unstandardized Coefficients Standardized Coefficients B Std. Error Beta t Sig a. Dependent Variable: ROA The above table indicates the coefficient of the regression equation. From the table it can also be inferred that the variables have a coefficient that are significant at d.f. =8 with 1% level of significance. Another thing is that the variables in the model are free from Multicollinearity.

14 128 ASA University Review, Vol. 5 No. 1, January June, 2011 Table:07 Model Summary b a. Predictors: (Constant), ARD, CLTA, CASA b. Dependent Variable: ROTA The adjusted R-square of the model indicates 23.1% variation in ROA of textiles industry that can be explained by the regression model. The unexplained part of the model is the error term. The Durbin-Watson test indicates that there exists no auto-correlation in the model in which the value of D-W statistic is Table:08 Coefficients a Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta 1 (Constant) CASA CLTA ARD a. Dependent Variable: ROA t Sig The above table indicates the coefficient of the regression equation. From the table it can also be inferred that the variables have a coefficient that are significant at d.f. =8 with 1% level of significant. Another thing is that the variables in the model are free from Multicollinearity. Table: 09 Model Summary b Std. Error Change Statistics Model R R Square Adjusted R Square of the Estimate R Square Change F Change df1 df2 Sig.F Change Durbin- Watson a Std. Error Change Statistics Model R R Square Adjusted R Square of the Estimate R Square Change F Change df1 df2 Sig.F Change Durbin- Watson a a. Predictors: (Constant), APD, CLTA, CASA b. Dependent Variable: ROTA The adjusted R-square of the model indicates 32.1% variation in ROA of textiles industry can be explained by the regression model. The unexplained part of the model is the error term. The Durbin-Watson test indicates that there exists no auto-correlation in the model in which the value of D-W statistic is Table:10 Coefficients a Model 1 (Constant) CASA CLTA APD a. Dependent Variable: ROA Unstandardized Coefficients Standardized Coefficients B Std. Error Beta t Sig

15 Working Capital Management and Profitability 129 The above table indicates the coefficient of the regression equation. From the table it can also be inferred that the variables have a coefficient that is significant at d.f. =8 with 1% level of significant. Another thing is that the variables in the model are free from Multicollinearity. Table: 11 Model Summary b Std. Error Change Statistics Model R R Square Adjusted R Square of the Estimate R Square Change F Change df1 df2 Sig.F Change Durbin- Watson a a. Predictors: (Constant), CCCD, CLTA, CASA b. Dependent Variable: ROTA The adjusted R-square of the model indicates 42.5% variation in ROA of textiles industry that can be explained by the regression model. The unexplained part of the model is the error term. The Durbin-Watson test indicates that there exists no auto-correlation in the model in which the value of D-W statistic is Table:12 Coefficients a Unstandardized Coefficients Standardized Coefficients Model B Std. Error Beta t Sig. 1 (Constant) CASA CLTA INVD a. Dependent Variable: ROA The above table indicates the coefficient of the regression equation. From the table it can also be inferred that the variables have a coefficient that are significant at d.f. =8 with 1% level of significant. Another thing is that the variables in the model are free from Multicollinearity. Conclusion Considering the coefficients and their significance level, it can be concluded that in Textiles, the nature of working capital policy ( CA to Sales), financing of working capital (CL to TA), inventory holding period (Inventory Turnover in Days), Accounts Receivable Collection Period (Accounts Receivable Turnover in Days), Accounts Payable Period ( Accounts Payable Turnover in Days), and Cash Conversion Cycle in Days play an important role in determining textiles overall profitability Return on Total Assets (ROTA). From the correlation matrix it is clear that there is positive correlation between working capital efficiency and profitability ratios of the selected textiles with some exceptions where the correlation is negative. From the profitability ratios it is clear that the performance of the selected textiles under the study period is not satisfactory. On the other hand, from the working capital ratios it is clear that the working capital position is not also satisfactory. From the regression and correlation analysis it can be concluded that the poor management of working capital is one of the important causes for poor performance or poor profitability position of the selected textiles under the study period.

16 130 ASA University Review, Vol. 5 No. 1, January June, 2011 Textiles play a vital role in the economic development of the country. It is found from the study that the working capital management of textiles industry in inefficient. This is evident from the study that working capital plays an important role in the overall performance of the industry. Findings from the questionnaire indicate that the sample textiles have been inefficient in managing cash, accounts receivable, inventories and accounts payables. The liquidity position of the selected textiles is not satisfactory due to poor turnover of Current Assets, Inventory, Debtors and Cash Balances. The collection of receivables is not good due to inefficient credit and collection policy. The textiles should be cautious in formulating working capital policy. However, in view of the concluding remarks, the following suggestions are given for increasing efficiency in working capital management as well as profitability on the basis of the analysis as well as information gathered through questionnaire: a. Monthly performance evaluation should be done as maximum textiles under the study evaluate the same. b. Inventory should be turned out quickly. c. Fund flow statement should be prepared periodically. d. Cost audit should be done continuously. e. For cash management, cash budget, cash flow statement, cost minimizing model like Baumol Model, Miller-Orr, etc. Model should be used. f. Lead time should be reduced. g. Account Receivable turnover in days should be reduced. h. Inventory turnover in days should be reduced. i. Cash Conversion Cycle is said to be the heart of working capital management. The study reveals that the cash conversion cycle should be reduced. j. Investment in Current Assets should be increased. k. Current Liabilities should be reduced. l. For most of the selected textiles the net working capital is negative. It should be improved. m. Liquidity management should be more organized.

17 Working Capital Management and Profitability 131 References Chowdhury, A. and Amin, M.M (2007). Working Capital Management Practiced in Pharmaceutical Companies Listed in Dhaka Stock Exchange. Brac University Journal, Vol. iv, No. 2, pp Deloof, M. (2003). Does Working Capital Management Affect Profitability of Belgian Firms?, Journal of Business Finance & Accounting, Vol.30, No. 3 & 4, pp Eljelly,A. (2004). Liquidity-Profitability Tradeoff: An Empirical Investigation in an Emerging Market, International Journal of Commerce and Management, Vol. 14, No. 2, pp Ganesan, V. (2007). An Analysis of Working Capital Management Efficiency in Telecommunication Equipment, Rivier Academic Journal, Vol. 3, No. 2, pp 1-3. Lazaridis, I. and Tryfonidis, D. (2006). Relationship between Working Capital Management and Profitability of Listed Companies in the Athens Stock Exchange, Journal of Financial Management and Analysis, Vol. 19, No. 1, pp Padachi, Kesseven (2006). Trends in Working Capital Management and Its Impact on Firm s Performance: An analysis of Mauritian Small Manufacturing Firms, International Review of Business Research Papers, Vo. 2 No. 2 (October), pp Raheman, A. and Nasr, M. (2007). Working Capital Management and Profitability- Case of Pakistani Firms, International Review of Business Research Papers, Vol.3, No. 1, pp Salauddin, D. A. (2001). Profitability of Pharmaceutical Companies of Bangladesh The Chittagong University Journal of Commerce, Vol.16, pp. 54. Scherr, F. C. (2007). Modern Working Capital Management, Prentice-Hall International, Inc. pp Shin, H. H. and Soenen, L. (1998). Efficiency of Working Capital and Corporate Profitability, Financial Practice and Education, Vol. 8, No. 2, pp Syaduzzaman, M. (2006). Working Capital Management: A Study on British American Tobacco Bangladesh Company Limited, The Journal of Nepalese Business Studies, Vol. III, No. 1, pp Appendix Table:13 List of the Selected Textiles Name of the Textiles Modern Dying and Sceen Printing Ltd. Square Textiles Ltd Saiham Textiles Mills Ltd Bextex Ltd. Prime Textiles and Spinning Mills Ltd. Desh Garments Ltd. Metro Spinning Ltd. H.R. Textiles Mills Ltd. Alltex Industries Ltd. MDSPL STL STML BL PTSML DGL MSL HRTML AIL

18 132 ASA University Review, Vol. 5 No. 1, January June, 2011 Table: 14 Working Capital Position of Selected Textiles Ratios MDSPL STL STML BL PTSML DGL MSL HRTML AIL Year Accounts Receivable Days Accounts Payable Days Inventories Days Cash Conversion Cycle CA to Sales or Gross WC to Sales CL to TA Source: Annual Report and Official Records of the selected Textiles Enterprises ( to ) S. D. C. V S. D. C. V S. D. C. V S. D. C. V S. D. C. V S. D. C. V

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