investigating the relationship between working capital ...ashm-journal.com/test/vol2-6/12.pdf ·...

Applied mathematics in Engineering, Management and Technology 2 (6) 2014:74-83

www.amiemt-journal.com

74

ABSTRACT:

This study has paid to investigate the relationship between working capital

management and net trade cycle, with the profitability of listed companies in Tehran

Stock Exchange. To this end, were selected 130 companies during the period 2007-

2011. In this connection, we have studied the components of working capital,

including cash conversion cycle and net trade cycle, with return on assets, return on

sales and return on equity firms. Company size (as measured by the natural

logarithm of sales) and financial leverage has been used as a control variable. For

the analysis, was used a panel of multiple regressions - data. The results show that

there was no significant relationship between cash conversion cycle and return on

equity. But there is an inverse relationship between the cash conversion cycle and

return on assets and return on sales. There is also a significant inverse relationship

between net trade cycle, with the indicators of profitability (return on assets, return

on sales, return on equity). The results show that if the cash conversion cycle and

net trade cycle rise led to a decline indexes in corporate profitability and managers can reduce the cash conversion cycle

and net trade cycle minimum level may produce a positive value for shareholders.

Keywords: working capital management, profitability, cash conversion cycle, net trade cycle.

1.Introduction

More than a hundred years of financial management as a scientific discipline has undergone major

developments and every day has become more widespread, and various areas to become more specialized, and

continue to play its role in organizations. In the past century, manufacturing companies produce large

quantities of goods in quantity and they make huge profits. This will gradually be used in financial

management, planning and control problems, especially in terms of liquidity power and working capital

management to become a specialist sector entity and many managers spend their time the daily full of energy

and manage their working capital (Vakili Fard et al., 2010). The economic world is rapidly changing. Keep

pace with rapid technological change, increasing global competition, the heavier will be the responsibility of

managers in their activities. One of the basic activities of the management decisions. There is in all fields of

financial decision making problem, and this is no exception of working capital management (Rahnamay

Rudposhti and Kiani, 2008). In the present study, which is conducted in the field of financial management,

attempts to use the concepts and theories of financial management, library research, the relationship between

working capital management and profitability are examined and explained in firms listed in Tehran Stock

Exchange.

2.Problem Statement

Working capital management is considered one of the important fields of financial management, organizational

management, because it directly affects the liquidity and profitability of the company. There is the possibility of

bankruptcy for firms that are exposed to the mismanagement of working capital, even if positive profits.

Working capital management is related assets and current liabilities. Current assets of a company, makes up a

significant part of its total assets. Excessive levels of current assets can lead to the realization of the return on

Investigating the Relationship between Working Capital

Management and Net Trade Cycle, with the Profitability: Evidence

from Tehran Stock Exchange

Hadi Yahyaee

*1, Abbasali Pouraghajan

2

1Department of Accounting, Science and Research Branch, Islamic Azad University, Mazandaran, Iran 2Department of Accounting, Qaemshahr Branch, Islamic Azad University, Qaemshahr, Iran

Corresponding Author Email: [email protected]

Applied mathematics in Engineering, Management and Technology 2014

H. Yahyaee et al

75

investment is less than the standard minimum. However, companies that have little current assets, will be

shortages and difficulties in the process of normal operations (Rahman and Nasr, 2007).

A common criterion for assessing the working capital management, cash conversion

cycle is the time between expenditures for the purchase of raw materials, and the receipt of goods sold amounts.

The longer this period, the additional investment is done in working capital. Long cash cycle might increase

profitability because it leads to increased sales. However, if the cost of more investment in working capital is

greater than the benefits of holding inventories, or more trade credit to customers, profitability of the entity may

be reduced by increasing the cash cycle. An another criterion for assessing the management of working capital

is net trade cycle. Net trade cycle can tell a company how many cycles over the years and how much money

remains stuck in this cycle. It shows how much money will stuck every day, in every floor accounts receivable,

inventory or accounts payable (Shin and Sonen, 1998). The above discussion about the importance of working

capital management, its constituent components, and its impact on profitability, which leads us to the problem

we are trying to analyze it. The problem we are trying to analyze it, is of whether there is relationship between

working capital management and Profitability of the listed companies in Tehran Stock Exchange, and how is

this related?

3.Importance and necessity of research

Working capital management has been studied in many other countries during the years 1995 to 2008.

Including, the research can be cited research (Lambrson, 1995), (Dylof, 2003), (Ghosh and Majy, 2003), (Filbak

and Kruger, 2005), (R & nasr, 2007), (Nazir & afza, 2007) and (Samylog & dymrns, 2008). Working capital

management is one of the sectors which plays a vital role in the management structure of an organization so

that, in some cases, discussion of working capital and liquidity have been likened as the blood in the veins of a

business unit to business unit is able to survive and management is mentioned in this section, the beating heart

of the business, which is responsible for pumping blood into the arteries of duty. (Casy Van 2006)

4.Research goals

Working capital management is important because it will affect the profitability, risk and subsequently the firm

value. Therefore, managers need to know how to operate an efficient working capital management, to ensure

growth, profitability and long term success of the company (Baker and Powell, 2005). Given the above, it

should be examined whether the working capital management, will be associated with the efficiency and

profitability of listed companies in Tehran Stock Exchange and whether there is a relationship between different

components of working capital management and profitability of listed companies in Tehran Stock Exchange

5.The nature and importance of working capital

The working capital satisfy short-term financing needs of business enterprise. The working capital is a trading

capital of the company remains in a year. The money is invested in these items during business operation

changes. The need to maintain adequate the working capital can hardly be questioned. As blood flow in the

human body needs to maintain the life of a very important cash flow is essential for the continuity of business

operations (Casey Van, 2006). The success of an economy unit depends on its ability to receive a cash is more

than payment. Cash flow problems is difficulty many small businesses have due to poor financial management

and lack of planning in particular needs cash (Jaro Visytal, 1996).

6.Various components of working capital

6.1.Cash Conversion Cycle

Cash conversion cycle is one of the criteria for evaluation the working capital. Cash conversion cycle refers the

time between the purchase of raw materials and collecting the proceeds from the sale of manufactured goods.


H. Yahyaee et al

76

Whatever is the longer, more investment in the working capital is required. Longer cash conversion cycle might

increase profitability through increased sales. However, if the cost of investing in the working capital is more

than gains from investments in stock or granting trade credit, profitability may be reduced (Mark Dlaf, 2003).

When using this criterion should be considered the following points:

1- To calculate the cash conversion cycle will be deducted delay in payment of accounts payable from the

period of operation. So what is the period of delay in accounts payable is more cash conversion cycle is

shortened and apparently the shorter the cash conversion cycle is represents better liquidity position while the

delay in the payment of accounts payable can be proved inadequate cash position. The longer the delay, the

situation is the worse, but this figure to calculate the cash conversion cycle to apply a different result is

obtained. The longer delays lead to lower cash conversion cycle and represents an appropriate liquidity.

Therefore, the probable inconsistency should be elevated in such a way.

2- In the cash conversion cycle measures does not pay attention cash balance the company. Therefore, in

addition to the cash needed for optimal level surplus cash, companies should be considered.

3- The cash conversion cycle measures is merely considered debt collection period and the payment

period and its value is ignored. If we consider two firms cash conversion period of two months but 90% of total

accounts payable the first company is receivables and inventory and to second company ratio is 50% obviously,

the first volume of the company's commitment are to their volume of current assets convertible to cash

compared with the second company, which is less than, liquidity conditions are unsuitable indicator the cash

conversion cycle is not reference to it (Khoram Nejad, 2007).

6.2.Net Trade Cycle

The net trading cycle is alternative evaluating efficiency of working capital management. In many papers,

working capital management assessment such as shin and sonen (1998), this measure is used. The decrease in

net trade cycle, corporate profitability has increased. Thus, efforts to reduce the period of time is approved. Net

trade cycle can say that a company is a year contains several operating cycles and the amount of total of these

cycles have what amounts. This cycle shows that the amount per day and per category of accounts receivable,

inventory or accounts payable to be assigns. When increases the number of days in accounts receivable or

inventory, firms have reduced cash flow and reach cash balances. When reduced the number of days, companies

increase cash flow and will be cash balance (Rahman et al., 2010). There are distinction between net trade cycle

and cash conversion cycle. Cash conversion cycle, contains elements that are not the common denominator. In

contrast, net trade cycle that are included components in the denominator of common components (net sales) is

used, the components together is an expression of the percentage of sales. Net trade cycle, show the number of

days to sell a company's to finance the working capital. This component is in fact an easy estimate for the

amount of additional financing needs with respect to working capital expressed as a function of anticipated

sales growth provides. Net trade cycle also is attentive to assess the company and create value for shareholders

(Shin and sonen, 1998).

7.Profitability

One of the important parameters is used always an important indicator of the companies in the analysis is

profitability. Profit as a criterion and guide investment and decisions, one of the important tools to predict

future earnings and trend of future profit, measure of management efficiency in corporate governance,

evaluation criterion management monitoring of the company's assets and economic resources.

Profitability refers to the company's ability to earn income over expenditure. Profitability the end result is all the

programs and financial decisions and the last answer about how to manage the company, suggest to analysts.

Usually, the variable profit to sales, return total assets, return on equity, used to measure profitability (Casey

Van, 2006).

8.The impact of working capital management on profitability


H. Yahyaee et al

77

Working capital management is an important area of financial management involves, and may have a

significant impact on the liquidity and profitability of the firm (Shin & Sonen, 1998). According to Eduardo and

Si (2002), as well as financial management decisions and plays a major role in the short-term corporate

function. And efficient use of working capital has a significant impact on profitability and so the company's

value. Cash conversion cycle is common tool measure of working capital management (Dylof, 2003). This

cycle represents the average number of days between the time of receipt of funds of products sold to customers,

and payment for the purchase of raw materials and labor (Baker and Powell, 2005). Decisions about investment

in accounts receivable and inventories, and the amount of credit received from suppliers, the company is

reflected in the cash conversion cycle (Troner & Solano, 2007). Through proper management of the cash

conversion cycle of three components, namely, accounts receivable, inventory and accounts payable, it will

maximize the company's profitability and growth (Lazarydys and Trayfonydys, 2006).

9.Literature

Setayesh et al. (2009) examined the effect of working capital management on the profitability of listed

companies in Tehran Stock Exchange. The results of this study indicate that between debt collection period

inventory conversion period, the cash conversion cycle and financial leverage is negative relationship with

profitability. In addition, sales growth has a significant positive relationship with profitability and accounts

payable payment period is not significant effect on profitability.

Ahmadi (2012), a paid research explores the relationship between working capital management and profitability

of member companies of the food industry in Tehran Stock Exchange. This study was conducted for a period of

5 years between 2006-2011 and examined the effect of different variables of working capital management

including the average account balance of the collection cycle, cash conversion cycle and medium-term debt on

the company's operating profit. The results showed an inverse relationship between the variables of working

capital management and profitability.

Shin and Sonen (1998), investigated the relationship between a measure of the cash conversion cycle and

corporate profitability for a large sample of U.S. firms for the period 1975-1994. They found a significant

negative relationship between them, which suggests that managers can create value to this by reducing the cash

conversion cycle to a reasonable minimum for shareholders.

Nasr and Rahman (2007), investigated the impact of working capital management on profitability of 94

companies listed on the Stock Exchange during the period 1999-2004 in Pakistan. He studied the effect of

different variables of working capital including average debt collection period, inventory turnover period,

average payment period and cash conversion cycle on net operating profit. And concluded that there is a strong

negative relationship between the ratio of working capital and corporate profitability. In addition, managers can

create value for their shareholders by reducing the cash conversion cycle to a optimum level. This study

confirms the results of other studies on the relationship between working capital and profitability.

Karadagly (2012), the paper focuses on the performance of the company, with a focus on working capital

management because the measure is a measure of net trade cycle and the cash conversion cycle. For this study,

the use of Turkish companies in the SME, in order to evaluate and measure the potential difference profitability

effects of working capital management and whether net trade cycle can be converted into cash alternative to be

assessed as a measure of working capital management. This research using pooled table, has done an analysis of

annual data for the period 2010-2002. The findings show that the increase in the cash conversion cycle and net

trade cycle makes improvement in the operating profit of the company performance and increase the efficiency

of the stock market for SMEs. However, for large firms, this result is obtained for the reduction of these two

criteria. Furthermore, these findings indicate that net trade cycle managers can use the cash conversion cycle.

10.Research hypotheses

10.1.The main hypotheses

There is a significant relationship between working capital management and profitability of listed companies in

Tehran Stock Exchange.


H. Yahyaee et al

78

10.2.Secondary hypothesis

1) There is a significant relationship between cash conversion cycle and return on assets.

2) There is a significant relationship between cash conversion cycle and return on sales.

3) There is a significant relationship between cash conversion cycle and return on equity.

4) There is a significant relationship between the net trade cycle and return on assets.

5) There is a significant relationship between net trade cycle and return on sales.

6) There is a significant relationship between net trade cycle and return on equity.

10.3.Statistical Society

Companies surveyed included all firms listed in Tehran Stock Exchange, which has the following conditions:

• The end of the financial year, it is the end of March.

• Is not part of the financial companies and investment.

• Information that is available.

• Since 2006, there have been continuous in Iran's stock.

• In fiscal year has not changed during the study period.

The number of companies, 130 companies were selected and analyzed.

10.4.Period of study

Period of five years, and has been used for sampling corporate data from 2007 to 2011.

11.Research Methodology

The present research methodology is applied research from nature, the experimental method. In this study to

estimate the causal relationship between working capital management profitability by using multiple regression

analysis using the panel -data.

12.Variables

Return on Assets

(Dependent variable)

ROA Profit after interest and taxes divided by total assets

Return on sales

(Dependent variable)

ROS Operating profit divided by sales

Return on equity

(dependent variable) ROE

Profit after interest and tax divided by average shareholders

equity

Cash Conversion Cycle

(Independent variables)

CCC (Cycle Inventories + receivables collection period - the period of

debt)

Net trade cycle

(Independent variables)

NTC

According to research shin&sonen (1998), (365 multiplied by

average accounts receivable divided by net sales annual) + (365

multiplied by average inventory divided by annual net sales) -

(Average accounts payable multiplied by 365, divided by annual

net sales)

Firm size(Control

variable) LOS The natural logarithm of sales

Financial Leverage(

Control variable) DR Debt divided by the sum of total assets


H. Yahyaee et al

79

13.Research Model

1- Models used to test the first hypothesis

1) ROAit = £+ β1CCCit+ β2LOSit + β3DRit+ €it

2- Models used to test the second hypothesis 2)

ROSit = £+ β1CCCit+ β2LOSit + β3DRit+ €it

3- Models used to test the third hypothesis: 3) ROEit = £ + β1CCCit + β2LOSit + β3DRit + €it

4- Models used to test the fourth hypothesis: 4) ROAit = £ + β1NTCit + β2LOSit + β3DRit + €it

5- Models used to test the fifth hypothesis: 5) ROSit = £ + β1NTCit + β2LOSit + β3DRit + €it

6- Models used to test the sixth hypothesis: 6) ROEit = £ + β1NTCit + β2LOSit + β3DRit + €it

14.Results of data analysis

Hypotheses regarding the proposed section of the test pattern before, and through statistical software Eviews

and the 95% confidence level was performed and the results are presented. In each regression tests to establish

the basic assumptions of regression, is taken into consideration in order to assess the validity of the fitted

regression.

15.The results of a descriptive analysis of the variables

Table 2. Descriptive statistics of variables

ROS CCC ROE DR LOS NTC ROA

0.150895 114.7896 0.252260 0.60782 13.39491 0.472799 0.111571 Mean

0.124577 95.72247 0.254744 0.61959 13.23552 0.176482 0.094593 Median

0.778939 2451.626 1.706186 0.97873 18.60359 32.41014 0.620383 Maximum

-1.233697 -1713.856 -1.949042 0.15465 10.45844 0.000231 -0.248580 Minimum

Std.Dev ا 0.134071 1.471793 1.400890 0.16262 0.309665 169.8665 0.182798

-0.703457 2.009974 -2.325875 -0.25368 0.911977 16.29116 0.825683 Skewness

12.77028 81.76476 18.61188 2.59078 4.243767 343.7055 5.576314 Stretch

650 650 650 650 650 650 650

No. of

observation

s

Source: Based on Software Eviews

16.Reviews normality of the variable (s) dependent

Statistical assumptions of the test are as follows.

Table 3) Dependent variables normally distributed test result

Variable Jarkko- bera

statistics

Significant

level

Return on Assets 12.144 0.078

Return on equity 9.187 0.072

Return on sales 26.389 0.054



H. Yahyaee et al

80

17.The results of the test the first hypothesis

The first research hypothesis predicted that there is a significant relationship between cash conversion cycle and

return on assets.

Table 4: Results of statistical analysis to test the first hypothesis

ROA it=β0+β1CCC it +β2 LOS it +β2 DR it +€ it

Significant level F Statistics f

Watson statistic R

2

0.000 37.93 1.649 0.245

Significant level (P-value) Statistics t The size of the coefficient β Variable

0.005 -2.575 -0.001 CCC

0.000 3.74 0.011 LOS

0.000 -10.442 -0.014 DR


Overall, the results showed that there is an inverse relationship and significant between return on assets and

cash conversion cycle. This finding is consistent with claims in the first hypothesis, and therefore the hypothesis

is accepted at the 95% confidence level.

The results of the test the second hypothesis

In the second hypothesis of the study predicted that there is a significant relationship between cash conversion

cycle and return on sales.


Overall, the results showed that there is an inverse relationship and significant between the cash conversion

cycle, and return on sales. This finding is consistent with claims in the second hypothesis, and therefore the

hypothesis is accepted at the 95% confidence level.

In the third hypothesis of the study predicted that there is a significant relationship between cash conversion

cycle and return on equity

Table 5: Results of statistical analysis to test the second hypothesis

ROS it=β0+β1CCC it +β2 LOS it +β2 DR it +€ it

Significant level F Statistics f

Watson statistic R2

0.000 43.769 1.901 0.265

Significant level

(P-value) Statistics t

The size of the

coefficient β Variable

043/0 -2.027 -0.008 CCC

0.000 7.822 0.037 LOS

0.000 -9.401 -0.021 DR


H. Yahyaee et al

81

Table 6: Results of statistical analysis to test the third hypothesis

ROE it=β0+β1CCC it +β2 LOS it +β2 DR it +€ it

Significant level F Statistics f Watson statistic R2

0.000 35.589 2.102 0.175

Significant level


The size of the


083/0 -1.732 -0.014 CCC

0.000 3.356 0.035 LOS

0.000 -7.831 -0.674 DR


Overall, the results showed that there is not an inverse relationship and significant between the cash conversion

cycle, and return on equity. This finding is inconsistent with the claims of the third hypothesis and therefore the

hypothesis is rejected at the 95% confidence level.

The results of the test the fourth hypothesis

The fourth research hypothesis predicted that there is a significant relationship between net trade cycle and

return on assets.

Table 7: Results of statistical analysis to test the fourth hypothesis

ROA it=β0+β1NTC it +β2 LOS it +β2 DR it +€ it


0.000 24.42 1.647 0.201

Significant level(P-value)

Statistics t The size of the

coefficient β

Variable

0.000 -6.047 -0.016 NTC

0.000 2.05 0.006 LOS

0.000 -10.776 -0.014 DR


Overall, the results showed that there is an inverse relationship and significant between the net trade cycle, and

return on assets. This finding is consistent with claims in the fourth hypothesis, and therefore the hypothesis is

accepted at the 95% confidence level.

The results of the test the fifth hypothesis

The fifth research hypothesis predicted that there is a significant relationship between net trade cycle and return

on sales.

Table 8: Results of statistical analysis to test the fifth hypothesis

ROS it=β0+β1NTC it +β2 LOS it +β2 DR it +€ it


0.000 69.426 1.868 0.24

Significant level(P-value) Statistics t The size of the coefficient β Variable

0.000 -8.228 -0.036 NTC

0.000 5.313 0.025 LOS

0.000 -10.01 -0.021 DR


Overall, the results showed that there is an inverse relationship and significant between the net trade cycle, and

return on sales. This finding is consistent with claims in the fifth hypothesis, and therefore the hypothesis is


The results of the test the sixth hypothesis

The sixth research hypothesis predicted that there is a significant relationship between net trade cycle and return

on equity.


H. Yahyaee et al

82

Table 9: Results of statistical analysis to test the sixth hypothesis

ROE it=β0+β1NTC it +β2 LOS it +β2 DR it +€ it


0.000 40.178 2.101 0.194

Significant level


The size of the


0.000 -4.253 -0.033 NTC

0.006 2.737 0.028 LOS

0.000 -7.925 -0.666 DR


Overall, the results showed that there is an inverse relationship and significant between the net trade cycle and

return on equity. This finding is consistent with claims in the sixth hypothesis, and therefore the hypothesis is


18.practical suggestions

1) The directors of nonprofit entities recommended that special attention had working capital items and adopt

appropriate approaches to manage these items based on unit capacity under management.

2) The directors of nonprofit entities proposed to be, which try to provide the resources needed for working

capital, use of internal resources, and take action to lower financing through debt.

19.Suggestions for future research

1) Examine the impact of working capital management on financial performance firms.

2) Examine the relationship between working capital management practices corporate finance and capital

structure. 3) Examine the relationship between working capital management efficiency investments

4) Examine the reaction of investors to the company's cash holdings and the amount of

working capital of firms. 5) The relationship between net trade cycle industrial break down with

profitability.

References

Rudpohti.R,F, Kiai, A., (2008), "investigate and explain working capital management strategies in companies listed in

Tehran Stock Exchange", Journal of Accounting Research 13 .

Vakili fard,H., Yaghobi,A., Babayi,A., (2010), "The relationship between working capital management and profitability of

listed companies in Tehran Stock Exchange", Journal of Financial Engineering and Portfolio Management. No. 2

ston, F., Brigham, u., (1996),Financial Management, , translated by H. Abdo Tabrizi and P. Moshirzade, Agah Publishing.

Raymond,p., Novo, (2001), Financial Management, Volume I, translated and adapted from Jahankhany. A and A.

Parsaeian, samt publishing.

Rostami, N., Namazi, M.,( 2006). “Examine the relationship between financial ratios and stock returns for firms listed in

Tehran Stock Exchange”, Journal of Accounting and Auditing studies. (2) 13.

Delavar, A.( 1996). Theoretical principles and scientific research in the humanities and social sciences, Tehran, roshd

publishing, Second Edition.

Valipoor, H., Sadat Hosseini, Z. (2009). "Politics and the profitability of equity working capital". Financial Studies, Vol II,

No. I, 15-33. Khoram Nejad, M. (2007). "A Study of Factors Affecting Operating Working Capital Management (with

emphasis on the type of industry)". Accounting and Auditing Review, No. 42, pp 95-75. MSc thesis, Ferdowsi University

of Mashhad.

Ahmadi. (2012). "Relationship between working capital management and profitability in Tehran Stock Exchange: A Study

of the Food Industry". Reserch Journal of Applied seiences Engineering and Technology. 4 (13). Pp 1868-1874.

Wang ,Y.J ,(2002) , "Liquidity manangement operating performance, and corporate Value :Evidence from Japan and

Taiwan . Journal of Multinational Financial manangement .Vol . 12 , pp .152-62


H. Yahyaee et al

83

Wilner , B.S ,(2000), " The Explanation of Relationship in Financial Distress : the case of trade credit ", Journanl of

Finance , Vol .55 , pp. 153-78.

Arbidane , Lgnatjeva , (2013), "The Relationship between Working capital manangement and profitability : A Latvian

case ", Global Review of Acconting and Finance , Vol. 4. No 1. Pp 148-158.

Karadagli.C, (2012), " The Effet of Working capital manangement on profitability of Turkish SMEs ". British Journal of

Economics, Finance and manangement Sciences, Vol .5(2).

Raheman and nasr, (2007) , “working capital management and profitability – case of Pakistan firms” international review

of business research papers, vol.3 , pp.279-300 .

Deloof M, (2003) ,"Does working capital management affect profitability of Belgian Firms? ", journal of Business,

Finance and Accounting. Vol .30,pp. 573-87 .

Shin , and L.Soenen ,(1998) ," Efficiency of working capital and corporate profitability " ,Financial practice and Education

, Vol .8 ,pp.37-45 .

Soenen L., (1993),"Cash conservation cycle and corporate profitability", Journal of cash management, Vol.13, no.4, pp.53-

7.

Garcia – Teruel P.J., and P .M .Solana , (2007) ,"Effects of working capital management on SME profitability " ,

International journal of managerial Finance , Vol. 3, no.2, 2007 .pp.164-177 .

investigating the relationship between working capital ...ashm-journal.com/test/vol2-6/12.pdf ·...

Documents