Working
Capital Management refers to all management decisions and actions that
ordinarily influence the size and effectiveness of the working capital. It is
concerned with the most effective choice of working capital sources and the
determination of appropriate levels of the current assets and their use. It
focuses attention to the managing of current assets, current liabilities and
the relationships that exist between them. In the present day of rising capital
cost and scarce funds, the importance of working capital needs special
emphasis. It has been widely accepted that the profitability of a business concern
likely depends upon the manner in which its working capital is managed. The
inefficient management of working capital not only reduces profitability but
ultimately may also lead a concern to financial crises. On the other hand,
proper management of working capital leads to a material savings and ensures
financial returns at the optimum level even on the minimum level of capital
employed.
Every
organization whether, profit oriented or not, irrespective of size and nature
of business, requires necessary amount of working capital. Working capital is
the most crucial factor for maintaining liquidity, survival, solvency and
profitability of business (Mukhopadhyay, 2004).
Working
capital management is one of the most important areas while making the
liquidity and profitability comparisons among firms (Eljelly,
2004), involving the decision of the amount and composition of current assets
and the financing of these assets. The greater the relative proportion of
liquid assets, the lesser the risk of running out of cash, all other things
being equal. All individual components of working capital including cash,
marketable securities, account receivables and inventory management play a
vital role in the performance of any firm. Shin and Soenen,
(1998) argued that efficient working capital management is very important to
create value for the shareholders while Smith et. al., (1997) emphasized that
profitability and liquidity are the salient goals of working capital
management. Therefore, many
organizations that are profitable on which are forced to cease their operations
due to an inability to meet their short-term debt obligations. In order to
sustain the business, it is essential for any organization to successfully
manage its working capital.
Firms may
have an optimal level of working capital that maximizes their value. Large
inventory and a generous trade credit policy may lead to high sales. Larger
inventory reduces the risk of a stock-out. Trade credit may stimulate sales
because it allows customers to assess product quality before paying (Long, Maltiz and Ravid, 1993, and Deloof and Jegers, 1996). Another
component of working capital is accounts payable. Delaying payments to
suppliers allows a firm to assess the quality of bought products, and can be an
inexpensive and flexible source of financing for the firm. On the other hand,
late payment of invoices can be very costly if the firm is offered a discount
for early payment. A popular measure of Working Capital Management (WCM) is the
cash conversion cycle, i.e. the time lag between the expenditure for the
purchases of raw materials and the collection
of sales of finished goods. The longer this time lag, the larger the investment
in working capital (Deloof 2003).
According to
a survey made by CFO Magazine, working capital management is one of the key
issues facing by financial executives in the 21st century. The most salient
example of working capital management importance and its effect on the
companies relates to Amazon Company which is one of the biggest active
companies in electronic business and different kinds of goods. In about the
middle of 2000, it was specified that the working capital management in this
company has caused share holding Price decrease according to the accomplished
survey.
OBJECTIVES OF THE STUDY:
A longer
cash conversion cycle might increase profitability because it leads to higher
sales. However, corporate profitability might also decrease with the cash
conversion cycle, if the costs of higher investment in working capital rise
faster than the benefits of holding more inventories and/or granting more trade
credit to customers. This discussion of the importance of working capital
management, its different components and its effects on profitability leads us
to the problem statement which we will be analyzing. This study is specifically
designed to investigate the dependence of profitability on working capital
management of ACC Ltd., the leading cement manufacturer of Indian cement
industry for the period 2000-2010. The problem statement to be analyzed in this
study is, “Does Working Capital Management Affect Profitability of Indian
Cement Companies?”
ABOUT THE COMPANY – ACC LTD.
ACC
Limited is India’s foremost cement manufacturer with a countrywide network of
factories and marketing offices. Established in 1936, ACC has been a pioneer
and trend-setter in cement and concrete technology. Among the first companies
in India to include commitment to environment protection as a corporate
objective, ACC has won accolades for environment friendly measures taken at its
plants and mines, and has also been felicitated for its acts of good corporate
citizenship. ACC is the most preferred cement brand name in India. ACC is now
part of the worldwide Holcim Group.
ACC (ACC Limited) is India's
largest manufacturer of cement and concrete. ACC's operations are spread
throughout the country with 16 modern cement factories, more than 40 Ready mix
concrete plants, 21 sales offices, and several zonal offices. It has a
workforce of about 9,000 persons and a countrywide distribution network of over
9,000 dealers.
Since
inception in 1936, the company has been a trendsetter and important benchmark
for the cement industry in many areas of cement and concrete technology. ACC
has a unique track record of innovative research, product development and
specialized consultancy services. The company's various manufacturing units are
backed by a central technology support services center - the only one of its
kind in the Indian cement industry.
ACC
has rich experience in mining, being the largest user of limestone. As the
largest cement producer in India, it is one of the biggest customers of the
domestic coal industry, of Indian Railways, and a considerable user of the
country’s road transport network services for inward and outward movement of
materials and products.
Among
the first companies in India to include commitment to environmental protection
as one of its corporate objectives, the company installed sophisticated
pollution control equipment as far back as 1966, long before pollution control
laws came into existence. Today each of its cement plants has state-of-the art
pollution control equipment and devices.
ACC
plants, mines and townships visibly demonstrate successful endeavors in quarry
rehabilitation, water management techniques and ‘greening’ activities. The
company actively promotes the use of alternative fuels and raw materials and
offers total solutions for waste management including testing, suggestions for
reuse, recycling and co-processing.
ACC
has taken purposeful steps in knowledge building. We run two institutes that
offer professional technical courses for engineering graduates and diploma
holders which are relevant to manufacturing sectors such as cement. The main
beneficiaries are youth from remote and backward areas of the country.
ACC
has made significant contributions to the nation building process by way of
quality products, services and sharing expertise. Its commitment to sustainable
development, its high ethical standards in business dealings and its on-going
efforts in community welfare programs have won it acclaim as a responsible
corporate citizen. ACC’s brand name is synonymous with cement and enjoys a high
level of equity in the Indian market. It is the only cement company that
figures in the list of Consumer Super Brands of India.
REVIEW OF LITERATURE:
A significant
portion of financial research is concerned with the management of working
capital. This issue has been extensively investigated at both conceptual and
empirical levels. Very few studies have been made in relation to Working
Capital Management (WCM) especially in the cement industry in India. The study
made by S.K.Ghosh and S.G.Maji
is worth noting. They examined the efficiency of working capital management of
Indian cement companies by taking a sample size of 20 large cement companies of
India for the period 1992-93 to 2001-2002. They observed that the Indian Cement
industry did not perform remarkably well during this period. Industry average
for efficiency index was greater than one in 6 years out of 10 years study
period. Though some of the sample firms had successfully improved efficiency
during these years, the existence of a very high degree of inconsistency in
this matter clearly points out the need for adopting sound working capital
management policies by these firms. Further, they concluded that, in the matter
of achieving the target level (industry norm) of efficiency by the firms,
Associated Cement and Dalmia were the most successful
firm followed by Decan, Kanoria&
Madras. In view of the observed b values, once again it may not be unwise to conclude that firms under
study should take necessary steps in order to improve efficiency in this
regard.
In other
study, (Shin & Soenen, 1998) used net-trade cycle
(NTC) as a measure of working capital management to discover the relationship
between efficient working capital management and firm’s profitability. NTC is
basically equal to the CCC whereby all three components are expressed as a
percentage of sales. The reason by using NTC because it can be an easy device
to estimate for additional financing needs with regard to working capital
expressed as a function of the projected sales growth. This relationship is
examined using correlation and regression analysis, by industry and working
capital intensity. Using a sample of 58,985 firm years covering the period
1975-1994, in all cases, they found, a strong negative relation between the
length of the firm's net-trade cycle and its profitability. In addition,
shorter NTC are associated with higher risk-adjusted stock returns. In other
word, (Shin & Soenen, 1998) suggest that one
possible way the firm to create shareholder value is by reducing firm’s NTC.
Deloof (2003)
found a significant negative relation between gross operating income and the
number of days accounts receivable, inventories and accounts payable of Belgian
firms. These results suggested that managers can create value for their
shareholders by reducing the number of days accounts receivable and inventories
to a reasonable minimum. The negative relation between accounts payable and
profitability inconsistent with the view that less profitable firms wait longer
to pay their bills.
Eljelly (2004)
identified the relation between profitability and liquidity who was examined,
as measured by current ratio and cash gap (cash conversion cycle) on a sample
of joint stock firms in Saudi Arabia. The study found that the cash conversion
cycle was of more importance as a measure of liquidity than the current ratio
that affects profitability. The size variable was found to have significant
effect on profitability at the industry level. The results were stable and had
important implications for liquidity management in various Saudi firms. First,
it was clear that there was negative relationship between profitability and
liquidity indicators such as current ratio and cash gap in the Saudi sample
examined. Second, the study also revealed that there was great variation among
industries with respect to the significant measure of liquidity.
The study
of, (KessevenPadachi 2006) used return on total
assets as a measure of profitability and the relation between working capital
management and corporate profitability is investigated for a sample of 58 small
manufacturing firms, using panel data analysis for the period 1998 – 2003. The
regression result of their study indicates that high investment in inventories
and receivables is associated with lower profitability. The key variables used
in the analysis are inventories days, accounts receivables days, accounts
payable days and cash conversion cycle. Their study also reveals significant
relationship between working capital management and profitability has been
found in previous empirical work. An analysis of the liquidity, profitability
and operational efficiency of the five industries shows significant changes and
how best practices in the paper industry have contributed to performance. The
findings also reveal an increasing trend in the short-term component of working
capital financing.
Raheman and Nasr
(2006) discussed working capital management and its effect on liquidity as well
as on profitability of the firm. They have studied the effect of different
variables of working capital management including the Average collection
period, Inventory turnover in days, Average payment period, Cash conversion
cycle and Current ratio on the net operating profitability of Pakistani firms.
Debt ratio, size of the firm (measured in terms of natural logarithm of sales)
and financial assets to total assets ratio have been used as control variables.
The results found that there is a strong negative relationship between
variables of the working capital management and profitability of the firm. It
means that the cash conversion cycle increases it will lead to decreasing
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.
They found that there is a significant negative relationship between liquidity
and profitability. They also found that there is a positive relationship
between size of the firm and its profitability. There is also a significant
negative relationship between debt used by the firm and profitability.
Lazaridis and Tryfonidis (2006) investigated the relationship of
corporate profitability and working capital management. The purpose of there’s paper is to establish a relationship that is
statistically significant between profitability, the cash conversion cycle and
its components for listed firms in the ASE. The results of their research
showed that there is statistical significance between profitability, measured
through gross operating profit, and the cash conversion cycle. Moreover
managers can create profits for their firms by handling correctly the cash conversion cycle and keep each different component
(accounts receivables, accounts payables, inventory) to an optimum.
Jafar and Sur
(2006) studied the efficiency of the working capital management in the National
Thermal Power Corporation (NTPC), and showed that the company achieved a higher
level of efficiency in managing its working capital during the
post-liberalization era by adapting itself to the new environment which had
emanated from liberalization, globalization and competitiveness. They pointed
out that, while many of the public enterprises are learning to survive and grow
by adapting themselves to the new situation, a large group of public sector
undertakings, significant both in number and investment, have been beset with
serious problems like slow growth, low productivity, inadequate emphasis on
research and development, inefficient working capital management, and so on.
Vishnani and Shah
(2007) investigated the impact of working capital management policies on the
corporate performance of the Indian consumer electronics industry. They noted
that inventory holding period, debtors’ collection period and net working
capital cycle had negative relationship on
the profitability of firms. Whereas, the average payment period had positive
correlation with profitability.
Chakraborty (2008)
evaluated the relationship between working capital and profitability of Indian
pharmaceutical companies. He pointed out that there were two distinct schools
of thought on this issue: according to one school of thought, working capital
is not a factor of improving profitability and there may be a negative
relationship between them, while according to the other school of thought,
investment in working capital plays a vital role to improve corporate
profitability, and unless there is a minimum level of investment of working
capital, output and sales cannot be maintained - in fact, the inadequacy of
working capital would keep fixed asset inoperative.
In their
study of relationship between efficient working capital management and firm’s
profitability, A.K. Sharma & Satish Kumar, 2008
collected data about a sample of 263 non-financial BSE 500 firms listed at the
Bombay Stock (BSE) from 2000 to 2008 and evaluated the data using OLS multiple
regression. Their findings significantly depart from the various international
studies conducted in different markets. The results reveal that working capital
management and profitability is positively correlated in Indian companies.
Their study further reveals that number of days and accounts payable are
negatively correlated with a firm’s profitability, whereas number of days
accounts receivables and cash conversion period exhibit a positive relationship
with corporate profitability.
Samiloglu and Demirgünes (2008) analyzed the effect of working capital
management on firm profitability in Turkey for period of 1998-2007.Empirical
results showed that account receivables period, inventory period and leverage
significantly and negatively affect on profitability, while, firm growth
significantly and positively. And also they proved that cash conversion cycle,
size and fixed financial assets had no statistically significant effect on
profitability.
Singh and Pandey (2008) discussed the impact of working capital
management in the profitability of Hindalco Industries Limited. Regression results showed that
current ratio, liquid ratio, receivable turnover ratio and working capital to
total assets had statically significant impact on profitability.
Ramachandran and Janakiraman (2009) analyzed the relationship between
working capital management efficiency and earnings before interest and tax of
the paper industry in India. The study revealed that cash conversion cycle and
inventory days had negative correlation with earning
before interest and tax, while accounts payable days and accounts receivable
days related positively with earning before interest
and tax.
Dong and Su (2010) examined the relationship between profitability, the
cash conversion cycle and its component for listed firms in Vietnam stock
market for period (2006-2008).They resulted that there is strong negative
relationship between cash conversion cycle and the profitability.
All the
above studies provide us a solid base and give us idea regarding working
capital management and its components. They also give us the results and
conclusions of those researches already conducted on the same area for
different countries and environment from different aspects. On basis of these
researches done in different countries, we have developed our own methodology
for research.
Research
Methodology
The
following are the methods and techniques adopted for collection of data and for
their analysis in this study.
Collection
of data:
The data of
ACC Ltd. for the period 1999-2000 to 2009-10 used in this study have been
collected from secondary sources i.e. Annual reports of the company as well as
from the website moneycontrol.com. Editing, classification and
tabulation of the financial data collected from the above-mentioned sources
have been done as per the requirement of the study.
Variables:
For
analyzing the data, simple mathematical tool like ratio and percentages have
been used. The dependent variable was the Operating Profit Margin (PBIT/Sales)
as a measure of Profitability. In this study eight independent variables were
taken to measure the Working Capital. These variables include:
Independent
Variables:
· Assets Turnover Ratio(ATR) : Net Sales/Total
Assets
· Gearing Ratio (GRR) : Total Debt/Total Assets
· Current Assets to Total Assets(CATA): Current
Assets/Total Assets
· Total Debtors to Current Assets(TDCA): Total
Debtors/Current Assets
· Current Liabilities to Total Assets (CLTA) :
Current Liabilities/Total Assets
· Inventory Turnover Ratio (ITR): Net
Sales/Average Inventory
· Debtors Turnover Ratio (DTR) : Net Credit
Sale/Average Debtors
· Number of Days in Working Capital (NWC) :
Average Working Capital x 365 / Net Sales
· Current Ratio(CR) : Current Assets/Current
Liabilities
· Quick Ratio (QR) : Quick Assets/Current Liabilities
Dependent
Variable:
Operating
Profit Margin (OPM) = PBIT/Net Sales
Hypotheses
Since the
objective of this study is to examine the relationship between profitability
and working capital management of ACC Ltd. only, only one testable hypothesis
is formulated for this study purpose; {The Null Hypotheses H0
versus the Alternative ones H1}.
H0: There is no relationship between working
capital management and profitability of ACC Ltd.
H1: There is a possible positive relationship
between working capital management and profitability of ACC Ltd.
(Impact of
Working Capital on Profitability)
|
|
Profitability |
|
CR QR ATR GRR ITR DTR NWC CATA TACA CLTA |
|
Statistical
Tools used in the Study:
This study
makes use of the Statistical tools for both its descriptive and quantitative
analysis. The Mean and Standard Deviation are used in the descriptive portion
of the analyses to determine the Mean values of each set of variables and their
Standard Deviation. In the quantitative analysis portion, a statistical
Correlation analysis is made to determine the relationship between an efficient
management of working capital and corporate profitability for the sample under
study. The Quantitative analysis also includes Multiple Regression analyses in
order to shed more light on, and develop a better understanding of, the
relationship of WCM and Profitability of the firm under study.
The
Regression Model:
The Multiple Regression analysis was employed in the study to explore
the combined effect of the variables of working capital management on
profitability. The Regression Equation is given below: