Working Capital Management
Working Capital Management
Working capital management (WCM) is arguably one of the most important components in Corporate Finance because it affects the profitability and liquidity of the firm as well as the ultimate objective of firm value (Smith, 1980). The greater the investment in current assets leads to the lower risk in terms of settling short term obligation, while gaining lower profitability because of the inability to invest in the profitable long-term investments.
Efficient management of working capital (WC) l is a fundamental part of corporate strategy as a financial manager’s responsibility is to maximize shareholders’ wealth. This can be done by creating an optimal balance between each of the WCM components; Cash, marketable securities, accounts receivables, accounts payables and inventory (Amarjit, 2011). However, in reality, it is challenging to achieve optimal balance because there are bound to be tradeoffs. As such, determining the optimal balance occupies a major portion of a financial managers time and attention because it is difficult to identify the appropriate level of WC (Harris, 2005, Richards and Laughlin, 1980).
The next section reviews existing literature relating to WCM and firm value. Following that, the research objectives are briefly described in section 3. Data and methodology that was used to obtain the empirical evidence for the study is outlined in section 4. Next, evidence is presented and analyzed in detail. Section 6 summarizes the paper. The final section will describe the limitations and further research that can be done.
WCM is important because of its impact on the firm’s profitability and liquidity, and consequently its value (Smith, 1980, Bandara, 2011).
Over the years, many academic literatures (Deloof, 2003, Mathuva, 2010, Gill et al., 2010, Gulia, 2014) have investigated the relationship between WCM and firm profitability. I would say the findings were contradicting. In the study of Ganesan (2007), he found that WCM is not significantly negatively related to profitability in the telecommunication equipment industry. Whereas Chowdhury and Amin (2007) evidenced that there is a positive relationship between WCM and firm profitability in Bangladesh’s Pharmaceutical industry.
Cash Conversion Cycle (CCC) had been widely used as a major component that represents WC. The importance of CCC is well documented through the comparison illustrated by Shin and Luc (1998). In 1994, Wal-Mart and Kmart were two similar companies in terms of capital structures, but Kmart had a considerably higher Net Working Capital relative to its sales in comparison to Wal-Mart. Kmart went into financial distress due to the financial costs of its poor WCM. The firm ultimately