The Impact of Working Capital on the Profitability: Evidence from the Indian Firms

Abstract

In order to run the company successfully, the fixed and the current assets play a commendable role. Managing the working capital is mandatory because, it has a major significance on profitability and liquidity of the business concern. Usually, it was observed that, if firm wants to take a bigger risk for bumper profits and losses, it minimises the dimension of its working capital in relation to the revenues it generates. If it is willing to improve its liquidity, that in turn raises the level of its working capital. Nevertheless, this technique might tend to reduce the sales volume and consequently, it would affect the profitability. Thus, a company needs to have a striking balance between the liquidity and the profitability. This research has analysed the impact of working capital on the profitability for a sample of 100 Indian companies listed in the Bombay Stock Exchange for a period of 2 years from 2010-2011. The various components for measuring the working capital management include the Receivable days, Inventory turnover days, Payable days, Cash conversion cycle, Current ratio and Quick ratio on the Net operating profitability of the Indian companies. The controlled variables like; Fixed assets on total assets, the Debt ratio and the size of the firm (measured in terms of natural logarithm of sales) have also been used for measuring of the working capital management. Descriptive Statistics, Pearson’s Correlation, Regression Analysis are used for analyzing this research. All these tests are used so as to correlate the theories contributed by the literature by several authors with the statistical results.

The results depict that, there is a strong negative association between the components of the working capital management and the profitability ratios of the Indian firms which indicates that, as the cash conversion cycle increases it would tend to reduce the profitability of the company, and the managers might increase the the shareholder’s value by shortening this cash conversion cycle to a minimum level. It is also observed that the negative association also persists between the liquidity and the profitability of the Indian firms. Nevertheless, there is a positive relationship between the size and the profitability of the firm. This indicates that, as the size of the firm increases the profitability of the firm also increases.

Finally a negative relationship is observed between the debt and profitability of the Indian firms. The results derived from this research signify that, the managers might able to raise their profits by diminishing the time period for the debtors and inventories so that, time period for payables would increase.

Keywords: Working Capital Management