Impact of Working Capital Management on Profitability: A Study on Listed Manufacturing Companies in Colombo Stock Exchange

Abstract

In Sri Lankan context, manufacturing sector has been recognized as an important strategic sector for socio-economic development and provides a significant contribution to the growth of the economy (Press Note Annual Estimates of GDP, 2012, p.5). Hence, it plays a vital role, which determines the driving force of the economy (Press Note Annual Estimates of GDP, 2012, p.5). Consequently, manufacturing companies encounter several issues and challenges in the effort of enhancing their profitability and reduce the threat of insolvency. Specifically, the Sri Lankan manufacturing sector is faced with the dilemma of maintaining an appropriate trade-off between working capital (WC) and profitability. In this study an attempt has been made to identify the impact of WC management on profitability of listed manufacturing companies. This study is primarily based on secondary data that were extracted from the annual reports of the 20 manufacturing companies listed in Colombo Stock Exchange (CSE). Balanced Panel Data (BPD) of these 20 manufacturing companies were analyzed by using the Pearson’s Correlation and Ordinary Least Squire (OLS) regression model to establish the relationship between WCM and the profitability. The study found a negative relationship between the profitability and Debtor’s Conversion Period (DCP), Inventory Conversion Period (ICP) and Cash Conversion Cycle (CCC), but a positive relationship between profitability and Creditor’s Conversion Period (CCP). Moreover the financial leverage, sales growth and firm size also have a significant impact on the profitability. Based on the key findings from this study it has been concluded that the management of a firm can create value for its shareholders by reducing the DCP. The management can also create value for its shareholders by increasing inventories to a reasonable optimum level. Firms can also take long period to pay their creditors as far as they do not strain their relationship with them. As a recommendation it is suggested for all the manufacturing companies to have a greater focus on the relationship between WCM and profitability, by adopting an appropriate management which will ultimately lead to higher profitability and lower threat of insolvency.

Keywords: Working Capital Management, Profitability, Manufacturing Sector, Insolvency, Colombo Stock Exchange

JEL Classification: Q56