A COMPARATIVE ANALSIS OF THE EFFECT OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF SMALL AND LARGE COMPANIES LISTED AT KARACHI STOCK EXCHANGE

Abstract

Working Capital Management has an overriding impact on a firm’s profit performance. However, the profitability of large firms, unlike small ones, might show a different degree of sensitivity to the efficient management of working capital. Presumably small firms and large firms are different from each other in that working capital management may affect more (or less) the profitability of one or the other. One wonders as to which type of firms (small or large) exhibit more escalation in their profitability as a result of a decent management of their working capital. Exploring the answer to this query is the basic aim of this research dissertation. To do that, effect of working capital management was determined on the profitability of the two forms of organizations separately and then the results so derived were compared in order to determine the difference in the possible effect of WCM on profitability of the two organization types, if any. To serve the purpose, two distinct samples were made, one having all the SME’s listed in the Karachi Stock Exchange and the other including the largest non-financial firms of the country listed in KSE, the data of which was available. Related data was gathered for firms in both samples for a period of six years from 2003 to 2008. All the relevant and the required financial information was acquired from an official document titled, “Balance Sheet Analysis of Joint Stock Companies Listed on the Karachi Stock Exchange --- (2003-2008)”, formally published by the Statistics and DWH Department of the State Bank of Pakistan (SBP). This document contained the Balance Sheet analysis of all the non-financial firms listed on the Karachi Stock Exchange as at June 30, 2008. Hence the research was entirely based on the Secondary data. It should be stated that the financial corporations like Banking Companies, Insurance Companies, Leasing Companies and Modarabas etc. were not included in this study. A total of 40 (out of 93) small firms were included in the first sample (known as Sample 1) for six years which led to 240 firm-year observations. Similarly, 103 (out of 343) large companies were incorporated in the second sample (known as Sample 2) for six consecutive years leading to 618 firm-year observations. Working Capital Management was measured by the Cash Conversion Cycle. As for the measurement of profitability, two variables were used; the Return on Assets and the Operating Profit to Sales. The Pearson Product Moment Coefficient of Correlation and the Linear Regression Analysis were used to examine the relationship between the Cash Conversion Cycle and that of the profitability variables. The correlation analyses were separately made for all the firms included in the two samples individually and then for the pooled data of each sample collectively so as to make a clear comparison. As for the Regression, two separate analyses were made, one detecting the influence of working capital management on the Return on Assets, and the other finding out the impact of WCM on the Operating Profit to Sales for both the samples. Results of the individual Correlation analysis for the two samples did not present a clear picture of whether the indicators of WCM had more, or less, influence on the profitability of small, or large, firms or vice versa. However, a comparison of the results of the Pooled Correlation analysis of the two samples suggested that the indicators of working capital management had a more visible impact on the profitability of firms of relatively larger size. In the first Regression analysis (called the Regression Analysis ‘A’), no significant associations were detected between the indicators of WCM and the Return on Assets for Sample 1. As for Sample 2, one of the WCM indicators, however, was found to be negatively and significantly related with the Return on Assets. The Regression analysis ‘B’, nonetheless, brought very clear demarcation between the effects of WCM on the profitability (Operating Profit to Sales) of the two samples. On the one hand, a very few significant relationships were found between the indicators of WCM and the profitability for Sample 1. And in contrast, the pooled data of Sample 2 displayed highly significant relationships of Operating Profit to Sales with all the indicators of working capital management including the Inventory Conversion Period, Receivable Collection Period, Payable Deferral Period and the Cash Conversion Cycle. This is a clear indication of the fact that the efficiency of managing working capital has more constructive effect on the profitability of larger firms. Hence, it is suggested for the managers of large-sized corporations to redouble their thought on the effective and vigilant management of their working capital so as to invigorate profitability.