Effects of working capital management on corporate profitability

Abstract

Working capital management is considered to be a vital issue in financial management decisions and it has its effect on the liquidity as well as on the profitability of a firm. A liquidity crisis is prevalent worldwide and has affected virtually all corporate entities. This has necessitated the effective and efficient management of any available cash needed to ensure that companies break even and survive this distressed time since credit is not easily come by. Moreover, an optimal working capital management positively contributes to creating firm value. This study examined the influence of working capital management components on the profitability of firms listed on the Johannesburg Stock Exchange (JSE). Specifically, the study used a survey of documentary analysis of companies' audited financial statements. Consequently, 20 listed companies for a period of five years (2008-2012) with a total of 100 observations were sampled. The data obtained was analysed quantitatively using Pearson's correlation and Oridnary least square (OLS) regression analysis. The key findings from the study indicated the following. First, a significant negative relationship between profitability and working capital management. This negative relationship suggests that managers can create profits or value for their companies and shareholders by correctly handling the cash conversion cycle and keeping each different component of working capital to a possible optimum level. Second, a significantly negative relationship between liquidity and profitability. This suggests that corporate managers can adopt a more generous credit policy to improve profitability by reducing the credit period granted to their customers and third, a significantly positive relationship between size and firm profitability is evident. This is consistent with the theoretical views of large firms higher economic of scale and good will in the market. Therefore, using these market diversifications is the right avenue, as they increase sales and maximize profitability. The debt used is negatively correlated with profitability, but this negative effect is negligible.