3.3 Hypotheses Testing
Objective of this study is to look at the relationship between profitability and working capital management, the study uses the same hypotheses as used by Raheman & Nasr(2007)
Hypothesis 1
The first hypothesis of this study is as follows:
H01: There does not exist any relationship between efficient working capital management and profitability of firms.
H11: There is a relationship between efficient working capital management and profitability of firms.
Hypothesis 2
The second hypothesis of the study is as follow.
H02: There is no relationship between liquidity and size and profitability of firms.
H12: There may exist a negative relationship between liquidity and size of Pakistani firms and profitability.
3.4 Model Specifications:
The model used in the Study is similar to that used by Raheman & Nasr (2007) which can be specified as;
NOP it = β0 + β1 (ACP it) + β2 (ITID it) + β3 (APP it) + β4 (CCC it) + β5 (CR it) + β6 (DR it) +
Β7 (LOS it) + β8 (FATA it) + ε (Eq. 3.2)
Where:
NOP: Net Operating Profitability
ACP: Average Collection Period
ITID: Inventory Turnover in Days’
APP: Average Payment Period
CCC: Cash Conversion Cycle
CR: Current Ratio
DR: Debt Ratio
LOS: Natural logarithm of Sales
FATA: Financial Assets to Total Assets
E: The error term.
4. Results and Discussion
Two types of analysis are used, descriptive and quantitative. The results of these analysis are discussed in this section
4.1 Descriptive Analysis
Descriptive analysis is the first step in analysis; it will help to describe relevant aspects of occurrence of cash conversion cycle and provide detailed information about every relevant variable. Research has already been conducted in this area of study and a...
... middle of paper ...
...has a negative coefficient – 0.2237.But it is significant at ά. = 5%. It means that if the firm is able to decrease this time period known as cash conversion cycle, it can increase its profitability.
By analyzing the results it is concluded that if the firm is able to reduce these time periods, then the firm is efficient in managing working capital. This efficiency will lead to increasing its profitability.
Current ratio is a traditional measure of checking liquidity of the firm. In this analysis the current ratio has a significant negative relationship with profitability (measured by net operating profitability). The coefficient is – 0.1357. The result is significant at ά. = 1%. It indicates that the two objectives of liquidity and profitability have inverse relationships. So, the Pakistani firms need to maintain a balance or tradeoff between these two measures.
Net working capital represents organization’s operating liquidity. In order to compute the net working capital, total current assets are divided from total current liabilities. When there is sufficient excess of current assets over current liabilities, an organization might be considered sufficiently liquid. Another ratio that helps in assessing the operating liquidity of as company is a current ratio. The ratio is calculated by dividing the total current assets over total current liabilities. When the current ratio is high, the organization has enough of current assets to pay for the liabilities. Yet, another mean of calculating the organization’s debt-paying ability is the debt ratio. To calculate the ratio, total liabilities are divided by total assets. The computation gives information on what proportion of organization’s assets is financed by a debt, and what is the entity’s ability to pay for current and long term liabilities. Lower debt ratio is better, because the low liabilities require low debt payments. To be able to lend money, an organization’s current ratio has to fall above a certain level, also the debt ratio cannot rise above a certain threshold. Otherwise, the entity will not be able to lend money or will have to pay high penalties. The following steps can be undertaken by a company to keep the debt ratio within normal
This, in turn, also improved the cash conversion cycle from 72.1 days to 57.1 days. The EBITDA margin decreased, however, this decrease would have been more if the underperforming stores were still operating. Source: Televisory’s Research Source: Televisory’s Research. Source: Televisory’s Research. Source: Televisory’s Research.
In order to determine the value of operations, and using proforma income statement and balance sheet statement, Cash flow statement was formulated for the next 5 years. The Account Receivables plus the Inventory minus the Account Payable was determined as Net Operating Working Assets. An organization cost of 0,000 was amortized over the 5-year period.
Also, it means that the company has to keep less working capital for its current assets and can manage its cash flow more efficiently.
In Be Our Guest, Inc.’s scenario, we can see that the total cash flow from operations increased from 1995, $168,000, to 1997, $229,000, by 37%. This increase to the CFO is a result of a few different accounts. Although net income decreased 22.8% from 1995 to 1997, because depreciation increased 25.8% from 1995 to 1997, the total net income adjusted for non-cash charges increased by 4% from $250,000 to $259,000, from 1995 to 1997. The changes to Accounts Receivable over the years reduce cash flow from operations by $75,000, $46, $42,633 in 1995, 1996, and 1997, respectively. These increases in accounts receivable cause the cash flow from operations to decrease because Be Our Guest, Inc. collected less money from their customers compared to the sales. Whereas, the changes in Accounts payable & accruals of, $5,768, $19,063, and $14,859, in 1995, 1996, and 1997, respectively, caused the cash flow from operations to increase because Be Our Guest, Inc. is paying their suppliers less, indicating they are retaining more cash for
Current Ratio. The current ratio can indicate a company’s liquidity and is considered one of the most valuable ratios in analyzing
Overall, Horizontal analysis and financial ratios are essential factors that businesses use to monitor its liquidity. Therefore, in order to improve Apple’s ratios and profitability, the company needs to implement a strategy to increase the company’s liquidity. Business owners or managers should monitor current ratio and acid test ratio as these ratios help us to ensure the company has the proper liquid assets to pay current liabilities, to stay in operations and to expand the company. As we noted in our acid test ratio and current ratio for the company, we show a lower ratio for acid test ratio than the current ratio, which means that the company’s current assets rely on inventory. Therefore, the company needs to convert old inventory into
In regards to the corporation’s balance sheet, it is necessary to place an importance on liquidity ratios to demonstrate the company’s ability to pay its short term obligations such as accounts payable and notes that have a duration of less than one year. These commonly used liquidity ratios include the current ratio, quick ratio, and cash ratio. All three ratios are used to measure the liquidity of a company or business. The current ratio is used to indicate a business’s ability to meet maturing obligations. The quick ratio is used to indicate the company’s ability to pay off debt. Finally the cash ratio is used to measure the amount of capital as well short term counterparts a business has over its current liabilities.
This is where the cash flow reaches its peak but also at the point of
Liu, C., Spector, P. E., & Shi, L. (2008). Use of Both Qualitative and Quantitative
The horizontal analysis shows that IQ’s total current assets increased by 25% and its total current liabilities increased by 40% during 2005. This is largely explained by the increase in trade receivables, the increase in inventory, the increase in trades payable, and the increase in term loans (notes 5, 6, 12, and 13 of the 2005 financial statement). The higher increase in total current liabilities than in total current assets explains why the current and acid-test ratios decreased from 4.66 to 4.17 and from 4.02 to 3.5, respectively. However, IQ seems to remain highly liquid considering the values of the mentioned liquidity ratios.
Ratios traditionally measure the most important factors such as liquidity, solvency and profitability, as well as other measures of solvency. Different studies have found various ratios to be the most efficient indicators of solvency. Studies of ratio analysis began in the 1930’s, with several studies of the concluding that firms with the potential to file bankruptcy all exhibited different ratios than those companies that were financially sound. Among the study’s findings were that the deciding factor of the predictor of bankruptcy should not be only a few ratios, as the measure of a company’s financial solvency may differ as the firm’s situations differ. The important question is to which ratios are to be used and of those ratios chosen, which ratios are given priority weight.
Maintaining a company’s financial assets is a daunting task. Cash management techniques and short-term financing provide accounting executives with the tools needed to survive the constant changes within the economy. The combination of these tools and the knowledge of the world economy will assist companies in maintaining current assets and facilitates growth.
A two-phase sequential explanatory strategy was used for the study. The two- phases are ordered in the sequence that was proposed as priority was placed on quantitative data collection and analysis. In the second phase, qualitative data was collected and used to refine the results of the quantitative data presented in the first phase.
If there is sufficient working capital than we can assume that it has sound financial position and if the business is under trading than there will be increment in liquid assets which shows that the funds are not been utilized and kept ideal.