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UNIVERSITY OF GHANA
QUADRATIC RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT
AND THE PROFITABILITY OF LISTED MANUFACTURING COMPANIES IN
GHANA
BY
YAW BAMFO-DEBRAH
(10700592)
A LONG ESSAY SUBMITTED TO THE UNIVERSITY OF GHANA, LEGON IN
PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF A
MASTER OF SCIENCE IN ACCOUNTING AND FINANCE
AUGUST 2019
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DECLARATION
I, YAW BAMFO-DEBRAH thusly pronounce that this work is my own work towards the
honor of the Master of science qualification and that, as far as I could possibly know, it contains
no material recently distributed by someone else nor material which has been acknowledged
for the honor of some other college degree, aside from where due affirmations has been made
in the content.
I bear sole responsibility for any shortcomings.
……………………………... ………………………..
YAW BAMFO-DEBRAH DATE
(10700592)
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CERTIFICATION
This is to guarantee that this long essay was duly supervised as per the procedures laid down
by the University of Ghana.
……………………. ……………………
DR. R. A. BEKOE DATE
(SUPERVISOR)
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DEDICATION
This long essay is primarily dedicated to God Almighty. This work is likewise dedicated to my
dear parents Mr. and Mrs. MANU-DEBRAH for supporting and empowering me all through
my study. I am genuinely grateful for having both of you in my life. This work is additionally
devoted to my sisters NANA YAA POKUAH-DEBRAH, MAME YAA POKUAH-DEBRAH
and AKOSUA TAKYIWA-DEBRAH.
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ACKNOWLEDGEMENT
I would like to thank the Almighty God for His immense mercies and guidance throughout my
studies. I wish to also recognize the massive commitment of my supervisor, Dr. R. A. BEKOE
for her unparalleled tolerance, insightful guidance and ageless commitment all through the
supervision of this work.
I likewise recognize and appreciate the commitments and contributions of JOAN ESINAM
AKOSUA AGBENYA and ADWOA FREMAH NTOSOUR-AMPONSEM who assisted me
with the effectively culmination of this long exposition.
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TABLE OF CONTENT
DECLARATION .................................................................................................................. ii
CERTIFICATION ............................................................................................................... iii
DEDICATION ..................................................................................................................... iv
ACKNOWLEDGEMENT ..................................................................................................... v
TABLE OF CONTENT ....................................................................................................... vi
LIST OF TABLES ............................................................................................................. viii
LIST OF FIGURES ............................................................................................................. ix
ABSTRACT ......................................................................................................................... x
CHAPTER ONE ................................................................................................................... 1
INTRODUCTION ................................................................................................................ 1
1.1 Background ................................................................................................................. 1
1.2 Rationale of the Study .................................................................................................. 2
1.3 Aim ............................................................................................................................. 3
1.4 Objectives .................................................................................................................... 3
1.5 Limitation of the Study ................................................................................................ 4
1.6 Plan of Dissertation ...................................................................................................... 4
1.7 Summary ..................................................................................................................... 4
CHAPTER TWO .................................................................................................................. 5
LITERATURE REVIEW ...................................................................................................... 5
2.1 Introduction ................................................................................................................. 5
2.2 Approaches to Working Capital Management .............................................................. 5
2.2.1 Defensive policy.................................................................................................... 5
2.2.2 Aggressive Policy .................................................................................................. 6
2.2.3 Conservative Approach ......................................................................................... 7
2.3 Review of Empirical Literature .................................................................................... 7
2.3.1 Research on Linear Connection between Working Capital Management and Firm
Performance .......................................................................................................... 7
2.3.2 Research on the quadratic connection between Working Capital management and
Firm Performance................................................................................................ 16
2.3 Summary ................................................................................................................... 18
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CHAPTER THREE ............................................................................................................. 19
RESEARCH METHODOLOGY......................................................................................... 19
3.1 Introduction ............................................................................................................... 19
3.2 Research Approach .................................................................................................... 19
3.3 Data Source and Sample Selection ............................................................................. 19
3.4 Measurement of Estimation Variables ........................................................................ 20
3.5 Empirical Estimation Models ..................................................................................... 21
3.6 Summary Statistics and Correlation Analysis ............................................................. 21
3.6.1 Descriptive Statistics ........................................................................................... 21
3.6.2 Correlation Analysis ............................................................................................ 22
3.7 Methodological Issues ............................................................................................... 23
3.8 Summary ................................................................................................................... 23
CHAPTER FOUR ............................................................................................................... 24
PRESENTATION AND ANALYSIS OF RESULTS .......................................................... 24
4.1 Introduction ............................................................................................................... 24
4.2 Cash Conversion Cycle and Profitability .................................................................... 24
4.3 Components of Cash Conversion Cycle and Profitability ........................................... 26
4.3.1 Receivable Period and Profitability ...................................................................... 26
4.3.2 Inventory Period and Profitability ........................................................................ 28
4.3.3 Payable Period and Profitability .......................................................................... 30
4.4 Optimal Working Capital Policies .............................................................................. 32
4.5 Summary ................................................................................................................... 38
CHAPTER FIVE ................................................................................................................ 39
CONCLUSIONS AND RECOMMENDATIONS ............................................................... 39
5.1 Introduction ............................................................................................................... 39
5.2 Summary ................................................................................................................... 39
5.3 Recommendations...................................................................................................... 40
REFERENCES ................................................................................................................... 42
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LIST OF TABLES
Table 3.1 Descriptive Statistics…..........................................................................................22
Table 3.2 Correlation Matrix..................................................................................................23
Table 4.1 Regression 1 Results…………..............................................................................25
Table 4.2 Hausman Test 1……………….............................................................................25
Table 4.3 Regression 2 Results.............................................................................................27
Table 4.4 Hausman Test 2………………............................................................................27
Table 4.5 Regression 3 Results............................................................................................29
Table 4.6 Hausman Test 3………………...........................................................................29
Table 4.7 Regression 4 Results...........................................................................................31
Table 4.8 Hausman Test 4.………………..........................................................................31
Table 4.9 Roots and Turning Points....................................................................................33
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LIST OF FIGURES
Figure 1.1 Maximum Quadratic Relationship Illustration ..................................................2
Figure 4.1 NPM-RP Quadratic Relationship Curve…………...........................................34
Figure 4.2 NPM-IP Quadratic Relationship Curve……....................................................35
Figure 4.3 NPM-PP Quadratic Relationship Curve...........................................................36
Figure 4.4 NPM-CCC Quadratic Relationship Curve........................................................37
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ABSTRACT
As of late, analysts have led concentrates to explore the straight connection that may exist
between working capital administration and profitability. Some researchers have discovered a
positive linear connection between working capital administration and profitability while
others have discovered a negative straight connection between working capital and
profitability. A couple of different specialists have likewise discovered blended outcomes with
regards to the connection between working capital administration and profitability. Is it
possible that the researchers finding a positive linear connection between working capital
administration and profitability are seeing one side of a maximum quadratic curve while the
studies that found a negative straight connection are also taking a gander at the opposite side?
This study consequently looks to analyze the quadratic connection that may exist between
working capital administration and profitability and furthermore endeavor to determine the
ideal working capital policies that would guarantee greatest profitability.
Listed manufacturing companies in Ghana were the entities used for this study. The study
considered the audited annual financial statements of these entities from 2006 to 2015. The
results of the investigation revealed that there is a quadratic connection between working
capital management and profitability and that there is an optimum cash conversion cycle
period, receivables collection period, inventory turnover period and payables payment period
that would have maximum positive impact on profitability measured by net profit margin.
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CHAPTER ONE
INTRODUCTION
1.1 Background
Over the years, countless number of articles have been published on the impact of working
capital management on business profitability. The majority of these articles investigated the
linear connection that may exist between working capital management and profitability. Kasozi
(2017), Jakpar et al (2017), Akoto et al (2013) and others under took similar studies and
discovered a positive linear connection between working capital management and profitability.
These researchers attributed the positive influence of working capital management on
profitability to potential increase in sales as a result of increase in credit period to customers.
They also mentioned that elimination of stock out which catalyses low production can also be
achieved by keeping high levels of inventory. Likely discounts from suppliers who are paid
quickly was another reason given for the positive linear relationship between working capital
management and profitability. These researchers also asserted that default risk is reduced when
high levels of current assets relative to current liabilities are kept because there would be more
than enough current assets to defray short term liabilities (Vishnani and Shah, 2007).
On the other hand, Raheman & Nasr (2007), Gill, Biger & Mathur (2010), Mathuva (2010) and
some others found a negative linear connection between working capital and profitability.
These researchers argued that keeping high levels of current assets result in locked up funds.
Funds held in receivables do not yield returns with time and therefore loss value. Having high
levels of receivables also increase the risk of experiencing rampant bad debts which negatively
impact profitability. The findings of these researchers have advocated the aggressive approach
to working capital management which says that it is better to fund short term assets with short
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term liabilities because short term liabilities are generally cheaper than long term liabilities
(Andrew and Gallagher, 2000).
Why are some researchers finding a negative linear connection between working capital
management and profitability and others finding a positive linear connection between working
capital management and profitability? Are these researchers looking at different sides of a
curve (see figure 1.1)? Is there an optimum cash conversion cycle period for maximum
profitability?
Figure 1.1 Maximum Quadratic Relationship Illustration
1.2 Rationale of the Study
A study was made on 160 companies listed on the alternative investment market to ascertain
how working capital level influence SME profitability (Afrifa et al, 2016). According to Afrifa
et al (2016), there is a quadratic connection between working capital level and profitability and
Profi
Cycle Period
Red area- The red area signifies the area of positive connection between cycle period
and profitability.
Blue area- The blue area signifies the area of negative connection between cycle
period and profitability.
Profitability
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that there is an optimal working capital level at which SMEs can maximize their profitability.
Abdul-Hamid et al (2017) also recently tried to address the above questions by studying the
quadratic connection between working capital management and firm performance. Their study
considered 75 non-financial firms listed on the Nigerian stock exchange from 2007 to 2015.
This study concluded that the connection between working capital management and
profitability is quadratic. This is to suggest that an optimal level of investment in working
capital exists. A general recommendation made by Abdul-Hamid et al (2017) was that more
studies should be conducted to further understand the quadratic connection between working
capital management and profitability, hence the justification for the study.
1.3 Aim
The general objective of the study is to investigate the quadratic connection that may exist
between working capital management and the profitability of listed manufacturing firms in
Ghana.
1.4 Objectives
The study seeks to:
1. Examine the quadratic connection that may exist between cash conversion cycle and
profitability of listed manufacturing companies in Ghana
2. Examine the quadratic connection that may exist between the various components of
cash conversion cycle and the profitability of listed manufacturing companies in Ghana
3. Determine the roots and turning points of the quadratic functions estimated in objective
1 and 2.
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1.5 Limitation of the Study
The study has a few limitations which will be elaborated in this section. Firstly, the study is
limited by geography. The study only considers entities in Ghana and therefore results from
this study cannot be generalized beyond Ghana. The second limitation is that the study
considers only manufacturing companies in Ghana. This makes the results of this study
industry specific. The results of this study can only therefore be associated with manufacturing
concerns.
1.6 Plan of Dissertation
The organization of the remaining chapters of this long essay will be described in this section.
Chapter 2 contains a discussion of the various approaches to working capital management and
empirical literature pertinent to the area of study. Chapter 3 spells out the research approach,
Data source and sampling, estimation variables and methods and a statistical description of
empirical data. Chapter 4 presents analysis of data as well as a discussion of the findings and
discoveries that were made in the course of the analysis. Lastly, chapter 5 concludes the
discourse and gives recommendations for further studies.
1.7 Summary
This chapter discusses the background and rational of this study. The chapter also spells out
the general aim and specific objectives of the research. The limitation of the study as well as a
description of the outline of the dissertation can also be found in this chapter. The next chapter
reviews the various approaches to working capital management and empirical literature to
support the gap identified in section 1.2.
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
In this chapter, the ways to deal with working capital management as it identifies with
profitability are discussed. Additionally, the findings of other researchers who have conducted
similar studies in other jurisdictions and populations have also been reviewed.
2.2 Approaches to Working Capital Management
Working capital administration approach can be best depicted as a system which gives the rule
to deal with the present resources and current liabilities in a manner that lessens the danger of
default (Brian, 2009). Working capital approach is for the most part centered around making
enough short term resources accessible so as to meet short term obligations. When the level of
liquidity is excessively high, an organization has a lot of inactive assets and will have to
shoulder the cost of these inert assets. Be that as it may, in the event that the liquidity is
excessively low, the company will face scarcity of assets to meet its short term obligations
(Vishnani and Shah, 2007). Short term resources are key parts of working capital and the
working capital policy also relies upon the level of short term resources against the level of
current liabilities (Afza and Nazir, 2007). Accounting and finance literature by and large
classify working capital strategy into three categories (Arnold, 2008).
2.2.1 Defensive policy
An organization pursues defensive strategy by utilizing long haul obligations and equity to
back its long term resources and major portions of short term assets. Accordingly, such an
organization encounters extremely low risks as there will be all that could possibly be needed
to settle current liabilities. This methodology consequently influences profitability in light of
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the fact that long haul obligations offers high loan fee which will shoot up the cost of financing
(Andrew and Gallagher, 2000). This suggests that such an organization is not eager to take
risks and feels it is suitable to keep money or close to money balances, high inventories and
maintain liberal credit terms. Generally, the organizations that are working in an uncertain
environment prefer to adopt such an approach since they do not know what prices, demands
and transient financing cost will be on a later date. In such a circumstance, it is smarter to have
a high level of current assets. A typical exemplary scenario is to keep elevated amounts of
inventory so as to meet the unexpected ascent in demand and to dodge the danger of stoppage
in production. This approach gives a more drawn out cash conversion cycle for the
organization. Defensive policy gives the shield against distress caused by the absence of assets
to meet short term obligations yet as talked about before, long haul obligations for the most
part have high interest cost which will build the cost of financing. Furthermore, capital tied up
in a business on account of liberal credit arrangement of the organization consiquently have its
opportunity cost. Hence, this arrangement may decrease the profitability and the cost of
following this strategy may surpass the advantages of the approach (Arnold, 2008).
2.2.2 Aggressive Policy
An organization pursue aggressive strategy by financing its current assets with short term funds
since it gives low financing cost however the hazard related with momentary obligation is
higher than long haul obligation. This methodology is exceptionally unsafe on the grounds that
the contrast between liquid resources and momentary liabilities turns practically nothing. Also,
few managers go out on a limb by financing long haul resources with short term funds and this
methodology sometimes pushes working capital to a negative. Managers attempt to enhance
profitability by paying lesser interest rates, however this methodology can demonstrate
exceptionally dangerous if transient financing costs change or the money inflows are not
sufficient to satisfy the present liabilities (Andrew and Gallagher, 2000). Such an approach is
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embraced by an organization which is working in a steady economy and is very sure about
future money streams. An organization with aggressive working capital strategy offers short
credit period to clients, holds minimal inventory and has a limited amount of money close by.
This arrangement builds the danger of default in light of the fact that an organization may
encounter an absence of assets to meet the transient liabilities yet it gives an exceptional yield
as the exceptional yield is related with high risk (Vishnani and Shah, 2007).
2.2.3 Conservative Approach
A number of organizations decide neither to be aggressive by decreasing the level of current
assets relative to current liabilities nor to be defensive by expanding the level of current assets
relative to current liabilities. So as to balance risk and return, these organizations pursue the
conservative approach. This methodology is a blend of defensive working capital policy and
aggressive working capital policy. With this methodology, temporary current assets which
show up on the statement of financial position for brief period are financed with the transient
borrowings whiles long haul obligations are utilized to back fixed resources and permanent
current assets. Along these lines, the adherent of this methodology finds the moderate level of
working capital with moderate risk and return (Andrew and Gallagher, 2000). In addition, this
arrangement lessens the danger of default, also it likewise diminishes the opportunity cost of
extra interest in the current resources.
2.3 Review of Empirical Literature
2.3.1 Research on Linear Connection between Working Capital Management and Firm
Performance
Kasozi (2017) conducted an investigation into the impact of working capital administration on
profitability of listed manufacturing firms in South Africa. In this study, the researcher sought
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to explore the association between working capital administration and profitability, estimated
utilizing the cash conversion cycle and the return on assets of his population respectively. He
likewise tried to evaluate the association between the different segments of working capital
administration (in this way, receivables gathering period, payables payment period and
inventory turnover period) and profitability. The discoveries of the investigation uncovered
that average receivables gathering period and average payment period are negatively related
with profitability. This is to propose that entities that give shorter credit periods to their clients
and pay their suppliers on time enjoy better profitability. Inventory holding period was
observed to be positively corresponded with profitability. This is likewise to recommend that
organizations which stock-up and keep up their stock level endure less stock-outs and dodge
difficulties in securing financing when required (Kasozi, 2017). In Kasozi's investigation, it
was not determined as to whether a shorter or longer cash conversion cycle improves the
profitability of the organizations.
Jakpar et al (2017) directed an investigation on the association between working capital
administration and profitability in Malaysia's manufacturing sector. This analysis tried to test
five (5) hypothesis. These are:
1. H1: There is an association between log of money conversion cycle and company's
profitability
2. H2: There is an association between the log of average collection period and firm's
profitability
3. H3: There is an association between the log of inventory turnover period and firm
profitability
4. H4: There is an association between debt ratio and firm profitability
5. H5: there is an association between firm size and firm profitability
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The discoveries of the analysis depicted above uncovered that the log of the money conversion
cycle had no power over firm profitability and in this manner an organization that improves its
money conversion cycle would not enjoy any additional profitability. The investigation
additionally uncovered that there is a positive association between the log of average collection
period and firm profitability. This additionally implies that managers ought to be urged to give
clients longer credit periods so as to enhance profitability. The investigation likewise found a
positive association between the log of inventory turnover period and firm profitability. This
infers that firms with higher inventory turnover periods have better profitability. The analysis
further uncovered that there is a negative association between debt ratio and firm profitability,
while there exists a positive association between firm size and profitability.
Akoto et al (2013) spearheaded an analysis of working capital administration and profitability
of listed Ghanaian manufacturing organizations. The goal of this investigation was to look at
how the working capital administration practices of listed manufacturing firms in Ghana sway
their profitability for the period covering 2005-2009. The discoveries of this investigation
uncovered that accounts receivable days is contrarily connected with profitability. It likewise
found that there is a positive inconsequential association between accounts payable period and
profitability. This is to assert that the accounts payable period is not so significant with regards
to ascertaining the profitability of a manufacturing company. The analysis additionally found
that there exists a positive association between money conversion cycle and firm profitability.
This suggests that so as to improve profitability, supervisors should chip away at keeping up
longer money conversion cycles. This investigation likewise asserted that current assets and
sales essentially and positively determine profitability. Supervisors are hence to keep up
adequate current assets and produce most feasible extreme sales so as to improve profitability
(Akoto et al, 2013).
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Raheman and Nasr (2007) found a solid negative association between the net operating profit
and debt gathering period, inventory holding period and credit payment period when they
played out a comparative report on 94 listed Pakistani firms. Their analysis found that
supervisors can make additional profit for their investors by lessening the number of days for
gathering receivables and the number of days for inventory turnover. Raheman and Nasr (2007)
additionally referenced that the negative association between accounts payable period and
profitability is consistent with the view that less lucrative firms take longer in paying their bills.
Khalid (2012) studied the association between working capital efficiency and profitability, with
a sample of sixteen (16) Indian firms recorded on Bombay Stock Exchange (BSE) for the time
of 2006-2011. The results of the investigation demonstrated that there is a negative association
between the variables of money conversion cycle and profitability. Khalid (2012) concluded
that if account receivables and inventory holding days are decreased the organization will make
more profit and the negative association of the accounts payable with profit additionally affirms
other writings that say less profitable firms will haggle for longer periods to pay obligation.
Rehn (2012) considered the impact of working capital administration on organizational profit.
It was an industry-wise study of Finnish and Swedish public organizations. The factors used to
determine working capital administration was money conversion cycle and net trade cycle. The
results demonstrated that there is a noteworthy impact of working capital administration on
gross profit. The connection between the working capital variables and gross profit were
negative. This proposes that effective administration of working capital can build profitability
in those businesses.
Badu and Asiedu (2013), inspected the impact of working capital administration on the
profitability of manufacturing organizations listed on the Ghana Stock Exchange (GES),
explicitly those in the Accra. The principal target of the analysis was to look at the effect of the
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different working capital administration variables on the profitability of listed manufacturing
organizations in Ghana, and to likewise set up the association between liquidity and
profitability of listed manufacturing organizations. The outcome of the analysis demonstrated
that there is a negative association between accounts payable days and net operating profit in
spite of the fact that the measurable outcome was of no noteworthy incentive on profit; it infers
that the shorter the account payable period the more profitable the organization is. Furthermore,
a negative association was found between the inventory holding time frame and net operating
profit, the statistical worth is of no noteworthy incentive on profit; it proposes that whether it
takes longer or shorter period to sell the products it does not generally have any effect on the
benefit of the organization. Be that as it may, there was a positive association between money
conversion cycle and net operating profit. This shows the period between payment of liabilities
and collection of credit sales affects profit. Therefore, these factors ought to be overseen
appropriately and productively to an ideal level so the desired profit of the company can be
accomplished.
Bhunia and Das (2015) examined the fundamental association between working capital
administration and profitability of pharmaceuticals organizations in India for the time of 2004-
2013 with a sample of 140 pharmaceutical organizations. In the investigation, 8 ratios were
recognized as pointers of working capital; current ratio, quick ratio, money position proportion,
debt to equity ratio, inventory turnover ratio, indebted individuals' turnover proportion, lenders'
turnover proportion and working capital cycle whereas one ratio was used as a pointer of
profitability, return on capital utilized. The investigation of results demonstrated that there is
no critical association between working capital administration and profitability despite the fact
that the working capital cycle demonstrated some impact on the profit, it is not huge.
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Gill, Biger and Mathur (2010) endeavored to assess the association between working capital
administration and profitability of 88 firms listed on the New York stock exchange. No huge
association was found between inventory holding period and profitability whereas a positive
association was found between money conversion cycle and profitability. Directors can make
wealth for investors by decreasing the number of days for accounts receivables collection (Gill,
Bigger and Mathur, 2010).
Mathuva (2010) additionally examined the impact of working capital administration
components on corporate profitability. It was found that there exists an exceptionally
noteworthy negative association between cash collection period and corporate profitability, a
profoundly huge positive association between inventory turnover period and corporate
profitability and very huge positive association between payment period and corporate
profitability.
Baveld (2012) explored the administration of working capital in the most productive ways,
during non-crisis period and crisis period. 37 listed organizations from the Netherlands were
examined with the non-crisis period going from 2004-2006 and the crisis time frame going
from 2008 to 2009. The analysis uncovered that the number of days of accounts receivable has
a negative association with the firm profitability during a non-crisis period whiles in the crisis
time frame, there was no noteworthy association. This suggests that the association between
number of days of account receivables and a firm profitability changes in the midst of crisis.
The accounts payable and profitability additionally demonstrated a negative association in the
two time frames. Conceivable reason cited for this was that firms who pay earlier, get discount
which results in a higher profit. There was negative association among inventory turnover
period and profitability in the two time frames. This recommends that during crisis and non-
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crisis periods, more consideration ought to be given to inventory and it ought to be kept up at
a minimal level.
NG'ANG'A (2009) also explored the association between working capital and profitability of
listed organizations in the Nairobi Stock Exchange. The scientist studied 23 firms, a sample of
firms listed at Nairobi Stock Exchange (NSE) for a time of 2003-2008. As per NG'ANG'A, in
Kenya, studies have focused on explicit drivers such as creditor liabilities, accounts receivables
and their effect on profitability without evaluating the association with working capital in its
entirety. The return on assets was utilized as the dependent variable while money conversion
cycle, debt collection period, creditor period, inventory period and leverage were utilized as
independent variables. Empirical discoveries of the investigation demonstrated that accounts
receivable period, creditor period, inventory period and money conversion cycle influence the
firm profitability adversely. In its conclusion, the investigation proposed some strategy
implications for the managers and financial specialists of Kenyan markets. The researcher
recommended that organizations need to blend policies of cash levels with that of trade
payables and inventory so the balances are streamlined or optimized. In view of the
investigation's discoveries, firms should concentrate on decreasing the accounts receivable
period, creditor period and inventory period.
Aondona et al (2014) analyzed the effect of working capital administration on profitability of
Nigerian cement industry for a time of eight (8) years; 2002 to 2009. The data set constituted
4 out of 5 cement organizations listed on the Nigeria stock exchange. The investigation found
a negative irrelevant association between firm profitability and accounts receivable period. The
analysis likewise uncovered a critical negative association between profitability and the
number of days within which inventory is held. However, the association between profitability
and the money conversion cycle was observed to be altogether positive. The analysis
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recommended that the number of days within which inventory is held and the money
conversion cycle are significant and huge in improving profitability. Consequently, directors
should screen the inventory levels so as to diminish the number of days within which inventory
is held in stock before sales. This will upgrade profitability, liquidity and furthermore augment
investors' wealth.
Atta et al. (2017) looked into the relationship between the working capital and corporate
performance in the textiles sector in Pakistan for the period 2008 to 2012. The data set was the
yearly report of textile organizations published for that period. This study uncovered that
average conversion period, money conversion cycle and operating cycle are significantly and
positively connected with firm profitability.
Golas et al (2013) conducted an analysis of the association between working capital and
profitability in the food industry of Poland. Inventory administration, receivables, current
liabilities and operating indicators were utilized in dissecting the effectiveness of working
capital administration. Return on Non-financial assets was the variable utilized in estimating
the profitability of the various food companies. The objective was to decide the direction and
quality of the effect of the cycles on profitability. The dissection indicated unmistakably that
shorter cycles result in higher profitability. This proposes so as to make organizations in the
Polish food industry profitable, managers should attempt to deal with their operating and
money conversion cycles so as to keep them as short as feasible.
In a research carried out by Garg and Gumbochuma (2015) on the association between working
capital administration and profitability in Johannesburg Stock Exchange listed retail
organizations, it was expressed that literature on this area of study have been uncertain on the
association between working capital and profitability but have nonetheless, found a negative
association between working capital and profitability. The consequences of Garg and
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Gumbochuma's analysis showed that working capital administration influenced profitability
and ought to be a necessary piece of the company's financial plan. In this present global
environment of aggressive competition, practically all organizations have no other reasonable
choice but to cut the expense of activities so as to be aggressive and be monetarily solid.
Accordingly, productive working capital administration is an indispensable part of the overall
corporate methodology to make investors wealthy. Dealing with an association between
working capital and benefit is such a crucial thing for the association's survival (Khakhdia,
2014).
Syed et al (2010) conducted an exploration on the association between working capital strategy
and profitability of Swedish firms. A sample of 37 listed organizations on the OMX Stockholm
stock exchange for a time of 5 years, that is 2004 to 2008 were utilized. Gross operating profit
was used as an indicator of profitability and the money conversion cycle was used to determine
the aggressiveness of the working capital strategy. The working capital strategy can either be
aggressive, defensive or moderate. The results demonstrated that there exists no association
between money conversion cycle and profitability. Nonetheless, profitability is positively
connected with inventory holding period and payables payment period but has a negative
connection with receivables collection period.
Temtime (2016) inspected the association between working capital administration strategies
and profitability of small manufacturing firms. The study made use of financial information for
the period 2004 to 2013 of a sample of 176 publicly traded small United States manufacturing
organizations. A regression analysis was performed where the measure of profitability was
gross operating profit, return on asset and Tobin's q. The outcome affirmed that working capital
administration and working capital strategies have a critical constructive effect on firms'
profitability.
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2.3.2 Research on the quadratic connection between Working Capital management and
Firm Performance
Thapa et al (2013) attempted an analysis of how profitability is influenced by working capital
administration in the food and beverages industry. The study in its survey of related writing
referenced that leverage, growth, cash flow, size, age, tangible fixed assets and profitability
were a portion of the elements that impacted working capital administration. Right off the bat,
dissimilar to past studies which promote a straight association between the working capital
administration and gainfulness, the investigation researched the presence of a conceivable non-
linear association. Additionally, the proficiency of working capital administration was checked
utilizing performance index, utilization index and efficiency index as opposed to utilizing the
regular turnover ratios. It was seen that the working capital measure, the money conversion
cycle was positively identified with profitability and cash flow. Then again, the money
conversion cycle was adversely connected with leverage, growth, size, age and fixed assets to
total asset ratio. The analysis additionally dissected the non-linear association between
profitability and the money conversion cycle. The positive and critical regression coefficient
of money conversion cycle and its square proposed that there exists a non-linear connection.
Ville (2015) examined the effect of working capital on corporate profitability and investor
value in 1683 publicly listed US computer and electrical equipment organizations from
1990−2013. This exploration inspected the quadratic association between operational working
capital and profitability. It additionally evaluated the impact of working capital on market
value, that is to discover how equity holders’ worth is affected by working capital.
The discoveries of this exploration demonstrates a concave association between the money
conversion cycle and return on asset, which suggests that, a perfect level of working capital
must be reached so as to maximize profit. When working capital falls beneath that perfect level,
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it diminishes the profitability. A further decrease expands the danger of illiquidity and distress
cost whiles too high increments tied-up capital and lost opportunity, thus opportunity cost. This
declaration is in concurrence with that of Arnold (2008) and Vishnani and Shah (2007).
However, money conversion cycle negatively affected return on equity, that is, as working
capital expands the value of equity holders lessens.
In 2016, an investigation was conducted to study the association between working capital level,
estimated by the cash conversion cycle and profitability of small and medium enterprises
(Afrifa et al, 2016). The analysis was performed on 160 organizations listed on the alternative
Investment market of Ghana to discover how working capital level impacts SME profitability
for the period of 2005-2010. The discoveries of this analysis uncovered that there is a concave
association between working capital level and firm profitability and that there is an ideal
working capital level at which firms' profitability is maximized. Moreover, an analysis with
respect to whether deviations from the ideal working capital level diminishes firm profitability
shows that deviations above or beneath the ideal declines profitability.
Most recently, Abdul-Hamid et al (2017) also decided to also probed the quadratic connection
that may exist between working capital administration and firm performance utilizing proof
from the Nigerian economy. The investigation was carried out on an aggregate of 75 firms
listed on the Nigerian Stock Exchange (barring money related firms). The investigation
considered the period spreading over from 2007 to 2015. The empirical results of this
investigation found that there is a quadratic association between working capital administration
and firm performance. This advocates that there is an ideal level of interest in working capital
that maximizes firm performance. In this same research, Abdul-Hamid et al (2017) made a
general proposal that more research ought to be done on the quadratic association between
working capital administration and profitability.
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2.3 Summary
The chapter gives a thorough review of literature on the connection between working capital
management and profitability. The general observation is that there are numerous researches
conducted to investigate the linear connection between working capital management and
financial performance as against the few researches conducted to investigate the quadratic
connection that may exist between working capital management and financial performance. As
such, this study seeks to continue investigations into the possibility of a quadratic connection
between working capital management and financial performance. If indeed there exists a
quadratic connection between working capital management and financial performance, this
would lead us to ascertain the optimum working capital policies that would yield high financial
performance.
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CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
The purpose of this chapter is to elaborate on the research methodology chosen in conducting
this study. The chapter will explain the research approach, source of data collected, sample and
selection criteria, execution strategy and other methodological issues.
3.2 Research Approach
Research may take three forms; quantitative approach, qualitative approach or mixed approach,
which is a blend of the first two approaches. This study would be carried out using the
quantitative approach because its objectives require the quantitative measurement of working
capital management and profitability using numerical variables gathered from secondary data
and the analysis of the econometric connection that may exist between these variables.
3.3 Data Source and Sample Selection
The study period will consider 2006-2015 so as to cover the most recent years with available
data. Secondary data will be sourced from the annual audited financial statements of
manufacturing companies listed on the Ghana Stock Exchange.
The population for the study includes all eleven (11) manufacturing companies listed on the
Ghana Stock Exchange and the entire population would be used for the study so as to capture
all instances of the population. Manufacturing companies are the focus of this study because
of the current government of Ghana’s intentions to industrialize the country by establishing
one factory in every district (New Patriotic Party,2016). The results of this study will give the
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management of these to-be-established factories a guide as to how they can manage their
working capital in a fashion that will positively impact financial performance.
3.4 Measurement of Estimation Variables
The study will make use of four (4) regressions. The dependent variable for all for regressions
will be the Net Profit Margin (NPM). This variable will be used as a measure of the profitability
of the various companies that would be analyzed in this study. For the first regression, the
primary independent variables will be Cash Conversion Cycle (CCC) and its square (CCC2).
This particular regression will be used to determine whether there is a concave connection
between NPM and CCC as a whole. The primary independent variables for the second
regression will be Receivables Collection Period (RCP) and its square(RCP2). The second
regression seeks to determine if there exists a non-linear connection between NPM and RCP
as a component of working capital management. The primary independent variables of the
third regression will be the Inventory Turnover Period (ITP) and its square (IPT2). This
regression seeks to determine the quadratic connection that may exist between NPM and ITP
as a component of working capital management. Lastly, the primary independent variables for
the fourth regression will be Payables Payment Period (PPP) and its square (PPP2). This last
regression will be used to ascertain if there exists a quadratic connection between NPM and
PPP as a component of working capital management.
Consistent with empirical studies (Afrifa, 2016; Abdul-Hamid et al, 2017; Ville, 2015), the
following control variables will be included in all the regressions because other literature have
established that they are also factors that affect profitability. These controls include the age of
the company (AGE), the size of the company measured with total assets (SIZE), the financial
leverage of the company measured with total debt ratio (LEV) and its liquidity measured with
current ratio (CR).
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3.5 Empirical Estimation Models
In order to achieve objective one (1) in chapter one, the following econometric model will be
used:
NPMit = β0 + β 1CCC2it + β 2CCCit + β 3AGEit + β 4SIZEit + β 5LEVit + β 6CRit + ℰit - (1)
Objective two (2) of this study will be achieved using the regression models below:
NPMit = β 0 + β 1RP2it + β 2RPit + β 3AGEit + β 4SIZEit + β 5LEVit + β 6CRit + ℰit - (2)
NPMit = β 0 + β 1IP2
it + β 2IPit + β 3AGEit + β 4SIZEit + β 5LEVit + β 6CRit + ℰit - (3)
NPMit = β 0 + β 1PP2it + β 2PPit + β 3AGEit + β 4SIZEit + β 5LEVit + β 6CRit + ℰit - (4)
Objective three of the study will be achieved by using calculus and algebra in finding the roots
and turning points of the quadratic functions derived from objective 1 and 2. These will help
estimate the optimal working capital management policies for maximum profitability.
3.6 Summary Statistics and Correlation Analysis
3.6.1 Descriptive Statistics
Table 3.1 presents a statistical description of the data used for this study. NPM has a mean of
5% and maximum and minimum of 27% and -78% respectively. RP has a mean of 60 days and
a minimum and maximum of 0.72 day and 185 days respectively. The minimum and maximum
of IP is 28 and 389 days respectively with a mean of 130 days. PP has a maximum of 589 days
and a minimum of 28. The mean PP however, is 144 days. CCC shows a mean of 47 days, a
maximum of 360 days and a minimum of -434 days. The oldest company in the population is
80 years old whereas the youngest is 14 years old. The mean age is 41 years. The biggest
company in the population has a total asset value of GH¢419.38million and the smallest
company has a total asset value of GH¢1.58million. The mean size is GH¢76.18million. The
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mean LEV is 54%, the minimum is 8% and the maximum is 108%. CR also has a maximum
of 9.81 times, a minimum of 0.18 times and a mean of 1.56 times.
Table 3.1 – Descriptive Statistics
3.6.2 Correlation Analysis
Table 3.2gives the correlation matrix of the data for this study. The correlation coefficients of
the variables will be analyzed based on the regression models indicated in section 3.5 above.
The correlation coefficient between CCC and NPM depicts a positive connection between the
two variables. On the other hand, RP is also seen to be negatively correlated with NPM. The
correlation matrix also reveals a positive connection between IP and NPM. Also, PP is shown
in the correlation matrix to be negatively correlated with NPM. NPM is positively correlated
with CR and SIZE but negatively correlated with AGE and LEV. The remaining control
variables show no correlation coefficient greater than 0.8. This suggests that multicollinearity
is unlikely to be present (Field, 2005).
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Table 3.2 – Correlation Matrix
3.7 Methodological Issues
Firstly, outliers were detected during a preliminary data analysis conducted. As recommended
by Beiner et al (2006), these outliers were dealt with by removing them from the data. Since
this study involves panel data, the Hausman test was performed to determine whether to use
Fixed Effect or Random Effect in estimating the panel regression model. After estimating the
regression models, the turning points and roots of the curves were determined by using calculus
and algebra respectively. With the turning points and roots of the curves, an estimate of
optimum working capital management policies that would maximize profitability can be
determined. These policies refer to those that affect receivable collection period, inventory
turnover period, payable payment period and cash conversion cycle as a whole.
3.8 Summary
This chapter gives detailed explanation of the research approach, the data source and sample
selection. It also talks about the various variables, estimation models and methodological issues
that were essential in obtaining the results presented in the next chapter.
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CHAPTER FOUR
PRESENTATION AND ANALYSIS OF RESULTS
4.1 Introduction
This chapter presents the results and findings of the study. This chapter is organized to address
the objectives as stated in chapter one. The first part elaborates on the results and findings from
studying the quadratic connection between cash conversion cycle and financial performance.
The second part gives the outcome from the study of the quadratic connection that may exist
between the components of cash conversion cycle and profitability of listed manufacturing
firms in Ghana. The last part seeks to present the results after determining the roots and turning
points of the quadratic model estimated in the first and second part.
4.2 Cash Conversion Cycle and Profitability
In studying the quadratic connection between cash conversion cycle and profitability, model 1
in chapter 3 was used as the empirical estimation model. In this model, profitability measured
by NPM was dependent on CCC and CCC2 as well as some other control variables. The results
of this estimation is presented in table 4.1.
In the table, the adjusted R2 shows that about 35% of the variations in NPM are accounted for
by the independent variables in the regression model. The F statistic value also suggests that
the independent variables as a whole are significant in determining the NPM of listed
manufacturing companies in Ghana. The results also depict that CCC2 is statistically significant
in determining NPM at 1% level of confidence. CR which is one of the control variables and
the intercept also show statistical significance in determining the NPM of the study population
at a 10% level of confidence. From basic algebra, the negative coefficient of CCC2 signifies
that the quadratic connection between CCC and NPM is maximum in nature. The random effect
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panel regression was used for the model estimation because the probability value from the
Hausman test as shown in table 4.2 upholds the random effect panel regression. Using the
coefficients in table 4.1, model 1 in chapter 3 can be rewritten as:
NPMit = 1.70E-01 - 2.26E-06CCC2it + 1.93E-04CCCit - 1.15E-03AGEit - 9.00E-05SIZEit -
1.35E-01LEVit + 2.35E-02CRit + ℰit - (5)
Table 4.1 Regression 1 Results
Standard errors are reported in parentheses. *, **, *** indicates significance at the 10%, 5%,
and 1% level respectively
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Table 4.2 Hausman Test 1
4.3 Components of Cash Conversion Cycle and Profitability
4.3.1 Receivable Period and Profitability
The results of the study on the quadratic connection between receivable period and profitability,
measured by NPM is illustrated in table 4.3 Model 2 in chapter 3 was the empirical model used
to conduct this investigation. Table 4.3 shows the estimation output after running regression 2
in chapter 3. In this regression, the dependent variable was NPM and the primary independent
variables were RP and RP2, together with other control variables as explained in chapter 3.
The adjusted R2 for this regression as shown in table 4.3 denotes that about 14% of variations
in NPM can be accounted for by the regressors of the regression. The F-statistic value also
suggests that the predictors in the regression as a whole are significant in determining the
profitability of the sample firms. However, the only variable that showed singular significance
in determining the NPM was LEV. LEV showed a significant positive connection with NPM
at a 1% confidence level. The intercept also demonstrated significance at the 5% level of
significance. The quadratic connection between RP and NPM can be said to be maximum
because the coefficient of RP2 is negative. The random effect panel regression was used in the
model estimation because the probability value from the Hausman test as shown in table 4.4
upholds the random effect panel regression. We can also rewrite model 2 in chapter 3 as follows
using the coefficients of the variables from the regression:
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NPMit = 2.44E-01 – 5.63E-06RP2it + 5.07E-04RPit - 1.82E-03AGEit + 6.90E-05SIZEit -
2.86E-01LEVit + 1.69E-02CRit + ℰit - (6)
Table 4.3 Regression 2 Results
Standard errors are reported in parentheses. *, **, *** indicates significance at the 10%, 5%,
and 1% level respectively
Table 4.4 Hausman Test 2
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4.3.2 Inventory Period and Profitability
The results of the study on the quadratic connection between Inventory Turnover Period and
profitability, measured by NPM is illustrated in table 4.5. The model used to conduct this
investigation is model 3 as found in chapter 3 of this study. Table 4.5 shows the estimation
output after running regression 3 in chapter 3. In this regression, the dependent variable was
NPM and the primary independent variables were IP and IP2, together with other control
variables as explained in chapter 3.
Table 4.5 gives the results of the regression. The adjusted R2 as reported in the table is about
14%. This signifies that 14% of the variations in NPM can be accounted for by the predictors
in the regression model. The F statistic value also signifies that the independent variables in
the regression contribute largely to determining NPM. LEV was the only predictor that showed
positive connection with NPM at a 1% degree of confidence. IP also showed a significant
positive connection with NPM at a 10% degree of confidence. Because the coefficient of IP2 is
negative, the nature of the quadratic connection between IP and NPM can be said to be
maximum in nature. The random effect panel regression was used for the model estimation
because the probability value from the Hausman test as shown in table 4.6 upholds the random
effect panel regression. The coefficients in table 4.5 can be used in rewriting model 3 in chapter
3 as follows:
NPMit = 1.78E-01 - 2.80E-06IP2it + 1.32E-03IPit - 2.75E-03AGEit + 8.36E-05SIZEit - 2.86E-
01LEVit + 1.07E-02CRit + ℰit - (7)
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Table 4.5 Regression 3 Results
Standard errors are reported in parentheses. *, **, *** indicates significance at the 10%, 5%,
and 1% level respectively
Table 4.6 Hausman Test 3
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4.3.3 Payable Period and Profitability
The last regression performed in this study was performed to understand the quadratic
connection that may exist between NPM and PP. Model 4 as found in chapter 3 was used in
studying this connection. In this model, the dependent variable is NPM and the primary
independent variables are PP and PP2. The results of this regression is presented in table 4.7
below.
In the table, adjusted R2 is reported to be about 23%. This denotes that about 23% of the
variations in NPM can be accounted for by the predictors in model 4 as found in chapter 3. The
F statistic also suggests that the independent variables in the model have overall significance
in determining NPM. PP2 showed a high significance at a 1% level of confidence, whereas PP
and LEV showed significance at 5% degree of confidence. The intercept however showed
significance at 10% degree of confidence. The coefficient of PP2 suggests that the nature of the
quadratic connection between PP and NPM is maximum in nature. The random effect panel
regression was used for the model estimation because the probability value from the Hausman
test as shown in table 4.8 upholds the random effect panel regression. Model 4 in chapter 3 can
therefore be rewritten as follows using the coefficients from table 4.7:
NPMit = 1.66E-01 - 1.95E-06PP2it + 8.67E-04PPit - 2.42E-03AGEit + 1.56E-05SIZEit -
2.21E-01LEVit + 2.07E-02CRit + ℰit- (8)
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Table 4.7 Regression 4 Results
Standard errors are reported in parentheses. *, **, *** indicates significance at the 10%, 5%,
and 1% level respectively
Table 4.8 Hausman Test 4
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4.4 Optimal Working Capital Policies
In this section, the functions derived from the four regressions will be further analyzed to
determine the optimal cash conversion cycle period for maximum profitability. The turning
point of the curve gives the value of the primary predictor that gives maximum NPM. The roots
of the curve give that range of values of the predictor for which positive NPM would be
obtained.
Model 1 as found in chapter 3 was used in studying the quadratic connection that may exist
between CCC and NPM. In this model, the primary predictors were CCC2 and CCC whiles
the regressand was NPM. From the results of the regression, model 1 was rewritten to become
model 5 as found below:
NPMit = 1.70E-01 - 2.26E-06CCC2it + 1.93E-04CCCit - 1.15E-03AGEit - 9.00E-05SIZEit -
1.35E-01LEVit + 2.35E-02CRit + ℰit - (5)
By taking the first derivative of the function with respect to CCC using calculus, we get:
d NPM = -4.52E-06CCC + 1.93E-04
d CCC
At the turning point of a quadratic curve, the first derivative is equal to Zero. This implies that:
0 = -4.52E-06CCC + 1.93E-04
CCC = 42.7 days
Therefore, in order to obtain maximum NPM, managers are to put in place working capital
management policies that will ensure that CCC is approximately 43 days long. This assertion
is true when the effect of the other variables on NPM are nullified.
In basic algebra, at the roots of a quadratic function, the dependent variable is equal to zero.
This means that model 5 has to be equated to zero in order to determine its roots.
0 = 1.70E-01 - 2.26E-06CCC2it + 1.93E-04CCCit - 1.15E-03AGEit - 9.00E-05SIZEit - 1.35E-
01LEVit + 2.35E-02CRit + ℰit
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By using the quadratic formula, and nullifying the effects of the other augmenting predictors,
we have:
CCC = -b ± √ (b2 -4ac)
2a
= -1.93E-04 ± √((1.93E-04)2 -4(-2.26E-06) (1.70E-01))
2(-2.26E-06)
CCC= -234 and CCC=320
The above exercise was performed on the other three regression models. The results are shown
in Table 4.9, figure 4.1, figure 4.2, figure 4.3 and figure 4.4.
Table 4.9
In section 2.2.1 in chapter two, the defensive approach to managing working capital was
discussed extensively. This approach seeks to take advantage of the benefits that come with
having more than enough current assets to defray current liabilities. Such advantages include
the low risk of current liability default and the ability to meet demand anytime it rises in an
uncertain environment (Arnold, 2008). As such, companies that adopt this approach will be
ready to receive supplies for cash and give customers liberal credit terms.
In section 2.2.2 in chapter two, there is a discussion on the aggressive approach to managing
working capital. This approach holds an opposing view from that of the defensive approach.
The aggressive approach funds its short term assets with short term liabilities. This approach
sometimes funds long term assets with short term liabilities. In this way, the firm would pay
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lesser finance cost (Andrew & Gallagher,2000). The main aim of this approach is to make sure
that funds are not tied up in receivables or inventory at an expensive opportunity cost.
The question that arises is: is there an optimum policy for managing working capital that would
maximize profitability and balance the risk and returns that come with the two extreme
approaches described above? The answer to this question can be found in Table 4.9 and
illustrated in figure 4.1, figure 4.2, figure 4.3 and figure 4.4.
Figure 4.1 NPM-RP Quadratic Relationship Curve
Figure 4.1 gives an illustration of the quadratic connection that exists between receivables
collection period and net profit margin. The curve is a maximum curve because the coefficient
of the quadratic term in model 6 (RP2) is negative. This means the curve is a rise and fall curve.
According to the results of this study, the optimum receivables collection period that
maximizes net profit margin is 45 days. The first root which is -168 days signifies that taking
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prepayments from customers beyond 168 days will result in negative net profit margin. The
second root which is 258 days also signifies that offering credit period to customers beyond
258 days will result in negative net profit margin. It is therefore recommended that prepayment
period should not exceed 168 days and credit period should also not exceed 258 days. However,
the optimum credit period for maximum net profit margin is 45 days. These assertions are true
if the effects of other factors on net profit margin are nullified and the focus is placed on
receivables collection period.
Figure 4.2 NPM-IP Quadratic Relationship Curve
Figure 4.2 illustrates the quadratic connection that exists between inventory turnover period
and net profit margin. This curve is also maximum because the coefficient of the quadratic term
(IP2) in model 7 is also negative. This means the curve rises and falls. According to the results
of this study, the optimum inventory turnover period for maximum net profit margin is 236
days. Obviously, it is impractical to have a negative inventory turnover period in the
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manufacturing sector so, the first root of the curve can be ignored. Nevertheless, the second
root signifies that if inventory turnover period grows beyond 582 days, the result will be
negative net profit margin. However, the optimum inventory turnover period for maximum net
profit margin is 236 days. These assertions are true if the effects of other factors on net profit
margin are nullified and the focus is placed on inventory turnover period.
Figure 4.3 NPM-PP Quadratic Relationship Curve
Figure 4.3 graphically illustrates the nature of the quadratic connection between payable
payment period and net profit margin. This curve is also maximum because the coefficient of
PP2 in model 8 is negative. This suggests that the curve rises then falls. The results of this study
indicate that the optimum payable payment period for maximum net profit margin is 222 days.
The first root of the quadratic curve suggests that a negative net profit margin will be
experienced if companies pay their suppliers more than 144 days before an invoice is raised.
The second root also signifies that if it takes a manufacturing company in Ghana more than
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589 days to pay its suppliers, this company will experience negative Net Profit Margins. In
order to make maximum net profit margins, the payable payment period should be around 222
days. These assertions are true if the effects of other factors on net profit margin are nullified
and the focus is placed on payable payment period.
Figure 4.4 NPM-CCC Quadratic Relationship Curve
Figure 4.4 gives an illustration of the quadratic connection that exists between cash conversion
cycle and net profit margin. The curve is a maximum curve because the coefficient of the
quadratic term in model 5 (CCC2) is negative. This means that the curve is expected to rise and
fall. The results of the study indicate that manufacturing companies in Ghana are likely to
experience maximum net profit margin, if they maintain a cash conversion cycle of about 43
days, ceteris paribus. Furthermore, the results suggest that in order to keep experiencing
positive net profit margin, the cash conversion cycle should not exceed 320 days, also the
payable payment period should not exceed the sum of the receivable collection period and the
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inventory turnover period by more than 234 days. This will ensure that the net profit margin of
such entities remain in the positive region.
4.5 Summary
The chapter contains a presentation of the results of the study as well as a discussion of the
findings from the study. The results indicate that there is a quadratic connection between cash
conversion cycle and profitability. There is also a quadratic connection between the
components of cash conversion cycle and profitability. The results of the study revealed the
optimum working capital management policies that would ensure maximum profitability.
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CHAPTER FIVE
CONCLUSIONS AND RECOMMENDATIONS
5.1 Introduction
This chapter contains a summary of the study. It provides the motive for the research, the
findings that were made as well as recommendations for further studies on the quadratic
connection between working capital management and profitability.
5.2 Summary
Over the years, a lot of studies have been conducted to examine the connection between
working capital management and profitability. These studies can be broadly classified into
three groups. The first group of studies sought to suggest that there exists a positive connection
between working capital management and profitability. The findings of these studies support
the defensive approach to working capital management as discussed in section 2.2.1 of this
study. The second group of studies discovered a negative connection between working capital
management and profitability. This group of studies on the subject advocate the aggressive
approach to managing working capital as explained in section 2.2.2 of this study. The last group
of studies advocate the conservative approach to managing working capital. This approach
seeks to balance the risk and returns from working capital in order to maximize profitability.
However, the optimum working capital management policies with which profitability can be
maximized is not known. The objective of this study was therefore to examine the quadratic
connection that may exist between cash conversion cycle as well as its components and
profitability. The study also attempted to use the roots and turning points of the quadratic curves
to determine the optimum working capital policies that would maximize profitability, measured
with net profit margin.
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The findings suggest that, when all other factors are held constant or nullified, manufacturing
companies in Ghana have to maintain a cash conversion cycle period of about 43 days in order
to maximize profitability. The regression model derived suggests that positive net profit
margin will be experienced if cash conversion cycle can be maintained between -234 and 320
days.
The range of receivable collection period for which positive net profit margin will be
experienced, according to the results of this study was identified to be between -168 and 258
days. However, the optimum level of receivables collection period for maximum net profit
margin is 45 days.
The study on the quadratic connection between inventory turnover period and net profit margin
also revealed that 236 days is the ideal inventory turnover period that manages to risk and
return such that maximum net profit margin is achieved. The study further revealed that in
order to keep net profit margin in the positive zone, inventory turnover period should be
between -109 and 582 days. However, inventory cannot practically be a negative so the range
was revised to be between zero (0) and 582 days.
Lastly, the quadratic connection between payables payment period and net profit margin was
examined. The results of this analysis also revealed that the optimum payable payment period
that will maximize net profit margin is 222 days. Furthermore, the range of payables payment
period that will ensure positive net profit margin is between -144 and 589 days.
5.3 Recommendations
The research focused on the Ghanaian setting of listed manufacturing companies. This limits
the scope of the research which can be augmented by further research into a wider sample of
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manufacturing companies including unlisted manufacturing companies in Ghana, unlisted and
listed manufacturing companies in other countries.
The industrial focus of the study also poses as a limitation to the study. The manufacturing
industry was the focus of the study and therefore results and interpretations made were pertinent
to manufacturing concerns. It is recommended that a similar study be conducted to focus on a
different setting like the trading industry.
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REFERENCES
Abdul-Hamid M., Sawandi N., Simon S. (2017). The quadratic relationship between working
capital management and firm performance: Evidence from the Nigerian economy.
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