quadratic relationship between ... - university of ghana

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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

University of Ghana http://ugspace.ug.edu.gh

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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.


12

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-


13

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


14

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


15

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,


17

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.


18

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.


19

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


20

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).


21

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


22

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).


23

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.


24

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


25

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


26

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:


27

NPMit = 2.44E-01 – 5.63E-06RP2it + 5.07E-04RPit - 1.82E-03AGEit + 6.90E-05SIZEit -

2.86E-01LEVit + 1.69E-02CRit + ℰit - (6)






28

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)


29






30

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)


31






32

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


33

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


34

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


35

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


36

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


37

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


38

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.


39

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.


40

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


41

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.


42

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