Relationship Of Cash Conversion Cycle With Profitability: An Analysis Of Power Sector In India

Transcription

1 Relationship Of Cash Conversion Cycle With Profitability: An Analysis Of Power Sector In India Dr Harsh Vineet Kaur*, Amandeep Singh** *Assistant Professor, School of Commerce and Management, Sri Guru Granth Sahib World University, Fatehgarh Sahib, Punjab, **Research Scholar, Sant Baba Bhag Singh University, Padhiana, Jallandhar, Abstract The length of Cash Conversion Cycle is one of the fundamental ingredients of working capital management of a firm. It has an influential role in determining the level of profitability of an organization. The current paper tends to examine the impact of Cash Conversion Cycle as a barometer of working capital efficiency on the profitability of Power Sector in India. Based on S & P BSE POWER Index the paper tends to examine the relationship between liquidity and profitability using Karl Pearson Correlation. The paper also focuses on impact of Cash Conversion Cycle on profitability measured by RoA and RoE using regression analysis. The results of liquidity analysis found a strong significant relationship between the measures of liquidity and corporate profitability. The findings suggest that managers can increase profitability by efficiently managing liquidity. The results of regression analysis reveals that there is a postive relationship between profitability both measured by RoA and RoE and accounts receivables days, accounts payable days and cash conversion cycle. Key words: Cash Conversion Cycle, Return on Assets, Return on Equity 1 Introduction The working capital management was traditionally a lesser focused topic in financial management literature. The focus of research is particularly on examining investments, capital structure, dividends or company valuation decisions, risk and return, among other topics. However, current assets and liabilities are important components of total assets and play a crucial role in success of a firm. Working Capital Management, also referred as liquidity management demands a careful attention since it plays a three dimensional role in firms profitability, risk, and its value (Smith, 1980). An excessive level of current assets leads to idle funds, non-profitable for business, poor ROI, and Credit worthiness suffers on one hand and due to low rate of return on investments, the market value of shares may fall on other hand. However, firms having too few current assets may have to find external financing to pay of its short term debts, and may find difficulties in maintaining smooth operations. VOLUME 1, ISSUE 1, MARCH

2 The level of working capital as well as the length of Cash Conversion Cycle is considered among the fundamental ingredients of the working capital management (Appuhami, 2008; Keown et al., 2003; and Bodie and Merton, 2000). The current paper tends to examine the impact of Cash Conversion Cycle as a barometer of working capital efficiency on the profitability of Power Sector in India. Power or electricity is very essential constituent of infrastructure affecting economic growth and welfare of the country. India is the 5th largest producer of electricity in the world( Fintech,2015). At an electricity-gdp elasticity ratio of 0.8, electricity will continue to remain a key input for India s economic growth. Electricity demand is likely to reach 155 GW by & 217 GW by whereas peak demand will reach 202 GW & 295 GW over the same period respectively. In India, the total power generated has been BU during the FY There has been a shift to renewable power as the same constitutes of 27.25% of the total installed capacity (Fintech, 2015). 2. Review of Literature A brief study of some of the literary works already carried conducted in the field of working capital management is presented hereby Table 1: Summary of review of literature Author/s Year Findings Muturi 2015 Cash Conversion Cycle significantly negatively affects the firm s profitability. Nwakaego and Ikechukwu 2015 Cash Conversion Cycle and Debt Ratio had negative but significant effect on the Profitability Muscettola 2014 Average Receivables Period had significantly positive association with profitability while lesser Cash Conversion Cycle does not mean greater profitability. Yasir et al 2014 Negative relationship between firms cash conversion cycle and profitability. Anser and Malik 2013 cash conversion cycle had significantly inverse association with both return on assets and equity which indicated that lesser the cash conversion cycle greater would be the profitability measured through return on VOLUME 1, ISSUE 1, MARCH

3 assets and equity. Al-Shubiri and Aburumman 2013 No significant relationship with profitability indicator and Cash Conversion Cycle. Abbasi and Bosra 2012 Net Cash Conversion Cycle and the number of days inventory holding did not have significant effect but number of days receivable accounts and number of days payable accounts had significant negative effect on operational gross profit to assets ratio Attari and Raza 2012 significant negative correlation between the Cash Conversion Cycle and the firm size in terms of total assets, and a negative correlation between Cash Conversion Cycle and profitability in terms of return on total assets Bhutto et al 2011 Cash Conversion Cycle had positive relationship between firms aggressive investing policies and conservative financing policies. Cash Conversion Cycle had negative relationship with sales revenue, return on equity (ROE) and financing policies of the firms and has positive relationship with total assets, return on assets. Mansoori and Muhammad 2012 positive relation between shorter Cash Conversion Kumar 2011 Cycle and higher profitability Azhar and Noriza 2010 Nobanee, Abdullatif and Al 2009 Haijjar Hutchison et al positive relation between shorter Cash Conversion Cycle and higher profitability Khan, Hijazi, and Kamal 2006 profitability is negatively related to days inventory outstanding, days payable outstanding and Cash Conversion Cycle 3 Research Methodology 3.1 Objectives To establish relationship between liquidity and profitability To investigate the impact of net working capital management on the firm s performance. 3.2 Data and Sample Size The sample is based on data obtained from S & P BSE POWER INDEX. The index comprises constituents of the S&P BSE 500 that are classified as members of the heavy electrical VOLUME 1, ISSUE 1, MARCH

4 equipment & electric utilities sector as defined by the BSE industry classification system. The index consists of 19 companies that belong to heavy electrical and power utilities sector. Data from the year to has been obtained from moneycontrol.com for these companies. 3.3 Variables under Study Table 2: Description of variables used for study Variable Abbreviation Formula Inventory Period INV days (Inventory/Cost of Goods Sold)*365 Receivable Period AR days (Account Receivable/Net Sales)*365 Payable Period AP days (Account Payable/Cost of Goods Sold)*365 Cash Conversion Cycle CCC INV days + AR days- AP days Return on Assets RoA Net Income / Total Assets Return on Equity RoE Net Income/ Shareholders Equity Size of firm Size f logarithm of assets Growth in Sales G R Sales (Sales1-Sales0)/ Sales 0 Size of Sales Size S logarithm of sales Financial Debt Ratio Debt Debt / Total assets Current Assets to Total CATA Current Assets / Total Assets Assets Current Liabilities to Total CLTL Current Liabilities / Total Liabilities Liabilities Current Assets Turnover Ratio CATR Net Sales/ Average Total Assets 3.4 Model Specifications and Research Techniques To establish the relationship between Liquidity as measured by INV days, AR days, AP Days, CCC and Profitability as measured by RoA and RoE, Karl Pearson Correlation has been calculated between the above variables. For calculating the impact of working capital management, regression analysis has been done using Least Square Method. For the purpose of analysis RoA and RoE have been taken as Dependent variables, AR Days, INV Days, AP Days, CCC as Independent Variables and Size f,gr Sales,Size S, Debt, CATA, CLTL, CATR as Control Variables. VOLUME 1, ISSUE 1, MARCH

5 Table 3: Details of Regression Equations used Regression equation 1 Regression Equation 2 ROA it = β0 +β1ar Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it ROA it = β0 +β1inv Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it +β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression Equation 3 ROA it = β0 +β1ap Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression Equation4 ROA it = β0 +β1ccc it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression equation 5 ROE it = β0 +β1ar Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression Equation 6 ROE it = β0 +β1inv Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it +β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression Equation 7 ROE it = β0 +β1ap Days it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it Regression Equation 8 ROE it = β0 +β1ccc it +β2 Size f it +β3 GR Sales it+β4 Sales S it + β5 Debt it + β6 CATA it +β 7 CLTA it +β 8 CATR it + ε it 4. Data Analysis and Interpretation The following results were found on analysis of data Table 4 reveals correlation between various liquidity parameters and profitability parameters. There is significant positive association between Cash Conversion Cycle and Return on Assets (.984, significant at.001%), Return on Equity (.028, significant at.05%). Similarly, other parameters also have positive association with RoA and RoE even though it is low. VOLUME 1, ISSUE 1, MARCH

6 Table 4: Pearson s Correlation Coefficient INV days AR days AP days CCC RoA RoE INV days Pearson Correlation **.672 ** AR days Pearson Correlation.849 ** ** AP days Pearson Correlation.672 **.920 ** * CCC Pearson Correlation **.028* RoA Pearson Correlation ** RoE Pearson Correlation * **. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed)..028* Results for regression equation for Working Capital Management and Profitability as measured by RoA Table 5 shows the results of regression equation1. The regression analysis shows that there is positive relationship between days accounts receivables and profitability. The regression results show that increase in one unit of days accounts receivables results in increase in.016 units of profitability. This suggests that managers of more profitable firms tend to follow a liberal credit policy by extending credit for a longer duration resulting in increased sales and higher subsequently higher profitability. The other variables of the equation show a positive relationship between profitability & size of sales and current assets turnover ratio and a negative relationship between profitability & size of firm as measured by natural logarithm of assets, growth of sales, debt, current assets to total assets ratio, current assets turnover ratio and current liabilities to total liabilities ratio. The multiple correlation s are.798 and adjusted R 2 is.595. VOLUME 1, ISSUE 1, MARCH

7 Table 5: Impact of Working Capital Management on Profitability : Regression Equation 1 Variable Regression Standard error of regression t value Sign t AR days Size f GR Sales Size S Debt CATA CLTL CATR Constant Multiple R=.798 R 2 =.636 Adj R 2 =.595 SE of R= Table 6: Impact of Working Capital Management on Profitability: Regression Equation 2 Variable Regression Standard error of regression t value Sign t INV days Size f GR Sales Size S Debt CATA CLTL CATR Constant Multiple R=.768 R 2 =.591 Adj R 2 =.544 SE of R= Table 6 shows the results of regression equation2. The regression results reveal that there is positive relationship between days inventory and profitability even though this relationship is quite negligible as increase in one unit of days inventory results in units of increase in profitability. The results of other variables of the equation a positive relationship between profitability and size of sales as measured by natural logarithm of sales, current assets to total assets ratio and a negative relationship between size of firm as represented by logarithm of VOLUME 1, ISSUE 1, MARCH

8 assets, growth of sales debt and current liabilities to total liabilities ratio and current assets turnover ratio. The multiple correlation s are.768 and adjusted R 2 is.544. Table 7 Impact of Working Capital Management on Profitability: Regression Equation 3 Variable Regression Standard error of regression t value Sign t AP days Size f GR Sales Size S Debt CATA CLTA CATR Constant Multiple R=.787 R 2 =.619 Adj R 2 =.576 SE of R= Table 7 shows the results of regression equation 3.The analysis reveals a positive relationship between accounts payables days and profitability i.e increase in one unit of accounts payables days increases the profitability by.001 units. This means that the managers can increase the profitability of the firms by increasing the accounts payables days as delaying the payments to the creditors the managers can keep the cash in the firm for a longer duration and save the cost of external financing. The other variables of the equation a positive relationship between profitability & size of sales and a negative relationship between profitability & size of firm as measured by natural logarithm of assets, growth of sales, debt, current assets to total assets and current assets turnover ratio current liabilities to total liabilities ratio. The multiple correlation s are.787 and adjusted R 2 is.576. Table 8 shows the results of regression equation 4. The regression results reveal that there is negative relationship between cash conversion cycle and profitability even though this relationship is quite negligible as increase in one unit of cash conversion cycle results in 1.92 units of increase in profitability. The results of other variables of the equation a positive relationship between profitability and size of sales as measured by natural logarithm of sales, VOLUME 1, ISSUE 1, MARCH

9 growth of sales, current assets to total assets ratio and a negative relationship between size of firm as represented by logarithm of assets, growth of sales, debt and current liabilities to total liabilities ratio and current assets turnover ratio. The multiple correlation s are.768 and adjusted R 2 is.544. Table 8: Impact of Working Capital Management on Profitability: Regression Equation 4 Variable Regression Standard error of regression t value Sign t CCC Size f GR Sales Size S Debt CATA CLTL CATR Constant Multiple R=.768 R 2 =.591 Adj R 2 =.544 SE of R= Results for regression equation for Working Capital Management and Profitability as measured by RoE Table 9 shows the results of regression equation 5. The analysis shows that there is positive association between day s accounts receivables and profitability. Increase in one unit of accounts receivable days results in increase of.022 of profitability. This suggests that firms can improve their profitability by increasing the number of account receivable days i.e by selling more goods on credit. The other variables of the equation a positive relationship between profitability and size of firm, growth of sales, current assets to total assets and current assets turnover ratio and a negative relationship between size of sales, debt and current liabilities to total liabilities ratio. The multiple correlation is.622 and adjusted R 2 is.387. VOLUME 1, ISSUE 1, MARCH

10 Table 10 : Impact of Working Capital Management on Profitability: Regression Equation 5 Variable Regression Standard error of regression t value Sign t AR days Size f GR Sales Size S Debt CATA CLTL CATR Constant Multiple R=.622 R 2 =.387 Adj R 2 =.350 SE of R= Table 11 shows the results of regression 6. The analysis shows that increase in one unit of number of days of inventory in the organisation results in increase in profitability by units. This means the more the inventory is in circulation the better is the profitability of the organisation as this reduces the losses due to obsolescence, pilferage of the inventory and depicts that production is being carried on smoothly on thee organisation. The results are however not consistent with some of the earlier studies by Lazaridis & Tryfondis(2006), Padachi(2006) and Mathuva(2010). The other variables of the equation a positive relationship between profitability and size of firm, growth of sales, current assets to total assets and current assets turnover ratio and a negative relationship between size of sales, debt and current liabilities to total liabilities ratio. The multiple correlation s is.611 and adjusted R 2 is.334. Table 12 shows the results of regression equation 7. The results a positive relationship between number of days of accounts payables outstanding and profitability i.e the increase in one unit of number of days of accounts payables results in increase of.019 units of profitability. Contrary to the results of Deloof (2003) and Raheman & Nazr (2007) the results of the power sector reveal that more profitable firms wait longer to pay their bills. This implies that such firms prefer to hold cash with them to satisfy their working capital needs. The other variables of the equation a VOLUME 1, ISSUE 1, MARCH

11 positive relationship between profitability and growth of sales, size of sales, current assets to total assets and current assets turnover ratio and a negative relationship between size of firm, debt and current liabilities to total liabilities ratio. The multiple correlation s are.616 and adjusted R 2 is.341. Table 11: Impact of Working Capital Management on Profitability: Regression Equation 6 Variable Regression Standard error of regression t value Sign t INV days Size f GR Sales Size S Debt CATA CLTA CATR Constant Multiple R=.611 R 2 =.373 Adj R 2 =.334 SE of R= Table 12 : Impact of Working Capital Management on Profitability: Regression Equation 7 Variable Regression Standard error of regression t value Sign t AP days Size f GR Sales Size S Debt CATA CLTA CATR Constant VOLUME 1, ISSUE 1, MARCH

12 Multiple R=.616 R 2 =.379 Adj R 2 =.341 SE of R= Table 13 shows the results of regression equation 8.The results show a positive relationship between cash conversion cycle and profitability. The results are inconstistent with earlier studies like those done by Shin and Soenen (1998), Lazaridis and Tryfonidis (2006), and Raheman and Nasr (2007) which indicate an inverse relation between CCC with profitability of firms. The other variables of the equation a positive relationship between profitability and size of firm, growth of sales, size of sales, current assets to total assets and current assets turnover ratio and a negative relationship between debt and current liabilities to total liabilities ratio. The multiple correlation s are.615 and adjusted R 2 is.340. Table 13 Impact of Working Capital Management on Profitability: Regression Equation 8 Variable Regression Standard error of regression t value Sign t CCC Size f GR Sales Size S Debt CATA CLTA CATR Constant Multiple R=.615 R 2 =.379 Adj R 2 =.340 SE of R= Conclusion The results of liquidity analysis found a strong significant relationship between the measures of liquidity and corporate profitability. The findings suggest that managers can increase profitability by efficiently managing liquidity. The results of regression analysis reveals that there is a postive relationship between profitability both measured by RoA and RoE and accounts receivables VOLUME 1, ISSUE 1, MARCH

13 days, accounts payable days and cash conversion cycle. Thus, managers can create value for their firms by effectively managing the various components cash conversion cycle. References Abbasi, Ebrahim and Bosra, Said Ali Hashemi (2012), The Effect Of The Cash Conversion Cycle On Profitability In Tehran Stock Exchange, World Research Journal Of Financial Economics and Stochastics, Volume 1, Issue 1, pp Anser, Raheem and Malik Qaisar Ali(2013), Cash Conversion Cycle and Firms Profitability A Study of Listed Manufacturing Companies of Pakistan, IOSR Journal of Business and Management, Volume 8, Issue 2, pp Appuhami, Ranjith B.A., (2008), The Impact of Firms Capital Expenditure on Working Capital Management: An Empirical Study across Industries in Thailand, International Management Review; l4(1), pp 8-21 Attari, Muneeb Ahmad, and Kashif Raza(2012). "The Optimal Relationship Of Cash Conversion Cycle With Firm Size And Profitability". International Journal of Academic Research in Business and Social SciencesVol.2.Iss.4 Azhar, N., & Noriza, M. (2010), Working Capital Management: The Effect of Market Valuation and Profitability in Malaysia, International Journal of Business and Management, 5 (11), Bodie, Z. and Merton, R. C., (2000). Finance, International Edition, Prentice-Hall, New Jersey. Deloof, M., (2003), Does Working Capital Management Affects Profitability of Belgian Firms?, Journal of Business Finance & Accounting, 30 (3 & 4), pp Deloof, M., (2003). Does working capital management affect profitability of Belgian firms, Journal of Business and Finance Accounting., 30: Faris Nasif Al-Shubiri), Nassem Mohammad Aburumman (2013), The relationship between cash conversion cycle and financial characteristics of industrial sectors: an empirical study, Investment Management and Financial Innovations, Volume 10, Issue 4, pp Fintech Accord(2015), Power sector in India, Financial Express, Oct 19, 2015 Harrison Mwangi Muturi (2015), Effects Of Cash Conversion Cycle On Profitability Of Tea Factories In Meru County, Kenya, International Journal of Economics, Commerce and Management United Kingdom Vol. III, Issue 8, pp Hutchison, P. D., Farris II, M. T. and Anders, S. B. 2007, Cash-to-cash analysis and Management, The CPA Journal, Vol. 77, No. 8, pp Keown, A. J., Martin, J. D., Petty, J. W. and Scott, D. F., (2003). Foundations of Finance, 4th ed., Pearson Education, New Jersey Khan, S. U., Hijazi, S. T. and Kamal, Y.( 2006), Impact of Working Capital Management on the Profitability of Firms: A Case of Listed Pakistani Companies, Journal of Social sciences, AIOU, Islamabad, Vol 13, pp VOLUME 1, ISSUE 1, MARCH

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