Impact of Short Term Assets and Liabilities on Profitability of the firm (A case study of Cement Industry in Pakistan)

Transcription

1 Abstract: Impact of Short Term Assets and Liabilities on Profitability of the firm (A case study of Cement Industry in Pakistan) Faisal Abbas, Department of Commerce, University of Central Punjab Lahore, Pakistan (Sargodha Campus) Mutee-ur-Rahman, Lecturer University of Sargodha, Sargodha, Pakistan The main purpose of this study is to investigate the impact of short term assets and short term liabilities in cement industry of Pakistan for the period of last twelve years Our intention was about the use of current assets and current liabilities how effecting the profitability of this sector. The data were collected from the financial analysis of the State Bank of Pakistan for non-financial company s analysis. The population of this study was the complete cement industry of the Pakistan. We have used multiple regressions through SPSS for the testing of this study hypothesis. The results show that cash is significant at 5% level of significance. Inventory and debtors are insignificant at 5% level of significance. The results also show that current liabilities and sales are highly significant at 5% level of significance. The current liabilities are negatively affecting the profitability. The variable sales are positively affecting the profitability. The current assets are also significant at 5% level of significance. Key Words: Profitability, Current Assets, Current liabilities, Regression and Correlation Introduction According to the topic of this study the firm has less short term assets and more short term liabilities is in problem to manage its day to day operational needs. If the firm has more short term assets it means that the return on investment of the company is not in perfect conditions. There should be a balance between short assets and short liabilities in order to maintain the liquidity of the firm which ultimately leads to better profitability. The main purpose of this study is to investigate the impact of short term assets and liabilities on the profitability of the cement industry in Pakistan. In this study we are going to analyze that how much the current assets can effect the profit of the cement industry in Pakistan and how much current liabilities affecting the profitability of this industry in Pakistan. In short term assets we have selected cash, inventory, accounts receivables and current assets as a whole for the analysis this study. In case of Liabilities we have chosen creditors and current liabilities as whole for our analysis of this study. The profitability includes earning before tax for the purpose of this study. As we know that cash and inventories and accounts receivable are consider to much important component for day to day operations because these are playing a vital role in the performance of the business. We are going to test the relationship of these assets with profitability in a sense that weather these are positively effecting or negatively. Our main purpose is to test these assets and liabilities individually and as a whole. We want to test that cash is positively affecting the profitability or negatively same as inventory, accounts receivables separately and what the relationship of current assets and current liabilities is as a whole with profitability in cement industry of Pakistan. The above concept is also explained the importance of the liquidity of the firm because the most of the experts have idea that the firm have better liquidity have better return. To following the concept of different researchers we have selected the liquidity component of the firm for our analysis. > RJSSM: Volume: 03, Number: 01, May-2013 Page 68

2 Objectives of the Study There is multiples objective of this study and the list of those important objectives is as under 1) To investigate the relationship of Cash with profitability. 2) To investigate the relationship of Inventory with profitability. 3) To investigate the relationship of Accounts Receivables with profitability. 4) To investigate the relationship of current assets as whole with profitability. 5) To investigate the relationship of current liabilities as whole with profitability. 6) To provide information about the use of short term assets and their impact on the performance of the cement industry of the Pakistan. 7) To contribute the literature for further researcher on this domain. Importance of Cement Industry This sector is important with respect to the different aspect of the country such as this sector is providing revenue to the government in forms of taxes and this sector is also providing the input for restructuring of the different projects of the economy. This sector is also providing employment opportunity to the population of country. This sector is also contributing in economy by the way of foreign exchange through export of cement to different countries. Cement sector is important as locally as well as internationally because this product is the common need of the whole world. This sector is contributing the world common need and providing the opportunity for the growth of working force and different executives for their futures. Literature Review There are so many previous studies which identified the relationship of short term assets and liabilities and profitability. The summary of some related past studies are presented below for the analysis of the effect of the short term assets and liabilities on the profitability. Deloof (2003) investigated that the way that working capital is managed has a significant impact on profitability of firms. He has also been proved that by minimizing the amount of funds tied up in current assets; firms can reduce financing costs or increase the funds available for expansion. Cote and Latham (1999, p. 261) investigated that the management of liquidity has positive impact on the cash flows of the organizations which leads to better profitability. Lazaridis and Tryfonidis (2006), companies get better rates from supplier when they have sufficient cash and companies can improve their profit. We can say that liquidity have positive effect on the profitability of the organization. There should be balance in cash and its management and investment of cash in fixed assets. Louderback, et.al They found that in their study that proper investment of current assets provides better return. They are explain the measure of current ratio and also explain the ratio of current assets against current liabilities. Brigham E. and Gapenski, L., 1997.depicted in their study that working capital can be calculated with the help of current assets and current liabilities effectively. They also explained that it can be used for the comparison intension of the company s current assets and current liabilities. Eljelly in 2004 investigated the relationship of liquidity and profitability using a sample of different firms. He explained the results that the Cash Conversion Cycle is valid test for the measurement of liquidity as compare to other current ratio. The results his study also investigated a strong negative relationship between profitability and liquidity. The size of the firm was pointed to have a strong impact on its profitability. Dr D. Mukhopadhyay (2004) investigated that current assets have no significant role in the profit maximization of the firms under study. Another study was conducted to analyze the short term assets management efficiency and profitability in different organizations by Dr Santanu Kr. Ghosh and Santi Gopal Maji (2003) the results of their study intended a positive relationship between effective and efficient use of short term assets and profitability. According to their point of view the cement industry performance is not up to the > RJSSM: Volume: 03, Number: 01, May-2013 Page 69

3 required level. D. Sur, J. Biswas and P. Ganguly (2001) depicted that a significant relationship between profitability and short term assets in different firms. D. Govind Rao and P. M. Rao (1999) investigated in his study on Indian Cement industry and concluded that working capital component have mixed positive and negative impact on profitability. A. Vijaykumar and A. Venkatachalam (1995) explored in their study that there is negative correlation between short term assets and profit of the firms. Bardia (2004) found a positive association with liquidity and profitability. Narware (2004), however, explored in their study on fertilizer, NFL companies that there is positive and negative interrelationship between working capital management and profitability. Raheman et all, 2007 found that there should be tradeoff between liquidity and profitability of the firm. Singh and Pandey (2008) in their study on Hindalco Industries limited explained that current assets and permanent assets play an important role in working of any business. According to their point of view the proper management of short term assets has positive influence on the return of the organizations. Chakraborty2008 in his study on Indian pharmaceutical firms and explore the relationship between working capital and profitability. According to his study, working capital is necessary for the proper working of fixed assets of the firms. Bhunia and Brahma 2011 conducted a study on private sector steel industry in India and they evaluated the importance of liquidity management on the profitability. Kargar and Bluementhal, 1994 depicted the relationship of profitability and liquidity and according to their point of view, there should be balance with short term assets and profitability of the firm because mismanagement of working capital may likely to fail and face bankruptcy. Jarvis et al, 1996 explained that a firm must management more cash receipts than payments. The lack of cash for operational activities is considered as a poor management of cash. According to Wang in 2002, investigated that the working capital has a positive effect on the return of the organizations and the firms can increase the profitability by reducing the debtors collection period and inventory period. He also explained that short cash conversion cycle is better for best performance of the firms. Methodology and Data Collection We have used SPSS to test the hypothesis of this study. Our population is cement industry of Pakistan and we have chosen the companies which are listed at Karachi Stock Exchange of Pakistan (KSE). Data on Accounts Receivables, Inventory, Cash, Current assets, Current Liabilities, sales and earnings before tax were collected from available source. We have collected secondary data from financial analysis of state bank of Pakistan for non financial companies for the period of twelve year The SPSS was used to test the significant relationship among variables. For this purpose, Tests of Correlation, and multiple regression analysis were performed. Conceptual Frame work of the study Dependent Variables Earnings before Tax Independent Variables Inventory Cash Current Liabilities Accounts Receivables Where we have also test the relationship of Current Assets and Sales of the cement industry with profitability of the firm for the period of twelve years > RJSSM: Volume: 03, Number: 01, May-2013 Page 70

4 Development of Hypotheses: Ho. There is no relationship between Cash and Profitability of Cement industry in Pakistan. Ho. There is no relationship between Inventory and Profitability of Cement industry in Pakistan. Ho. There is no relationship between Debtors and Profitability of Cement industry in Pakistan. Ho. There is no relationship among Current liabilities, Current Assets, Sales and Profitability. Models for this study Three regression models were estimated to test the above developed hypothesis for this study. EBT =βo + β1 (Cash) + β2 (Current Assets) + β3 (Current Liabilities) + β4 (Sales) + Error EBT = βo + β1 (Inventory) + β2 (Current Assets) + β3 (Current Liabilities) + β4 (Sales) + Error EBT = βo + β1 (Debtors) + β2 (Current Assets) + β3 (Current Liabilities) + β4 (Sales) + Error Data Analysis and Results Discussion Descriptive Statistics N Minimum Maximum Mean Std. Deviation EBIT Sales Current Liabilities Current Assets Cash Inventory Debtors In above table the detail descriptive statistics are given for all the variables. There are 132 observations for each variable. According to the results mean of earnings before interest and tax is while the stander deviation is The sales have mean with 5500 stander deviation while current liabilities mean is and stander deviation is The mean of Current assets is and stander deviation is The mean of cash is and stander deviation is while the mean of inventory is and stander deviation is The mean of debtors are and stander deviation is Table 2: Pearson s Correlation for all used variables Variables EBIT Sales C.Liabilities C.Assets Cash Inventory Debtors EBIT **.238 **.350 **.363 **.333 **.213 * Sales **.699 **.284 **.851 **.294 ** C.Liabilities **.189 *.847 **.133 C.Assets *.628 **.126 Cash * Inventory Debtors 1 *. Correlation is significant at the 0.05 level (2-tailed). ** Correlation is significant at the 0.01 level (2-tailed) From the above table we can understand the relationship of earnings before interest and tax, sales, current liabilities, current assets, cash, inventory and debtors. The result of Pearson s correlation clearly defining the relationship among all variables which one variable is positively correlated with one and which one is negatively correlated with which variable. > RJSSM: Volume: 03, Number: 01, May-2013 Page 71

5 Model A Ho. There is a no relationship between Cash and Profitability of Cement industry in Pakistan. The regression results reveal that the null hypothesis is rejected at 5% level of significance which means that there is a positive relationship between cash and profitability of cement industry in Pakistan. It means that the availability of cash is basic requirement for better profitability of this sector. The logic behind this is that the early payment to supplier is useful for attainment of maximum discount from them and early recoveries from receivables reduce the uncollectable. The results also indicate that sales and current liabilities are highly significant at 5% level of significance. The current liabilities are negatively affecting the profitability. Current assets are also significant at 5% level of significance. To analyze the multicollinearity, VIF is calculated and the result of VIF shows that there are no high multicollinearity among the independent variables as VIF is less than 10. The adjusted R square is 56% which explain that after adjusting for degree of freedom model can explain the 56% of profitability. For the purpose of testing the auto correlation among residuals Durbin-Watson test is used while the Durbin-Watson test results indicate that residuals are not auto-correlated because the Durbin-Watson test results are more than 1 but less than 3. F. Statistics shows the overall goodness of the model as F calculated value is 44. Model (A) Model A Standardiz ed Unstandardized Coefficien ts Collinearity Statistics Std. B Error Beta t Sig. Tolerance VIF 1 (Consta nt) Cash Sales C.Asset s C.Liabil ities Model Summary (A) Model R R Square Adj.R Square Std.Error Durbin-Watson F. Statistics A Model B Ho. There is a no relationship between Inventory and Profitability of Cement industry in Pakistan. According to the model B the regression model null hypothesis is accepted because the results show that t value is -.22 and p value is also too much high which is.826 according to our data results inventory is insignificant at 5% level of significance. The results also indicate that sales and current liabilities are highly significant at 5% level of significance. The current liabilities are negatively affecting the profitability. Current assets are significance at 5% level of significance. To analyze the multicollinearity VIF is calculated and the shows there are no high multicollinearity among the independent variables because the VIF is less than 10. The adjusted R square is 55% which explain that after adjusting for degree of freedom model can explain the 55% of profitability. For the purpose of testing the auto correlation among residuals Durbin-Watson test is used while the Durbin-Watson > RJSSM: Volume: 03, Number: 01, May-2013 Page 72

6 test results indicate that residuals are not auto-correlated because the Durbin-Watson test results are more than 1 but less than 3. According to F. Statistics the fit is good for model because F calculated value is 40. Model (B) Model B Unstandardized Standardized Collinearity Statistics B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) Sales C.Assets C.Liabilities Inventory Model Summary (B) Model R R Square Adj.R Square Std.Error Durbin-Watson F. Statistics B Model C 3 Ho. There is no relationship between Debtors and Profitability of Cement industry in Pakistan. According to the model C the null hypothesis is accepted because the results show that debtors are insignificant at 5% level of significance. The t value of Debtors is and p value is.192. The results also indicate that sales and current liabilities are highly significant at 5% level of significance. The current liabilities are negatively affecting the profitability. Current assets are significant at 5% level of significance. To analyze the multicollinearity VIF is calculated and the shows there are no high multicollinearity among the independent variables because the VIF is less than 10. The adjusted R square is 55% which explain that after adjusting for degree of freedom model can explain the 55% of profitability. For the purpose of testing the auto correlation among residuals Durbin-Watson test is used while the Durbin-Watson test results indicate that residuals are not auto-correlated because the Durbin-Watson test results are more than 1 but less than 3. According to F. Statistics the fit is good for model because F calculated value is 41. Model (C) Model C Unstandardized Standardized Collinearity Statistics B Std. Error Beta t Sig. Tolerance VIF 1 (Constant) Sales C.Assets C.Liabilities Debtors Model Summary (C) Model R R Square Adj.R Square Std.Error Durbin-Watson F. Statistics C > RJSSM: Volume: 03, Number: 01, May-2013 Page 73

7 Conclusion This study shows the effect of short term assets and short liabilities on the profitability in cement industry of Pakistan for the period of twelve years from After analyzing the data for cement industry of Pakistan by using regression and correlation analysis it is found that profitability of the cement industry is depends on the short term assets and short liabilities. This sector can increase its profitability by managing its short term assets and short term liabilities according to the requirements. According to the multiple regression results cash is significant at 5% level of significance, inventory and debtors are insignificant at 5% level of significance. The results also explain that sales and current liabilities are highly significant at 5% level of significance where current liabilities are negatively affecting the profitability and sales are positively affecting the profitability of this sector. Current assets are also significant. It means that there should be balance between Current assets and current liabilities. Reference: (1) Cote, J. M., & Latham, C. K.. (1999). The Merchandising Ratio: A Comprehensive Measure of Working Capital Strategy. Issues in Accounting Education, 14(2), (2) Deloof, M. (2003). Does Working Capital Management Affect Profitability of Belgian Firms?. Journal of Business Finance & Accounting, 30 (3& 4), p (3) Brigham, E. and Gapenski, L Financial Management Theory and Practice, 8th ed. The Dryden Press, Fort Worth TX p. 48, (4) Louderback, et.al Managerial Accounting 9th ed. South-western College Publishing Thomson Learning Asia Singapore p.365 (5) Eljelly, A. (2004). ³ Liquidity-Profitability Tradeoff: An empirical Investigation in an Emerging Market. I nte r national Journal of Commerce & Management, Vol. 14. No. 2, (6) Mukhopadhyay, D. (2004). ³ Working Capital Management in Heavy Engineering Firm s A Case Study. [Online] Available: (7) Ghosh, S.K. and Maji, S.G. (May 2004). ³ Working Capital Management Efficiency: A Study on the Indian Ceme Industry. The M anagement Accountant, (8) Su r, D., Biswas J. and Ganguly P. (June 2001). ³ Liquidity Management in Indian Private Sector Enterprises: A Ca Study of Indian Primary Aluminium Producing Industry. Indian Journal of Accounting, (9) Govind Rao, D. and Rao, P.M. (1999). ³ Impact of Working Capital on Profitability in Cement Industry A Correlation Analysis. Working Capital Management. (Deep & Deep Publications Pvt. Ltd., New Delhi), (10) Vijaykumar, A. and Venkatachalam, A. (June 1995). ³ Working Capital and Profitability An Empirical Analysis. The Management Accountant. ICWAI, Kolkata, (11) Bardia, S.C. (June 2004). ³ Liquidity Management: A Case Study of Steel Authority of India Ltd.. The Management Accountant. ICWAI, Kolkata, (12) Narware, P. C. (2004). ³ Working Capital and Profitability An Empirical Analysis. The M anagement Accountant. ICWAI, Kolkata. (13) Raheman, A. & Nasr, M. (2007). Working capital management and profitability case of Pakistani firms. International Review of Business Research Papers, Vol. 3 No. 1. pp (14) Singh, J.P. and Pandey, S. (2008). Impact of Working Capital Management in the Profitability of Hindalco Industries Limited, The ICFAI University Journal of Financial Economics, Volume (6) 4, (15) Chakraborty, K. (2008). Working Capital and Profitability: An Empirical Analysis of Their Relationship with Reference to Selected Companies in the Indian Pharmaceutical Industry, The ICFAI Journal of Management Research, December, > RJSSM: Volume: 03, Number: 01, May-2013 Page 74

8 (16) Bhunia, A. and Brahma, B. (2011). Impact of Liquidity Management on Profitability, Asian Journal of Business Management, Volume (3) 2, (17) Jarvis, R., Kitching, J., Curran, J. and Lightfoot, G , The Financial Management of Small Firms: An Alternative Perspective, ACCA Research Report No. 49 (18) Kargar, J. and R. A. Blumenthal, (1994). Leverage Impact of Working Capital in Small Businesses. TMA Journal. 14(6), (19) Wang, Y.J. (2002). Liquidity Management, Operating Performance, and Corporate Value: Evidence from Japan and Taiwan. Journal of Multinational Financial Management. 12, (20) Lazaridis, I., Tryfonidis, D. (2005). The relationship between working capital management and profitability of listed companies in the Athens Stock Exchange. SSRN.com. [Online Available] > RJSSM: Volume: 03, Number: 01, May-2013 Page 75