The Relationship between working capital management and profitability for companies listed on the Nairobi Stock Exchange.
Mathuva, David Mutua
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This study examined the effect of working capital management (WCM) practices on company profitability. Using agency, transactions cost and trade-off theories, the study also sought to establish whether the hypothesized relationships between working capital practices and profitability can be defended from both financial and managerial perspectives. Data for this study were collected from the annual financial reports and questionnaires from 30 companies listed on the Nairobi Stock Exchange. The financial data covered a 16- year period (1993 to 2008). The variables of interest included various measures of working capital management, profitability and company characteristics. The financial data were analyzed using pooled ordinary least squares, fixed effects and two-stage least squares estimations. Five regression models were run incorporating each of the key independent variables in each model. Data collected from questionnaires were analyzed using frequency tables. Chi-square tests were also performed on the questionnaire data. Consistent with prior research, this study established that there existed an overall negative relationship between working capital management and profitability. Key findings from the study from both financial and questionnaire data analyses were: (1) a highly significant negative relationship exists between the time it takes companies to collect cash from their customers (accounts collection period) and profitability (p<O.Ol); (2) there exists a highly significant positive relationship between the time it takes the company to pay its creditors (average payment period) and profitability (p<O.Ol); (3) there exists a significant negative relationship between the cash conversion cycle and profitability (p<O.lO). The only inconsistent result from both analyses was the relationship between inventory conversion period and profitability. This finding was explained by the different ways in which companies manage their inventories. The main techniques employed by companies in working capital management were: (1) setting credit limits for customers (mean = 4.42, standard deviation (SD there after) = 0.70), (2) aging of debtors (mean = 4.40, SD = 1.73), (3) aggressive collection policies (mean 4.35, SD = 0.81), (4) preparing cash budgets (mean 4.32, SD = 0.96) and (5) negotiating with suppliers (mean 4.25, SD = 0.51). Key challenges identified with regard to working capital management were: (1) difficulty in collecting trade receivables (mean = 3.75, SD = 1.04), (2) cash not readily available when needed (mean = 3.63, SD 1.21), (3) difficulty in managing bad debts (mean=3.40, SD = 1.02), (4) lack of adequate working capital finance (mean = 3.40, SD = 1.25) and (5) difficulty in identif’ing working capital risks (mean = 3.30, SD = 1.10). These techniques and challenges further explained the reason as to why companies focused on various WCM components and profitability.