Effect of the adoption of International 
Financial Reporting Standards on the 
relationship between working capital 
management and profitability
David Mathuva
Special Thanks to: Dr. Ruth Kiraka (SU),  Dr. Jim Boyd McFie (SU), Prof. 
Jacquelyn Sue Moffit (LSU), Dr. Ismael Ateya (SU) and Mr. Peter Ochuodho (SU)
Strathmore university research week 2009
On going research
Research area: Financial Management and 
Financial Reporting Standards
ABSTRACT
 This study examines the potential effects of and
issues arising from the adoption of the International
Financial Reporting Standards (IFRSs) on the
relationship between working capital management
(WCM) and profitability.
 A sample of 36 companies listed in the Nairobi
Stock Exchange (NSE) for the periods before and
after adoption of the IFRSs (i.e., 1994 to1998; 1999
to 2003 and 2004 to 2008) will be used.
Friday, August 07, 2009 2Effect of the adoption of IFRSs on the relationship between WCM and profitability
Abstract cont’d
 This data will comprise of the various measures of
WCM (as measured by the average collection
period, the inventory conversion period and the
average payment period), profitability (as
measured by the gross operating profit ratio),
control variables (such as the cash conversion
cycle, current ratio, company size, sales growth,
leverage and age) and indicator variables (that is,
industry and auditor dummies).
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 3
Introduction 
 WCM, which deals with the management of current
assets and current liabilities, directly affects the
liquidity and profitability of the company (Deloof,
2003; Eljelly, 2004; Raheman and Nasri, 2007;
Appuhami, 2008; Christopher and Kamalavalli,
2009; Dash and Ravipati, 2009).
 The adoption of IFRSs presents an opportunity to
firms in transforming their finance functions and
creating more value for their companies by creating
operational efficiencies (Accenture, 2009). Various
studies have found out that accruals management
has a negative relation to a firm’s performance
(Sloan, 1996; Chan et. al., 2004; Chan et. al.,
2006; Huang et. al., 2008b).
Friday, August 07, 2009 4Effect of the adoption of IFRSs on the relationship between WCM and profitability
Background to the study
 There is a growing number of studies that question
the quality and relevance of International Financial
Reporting Standards (IFRSs) to developing and
emerging economies (see World Bank, 2001).
 The adoption of IFRSs has largely been supported
by the fact that IFRSs are associated with greater
accounting quality (Barth et.al. 2006; Barth et. al.,
2008).
Friday, August 07, 2009 5Effect of the adoption of IFRSs on the relationship between WCM and profitability
Problem Statement
 The study will be aimed at examining the issues
associated with the adoption of the IFRSs in
relation to WCM and profitability.
 This study will further seek to examine the
relationship between working capital management
and profitability for listed companies on the NSE
and the effect of the adoption of the IFRSs.
 The study seeks to find out whether the adoption of
IFRSs presents an opportunity to firms in
transforming their finance functions and creating
more value for their companies by creating
operational efficiencies as postulated by Accenture
(2009).
Friday, August 07, 2009 6Effect of the adoption of IFRSs on the relationship between WCM and profitability
Objectives of the study
1. To examine the issues associated with the
adoption of the IFRSs in relation to the
company’s WCM and profitability.
2. To establish the relationship between WCM
components and Profitability.
3. To establish the effect of the adoption of the
IFRSs on the relationship between working
capital management and corporate profitability.
Friday, August 07, 2009 7Effect of the adoption of IFRSs on the relationship between WCM and profitability
Research questions
 To achieve the above objectives, the following
research questions will be developed and tested
against each research objective:
1. What are the issues arising from the adoption of
IFRSs in relation to WCM and profitability?
2. What is the relationship between WCM and
profitability?
3. What is the effect of the adoption of IFRSs on
the relationship between WCM and corporate
profitability?
Friday, August 07, 2009
Effect of the adoption of IFRSs on the relationship between WCM and profitability 8
Extant Research
 Deloof (2003) defines working capital management
(WCM) as the cash conversion cycle (see also
Shin and Soenen,1998; Raheman and Nasr, 2007).
 Profitability is the rate of return on company’s
investment (Deloof, 2003). An unwarranted high
investment in current assets would reduce this rate
of return (Vishnani, 2007).
 According to Lazaridis and Tryfonidis (2006), there
seems to be a strong negative relation between the
cash conversion cycle of a firm and its profitability
(see also Shin and Soenen, 1998; Deloof, 2003;
Padachi, 2006; Raheman and Nasr, 2007).
Friday, August 07, 2009 9Effect of the adoption of IFRSs on the relationship between WCM and profitability
Extant research cont’d
 The adoption of IFRSs presents an opportunity to
firms in transforming their finance functions and
creating more value for their companies by creating
operational efficiencies (Accenture, 2009).
 Sloan (1996) indicates that the extent to which
income reported reflects the firm’s economic
fundamentals decreases in the magnitude of the
accrual component of income and increases in the
magnitude of cash flow component of income (see
also Huang et. al., 2008b).
 Huang et. al. (2008b) observes that there is
substantial evidence in support of managerial
manipulation of earnings by adopting aggressive
accounting choices (see also Burns and Kedia,
2008 ; Huang et. al. 2008a; Kao et. al., 2008).
Friday, August 07, 2009 10Effect of the adoption of IFRSs on the relationship between WCM and profitability
Operating and the cash conversion cycle
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 11
Average 
Payment 
Period 
Cash Conversion 
Cycle
Average 
Collection Period
Inventory 
Conversion Period
Inventory 
sold
Inventory 
purchased
Time
Cash paid 
for 
inventory
Operating 
Cycle
Cash 
received
Source: Ross et. al. (2003, p. 167)
Conceptual framework
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability
12
DEPENDENT VARIABLE
Gross operating profit 
(GOP)
INDEPENDENT VARIABLES
1. Average Collection Period 
(ACP)
2. Inventory Conversion 
Period (ICP)
3. Average Payment Period 
(APP)
CONTROL VARIABLES
1. Cash Conversion Cycle 
(CCC)
2. Current Ratio (CR)
3. Company Size (CS)
4. Sales Growth (SG)
5. Financial Debt Ratio (FDR) 
6. Age (Age)
INDICATOR VARIABLES
1. Industry (Ind)
2. Auditor (Aud)
 This study will be a cross-sectional study using
longitudinal data to establish a causal relationship
between the variables under study (i.e. IFRSs,
WCM components and corporate profitability).
 Examining panel data for this study requires a
cross sectional analysis to find out the relationships
existent amongst the variables under study over a
given time period (Huang et. al. 2008b).
 Since the study also seeks to find out the effect of
the adoption of IFRSs on the key variables under
study (i.e., WCM and profitability), this will require a
test for the strength of the models developed, both
during the pre and post adoption periods.
Friday, August 07, 2009
Effect of the adoption of IFRSs on the relationship between WCM and profitability 13
Research methodology
Data set and sample
 The data used in this study will be acquired from
the Kenyan Capital Market’s Authority library, the
internet and web sites of the Nairobi Stock
Exchange and firms under study. Data will be
obtained from the financial statements for a
selected sample of Kenyan firms listed on Nairobi
Stock Exchange (NSE) for a period of fifteen years
(1994 to 1998; 1999 to 2003 and 2004 to 2008)
 For the purpose of this research, certain industries
will be omitted due to their type of activity.
 In obtaining this data, this study will follow the
classification of NSE from which banking and
financial institutions, insurance, some commercial
and service firms and some companies listed under
industrial and allied segment will be omitted.
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 14
Sample representation
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 15
Segment
Number  of 
Companies Listed*
Number included in 
the sample
Percentage  of 
companies included
Agricultural 4 4 100%
Commercial and services 12 9 75%
Industrial and allied 18 15 83%
Alternative Investment
Market Segment
8 8 100%
Total 42 36 86%
Years
Estimated number of 
firm year 
observations
Percentage of  firm 
year observations
1994 – 1998 180 33.3%
1999 - 2003 180 33.3%
2004 - 2008 180 33.4%
Total 540 100%
Research conceptualization
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 16
(A) EXAMINE THE ISSUES RELATED WITH THE ADOPTION OF THE IFRSs 
IN RELATION TO WCM & PROFITABILITY
(1994-1998): 
IFRSs Pre-
Adoption Period: 
Examine the 
relationship 
between WCM & 
Profitability
(1999-2003): 
Immediate IFRSs 
Post-Adoption 
Period: Examine 
the relationship 
between WCM & 
Profitability
(2004-2008): Most 
recent IFRSs 
Post-Adoption 
Period: Examine 
the relationship 
between WCM & 
Profitability
(B) Compare the adjR2, F-
statistic and P-values
(C) Compare the adjR2, F-
statistic and  P-values
Final Analysis
Examine (A), compare (B) and (C) and then make 
conclusions
Data collection and analysis
 The data will be collected from listed firms in the
Nairobi Stock Exchange Market.
 The collected data will be analyzed and interpreted
with the help of different point in time financial ratio
estimates, the OLS regression using Minitab
software, correlation analysis (both Pearson and
Spearman’s for comparison) and the F-test through
the Analysis of Variance (ANOVA) at 95%
confidence level.
 To examine the issues associated with the
adoption of IFRSs in relation to company’s WCM
and profitability, a structured interview will be
developed and applied to all companies under
survey. The results will be analyzed in form of
tables, graphs and histograms.
Friday, August 07, 2009
Effect of the adoption of IFRSs on the relationship between WCM and profitability 17
Variables
Independent variables
 The average collection period (ACP) will be used 
as proxy for the collection policy as an independent 
variable
 Inventory conversion period (ICP) will be used as 
proxy for the inventory policy is also an 
independent variable.
 Average payment period (APP) will be used as 
proxy for the Payment Policy is also an 
independent variable
 (see Deloof and Jegers, 1996; Soenen, 1998; Deloof, 2003; 
Raheman and Nasri, 2007).
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 18
365
/

Sales
RA
ACP
365
COGS
Inventory
ICP
365
/

Purchases
PA
APP
Control variables
 The cash conversion cycle (CCC)
 Current ratio (CR)
 Sales growth (SG)
 Leverage
 Age
 (See Emery, 1984; Kamath, 1989; Shin and Soenen (1998);
Deloof, 2003; Howorth, and Westhead,2003; Myers, 2003;
Kieschnic et. al., 2006; Vishnani, 2007; Huang et. al., 2008b).
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 19
APPICPACPCCC 
abilitiesCurrrentLi
etsCurrentAss
CR 
0
01
S
SS
SG


TA
LTLSTL
FDR


YearsAge ln
Indicator variables
 In order to control for the possibility that auditors
could influence the use of accrual management, an
indicator will be used to reveal the presence of the
Big Four auditors where 1 will be used to represent
the Big Four while 0 will represent any other
auditor (see Davidson et. al., 2006; Huang et. al.,
2008b).
 The industry will be defined as 1 for agricultural
companies, 0 otherwise; 1 for commercial and
service companies, 0 otherwise; 1 for industrial and
allied companies, 0 otherwise and 1 for alternative
investment market segment, 0 otherwise (see
Hawawini, et. al., 1986; Shin and Soenen, 1998;
Lazaridis and Tryfonidis,2006)
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 20
Dependent variable
 Consistent with Deloof (2003) and Lazaridis and
Tryfonidis (2006), the gross operating profit ratio,
(GOP) which is a measure of Profitability of the firm
will be used as the dependent variable
 The reason for using this variable is because the
study aims to associate the company’s operating
'success' or 'failure' with an operating ratio and
relate this variable with other operating variables
(i.e. cash conversion cycle).
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 21
FATA
COGSSales
GOP



Regression model specifications
 The OLS to used will be as follows:
 Four regression models will be run.
Friday, August 07, 2009 Effect of the adoption of IFRSs on the relationship between WCM and profitability 22
iititititit
ititititititit
AudIndAgeFDRSG
CSCRCCCAPPICPACPGOP




1110987
6543210
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END
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