THE EFFECT OF WORKING CAPITAL MANAGEMENT ON

FIRMS ‘PROFITABILITY:

A CASE OF SELECTED MANUFACTURING COMPANIES IN

DAR ES SALAAM

THE EFFECT OF WORKING CAPITAL MANAGEMENT ON

FIRMS ‘PROFITABILITY:

A CASE OF SELECTED MANUFACTURING COMPANIES IN

DAR ES SALAAM

By

Emmanuel Fredrick

A Research Dissertation Submitted in Partial Fulfillment of the Requirements for theAward of the Degree of Master of Science in Accounting and Finance (MSc-A&F)of Mzumbe University Dar es Salaam Campus College

2013

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CERTIFICATION

The undersigned certifies that he has read and hereby recommends for acceptance by

the Mzumbe University a dissertation entitled:“The effect of Working Capital

Management on Firms' Profitability: A Case of Selected Manufacturing

Companies in Dar es Salaam, in partial fulfillment of the requirements for award of

the degree of Masters of Science in Accounting and Finance of Mzumbe University.

……………………………………..

Major Supervisor

………………………………….

Internal Examiner

………………………………

External Examiner

Accepted for the Board of MUDCC

…………………………………………………………

CHAIRPERSON, FACULTY/DIRECTORATE BOARD

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DECLARATION

I, Emmanuel Fredrick, declare that this thesis is my own original work and that it

has not been presented and will not be presented to any other University for a similar

or any other degree award.

Signature……………………………….

Date……………………………………..

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COPYRIGHT

© 2013

This dissertation is a copyright material protected under the Berne Convention, the

Copyright Act 1999 and other international and national enactments, in that behalf,

on intellectual property. It may not be reproduced by any means in full or in part,

except for short extracts in fair dealings, for research or private study, critical

scholarly review or discourse with an acknowledgement, without the written

permission of Mzumbe University, on behalf of the author.

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ACKNOWLEDGMENTS

First of all I am thankful to GOD the most beneficial and merciful who gave me the

courage to finish my dissertation.

Secondly, I wish to express my gratitude to my supervisor Dr. D.M.L. Kasilo for his

constructive advice, directions, comments, support and professional guidance.

Finally, I wish to thank Mr&MrsF. N.Olotu, and all sister and brothers for their

prayers which played an important role in the completion of my dissertation. Without

their moral and financial support it would have been impossible for me to write this

dissertation report.

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ABBREVIATIONS AND ACRONYMS

CCC - Cash conversion cycle

EBIT - Earnings before interest and taxes

NSE - Nairobi stock exchange

NTC - Net-trade cycle

OLS - Ordinary least square

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ABSTRACT

This research has examined the effect of working capital management on

profitability of manufacturing companies

Working capital management is a very important component of corporate finance

because it directly affects the liquidity and profitability of the company. It’s not

enough with high profitability to be a successful company but an effective managed

working capital is also important to success. Neglecting working capital management

can in the worst case lead to the downfall of a company even if it has profitability.

In this study, the Researcher selected a sample of 4 Tanzania manufacturing

companies listed on Dar es Salaam Stock Exchange and collected data for a period of

4 years from 2008 to 2011. The Researcher studied the effect of different variables of

working capital management including accounts receivable days, accounts payable

days, inventories days and cash conversion cycle on the net operating profit of

Tanzania manufacturing firms. Financial data were extracted from companies

audited annual reports from respective company’s websites. Pooled ordinary least

square (OLS) regression analysis has been used to analyse financial data.

The results show that accounts receivable days and cash conversion cycle have a

positive relation with profitability but with no significance. Accounts payable days

and inventories days have a positive relation with profitability and are highly

significant.

Working capital management directly affects the firm’s profitability. Managers

responsible for value creation and wealth maximization can achieve their objective,

by managing working capital effectively. The policy implication of this study is that

accounts payable days need more consideration. Also this research indicates that

companies should have proper inventory management system to avoid overstocking.

Accounts receivable days and cash conversion cycle also need to be taken into

consideration as they have been ignored.

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TABLE OF CONTENTS

Pages

CERTIFICATION ...................................................................................................... iDECLARATION........................................................................................................ iiCOPYRIGHT ............................................................................................................ iiiACKNOWLEDGMENTS ........................................................................................ ivABBREVIATIONS AND ACRONYMS.................................................................. vABSTRACT............................................................................................................... viTABLE OF CONTENTS......................................................................................... viiLIST OF TABLES ..................................................................................................... xLIST OF FIGURES .................................................................................................. xi

CHAPTER ONE: INTRODUCTION STATEMENT OF THE PROBLEM ANDOBJECTIVES ............................................................................................................ 1

1.1 Introduction ............................................................................................... 11.2 Background ............................................................................................... 11.3 Statement of the problem .......................................................................... 41.4 Research objectives ................................................................................... 51.4.1 Main Objective.......................................................................................... 51.4.2 Specific Objectives.................................................................................... 61.5 Research Questions ................................................................................... 61.5.1 Main Question ........................................................................................... 61.5.2 Specific Questions..................................................................................... 61.6 Significance of the Study .......................................................................... 61.7 Limitations ................................................................................................ 7

CHAPTER TWO: LITERATURE REVIEW......................................................... 82.1 Introduction ............................................................................................... 82.2 There are two concepts of working capital namely, Gross working capital

concept and Net working capital concept. ................................................ 92.2.1 Gross Working Capital Concept ............................................................... 92.2.2 Net Working Capital Concept ................................................................. 102.3 Working Capital Management Concepts ................................................ 102.4 Accounts Receivable Days and Profitability........................................... 112.4.1 Accounts Receivable ............................................................................... 112.4.2 The Effect of Accounts Receivable Days on Profitability ...................... 122.5 Accounts Payable Days and Profitability................................................ 132.5.1 Accounts payable .................................................................................... 132.5.2 The Effect of Accounts Payable Days on Profitability ........................... 142.6 Inventories Days and Profitability........................................................... 162.6.1 Inventories............................................................................................... 162.6.2 The Effect of Inventories Days on Profitability ...................................... 172.7 Cash conversion Cycle and Profitability................................................. 182.7.1 Cash conversion cycle............................................................................. 182.7.2 The effect of Cash Conversion Cycle on Profitability ............................ 20

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2.8 Liquidity Ratios....................................................................................... 232.9 Factor leading to Corporate Performance ............................................... 24

CHAPTER THREE: ANALYTICAL FRAMEWORK ....................................... 273.1 Framework: Variables / Concept............................................................. 273.2 Analytical Framework............................................................................. 293.3 Hypothesis ............................................................................................... 333.4 Effective of Working Capital Management ............................................ 333.5 Operational Definition............................................................................. 333.6 Financial Strength ................................................................................... 343.7 Effective Corporate Performance............................................................ 34

CHAPTER FOUR: THE RESEARCH DESIGN ................................................. 354.1 Introduction ............................................................................................. 354.2 Type of Research..................................................................................... 354.3 Research Design...................................................................................... 364.4 Study Area............................................................................................... 374.5 Population................................................................................................ 374.6 Sample..................................................................................................... 374.6.1 Meaning of Sample ................................................................................. 374.6.2 Sample Size ............................................................................................. 374.7 Sampling Techniques .............................................................................. 384.7.1 Sample Procedures .................................................................................. 384.8 Data Sources and Data Collection Methods............................................ 394.8.1 Data Analysis .......................................................................................... 394.9 Data Analyses Strategy and Decision Criteria ........................................ 424.9.1 Variables and Measurement .................................................................... 424.9.2 Validity.................................................................................................... 434.10 Conclusion............................................................................................... 44

CHAPTER FIVE: DATA ANALYSE AND DISCUSSIONS ON THEFINDINGS ................................................................................................................ 45

5.1 Introduction ............................................................................................. 455.2 The Effect of Accounts Receivable Days on Profitability of

Manufacturing Companies ...................................................................... 475.3 The Effect of Accounts Payable Days on Profitability of Manufacturing

Companies............................................................................................... 475.4 The Effect of Inventories Days on Profitability of Manufacturing

Companies............................................................................................... 485.5 The Effect of Cash Conversion cycle on profitability of Manufacturing

Companies............................................................................................... 505.6 Findings and Discussion.......................................................................... 515.6.1 Profitability of the selected Manufacturing companies........................... 515.6.2 Gross Profit Margin................................................................................. 515.6.3 Net Profit Margin .................................................................................... 515.6.4 Operating Profit Ratio ............................................................................. 51

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CHAPTER SIX: CONCLUSION AND RECOMENDATION............................ 526.1 Introduction ............................................................................................. 526.2 Conclusions ............................................................................................. 526.2.1 The Effect of Accounts Receivable Days on Profitability of

Manufacturing Companies. ..................................................................... 536.2.2 The Effect of Accounts Payable Days on Profitability of Manufacturing

Companies............................................................................................... 546.2.3 The Effect of Inventories Days on Profitability of Manufacturing

Companies............................................................................................... 546.2.4 The Effect of Cash Conversion Cycle on Profitability of Manufacturing

Companies............................................................................................... 556.3 Limitations of the Study.......................................................................... 556.4 Areas for Further Research ..................................................................... 566.5 Recommendation..................................................................................... 57

REFERENCES......................................................................................................... 58

APPENDICES .......................................................................................................... 61Appendix 1: Questionnaire ................................................................................ 61Appendix 2: Financial data of manufacturing companies from 2008 to 2011 .. 65Appendix 3: Regression summary output.......................................................... 66

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LIST OF TABLES

Pages

Table 5.1: Regression output: Accounts receivable days and profitability ......... 47

Table 5.2: Regression output: Accounts payable days and profitability ............ 47

Table 5.3: Regression output: Inventories days and profitability........................ 48

Table 5.4: Regression output: Cash conversion cycle and profitability ............. 50

xi

LIST OF FIGURES

Figure 2.1: Operating and cash conversion cycle ................................................. 19

Figure 3.1: Presents the diagrammatically the conceptual framework for this

research............................................................................................... 32

1

CHAPTER ONE

INTRODUCTION STATEMENT OF THE PROBLEM AND OBJECTIVES

1.1 Introduction

Capital structure and working capital management are two very widely revisited

areas by academicians. This area of finance has been approached in various ways by

many academicians in many countries over the world. Some has focused mainly on

optimizing accounts receivable so that firms can maximize profit.

The impact of working capital management on the profitability of manufacturing

Firms has attracted the attention of researchers in different countries of the world in

recent times. This research expands the horizon of knowledge in this area by

Shedding more light on working capital management as measured by the cash

conversion cycle (CCC), and how the individual components of the CCC influence

the profitability of world leading beer brewery firms. Multiple regression equations

were applied to a cross sectional time series data of five world leading beer brewery

firms after ensuring that the data are stationary and co-integrated. The outcome of the

analysis clearly pinpoint that working capital management as represented by the cash

conversion cycle, sales growth and lesser debtors’ collection period impacts on beer

brewery firms’ profitability.

In this chapter, researcher gives an introduction to the chosen subject and presents

the statement of the problem, which leads to research objectives and research

questions. Researcher also presents the significance of the study.

1.2 Background

Working capital management is important part in firm financial management

decision. Working capital refers to a company’s Current assets. Current assets are

cash and equivalents, accounts receivable, and inventory. Working Capital

Management is applying Investment and Financing decisions to current assets.

Working capital management is a very important component of corporate finance

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because it directly affects the liquidity and profitability of the firm (Raheman& Nasr,

2007).

An optimal working capital management is expected to contribute positively to the

creation of firm value. To reach optimal working capital management firm manager

should control the tradeoff between Liquidity (ability to pay bills, keep sales coming

in, keep customers happy, play it safe ) and Profitability (size of earnings after taxes)

accurately. Working capital management is the lifeblood of business, every

manager’s primary task is to help keep it flowing, and to use the cash flow to

generate profits. Working capital in business is considered as lifeblood in human

body.

Firms may have an optimal level of working capital that maximizes their value.

Large inventory which indicates longer inventories days and generous trade credit

policy may lead to high sales. The larger inventory also reduces the risk of a stock-

out. Trade credit which leads to longer accounts receivable days may stimulate sales

because it allows a firm to access product quality before paying (Raheman& Nasr,

2007). Another component of working capital is accounts payable days. Raheman

and Nasr (2007) state that delaying payment of accounts payable to suppliers allows

firms to access the quality of bough products and can be inexpensive and flexible

source of financing. On the other hand, delaying of such payables can be expensive if

a firm is offered a discount for the early payment. By the same token, uncollected

accounts receivables can lead to cash inflow problems for the firm.

In traditional view of relationship between cash conversion cycle (as measure of

working capital management) and profitability is ceteris paribus. The shorter firm

cash conversion cycle, the better a firm profitability. This shows that less of time

money tied up in current asset and less external financing. While, the longer cash

conversion cycle will hurt firm’s probability. The reason is that firm having low

liquidity that would affect firm is risk. However, if firm has higher level of account

receivable due to the generous trade credit policy it would result to longer cash

3

conversion cycle? In this case, the longer cash conversion cycle will increase

profitability. Thus, the traditional view cannot be applied to all circumstances.

For many manufacturing firms the current assets account for over half of their total

assets (Raheman& Nasr, 2007 p. 279). The management of working capital may

have both negative and positive impact of the firm’s profitability, which in turn, has

negative and positive impact on the shareholders’ wealth. The present study seeks to

examine the effects of accounts receivable days, accounts payable days, inventories

days and cash conversion cycle on profitability of manufacturing firms.

A variety of variables related to working capital management that might potentially

be associated or ‘responsible’ for the profitability of manufacturing firms can be

found in the literature. In this study, the choice of explanatory variables is consistent

with those of Deloof (2003) and other empirical literature related to working capital

management and profitability. As a result, the final set includes five proxy variables:

accounts receivable days, accounts payable days, inventories days, cash conversion

cycle and net operating profit.

The corporate finance literature has traditionally focused on the study of long-term

financial decisions, particularly investments, capital structure, dividends or company

valuation decisions. However, short-term assets and liabilities are important

components of total assets and needs to be carefully analyzed. The current study

examine the effects of accounts receivable days, accounts payable days, inventories

days and cash conversion cycle on profitability of manufacturing firms by taking a

sample of 4 manufacturing firms for the period of four years from 2008 to 2011.

Using single regression analysis, researcher's results answered the research specific

questions. Specifically, results indicate that the cash conversion cycle and all its

major components, namely, accounts receivable days, accounts payable days,

inventories days, are associated with firm’s profitability.

4

The remainder of the study is organized as follows: Chapter one provides statement

of the problem, research objectives and research question. In chapter, two is literature

review both theoretically and empirically. Chapter three is methodology. Research

findings are discussed in chapter four and conclusions and policy implication are

presented in the last chapter.

1.3 Statement of the problem

Working capital management is a very important component of corporate finance

because it directly affects the liquidity and profitability of the company. It deals with

current assets and current liabilities. Working capital management is important due

to many reasons. First, the current assets of a typical manufacturing firm accounts for

over half of its total assets. For a distribution company, they account for even more

(Horne &Wachowicz, 2000). Efficient working capital management involves

planning and controlling current assets and current liabilities in a manner that

eliminates the risk of inability to meet due short term obligations on the one hand and

avoid excessive investment in these assets on the other hand (Eljelly 2004, p. 48).

Working Capital Management is a very sensitive area in the field of financial

management (Joshi, 1994). It involves the decision of the amount and composition of

current assets and the financing of these assets. Current assets include all those assets

that in the normal course of business return to the form of cash within a short period,

ordinarily within a year and such temporary investment as may be readily converted

into cash upon need. The Working Capital Management of a firm in part affects its

profitability. The ultimate objective of any firm is to maximize the profit. However,

preserving liquidity of the firm is an important objective too. The problem is that

increasing profits at the cost of liquidity can bring serious problems to the firm.

Therefore, there must be a tradeoff between these two objectives of the companies.

One objective should not be at cost of the other because both have their importance.

If we do not care about profit, we cannot survive for a longer period. On the other

hand, if we do not care about liquidity, we may face the problem of insolvency or

bankruptcy. For these reasons, working capital management should be given proper

consideration and will ultimately affect the profitability of the firm.

5

Pass and Hike (2007) elucidated that it is not enough with high profitability to be a

successful company but an effective managed working capital is also important to

success. A neglected managed working capital management can, in worst-case lead

to the downfall of a company even if it has a high profitability.

In spite of the importance of working capital management and its effects on the

profitability of firms, this area has been neglected for research for a long time.

Although abundant researches and theoretical development have been done in the

area of investment and long-term finance but this gray area of short-term finance, in

particular working capital management has been neglected for a very long time. Such

neglect might have been acceptable, if working capital had a relatively little

importance to the firm, but effective working capital management has a crucial role

to play in enhancing the profitability and growth of the firm.

Keeping this in view and the wider recognition of the potential contribution of

manufacturing sector to the economies of developing countries, this research intends

to analyze the relevance of working capital management on the profitability of

manufacturing companies. The researcher work would contribute by providing

empirical evidence regarding the management of working capital and is relevance to

the profitability of manufacturing firms in Tanzania.

1.4 Research objectives

1.4.1 Main Objective

The main objective of this research is to analyze the effect of working capital

management on firm profitability. In accordance with this aim, to consider

statistically significant relationships between firm profitability and the components

of cash conversion cycle at length, a sample consisting of Dar es Salaam Stock

Exchange (DSE) listed manufacturing firms for the period of 1998-2007 has been

analyzed under a multiple regression model. Empirical findings show that accounts

receivables period, inventory period and leverage affect firm profitability negatively;

while growth (in sales) affects firm profitability positively

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1.4.2 Specific Objectives

The specific objectives of this study are:

(i) To find out the effect of accounts receivable days on profitability of

manufacturing companies.

(ii) To find out the effect of accounts payable days on profitability of

manufacturing companies.

(iii) To find out the effect of inventories days on profitability of manufacturing

companies.

(iv) To find out the effect of cash conversion cycle on profitability of

manufacturing companies.

1.5 Research Questions

1.5.1 Main Question

The main question guiding this research reads:

Does working capital management affect the profitability of manufacturing

companies?

1.5.2 Specific Questions

(i) What is the effect of accounts receivable days on profitability of

manufacturing companies?

(ii) What is the effect of accounts payable days on profitability of

manufacturing companies?

(iii) What is the effect of inventories days on profitability of

manufacturing companies?

(iv) What is the effect of cash conversion cycle on profitability of

manufacturing companies?

1.6 Significance of the Study

The effect of working capital management on firms’ profitability has been studied in

Tanzania.(Kasilo,1997) Muzumbe Library Therefore, this research contributes to

negatively the gap in knowledge. By their numbers alone manufacturing companies

7

are the key driver for Tanzania economy. Understanding how manufacturing

companies achieve high performance has significant implications for companies

owners/managers, employees, and the national economy. High level of performance

can facilitate a firmsgrowth and subsequent profit performance, which in turn can

yield employment gains and contribute to the general economic health of Tanzania.

Conversely, low performance may lead to firm stagnation or failure, and the negative

economic ramifications commensurate with these outcomes. Therefore,

understanding the effect of working capital management on firm's profitability is

vitally important to the manufacturing sector .This research has also be submitted in

partial fulfillment of the requirements for the award of degree of Masters of Science

in Accounting and Finance at Mzumbe University.

1.7 Limitations

Every study conducted has to experience limitations, some limitations have occurred

and still the researcher will tend to experience in the process of conduction the study.

Limitations do cover mainly in collection of data processing and analysis of data.

Some of the main limitations of the study are:

Cost of the study, in that the researcher will Incur high cost of printing, as well as

photocopying to maintain the hard copy of the study. Because the research involves

Internet applications hence costs to use internet in observing trading activities has to

be taken into consideration.

Time limit has been also a limitation on the completion to the proposal. Time is not

in our side for us to complete the study in the time provided.

This has been caused mainly by the limited availability of resources to work on the

research such as computers and employment activities where by most of time

spending in the office.

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

Literature review researcher presents theoretical and empirical literature review of

related studies highlighting the theories and findings of different researchers as well

as conceptual framework regarding working capital management.

Profit maximization is the ultimate objective of firm`s as well as protecting liquidity

is an important objective too. The difficult of working capital management is to

achieve the two objectives optimally within an operating period if profit increases at

the cost of liquidity and this may create serious problem to firms. Therefore, to solve

such problems, there must be some compromise between these two objectives of

firms. One objective will not achieve at the cost of other as both objectives have their

own importance to firms. If firms do not care about profitability, they may not

survive for a longer longer period. On the other hand, if firms do not care about

liquidity, they may face problem of insolvency or bankruptcy.

Working Capital Concepts

Working capital refers to firm's investment in short-term assets, such as cash,

accounts receivable and inventories of raw materials, work-in-process and finished

goods. It can also be regarded as that portion of the firm's total capital, which is

employed in short-term operations. It refers to all aspects of current assets and

current liabilities. In simple words, we can say that working capital is the investment

needed for carrying out day-to-day operations of the business smoothly. The

management of working capital is no less important than the management of long-

term financial investment (Kuchhal, 1985).

All companies produce an annual set of accounts consisting of a balance sheet, profit

and loss accounts and Cash flow statement. Most of these companies also produce

interim set of accounts during the year, usually on a monthly or quarterly basis.

9

These interim accounts are called management accounts and are not available to

people outside the company, they are for the company managers only enabling them

to monitor progress on a regular basis. To do this ratio analysis can be used.

Managers need to know how well they are performing now to enable them to make

business perform better in the future. They need to know the baseline from which

their performance as a manager will be measured. An awareness of the current

business performance and position will help them to focus their efforts.

According to Deloof

(2003) the way that working capital is managed has a significant impact on

profitability of firms. It has also been proved that by minimizing the amount of funds

tied up in current assets; firms can reduce financing costs and/or increase the funds

available for expansion. Cote and Latham (1999, p. 261) argued the management of

receivables, inventory and accounts payable have tremendous impact on cash flows,

which in turn affect the profitability of firms. As found by Lazaridis and Tryfonidis

(2006), companies enjoy better pricing when they hold enough cash to purchase from

own suppliers and thus they may enhance their profit. So having enough liquidity

also affects the profitability of the firm.

2.2 There are two concepts of working capital namely, Gross working capital

concept and Net working capital concept.

2.2.1 Gross Working Capital Concept

Gross working capital refers to firm’s investment in current assets. Current assets are

the assets which can be converted into cash within an accounting year include trade

receivables, cash and inventories. According to this concept, working capital means

Gross working capital which is the total of all current assets of a business; it can be

represented by the following equation (Mead, 1993):

Gross working capital = Total current assets

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2.2.2 Net Working Capital Concept

Net working capital refers to the difference between current assets and current

liabilities. Current liabilities are those claims of outsiders that are expected to mature

for payment within an accounting year and include trade payables and outstanding

expenses. Net working capital can be positive or negative. A positive net working

capital will arise when current assets exceed current liabilities. A negative net

working capital occurs when current liabilities are in excess of current assets, it can

be represented by the following equation (Gitman, 1997);

Net working capital = Current assets – current liabilities.

It is hardly to find a running business firm, which does not require some amount of

working capital. Even fully equipped manufacturing firms are sure to collapse

without (a) an adequate supply of raw materials to process, (b) cash to meet the wage

bill, (c) the capacity to wait for the market for its finished products, and (d) the

ability to grant credit to its customers. Working capital, thus, is the life-blood of a

business. Actually, any organization, whether profit-oriented or otherwise, will not

be able to carry on day-to-day activities without adequate working capital (Kuchhal,

1985).

2.3 Working Capital Management Concepts

The working capital meets the short-term financial requirements of a business

enterprise. It is the investment required for running day-to-day business. It is the

result of the time lag between the expenditure for the purchase of raw materials and

the collection for the sales of finished products. The components of working capital

are inventories, accounts to be paid to suppliers, and payments to be received from

customers after sales. Financing is needed for receivables and inventories net of

payables. The proportions of these components in the working capital change from

time to time during the trade cycle. The working capital requirements decide the

liquidity and profitability of a firm and hence affect the financing and investing

decisions. Lesser requirement of working capital leads to less need for financing and

less cost of capital and hence availability of more cash for shareholders. However,the

11

lesser working capital may lead to lost sales and thus may affect the profitability. The

management of working capital by managing the proportions of the working capital

management components is important to the financial health of businesses from all

industries. To reduce accounts receivable, a firm may have strict collections policies

and limited sales credits to its customers. This would increase cash inflow. However,

the strict collection policies and lesser sales credits would lead to lost sales thus

reducing the profits. Maximizing account payables by having longer credits from the

suppliers also has the chance of getting poor quality materials from supplier that

would ultimately affect the profitability. Minimizing inventory may lead to lost sales

by stock-outs. The working capital management should aim at having

balanced;optimal proportions of the working capital management components to

achieve maximum profit and cash flow (Vedavinayagam, 2007).

Working capital concepts give an idea of what working capital is all about and

working capital management concepts explain the management of components of

working capital and how they may affect profit of the firms. Hereunder researcher

shows what literature says both theoretically and empirically about the components

of working capital management and its effect on profitability.

2.4 Accounts Receivable Days and Profitability

2.4.1 Accounts Receivable

All the businesses have either products or services to sell to the customers, they also

want to maximize their sales so, in order to increase the level of their sales they use

different policies to attract customers and one of them is offering a trade credit. It

means a company sells its product now to receive the payment at specify date in the

future and this is when accounts receivable arise. Hill &Sartoris (2005) found that

one sixth of total assets for manufacturing corporations consist of accounts

receivable and because of its huge proportion in the total assets, it can become a

problem for the organization in a way that it requires more financing for the period

for which payment is due from the customers. Accounts receivable also have

opportunity cost associated with them because company cannot invest this money

12

elsewhere until and unless it collects its receivables. More accounts receivable can

raise the profit by increasing the sale but it is also possible that because of high

opportunity cost of invested money in accounts receivable and bad debts the effect of

this change might turn difficult to realize. On the other hand if a company adopts a

policy to have a low level of accounts receivable then it can reduce the profitability

by reducing the sales but it can contribute to the profit by reducing the risk of bad

debts and by reducing investment in the receivable (Andrew & Gallagher 1999,

ph.465).

2.4.2 The Effect of Accounts Receivable Days on Profitability

The time between the sale and the receipt of payment is known as trade credit period

or accounts receivable days. It is believed that longer period of collection of accounts

receivable or longer credit period offered by the company results into higher sales,

and more sales bring more profit in the business. Therefore, there could be an

existing relationship between the number of day’s accounts receivable and

profitability of the firm. On the other hand large time span between the sale and

receipt of accounts receivable result in decline of cash flows and may result in bad

debts, which in turn may reduce the profit of the firm (Brealey& Myers 2006, p.

814).

Theoretically, accounts receivable days may lead either to an increase or to decrease

of the firms’ profitability, and which period of collection is preferable, having long

accounts receivable days or short accounts receivable days? This question will be

answered by empirical results of the related study of the following researchers.

To test the relationship between working capital management and corporate

profitability, Deloof (2003, p. 573) used a sample of 1,009 large Belgian non-

financial firms for a period of 1992-1996. By using correlation and regression tests,

he found significant negative relationship between gross operating income and the

number of day’s accounts receivable of Belgian firms. Based on the study results, he

suggests that managers can increase corporate profitability by reducing the number

of day’s accounts receivable.

13

Other researchers Nobanee and AlHajjar (2009b) who studied the relationship

between working capital management and corporate profitability of Japanese firms

analyzed a sample of 2,123 Tanzania non-financial companies listed in the Dar es

salaam Stock Exchange for the period 1990-2004 and they concluded that company

managers can increase profitability by shortening the receivables collection period.

On the other hand Ramachandran and Janakirama (2006 p. 61) studied the firm’s

efficiency in working capital management in the paper industry in India. They

analyzed the relationship between working capital management efficiency and

Earnings before interest and taxes (EBIT). Using regression analysis it was found

that there is a positive relationship between collection period and EBIT. This means

credit facility increases sales of firm, which ultimately increases profitability.

The study results of Deloof (2003, p.573) and Nobanee and AlHajjar (2009b) are the

same as they suggest that managers can only increase corporate profitability by

reducing the number of days accounts receivable however their results contradict

with Ramachandran and Janakirama (2006, p.61) as they found that corporate

profitability can only be increased by increasing accounts receivable days. The

mixed results may be due to different period and selection of companies of their

researches.

2.5 Accounts Payable Days and Profitability

2.5.1 Accounts payable

Accounts payable are generated when company purchases some products for which

payment has to be made no later than a specified date in the future. Accounts payable

are a part of all the businesses and have some advantages associated with it e.g. it is

available to all the companies regardless of the size of the company and earlier

payment can bring cash discount with it (Arnold 2008, p.479). Companies should try

prolonging the time of payment as long as possible as they can use the advantage of

their suppliers financing their investments until payment has been made. Another

argument for prolonging the time for payment is that the producing companies, for

14

example, need some time to convert their purchased raw materials into products they

can get sold and get cash in return (Maness &Zietlow 2005, 235). Some suppliers

offer their customers discount rates as an attempt to get them to pay their receivables

before maturity date, which may sound tempting, but this is not always the most

profitable option. To avoid being misled by these discounts offers, companies should

carefully consider every discount offer they get to see that it is beneficial in terms of

their conditions. For a discount to be beneficial for the buyer the discount rate should

be higher than the interest rate the company would have to pay for a loan over the

same period as the discount period (Maness &Zietlow 2005, p. 235). If there is no

discount offer given companies should use the whole credit period and pay their

payables on due date. Paying after due date should always be avoided unless the

company has fallen in financial difficulties and there is no other choice. The reason

for this is that delayed payments can result in unnecessary costs as late fees

(Dolfe&Koritz 2000, p. 49).

2.5.2 The Effect of Accounts Payable Days on Profitability

An accounts payable day is a time between the purchase of goods and its payment. If

the firm is unable to pay its accounts payable on time then it signals to the market

that firm have some financial problem and it might go bankrupt resultantly its

goodwill will be spoiled and the value of its shares will go down. Therefore, it is

necessary for the firm to manage the day’s accounts payable in a way that it does not

create any trouble for it. Shorter duration of day’s accounts payable can be beneficial

for an organization as it has some discount associated with it but at the same time, it

will force a company to reduce the collection period, which might cause the

reduction of sale.

Therefore, companies have to be very careful while deciding on the duration of day’s

accounts payable. For us it is better for a company to have larger duration of day’s

accounts payable (Arnold, 2008, p.531).

15

Longer accounts payable days are preferable theoretically delaying payment of

accounts payable to suppliers allows firms to access the quality of bought products

and can be inexpensive and flexible source of financing. On the other hand, delaying

of such payables can be expensive if a firm is offered a discount for the early

payment or is being charged for late payment. The following researchers give us

empirical evidence on effect of accounts payable days on firms profitability, and

these are as follows,

Ghosh and Maji (2003) studied the firm’s efficiency in working capital management

in the cement industry in India. They analysed the relationship between working

capital management efficiency and EBIT. Using regression analysis it was found that

there is a positive relation between payable period and EBIT, which means profitable

firms delay their payables.

Falope and Ajilore (2009, p. 73) used a sample Tanzania quoted non-financial firms

for the period 2008 -2011. Their study utilized panel data econometrics in a pooled

regression, where time-series and cross-sectional observations were combined and

estimated. They found a significant negative relationship between net operating

profitability and average payment period for a sample of Tanzania firms listed on

Dar es Salaam Stock Exchange. As the firm’s corporate profitability can only be

increased by reducing payment period.

According to Garcia-Teruel and Martinez-Solano (2007, p 164) who studied the

effects of working capital management on the profitability of a sample of 8,872 small

and medium-sized enterprises (SMEs) from Tanzania covering the period 2008 -

2011. They found that managers can create value by reducing their number of days

for which their accounts are outstanding as this will improve the firm’s profitability.

From empirical results we get mixed results as Ghosh and Maji (2003) claim that

profitable firms delay their payables means they have longer duration of days

accounts payable as Arnold (2008, p.531) suggested. But Garcia-Teruel and

Martinez-Solano (2007, p 164) and Falope and Ajilore (2009, p. 73) found that

16

managers can only increase profit by reducing numbers of accounts payable as firms

benefit discount for the early payment and avoid being charged for late payment.

2.6 Inventories Days and Profitability

2.6.1 Inventories

Inventories comprise raw material, finished goods and work in process. It is not

necessary for a firm to hold high level of raw materials inventory, in fact, a firm can

order raw material on the daily basis but the high ordering cost is associated with

such a policy. Moreover, the delay in supply might stop the production. Similarly,

firm can reduce its finished goods inventory by reducing the production and by

producing the goods only to meet, the current demand but such a strategy can also

create trouble for the company if the demand for the product rises suddenly. Such a

situation might cause the customer dissatisfaction and even a loyal customer can

switch to the competitors brand. Therefore, the firm should have enough inventories

to meet the unexpected rise in demand but the cost of holding this inventory should

not exceed its benefit (Brealey& Myers 2006, p.821).

Companies should keep inventory at a level, which maximizes the profit, and this

level is known as optimal level. There are costs associated with inventory i.e.

carrying cost and ordering cost. Carrying cost involves all the expenses, which firm

has to bear for on handling inventory and this involve insurance, warehouse

expenses, security expenses etc. Ordering cost is a cost that is associated with one

order. It includes telephone expenses, management time, and clerical expenses etc.

Ordering cost is a fixed cost and its effect can be reduced by ordering a big lot but

big lot will increase the carrying cost. On the other hand, if a finance manager saves

the carrying cost by ordering twice or thrice rather than one big lot then ordering cost

will increase. In both cases, profitability is directly affected. Therefore, in order to

find an optimal level managers have to find a balance between cost and benefit

associated with different inventory levels (Andrew & Gallagher 1999, p.472).

17

2.6.2 The Effect of Inventories Days on Profitability

Inventories days can be defined as the time between the receipt of raw material and

delivery of finished goods. The effect of inventories days on profitability depends on

the policy which a company adopts towards working capital. A company with

aggressive working capital policy holds minimal inventory and has few days for

which they held inventory. This policy tends to enhance the profitability of the firm,

as carrying costs associated with inventory tends to be low.

While a company with defensive, policy has higher level of inventory and has longer

inventories days. Hence, this policy might reduce the profitability because of the

funds tied up in inventory and due to higher carrying costs associated with higher

level of inventory (Andrew & Gallagher, 1999).

In theory the policy of the company will determine the inventory conversion period

and this will have an effect on profitability accordingly. The study results of the

different researchers on the effect of inventories days on firms’ profitability are as

follow;

Mathuva (2009, p. 1) examined the influence of working capital management

components on corporate profitability by using a sample of 30 firms listed on tDar es

Salaam Stock Exchange (DSE) for the periods 2008 to 2011. He used Pearson and

Spearman’s correlations, the pooled ordinary least square (OLS), and the fixed

effects regression models to conduct data analysis. The key findings of his study

were that there exists a highly significant positive relationship between the period

taken to convert inventories into sales (the inventory conversion period) and

profitability.

The research conducted by Lazaridis and Tryfonidis (2006, p. 26) who studied 131

companies listed on Dar es Salaam Stock Exchange for 2008 to 2011 to investigate

the impact of profitability and managing working capital. By using regression and

correlation analysis it was found that there is significant relation between

18

profitability and components of working capital. They found a significant positive

relationship between profit margins and inventory.

On the other hand Samiloglu and Demirgunes (2008, p. 44) conducted the study to

examine the effect of working capital management on company profitability of listed

manufacturing companies in Dar es Salaam Stock Exchange for the period from

2008 to 2011 inventory period used to measure the effect of working capital

management, return on assets is used as a profitability measure. Results from

regression analysis show that profitability has a significant negative relation with

inventory period.

Mathuva (2009, p. 1) and Lazaridis and Tryfonidis (2006, p. 26) suggested that there

is positive relationship between profitability and inventory conversion period as

managers can increase corporate profitability by having longer inventory conversion

period. However Samiloglu and Demirgunes (2008, p. 44) their results show that

profitability has a significant negative relation with inventory period so managers can

increase corporate profitability by reducing the number of inventories period. This is

obvious that companies used for their studies had different inventories policies.

2.7 Cash conversion Cycle and Profitability

2.7.1 Cash conversion cycle

It is a time span between the payment for raw material and the receipt from the sale

of goods. For a manufacturing company we can define it more precisely, it is a time

for which raw material is kept for the processing plus the time taken by the

production process plus the time for which finished goods are kept and sold and the

time taken by the debtors to pay their liability, minus the maturity period of account

payable. By this definition it is quite clear that longer cash conversion cycle require

more investment in the current assets (Arnold 2008, p. 530). Cash conversion cycle

is likely to be negative as well as positive. A positive result indicates the number of

days a company must borrow or tie up capital while awaiting payment from a

19

customer. A negative result indicates the number of days a company has received

cash from sales before it pay its suppliers (Hutchison et al 2007, p. 42).

Inventories days

+

Cash conversion cycle = Accounts receivable days

–

Accounts payable days

As can be seen in figure 2.1, the cash conversion cycle period is determined by the

inventory and accounts receivable period minus the accounts receivable period

(Uyar, 2009)

Figure 2.1: Operating and cash conversion cycle

Source: Uyar (2009 p. 188). The relationship of cash conversion cycle with firm size

and profitability: An empirical investigation in Turkey.

20

2.7.2 The effect of Cash Conversion Cycle on Profitability

As cash conversion cycle is the time span between the expenditure for the purchases

of raw materials and the collection of sales of finished goods. The longer the time

lag, the larger the investment in working capital. A longer cash conversion cycle

might increase profitability because it leads to higher sales.

However, corporate profitability might also decrease with the cash conversion cycle,

if the costs of higher investment in working capital rise faster than the benefits of

holding more inventories and/or granting more trade credit to customers (Deloof

2003, p 573).

Therefore, the ultimate goal is having shorter cash conversion cycle. Cash conversion

cycle can be shortened by reducing the inventory conversion period via processing

and selling goods more quickly; or by decreasing the receivables collection period

via speeding up collections; or by lengthening the payables deferral period through

slowing down payments to suppliers. This increases companies’ efficiency of

internal operations and results on higher profitability (Nobanee, 2009).

The above literature supports shorter cash conversion cycle as it will lead to an

increase in firms’ profitability. Various researchers who studied the effect of cash

conversion cycle on profitability came up with the following results as follows;

Shin and Soenen (1998, p 37) researched the relationship between working capital

management and value creation for shareholders. The standard measure for working

capital management is the cash conversion cycle (CCC).

In their study, Shin and Soenen (1998, p 37) used net-trade cycle (NTC) as a measure

of working capital management. NTC is basically equal to the CCC where all three

components are expressed as a percentage of sales. They examined this relationship

by using correlation and regression analysis, by industry, and working capital

intensity. Using a COMPUSTAT sample of 58,985 firm years covering the period

1975-1994, they found a strong negative relationship between the length of the firm's

21

net-trade cycle and its profitability. Based on the findings, they suggest that one

possible way to create shareholder value is to reduce firm’s NTC.

In a study conducted by Raheman and Nasr (2007, p. 279) who studied the effect of

different variables of working capital management including cash conversion cycle

on the net operating profitability of Pakistani firms. They selected a sample of 94

Pakistani firms listed on Karachi Stock Exchange for a period of six years from 1999

- 2004 and found a strong negative relationship between variables of working capital

management and profitability of the firm. They found that as the cash conversion

cycle increases, it leads to decreasing profitability of the firm and managers can

create a positive value for the shareholders by reducing the cash conversion cycle to

a possible minimum level.

On the other hand, other researchers support that investing more in cash conversion

cycle may lead to increased profitability since maintaining high inventory levels is

expected to increase sales, reduce supply costs, reduce cost of possible interruption

in production and protect against price fluctuations (Blinder &Maccini, 1991, p. 291)

Once again there are mixed results as Shin and Soenen (1998, p. 37) and Raheman

and Nasr (2007, p. 279) suggest that only possible way to create shareholders value

means increasing profitability is by reducing the firm’s cash conversion cycle.

However, Blinder and Maccini (1991, p. 291) support for higher cash conversion

cycle as it leads to higher profitability. Different results may be due to different

policies these companies might have been used in controlling elements of cash

conversion cycle

Working capital management has identified as independent variable while

profitability of the manufacturing sector as dependent variable. Inventory days,

accounts receivable days, accounts payable days and cash conversion cycle has

identified as indicators of working capital management and net operating profit as

indicator of profitability. When there are a less number of inventory days, and a less

number of accounts receivable days and higher number of accounts payable days, it

22

says that there is a good cash conversion cycle. A good cash conversion cycle

indicates proper working capital management. According to literature since there is a

negative relation between proper working capital management and profitability, a

shorter cash conversion cycle finally leads to higher performance in firms.

In summary, the literature review indicates that working capital management affects

profitability of the firm. From different researches we get different results and

conclusions which help the researcher to come up with specific research questions

and developing research methodology as follows:

Specific research questions:

(i) What is the effect of accounts receivable days on profitability of

manufacturing companies?

(ii) What is the effect of accounts payable days on profitability of manufacturing

companies?

(iii) What is the effect of inventories days on profitability of manufacturing

companies?

(iv) What is the effect of cash conversion cycle on profitability of manufacturing

companies?

In spite of the impact working capital management may have on firms’ profitability,

not much has been done in the area of the provision of empirical evidence in support

of the claims of working capital management on profitability performance of

Tanzania firms. Given this rareness of empirical studies, it is hoped that this study

will fill a gap and provide useful support for understanding the effect of working

capital management on firms’ profitability in Tanzania.

23

2.8 Liquidity Ratios

Liquidity ratios provide information about a firm’s ability to meet its short-term

financial obligations they are of particular interest to those extending short term

credit to the firm. There are many types of liquidity ratios as follows.

a) Current Ratio,

Current assets divided by Current Liabilities. These assesses whether you have

sufficient assets to cover your liabilities. A ratio of 2 shows you have twice as many

current assets as current liabilities. This ratio is also known as working Capital ratio

because it is about the excess of current assets over current liabilities. It is calculated

using the following formula.

Current Ratio= Current Assets

Current liabilities

b) Quick or Acid Ratio,

Current Assets (excluding stock) divided by current liabilities. A ratio of 1 shows

liquidity levels are high- an indication of solid financial health. Mathematically it is

expressed as

Acid test Ratio= Current Assets- stock

Current liability

Current Liabilities are those liabilities which must be paid shortly such as creditors

and bank overdrafts. A bank overdraft is considered to be a current liability because

it can be recalled without notice. The ideal ratio should be around 1:1.

c) Defensive Interval,

Liquid assets divided by daily operating expenses. This measures how long your

business could survive without cash coming in. This should be between 30 and 90

days. It is calculated by using the following formula.

Defensive Interval= Current assets- stock

Daily operating expenses

d) Cash Ratio,

It is the most conservative liquidity ratio. It excludes all current assets except the

most liquid. Cash and cash equivalents. The cash ratio is defined as follows;

24

Cash ratio= cash marketable securities.

Current liabilities

The cash ratio is an indication of the firm’s ability to pay off its current liabilities if

for some reason immediate payment were demanded.

2.9 Factor leading to Corporate Performance

a) Technology Forces

Technology refers to the means chosen to do useful work. Technological forces

include not only the glamorous invention that revolutionizes our lives but also the

gradual improvements in methods, in materials, in design, in application, in diffusion

into new industries and in efficiency.

For centuries the simple process of handling business correspondence has involved

dictation, made the process more efficient, include the creation of standardized

shorthand writing system, the invention of type writer, the use of voice recording

machines for dictation and the use of microcomputer for transcription and editing.

All four represent technological change even though only the typing recording and

word processing activities involve machines. So this technology has many effects on

corporate performance since it lead to new product, alternative product and change in

complementary product or services.

b) Social Forces

Social forces include factors that relate to the values, and demographic

characteristics of an organization’s customers. Dynamic social forces can

significantly influence the demand of an organization products or services and can

alter its strategic decision.

The behavior patterns of individuals and groups reflect their attitudes, beliefs, and

values. The social environment includes the altitudes and values of society as well as

behavior which are motivated by those values. The impact of the social factor is felt

in changing needs, taste, and preference of consumers in relation with employees and

in expectations of society about how the organization should fulfill its citizenship

25

role. Expectation concerning responsible use of the physical environment has greatly

increased in business organizations. The attitudes of employee and consequently, the

relationship of employees to the firm are also changing. The willingness to put effort

to earn more money is less evident that it was in the past, a employees opt for more

leisure and depend less on work to meet their needs for esteem and fulfillment so this

led to ineffective corporate performance.

c) Market share.

Market share is the percentage of a market [defined in terms of either units or

revenue] accounted for by a specific entity in a server.

Market need to be able to translate sales targets into market share because the will

demonstrate weather forecasts are to be attained by growing with the market or by

capturing share from competitors.

The latter will almost be more difficult to achieve. Market share is closely monitored

for signs of change in the competitive landscape. And it frequently drives strategic or

tactical action. Increasing market share is one of the most important objectives of

business.

The main advantage of using market share as a measure of business performance is

that it is less dependent upon micro environmental variables such as the state of the

economy or change in tax policy. However increasing market share may be

dangerous of market of fungible hazardous productizes.

Market share is a key indicator of market competitiveness that’s how well a firm is

doing against its competitors. This metric supplemented by changes in salaries

revenue helps managers evaluate both primary and selective demand in their market.

That is enables them to judge not only total market growth or decline but also trends

in customers selections among competitors.

26

Generally sales growth resulting from primary demand (total market growth) is less

costly and more profitable than that achieved by capturing share from competitors.

Conversely loses in market share can signal serious long term problems that require

strategic adjustment firms with market shares below a certain level may not be

viable. Similar within a firms products line market shares trends for individual

product are considered early indicators of future opportunity or problem.

d) Quality of staff is another factor led to effective corporate performance since

employee and other workers of the company are the one who can effluence

the effective corporate performance or ineffective. The quality of staff can be

build by good system of providing employment through required

specification. Equal and good reward and punishment system.

e) Company policy Implementation.

27

CHAPTER THREE

ANALYTICAL FRAMEWORK

3.1 Framework: Variables / Concept.

Variable is the operational zed way in which the attribute is presented for further data

processing. In data processing data are often represented by a combination of items.

Researcher use an experiment to search cause and affect relationships, they design

experiment so that changes to one independent variable led to change of dependent

variables.

In order to analyze the effects of working capital management on the firm’s

Profitability, we used the return on assets (ROA) as the dependent variable.

We defined

This variable as the ratio of earnings before interest and tax to assets. With regards to

the independent variables, we measured working capital Management by using the

number of days accounts receivable, number of days of Inventory and number of

day’s accounts payable. In this respect, number of days

Accounts receivable (AR) is calculated as 365 × [accounts receivable/sales]. This

Variable represents the average number of days that the firm takes to collect

payments from its customers

The higher the value, the higher its investment in accounts receivable.

We calculated the number of days of inventory (INV) as 365 ×

[Inventories/purchases].

This variable reflects the average number of days of stock held by the firm. Longer

storage times represent a greater investment in inventory for a Particular level of

operations.

6

29

The number of days accounts payable (AP) reflects the average time it takes firms to

pay their suppliers. We calculated this as 365 × [accounts payable/purchases].

The higher the value, the longer firms take to settle their payment commitments to

their suppliers

Considering these three periods jointly, we estimated the cash conversion cycle

(CCC). this variable is calculated as the number of days accounts receivable plus the

Number of days of inventory minus the number of days accounts payable. The longer

the cash conversion cycle, the greater the net investment in current assets, and hence

the greater the need for financing of current assets.

Together with these variables, we introduced as control variables the size of the firm,

the growth in its sales, and its leverage. We measured the size (SIZE) as the

logarithm of assets, the sales growth (SGROW) as (Sales1 – Sales0)/Sales0, the

leverage (DEBT) as the ratio of debt to liabilities.

3.2 Analytical Framework

Dependent variable is what you measure in the experiment and what is affected

during the experiment. The dependent variable responds to the independent variable

is called dependent because it depends on the independent variable. In this research

the dependent variable is Corporate Performance.

Independent Variables are the variables you have control over what you choose and

manipulate. It is usually what you think will affect the dependent variable. In some

cases you may not able to manipulate the independent variable. It may be something

that is already there and is fixed, something you would like to evaluate with respect

to how it affects something els

Working capital management has identified as independent variable while

profitability of the manufacturing sector as dependent variable. Inventory days,

accounts receivable days, accounts payable days and cash conversion cycle has

identified as indicators of working capital management and net operating profit as

30

indicator of profitability. When there are a less number of inventory days, and a less

number of accounts receivable days and higher number of accounts payable days, it

says that there is a good cash conversion cycle. A good cash conversion cycle

indicates proper working capital management. According to literature since there is a

negative relation between proper working capital management and profitability, a

shorter cash conversion cycle finally leads to higher performance in firms.

The measure of working capital management is cash conversion cycle. And it is

described by the following equation: Cash conversion cycle=Receivables collection

period + Inventory turnover period –Payable deferral period

For the purpose of analysis, the ultimate measurement of profitability has been

chosen to be return on asset (ROA). The method of calculating cash conversion cycle

(CCC) has been shown earlier as well. The variables are calculated as shown in the

table following. Only the CCC and its components have a unit of days, except for

these, all other variables are expressed in terms of proportion or ratio. The variables

that have been used are as follows: No Variables Method used for Calculation

(i) Return On Asset (ROA) Net Profit / Total Asset

(ii) Net Profit Margin (NPM) Net Profit / Sales

(iii) Interest Coverage Ratio (ICR) Earnings Before Interest and Taxes/Interest

Expense 4 Quick Ratio (QR) (Current Asset - Inventory)/Current Liability

(iv) Cash Conversion Cycle (CCC) RCP + PDP – ITP

(v) Receivables Collection Period (RCP) 360 / (Sales/ Accounts Receivables)

(vi) Payable Deferral Period (PDP) 360 / (COGS/Accounts Payable)

(vii) Inventory Turnover Period (ITP) 360 / (COGS/Inventory)

(viii) Cash to Current Liability ( CTCL) Cash/Current Liability

(ix) Cash to Sales (CTS) Cash/Sales

The ratio of cash to sales has been taken to have an idea if the companies are

enjoying any benefit out of holding cash which reflects in the company’s

profitability. As it has been explained as a probable reason by Lazaridis and

Tryfonidis (2006) that companies enjoy better pricing when they hold enough cash to

31

purchase from own suppliers. Cash to current liability has been taken to observe if

the companies are cautious enough to keep up with their maturing dues or obligations

and if they are benefitting out of this performance as well. Many other variables

have also been considered for the purpose of this study, but those have been excluded

later as they do not show statistically significant relationship with the dependent

variables. Finally the dependent variables used for the research are mainly the

profitability ratios and debt coverage ratio or ROA, NPM and ICR respectively. But

NPM and ICR has also been used as independent variable to assess their impact on

ROA. All other variables are considered to disclose the working capital condition or

cash position of the firm and are used as independent variable against the earlier said

dependent variables.

32

Figure 3.1: Presents the diagrammatically the conceptual framework for this

research

Firms/corporate

performance

Working

Capital

Proper

management of

receivable

(Account

receivable days)

Proper

management of

stock (inventories

days)

Social

factor

Quality of

staffs

Proper

management

payable

(Accounts

payable days)

Financial Indicators

Profitability

(i) The gross profit margin

(ii) Net profit Margin to asset

(iii) Return on capital employed

(iv) Return on investment

Financial indicators

Liquidity

(i) Current and quick ratios

(ii) Debt to equity and debt

(iii) > Cash flow ratios

33

3.3 Hypothesis

The hypotheses developed based on relationship involved between dependent

variable and the Independent variables.

Ho: Firms or Corporate Performance is influenced by inventorydays, accounts

receivable day, account payables day and cash conversion cycle.

Ha: Firms or Corporate Performance is not influenced by inventorydays, accounts

receivable day, account payables day and cash conversion cycle.

3.4 Effective of Working Capital Management

Effective Firms Corporate Performance is encompasses Strategic planning,

budgeting, forecasting workflow, reporting, modeling, scenario planning, and

profitability analysis.

According to key performance indicator such as revenue, return on Investment

(ROI), Overhead, and Operational cost. Indicators of Effective Performance can be

measured by looking profitability ratio as The Gross Margin ratio, Net Profit Margin,

Return on Capital Employed (ROCE) and Return on Investment (ROI), The type of

data required to be collected for analysis will be Income, Cash and Capital and

Carriers of data will be Statement of Financial Position and Cash flow Statement.

3.5 Operational Definition

Financial statement is measured by using financial ratio. Financial ratios are useful

indicators of a firm performance and financial situation. Most ratio’s can be

calculated from information provided by the financial statement’s financial ratio can

be used to analyze trends and to compare the firm’s financial to those of other firms.

In some cases, ratio analysis’ can predict future bankruptcy. Ratio analysis is a good

way to evaluate the financial results of your business in order to gauge its

performance. Ratio allows you to compare your business against different standards

using the figures on your balance sheet.

34

Accounting ratios can offer an invaluable insight into a business performance.

Ensure that the information used for comparison is accurate otherwise the results will

be misleading. The financial ratio is about five types which are activity ratio,

profitability ratio, liquidity ratios, leverage ratios, and stock market ratios

3.6 Financial Strength

Financial Strength ratios go by many names (liquidity, Solvency, Financial

Leverage) but they all point to the same thing. What is the business’s financial

strength and position? A balance sheet oriented value investor looks closely to make

sure that the company will be around tomorrow.

Value investors first look at financial strength for obvious danger. The Indicator of

Financial Strength is as Current and Quick ratios, Debt to Equity and Debt to Assets

and Cash flow ratios The type of data required to be collected for analysis will be

company assets for five years conservative, Company capital, Company Liability and

company Cash and Cash equivalent for five conservative years. And carriers of data

will be Statement of Financial Position and Cash flow Statement.

3.7 Effective Corporate Performance

Effective Corporate Performance is encompasses Strategic planning, budgeting,

forecasting workflow, reporting, modeling, scenario planning, profitability analysis.

According to key performance indicator such as revenue, return on Investment

(ROI), Overhead, and Operational cost. Indicators of Effective Performance can be

measured by looking profitability ratio as The Gross Margin ratio, Net Profit Margin,

Return on Capital Employed (ROCE) and Return on Investment (ROI), The type of

data required to be collected for analysis will be Income, Cash and Capital and

Carriers of data will be Statement of Financial Position and Cash flow Statement.

35

CHAPTER FOUR

THE RESEARCH DESIGN

4.1 Introduction

This chapter covers type of research, research design used, study area, population,

sample size and sampling techniques. Data sources/data collection methods, data

analysis/statistical approaches used including units of analysis, variables and their

measurements, and issues related with internal and external validity.

A good research design is essential for a successful research process. In research

process you have to plan in advance the study areas, the type of research to be

carried out, method of obtain required data, A sample from which data is to be

collected, method to use in collecting and analyzing data, and duration and fund

required to complete the study. A research design will indicate a plan of how you are

going to approach the research question to provide the required answers.

Aaker et all (2002) defined a research design as the detailed blue print used to guide

a research study towards its objectives.

4.2 Type of Research

When it comes to the collections of data it is important to choose data that is suitable

for the study. Two approaches to choose amongst when doing a study within social

science are the qualitative method and the quantitative method (Halvorsen, 1992, p.

78).

The qualitative method is relevant for studies whose objective is to enter more deeply

into a special topic by using a minor population and several variables. The focus with

a qualitative study is directed towards discovering the specific and extraordinary

within a special area in order to obtain an enhanced understanding as a result. To

facilitate such particular result, a closer relation between the researcher and its

36

information objects is often required in difference to the quantitative method

(Halvorsen, 1992, p. 82-83).

As regards to the quantitative method, this methods’ features are focusing more on

the present time and the research is carried out in a more structured and standardize

way in contrast to the qualitative method. The collected data used are more empirical

and quantified and with the help of statistics, researchers use this data to verify or

falsify hypothesises or replicate earlier studies to see if their results agree and can be

generalized (Olsson &Sörensen, 2007).

Researcher has chosen to apply the quantitative approach for her study with the

motivation that she intends to collect data from the companies’ annual reports and

use statistics to determine the statistical relationship between two or more variables.

Since researcher intends to use numerical data to answer research questions she finds

the quantitative method more suitable for this study. Researcher’s intention is not to

interpret her findings but to test and see how well her results agree with earlier

studies.

4.3 Research Design

Research design is a plan for collecting and utilizing data so that desired information

can be obtained with sufficient precision in to test a hypothesis properly or to answer

research questions.

The research is to be conducted in Dar es Salaam city, all manufacturing companies

in Dar es Salaam are referred to as Population of study. From the population a

sample will be selected using judgment sampling technique. The data will be

collected from respective company’s websites.

The analysis of data will be primarily guided by previous empirical studies, namely

Deloof (2003). Pooled ordinary least square regression analysis will be used to

examine the effect of accounts receivable days, accounts payable days, inventories

days and cash conversion cycle on profitability of manufacturing companies. Once

37

research questions have been answered the conclusion will be drawn from the

findings and comparing with the previous researchers’ findings.

4.4 Study Area

The researcher will confine herself in Dar es Salaam city. All Dar es Salaam

municipalities will be taken into consideration and these are Kinondoni, Ilala and

Temeke. Researcher has selected this city because most of the listed manufacturing

companies at stock exchange are in Dar es Salaam. However the chosen area of study

represents the other areas in Tanzania.

4.5 Population

Population is a group of individual’s persons, objects, or items from which samples

are taken for measurement. The entire manufacturing companies in Dar es Salaam

city form the population of the study.

4.6 Sample

4.6.1 Meaning of Sample

A sample is a finite part of a statistical population whose properties are studied to

gain information about the whole (Webster, 1985).

It is difficult and often impossible to study the whole population due to constraints

such as time frame, financial and material resources, etc. It is in this regards that in

this study researcher choose to use sample as her study unit and then after the results

she gets from the sample will be inferred to the whole population.

4.6.2 Sample Size

Kothari (2004 p. 56) defines sample size as the number of items to be selected from

the universe to constitute a sample. The samples have been drawn from the listed

manufacturing companies of Dar es Salaam stock exchange (DSE). The justification

of taking DSE listed companies is that companies listed in the stock markets are

likely to go through a formal regulated audit process and have an incentive to attract

38

new investors and make an impression by presenting profits if those exist in order to

make their shares more attractive. But firms not listed with the stock exchange have

less of an incentive to present true operational results and hide true profit in order to

avoid corporate tax, as according to Lazaridis and Tryfonidis (2006).

The sample size of 4 firms was obtained from 4 industries. And the duration covered

in this study is from year 2008 - 2011. In this study researcher excluded finance

companies such as banks and insurance, service companies like airlines because of

their different nature of operations.

4.7 Sampling Techniques

In line with the objective the researcher’s study, the judgment sampling technique

was be used in the selection of samples. At first the industries were selected. The

sample industries were drawn on the basis of judgmental sampling in order to ensure

diversification in the nature of business. Initially 6 industries were selected from

which 4 industries were finalized.

The selected industries are cement Industry, food processing Industry, tobacco

Industry and beverage Industry. The firms selected from each industry were also

based on judgmental sampling method. From the cement Industry 1company has

been taken, 1 company from food processing Industry, another 1 company from

tobacco Industry, and 1 company from beverage Industry. So the sample size of

firms is 4 (n = 4) of the four industries. And the duration covered in this study is

from year 2008 to year 2011. These specific firms are Tanzania Breweries Ltd, East

African Breweries Ltd, Tanzania Portland Cement Company Ltd and Simba Cement

Company Ltd.

4.7.1 Sample Procedures

The method of sampling will be non probability under judgmental or purposive

sampling that the decision to which element to be included or excluded in the sample

rests on the researcher judgment.

39

Measurements have to be taken into consideration when data is collected. The

method involved will be quantitative approach. Data type will be secondary data

collected by using written sources from the field concerned. Secondary data is the

data that have been already collected by and readily available from other sources.

Such data are cheaper and more quickly obtainable than the primary data and also

may be available when primary data cannot be obtained at all. The information

collected will be critically analyzed to indicate the effective working capital

management.

4.8 Data Sources and Data Collection Methods

The data used in this study have been collected from secondary sources, that is, the

company’s audited annual reports. Data for this study were collected from respective

company’s websites.

4.8.1 Data Analysis

Data analysis is intended to derive descriptive statistics by classifying, organizing

and summarizing the data into tables and graphs based on research conducted. In

addition data analysis will lead to the development of inferential statistics to test the

hypothesis and to allow room for decision making in the improvement of financial

statement analysis in making financial decision within the country.

The statistical tools will also be used in the inferential analysis to reach conclusions

and interpretation on the study. The research will be analyzed based on the objectives

and goals to be achieved in the study and coming up with proper decision.

The analysis of data was primarily guided by previous empirical studies, namely

Deloof (2003). The quantitative data analysis has been adopted by using pooled

Ordinary Least Square (OLS) regression analysis in order to examine the effect of

accounts receivable days, accounts payable days, inventories days and cash

conversion cycle on profitability of manufacturing companies.

40

There are two types of analysis under quantitative analysis which are correlation

analysis and regression analysis. Correlation analysis used to measure the direction

of the linear relationship between two variables as well as to measure the strength of

association between variables (Kothari 2004, p.139).

While Regression analysis determines the statistical relationship between two or

more variables (Kothari 2004, p.141).

As a researcher tends to study the effect of accounts receivable days, accounts

payable days, inventories days and cash conversion cycle on profitability of

manufacturing companies, regression analysis has been used. Due to type of data

available, quantitative data and for the purpose of identifying each variables

influence separately single regression has been chosen.

The limitation of this data analysis is that the technique is demanding because it

requires quantitative data relating to several years. And also Regression analysis is

likely to reach the conclusion that there is a strong link between two variables,

whereas the influence of other, more important, variables may not have been

estimated (this error is called data snooping).

The tool should therefore be used with care. The regression analysis considered net

operating profit as dependent variable and accounts receivable days, accounts

payable days, inventories days and cash conversion cycle as independent variables.

The dependent variable has been regressed against each Independent variable. And

the results have been expressed in the form of regression equation as follows:

γi = αi+ βiXit + εit

Where;

γi = dependent variable of firm i at time t

αi = the intercept of the equation

Xit = different independent variables of firm i at time t

βi = co-efficient of Xit variables

41

εit= the error term

t= time 1, 2….n, where n is the total number of years, n = 4

i= 1…… n, where n is the total number of firms, n = 4

Operational models:

From the general equation various regression models have been formulated as

follows:

Model 1

This model is used to find out the effect of accounts receivable days on net operating

profit

N.O.Pit = αi+ βi (ARDit) + εit

Model 2

This model is used to find out the effect of accounts payable days on net operating

profit

N.O.Pit = αi+ βi (APDit) + εit

Model 3

This model is used to find out the effect of inventories days on net operating profit

N.O.Pit = αi+ βi (IDit) + εit

Model 4

This model is used to find out the effect of cash conversion cycle on net operating

profit

N.O.Pit = αi+ βi (CCCit) + εit

Where;

N.O.Pit = net operating profit for firm i in year t

ARDit = accounts receivable days for firm i in year t

APDit = accounts payable days for firm i in year t

IDit = inventories days for firm i in year t

42

CCCit = cash conversion cycle for firm i in year t

4.9 Data Analyses Strategy and Decision Criteria

After collection, data editing and cleaning will be done to ensure data consistency,

uniformity and completeness. The researcher will employ the use of computer

software such as Ms Excel for analysis and presentation. This is due simplicity and

ability to draw graphs and tables and hypotheses testing.

Data analysis is intended to derive descriptive statistics by classifying, organizing

and summarizing the data into tables and graphs based on research conducted. In

addition data analysis will lead to the development of inferential statistics to test the

hypothesis and to allow room for decision making in the improvement of financial

statement analysis in making financial decision within the country.

The statistical tools will also be used in the inferential analysis to reach conclusions

and interpretation on the study. The research will be analyzed based on the objectives

and goals to be achieved in the study and coming up with proper decision

4.9.1 Variables and Measurement

The choice of variables was also guided by previous empirical studies and by the

availability of data. Thus, the variables are defined to be consistent with those of

Deloof (2003) and other empirical literature cited above.

Net operating profit that is a measure of profitability of firm is used as dependent

variable. It is defined as:

Net operating profit = Sales - Cost of sales

Total assets - Financial assets.

Accounts receivable are customers who have not yet made their payment for goods

or services, which company has already provided. The number of day’s accounts

receivable reflects the time between the sale and the receipt of payment. In this

43

respect, number of days accounts receivable used as proxy for the collection policy

and is an independent variable. It is calculated as

Accounts receivable days = Accounts receivable x 365

Sales

Inventories are lists of stocks of raw materials, plus work in progress or finished

goods waiting to be consumed in production or to be sold. The number of days

inventories reflects the number of days of stock held by a firm. It was used as a

proxy for the inventory policy also is an independent variable, and is calculated as

Inventories days = Inventories x 365

Cost of goods sold

Accounts payable are suppliers whose invoices for goods or services have been

processed but who have not yet been paid. The number of days accounts payable,

reflects the time it takes companies to pay their suppliers. It was used as a proxy for

the payment policy and is also an independent variable. It is calculated as

Accounts payable days = Accounts payable x 365

Cost of goods sold

The cash conversion cycle used as a comprehensive measure of working capital

management is another independent variable. It is calculated as

Cash conversion cycle = Accounts receivable days + Inventories days – Accounts

payable days

4.9.2 Validity

Bryman and Bell (2005, p. 597) refers to validity as “a measure of how well a

specific measurement of a concept, really gives an accurate picture of the concept”.

In this study researcher aims to examine the effect of accounts receivable days,

44

accounts payable days, inventories days and cash conversion cycle on profitability of

manufacturing companies. The data consist of figures collected from companies’

annual reports so there is no risk for misinterpretation of the numbers. The figures

are converted into number of days according to the cash conversion cycle equation

which is a well-known concept which strengthen the validity that the components

give an accurate picture of the concept.

4.10 Conclusion

The conclusion will be drawn by interpreted those financial ratio calculated from

financial statement of Twiga Cement over five conservative years to evaluate the

effective Corporate Performance.

45

CHAPTER FIVE

DATA ANALYSE AND DISCUSSIONS ON THE FINDINGS

5.1 Introduction

Data were obtained from a sample of four Manufacturing companies, availability of

information, and year of establishment were also considered for selecting the sample

Industries. The study covered a period of four years from 2008 to 2011. This study

was based on both primary and secondary data. The primary data were collected

through questionnaire survey with an object to know the real practices of working

capital management in Industries

The Questionnaire was divided into four parts in accordance with the major

dimension of working with the major dimension of working capital management.

Working Capital Management, Cash Management, Inventory Management,

Accounts Receivable Management and others. Secondary time series data were

taken to see the profitability and the link between profitability and working capital

management.

For the purpose of examining and providing empirical evidence on the effects of

accounts receivable days, accounts payable days, inventories days and cash

conversion cycle on profitability of the manufacturing companies, researcher has

used single pooled OLS regression analysis. Ordinal least square is the method for

estimating the unknown parameter in a linear regression model.

Findings have been categorized according to specific research questions and

objectives, and these are as follows

47

5.2 The Effect of Accounts Receivable Days on Profitability of

Manufacturing Companies

Table 5.1: Regression output: Accounts receivable days and profitability

Variable Accounts receivable days

Coefficient 0.000104771

P – value 0.960911843

R square 0.000165537

Table 5.2. Presents the regression output on the effects of accounts receivable days

on profitability of manufacturing companies. The results indicate that the coefficient

of accounts receivable days is positive (Coefficient: 0.0001) but the relationship is

not statistically significant because its p-value which is 0.96 is definitely larger than

0.05. R-square is 0.00016; means that only 0.016% variation in profitability is caused

by changes in accounts receivable days this makes the results to be insignificant.

The findings are different from the study results of Deloof (2003, p.573) and

Nobanee and AlHajjar (2009b) who found significant negative relationship between

gross operating income and the number of days accounts receivable. However the

findings are the same with Ramachandran and Janakirama (2006, p.61) as through

regression analysis it was found that there is a positive relationship between

collection period and EBIT though the above findings are not statistically significant.

5.3 The Effect of Accounts Payable Days on Profitability of Manufacturing

Companies.

Table 5.2: Regression output: Accounts payable days and profitability

Variable Accounts payable days

Coefficient 0.001087677

P – value 0.046696781

R square 0.238505872

48

Table 5.3.1 presents the results of the effect of accounts payable days on profitability

of manufacturing companies. The accounts payable days positively impacting the

profitability (Coefficient: 0.0011) though is too low.

The relationship is significant as p-value is 0.05. R-square is 0.238, indicating that all

things being equal, 23.8% of the variations in profitability is caused by changes in

accounts payable days. Even though the results are not highly significant but do

make economic sense, since the longer a firm delays its payments the higher level of

working capital levels it reserves and uses in order to increase profitability. Thus, the

more profitable firms wait longer time to pay their bills.

The results are the same as Ghosh and Maji (2003) findings who through regression

analysis they found that there is a positive relation between accounts payable period

and EBIT, which means profitable firms delay their payables. However findings

differ from Falope and Ajilore (2009, p. 73) who used a sample of 50 Nigerian

quoted non-financial firms for the period 1996 -2005 and Garcia-Teruel and

Martinez-Solano (2007, p 164) who studied the effects of working capital

management on the profitability of a sample of 8,872 small and medium-sized

enterprises (SMEs) from Spain covering the period 1996 - 2002 as they found a

significant negative relationship between net operating profitability and average

payment period.

5.4 The Effect of Inventories Days on Profitability of Manufacturing

Companies.

Table 5.3: Regression output: Inventories days and profitability

Variable Inventories days

Coefficient 0.001792273

P – value 0.000213248

R square 0.610339671

49

Table 5.4.1 presents the results of the effect of inventories days on profitability of

manufacturing companies. Inventories days affect profitability positively

(Coefficient: 0.002). The relationship between inventories days and profitability is

statistically significant at 1 per cent significance level as p - value is 0.0002. R-

square is 0.6103, indicating that all things being equal 61.03 per cent of the

variations in profitability has been caused by changes in inventories days.

This means that maintaining high inventory levels reduces the cost of possible

interruptions in the production process and the loss of business due to scarcity of

products. Maintaining high levels of inventories also helps in reducing the cost of

supplying the products and protects the firm against price fluctuations.

This is consistent with Mathuva (2009, p. 1) who examined the influence of working

capital management components on corporate profitability by using a sample of 30

firms listed on the Nairobi Stock Exchange (NSE) for the periods 1993 to 2008 and

Lazaridis and Tryfonidis (2006, p.26) who studied 131 companies listed on Athens

Stock Exchange for the period of 2001 to 2004 to investigate the impact of

profitability and managing working capital as they found a significant positive

relationship between profit margins and inventory and they suggested that managers

can increase corporate profitability by having longer inventory conversion period.

However the findings are contrary to Samiloglu and Demirgunes (2008, p. 44) who

conducted the study to examine the effect of working capital management on

company profitability of listed manufacturing companies in Istanbul Stock Exchange

for the period from 1998 to 2007 as the results from regression analysis show that

profitability has a significant negative relation with inventory period.

50

5.5 The Effect of Cash Conversion cycle on profitability of Manufacturing

Companies.

Table 5.4: Regression output: Cash conversion cycle and profitability

Variable Cash conversion cycle

Coefficient 0.000780167

P – value 0.226600907

R square 0.095835213

Table 5.5.1 shows the results of the effect of cash conversion cycle on profitability of

manufacturing companies. With the positive coefficient of 0.0008 means that the

relationship is positive but not statistically significant as p-value of 0.22 being larger

than 0.05. R-square is 0.096, means that all other things remain constant only 9.6%

variations in profitability is caused by changes in cash conversion cycle hence makes

the whole results to be insignificant.

The findings are contrary to Shin and Soenen (1998, p 37) who researched the

relationship between working capital management and value creation for

shareholders and Raheman and Nasr (2007, p. 279) who studied the effect of

different variables of working capital management including cash conversion cycle

on the net operating profitability of Pakistani firms.

Their results show a strong negative relationship between the cash conversion cycle

and its profitability as managers can create a positive value for the shareholders by

reducing the cash conversion cycle to a possible minimum level.

The research objectives has been achieved as researcher has been able to produce the

findings of the effect of accounts receivable days, accounts payable days, inventories

days and cash conversion cycle on profitability of the manufacturing companies in

Tanzania.

51

5.6 Findings and Discussion

There are four parts in this section. The first part shows the profitability position of

the manufacturing companies.

In the second part the position of working capital is analyzed. The third part focuses

on correlation between profitability and working capital management and the last

part showed the impact of working capital management on profitability

5.6.1 Profitability of the selected Manufacturing companies

Profitability of the Firm`s can be assessed by gross profit margin ratio, net profit

ratio, return on investment, operating profit ratio, return on capital employed and

return on total assets

5.6.2 Gross Profit Margin

The earnings in terms of sales can be accessed through the profit margin. The gross

profit margin reflects the effectiveness of pricing policy and of production efficiency.

Some authors consider that a profit margin ratio ranging from 20% to 30% may be

considered as the standard norm for any industrial enterprise.

5.6.3 Net Profit Margin

The ratio of net profit margin reveals the overall profitability of the concern, that’s

why it is very useful to the shareholders and the prospective investors. It also

indicates management efficiency.

5.6.4 Operating Profit Ratio

It represents the overall earnings of an enterprise and one can get a clear idea about

the efficiency of an enterprise from its operating profit ratio. The higher the ratio, the

better is the overall efficiency of the enterprise. Operating profit ratio ranging from

4% to 6% is considered the norm for the purpose of comparison and control by some

authors

52

CHAPTER SIX

CONCLUSION AND RECOMENDATION

6.1 Introduction

This study shows the effect of accounts receivable days, accounts payable days,

inventories days and cash conversion cycle on profitability of Tanzania

manufacturing firms. After analyzing the data for the period of 4 years from 2008-

2011 by using pooled ordinary least square regression analysis, conclusion has been

drawn based on specific research objectives as follows;

6.2 Conclusions

This study finds a negative relationship between cash conversion cycle and

profitability of the Firm. This study extends the earlier said studies in the sense that

this study shows a strong positive relationship of profitability with the firms’ cash

holding position along with other indicators. And it also recommends that the firms

should forecast their sales and hold cash enough as according to their projected sales

level, so that they are able to take advantage of the bargaining position while making

purchases and thus reduce cost.

It is very clear that the efficient management of working capital and liquidity has a

positive effect on the firms’ profitability. So this study clearly asserts that, firms in

the manufacturing companies in Tanzania have enough scope to enhance their

profitability by handling their working capital in more efficient ways. Especially, the

inventory turnover if handled efficiently can produce a significant positive impact on

profitability of the firm. Thus this study finds enough evidences that a firm is likely

to enjoy better profitability if the firm manages its working capital with better

efficiency and focuses on cash position with more care.

This study aimed to examine the effect of working capital management on firm`s

profitability

53

6.2.1 The Effect of Accounts Receivable Days on Profitability of

Manufacturing Companies.

The research objective was to find out the effect of accounts receivable days on

profitability of manufacturing companies. Previous researchers found negative

relationship between accounts receivable days and corporate profitability (Deloof

(2003, p.573) and Nobanee and AlHajjar (2009b)).

But Ramachandran and Janakirama (2006, p.61) found a positive relationship

between accounts receivable days and net operating profitability.

However from the findings I found a positive relationship between accounts

receivable days and profitability of manufacturing companies in Tanzania but with

no significance. This may be due to sample size being too small to warrant

meaningful interpretation as OLS regression analysis requires quantitative data

relating to several years.

The policy implication of this study is that accounts receivable days need more

consideration. Accounts receivable have opportunity cost associated with them

because company cannot invest this money elsewhere until and unless it collects its

receivables.

More accounts receivable can raise the profit by increasing the sale but it is also

possible that because of high opportunity cost of invested money in accounts

receivable and bad debts the effect of this change might turn difficult to realize. On

the other hand if a company adopts a policy to have a low level of accounts

receivable then it can reduce the profitability by reducing the sales but it can

contribute to the profit by reducing the risk of bad debts and by reducing investment

in the receivable (Andrew & Gallagher 1999, p.465).

54

6.2.2 The Effect of Accounts Payable Days on Profitability of Manufacturing

Companies.

Another specific research objective was to find out the effect of accounts payable

days on profitability of manufacturing companies. Researcher found a positive

significant relationship between accounts payable days and net operating

profitability. This means the longer the accounts payable days the higher the

profitability of manufacturing companies in Tanzania.

Researcher’s findings are consistency with Ghosh and Maji (2003) as they reported a

positive relation between payable period and Earnings before interest and tax.

However the policy implication of this is that even though the companies should try

to prolong the time of payment as long as possible as they can use the advantage of

their suppliers financing their investments until payment has been made, but on the

other hand, delaying of such payables can be expensive if a firm is offered a discount

for the early payment or is being charged for late payment so manufacturing

companies need to take into consideration about the accounts payable days.

6.2.3 The Effect of Inventories Days on Profitability of Manufacturing

Companies.

To find out the effect of inventories days on profitability of manufacturing

companies was another specific research objective. As a result researcher found that

there is significant positive relationship between inventories days and net operating

profit. Her findings are in line with Mathuva (2009, p. 1) and Lazaridis and

Tryfonidis (2006, p. 26) findings as they suggested that managers can increase

corporate profitability by having longer inventory conversion period.

The policy implication of this result is that there should be a proper inventory

management system to avoid over stock of inventory resulting efficient outcome of

investment.

55

6.2.4 The Effect of Cash Conversion Cycle on Profitability of Manufacturing

Companies.

Finding the effect of cash conversion cycle on profitability of manufacturing

companies was one of the specific research objectives. From the findings I found a

positive relationship between cash conversion cycle and net operating profitability

but with no significance. Again this may be due to sample size being too small to

warrant meaningful interpretation as OLS regression analysis requires quantitative

data relating to several years.

The policy implication here is that manufacturing companies need to pay attention on

cash conversion cycle as longer cash conversion cycle might increase profitability

because it leads to higher sales.

However, corporate profitability might also decrease with the cash conversion cycle,

if the costs of higher investment in working capital rise faster than the benefits of

holding more inventories and/or granting more trade credit to customers (Deloof

2003, p 573).

6.3 Limitations of the Study

This study is limited to the sample of Dar es Salaam manufacturing firms which are

listed on Dar es Salaam stock exchange. The findings of this study could only be

generalized to manufacturing firms similar to those that were included in this

research.

The study conducted to examine the effect of working capital management on firms’

profitability, there are lots of measures one can choose to measure the profitability of

the firm like gross operating profit, net operating profit, return on assets, return on

capital etc. However is not possible for researcher to conduct a research by

considering all the measures of the profitability. So, net operating profit was chosen

by researcher as a measure of profitability.

56

Lastly, the study was conducted over the period of four years from 2008 to 2011

which is shorter compare to other researchers of different countries. Researcher also

was unable to get some of the financial data of some companies for some years

which lead her not to produce meaningful interpretation for some of the specific

research objectives. Those objectives are to find out the effect of accounts receivable

days and cash conversion cycle on profitability of manufacturing companies

Throughout this study the researcher face some limitation in carrying out the study,

common limitation where disclosure of some of the information, interviewee to

reveal their education level, failure to return questionnaires on time and cooperation

from the subject of the study, these are discussed below

(i) Information disclosure: This is the one of the limitation researcher face when

carrying out the study, Interview where having time hard time to give

sensitive information on what they have done so far, the reasons observed

was fear of being seen as if they have done not too much to society.

(ii) Education: The researcher also getting hard time to know interview profile,

the one with high level of education were cooperative in giving their

education profile.

(iii) Corporation: Research received little corporation from some of the

interviewe,the reasons behind is that they are too busy to get time to be

interviewed or even to fill questionnaires and give detailed information

6.4 Areas for Further Research

Further empirical studies to be undertaken on the same topic with different sectors

and extending the years of the sample in order to warrant meaningful interpretation

as regression analysis requires quantitative data relating to several years. The scope

of further research may be extended to the working capital management components

including cash, marketable securities etc.

57

6.5 Recommendation

However, in view of the concluding remarks, the following suggestions are given for

increasing efficiency in working capital management as well as profitability on the

basis of the analysis as well as information gathered through questionnaire:

(i) Monthly performance evaluation should be done as maximum textiles under

the study evaluate the same.

(ii) Inventory should be turned out quickly.

(iii) Fund flow statement should be prepared periodically.

(iv) Cost audit should be done continuously.

(v) For cash management, cash budget, cash flow statement, cost minimizing

model like Baumol Model, Miller-Orr, etc. Model should be used.

(vi) Lead time should be reduced.

(vii) Account Receivable turnover in days should be reduced.

(viii) Inventory turnover in days should be reduced.

(ix) Cash Conversion Cycle is said to be the heart of working capital

management. The study reveals that the cash conversion cycle should be

reduced.

(x) Investment in Current Assets should be increased.

(xi) Current Liabilities should be reduced.

(xii) For most of the selected textiles the net working capital is negative. It should

be improved. m. Liquidity management should be more organized.

58

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61

APPENDICES

Appendix 1: Questionnaire

This questionnaire is part of the research study on the Effect of working capital

management on Firm` profitability a case of selected manufacturing companies in

Dar es Salaam in Tanzania. The research is in partial fulfillment of Finance for

Emmanuel Fredrick a student of Mzumbe University.

The information communicated in this form is strictly confidential and will not, in

any circumstances, be divulged to third parties. You are therefore kindly requested to

answer the questions herein as honestly, objectively and accurately as possible. The

results of this survey will be used solely for the purpose of the research investigation

and no direct mention or allusion to respondents or the organization they represent

will be made.

Please answer all the following questions according to the instruction given. You are

therefore kindly asked to complete this work within a week from the date of

submission.

You name will not appear anywhere in this questionnaire.

I thank you for taking time to complete this survey questionnaire.

62

Please answer the questions according to the instruction:

SECTION A: (MANAGEMENT AND EMPLOYEES).

Fill the blanks or Tick the appropriate answer

1. Gender

Male………………. Female…………..

2. What your Position in these companies?

(i) Director

(ii) Manager

(iii) Supervisor

(iv) Others specify……………….

3. What is your experience (years) concerning your position?........................

4. Do you have ability and competencies to lead these companies?

(i) Yes

(ii) No

5. If the answer above is yes mention at least four reasons you able and

competent to lead

(i) ………………………………………….

(ii) …………………………………………

(iii) ………………………………………..

6. Referring to the question above, of being able and competent to lead, how do

you perform your leadership role in these companies?

7. Does working capital management affect the profitability of manufacturing

companies?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

63

If yes how working capital management affect on firm's profitability Tanzania

………………………

8. Does an Account receivable day on profitability affect manufacturing

companies?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

9. Does an Account payable day on profitability affect manufacturing

companies?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

10. Does Inventories days on profitability affect manufacturing companies?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

11. Does Cash conversion cycle on profitability affect manufacturing companies?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

12. Are there any challenges/problems on profitability manufacturing companies?

Yes [ ]

No [ ]

I don’t know [ ]

64

13. Is it true that working capital management on firm's profitability affect

manafacturing Companies in Tanzania?

(i) Yes [ ]

(ii) No [ ]

(iii) I don’t know [ ]

14. Below are factors which are affect working capital management on Firms'

profitability manucturing companies, choose only four factor only

(i) Accounts receivable days [ ]

(ii) Accounts payable days [ ]

(iii) Inventories days [ ]

(iv) Cash conversion cycles on profitability [ ]

(v) Economic factor [ ]

15. Please state five reasons why you think there is a the effect of working capital

management on firm profitability

(i) …………………………………………………………………………

(ii) …………………………………………………………………………

(iii) …………………………………………………………………………

(iv) …………………………………………………………………………

(v) …………………………………………………………………………

THE RESEARCHER THANKS YOU AND APPRECIATES YOUR

COOPERATION.

65

Appendix 2: Financial data of manufacturing companies from 2008 to 2011

COMPANY

NAME CODE YEAR

DEPENDENT

VARIABLE

INDEPENDENT

VARIABLES

Tanzania

Breweries

Ltd

Net Operating

Profit

Accounts

receivable

days

Accounts payable

days

Inventories

days

Cash

conversion

cycle

1 2008 0.62361648 24.55535497 128.577632 86.63997039 -17.38230662

1 2009 0.521048317 25.53057977 99.70129226 98.30953839 24.13882591

1 2010 0.497274897 20.08631679 114.0602447 110.9373867 16.96345882

1 2011 0.539787817 11.56692504 115.5131498 113.7201702 9.773945417

East African

Breweries

Ltd

2 2008 0.522498058 46.20309069 198.1157638 143.3196293 -8.593043816

2 2009 0.483599796 44.13848493 193.0837885 148.4509475 -0.494356028

2 2010 0.499496583 52.78316398 185.3712685 64.73612274 -67.85198181

2 2011 0.444707481 57.44770062 217.1240676 70.33259659 -89.3437704

Tanzania

Portland

Cement

Company

Ltd

3 2008 0.407082911 6.331637697 111.7686557 103.9231692 -1.513848777

3 2009 0.480642457 9.420909891 108.4814782 124.5340944 25.4735261

3 2010 0.468882132 9.696048409 72.62557157 150.5165746 87.58705145

Simba

Cement

Company

Ltd

4 2008 0.590762422 13.83866042 76.43666692 112.0298375 49.43183095

4 2009 0.482755703 11.59462426 60.7696256 98.22622292 49.05122159

4 2010 0.418504879 17.42300022 50.00286327 102.9833084 70.40344537

4 2011 0.333367985 19.05567363 61.30167297 108.4240467 66.17804732

66

Appendix 3: Regression summary output

• Accounts receivable days as independent variable

Regression Statistics

Multiple R 0.012866137

R Square 0.000165537

Adjusted R Square -0.066490093

Standard Error 0.136513573

Observations 17

ANOVA

Df SS MS F Significance F

Regression 1 4.62819E-05 4.62819E-05 0.002483473 0.960911843

Residual 15 0.279539335 0.018635956

Total 16 0.279585617

Coefficients Standard

Error

t Stat P-value Lower 95% Upper 95%

Intercept 0.52531367 0.061140936 3.53694E-07 0.394994849 0.65563249

Accounts

receivable

days

0.000104771 0.002102371 0.049834458 0.960911843 0.004376328 0.004585869

• Accounts payable days as independent variable

Regression Statistics

Multiple R 0.48837063

R Square 0.238505872

Adjusted R Square 0.187739597

Standard Error 0.119136562

Observations 17

67

ANOVA

Df SS MS F Significance F

Regression 1 0.066682811 0.066682811 4.6981164 0.046696781

Residual 15 0.212902806 0.01419352

Total 16 0.279585617

Coefficients Standard

Error

t Stat P-value Lower 95% Upper 95%

Intercept 0.387478134 0.070925975 5.46313437 6.543E-05 0.236302996 0.538653271

Accounts

payable

days

0.001087677 0.000501808 2.167513884 0.0466968 1.80974E-05 0.002157256

• Inventories days as independent variable

Regression Statistics

Multiple R 0.78124239

R Square 0.610339671

Adjusted R Square 0.584362316

Standard Error 0.08522262

Observations 17

ANOVA

Df SS MS F Significance F

Regression 1 0.170642194 0.170642194 23.49506581 0.000213248

Residual 15 0.108943424 0.007262895

Total 16 0.279585617

Coefficients Standard

Error

t Stat P-value Lower 95% Upper 95%

Intercept 0.298999271 0.051544264 5.800825272 3.49549E-05 0.189135273 0.408863269

Inventories

days

0.001792273 0.000369756 4.847170908 0.000213248 0.001004156 0.00258039

68

• Cash conversion cycle as independent variable

Regression Statistics

Multiple R 0.309572629

R Square 0.095835213

Adjusted R Square 0.03555756

Standard Error 0.129818199

Observations 17

ANOVA

Df SS MS F Significance F

Regression 1 0.026794147 0.026794147 1.589896234 0.226600907

Residual 15 0.25279147 0.016852765

Total 16 0.279585617

Coefficients Standard

Error

t Stat P-value Lower 95% Upper 95%

Intercept 0.5098764 0.034570192 14.74901858 2.46285E-10 0.436191781 0.583561019

Cash

conversion

cycle

0.000780167 0.000618733 1.260910875 0.226600907 -0.000538631 0.002098965