Working Capital Management and Profitability: A Case Study of Automobile Industry in India

(ProQuest: ... denotes formulae omitted.)IntroductionWorking capital is the amount of fund invested in the current assets of an enterprise, while working capital management refers to management of current assets and current liabilities (Raheman & Nasr, 2007). It can be divided into two categories, namely permanent working capital (required to meet long term minimum requirement) and temporary working capital (varies with seasonal requirement) (Van Home & Wachowicz, 2008).Working capital management directly affects the profitability and is considered one of the most important parts of financial decision making and thereby affects the risk factor of the firms, and hence resulting increase in the value of firms (Smith, 1980). Mismanagement of working capital leads a firm to liquidity crisis by reducing its profitability and creditability, so managing working capital effectively is necessary for going concern of the business and also for its profitability.The present study aims to examine the association between profitability (Return on Capital - ROC) and working capital management attributes, such as Current Ratio (CR), Liquidity Ratio (LR), Debtors' Turnover Ratio (DTR) and Inventory Turnover Ratio (ITR), of selected automobile companies in India. It consisted of two main variables, i.e. working capital management as independent variable and profitability as dependent variable. To measure the relationship between working capital management and the profitability among selected Indian automobile companies, a linear regression model has been developed.It is hypothesized for the study that there is no significant relationship between working capital management attributes (such as CR, LR, DTR and ITR) and the profitability (ROC) among selected automobile companies in India.This study is organized as follows: the next section following introduction discusses the review of relevant literature. Third section throws light on methodology. The details of the results and analysis of the available data are described in fourth section and the final section presents the main findings, suggestions and conclusion.Literature ReviewThe US firms piled-up their inventories and Japanese firms had higher percentage of receivables to total assets (Suk, et ah, 1992). US firms had negative relationship between net trade cycle length as well as cash conversion cycle with profitability i.e. return on investment (Soenen, 1993) (Jose, et al., 1996) (Shin «fe Soenen, 1998) (Shah «fe Sana, 2006); while listed firms at Athens observed direct relationship between cash conversion cycle and profitability (Lazaridis «fe Tryfonidis, 2006). Even Saudi listed companies observed significant negative relation between cash gap and profitability (Eljelly, 2004). Even Belgium non-financial firms had negative relationship between day's receivables and inventory with gross operating profit (Deloof, 2003); it means that a high investment in inventories and receivables was associated with lower profitability (Padachi, 2006).Indian paper industry also experienced that cash conversion cycle and inventory days had negative correlation with earnings before interest and tax. While accounts payable days and accounts receivable days related positively with earnings before interest and tax (Ramachandran «fe Janakiraman, 2009). Elence, there is significant relationship exist between profitability and working capital management (Narware, 2004). Profitability can also be affected by ineffective and disorder of management of receivables (Khandelwal, 1985).From the above review of empirical works, it is clear that different authors have approached working capital management and performance in different ways in varying levels of analysis. These different approaches helped in the emergence of more and more literature on the subject over a period of time. It gives an idea on extensive and diverse works on role of working capital management on performance. …