Working Capital Management and Profitability : An Empirical Analysis of Infrastructure Companies

IntroductionWorking capital management plays a vital role in any business organisation. It speaks a lot about the decision making efficiency of the management regarding short-term financing need of the business; and hence not paying attention to this aspect can lead to devastating outcome which can impact the business to a great extent. Typically, working capital is the difference between current assets and current liability; a positive outcome means positive working capital while a negative outcome means negative working capital. Historically, there is a conflict between positive working capital policy and negative working capital policy. Whether management should implement a positive policy or a negative one policy becomes a subjective matter, because both positive and negative working capital have their own pros and cons. Traditional view of working capital deals with positive working capital policy. It says that an ample amount of working capital reserve should be maintained in order to mitigate risks associated with the business, such as repayment of debt, payment for raw material and salaries, day to day need of business etc. It also helps in mitigating risks associated with sudden unfavorable change in political, economic, social and environmental condition. Applying traditional aspect of working capital will ensure healthy business scenario on the one hand; but on other hand, there will be a high cost of working capital and also will have an opportunity cost component associated with it. Huge working capital reserve means that a firm is not using its working capital efficiently and funds are lying ideal without yielding any return.Modern view of working capital deals with negative working capital policy; it says that a firm's current liability finances the current asset, which implies working capital is being generated through the business operations such as collection of cash from sundry debtors, cash collection from sale etc. in order to finance the working capital need of business. This view ensures low cost of working capital; it also shows efficient and effective decision making skill of business managers as well as high operational efficiency of business. Having said this, modern view of working capital can be deadly to business, if there is a sudden unfavorable change in political, economic, social and environmental condition or failure of business strategy.Working capital management of construction industry is different from other industry due to its uniqueness such as legal and tax policy, financial closure, supply chain and logistics and their relationship with construction project phase, credit policy and its relationship with creditors and debtors, political-social-technological-economic condition and their relation with project, stake holder and their relationship with projects. As stated by Wieslaw Meszek et al. in their research paper Certain aspects of working capital in a construction company, cash conversion cycle has a positive correlation with working capital, which means that increase in working capital will lead to increase in cash conversion cycle and vice versa. For construction companies having a negative conversion cycle, their liability cycle is longer than receivable cycle, which means the companies should have an effective and efficient credit policy to nullify the effect of negative conversion cycle.Literature ReviewWhile conducting an analysis of working capital management in select construction companies, Kandpal (2015) found that increase in working capital ratios of the company decreases the profitability of construction firms and significantly effecting ROI. He also concluded that the liquidity of the company has an impact on profitability. When there is an increase in liquidity, the profitability of the company decreases and vice versa. Ramana et al. (2015) performed a comparative study of Hindustan Construction Company (HCC) and Simplex Infrastructure Limited (SIL) examining working capital management practice, the analysis shows that HCC needs to focus more on inventory and cash management where as SIL should focus more on receivable management. …