Relationship between Working Capital Management and Profitability

Business is crucial for a country's capital formation and plays a vital role in a growing economy. So, effective management is essential. Fund managers face the challenge of procuring and deploying funds for maximum returns. The purpose of this study is to find out the effect of working capital management on company profitability. In light of this objective, the study adopted quantitative approaches to test the research hypotheses. A sample of three (3) manufacturing companies listed on the Dar es Salaam Stock Exchange (DSE) was used for a period of ten years (2002-2012) with a total of 30 observations. Annual financial statements (statement of comprehensive income and statement of financial position) for the period of ten years from 2002 to 2012 were used to collect data for this study. The data was analyzed on a quantitative basis using Pearson’s correlation and Regression analysis (Ordinary Least Square). The main findings from the study are; Firstly, there exists a positive relationship between the cash conversion cycle and profitability of the firm. This means if the cash conversion cycle increases it will lead to an increase in the profitability of the firm, and managers can create a positive value for the shareholders by increasing the cash conversion cycle to a reasonable level. Secondly, there is a negative relationship between liquidity and profitability showing that as liquidity decreases, the profitability also increases. Thirdly, there exists a highly significant negative relationship between average collection period and profitability indicating that a decrease in the number of days a firm receives payment from sales affects the profitability of the firm positively. Fourthly, there is a highly significant positive relationship between the average payment period and profitability. This implies that the longer a firm takes to pay its creditors, the more profitable it is. Fifthly, there exists a highly significant negative relationship between inventory turnover in days and profitability hinting that firms which maintain sufficiently low inventory levels reduce the cost of storing the inventory which results in higher profitability. The management of working capital is one of the most important financial decisions of a firm. A sufficient level of working capital should be present for the smooth running of a company regardless of the nature of the business. Future research should investigate the generalization of the findings beyond the companies listed on the Dar es Salaam Stock Exchange.