Relationship between working capital management

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Relationship between working capital management and profitability of Indian textile companies

Dr. Sangeeta Mittal1, Lavina2 & Minaxi Mittal3 1

Assistant Professor, HSB GJUS&T, Hisar [email protected] 2

Research Scholar, HSB GJUS&T, Hisar [email protected]

3

Research Scholar, HSB GJUS&T, Hisar [email protected]

Abstract Investing and financing current assets in such a way that maintains balance between liquidity and profitability and at the same time maximizes the profitability of a business and this particular issue can be best dealt with working capital management. The present study examine the relationship between working capital management and profitability of top 25 BSE listed Indian textile companies using panel data of 5 years (2012 to 2016). Panel data regression model and correlation analysis have been used in the study. Profitability analysis makes the Premco Global at leading position in terms of gross profit margin, net profit margin , return on capital employed and return on net worth while Bombay Rayon Fashions leads the rest of the textile companies in terms of operating profit margin. Profitability position of JJ Exporters is not healthy. Among various working capital management ratios i.e. current ratio, quick ratio, debtor turnover ratio and inventory turnover ratio only inventory turnover ratio has impact on gross profit margin positively and significantly determine the profitability of selected Indian textile companies. Keywords: Profitability, working capital, gross profit, net profit, liquidity.

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Introduction Efficient running of a business is determined through successful and efficient management of its working capital. It is highly concerned with managing the short term liquidity and establishing a balance amongst profitability, liquidity and returns to shareholders. The basic aim of working capital management is to be sure that the company always keeps sufficient cash to meet its short term obligations. Working capital can be both positive and negative. Positive working capital reveals that the company is able to satisfy its current obligations while the latter indicates that company has not enough current assets to pay its current liabilities. According to C.W. Gestenbergh “Working capital has ordinarily been defined as the excess of current assets over current liabilities”. There are two concepts of working capital i.e. gross working capital concept and net working capital concept. Gross working capital is the total of all current assets in a business while the latter is the excess of current assets over current liabilities. For manufacturing business, management of working capital is of utmost importance as the major part of capital is employed in current assets. How well, the manufacturing business manages working capital is significantly based upon the efficiency of operating cycle. Operating cycle of a business begins when cash is converted into raw material to commence manufacturing, during the same process raw material is turned into work-in-progress, then work-in-progress is converted into finished goods, finished goods are changed into debtors through credit sales and finally debtors are converted into cash. Financial manager can measure the efficiency of working capital management various ratios such as working capital ratio, quick ratio, inventory turnover ratio, debtor turnover ratio, current asset to sale ratio and cash turnover ratio. This paper deals with the relationship between working capital management and profitability of 25 selected Indian textile companies by using ratios namely current ratio, quick ratio, debtor turnover ratio, inventory turnover ratio. The profitability position of textile companies has been shown by different ratios i.e. gross profit ratio, net profit ratio, operating profit ratio, returns on capital employed, return on net worth. The impact of working capital ratios on profitability (gross profit margin) of selected textile companies has also been shown so that the textile companies can improve their profitability position by increasing the working capital management efficiency.

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Objectives of the study 1. To analyze the profitability position of selected textile companies. 2. To show the impact of working capital management on profitability of selected textile companies. Review of literature Leghari (2015) analyzed the impact of working capital on profitability in sugar industry. The study was taken for a period of 10 years. The sample consisted of 28 companies listed in Karachi Stock Exchange. The author used ratio analysis, correlation and pooled panel data regression analysis. The results shown that day’s inventory, cash conversion cycle, cash ratio, account receivable to sale ratio, short term investment ratio, secured short term obligation and fixed asset ratio are negatively affecting the profitability of the firm. Further quick ratio, days account receivable and working capital shown positive relationship with profitability. Senthikumar and Sengottaiyan (2015) analyzed the efficiency of working capital management in selected textile companies. The main objective of the study was to analyze the growth and pattern of skill of utilization of working capital management. The sample consists of 20 companies analyzed for a period of 15 years. The authors used the performance, utilization and efficiency indexes to examine the efficiency in utilizing working capital. The results found that the textile industry was not managing its working capital efficiently and had poor liquidity position. Agha (2014) examined the impact of working capital management on profitability of Pharmaceutical Company in Pakistan. The study included a period ranging from 1996-2011. Descriptive statistics, correlation analysis and regression model have been used by in the study. The result shown that debtor turnover ratio, inventory turnover ratio and creditors turnover ratio have a significant relationship with profitability. Sudana and Raju (2013) analyzed the liquidity and profitability position of textile industry in India. The sample of the study consisted of three textile companies namely Cotton textile industry, Man Made textile industry and All India Industry. The study used data of 10 years. Ratio analysis and descriptive analysis were used in the study. The study found that liquidity position of the cotton textile companies and man made textile companies was not good. Further All India industry was good in terms of profitability. 3|Page

Jagongo and Makori (2013) analyzed the effect of working capital management on profitability in Kenya. The sample of the study consisted of 5 manufacturing and construction companies each, studied for a period of 10 years. Ratio analysis, Pearson’s correlation and ordinary least square model were used. The study found that there was a negative relationship between average collection period, cash conversion cycle and return on assets. Further there was a positive relationship between return on inventory holding period, accounts payment period and return on asset. Akoto et al. (2013) evaluated the relationship between working capital and profitability of manufacturing companies in Ghana. The sample consisted of 13 listed manufacturing companies studied for a period of 5 years. The study used panel data methodology. The study found a significant negative relationship between profitability and accounts receivable days. Further cash conversion cycle, current asset ratio, size, and current asset turnover had shown a significant positive impact on profitability. Rastogi and saxena (2013) analyzed the relationship between working capital management and profitability in National Fertilizers Ltd. The main objective of the study was to find out the impact of working capital ratios on profitability of the selected company. Correlation and regression tools were used in the study. The result shown that working capital ratio, acid test ratio, and current assets to total assets ratio, inventory turnover ratio, debtor turnover ratio and cash turnover ratio had negative impact on profitability. Further account receivable had a positive impact on profitability. The results have also shown that liquidity position of the selected company was good. Arshad and gondal (2013) conducted an empirical study to analyze the relationship between working capital management and profitability in cement sector of Pakistan. The sample of the study consisted of 21 listed companies studied for a period of 7 years. Multiple regression analysis and ratio analysis were used. The results found that there is a significant and negative relationship between working capital management and profitability in selected cement companies. Bagchi et al. (2012) analyzed the impact of working capital management on profitability of selected Indian FMCG companies. The sample of the study consisted

of 10 FMCG

companies studied for a period of 10 years. Pearson’s correlation analysis and panel data regression analysis were used in the study. The results found that there was a negative

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relationship between working capital management variables and profitability of the selected companies. Rahman (2011) analyzed the profitability and working capital position of the textile industry in Bangladesh. The study included 9 textile companies for a period of three years i.e. from 2005 to 2008. Ratio analysis, descriptive statistics, correlation analysis and regression analysis were used. The results shown that the working capital position of the selected companies was not satisfactory. Saghir (2011) analyzed the relationship between working capital management and profitability. The sample of the study included 60 textile companies studied for a period of 6 years i.e. from 2001-2006. Correlation, ANOVA, and regression tools were used. The results had shown that there was a negative relationship between profitability and cash conversion cycle. Research methodology Sample and data: The sample of the study consists of 25 BSE listed Indian textile companies. The sample has been selected on the basis of market capitalization. These companies are analyzed for a period of 5 years i.e. from 2012 to 2016. The data is of secondary nature. The data has been collected from moneycontrol.com and CMIE PROWESS. Profitability analysis of selected textile companies Profitability analysis of selected textile companies from 2012 to 2016 has been shown in table 1. 1. Gross profit margin (%): Gross profit margin is a ratio used to measure a company’s financial health. This ratio compares the gross margin of the company to its sales. It is the proportion of gross margin and net sales. Gross Profit Margin = Gross Margin/Net Sales Figure 1 shows the average gross profit margin of selected textile companies from 2012 to 2016. Premco Global shows the highest average gross profit margin i.e. 17.494 while JJ Exporters shows the lowest and negative average gross profit margin i.e. -44.19.

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-10

-20

-30

-40

0

-10

-20

-30

-40 Bombay rayon… Sutlej Textile and… Garwell Wall Ropes Bannari Amman… Premco Global SEL manufacturing… Richa Industries Alps Industries RLF Himatsingka Seide JJ Exporters Thomas Scott India Sangam India RSWM Indo Rama… Banswara Syntex APM industries Winsome Textile… Damodar Industries Suryalata Spinning… Reliance Chemotex… Swasti Vinayaka… Fairdeal Filaments Rajvir Induatries

0

Bombay rayon… Sutlej Textile and… Garwell Wall Ropes Bannari Amman… Premco Global SEL manufacturing… Richa Industries Alps Industries RLF Himatsingka Seide JJ Exporters Thomas Scott India Sangam India RSWM Indo Rama… Banswara Syntex APM industries Winsome Textile… Damodar Industries Suryalata Spinning… Reliance… Swasti Vinayaka… Fairdeal Filaments Rajvir Induatries

Figure 1: Average Gross profit margin

30

20

10

Gross profit margin

-50

Source: Moneycontrol.com

2. Net profit margin (%): It is also known as net margin. It is one of the widely used

measures of profitability. Net profit margin is the proportion of net profit after taxes and net

sales.

Net Profit Margin = Net profit after taxes/net sales. Figure 2 shows the average net profit

margin of selected textile companies from 2012 to 2016. Premco Global shows the highest

average net profit margin i.e. 11.53 while JJ Exporters shows the lowest and negative average

net profit margin -51.93.

Figure 2: Average net profit margin

20

10

net profit margin

-50

-60

Source: Moneycontrol.com

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Table 1: Average profitability analysis of selected textile companies from 2012 to 2016

Name of the Company Bombay rayon Fashions Sutlej Textile and Industries Garwell Wall Ropes Bannari Amman Spinning Mill Premco Global SEL manufacturing Company Richa Industries Alps Industries RLF Himatsingka Seide JJ Exporters Thomas Scott India Sangam India RSWM Indo Rama Synthetics Banswara Syntex APM industries Winsome Textile Industries Damodar Industries Suryalata Spinning Mills Reliance Chemotex Industries Swasti Vinayaka Synthetics Fairdeal Filaments Rajvir Induatries Source: Moneycontrol.com

Average gross profit margin (%) 13.568 7.994 8.136 8.18 17.494 3.152 12.336 9.078 12.418 11.558 -44.19 -22.062 8.238 6.954 -1.946 8.592 10.254 11.558 6.028 2.712 5.506 7.738 3.854 3.122

Average Average Average Average net operating return on return profit profit capital on net margin margin employed worth (%) (%) (%) (%) -0.338 20.468 6.662 -0.64 5.214 12.014 17.95 20.798 5.03 10.29 17.092 11.876 2.022 13.606 9.198 5.81 11.53 20.158 32.632 22.49 -5.254 11.628 4.962 -14.868 2.988 14.754 13.812 9.848 -14.732 -2.694 -6.826 22.094 -18.048 -37.904 3.792 -3.252 8.784 16.73 11.032 11.716 -51.93 -28.05 -12.514 -342.338 -21.33 -21.168 -30.396 -31.06 3.222 13.378 14.94 13.52 2.308 11.414 14.314 15.738 0.72 2.664 9.17 5.046 1.54 13.202 13.376 8.408 6.6 11.652 26.636 19.578 2.026 14.75 13.62 8.226 1.856 7.96 20.082 15.96 2.672 5.208 14.37 13.106 2.014 7.888 15.648 8.892 4.404 10.75 14.846 8.964 0.708 5.098 12.486 9.588 -5.262 9.302 6.978 -37.288

3. Operating profit margin (%): It is used to measure the operating efficiency of the business. It indicates the proportion of operating income and net sales. Operating profit margin = Operating Income/net sales Figure 3 shows the average operating profit margin of selected textile companies from 2012 to 2016. Bombay Rayon Fashions shows the highest average operating profit margin i.e. 20.468 while RLF shows the lowest and negative average operating profit margin i.e. 37.904.

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Figure 3: Average operating profit margin 30 20

0 -10

-20 -30 -40

Bombay rayon… Sutlej Textile and… Garwell Wall Ropes Bannari Amman… Premco Global SEL manufacturing… Richa Industries Alps Industries RLF Himatsingka Seide JJ Exporters Thomas Scott India Sangam India RSWM Indo Rama Synthetics Banswara Syntex APM industries Winsome Textile… Damodar Industries Suryalata Spinning… Reliance Chemotex… Swasti Vinayaka… Fairdeal Filaments Rajvir Induatries

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operating profit margin

-50

Source: Moneycontrol.com 4. Return on capital employed (%): It indicates the effective utilization of capital, employed by the business. It shows how efficiently the business is using its capital to achieve profitability. Return on capital employed = Earning before Interest and Tax/Capital employed. Figure 4 shows the average return on capital employed of selected textile companies from 2012 to 2016. Premco Global shows the highest average return on capital employed i.e. 32.632 while Thomas Scott India shows the lowest and negative average return on capital employed i.e. 30.396.

Figure 4: Average return on capital employed 40 30 20

-10 -20 -30 -40

JJ Exporters Thomas Scott … Sangam India RSWM Indo Rama… Banswara Syntex APM industries Winsome… Damodar… Suryalata… Reliance… Swasti Vinayaka… Fairdeal… Rajvir Induatries

0

Bombay rayon… Sutlej Textile… Garwell Wall… Bannari Amman… Premco Global SEL… Richa Industries Alps Industries RLF

10 return on capital employed

Source: Moneycontrol.com

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5. Return on net worth (%): It is also known as return on equity. This ratio indicates that how much return is received by the shareholders for their investment in the business. Return on net worth = Net Income/Equity. Figure 5 shows the average return on net worth of selected textile companies from 2012 to 2016. Premco Global shows the highest average return on net worth i.e. 22.49 while JJ Exporters shows the lowest and negative average return on net worth -342.338.

Figure 5: Average return on net worth 0 -50 -100 -150 -200 -250

Bombay rayon… Sutlej Textile and… Garwell Wall Ropes Bannari Amman… Premco Global SEL manufacturing… Richa Industries Alps Industries RLF Himatsingka Seide JJ Exporters Thomas Scott India Sangam India RSWM Indo Rama Synthetics Banswara Syntex APM industries Winsome Textile… Damodar Industries Suryalata Spinning… Reliance Chemotex… Swasti Vinayaka… Fairdeal Filaments Rajvir Induatries

50

return on net worth

-300 -350 -400

Source: Moneycontrol.com Working capital management ratios 1. Working capital ratio: This ratio is also known as current ratio. It is the proportion of current asset and current liabilities. This ratio indicates that the company is able to pay its short term liability or not. Working Capital Ratio = Current Assets/Current Liabilities 2. Quick ratio: This ratio is an indicator of short term solvency of the business. It is also known as acid-test ratio. It is calculated by dividing quick assets to current liability. This ratio mainly ignore illiquid asset i.e. stock. Quick Ratio: (Current Assets – Stock)/current Liability 3. Debtor turnover ratio: This ratio is an efficiency testing ratio. Debtor turnover ratio can be calculated by dividing the net credit sale to average account receivable. 9|Page

Debtor turnover ratio = Net credit sales/Average Account Receivable 4. Inventory turnover ratio: Inventory turnover is a key measure of efficiency of a business. It shows that how much inventory is sold over a period of time. Inventory Turnover Ratio= Net Sales/Average Inventory Research hypothesis H01: Current ratio is not a significant determinant of profitability of selected textile companies. H02: Quick ratio is not a significant determinant of profitability of selected textile companies. H03: Debtor turnover ratio is not a significant determinant of profitability of selected textile companies. H04: Inventory turnover ratio is not a significant determinant of profitability of selected textile companies. Panel data regression model: The study employed panel data of 25 Indian textile companies for 5 years i.e. from 2012-2016. Fixed effect model and random effect model of panel data have been applied by the researcher. After performing these two techniques of panel data the researcher used Hausman’s test in order to select the best regression model. H0: Random effect model is suitable. H1: Fixed effect model is suitable. Table 2: Correlated Random Effects- Hausman Test Test summary

Chi sq- statistic

Cross section random effect

20.487193

Chi sq d.f. 4

Prob. 0.0004

Source: Data Analysis The above table shows that the p-value of the test is 0.0004 which is less than .05 significance level. It is concluded that the fixed effect model is suitable for the analysis.

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Model specification In order to analyze the impact of working capital ratios on profitability, the researcher developed following regression equation. In the equation Y is the dependent variable and X1, X2, X3, and X4 are independent variables. Y= β0+ β1X1+ β2X2+β3X3+β4X4……………………….. Where Y= Gross Profit Margin X1 = Current ratio X2 = Quick ratio X3 = Debtor turnover ratio X4 = Inventory turnover ratio β0 is constant term of the regression equation, β’s are the coefficients of the model. Correlation analysis Table 3 shows the presence of correlation among selected independent variables. The multicollinearity is examined by the inter correlation matrix. If there is a presence of multicollinearity then the results of regression will be misleading. The problem of multicollinearity exists if correlation value of independent variables is more than 0.80. The following table shows that there is absence of multi-co linearity in our sample data. Table: 3 Inter correlation matrix for textile industry Quick ratio

Quick ratio

1

Current Ratio

.565472463

Debtor

turnover 0.369064058

Current

Debtor turnover Inventory turnover

Ratio

ratio

ratio

1 0.201397645

1

0.108361261

0.309105691

ratio Inventory

0.279962666

1

turnover ratio Source: Data Analysis 11 | P a g e

Analysis of regression results The results of Hausman’s test conclude that fixed effect model is appropriate. The result of fixed effect model in table 4 shows that the value of R- Square is 0.3882 which shows that 38 % variation in dependent variable is caused by the selected independent variables. Table: 4 fixed effect regression model Number of observations – 125

R-Square - 0.3882 Adjusted R square – 0.2098

Regression

F-Statistic - 2.176259

Coefficients

Prob value- 0.002809

Variables

Prob. Value

C

-531.1097

o.ooo8

Current Ratio

196.1799

0.1490

Quick Ratio

-113.5343

0.2110

Debtor Turnover Ratio

29.24962

0.1029

Inventory Turnover Ratio

31.24663

0.0197

Source: Data Analysis Current ratio: As per the result shown by table 4 the beta coefficient of current ratio is 196.1799 which is not significant and the probability value is 0.1490 which is more than .05 significance level. So the null hypothesis is accepted in this case. The conclusion is that the current ratio is not the significant determinant of profitability of the selected textile companies. Quick ratio: The beta coefficient associated with quick ratio is -113.5343 which shows insignificant relationship with profitability. The probability value is 0.2110 which is more than 0.05 significance level. The null hypothesis is also accepted. This concludes that profitability is not affected by quick ratio. Debtor turnover ratio: The beta coefficient of the debtor turnover ratio is 29.24962. The relationship of debtor turnover ratio with profitability is insignificant. The probability value is 0.1029 which is more than 0.05. So, the null hypothesis is accepted. It concludes that profitability in selected textile companies is not significantly affected by debtor turnover ratio. 12 | P a g e

Inventory turnover ratio: The beta coefficient of the inventory turnover ratio is 31.24663 is positive and is significantly affecting the profitability in textile companies. The probability value is 0.0197 which is less than .05 level and significant. It concludes that inventory turnover ratio is a significant determinant of profitability of Indian textile companies. Conclusion The present study examined the profitability position of selected textile companies and also the impact of various working capital management ratios on profitability. The results of profitability analysis show that Premco Global is the leader (most trusted brand) in terms of return on capital employed, net profit margin, gross profit margin and return on net worth. Further Bombay rayon fashions is at top most position in terms of operating profit margin. The profitability position of JJ exporters is not good as shown by the ratios namely return on net worth, net profit margin and gross profit margin. Further the study has also examined the impact of selected working capital management ratios on the profitability of selected textile companies. The results conclude that except inventory turnover ratio all other variables are insignificant. The inventory turnover ratio is a positive and significant determinant of profitability of Indian textile companies. So the textile industry should focus on improving their inventory turnover ratio in order to increase the profitability. References Agha, H. (2014). Impact of working capital management on profitability. European Scientific Journal, 10(1), 374-381. Akoto, R. K., Awunyo-Vitor, D., & Angmor, P. L. (2013). Working capital management and profitability: evidence from Ghanaian listed manufacturing firms. Journal of economics and International Finance, 5(9), 373- 379. Arshad, Z., & Gondal, M. Y. (2013). Impact of working capital management on profitability A case of the Pakistan cement industry. Interdisciplinary journal of contemporary research in business, 5(2), 384-390. Bagchi, B., Chakrabarti, J., & Roy, P.B., (2012). Influence of working capital management on profitability: a Study on Indian FMCG companies. International Journal of Business and Management, 7(22), 1-10.

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Bhat, S. (2008). Financial Management, New Delhi: Excel Books.

Jagongo, A. O., & Makori, D. M. (2013). Working capital management and firm profitability: empirical evidence from manufacturing and construction firms listed on Nairobi securities exchange, Kenya. International Journal of Accounting and Taxation, 1(1), 1-14.

Leghari, M. E. J. (2015). Working capital management and profitability in sugar industry of Pakistan. Interdisciplinary Journal of Research in Business, 3(10), 30-36.

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Rahman, M. M. (2011). Working capital management and profitability: a study on textiles industry. ASA University Review, 5(1), 115-132. Rastogi, S., & Saxena, P. (2013). Working capital management and profitability in state owned companies: a case analysis of National Fertilizers Ltd. International Journal of Science and Research IJSR, 4(5), 490-493.

Saghir, A. (2011). Working capital management and profitability: evidence from Pakistan firms. Interdisciplinary Journal of Contemporary Research in Business, 3(8), 1092-1105. Senthikumar, K., & Sengottaiyan, A. (2015). Efficiency of working capital management with reference to select textile industry in India. International journal of emerging research in management & technology, 4(7), 68-71. Sudana, M. T., & Raju, P. B. (2013). Analysis of liquidity and profitability in textile industry in India. International Journal of research in commerce, IT & Management, 3(12), 35-42.

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