Working capital management is one of the most important issues and believed to have a profound impact on firm’s profitability performance. In financial management the term “working capital” refers to the money needed for the firms to continue their day to day operational activities such as cash requires for the purchase of raw material, payment of salaries, payment of rent or any other day to day expenditures ( Ahmed et al., 2016). The concept of working capital management refers that Organizations managed their short term working capital. The aim of working capital management is to promote a satisfactory level of liquidity, profitability and create shareholder’s value. Working capital management is concerned to capabilities to control the current assets and current liabilities effectively and efficiently ( Ali, 2011). Furthermore, working capital management enhances the ability of the firms to maximize return on asset and minimize payments for a liability. The short term capital consists of current asset and current liability that companies use for their regular operation. A well manage working capital promotes a company’s well presence on the market and the term of liquidity and it also acts in the favor for the growth of shareholder value ( Samiloglu & Demirgunes, 2008). The term net working capital is actually the measurement of working capital in term of efficiency and hence represents the excess of current assets over current liabilities. Similarly, the working capital management refers to the proper planning and controlling of current assets and current liabilities in a way through which the firms can eliminate their risk of inability to meet short term obligation on hand and avoid from the extreme investment in these assets on the other hand ( Iqbal et al., 2014). Working capital management is concerned with those aspects of financial management of firms which not relates only getting the finance form the sources and uses of those finances by the firms but also the financial implication of investment, production, marketing and personnel decisions and the overall performance of the firms ( Eljelly, 2004). The main aim of working capital management is decision making that is concerned with managing the liabilities and assets to a balance desire. The masses involved in discussing firms short capitals need to be aware from sufficient capitals to carry on firms operation, and also in position to pay its short term liabilities. The span of time which converts raw materials to final goods and then goes to cash called cash conversions cycle (CCC). This is used as a scale for managements for flow of cash for companies. Therefore managers used conversions cycle to identify right level of receivables, payables, inventories and cash ( Qazi et al., 2011). Raheman & Nasr (2007) investigated the impact of working capital management on profitability of the nonfinancial sector for 94 Pakistani nonfinancial firms and found negative correlation of average payment period, average collection period, cash conversion cycle and average inventory turnover with firm profitably.

Several studies have carried out on the working capital management and its impact on firms profitability such as ( Alipour, 2011; Raheman et al., 2010; Deloof, 2003; Iqbal et al., 2016; Tran et al., 2016; Qazi et al., 2011) by examined the firms profitability using different indicators of working capital management in different countries by using multiple firms data of different sectors, however this study explore the effects of working capital management on firms profitability performance of manufactures firms by employing recently developed methods such as difference and system GMM. Furthermore, we also used static models for comparison purpose to compare the results with previous studies, however by using these methods, we have to admit that results are potentially inconsistent and biased due to endogeneity problem between independent and explanatory variables. In additions, the results of static models and difference GMM is not produce significant results, thus System estimator provide efficient results and can be strongly rely upon on the validity. According to our knowledge and searching no study have been carried out in manufacture sector of Pakistan recently which have used dynamic model. Therefore this is the first attempt to investigate relationship between working capital management and its effect on firm profitability performance in manufacturing sectors of Pakistan. The present study contributes to the existing literature by examining the effect of working capital management on profitability in the context of an emerging capital market such as Pakistan. In the next sections, the previous literature related to our paper is presented. The methodology and descriptive statistic are presented in section 3. Section 4 presents the results and findings. Section 5 concludes and policy implications etc.

The well management and use of current assets and current liabilities plays important role and stimulate the firm’s profitability performances. Working capital management is concerned to capabilities to control the current asset and current liability effectively and efficiently, as well as enhances the ability of the firms to maximize return on asset and minimize payments for liability. Padachi (2006) argue that a well manage working capital promotes a company’s well presence on the market and the term of liquidity and it also acts in the favor for the growth of shareholder value.

There is a growing literature on the association between working capital management and firm’s profitability over the last two decades, across the countries although the previous findings are inconclusive, varied, and ambiguous. Number of studies reported a negative relation between working capital management and firm’s profitability as well as some other indicators with firm’s profitability ( Aktas et al., 2015; Aregbeyen, 2013; Ebben & Johnson, 2011; Shin & Soenen, 1998; Haq et al., 2011; Ali & Ali, 2012). The relationship between working capital management and corporate profitability for Belgium non-financial firms examined by Deloof (2003) and found negative and insignificant relationship for cash conversion cycle while, mixed results for others variable’s. He further stated that managers can increase firm profitability by decreasing the number of day’s accounts receivable and inventories. Furthermore, Eljelly (2004) study the relation between profitability and liquidity for stock companies of Saudi Arabia. The empirical results show that firms’ profitability is found to be negative relationship with firm’s current ratios and cash ratios. He further stated that at the industry level, cash conversion cycle is of more significance as an amount of liquidity than current ratio that affects profitability. Simlarly, for Pakistani firms, Raheman & Nasr (2007) find out the working capital management impact on liquidity and profitability of the firm. They found a strong negative relationship between variables of the working capital management and profitability of the firm as well as liquidity. Similar study were carried out by Samiloglu & Demirgunes (2008) for Turkey manufacturing firms listed at Istanbul stock exchange and found that accounts receivables period, leverage, and inventory period affect firm profitability negatively. Similarly, using a sample of 1628 firms of Malaysian registered at Bursa capital market and by using OLS regression, Zariyawati et al. (2009) found that decrease in cash conversion cycle increases firms profitability. Using a large sample of America firms, Shin & Soenen (1998) find negative effects of CCC on firm profitability. They further highlighted that efficient working capital management (WCM) play significant role in creating value for the shareholders. For Iran, Alipour (2011) finds that there is a negative significant relation between number of day’s accounts receivable and Inventory on profitability and positive relationship number of day on accounts receivable. Likewise, using data from of 7 firms of oil and gas industry of Pakistani and, by employed fixed effect estimator, Shah & Sana (2005) find a negative relationship between gross profit margin and number of day’s accounts receivable and number of day’s inventory, sales growth and cash conversion cycle. Likewise, Afza & Nazir (2008) also find negative relationship between firm’s profitability’s and working capital management policies. Similar analyses were carried out by Ali (2011) for 160 textile firms of Pakistan and found that average day’s receivable and average day’s payable is negatively effects firm profitability. For six truism sectors firms, the effect of working capital management on profitability were examined by Korkmaz & Yaman (2019) and found that that accounts receivables, inventory turnover period, and cash conversion cycle have statistically negatively effects on firms profitability while accounts payables has indirect effects on tourism firms profitability. Moreover, using sample of 21 cement firms listed at Pakistan stock exchange, Arshad & Gondal (2013) carried out a study to examine the effects of working capital management on firm’s profitability of Cement sectors. The results suggested that working capital management negatively and significantly effects firms’ profitability. Likewise, for 40 small scale businesses, Afeef (2011) find that three working capital management indicators (WCM) has a visible and profound impact on firm’s profitability of aforementioned firms while PDP and CCC are statistically found insignificant. Using a big sample of Finland firms Enqvist et al. (2014) found that CCC is negatively effects firms’ profitability. He further stated that this effect is higher in economic downturns. Similar results were found by García-Teruel & Martínez-Solano (2007) for Spanish firms. Likewise, employing a sample of 17 firms, Cristea & Cristea (2016) partially confirmed the negative relation between cash conversion cycles and profitability of firms in CESEE region. They also confirmed negative relationship between the apparatuses of ROA and CCC. Similar results were found by Iqbal et al. (2014) for CCC indicator for Pakistani firms. Boţoc (2013) also confirmed the negative relationship between working capital management and profitability for Romanian listed firms. Similarly, one another study carried out on Romania firms by Danuletiu (2010) and found weak negative correlations. Korkmaz & Karaca (2014) investigated the association between profitability’s indicators and financial variables as well as the elucidation firm’s performance level by employing 78 manufacturing firms data listed on Istanbul Stock Exchange (ISE). They used panel models and came with findings that three indicators (TB/TA, DV/TA, and MDV/UVYK) are statistically significant negative relationship to explain the firm profitability performance level except model 1, while variable Net Sales /Current Assets (NS/DV) significantly positively affects Net Profit/Shareholder’s Equity (NK/OS) and Net Profit/Total Assets (NK/TA).

There are some studies documented in literature which indicates a positive, mix, or insignificant relationship on firm’s profitability by taken varied samples and sectors into consideration in different countries. For instance, Kung’u (2015) examines the effect of working capital management on profitability of manufacturing firms in Kenya. The result shows that there was positive relationship between all explanatory variable (credit policy, account payable practices, liquidity management practices, and working capital levels) and firm profitability. Similarly, for Pakistan Cements and foods sectors, Iqbal et al. (2016) find that current ratio and average collection period have positive relationship with firms profitably whereas, insignificant negative relationship of inventory turnover and average collection period on firms profitability. Likewise, another study carried out on Pakistani firms by Iqbal et al. (2014), and came up with results that account payable and inventory is a positive relationship. Similarly, Shah & Sana (2005) also find a positive relation between number of day’s accounts payables and profitability. Gill et al. (2010) examined the relationship between working capital management and firm’s profitability for 87 American firms and found significant positive relationship between the cash conversion cycle and profitability. Furthermore, using a panel static model and taken sample of 274 non-financial Pakistani firms, Nazir & Afsha (2009) examined the effects of aggressive working capital management and financing policies using Tobin Q and ROA. The empirical results suggest that conservative approach is better for manager to create value for shareholders, as well as investors prefer to invest in aggressive approaches firms. Recently, Biswas (2017) find the evidence of association of working capital management with firm profitability. Similar results were found by Jana (2018) for India. Using a sample of 263 non-financial firms registered at the Bombay stock exchange and by employing OLS regression Sharma & Kumar (2011) find that number of day’s accounts receivables and CCC significantly and positively affect firm’s profitability while inventory of number of days and number of days account payable are negatively effects firm’s profitability. Conversely, employing a sample from polish firms registered on Warsaw capital market Bolek (2013) find no evidence of association between profitability components and capital indicators. Furthermore, Agha (2014) finds the evidence of working capital management on firm profitability for cement firms. Yunos et al. (2015) investigate the effect of government linked corporation of working capital management effects on financial performance in Malaysia and found mix results of different indicators on firm’s profitability.

Several studies have proven the inverted U-shape relationship between firm’s profitability and working capital management across the globe for different sectors firms. For instance, using a panel data of sample of 937 high growth gazelles firms (HGF) from 13 Europe countries and utilizations different static and dynamic panel models, Boțoc & Anton (2017) investigated the association of firm’s profitability with working capital management. Their empirical results indicate an inverted U-shape relationship between firm profitability and working capital. They further suggest that HGF firms should uphold optimal working capital level for the purpose to increase firm profitability. Similar results were found by Afrifa & Padachi (2016) and Mun & Jang (2015). Moreover, taking a sample from nonfinancial firms of England, Baños-Caballero et al. (2014) also confirmed the concave association between trading cycle and its performance measure through Tobin Q. Furthermore, for Spanish, Baños-Caballero et al. (2012) confirm the concave relationship and stated that firms’ profitability declines as they travel away from their optimal level.

The aforesaid papers concentrated on different countries by using different approaches, as well as sample from many sectors or industries. There were only few studies carried out on Pakistan by using static models as well as sample from different sectors. We extend the previous papers closely related to our work by examining the causality relationship between firm profitability and working capital management within a multivariate framework (dynamic and static methods) for manufacturing firms of Pakistan.

Table 3 provides the association among the variables of interest in the study. Correlation analysis is used for data to see the association between variables such as working capital management indicators with profitability of the firms. Analyses

of correlation start from the results between the return on asset and receivable collection period. The result of receivable collection period (RCP) and current ratio (CR) show a weak negative association with return on asset while the inventory conversion period (ICP) and cash conversion cycle (CCC) is weak positive associate with return on asset. Furthermore, the payable deferral period (PDP), liquidity, and operating profit (OP) are strongly positive correlate with return on asset. The CCC correlation with ROA suggests that keeping inventories longer improves profitability as well as the PDP results also suggest that that cements firms shorten payments time to their creditors in order to make higher profits.

Table 4 presents the results of working capital management effects on firms’ profitability of manufacturing firms in Pakistan. Haussmann test statistic result indicates that fixed is appropriate model against the random effects. The ROE_it−a represent lag of dependent variable and this is correlated with error term, when we apply the static models such as pooled OLS estimators with random effect and fixed effect may create the problem of endogeneity and results may unbiased and unreliable. Therefore, to solve this problem we are only presenting GMM estimators results and the all other models results only used for comparison purpose. The estimated values of ROA_it−1 are statistically significant at 1 and 5 percent level of significant, which indicates that GMM methods is efficient and the empirical results are highly reliable to carry out statistical analysis. Moreover, the Sergan statistic estimated value is associated with a p-value higher than 10 percent in GMM and system GMM model which these outcomes confirm the validity of the two-step GMM and system GMM approach for undertaking the empirical analysis. Moreover, serial correlation test results reject the first order serial correlation (AR1) and accept the alternative hypothesis which indicates the absence of the second order serial correlation (AR2). The PDP has the estimated coefficient value of OLS is 0.011, the RE, FE, GMM and System GMM are 0.011, 0.010, 0.008 and 0.009 respectively which depicted that the PDP is positive relation with return on asset and highly significant which implies that if payable deferral period increase it would have positive effect on firm profitably and this results are align with the precious study Iqbal et al. (2014), Sharma & Kumar (2011), Rahman & Nasr (2007). While Korkmaz & Yaman (2019), Ali (2011), and Shah & Sana (2005), found positive relationship between PDP and ROA. Similarly, the estimated coefficient of ICP of pooled OLS, RE and FE are positive but statistically insignificant while the GMM and system GMM also positive but statistically significant which indicates that increase in ICP increases firms profitably (measured by ROA). Similar results were found by Iqbal et al. (2014), while Alipour (2011), Korkmaz & Yaman (2019), Samiloglu & Demirgunes (2008), and Sharma & Kumar (2011) found negative effects of ICP on firm’s profitability. Conversely, the variable CCC results of OLS, RE, FE and GMM are statistically non-significant, while the coefficient of system GMM results indicate statistically significant and negative relationship with firms profitability which implies

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. OLS, RE, FE, GMM and SGMM represent the pooled ordinary least square, random and fixed effect, generalized and system generalized method of moments respectively.

that as the cash conversion cycle rises it will goes to reducing profitability of the firms, and managers can create a positive value for the stakeholders by decreasing the cash conversion cycle to a possible minimum level. This result suggests that suggests that cement firms could add value by improving their cash cycles. Our results are aligned with previous studies of Cristea & Cristea (2016), Ali (2011), Enqvist et al. (2014) and Iqbal et al. (2014). On the other hand, the coefficient value of Operating profit (OP) increase perceived level of firms profitability in all models, therefore, even though this results is strong, is coherent with the common view about firms performance in literatures in which firms with strong working capital management (WMC) tend to perform well in terms of operating profit performance. The estimated coefficient of control variable “Liquidity” is seem to positively affect profitability of firms in model OLS, FE, and RE while the GMM results seem to negatively effects firms profitability which indicate that 1 percent increases in liquidity decreases firms profitability of firms. In additions, furthermore, the debt to equity ratio (DER) estimated coefficient sign are positive in all models but statistically insignificant. The variable CR results of pooled RE, FE and system GMM indicates a statistically non-significant relations with firms profitability while GMM results is positively and significantly effects return on assets at 10 percent level of significant which indicate that increase in liquidity increases firms profitability of the manufactures sectors of Pakistan and same results were found by Raheman & Nasr (2007), Eljelly (2004), Deloof (2003) and Khan et al. (2005). The pooled OLS and FE result also shows that R-square weighted is 75 percent which depicted that there is 75 percent variation in the dependent variable explained by the independent variable while in fixed effects model depicts only 55 percent variation.

Table 5 presents the results of working capital management effects on firms’ profitability of manufacturing firms in Pakistan. The regression analysis of fixed effects consists of five specifications: one each for the single explanatory variable of WCM, along with the control variables of current ratio (CR), operating profit (OP), liquidity, and debt to equity ratio (Der). Use return on asset as a dependent variable in Table 5 report that there are few differences with respect to explanatory and control variables. The CCC is significantly and positively effects firms’ profitability while the ICP is negatively significantly effects profitability of firms. The PDP and liquidity variables results are similar to the results given in Table 4 which confirm the results reliability and robustness while the debt to equity ratio (Der) significantly and positively effects firms’ profitability from specification (1) to (4).

Table 6 report the results of explanatory variables effects on firm’s profitability using return on assets (ROA) by employing GMM model from specifications (1) to (5). The results indicate that there are few differences with respect to explanatory and control variables.

The CCC and ICP are significantly and positively effects firms’ profitability (measured by ROA) while the ICP is negatively insignificantly effects profitability of firms. The estimated coefficient sign of “liquidity” variable in specification (1) to (4) are different in term of sign but specification 5 results are similar in term of sign to the results given in Table 4 of GMM model.

The PDP, DER and Operating profit (OP) variables result are similar to the result given in Table 4 which confirm the results reliability; while the ICP and current ratio (Cr) results are contrary to the results given in Table 4.

Table 7 presents the results of explanatory variables effects on firm’s profitability by using system GMM model from specifications (1) to (5) for each single

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. FE is fixed effect.

Note: (*) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. GMM represent the generalized method of moments.

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. OLS, RE, FE, GMM and SGMM represent system generalized method of moments respectively.

explanatory variable. The results indicate that there are few differences with respect to explanatory and control variables.

The results of payable deferral period (PDP) in specification (3) and operating profit (OP) in specifications (1) to (5) are similar to the results given in Table 5 while the results of ICP and RCP are different in term of signs and magnitude. Furthermore, the results of CCC are significantly and positively effects while the CCC results given in Table 5 are reverse. The debt to equity ratio (Der) results in specification (1) and (2) are similar but statistically significant while the other three specifications from (3) to (5) results are statistically insignificant which confirm the results validity. Moreover, the results of “Liquidity” variables are completely different in term of sign and magnitude.

Working capital management and firms’ profitability using ROE

This result is only presenting for robust check by taking return on equity is a dependent variable along with explanatory and control variables but this results is only for comparison purpose as these results are not part of conclusion or abstract.

Table 8 presents the results of working capital management effects on firms’ profitability of manufacturing firms in Pakistan. Using ROE as a dependent variable from model OLS to SGMM in Table 7 report that there are complete differences with respect explanatory and control variables to the results given in Table 4 of all model. The results revealed that only current ratio (CR) significantly positively affect firm’s profitability while the other all variables results such as ICP, RCP, PDP, CCC and Liquidity are statistically insignificant except the operating profit (OP) results in model OLS, RE and FE in term of sign.

Table 9 presents the results of working capital management effects on firms’ profitability of manufacturing firms in Pakistan. The regression analysis of fixed effects consists of five specifications: one each for the explanatory variables of WCM, along with the control variables of current ratio (CR), operating profit (OP), liquidity, and debt to equity ratio (Der). Using alternative specifications, model 1 to 5 of Table 9 report that there are certain differences with respect to controls variables in all specification.

The, PDP, CCC and Operating profit (OP) significantly and positively effects return on equity while RCP and ICP negatively effects which confirmed the results robustness given in Table 5. The specification (1), (2), (3), (4) and (5) results are similar to the results given in Table 5 which confirm the results reliability. Moreover, the estimated coefficient of current ratio (CR) is positively and significantly effects firm’s profitability from specification (1) to (5) and these results are contrary to the results given in 4. The result of Liquidity and debt to equity ratio (Der) is contrary with the results of Table 5, except the specification (4) results.

Using alternative specifications (1) to (5) in Table 10 reports that there are complete differences with respect to explanatory and control variables.

All the explanatory as well as control variables results are significantly and

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. OLS, RE, FE, GMM and SGMM represent the pooled ordinary least square, random and fixed effect, generalized and system generalized method of moments respectively

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. FE is fixed effect.

Note: (*) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. GMM represent the generalized method of moments.

statistically different in term of sign and magnitude from the results given in Table 6, except the specification (1) and (3) result of current ratio as well as all specification result of operating profit (OP) which indicates positive relationship with firm’s profitability.

Table 11 reports the results of explanatory variables effects on firm’s profitability (measured through ROE) by employing system GMM model from specifications (1) to (5). All the model results are completely different from the results given in Table 7 which indicate weak validity. Moreover, the results of “current ratio (CR)” is positively affect firms profitability from specification (1) to (5), which indicate that increase in current ratio increase firms profitability using return on equity.

The concept of working capital management refers that companies managed their short term working capital. The main objective is to promote a satisfactory level of profitability and create shareholder’s value. Working capital management is concerned to capabilities to control the current asset and current liability effectively and efficiently. Profit maximization is the main goal of every firm but at the same time the firms also want to maintain its liquidity because without liquidity the firms are unable to pay the short term dues or obligation or liability and without sufficient liquidity the firms cannot deliver goods or services to customers as they are unable to purchase the raw material, pay wages and salaries, rent etc. which effect their profitability very badly. If the firms want to increase the profitability without increasing their liquidity it creates many problems for the firms, firstly the firms do not maintain their existence for long time period as the firms’ need cash/money for their operations, secondly the firms may face the situations of bankruptcy as the firms not having sufficient cash for short term due to obligations. Based on the aforementioned reasons, the objective of the paper is to examine the effect of working capital management on firms’ profitability performance of Pakistan cement industry firms. The results of pooled OLS show that R-square weighted is 75 percent, which depicted that

Note: (***) sig at 1% level, (**) sig at 5% and (*) sig at 10% level, Standard error are in parenthesis. OLS, RE, FE, GMM and SGMM represent system generalized method of moments respectively.

there is 75 percent variation in the dependent variable explained by the independent variable while in fixed effects model only 55 percent variation. The results of system GMM indicate that PDP has positive effect on firms’ profitability (measured by ROA) which indicates if Payable Deferral period increases, it will cause to increase profitability of firms operating in Cement industry of Pakistan. The CCC estimated coefficient negatively and significantly affects firms’ profitability. This result implies that increase in cash conversion cycle reduces profitability of the firm, which suggests that managers can create a positive value for the stakeholders by decreasing the cash conversion cycle to a possible minimum level. Likewise, the estimated coefficient of ICP also is positive and statistically significant which revealed that increase in inventory conversion period rises firm’s profitability level while RCP estimated coefficient is positive but non-significant and shows no effect on firm’s profitability. It is clear from the above discussion that working capital indicators have an effect on firm’s profitability. Therefore this study suggests that managers should be properly managing the components of working capital management in order to get higher profitability. This study also suggested that if firms want to increase the profitability of the firms, there is a need to reduce the payable deferred period, and also reduce the cash conversion cycle. This study is limited to the sample of manufacturing sectors of Pakistan such as cement industries. Therefore, we suggest that in future study the researcher should include the other sectors of Pakistan and sample size should be increased, as well as must use the dynamic model.

The dataset on which the conclusions of the manuscript rely is a secondary data and it will be made available upon request.

We are thankful to the anonymous reviewers and journal editor for their useful comments and suggestions.

The authors declare no conflicts of interest regarding the publication of this paper.

Kafeel, Ali, J., Ud Din, M., Waris, A., Tahir, M., & Khan, S. (2020). Working Capital Management and Firms’ Profitability: Dynamic Panel Data Analysis of Manufactured Firms. Journal of Financial Risk Management, 9, 494-517. https://doi.org/10.4236/jfrm.2020.94027