Assessing the Effect of Working Capital Management on the Profitability of Small Business in Chiro Town, West Hararghe Zone, Ormia Region, Ethiopia

Tale Geddafa

doi:10.7176/rjfa/11-15-03

Abstract

An optimal working capital management is expected to contribute certainly to the profitability of firms. The main purpose of the study was to assess the effect of working capital management on profitability of small business in Chiro town, West Hararghe, Ethiopia. To collect primary data semi-structured questionnaire survey and key informant interview were employed. By using non-probabilistic purposive sampling technique, cross-sectional data were collected from 15 sampled small businesses. The effect of the inventory conversion period, accounts receivable period, accounts payable period and cash conversion cycle on return on asset was analyzed through descriptive statistics, Pearson’s Correlation and linear regression by using SPSS version 20. The result shows that there is positive relationship between accounts receivable period and accounts payable period with profitability of small business. However, inventory conversion period and cash conversion cycle have a negative significant impact on profitability. Keywords: Working capital Management, Small business, Profitability and Ethiopia. DOI: 10.7176/RJFA/11-15-03 Publication date: August 31 st 2020

Highlights

1.1 Theoretical background Management of working capital which aims at maintaining an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables is a fundamental part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses (Raheman and Nasr, 2007)
The higher the return on assets indicates that the firms is effective enough in generating profit from its available assets and the reverse is true for decrease in return on assets
The impact of account receivable period on the dependent variable (ROA) was very high which B coefficient of 0.001 (Table 7). This shows that when other variables in the regression model being constant, if number of days accounts receivable increased by one day, return on asset (ROA) of the firm on the average is increase by 0.1 percent

Summary

Introduction

1.1 Theoretical background Management of working capital which aims at maintaining an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables is a fundamental part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses (Raheman and Nasr, 2007). The maintenance of cash at a desirable level for the purpose of settling liabilities on maturity and using the investment opportunities that are indicative of the flexibility of the economic entity, the availability of material needed for production in order to enable the entity to provide the needs of its customers is indicative of the importance of working capital (Padachi, 2006). Managers have shortened the cash cycle through shortening the period of receivables collections and inventory turnover and lengthening the period of settling liabilities, in order to increase company profitability (Nobanee and Alhajjar, 2009). Any decision made by the managers of the entity in this context can significantly affect return of the entity stock which shall transform company value and increase shareholders wealth (Nobanee and Alhajjar, 2009)

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