Influence of Working Capital Management and Liquidity on Financial Soundness of Firms Listed At Karachi Stock Exchange

Abstract

This particular study tries to assess the nature of relationship of Working Capital Management (WCM) and liquidity with firm's performance. Most important issue for the firms is to decide the best suitable level of working capital which can satisfy both motives f liquidity and profitability. Financial performance is measured by return on capital employed while determinants of working capital and liquidity includes inventory turnover, accounts receivable turnover, current and quick ratio. A sample of 19 cement companies listed on Karachi Stock Exchange for a period of 2005 to 2010 has been taken out off 29 firms on the basis of availability of data. Finally outcomes of bivariate analysis suggested that efficient management of working capital and liquidity leads to financial success. Keywords - Accounts Receivable Turnover, Current Ratio, Inventory Turnover, Karachi stock exchange (KSE). I. INTRODUCTION Financing needs of the corporations are of two types. One is short term and other is long term. Many researchers have done remarkable work on long-term financing decisions of the firm. However from the perspective of short term financing needs financial managers are attempting to define the rational level of working capital, which ultimately enhance the shareholders equity. Working capital includes currents assets and currents liabilities of firm. Currents assets include the most liquid assets such as cash, account receivable, and inventory of the firm. Whereas account payable and short term debts are the elements of current liabilities. Another important factor to measure the firm's profitability is the cash conversion cycle (CCC). Basic aim of cash conversion cycle is to determine the extent of time that is required by the company to transform its resources into operating cash flows. It starts from the payment to supplier for purchase of raw material and ends up with the receipt of revenue from the customer through sales. In more precise manner cash to cash cycle looks at the time required to sell goods to customers, time required to collect receivable from the debtors and time span to mature its obligations regarding payables without affecting its credit ratings. Cash conversion cycle represents no. of days in which inventory is outstanding, days sales outstanding and the days in which payables are outstanding. Account payable is another element of cash conversion cycle. Account payable turnover days refer to the time period after which payment is due from the supplier. Delaying payment to its creditors enhance the firm ability to get better quality of raw material and elastic source of financing. However, too much delay in payment to the creditors will adversely affect the profitability and lowers the credit ratings for the firm in the business environment. The customary view regarding the association between the working capital and cash conversion cycle with the profitability is that shorter the cash conversion cycle better the profitability position of the firm and vice versa. Working capital management is a famous topic in scholars of corporate finance. Every business entity wants to enhance its profitability and liquidity with the passage of time. Every business organization has to deal with short term assets and liabilities in a best possible manner to maintain a good liquidity position. Horne and Wachowicz (2000) proposed that firms with best management of current assets and liabilities can achieve higher rate of return on their investment and strong liquidity position. Eljelly (2004) narrates the idea that when a firm is able to manage its short term resources and obligations efficiently, it will eliminate the inability of meeting short term obligations. Top level management has to deal with most of conceptual skills and decisions. Manager in many organizations spend significant time in taking assessment for making best combinations of current assets and current liabilities in order to maintain their strong liquidity and profitability position. Liquidity doesn't mean to pay back its debts at the time of liquidation but it means to maintain a good repute in the eyes of creditors in terms of short term day to day payments. So with this indication, it becomes an integral part of management decision making to select the best combination of current assets and current liabilities as clarified by joshi (1994).