working capital management term paper

Working capital management: a literature review and research agenda

Purpose – The purpose of this paper is to review research on working capital management (WCM) and to identify gaps in the current body of knowledge, which justify future research directions. WCM has attracted serious research attention in the recent past, especially after the financial crisis of 2008. Design/methodology/approach – Using systematic literature review (SLR) method, the present study reviews 126 articles from referred journal and international conferences published on WCM. Findings – Detailed content analysis reveals that most of the research work is empirical and focuses mainly on two aspects, impact of working capital on profitability of firm and working capital practices. Major research work has concluded that WCM is essential for corporate profitability. The major issues with prior literature are lack of survey-based approach and lack of systematic theory development study, which opens all new areas for future research. The future research directions proposed in this paper may help develop a greater understanding of determinants and practices of WCM. Practical implications – Till date, literature on classification of WCM has been almost non-existent. This paper reviews a large number of articles on WCM and provides a classification scheme in to various categories. Subsequently, various emerging trends in the field of WCM are identified to help researchers specifying gaps in the literature and direct research efforts. Originality/value – This paper contains a comprehensive listing of publications on the WCM and their classification according to various attributes. The paper will be useful to researchers, finance professionals and others concerned with WCM to understand the importance of WCM. To the best of the authors’ knowledge, no detailed SLR on this topic has previously been published in academic journals.

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• Working Capital Mgmt.
• Understanding It

Types of Working Capital

• Why Manage Capital?

Working Capital Cycle

• Limitations

The Bottom Line

• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Working Capital Management Explained: How It Works

What Is Working Capital Management?

Working capital management is a business strategy designed to manage a company's working capital. A company's working capital refers to the capital it has left over after accounting for its current liabilities. Working capital management ensures that a company operates efficiently by monitoring and using its current assets and liabilities to their most effective use. The efficiency of working capital management can be quantified using ratio analysis .

Key Takeaways

• Working capital management requires monitoring a company's assets and liabilities to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations.
• Managing working capital primarily revolves around managing accounts receivable, accounts payable, inventory, and cash.
• Working capital management involves tracking various ratios, including the working capital ratio, the collection ratio, and the inventory ratio.
• Working capital management can improve a company's cash flow management and earnings quality by using its resources efficiently.
• Working capital management strategies may not materialize due to market fluctuations or may sacrifice long-term successes for short-term benefits.

Investopedia / Sydney Saporito

Understanding Working Capital Management

Working capital is a key metric used to measure a company's short-term financial health and well-being. It is the difference between a company's current assets and current liabilities. As such, it is the capital that is left after accounting for its current liabilities. Working capital management is a strategy that companies use to manage their leftover cash.

Current assets include anything that can be easily converted into cash within 12 months. These are the company's highly liquid assets. Some current assets include cash, accounts receivable (AR), inventory, and short-term investments. Current liabilities are any obligations due within the following 12 months. These include accruals for operating expenses and current portions of long-term debt payments.

The primary purpose of working capital management is to enable the company to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations. A company's working capital is made up of its current assets minus its current liabilities.

Working capital management monitors cash flow, current assets, and current liabilities using ratio analysis, such as working capital ratio , collection ratio, and inventory turnover ratio .

Working Capital Management Components

Certain balance sheet accounts are more important when considering working capital management. Though working capital often entails comparing all current assets to current liabilities, there are a few accounts that are more critical to track.

The core of working capital management is tracking cash and cash needs. This involves managing the company's cash flow by forecasting needs, monitoring cash balances, and optimizing cash flows (inflows and outflows) to ensure that the company has enough cash to meet its obligations.

Because cash is always considered a current asset, all accounts should be considered. However, companies should be mindful of restricted or time-bound deposits .

Receivables

To manage capital, companies must be mindful of their receivables. This is especially important in the short term as they wait for credit sales to be completed. This involves:

• Managing the company's credit policies
• Monitoring customer payments
• Improving collection practices

At the end of the day, having completed a sale does not matter if the company is unable to collect payment on the sale.

Account Payables

Account payables refers to one aspect of working capital management that companies can take advantage of that they often have greater control over. While other aspects of working capital management may be uncontrollable, such as selling goods or collecting receivables, companies often have a say in how they pay suppliers, what the credit terms are, and when cash outlays are made.

Companies primarily consider inventory during working capital management as it may be the most risky aspect of managing capital. When inventory is sold, a company must go to the market and rely on consumer preferences to convert inventory to cash.

If this cannot be completed quickly, the company may be forced to have its short-term resources stuck in an illiquid position. Alternatively, the company may be able to quickly sell the inventory but only with a steep price discount.

In its simplest form, working capital is the difference between current assets and current liabilities. However, different types of working capital may be important to a company to best understand its short-term needs.

• Permanent Working Capital: Permanent working capital is the amount of resources the company will always need to operate its business without interruption. This is the minimum amount of short-term resources vital to a company's operations.
• Regular Working Capital: Regular working capital is a component of permanent working capital. It is the part of the permanent working capital that is required for day-to-day operations and makes up the most important part of permanent working capital.
• Reserve Working Capital: Reserve working capital is the other component of permanent working capital. Companies may require an additional amount of working capital on hand for emergencies, seasonality , or unpredictable events.
• Fluctuating Working Capital: Companies may be interested in only knowing what their variable working capital is. For example, companies may opt to pay for inventory as it is a variable cost . However, the company may have a monthly liability relating to insurance it does not have the option to decline. Fluctuating working capital only considers the variable liabilities the company has complete control over.
• Gross Working Capital: Gross working capital is simply the total amount of current assets of a business before considering any short-term liabilities.
• Net Working Capital: Net working capital is the difference between current assets and current liabilities.

Why Manage Working Capital?

Working capital management can improve a company's cash flow management and earnings quality through the efficient use of its resources. Management of working capital includes inventory management as well as management of accounts receivable and accounts payable . 

Working capital management also involves the timing of accounts payable like paying suppliers. A company can conserve cash by choosing to stretch the payment of suppliers and to make the most of available credit or may spend cash by purchasing using cash—these choices also affect working capital management.

In addition to ensuring that the company has enough cash to cover its expenses and debt, the objectives of working capital management are to minimize the cost of money spent on working capital and maximize the return on asset investments.

Working Capital Management Ratios

Three ratios that are important in working capital management are the working capital ratio, the collection ratio, and the inventory turnover ratio.

Working Capital Ratio

The working capital ratio or current ratio is calculated by dividing current assets by current liabilities. This ratio is a key indicator of a company's financial health as it demonstrates its ability to meet its short-term financial obligations.

A working capital ratio below 1.0 often means a company may have trouble meeting its short-term obligations. That's because the company has more short-term debt than short-term assets. To pay all of its bills as they come due, the company may need to sell long-term assets or secure external financing.

Working capital ratios of 1.2 to 2.0 are considered desirable as this means the company has more current assets compared to current liabilities. However, a ratio higher than 2.0 may suggest that the company is not effectively using its assets to increase revenues. For example, a high ratio may indicate that the company has too much cash on hand and could be more efficiently utilizing that capital to invest in growth opportunities.

Collection Ratio (Days Sales Outstanding)

The collection ratio, also known as days sales outstanding (DSO) , is a measure of how efficiently a company manages its accounts receivable. The collection ratio is calculated by multiplying the number of days in the period by the average amount of outstanding accounts receivable.

This product is then divided by the total amount of net credit sales during the accounting period. To find the average amount of average receivables, companies most often simply take the average between the beginning and ending balances.

The collection ratio calculation provides the average number of days it takes a company to receive payment after a sales transaction on credit. Note that the DSO ratio does not consider cash sales. If a company's billing department is effective at collecting accounts receivable , the company will have quicker access to cash which is can deploy for growth. Meanwhile, if the company has a long outstanding period, this effectively means the company is awarding creditors with interest-free, short-term loans.

Inventory Turnover Ratio

Another important metric of working capital management is the inventory turnover ratio. To operate with maximum efficiency, a company must keep sufficient inventory on hand to meet customers' needs. However, the company also needs to strive to minimize costs and risk while avoiding unnecessary inventory stockpiles.

The inventory turnover ratio is calculated as the cost of goods sold (COGS) divided by the average balance in inventory. Again, the average balance in inventory is usually determined by taking the average of the starting and ending balances.

The ratio reveals how rapidly a company's inventory is used in sales and replaced. A relatively low ratio compared to industry peers indicates a risk that inventory levels are excessively high, meaning a company may want to consider slowing production to ease the cost of insurance, storage, security, or theft. Alternatively, a relatively high ratio may indicate inadequate inventory levels and risk to customer satisfaction.

In addition to the ratios discussed above, companies may rely on the working capital cycle when managing working capital. Working capital management helps maintain the smooth operation of the net operating cycle, also known as the cash conversion cycle (CCC) . This is the minimum amount of time required to convert net current assets and liabilities into cash. The working capital cycle is a measure of the time it takes for a company to convert its current assets into cash, or:

Working Capital Cycle in Days = Inventory Cycle + Receivable Cycle - Payable Cycle 

The working capital cycle represents the period measured in days from the time when the company pays for raw materials or inventory to the time when it receives payment for the products or services it sells. During this period, the company's resources may be tied up in obligations or pending liquidation to cash.

Inventory Cycle

The inventory cycle represents the time it takes for a company to acquire raw materials or inventory, convert them into finished goods, and store them until they are sold. During this stage, the company's cash is tied up in inventory.

Though it starts the cycle with cash on hand, the company agrees to part ways with working capital with the expectation that it will receive more working capital in the future by selling the product at a profit .

Accounts Receivable Cycle

The AR cycle represents the time it takes for a company to collect payment from its customers after it has sold goods or services. During this stage, the company's cash is tied up in accounts receivable.

Though the company can part ways with its inventory, its working capital is now tied up in accounts receivable and still does not give the company access to capital until these credit sales are received.

Accounts Payable Cycle

The AP cycle represents the time it takes for a company to pay its suppliers for goods or services received. During this stage, the company's cash is tied up in accounts payable.

On the positive side, this represents a short-term loan from a supplier meaning the company can hold onto cash even though they have received a good. On the negative side, this creates a liability that needs to be managed.

Limitations of Working Capital Management

With strong working capital management, a company should be able to ensure it has enough capital on hand to operate and grow. However, there are downsides to the approach. Working capital management only focuses on short-term assets and liabilities. It does not address the long-term financial health of the company and may sacrifice the best long-term solution in favor of short-term benefits.

Even with the best practices in place, working capital management cannot guarantee success. The future is uncertain, and it's challenging to predict how market conditions will affect a company's working capital. Whether there are changes in macroeconomic conditions and customer behavior, or there are disruptions in the supply chain, a company's forecast of working capital may simply not materialize as expected.

While effective working capital management can help a company avoid financial difficulties, it may not necessarily lead to increased profitability. Working capital management does not inherently increase profitability, make products more desirable, or increase a company's market position. Companies still need to focus on sales growth, cost control, and other measures to improve their bottom line. As that bottom line improves, working capital management can simply enhance the company's position.

Working capital management aims at more efficient use of a company's resources by monitoring and optimizing the use of current assets and liabilities. The goal is to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations while maximizing its profitability. Working capital management is key to the cash conversion cycle, or the amount of time a firm uses to convert working capital into usable cash.

Why Is the Current Ratio Important?

The current ratio or the working capital ratio indicates how well a firm can meet its short-term obligations. It's also a measure of liquidity . If a company has a current ratio of less than 1.0, this means that short-term debts and bills exceed current assets, which could be a signal that the company's finances may be in danger in the short run.

Why Is the Collection Ratio Important?

The collection ratio, also known as days sales outstanding, is a measure of how efficiently a company can collect on its accounts receivable. If it takes a long time to collect, it can be a signal that there will not be enough cash on hand to meet near-term obligations. Working capital management tries to improve the collection speed of receivables.

Why Is the Inventory Ratio Important?

The inventory turnover ratio shows how efficiently a company sells its inventory. A relatively low ratio compared to industry peers indicates a risk that inventory levels are excessively high, while a relatively high ratio may indicate inadequate inventory levels.

Working capital management is at the core of operating a business. Without sufficient capital on hand, a company is unable to pay its bills, process its payroll, or invest in its growth. Companies can better understand their working capital structure by analyzing liquidity ratios and ensuring their short-term cash needs are always met.

Dr. Ajay Tyagi, via Google Books. " Capital Investment and Financing for Beginners ," Page 3. Horizon Books, 2017.

Dr. Ajay Tyagi, via Google Books. " Capital Investment and Financing for Beginners ," Page 4. Horizon Books, 2017.

Dr. Ajay Tyagi, via Google Books. " Capital Investment and Financing for Beginners ," Pages 4-5. Horizon Books, 2017.

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Analyzing the Efficiency of Working Capital Management: a New Approach Based on DEA-Malmquist Technology

• Original Research
• Published: 22 July 2022
• Volume 3 , article number  32 , ( 2022 )

Cite this article

• Ahmed Mohamed Habib   ORCID: orcid.org/0000-0003-1728-6028 1 &
• Nahia Mourad 2  

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In this study, we analyze the efficiency of working capital management (WCME) for Gulf companies before and during the coronavirus crisis, then explore the influence of the coronavirus crisis on WCME. This study uses several techniques to achieve its goals, including the Malmquist index (MI), data envelopment analysis (DEA), and Tobit regression. The results demonstrate that most firms (approximately 84%) adopt a conservative strategy for their WCM. The WCME results revealed a statistical difference in the technological and pure efficiency scores for companies before and during the coronavirus crisis, while the results revealed no statistical difference in the technical, scale, and total factor productivity scores. Tobit’s results show that the coronavirus crisis had no significant influence on companies’ WCM performance. Finally, our results indicate that firms that are efficient in terms of WCM have higher sales returns and net income. The findings of this study have important implications for stakeholders to increase their awareness of companies’ WCM performance before and during a crisis. In addition, the results could have implications for trading strategies as investors and financiers seek to invest in companies with good WCM. The implications of WCM performance on social interests would cause decision-makers to use the best strategies and procedures to enhance WCM activities to improve their investments and image in the community in which it operates. We advance a novel contribution to the literature by analyzing and appraising the WCME for companies before and during the coronavirus crisis using a new approach based on DEA-Malmquist technology and then examining whether the coronavirus crisis has affected the WCME.

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1 Introduction

Businesses strive to make the best use of their limited resources. Resource allocation theory states that firms choose the most cost-effective distribution and allocation of resources for various productive activities [ 1 , 2 ]. As a result, firms that strive for excellence manage their WC to achieve best practices. The WC term arose from corporate finance and was initially mentioned at the inception of the twentieth century [ 3 , 4 ]. The WC is one of the most confusing accounting concepts. The lack of clarity concerning the employment of WC may be excused by the fact that there is no analogous classification of WC in firms’ balance sheets. WCM appears to have been primarily disregarded in businesses, even though bad WC decisions are responsible for a considerable portion of business failures, and WCM is essential for corporate financial management because it directly affects a firm’s profitability [ 5 ]. This is more striking as a large share of past firm bankruptcies was created by ineffective or inadequate WCM [ 6 ]. As WC significantly influences a firm’s operational and financial security, the literature confirms that it is necessary to develop an optimal WC strategy for a firm [ 7 , 8 ]. The literature suggests three strategies for managing WC: conservative, moderate, and aggressive [ 8 – 10 ]. The conservative strategy is safe for a firm and provides a high level of liquidity as it keeps current assets at high levels compared to current liabilities. In contrast, the aggressive strategy keeps current assets at low levels compared to current liabilities. Finally, the moderate strategy is considered a sensible method as it aims to minimize the drawbacks of the aforementioned methods and maximize their benefits. Exploring the suitable linkages between the items of current assets and liabilities will help a firm to adopt a good WC strategy. Therefore, a firm should adopt and manage its WC strategy on a solid and secure basis to achieve best practices.

The literature on corporate finance recognizes the significance of short-term business decisions on firm profitability. WCM is a recurring topic on a global scale because it is critical to ensure a business’s optimal path. WC is essential during economic downturns because it acts as a liquidity buffer [ 11 , 12 ]. Additionally, WC practices benefit firm profitability by facilitating solid sales and income growth [ 13 , 11 ]. While inventory stockpiling protects businesses from price fluctuations, trade credit increases sales and strengthens customer relationships. In addition, short-term debt related to financing the WC has low interest rates and is unaffected by inflation [ 14 ]. In contrast, the PricewaterhouseCoopers (PwC) Global report notes that promoting WC could free up €1.3 trillion in cash, allowing for a 55% increase in capital investment [ 15 ]. Furthermore, the report identifies new calls for global publicly traded firms’ business performance over the last 5 years as capital expenses have decreased, cash has shifted to be more costly and tough to convert, and the WC has slightly improved. Firms must cultivate and enhance their WC practices to improve business performance. On the other hand, excessive investment in WC necessitates financing and, as a result, additional payments, which may produce negative consequences and sacrifices for stockholders [ 13 , 16 ]. Kieschnick et al. [ 17 ] argue that an increase in WC financing increases the likelihood of bankruptcy because it requires additional financing requirements and financing expenses.

Moreover, various components of WCM contribute significantly to its effectiveness. Firms must make critical decisions about how much stock to keep on hand as having a large inventory protects them from costly stockouts and manufacturing process interruptions. Customers who are given more credit are more likely to use and verify products before making a payment, which benefits the company [ 18 ]. According to de Almeida and Eid [ 19 ], WC is a critical component of operational cash flow and is used to calculate the free cash flow. Effective WCM reduces a firm’s reliance on external funding, frees up cash for additional investments, and increases its financial flexibility. Business administration is constantly striving to maintain optimal WC volume. Increased WC investment energizes the sales process and provides discounts to suppliers for prompt payments at low WC levels. Nonetheless, once a certain level of WC investment is reached, additional interest costs are incurred, eroding firm value [ 20 ].

Two approaches have been used to assess a firm’s efficiency in terms of WCM. The first approach for assessing the WCME is to use ratio analysis as a parametric method. For example, quick and current ratios have been used to assess a firm’s liquidity [ 21 ]. In addition, Zimon and Tarighi [ 8 ] explored the WCM strategies of small- and medium-sized firms in Poland using liquidity and turnover ratios, cash conversion cycle (CCC), and other ratios. This approach has been criticized for its inherently static nature as a parametric method [ 22 ]. The CCC proposed by Richards and Laughlin [ 23 ] was also criticized for being mathematically incorrect, failing to focus on the total amount of funds committed, and lacking differentiation in the weights assigned to each component of WC [ 24 ]. According to Goel and Sharma [ 24 ], other measurement ratios, such as weighted CCC, have calculation issues owing to a lack of relevant data. Accordingly, researchers have developed alternative methods for measuring the WCME to overcome the weaknesses of the traditional approach. DEA is one such measure that has been used to calculate WCME as a non-parametric method in previous studies [ 25 – 30 ].

The DEA approach is distinguished by its ability to capture relationships between multiple outputs and inputs [ 31 – 33 ]. Additionally, DEA is a non-parametric technique that does not require prior assumptions about the distribution form of data or its residuals, and does not require any previous knowledge of the variable weights [ 34 , 35 , 36 ]. In addition, DEA is distinguished by its powerful benchmark in assessing the efficiency of firms, as it focuses on the best practices of firms rather than traditional methods, such as ratios and regression analyses, which rely on measures of average and central tendencies as criteria for evaluation, as it benchmarks a firm’s performance with maximum relative performance or best practices [ 37 , 38 ]. Therefore, DEA is considered a powerful approach for the continuous improvement process as it provides critical benchmark information for inefficient firms in achieving the best practices [ 33 , 38 ].

Empirical evidence shows that WCM has garnered substantial interest in accounting and finance research. Considering the Gulf firms, WCM is vital to firms’ economic development. Gulf member states are monarchies with distinct legal structures, and their public corporations operate in distinct institutional, economic, and political environments [ 39 ]. To integrate with the global economy, they shifted their focus from an oil-based economy to a knowledge-based one [ 40 ]. Gulf firms outrank the Middle East and North Africa (MENA) regions but not other regions with comparable per capita income levels. Thus, inefficient employment of assets and WC impedes progress toward sustainable and equitable growth. Gulf firms should invest in balancing their assets and WC to alleviate this trend. In addition, the existing literature on WCM has rarely focused on this crucial phenomenon in Gulf firms. Therefore, more research is needed to analyze the WCME for firms operating in the Gulf and investigate the influence of the coronavirus crisis on WCM performance, which is considered a novel contribution to the literature. Therefore, this study analyzes the efficiency of WCM by integrating the data envelopment analysis approach and the Malmquist productivity index in the context of a unique Gulf setting. The objective of this study was to investigate data from 2018 to 2020. The DEA-Malmquist analysis is extended to capture the efficiency of WCM in terms of technical efficiency (effch), technological efficiency (techch), pure efficiency (pech), scale efficiency (sech), and total factor productivity (tfpch) before and during the coronavirus crisis. The efficiency of the WCM results revealed a statistical difference in the technological and pure efficiency scores before and during the coronavirus crisis. Tobit’s results show that the coronavirus crisis had no significant influence on Gulf firms’ WCM performance. The findings of this study have important implications for stakeholders to increase their awareness of companies’ WCM performance before and during a crisis. In addition, the results could have implications for trading strategies as investors and financiers seek to invest in companies with good WCM. The implications of WCM performance on social interests would cause decision-makers to use the best strategies and procedures to enhance WCM activities to improve their investments and image in the community in which it operates.

The motivation for the study stems from market characteristics and the economic prospects of the Gulf. Most Gulf countries experienced increased inflation during the study period, resulting in higher interest rates, influencing a firm cost of capital. The Gulf Statistics Centre recently released a report on the Gulf countries’ inflation rates, which were 3.5% in April 2021, up from 3.5% the previous year. In April 2021, Saudi Arabia had the highest inflation rate in the Gulf, at 5.3%, up from 3.1% in April 2020, followed by Kuwait (3.1%), Oman (1.6%), and Qatar (1.6%). In the United Arab Emirates and Bahrain, inflation decreased about 0.5% and 0.1%, respectively. Besides, the coronavirus epidemic, on the other hand, had a tremendous impact on the entire world, as every country, industry, and civilization were affected in some way [ 41 ]. Many activities have been restricted because of the pandemic to slow the spread of the virus. We should turn everything off to limit the negative impact. When public authorities take decisive action to address the emerging health threat of coronavirus, business leaders are faced with the challenge of channeling their WCM through the issue. Recognizing the crisis impact on the people who drive the firm’s operations is critical. That highlights the importance of a resilient leader in a fast-changing environment and working differently. Also, the author has not found any research by reviewing previous studies on WCM in the context of the coronavirus pandemic. Using MI and DEA, this study is thought to be one of the earliest attempts to analyze and appraise the WCM performance of the firms. Moreover, Gulf firms were adversely impacted by the numerous issues that arose because of the outbreak. Based on these arguments and evidence, this study investigates the following:

RQ1. Are there, on average, significant differences in firms’ WCME over the study period? RQ2. Has coronavirus crisis affected firms’ WCME over the study period?

The remainder of this paper is organized as follows. Section  2 presents a literature review and hypotheses formulation. Section  3 clarifies the data and the methodology used. Section  4 presents the empirical results. Finally, Sect.  5 presents a summary and conclusions of the study.

2 Literature Review and Hypotheses Formulation

WCM is a critical component of a firm’s success [ 42 , 43 ]. Furthermore, the WCM can help with risk management and increase the value of a business [ 44 ]. Furthermore, a conservative approach to WCM necessitates increased inventory and accounts receivable investment, which has the advantage of lowering supply-chain costs and price fluctuations, posing less risk to businesses [ 21 , 45 ]. Increased sales and market share generate profits [ 46 ]. Firms that take a proactive approach to WCM reduce risk exposure by reducing inventory investment and credit terms with customers [ 13 ]. Besides, a study of Indian industrial firms between 2004 and 2013 revealed continuous growth in WCME. The DEA-based approach effectively overcame the limitations associated with traditional WCME measures [ 26 , 27 ]. Furthermore, an examination of Indian industrial firms revealed a high degree of efficiency volatility among manufacturing firms, with those operating at 50 to 60% efficiency lacking liquidity management expertise [ 28 , 29 ]. According to Ukaegbu [ 47 ], there is a negative relationship between WCM and Egyptian manufacturing firm profitability. According to a study conducted in 46 countries, lowering CCC could increase business profitability and value [ 16 ]. Furthermore, publicly traded European hospitals with a low leverage ratio show that increasing WCM increases profitability [ 48 ].

Prior research in developed countries revealed various WCME and firm performance outcomes [ 49 ]. While these studies have been extensive in developed countries, they have only recently been extended to developing countries. In developing countries, the relationship between WCME and profitability has been documented using a variety of proxies. Over 10 years, Akinlo [ 50 ] investigated the relationship between WCME and non-financial sector firm profitability in Nigeria. Inventory days, average payment period accounts receivable, and WCM efficiency were all calculated by WCME. The data were analyzed using fixed effects and a pooled ordinary least squares model. Nigerian businesses’ return on assets (ROA) decreases as accounts receivable, accounts payable, and inventory turnover days increase, but increases as CCC decreases. Altaf [ 51 ] investigated the effect of WCME on the performance of the Indian hospitality sector using a two-step efficient GMM (generalized method of moments). WC financing is calculated using the short-term debt-to-working-capital ratio. The results were a non-monotonic relationship with ROA and Tobin Q. That means that a low level of short-term debt benefits the performance of the business.

Wasiuzzaman [ 49 ] calculated the WC using inventory, receivables, payables, and WC balance. According to this study, WC is negatively correlated with ROA in Malaysian manufacturing firms. The payables and hypothesized relationships were incompatible. Soukhakian and Khodakarami [ 52 ] investigated whether WCME could significantly improve the ROA and economic performance of publicly traded Iranian industrial firms. Even though CCC was negatively associated with ROA, there was no significant relationship between WCM and refined economic value added when endogeneity was considered. Wang et al. [ 46 ] investigated the corporate relationships of non-financial listed firms in Pakistan over their existence. According to the findings, an increase in WCME (as measured by the net trade cycle) decreased ROA regardless of the life cycle stage. Zimon [ 10 ] analyzed WCM in small firms in Poland using a sample of 96 commercial firms operating in the construction industry from 2015 to 2017. The results demonstrate that firms operating within purchasing groups focus on financial safety and adopt a moderate-conservative strategy. Lyngstadaas [ 53 ] investigated the link between WCM packages and financial performance using a sample of 589 firms in the USA from 2012 to 2019. The results indicate that out of the 11 effective packages in terms of WCM, six are significant. Additionally, the results confirm that the six packages systematically relate to operational and financial WC performance.

In addition, Chamberlain and Aucouturier [ 54 ] explore the influence of WCM on the performance of publicly traded companies in Europe from 2004 to 2016. The results indicate that the links between WCM, profitability, and firm value are positive and significant. This study suggests that directors should take a nuanced view of WCM’s influence on performance. Zimon [ 7 ] reviewed prior research on WCM. This study shows that higher WC levels enable firms to increase their sales volume. The study concludes that directors should base their WCM strategies on high sales volumes to enhance firms’ WCM efficiency, profitability, and financial security. Aldubhani et al. [ 55 ] explored the linkage between WCM policies and profitability of manufacturing firms in Qatar from 2015 to 2019. The results reveal that firms with a shorter duration of receivables and CCC, and a longer duration of accounts payable and inventory turnover are more profitable. Jaworski and Czerwonka [ 56 ] explored the linkage between WCM measures using a sample of 326 Polish firms from 1998 to 2016. The results revealed a significant nonlinear linkage between working capital, liquidity, and profitability. Mazanec [ 57 ] explored the influence of WCM on a firm’s performance using 3828 transport firms in the Visegrad Group in the European Union in 2019. The results indicate that cash ratio affects firm performance in all models, excluding the Polish and Czech models. In addition, small firms are at a disadvantage in terms of WCM compared to medium-sized firms in Slovakia and the Czech Republic. Zimon and Tarighi [ 8 ] examined the influence of the COVID-19 crisis on WCM using a sample of 61 Polish firms from 2015 to 2020. The results demonstrate that firms manage a moderately conservative strategy for their WCM. Additionally, the results indicated that the COVID-19 crisis did not significantly alter firms’ WCM strategies. Tarkom [ 58 ] investigates the influence of the COVID-19 crisis on firms’ WCM using a sample of 2542 US-publicly traded US firms from 2019 to 2021. The results show that firms with more investment options and government incentives operate at lower levels during cash-conversion cycles. Additionally, the results demonstrated a significant negative influence of COVID-19 on WCM. This finding suggests that the influence can be mitigated by increasing government incentives and investment opportunities. Struwig and Watson [ 59 ] critically examined the WCM research conducted during the COVID-19 crisis in South Africa. The study concludes that during a crisis, the WC examination focuses on workforce safety and demand volatility. This suggests that effective cash management and digital transformation shifts are necessary to relieve undesirable changes in supply chains. Based on these arguments and evidence, this study hypothesizes the following:

H 1 . On average, there were significant differences in firms’ WCME over the study period. H 2 . The coronavirus crisis has affected the firms’ WCME over the study period.

3 Data and Methodology

The sample size included 459 publicly traded companies in the following industries: communication services, consumer discretionary, consumer staples, energy, health care, industrials, materials, real estate, and utilities. These companies are located in Oman, Qatar, Saudi Arabia, Kuwait, Bahrain, and the United Arab Emirates. According to Pastor and Ruiz [ 60 ] and Portela et al. [ 61 ], negative data values would limit the capacity of the DEA model to perform the analysis. As a result, 273 firms were excluded due to negative values in some cases and a lack of data in others. As a result, the final decision-making units (DMUs) are 186 firms. The primary data sources were based on the annual reports of the selected firms. These firms’ annual reports were obtained from the standard and poor’s DataStream, the platform of Mubasher-info, and firms’ websites.

Among the numerous approaches available for assessing DMU efficiency scores, the DEA approach was chosen to evaluate the efficiency of the firms under study because of its unique characteristics. First, as Mourad et al. [ 31 ], Shahwan and Habib [ 32 ], and Tone [ 33 ] argue, DEA is a versatile and powerful technique for capturing the relationship between specific outputs and inputs. Furthermore, DEA can provide critical information for continuous improvement, assisting inefficient DMUs in achieving best practices. Second, like Cooper et al. [ 37 ] and Habib and Shahwan [ 38 ] argued, DEA stands out as a benchmark technique that focuses on the best practices of DMUs rather than traditional methods that rely on measures of central tendencies. Finally, as demonstrated by Habib and Kayani [ 36 ], Mourad et al. [ 31 ] and Tuskan and Stojanovic [ 35 ], DEA distinguishes itself as a non-parametric technique that does not require prior assumptions about the distribution form of data (or its residuals). Furthermore, DEA does not require any previous knowledge of the variable weights.

To calculate efficiency using DEA, we require a set of inputs and outputs pertinent to the analysis’s primary objective [ 36 , 37 , 62 ]. DMUs are expected to provide outputs based on their possible inputs related to the primary objective under analysis. According to prior research, e.g., Gill and Biger [ 25 ], Goel and Sharma ( 24 , 26 , 27 , and Seth et al. [ 30 ], the inputs for calculating the WCME should include those items that account for a significant portion of WC investments. Additionally, each firm invests in WC to maintain consistency and increase sales. Thus, firms that generate more sales while supporting the same WC can be considered more efficient. As a result, net sales should be chosen as an output variable. Almost all prior research has overlooked the significance of net income as a by-product of WCM. A business that generates a higher net income while investing the same WC is more efficient. Following a review of the prior literature, the current DEA-WCME model used inventory, accounts receivable, accounts payable, and cost of goods sold as inputs and net sales and net income as outputs. Finally, the radial Malmquist DEA model is obtained by solving the next linear optimization problem:

where \({x}_{\mathrm{in}}^{\mathrm{s}}\) (resp. \({y}_{\mathrm{rn}}^{\mathrm{s}}\) ) is the value of the \(i\) -th input (resp. \(r\) -th output) of the \(n\) -th DMU observed in period \(s\) , the \({\left({\lambda }_{\mathrm{n}}\right)}_{\left\{1\le \mathrm{n}\le \mathrm{N}\right\}}\) are the weights corresponding to the DMUs. The DMU is considered relatively efficient in period \(s\) measured by frontier technology \(t\) if \({\delta }^{\mathrm{s}}\left({X}_{\mathrm{n}}^{\mathrm{t}},{Y}_{\mathrm{n}}^{\mathrm{t}}\right)=1\) ; otherwise it is inefficient. It should be noted that, \({e}_{n}^{1}=\frac{1}{{\delta }^{1}({X}_{n}^{1},{Y}_{n}^{1})}\) (resp. \({e}_{n}^{2}=\frac{1}{{\delta }^{2}({X}_{n}^{2},{Y}_{n}^{2})}\) ) is the constant return to scale (CCR) efficiency score for the \(n\) -th DMU in the first (resp. second) period.

Following the evaluation of the firms’ WCME using the DEA approach, the current study used the Tobit regression analysis to identify the potential statistical effect of the coronavirus on firms’ WCME. This model is a valuable tool for assessing the relationships between variables when the dependent variable contains censored data or has a range constraint [ 38 ],Verbeek 2008). The equation represents the Tobit linear regression relationship:

where  \({e}_{i}\) represents each firm’s WCME; \({v}_{1}\) is the coronavirus as an independent variable defined by a dummy variable. To put it another way, if the time is related to the time before the coronavirus crisis, this indicator variable equals 1, and if it is associated with the time before the coronavirus crisis, it equals 0. Furthermore, to improve the accuracy of the analyses, the study used various control variables such as size, age, and leverage. Thus, \({v}_{2}\) represents the firm size as defined by the natural logarithm of total assets; \({v}_{3}\) represents the firm age as defined by the natural logarithm of firm age from the start of the activity until the end of the current year; \({v}_{4}\) represents firm leverage as defined by dividing a firm’s total liabilities by shareholders’ equity; \({v}_{5}\) refers to the communication services sector; \({v}_{6}\) refers to the consumer discretionary sector; \({v}_{7}\) refers to the consumer staples sector; \({v}_{8}\) refers to the energy sector; \({v}_{9}\) refers to the health care sector; \({v}_{10}\) refers to the industrials sector; \({v}_{11}\) refers to the materials sector; \({v}_{12}\) refers to the real estate sector. \({\beta }_{0}\) is a constant; \({\beta }_{i}\) represents the Tobit regression coefficients; and \({\varepsilon }_{i}\) are known by the Gaussian noises or errors.

4 Results and Discussion

4.1 results of the efficiency model.

Table 1 , panel A, shows the Malmquist index summary for the top ten DMUs under analysis (tfpch > 1) over the study period (2018–2020) in terms of WCME changes. In terms of improvement, the KWSE:HUMANSOFT achieved the best results (2.331), followed by the SASE:9510 (2.100), the DSM:NLCS (1.960), and so on. Table 1 , panel B, displays the Malmquist index summary for all DMUs under consideration during the study period (2018–2020) regarding WCME changes. According to the Malmquist index summary, technological efficiency or frontier-shift (techch) was the primary source of the increasing efficiency of the total factor productivity index of the DMUs under study, rather than technical efficiency or catch-up changes (effch). In terms of improvement (tfpch > 1), 100 DMUs out of 186 under investigation achieved the best results (tfpch > 1). Only 86 DMUs appeared to be inefficient, and they should reconsider operating processes and improve performance through necessary corrective actions to achieve best practices and improve overall factor productivity.

The DEA-Malmquist index summary of annual means in terms of WCME changes over the study period is shown in Table 2 , panel A. The Malmquist index increased by about 1.002 (0.2%) from the base year in the first period (2018–2019) before the coronavirus crisis. This increase is the result of an increase in technological efficiency or frontier-shift changes (techch) of about 1.083 (8.3%) multiplied by a decrease in technical efficiency or catch-up changes (effch) of about 0.926. (7.4%). Similarly, the situation has not changed significantly during the crisis; the Malmquist index for the second period (2019–2020) increased by about 1.034 (3.4%), with this increase attributed to the rise in technological efficiency changes of about 1.135 (13.5%) multiplied by a decrease in technical efficiency changes of about 0.911. (8.9%). Over the study period, the Malmquist index increased by about 1.018 (1.8%), the technological efficiency increased by approximately 1.108 (10.8%), and the technical efficiency decreased by about 0.918 (8.2%).

Table 2 , panel B, shows a complementary statistical test for confirming significant differences in firm efficiency scores regarding WCM over the study period using Wilcoxon tests (via IBM-SPSS ver26). The results showed no statistical difference in technical efficiency scores at a 5% significance level before and during the coronavirus crisis. Similarly, at a 5% significance level, there was no statistical difference in scale efficiency scores and total factor productivity scores. As a result, we retain the null hypothesis that the median of differences between effch (before the crisis) and effch (during the crisis) equals 0; sech (before the crisis) and sech (during the crisis) equal 0; tfpch (before the crisis) and tfpch (during the crisis) equal 0. Furthermore, the results revealed a statistical difference in technological efficiency scores and pure efficiency scores at a 5% significance level before and during the crisis. As a result, we reject the null hypothesis that the median of differences between techch (before the crisis) and techch (during the crisis) equals 0; pech (before the crisis) and pech (during the crisis) equals 0. All previous results indicate that H1 is partially supported.

4.2 Results of the Tobit Regression Model

Following the evaluation of the firms’ WCM performance using the DEA approach, it is helpful to identify some of the factors that affect WCM performance. In this section, the following factors are investigated for their impact on performance: the coronavirus crisis, size, age, leverage, and sector classification.

Tobit regression analysis was used to investigate factors influencing WCM performance using Stata/MP ver16. Table 3 depicts the effect of the variables under investigation on the WCM performance of the firms over the study period. Table 3 shows that firm size and sector (Sec1, the communication services sector; Sec2, the consumer discretionary sector) have a significant favorable influence at the 0.10 significance level or less. Furthermore, at the 0.10 significance level or less, the leverage and the industry sector (whether Sec5, the health care sector; Sec7, the materials sector) negatively influence.

The current study’s findings revealed that the coronavirus crisis had no significant influence on WCM performance. As a result, the H2 hypothesis is unsupported. This findings are consistent with Zimon and Tarighi [ 8 ] study as they reveal that the COVID-19 crisis did not significantly alter firms’ WCM strategies. In contrast, the findings are inconsistent with Tarkom [ 58 ] study, as they demonstrate a significant negative influence of the COVID-19 crisis on WCM. In contrast, the findings revealed that firm size and leverage significantly impact WCM performance. Moreover, the results showed that the sector category (whether Sec1, the communication services sector, Sec2, the consumer discretionary sector; Sec5, the health care sector; Sec7, the materials sector) have a significant influence on the WCM performance at the same time the sector category (whether Sec3, the consumer staples sector; Sec4, the energy sector; Sec6, the industrials sector; Sec8, the real estate sector) have no significant influence on the WCM performance.

4.3 Sensitivity Analysis and Model Validation

Internal and external validity can be used to analyze findings. Internal validity investigates whether the methods utilized to change the results are valid, whereas external validity explores whether could generalize the results away from the present data [ 63 , 38 , 64 ]. Sensitivity examinations are helpful for both types of evaluations. Thus, the internal validity is appraised by utilizing various variables’ combinations. Table 4 , panel A, presents the results of sequentially removing different variables used from the basic model. The current study adopted the Mann–Whitney U test to examine the efficiency scores of the modified DEA-WCME models to the original efficiency scores via the basic DEA-WCME model to verify if the removal of variable occurred a significant difference in the relative efficiency scores. Besides, the correlations of Spearman rank were computed as well.

It is exposed in Table 4 , panel A, that the accounts payable removal significantly decreased the model’s efficiency distinction by diminishing the average of firms’ efficiency scores of 0.61 to 0.51 and the rate of the efficient DMUs of 12.9 to 9.1%. Similarly, removing either input accounts receivable, cost of goods sold, or inventory significantly influenced the model results concerning the efficiency score distribution and the rate of the efficient DMUs. Moreover, the high correlations of Spearman ranks suggest that the firms’ rankings were not significantly altered through the efficiency models. It is not surprising that removing either input impacted the model results because they blend various resource kinds. Therefore, excluding each would occur significant information removal.

Finally, the current study used the consistency of the results over time to assess the external validity of the firms’ efficiency model. The firms’ efficiency model was re-applied utilizing 2018 data in this analysis and then matched the relative efficiency scores to the 2019 and 2020 results (Table 4 , panel B). The Mann–Whitney U test revealed no statistically significant variance in the efficiency score distribution for the study years 2018–2019 ( p  = 0.497), 2019–2020 ( p  = 0.944), and 2018–2020 ( p  = 0.684). The Kruskal–Wallis H test revealed no statistically significant variation in the efficiency score distribution over the study ( p  = 0.814). The correlation of Spearman rank between each year was also highly significant. As a result, the general distribution of efficiency scores and the rate of the efficient DMUs not appear to change significantly from period to period, and the firms ranked as efficient remain mostly harmonious from period to period.

5 Summary and Conclusion

Empirical evidence shows that WCM has garnered substantial interest in accounting and finance research. Tewolde [ 5 ] shows that inadequate WC decisions are responsible for a considerable portion of business failures, and that WCM affects a firm’s profitability. This is striking because an ineffective WCM strategy creates a large share of past firm insolvencies [ 6 ]. As WC significantly influences a firm’s operational and financial security, the literature confirms that it is necessary to develop a good strategy for a firm’s WCM [ 7 , 8 ]. Drawing on this, there are increasing concerns regarding the coronavirus crisis toward firms that adopt WCM strategies, which may harm their performance and value. Using a unique Gulf setting, this study analyzes the efficiency of WCM before and during the coronavirus crisis using an integration between the data envelopment analysis approach and the Malmquist productivity index, and then explores the influence of the crisis on WCME using Tobit regression. To the best of our knowledge, the current study is the first to develop and apply the data envelopment analysis methodology using the Malmquist productivity index to evaluate WCME. Besides, the authors advanced a novel contribution to the literature by examining whether the coronavirus crisis has affected the WCM for firms under investigation. This study is essential for regulators, management, and investors to increase their awareness of firms’ WCM performance before and during a crisis. In addition, it provides insight into how the coronavirus crisis affects firms’ WCM, which is likely to strengthen firms’ financial policy and improve their strategies. These findings are consistent with Zimon and Tarighi [ 8 ] study as they reveal that the COVID-19 crisis did not significantly alter firms’ WCM strategies. In contrast, the findings are inconsistent with Tarkom [ 58 ] study, as they demonstrate a significant negative influence of the COVID-19 crisis on WCM.

The results show that 157 firms (approximately 84%) adopt a conservative strategy as a safe strategy for their WCM, while 29 firms have adopted an aggressive strategy, suggesting that most firms strive to provide a high level of liquidity and maintain current assets at high levels compared to current liabilities. In addition, the results of the DEA-Malmquist analysis revealed that the annual means of WCME increased by approximately 0.2% before the coronavirus crisis due to technological efficiency or frontier-shift changes. The results did not change significantly during the coronavirus crisis, with only a 3.4% increase due to technological efficiency or frontier-shift changes. Furthermore, at the 5% significance level, the Wilcoxon test revealed no statistical difference in the efficiency scores of technical and scale efficiency, and total factor productivity before and during the coronavirus crisis. In contrast to previous findings, the results revealed a statistical difference in technological efficiency and pure efficiency scores at a 5% significance level. In addition, the current study’s findings showed that the coronavirus crisis and firm age have no significant influence on WCM performance. By contrast, the findings reveal that firm size and leverage substantially impact WCM performance. Furthermore, the results indicate that sector category (communication services, consumer discretionary, healthcare, and materials) significantly influences WCM performance. Finally, our results indicate that firms that are efficient in terms of WCM have higher sales returns and net income, as the sales and net income averages of firms with relative efficiency in terms of WCM are approximately 11 and 30 times higher, respectively, than inefficient firms in terms of WCM.

Given the study findings, decision-makers and WC managers of firms should develop the necessary means and schemes to ensure the best practices of WCME and address the inefficiency aspects in terms of technical efficiency and scale efficiency to ensure that a firm operates efficiently, which would likely positively reflect on the firm and the confidence of many stakeholders. These findings highlight the need to disclose WCM practices within traditional firm reports or integrated reporting, where conventional statements alone would be insufficient to appraise firm performance, especially given the current ecosystem’s rapid and consecutive development. The findings would also pique the interest of decision-makers and WC managers, who could use the DEA methodology to investigate and identify weaknesses in firm performance, and then take significant actions to optimize performance and achieve best practices.

This study has some limitations. This study focuses on 186 firms (558 firm-year observations) in the Gulf Cooperation Council (GCC), and the findings are limited to the period 2018–2020. Based on the findings of the sensitivity analysis and model validation, the findings can be generalized to other firms in GCC and Middle Eastern countries, and future research may include all non-financial sector firms for broader applicability. Managerial ability, intellectual capital, real earnings management, ESG criteria, and the likelihood of financial distress are also important elements of financial policy that are not considered in this study but can be investigated in future studies. Despite these limitations, our study contributes to the literature by providing empirical evidence that most firms adopt conservative WCM strategies. Additionally, the WCME results revealed a statistical difference in firms’ technological and pure efficiency scores before and during the coronavirus crisis. The study also shows that the coronavirus crisis had no significant influence on firms’ WCM performance. Finally, this study may have implications for many stakeholders, including decision-makers, WCM managers, financiers, investors, financial consultants, researchers, and others, in increasing their awareness of firms’ WCM performance before and during a crisis. In addition, the results could have implications for trading strategies as investors and financiers seek to invest in companies with good WCM. The implications of WCM performance on social interests would cause decision-makers to use the best strategies and procedures to enhance WCM activities to improve their investments and image in the community in which it operates.

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The first author conceived the project and planning; fundamental analysis; the framework and statistical models; collected data and analyzed it; wrote the abstract, introduction, literature review and hypotheses formulation, data and methodology, results and analyses, and conclusions and implications; reviewed and edited the manuscript; responding to coming reviewers’ comments. The second author conceived the project and planning; results and analyses; reviewed the manuscript.

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Habib, A.M., Mourad, N. Analyzing the Efficiency of Working Capital Management: a New Approach Based on DEA-Malmquist Technology. Oper. Res. Forum 3 , 32 (2022). https://doi.org/10.1007/s43069-022-00155-7

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Role of working capital management in profitability considering the connection between accounting and finance

Asian Journal of Accounting Research

ISSN : 2459-9700

Article publication date: 25 August 2020

Issue publication date: 7 December 2020

The study aims to explain the relationship between accounting and finance through measuring the effect of rational working capital management on profitability.

Design/methodology/approach

Employing the methodology of semi-structured interviews with sixteen financial managers.

The findings pointed out the relationship between accounting and finance is complementary, since it supports the accountant by the critical skills and information, like project evaluation, managing the company funding resources and working capital management. These skills put the accountant up to the financial manager stage. The working capital investment and financing policies have the most significant impact on profitability. These policies related to risk and return theory; since the conservative policy will reduce both the risk and return and the aggressive one will have the opposite impact.

Originality/value

It recommends accountants to be in professional stage and increase the profitability of the company to grab both accounting and finance information and skills.

• Working capital
• Profitability
• M4 Accounting and Auditing

Morshed, A. (2020), "Role of working capital management in profitability considering the connection between accounting and finance", Asian Journal of Accounting Research , Vol. 5 No. 2, pp. 257-267. https://doi.org/10.1108/AJAR-04-2020-0023

Emerald Publishing Limited

Copyright © 2020, Amer Morshed

Published in Asian Journal of Accounting Research . Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode

1. Introduction

Despite the strong correlation between accounting and finance, each of them influences the management of operations in a different direction ( Brief and Peasnell, 2013 ). This link leads some people, who are not experienced and do not have the relevant knowledge, to confuse these two terms and connect some unrelated job duties to accountants ( Droms and Wright, 2010 ). Cleary and Quinn (2016) mentioned that accounting is an essential component of financing operations since finance is a term that includes accounting information.

Thus, the information provided by accountants is the primary element in decisions made by managers in general and financial managers in particular. However, in this context, Fields (2016) added that financing incorporates more subjects than only accounting. It contains statistics, economics, mathematics and any matters which are required for financing.

The main objective of the company, in common, is to achieve the most significant profits. The company aims to gain the maximum profit, and this can be done by multiplying the volume of production or the operation. One of the essential portions of production, trading and providing service is the working capital. Therefore, companies provide liquidity for working capital to achieve business continuity. In obtaining the purposes of the company, most often, business and financial directors are entitled to implement relevant working capital management policies. These policies are needed for financing because errors in working capital management may lead the commercial operations to withdrawn. Consequently, the sequence follows up on the status of working capital. It is significant and in touch with the entire business position ( Muhammad et al. , 2016 ).

Accordingly, the study aims to explain the relationship between accounting and finance through measuring the effect of rational working capital management on profitability and discussing the financial managers' responsibility. This article applies different procedures than those applied by other studies related to working capital management. The methodology adopts the qualitative method by conducting interview via Skype with financial managers from various territories in Europe and Asia to collect the data. These data reflect the best practices of working capital management from different economies, industries and sizes of capital. Hence, the results will be more generalisable.

The article found that the corporate finance skills put the accountant up to the financial manager stage. The working capital models play a significant role in advancing the profitability. Moreover, investment and financing policies have a substantial impact on profitability. These policies are related to risk and return theory since the balance between conservative and aggressive policies will contribute positive results.

Section 2 discusses a literature review of the working capital management. Section 3 discusses the methodology. Section 4 is the findings and discussion. In the end, Section 5 points out the conclusion.

2. Literature review

Explaining the profitability importance, Cakici et al. (2017) concluded that the companies use profitability as one of the four segments applied for the analysis of financial statements and performance. The other three are efficiency, solvency and market prospects. Managers, creditors and investors use these crucial impressions to analyse the company performance and its future potential if operations are suitably achieved. Vintilă and Nenu (2016) added that resources such as cash, overdraft and liabilities are used to cover the variable and fixed costs of the production process and to purchase the stock for resale operations. Profitability is the relationship between revenue and expenses and how well the company is performing and the potential future growth of the company and how it manages its working capital.

To explore the working capital management's effects on the profitability, Anwar (2018) examined the influence of the length of the operation cycle and the turnover of receivables and inventory on the profitability index of listed firms in Indonesia. The article concluded that reducing the turnover of both receivables and inventory leads to a decrease in the operation cycle and an increase the companies' profitability. Lazaridis and Tryfonidis (2006) reached results which show a relation between profitability and the operating cycle. Further, directors are able to generate gains for their businesses by controlling the operating cycle carefully and maintaining every different factor of the working capital to the most appropriate level. Pais and Gama (2015) pointed out many outcomes that inform the drop in the period of collecting the trade receivables and the rise in the number of days to settle their commercial liabilities are related to higher profitability. Additionally, the profitability is also an advance in return on assets with a reduction of the working capital amount.

The role of working capital management policies arose when Padachi (2006) concluded that excellent working capital control and policy affect the formulation of a company's value. This conclusion came from the investigation of the working capital control policy objectives and its relation to companies' achievement and profitability. This was done by applying statistical methods using the return on total assets ratio. The results show that focussing heavily on investments in high capital causes low profitability ratios. Muhammad et al. (2016) added that firms can use working capital management, which is one of the essential determinants to influence their profitability. The result reveals that there is an association between working capital elements and profitability. This is defined as the increase in the cash conversion cycle influences the profitability negatively. Additionally, directors can produce a definite amount for the company by minimising the cash conversion cycle at the most suitable level and performing a proper working capital policy and by taking care of each element of it at a sharp level. The findings of the study of Singh et al. (2017) confirmed that working capital management is linked with profitability, which indicates that aggressive working capital investment and finance policies drive higher profitability. Moreover, the cash conversion cycle is observed to be related to profitability negatively. The paper examined the working capital management variations and profitability by analysing the connection among changes in working capital management and firm profitability.

The previous literature review provides evidence of the significant roles of working capital management on the accounting profitability and assures that both accounting and finance are strongly associated. This article will apply different procedures than those applied in other studies related to working capital management to provide a deep discussion of the role of working capital management in profitability with the connection between accounting and finance.

3. The methodology

Aiming to approach practical information related to the study purpose and find practical generalised implications, this paper examines the opinions of interviewees gathered from semi-structured interviews with a group of participants consisting of sixteen financial managers. All the interviewed persons are actively involved in the financial decisions of their companies. Those interviewed found a strong desire to study objects and thus produced a fruitful penetration in this article. The respondents were selected depending on the country, industry and the size of capital as in the following table (see Table 1 ):

The researcher conducted semi-structured interviews to gain relevant data for the research objective. The meetings were carried within a reasonably free connection. Therefore, some questions proposed were not planned. Only the main questions to start the conversation were planned.

Numerous questions were automatically asked through the interview, providing elasticity to both the interviewer and the participant. This elasticity helped to examine and explain additional features or to recognise other vital details. This is unlike a structured interview, where questions are designed and arranged beforehand.

The key questions of the interviews were:

Do you find corporate finance important to accounting?

How do working capital management models improve profitability?

How do working capital management policies affect the profitability?

The meetings were in the structure of a dialogue. The interviews were conducted via Skype during the period of May 2019 until February 2020. The meetings were in Arabic and English, and the Arabic interviews were translated into English. They were recorded, transcribed and coded manually by the researcher. Finally, the researcher compared the interview proceeds with related literature in order to find the results.

The method proceeded by including the analysis of discussion records and applying qualitative coding and manual recoding by the researcher. This technique depends on the researcher's qualifications of the subject since the researcher has an eleven years' experience in accounting and auditing and, additionally, professional certificates in accounting.

4. Findings and implications

For the purpose of exploring the connection between the accounting and finance, the conversation started by the question:

4.1 Do you find corporate finance important to accounting?

If you do not understand how to use corporate finance, you will pass as a simple accountant. It is called financial management. How can any manager take a financial decision without it?.

Accordingly, using hermeneutic analysis, financial management supports and advances the accountant to be a financial manager.

I have completed my master's degree in accounting and finance, and there were two compulsory subjects related to corporate finance. There are many universities that have departments named finance and accounting, that means the instructors have information on both accounting and finance.

I am a CMA holder; the second part of this certificate is ultimately about corporate finance. The association of chartered certified accountant providing the ACCA, and this certificate include two critical papers about corporate finance which are financial management and advanced financial management.

These abstracted sentences provide tangible evidence for the connection between accounting and finance. This realisation came from the point that professional accounting bodies consider financial management as an essential part in their certifications.

On the other hand, the participants provided valuable information related to accounting education. Universities provide the junior accountant to the market. Therefore, they should consider the financial management as a vital part of the accounting curriculum that improves the new graduates' skills.

Investment decision skills

The previous literature shows that investment decision skills are essential for the accountant to be a financial manager. They point out some of these skills, like the net present value (NPV), internal rate of return (IRR), payback method and the equivalent annual cost method ( Gardiner and Stewart, 2000 ; Hung and Liu, 2005 ; Daunfeldt and Hartwig, 2014 ).

Imaging yourself in a meeting with the CEO, and he asks you to appraise a project. Without investment appraisal skills, you are in an embarrassing situation. As a financial manager at a manufacturing company, I have to decide when the underlying machine should be replaced. Therefore, I use the equivalent annual cost method since it could be applied to compute a maximum replacement cycle.

Where I work, we do many projects in one year, and it is essential to predict the profitability of these projects and the time when the initial cost payback, so you have to be familiar with the NPV and payback methods.

I know many accountants are still doing the usual accounting occupation since they do not have investment appraisal skills like NPV and IRR.

(2)Funding from external sources

Many ways to source funds from external resources were mentioned during conversations, like bonds, deep discount bonds, convertible bonds and long-term bank loans ( Kiyama and Rios-Aguilar, 2017 ).

It is valuable to each accountant to be a professional financial manager to know how he can find the sources of funds for the company; especially the external funds. There are many types of funds available for any firm; some of them are internal and others are external, but the vital thing for the financial decision is the gearing. If you are a professional financial manager, you have to keep the WACC in optimal value.

The researcher, using hermeneutic analysis with meeting proceeds, found that gearing and capital structure have a vital impact on profitability. Four theories explain this impact. The quoted sentences were identical to the literature. Therefore, both were combined to avoid redundant wording.

Traditional view: Under the traditional view, the ideal capital combination leads to minimising the average cost of capital. The cost of debt remains fixed up to a particular percentage of gearing. Passing this scale leads to a higher debt cost. The financial risk increase if gearing raises this relationship causes the equity cost to increase ( Berry et al. , 1993 ).

Modigliani and Miller (MM): The firm operating level and its profits only specify the market value of the firm in the position of no tax. The risk is attached to these profits, so there is no relation to the gearing. In the case of tax, a high level of gearing decreases the cost of capital since the interest is taxable. ( Brusov et al. , 2011 ).

Market imperfections: In a high level of gearing, the company is unable to perform its interest obligation, leading to bankruptcy ( Sanstad and Howarth, 1994 ).

Pecking order theory: Firms favour retained earnings as the optimal source of finance and then straight debt, convertible debt, preference shares and equity shares ( De Jong et al. , 2011 ).

To discuss the second key question:

4.2 How do working capital management models improve profitability?

The participators mentioned that working capital management deals with the root of the operation and the daily transactions that include cash, receivables, trade payables and inventory.

Da Costa Moraes et al. (2015) and Righetto et al. (2016) mentioned that the Baumol model and the Miller–Orr model are critical to run the cash in the optimal value to keep the liquidity and earn a profit.

(4)Inventory

Previous studies mentioned the impact of inventory management on profitability and showed that models are being used to improve inventory management.

Economic order quantity:

The professional stock administration can be divided into three sections: (EOQ), discounts for bulk purchases, it could be more economical to purchase inventories in significant order quantities to achieve discounts, buffer inventories to reduce the stock-out risk.

(EOQ) is the ordering amount for an inventory item which reduces the costs of stocking and damage.

Just-in-time system:

(5)Accounts receivable

Braun et al. (2018) supported that a higher balance of bad debt improves sales size. Given that, when the progress of the sales passes the total addition to the cost of fixed expenses and bad debts and discounts, the policy of mitigating credit requirements is profitable.

Providing credit possesses a cost; the amount of the interest imposed on an overdraft to finance the credit time; additionally, the not collected cash misses the interest of the bank deposit. Improvement in profit of increased sales following from granting credit could balance this loss.

One of the methods mentioned to keep the accounts receivable as a profitable behaviour is a credit rating system.

Credit score:

Ajanaku and Ekundayo (2017) and Richard and Kabala (2019) mentioned that points are granted according to client efficiency components, the credit amount relay on their credit score.

The interviews contributed that “the institution may establish a credit rating scheme for different customers based on personal client characteristics (such as whether the client is the owner of a state, the customer, age and profession).”

The second method is factoring; it was coded from the transcript of many interviews.

Factoring is an agreement to possess debts gathered by a factoring firm, which prepays a balance of the money it is due to settle ( Van der Vliet et al. , 2015 ).

(6)Trade accounts payable

Attempting to receive a satisfying credit of suppliers. Endeavouring to enlarge credit times of cash deficit. Keeping relations with frequent and significant suppliers.

Accordingly, the researcher comprehended from the interviews that these models of working capital management are effective since almost the entire sample apply them.

The third key question during the meetings was:

4.3 How do working capital management policies affect the profitability?

(7)Working capital investment policy

Organisations must ascertain the significant risks linked to working capital and hence whether to adopt a conservative, aggressive or moderate method to investing in working capital.

The conservative working capital investment policy aims to decrease the risk of operation failure by maintaining high levels of working capital.

The aggressive working capital investment strategy aims to overcome this financing cost and improve profitability. That could be by using the method of lowering inventories, advancing recovering credit time of customers and lingering instalments to suppliers.

(8)Working capital financing policy

Working capital financing policies are divided into conservative, aggressive and moderate approaches to financing working capital. It is classified according to the size of working capital financing from short-term assets and long-term assets ( Mohamad and Saad, 2010 ; Wasiuzzaman and Arumugam, 2013 ; Kwenda and Holden, 2014 ).

Almost all the participators expressed the opinion “the relation between the selected policy and the profitability is ‘high-risk, high-return’”. That means that aggressive policies increase profitability. This opinion is supported by ( Pais and Gama, 2015 ; Baños-Caballero et al. , 2016 ; Gonçalves et al. , 2018 ; Chand et al. , 2019 ).

On the other hand, opinions expressed based on practical experiences prefer the moderate policies, “moderate policies meet the targets of higher profitability, that come by avoiding risk losses.” This opinion could be supported by studies by Sharma and Kumar (2011) and Abuzayed (2012) showing a positive relationship between an increasing cash conversion cycle (CCC) and increased profitability, since the increase in the CCC means moves to moderate and conservative policies.

5. Conclusion

The results of the conversations support the literature review of the article. There is consistency between what the participants contributed and the previous studies interpreted. This consistency provides results that the relation between accounting and finance is vital. It can be described as a complementary relationship.

The financial manager starts as an accountant. By getting experience, he can make critical accounting decisions. When he gains corporate finance knowledge and skill, he starts providing financial management decisions. Ultimately, by the continuous improvement in finance management and the experience, he achieves the position of the chief financial manager.

On the other hand, the relationship between working capital management and profitability is similar to the relationship between finance and accounting in many aspects. For example, the accountant needs to be familiar with financial models which provide practical methods to handle working capital elements like cash and inventory.

Additionally, many strategies can help them to manage the accounts receivable to avoid more interest that arises from the cash matching and to decrease the bad debt expense. All of the methods mentioned contribute to avoiding expenses to gain the maximum profit.

The working capital investment and financing policies have the most significant impact on profitability. These policies are related to risk and return theory since the conservative policy reduces both the risk and return and the aggressive one has the opposite impact.

The article recommends accountants to be in professional stage and increase the profitability of the company to grab both accounting and finance information and skills.

Despite the positive interview aspect, the challenges that were encountered with the meeting comprised the severe limitation of the study. When setting up the meetings with the participants, most of the sample apologised in the first attempt, and later many efforts the acceptance to conduct the meeting has been awarded. This situation has complicated the research timetable and forced the researcher to extend the research time plan to keep the methodology flow. Some meetings were time-restricted. Therefore, gaining information to suggest other research paths was not in a perfect manner.

However, the author suggests some topics for future research, for example, conducting research to provide more models to manage the working capital elements. Moreover, measuring the consequences of linking accounting with strategic management, governance and control management in education and practical experience should be done.

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Term Paper on Working Capital Management | Management

Here is a term paper on ‘Working Capital Management’ for class 11 and 12. Find paragraphs, long and term papers on ‘Working Capital Management’ especially written for school and management students.

Term Paper on Working Capital Management

Term Paper Contents:

• Term Paper on the Working Capital Management Policies

Term Paper # 1. Meaning and Definition of Working Capital Management:

One of the most important areas in the day-to-day management of the firm is the management of working capital. Working capital management is the functional area of finance that covers all the current accounts of the firm. It is concerned with the management of the level of individual current assets as well as the management of total working capital. Procurement of funds is firstly concerned for financing working capital requirement of the firm, secondly for financing fixed assets.

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Working capital refers to the funds invested in current assets, i.e., investment in stocks, sundry, debtors, cash and other current assets. Current assets are essential to use fixed assets profitably.

Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and interrelationship that exist between them. The term current assets refer to those assets which in the ordinary cause of business can be, or will be converted into cash within one year, without undergoing a diminution in value and without disrupting the operations of the firm.

The major current assets are cash, marketable securities, accounts receivable and inventory. Current liabilities are those liabilities which are intended at their inception to be paid in the ordinary course of business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills payable, bank overdraft and outstanding expenses.

“The goal of working capital management is to manage the firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained.” This is so because if the firm cannot maintain a satisfactory level of working capital. It is likely to become investment and may even be forced into bankruptcy.

The current assets should be large enough to cover its current liabilities in order to ensure a reasonable margin of safety. Each of the current assets must be managed efficiently in order to maintain the liquidity of firm while not keeping too high a level of any one of them.

Each of the short-term sources of financing must be continuously managed to ensure that they are obtained and used in the best possible way.

“The interaction between current assets and current liabilities is therefore the main theme of the theory of working capital management.”

The basic ingredient of the theory of working capital management may be said to include its definition, need, optimum level of current assets, the tradeoff between profitability and risk which is associated with the level of current assets and liabilities, financing-mix strategies and so on.

The requirements of current assets are usually greater than the amount of funds payable through current liabilities. In other words, the current assets are to be kept at a higher level than the current liabilities.

Term Paper # 2. Classification of Working Capital:

There are many classifications in use out of which a few important areas are as below:

1.  From the point of view of concept

2. From the point of view of time.

1. From the Point of View of Concept:

From the point of view of concept the term working capital can be used in two different ways:

(a) Gross Working Capital (GWC).

(b) Net Working Capital (NWC).

(a) Gross Working Capital (GWC):

The term gross working capital refers to investment in all the current assets taken together. The total of investments in all current assets is known as gross working capital.

The term net working capital can be defined in following two ways:

1. The most common definition of net working capital (NWC) is the difference between current assets and current liabilities.

NWC = CA — CL

CA = Current Assets

CL = Current Liabilities

(b) Net Working Capital (NWC):

The alternate definition of NWC is that portion of current assets which is financed with long-term funds. (Means part of those current assets whose liability does not lie with current liabilities).

NWC is commonly defined as the difference between current assets and current liabilities. Efficient working capital management requires that firms should operate into same amount of NWC, the exact amount varying from firm to firm and depending among other things, on the nature of industry.

The justification for the use of NWC to measure liquidity is based on the premise that the greater the margin by which the current assets cover the short-term obligations, the more is the ability to pay obligations when they become due for payment.

The NWC is necessary because the cash outflows and inflows do not coincide. In other words, it is the non-synchronous nature of cash flows that makes NWC necessary.

In general, the cash outflows resulting from payment of current liabilities are relatively predictable. The cash inflows are, however, difficult to predict.

a. The more predictable the cash inflows are the less -NWC will be required.

b. Where cash inflows are uncertain, it will be necessary to maintain current assets at a level adequate to cover current liabilities that are there must be NWC.

The task of the financial manager in managing working capital efficiently is to ensure sufficient liquidity in the operations of the enterprise. The liquidity of a business firm is measured by its ability to satisfy short-term obligations as they become due.

The three basic measures of a firm’s overall liquidity are:

(i) Current ratio.

(ii) Acid test ratio.

(iii) Net working capital.

The first two measures are very useful in inter-firm comparison of liquidity. Net Working Capital (NWC) as a measure of liquidity is not very useful for comparing the performance of different firms but it is quite useful for internal control.

The NWC helps in comparing the liquidity of the same firm overtime. For the working capital management, NWC can be said to measure the liquidity of the firm. In other words, the goal of working capital management is to manage the current assets and current liabilities in such a way that an acceptable level of NWC is maintained.

2. From the Point of View of Time:

From the point of view of time, working capital can be divided into following two categories:

(a) Permanent working capital.

(b) Temporary working capital.

(a) Permanent Working Capital:

It also refers to the hard core working capital. It is that minimum level of investment in the current assets that is carried by the business at all times to carry out minimum level of its activities.

(b) Temporary Working Capital:

It refers to that part of total working capital which is required by a business over and above permanent working capital. It is also called variable working capital.

Since the volume of temporary working capital keeps on fluctuating from time to time according to the business activities it may be financed from short-term services.

Term Paper # 3. Working Capital Cycle :

Working capital cycle refers to the length of time between the firms paying cash for materials, etc., entering into the production process/stock and the inflow of cash from debtors i.e., sales.

Suppose a company has a certain amount of cash it will need raw materials. Some raw materials will be available on credit but, cash will be paid out from the other part immediately. Then it has to pay labour costs and incurs factory overheads. These three combined together will constitute work-in-progress. After the production cycle is complete, work-in-progress will get converted into finished products.

The finished products when sold on credit get converted into sundry debtors. Sundry debtors will be realized in cash after the expiry of credit period. This cash can again be used for financing of raw materials, work-in-progress etc.

Thus there is a complete cycle from cash to cash wherein cash gets converted into raw materials, work-in-progress, finished goods, debtors and finally into cash again.

a. Short-term funds are required to meet the requirements of funds during this time period.

b. This time period is dependent upon the length of time within which the original cash gets converted into cash again.

c. This cycle is also known as operating cycles or cash cycle.

Working capital cycle indicates the length of time between a company’s paying for materials, entering into stock and receiving the cash from sales of finished goods. It can be determined by adding the number of days required for each stage in the cycle.

A company holds raw-material on an average for 60 days, it gets credit from the supplier for 15 days, production process needs 15 days, finished goods are held for 30 days and 30 days credit is entered to debtors.

Then, total no. of days = 60 – 15 + 15 + 30 + 30 = 120 days means 120 days is the total working capital cycle.

The determination of working capital cycle helps in the forecast, control and management of working capital. It indicates the total time lag and the relative significance of its constituent parts. The duration of working capital cycle may vary depending on the nature of the business.

The operating cycle (working capital cycle) consists of the following events which are continuing throughout the life of business:

1. Conversion of cash into raw materials.

2. Conversion of raw materials into work-in-progress.

3. Conversion of work-in-progress into finish stock.

4. Conversion of finished stock into account receivables through sales.

5. Conversion of accounts receivables into cash.

The duration of the operating cycle for the purpose of estimating working capital is equal to the sum of the durations of each of the above said events, less (-) the credit period allowed by the supplier.

In the form of an equation, the operating cycle process can be expressed as follows:

Operating cycle = R + W + F + D – C

R = Raw material storage period

W = Work-in-progress holding period

F = Finished goods store period

D = Debtors collection period

C = Credit period availed

Various components of the operating cycle can be calculated:

Above figure illustrates:

1. Level of current assets and cost of liquidity increases while cost of it illiquidity decreases.

i. A and B are financed by long-term financing.

ii. C are financed by short-term financing,

2. Conservative Approach:

This approach suggests that the estimated requirement by total funds should be met from long-term sources, the use of short-term funds should be restricted to only emergency situation or when there is an unexpected outflow of funds. In other words, under this approach a firm finances its permanent assets and also a part of temporary current assets with long-term financing. If relies heavily on long-term financing and is less risky so far as solvency is concerned, however the funds may be invested in such investment which fetch small returns to build up liquidity. Thus deviously affecting profitability.

Aggressive Approach :

The firm uses more short-term financing than is justified in this approach. The firm finances a part of its permanent current assets with short-term financing. This is more risky but may add to the return on assets.

Comparison of Hedging Approach with Conservative Approach :

The comparison of these two approaches can be done on the basis of following two attributes:

(a) Cost consideration

(b) Risk consideration

(a) Cost Consideration:

The cost of these financing plans has a bearing on the profitability of the enterprise. If in the previous example, the cost of short-term funds and long-term funds be 3% and 8% respectively.

Cost of financing under hedging plan can be estimated as:

(i) Cost of Short-Term Funds:

The cost of short-term funds is equal to average annual short- term loan × interest rate.