Working Capital Management and the Profitability of the Manufacturing Sector: A Case Study of Pakistan’s Textile Industry

Abstract

This study explores the association between working capital management and the profitability of textile firms in Pakistan. The efficiency of working capital management is reflected by three variables: cash conversion efficiency, days operating cycle, and days of working capital. We use return on assets, economic value added, return on equity, and profit margin on sales as proxies for profitability. A balanced panel dataset covering 160 textile firms for the period 2000–05 is analyzed and we estimate an ordinary least squares model and a fixed effect model. Return on assets is found to be significantly and negatively related to average days receivable, positively related to average days in inventory, and significantly and negatively related to average days payable. Also, return on assets has a significant positive correlation with the cash conversion cycle, which would suggest that a longer cash conversion cycle is more profitable in the textiles business. The findings of the regression analysis show that average days in inventory, average days receivable, and average days payable have a significant economic impact on return on assets. The findings of the fixed effect model reveal that average days in inventory and average days receivable both have a significant impact on return on assets.