Implication Of Working Capital Management On Profitability Finance Essay

Fiscal Management fundamentally deals with raising of fiscal resources and its proper allotment in order to maximise stockholders wealth. For a successful working of a concern organisation fixed and current assets play a critical function as organisation by and large invests in these options. A house ‘s working capital consists of its investings in current assets, which includes short-run assets like hard currency and bank balance, stock lists, receivable and short term investings. Therefore, the working capital direction refers to the direction of the degrees of all these single current assets. An effort has been made in this paper to analyze the on the job capital constituents and the impact of working capital direction policies on profitableness of ONGC Limited. The paper besides makes an effort to analyze the correlativity between liquidness, profitableness and Net income before Tax ( PBT ) of ONGC. The survey is based on secondary informations collected from one-year studies of ONGC for the period 2000 to 2012. In this paper there is an application of correlativity and arrested development analysis to place the important effects of Working capital direction on the profitableness. The Management of working capital is indispensable as it might hold a direct impact on profitableness and liquidness.

Keywords: Working capital direction, ONGC, Current Assets, Profitability & A ; Liquidity

Introduction:

Fiscal Management chiefly focuses on the survey of long-run fiscal determinations, peculiarly investings, capital construction, dividends or company rating determinations. However, short-run assets and liabilities are of import portion of entire assets of an organisation and demand to be carefully analyzed. The finance director is invariably engaged in policies to keep a sound working capital place. Working Capital is an of import portion of Finance and has an impact on the liquidness of an organisation. The direction of working capital is of import to the fiscal wellness of concerns of all sizes. The sums invested in working capital are frequently high in proportion to the entire assets employed and so it is critical that these sums are used in an efficient and effectual mode. Excess Working capital leads to unremunerated usage of scarce resources and unequal on the job capital interrupts the smooth flow of concern activity and profitableness. The balance allotment of working capital financess between stock lists, Debtors and other constituents of working capital is important in Working Capital Management ( WCM ) . Many research work related with WCM have found that directors spend a considerable clip on twenty-four hours to twenty-four hours working capital determinations since current assets are short lived investings that are continually being converted to other assets type. The endurance, growing and enlargement of the company depend on the ability to run into two critical facets of WCM ; profitableness and liquidness. The company has to keep an optimal degree of liquidness to run the concern on a uninterrupted footing without any break. If the liquid assets are equal to run into the short term committedness, fiscal soundness is automatically created and its recognition worthiness in the market is maintained. WCM is concerned with the jobs that arise in trying to pull off the current assets, current liabilities and the inter relationship that arise between them. Efficient working capital direction is cardinal constituent of the overall corporate scheme to make stockholder value. Some research work have been undertaken on the WCM patterns of both big and little graduated table organisations in India, UK, US and Belgium utilizing either a study based attack or by empirical analysis to place the push factors for organisations to follow good working capital patterns or econometric analysis to look into the association between WCM and Profitability. Specific research surveies entirely on the impact of WCM on profitableness of fabrication organisations are few in Numberss, particularly for the instance of India. Keeping this in position and the wider importance of the possible part of the fabrication sector to the economic system of developing states like India, this research paper is an effort in this way and analyse the impact of different WCM variables impacting the profitableness in fabrication houses.

Literature Review

An endeavor requires fixed every bit good as working capital. Firms can minimise their investings in fixed assets by leasing or renting works and equipment, but they can non avoid investing in current assets. A house can be and last without doing net income but can non last without working capital. Thus, working capital direction is of import because of its consequence on the house ‘s profitableness and hazard and accordingly its value ( Smith, 1980 ) . The literature of finance traditionally focused on long term fiscal determinations. There has been a conjunct attempt by theoretical economic experts to analyse fiscal determinations of concern houses within the context of the equilibrium theoretical accounts of fiscal markets. While these theoretical accounts have been employed to analyse the long term corporate investing and fiscal determinations, virtually no research has been conducted in an effort to use them to working capital determinations ( Cohn and Pringle, 1975 ) .

The literature of finance has neglected the short term fiscal determinations, which is working capital direction. Deficit of financess for working capital every bit good as the uncontrolled over-expansion of working capital has caused many concerns to neglect and in less terrible instances have stunted their growing ( Grass, 1972 ) . Particularly, in little houses, working capital direction may be the factor that decides success or failure ; in larger houses, efficient working capital direction can significantly impact the house hazard, return and portion ( Gitman, 1982 ) . Research workers have peculiarly offered surveies analysing investings, capital construction, dividends and company rating. However, the investing that house ‘s brand in current assets and the resources used with adulthoods one twelvemonth represent the chief portion of points on a house ‘s balance sheet which appears to hold been comparatively neglected in research.

Working capital direction is the direction of current assets and current liabilities. Keeping high stock list degrees reduces the cost of possible break in the production procedure or of loss of concern due to the scarceness of merchandises, reduces supply costs and protects against monetary value fluctuations among other advantages ( Blinder and Manccini, 1991 ) . Allowing trade recognition favours the house ‘s gross revenues in assorted ways. Trade recognition can move as an effectual monetary value cut ( Brennan et al. , 1988 ; and Petersen and Rajan, 1997 ) and an inducement to clients to get ware at times of low demand ( Emery, 1987 ) . However, houses that invest to a great extent in stock list and history receivable can endure low net income.

Therefore, greater the investing in current assets, lower is the hazard, and profitableness obtained. Similarly, trade recognition is a self-generated beginning of funding that reduces the sum required to finance the amounts tied up in the stock list and history receivables. The trade recognition can hold a really high implicit if early payment price reductions are available. In fact, the chance cost may transcend 20 per centums depending on the price reduction per centum and the price reduction period granted ( Ng et al. , 1999 ; and Wilner, 2000 ) .

Profitableness and liquidness comprise the salient and all excessively frequently conflicting ends of working capital direction. The struggle arises because the maximization of the house ‘s returns could earnestly endanger liquidness, and on the other manus, the chase of liquidness has a inclination to thin returns. Over the old ages, analysts have employed traditional ratio analysis as a primary instrument in the measuring of corporate liquidness in the house, of well-established ratios such as the current and speedy ratios ( Smith, 1997 ) .

Teruel and Solano ( 2007 ) conducted a survey to place the consequence of WCM on profitableness of little and average sized Spanish houses. From the survey it is found that there is a important negative relationship between an SME ‘s profitableness and figure of yearss of histories receivable and yearss of stock list. From the surveies conducted to place the tendencies in WCM and its impact on Mauritian little fabrication houses ( Pandachi 2006 ) identified that the on the job capital demands of an organisation alteration over clip as does its internal hard currency coevals rate. As such, the little houses should guarantee a good synchronism of its assets and liabilities. The analysis done by Kerstien and Rai ( 2007 ) tried to analyze the market reaction to positive and negative net incomes alterations influenced by big unexpected working capital accumulations ( LWCAs ) and predicts the fortunes where LWCAs lead to changing market outlooks of net incomes quality. This literature argues that the market is more likely to surmise net incomes direction and position net incomes as being of lower quality when house ‘s studies little additions in net incomes with the aid of positive or negative big working capital accumulations.

Raheman and Nasr ( 2007 ) conducted a survey to analyse the relationship between WCM and Profitability in instance of Pakistani Firms. The consequence shows that, there is a strong negative relationship between variables of WCM and profitableness of the house. It means that as the hard currency transition rhythm increases it will take to diminishing profitableness of the house and directors can make positive value for the stockholders by cut downing the hard currency transition rhythm to a possible minimal degree. There is a important negative relationship between liquidness and profitableness. It is besides find that there is positive relationship between size of the house and its profitableness every bit good as a important relationship between debt used by the house and its profitableness. Nazir and Afza ( 2009 ) look into the traditional relationship between WCM policies and a house ‘s profitableness.

It is found that directors can make value if they adopt a conservative attack towards working capital investing and working capital funding policies. The survey besides finds that investors give weight to the stocks of those houses that adopt an aggressive attack to pull offing their short-run liabilities.

The survey by Appuhami ( 2008 ) found that the house ‘s capital outgo in Thailand has a important impact on WCM. It revealed that the house ‘s operating hard currency flow has a important relationship with WCM. Most research workers have attempted to understand the factors that determine the WCM of an organisation. Deloof ( 2003 ) investigated the relation between WCM and corporate profitableness. The consequences suggest that directors can make value for their stockholders by cut downing the figure of yearss of histories receivable and stock lists to a sensible lower limit. The negative relationship between histories collectible and profitableness is consistent with the position that less profitable houses wait longer to pay measures i.e. , creditors ‘ turnover period is high.

As a portion of a survey of the luck 500 ‘s fiscal direction patterns, Gilbert and Reichert ( 1995 ) found that history receivable direction theoretical accounts are used in 59 % of these houses to better WCM undertakings, while, stock list direction theoretical accounts were used in 60 % of companies. Smith ( 1973 ) identified eight major attacks taken towards the direction of the on the job capital. He stresses the demand for the development of a feasible theoretical account with the double finance ends of profitableness and liquidness, and argues that merely such theoretical accounts will help practising fiscal directors in their twenty-four hours to twenty-four hours determination devising. A cross limited sample, Weinraub and Visscher ( 1998 ) observed a inclination of houses with low degrees of current ratios to hold low degrees of current liabilities. There are surveies associating to working capital direction in Indian context for different industry sectors every bit good as single houses. Yadav et Al. ( 2009 ) conducted a survey on Maharashtra ‘s majority drugs listed companies in their WCM. Singh and Pandey ( 2008 ) conducted survey on Hindalco Industries Limited and Vishnani et Al. ( 2007 ) conducted an empirical survey of Indian consumer electronic industry for measuring the impact of working capital policies and patterns on profitableness. Surendra et Al. ( 2001 ) analyzed the current WCM of three major oil sector companies, viz. IOCL, HPCL and BPCL for the period from 1988 to 1997. Saravanan ( 2001 ) conducted a survey on WCM in non-banking finance companies ( NBFC ) . Reddy ( 2001 ) , Mansur ( 2001 ) , Sur ( 1999 ) and Reddy ( 1992 ) besides studied about the working capital direction in different industry sectors. These surveies peculiarly explained by the fact that there are industry benchmarks to which houses adhere when puting their working capital investing policies ( Hawawini et al. , 1986 ) . The house can increase their profitableness by cut downing investing on histories receivable and stock lists to a sensible lower limit, indicated by the benchmarks for their industry ( Teruel and Solano, 2007 ) . Furthermore, as pointed out by Soenen ( 1993 ) , hard currency transition rhythm direction attempts to roll up hard currency influx every bit rapidly as possible, and postpone hard currency outflow every bit long as possible. This consequences in to the shortening of hard currency transition rhythm.

In add-on, to hold higher profitableness, the houses may give solvency and keep a comparatively low degree of current assets. When the houses do so, their profitableness will better, as less financess are tied up in the idle current assets, but their solvency will be threatened. Therefore, there must be a tradeoff between these liquidness and profitableness of the houses. One aim should non be at cost of the other because both have their importance. If we do non care about net income, we can non last for a longer period. On the other manus, if we do non care about liquidness, we may confront the job of insolvency or bankruptcy. For these grounds working capital direction should be given proper consideration and will finally impact the profitableness of the house. This treatment of the importance of working capital direction, its different constituents and its effects on profitableness leads us to the job statement which we will be analysing. This research is focused on working capital direction and its effects on profitableness for ONGC.

Aims of the Survey:

The chief aims of this research work are:

To set up a relationship between Working Capital Management and Profitability over a period of 13 old ages from 2000 to 2012.

To happen out the effects of different constituents of working capital direction on profitableness.

To Analyze a relationship between the aims of liquidness and profitableness of the ONGC Ltd.

Hypothesis:

Null Hypothesis ( Ho ) : There is no important relation between working capital ratios and profitableness

Alternate Hypothesis ( H1 ) : It is assumed that there is important relationship between working Capital ratios and Profitability

Methodology of Study: For the analysis of informations some of import ratios associating to working capital direction and the ratios which are important to steps of profitableness have been calculated on the footing of informations available of the ONGC Ltd. The ratios which have been applied for foregrounding the efficiency of working capital direction are Current Ratio ( CR ) . Quick Ratio ( QR ) , Current Assets to Total Assets Ratio ( CATAR ) , Current Assets to Gross saless Ratio ( CASR ) , Working Capital Turnover Ratio ( WCTR ) , Inventory Turnover Ratio ( ITR ) . Debtors Turnover Ratio ( DTR ) and Cash to gross revenues Ratio ( CTS ) and the step of profitableness which has been selected is Return on Investment ( ROI ) . For mensurating the grade of relationship between the working capital direction and the profitableness Pearson ‘s simple correlativity coefficient have been applied taking into account their grade. For judging the joint influence of the selected steps associating to working capital direction on the profitableness, multiple correlativity analysis has been applied. In order to measure the joint consequence of the selected steps of working capital direction on the profitableness, multiple arrested development analysis has been used. Further to analyze whether the computed values of correlativity coefficients, partial arrested development coefficients are statistically important or non, ‘t ‘ trial has been used and whether the multiple correlativity coefficient ( R ) is statistically important or non. ‘F ‘ trial has been used. In add-on to this, to judge the effectivity or the dependability of this relationship the multiple coefficient of finding ( denoted by R2 ) has been used and it is defined as the ratio of explained fluctuation to the entire fluctuation of the dependant variable ( ROI ) .

Analysis:

The intent of this research work is to analyse the consequence of Working Capital Management ( WCM ) policies on the profitableness of ONGC. This subdivision describes the analytical frame work of informations analysis, which describes fiscal consequence of ONGC and variables included in the survey, the distribution forms of the informations and applied statistical techniques like Correlation and Regression in look intoing the relationship between WCM and profitableness.

Table 1

Correlation analysis: The analysis shows that there is a negative correlativity between Return on Investment ( ROI ) on one manus and steps of Working Capital Management ( WCM ) like Current Ratio ( -.290 ) , Quick Ratio ( -0.4105 ) , Working capital turnover ratio ( -0.175 ) , Debtors Turnover Ratio ( -0.074 ) , Absolute Cash Ratio ( -0.500 ) and Cash to gross revenues ratio ( -0.273 ) . This shows that with the addition in Current ratio, Quick ratio, Working capital turnover ratio, Debtors turnover ratio, Absolute hard currency ratio and Cash to gross revenues ratio there is a negative impact i.e. there is a lessening in profitableness and frailty versa. Current Asset to Total assets Ratio ( 0.549 ) , Current assets to gross revenues ratio ( 0.285 ) and Inventory Turnover ratio ( 0.100 ) shows a positive relation with Return on Investment ( ROI ) . This shows that with addition in CATAR, CASR and ITR there is an addition in profitableness and frailty versa. Through Correlation matrix tabular array it is observed that there is a really high grade of correlativity between CATAR and CASR ( 0.9118 ) and between WCTR and CTS ( 0.923 ) . This high grade of correlativity indicates that there is an being of multicollinearity i.e. the being of high correlativity between the independent variables.

Correlation Matrix of ONGC for the clip period 2000 to 2012

Table 2

Arrested development Analysis: The impact of Working Capital ratio on Return on Investment of ONGC is shown with the aid of multiple arrested development analysis.

Table 3

Table 4

Table 5

Table 3 shows that profitableness is straight or positively affected with WCTR and CASR whereas QR, DTR and CTS shows a negative relationship with profitableness which means that with addition in QR, DTR and CTS there is a lessening in profitableness of ONGC. Table 3 shows that the impact of different working capital ratios on profitableness is statistically important at 5 % degree as seen from the values of the arrested development coefficient. A unit addition in Cash to gross revenues ratio would diminish ROI by 1.82 units. Similarly one unit addition in QR decreases the profitableness by 0.14 units whereas with one unit addition in DTR there is a lessening in ROI by 0.01 units. One unit alteration in CASR and WCTR increases the ROI by 0.10 units and 0.05 units severally. In Table 5, p value indicates that QR, WCTR and CTS have statistically important impact on Return on Investment as P value & lt ; 0.05 on the other manus DTR and CASR have statistically undistinguished consequence on profitableness.

Table 4 shows that the independent variables explain 75.5 % of the fluctuations in the profitableness of ONGC. Significance F value 0.041 shown by Table 5 indicates that there is a important impact of Working Capital ratios on profitableness of ONGC.

Decision:

The survey of correlativity reveals both positive and negative coefficients. Out of nine ratios associating to working capital direction selected during the period under survey, in instance of Current Ratio ( -.290 ) , Quick Ratio ( -0.4105 ) , Working capital turnover ratio ( -0.175 ) , Debtors Turnover Ratio ( -0.074 ) , Absolute Cash Ratio ( -0.500 ) and Cash to gross revenues ratio ( -0.273 ) shows a negative association with the selected profitableness ratio ( ROI ) and the staying ratios Current Asset to Total assets Ratio ( 0.549 ) , Current assets to gross revenues ratio ( 0.285 ) and Inventory Turnover ratio ( 0.100 ) have a positive relation with profitableness ( ROI ) . The survey of multiple coefficient of finding ( R2 ) reveals that 75.5 % of the entire fluctuations in the profitableness of ONGC is jointly explained by the independent variables ( QR, CASR, WCTR, DTR and CTS ) associating to working capital direction. Hence, it may be concluded that the addition in the Working capital ratios of the company decreases the profitableness of ONGC throughout the survey period i.e. significantly set uping ROI. The research paper shows that the liquidness of the company has an impact on profitableness. When there is an addition in liquidness the profitableness of the company decreases and frailty versa.