The Relationship Between Working Capital Management and Profitabilit

Topics: Accounts receivable, Balance sheet, Inventory Pages: 16 (5339 words) Published: November 10, 2012
International Research Journal of Finance and Economics ISSN 1450-2887 Issue 49 (2010) © EuroJournals Publishing, Inc. 2010

The Relationship between Working Capital Management and Profitability: A Vietnam Case Huynh Phuong Dong Faculty of Accounting, Danang University of Economics, Vietnam E-mail: Tel: +84989392392 Jyh-tay Su Assistant professor at Southern Taiwan University, No.1 NanTai St Yong Kang City, Tainan County, Taiwan R.O.C E-mail: Abstract The working capital management plays an important role for success or failure of firm in business because of its effect on firm’s profitability as well on liquidity. The study is based on secondary data collected from listed firms in Vietnam stock market for the period of 2006-2008 with an attempt to investigate the relationship existing between profitability, the cash conversion cycle and its components for listed firms in Vietnam stock market. Our finding shows that there is a strong negative relationship between profitability, measured through gross operating profit, and the cash conversion cycle. This means that as the cash conversion cycle increases, it will lead to declining of profitability of firm. Therefore, the managers can create a positive value for the shareholders by handling the adequate cash conversion cycle and keeping each different component to an optimum level. Keywords: Corporate Profitability, Working Capital management, Vietnam stock market.

1. Introduction
Assets in commercial firm consist of two kinds: fixed assets and current assets. Fixed assets includeland, building, plant, furniture, etc. Investment in these assets represents that of part of firm’s capital, which is permanently blocked on a permanent or fixed basis and is also called fixed capital that generates productive capacity. The form of these assets does not change, in the normal course. In the contrast, current assets consist of raw materials, work-in-progress, finished goods, bills receivables, cash, bank balance, etc. These assets are bought for the purpose of production and sales, like raw material into semi-finished products, semi- finished products into finished products, finished products into debtors and debtors turned over cash or bills receivables. The fixed assets are used in increasing production of an organization and the current assets are utilized in using the fixed assets for day to day working. Therefore, the current assets, called working capital, may be regarded as the lifeblood of a business enterprise. It refers to that part of the firm’s capital, which is required for financing short-term. The management of this working capital is known as working capital management. The basis objective of working capital management is to manage firm’s current assets and current liabilities, in

International Research Journal of Finance and Economics - Issue 49 (2010)


such a way, that working capital are maintained, at a satisfactory level. The working capital should be neither more nor less, but just adequate. Working capital management plays an important role in a firm’s profitability and risk as well as its value (Smith, 1980). There are a lot of reasons for the importance of working capital management. For a typical manufacturing firm, the current assets account for over half of its total assets. For a distribution company, they account for even more. Excessive levels of current assets can easily result in a firm’s realizing a substandard return on investment. However, Van Horne and Wachowicz (2004) point out that excessive level of current assets may have a negative effect of a firm’s profitability, whereas a low level of current assets may lead to lowers of liquidity and stock-outs, resulting in difficulties in maintaining smooth operations. Efficient management of working capital plays an important role of overall corporate strategy in order to create shareholder value. Working...
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