EFFECT OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY OF MANUFACTURING INDUSTRIES IN ETHIOPIA

Abstract

The purpose of this study is to examine the effect of working capital management on profitability of manufacturing share companies in Ethiopia with special reference to large tax payers. In light of this objective the study adopted quantitative approaches to test a series of research hypotheses. Financial statements of a sample of 14 manufacturing companies are used for a period of five year data (2011-2015) with the total of 70 observations. Data was analyzed on quantitative basis using descriptive and regression analysis (Ordinary Least Square) method. Non-probability Purposive sampling based on researcher judgment was used. It examined the components in working capital such as accounts receivable period, inventory holding period, accounts payable period, and cash conversion cycle in relation to return on asset (ROA).In addition the study used current ratio, used as liquidity indicator; firm size, as measured by logarithm of sales; firm growth rate as measured by change in annual sales and financial leverage, as control variables. The key findings from the study are; Firstly, there exists a significant negative relationship between average collection period and profitability indicating that an increase in the number of days a firm receives payment from sales affects the profitability of the firm negatively; secondly, there exists a negative relationship between inventory holding period with profitability and accounts payable period and profitability. But, both inventory holding period and accounts payable period was found to be insignificant in affecting profitability of the firms. Thirdly, there exists a negative relationship between cash conversion cycle and profitability of the firm. Which indicates that as the cash conversion cycle decreases it leads to an increase in profitability of the firm, and managers can increase profitability of their firms by shortening the time lag between a firm’s expenditure for purchases of raw materials and the collection of sales of finished goods. Finally, negative relationships between liquidity and profitability measures have also been observed. In general the study recommended that firms should minimize capital management components in order to maximize profitability.