A Research on The relationship between Working Capital Management and profitability in Construction Firms: A study of local Grade one Contractors in Addis Ababa

Abstract

The objective of this study is to find the relationship between working capital management and profitability for over six years for local construction firms in Addis Ababa. Financial statement of a sample of seventeen (17) construction companies is used with the total of 102 observations. The study examined the components of working capital such as accounts receivable period, account payable period, inventory conversion period and cash conversion cycle in relation to return on assets (ROA) and net operating profit (NOP). In addition the study used firm size, financial debt ratio, fixed asset ratio as control variables. Specifically, the study used survey of documentary analysis of companies’ audited financial statements. The study adopts descriptive and explanatory research design. Data were analyzed on quantitative basis using descriptive, correlation and regression analysis (fixed effect model and pooled OLS) method. Companies were selected based on simple random sampling method to give equal chance for all population and to minimize the existence of sampling biases. The key findings of the study show that firstly, there is positive and insignificant relation between average payment period and profitability measured by NOP and ROA ,the positive relationship indicates that increase in average payment period of accounts payables will result in an increase of the NOP and ROA. Secondly, there is significant and negative relation between average collection period and profitability measured by NOP and ROA which shows slow collection of account receivables is correlated with low profitability. Thirdly, there is significant and negative relation between cash conversion cycle and profitability measured by NOP and ROA. Finally there is a negative and insignificant relation between inventory conversion period and profitability. Which indicate that managers can increase profitability by shortening cash conversion cycle. In general the study recommended that firms should minimize cash conversion cycle, inventory conversion period and average collection period.