Effects of Working Capital Management on Profitability of Firms in Oil and Gas Industry in Kenya

Abstract

Working capital management is argued to positively influence profitability of firms across various sectors of an economy. Nevertheless, this is very difficult task for financial managers because of opposing interest of various stakeholders. For example, profit can be maximized if accounts payable are settled after a long period. However, this is against the interest of the creditors. In addition, higher prices and prompt collection of accounts receivable will fetch greater returns but customers will be hurt by such moves. These complexities are even worsened by the volatile nature of the oil and gas industry especially in Kenya. A sound and robust working capital management is thus needed. Thus, this study seeks to establish the effect of working capital management on profitability of oil and gas industry in Kenya. The study sampled ten firms out of which two are listed in the Nairobi Securities Exchange, one is government owned while the other seven are privately owned. Balanced panel data covering 2012-2017 period across the ten firms was obtained from respective firms’ annual financial reports and other relevant secondary sources. Data was collected on these firms’ Net profit after tax, accounts receivable, accounts payable, sales, purchases, inventory, current assets and current liabilities, total debt and total assets. Pooled ordinary least squares method was used to establish the effects of various WCM components on firm profitability measured using ROE. Correlation analysis was also be used as a complimentary analytical procedure. The study found out that days payables outstanding (DPO) has a significant positive impact on profitability of firms in the Kenyan oil and gas industry. Days sales outstanding (DSO) and days inventory outstanding (DIO) were found to have no significant impact in determining profitability. Liquidity, measured using current ratio, and debt-equity ratio used as control variables were found to be important determinants of profitability; the two ratios had a positive and negative relationship respectively with ROE. The study concludes that WCM is important in determining performance of firms in the oil sector. Finance managers should focus on making appropriate decisions that enhance efficiency in WCM. Supply agreements that allow the company long credit periods to settle their obligations are encouraged as this will affect profits positively. The study recommends that government and other policy makers should come up with a policy that allows oil marketing companies reasonable timelines to settle their obligations on imported products as this will cushion such companies from working capital deficits and losses related to finance charges.