The relationship between working capital management and profitability of manufacturing firms listed at the Nairobi Stock Exchange
Working capital management is undoubtedly one of the most crucial aspects of financial management. This study examined the relationship between working capital management and profitability of manufacturing firms listed at the Nairobi Stock Exchange. To achieve this objective, the study used secondary data obtained from the annual reports and financial statements of manufacturing companies listed on the NSE for the period 2006-2010. A sample of 17 companies was selected but the firms that were analyzed after the screening process finally became 14. A regression model was determined to establish .the relationship between net operating profit and the working capital variables namely, average collection period, inventory holding period, average payment period and cash conversion cycle. The control variables that were used included the age and leverage of the firms. Pearson's correlation and regression analysis were used for the analysis and tests of significance were carried out for all variables using t-test at the 95% level of significance. The results indicate that the model examined in this study is significant with an adjusted R2 of 56.4% and also that all the independent variables had a significant relationship individually with the NOP. The results further show that there is a strong negative relationship between average collection period, inventory holding period and cash conversion cycle. This is consistent with the view that the time lag between expenditure for purchases of raw material and the collection of sales of finished goods can be too long and that decreasing this time lag increases profitability. This suggests that managers can create value for their shareholders by reducing the number of days accounts receivable and inventories to a reasonable minimum. On the other hand, a positive correlation between the net operating profit and the accounts payment period, the age of the firm and the debt used by the firm was found, indicating that if the firm could lengthen these variables, then it would increase its profitability. The study concluded that working capital management affects profitability of the company and if the firm can effectively manage its working capital, it can lead to increasing profitability. Therefore, it will be important for a firm's management to understand the relationship that exists between various working capital components and profitability and the direction that they affect the profit for effective management of the working capital.