ANALYSIS OF WORKING CAPITAL MANAGEMENT

PRACTICES

(THE CASE OF WOLKITE FLOUR SHARE COMPANY)

A Research Proposal Submitted to Wolkite University, College of

Business and Economics, Department of Accounting and Finance in
Partial Fulfillment of the Requirements for BA Degree in Accounting

WOLKITE UNIVERSITY
COLLEGE OF BUSINESS & ECONOMICS

Prepared By Muhaba Nuramin

Advisor Kassu (MBA)

September, 2019
Wolkite, Ethiopia
ABSTRACT
The study seeks to add to existing literature the working capital management practices of
Wolkite Flour Share Company (WFSC). To achieve this, survey instrument will be
administered on 15 Finance and Management workers of Wolkite Flour Share Company.
Questionnaire will be administered for gathering information from the respondents.

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Table of Contents
ABSTRACT.........................................................................................................................i
LISTOF TABLES..............................................................................................................iv
ACRONYMS......................................................................................................................v
CHAPTER ONE.................................................................................................................1
INTRODUCTION..............................................................................................................1
1.1. Background to the Study......................................................................................1
1.2. Statement of the Problem.....................................................................................2
1.3. Objectives of the study.........................................................................................3
1.3.1. General Objective of the research.................................................................3
1.3.2. Specific Objectives of the Research.............................................................3
1.4. Research Questions..............................................................................................3
1.5. Scope of the Study...............................................................................................3
1.6. Limitations of the Study.......................................................................................3
1.7. Organization of the Study........................................................................................3
CHAPTER TWO................................................................................................................4
LITERATURE REVIEW...................................................................................................4
Introduction.....................................................................................................................4
2.1. An overview of Financial Management...................................................................4
2.2. Overview of Manufacturing Companies..................................................................5
2.3. Working Capital and Working Capital Management..............................................6
2.3.1. Working Capital................................................................................................6
[Link]. Definition of working capital....................................................................6
[Link]. Importance of Working Capital................................................................6
2.3.2. Working Capital Management..........................................................................7
[Link]. Definition of Working Capital Management............................................7
[Link]. Importance of Working Capital Management...........................................7
2.4. Working Capital Policies.........................................................................................8
2.5. Liquidity and Profitability......................................................................................10
2.6. Working Capital Management and Profitability....................................................11
2.7. Industry Effects on Working Capital.....................................................................12
2.8. Empirical Review...................................................................................................12
CHAPTER THREE..........................................................................................................13
RESEARCH METHODOLOGY......................................................................................13
3.1. Introduction........................................................................................................13
3.2. The Research Design.............................................................................................13
3.3. Data Source and Collection Methods....................................................................13

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 3.4. Method of Data Analysis.......................................................................................13
3.5. Methods of Data Presentation................................................................................13
CHAPTER FOUR.............................................................................................................14
TIME AND BUDGET PLAN..........................................................................................14
4.1. TIME SCHEDULE............................................................................................14
4.2. BUDGET PLAN................................................................................................14
REFERENCES.................................................................................................................15
APPENDIX.......................................................................................................................18

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LISTOF TABLES
Table 4.1: Time Plan ………………………………………………………………...….19
Table 4.2: Budget Plan …………………………………………………………….……19

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ACRONYMS
WCM = Working Capital Management
WFSC`= Wolkite Flour Share Company
S.C = Share Company
COGS= Cost of goods sold
NS= Net Sale
EBIT = Earnings before Interest and taxes
NFA= Net Fixed Asset

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CHAPTER ONE

INTRODUCTION

1.1. Background to the Study

Working capital refers to the capital that companies use in their daily operations and it consists of
companies’ current assets and current liabilities, and management of Working capital is the
ability to control the current assets and current liabilities in a manner that provides the firm with
maximum return on its assets and minimizes payments for its liabilities. Working capital
management efficiency is vital especially for manufacturing firms, where a major part of assets is
composed of current assets that will directly affect the profitability and liquidity of firms
(Raheman & Nasr 2007).

Wang (2002), shin and Soenen (1993), Lazaridis and Tryfonidis (2006), Falope and Ajilore (2009) have
shown that working capital management has an effect on profitability of a firm and Proper
estimation of working capital is a difficult task for the management because amount of working
capital varies across firms over the periods depending upon the nature of business, scale of
operation, production cycle, credit policy, availability of raw materials, etc. For this reason
significant amount of funds is necessary to invest permanently in the form of various current
assets. For instance, due to time lag between sale of goods and their actual realization in cash,
adequate amount of working capital is always required to be made available for maintaining the
desired level of sale (Blinder & [Link], 1991).

The working capital management practices also examine the impact of aggressive/conservative
working capital investment and financing policy. Wajahat & Syed (2010), Vishnani S & Shah B
(2007) argue that working capital is just an idle resource with a high cost and low benefit
associated with it so they advised companies to follow zero working capital policy but such a
policy is very risky because it reduces the liquidity and it might leads to a default. Other
researchers support companies to have a working capital policy because they believe that proper
management of components of working capital can balance cost and benefits of the company and
it will reduce the risk of default by raising the level of liquidity. Companies can choose among
three different types of working capital i.e. aggressive, conservative and moderate but their
choice depends on their desire level of liquidity and risk.

Investments in current assets are inevitable to ensure delivery of goods or services to the
ultimate customers, and a proper management should give the desired impact on profitability. If
resources are blocked at different stage of supply chain, this will prolong cash operating cycle.
Although this might increase profitability (due to increase sales), it may also adversely affect the
profitability if the costs tied up in working capital exceed the benefits of holding more inventory
and/or granting more trade credit to customers (Arshad, 2013). Modern Financial management
aims at reducing the level of current assets without ignoring the risk of stock outs. Proper

1
working capital management improves firms’ profitability and liquidity position, and thus
increasing the market value of the firm (Ali, 2011). Liquidity and profitability are two sides of
the same coin because they work in opposite directions. Increasing liquidity of the firm will
reduce profitability of the firm and vice versa. Therefore finance managers need to maintain a
level of working capital that will ensure liquidity of the firm but not reduce its profitability.

1.2. Statement of the Problem

Every firm is required to maintain a balance between profitability and liquidity while conducting
its day to day operations. As inadequate amount of working capital impairs a firm's liquidity,
holding of excess working capital results in the reduction of the profitability.

Working capital management concerned with two decision areas: Determination of appropriate
level of investment in current assets and decisions as to what method of financing to use and to
obtain funds for this investment. They are part of investment and financing decisions
respectively.

Pass and Pike (1987) emphasized that short term finance area particularly working capital
management was given very less attention in contrast to long term investment even if it played a
very vital and important role in the growth of firm and in enhancement of profitability.
Deficiency in the planning and control of working capital management is one of the main causes
of business failure and it is a neglected subject which has been too little investigated or written
about. The two main objectives need to be satisfied by working capital management is liquidity
and profitability but there should be a trade-off / balance between these two objectives. In
Ethiopia many private and public manufacturing sectors do not carrying out working capital
management practices due to obsolete business process and structure of the company. As a result
there is a huge deficiency problem in manufacturing sector Samuel & Tarekegn (2011.
Therefore; firms related to this sector are the target respondents for measuring the perception and
the application of these practices.

These industries are the main contributors towards economy, According to World Bank report
(2009), In 2013/14 the share of the manufacturing sector to the GDP is 14% and share of
manufacturing companies to the employment is 7% and also it contributes more than 3.8% for
trade balance.

In comparison to the globe working capital management practices in Ethiopia are still immature.
If manufacturing sector in Ethiopia adopts comprehensive working capital management, this
would be directly affecting profit and value maximization of the organization. (Ephrem, 2011)
To the best of researcher’s knowledge, no research has been done in case of working capital
management and profitability of manufacturing share companies in Addis Ababa. Thus the

2
researcher will conduct this study with the aim of providing the following basic research
objective:

1.3. Objectives of the study

1.3.1. General Objective of the research
The study is motivated by the desire to analyze the working capital management practices of
WFSC.
1.3.2. Specific Objectives of the Research
 To analyze the working capital management practices that WFSC employ to manage the
various components of working capital.
 To examine the factors that influence the choice of WCM practices by the WFSC.
 To establish the effectiveness of the WCM practices employed by WFSC.

1.4. Research Questions

 What working capital management practices do WFSC employ to manage each of the
components of working capital?
 What influence the choice of working capital management practices faced by the
company?
 What is the effectiveness of the WCM practices employed the company?

1.5. Scope of the Study

The study will be conducted in Gurage Zone Wolkite Town in Wolkite Flour Share Company
using a questionnaire, and an unstructured interview. The work will be centered on working
capital management practice which is one of the main branches of corporate finance with special
emphasis on managerial practices.

1.6. Limitations of the Study

The key limitations of this study is the constraints due to inadequate time and financial support.
There is the need for caution due to the fact that our data will be drawn from a single industry
and even that the number of cases to be studied were limited to only one flour factory.

1.7. Organization of the Study

The study will be organized in five main chapters. The first chapter will deal with the
introduction part of the study which comprises the background of the study, problem statement,
research questions, objectives of the research, and the like. Chapter two will deal with review of
related literature. Chapter three will present the methodology of the study. Presentation of
analysis of the data collected from the field will be contained in chapter four. Chapter five is
going to present the summary of findings, conclusions and will end with recommendations based
on the findings.

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CHAPTER TWO

LITERATURE REVIEW

Introduction
This chapter deals with the literature regarding working capital management. Structurally, the
chapter comprises in to ten sections. Section 2.1and section 2.2 explains An Overview of
Overview of Financial management and overview of manufacturing company in Ethiopia
respectively. Under section 2.3 and 2.4 Working capital, Working capital management and their
roles on firm’s profitability has been elaborated. section 2.5 explain the relation between
Working capital and liquidity section 2.6 examine different working capital policies 2.7 point out
the effect of different industries on working capital In section 2.8 different related literatures
summarizes and their result about the effect of Working capital management on profitability
presented. Section 2.9 presented the summery and knowledge gap from the reviewed literature
presented section 2.10 the conceptual framework has been presented.

2.1. An overview of Financial Management

Financial Management is an integral part of the overall management. It is concerned with the
duties of the financial managers in the business firm. Effective procurement and efficient uses of
finance lead to proper utilization of the finance by the business concern. Finance is the lifeblood
of business organization it needs to meet the requirements of the business concern. Each and
every business concern maintain adequate amount of financial management for their smooth
running of the business and also maintain the business carefully to achieve the goal of the
business. (John, T. A., & John, K. 1991).

One of the importance’s of financial management is proper use of current asset and current
liability that are the most important element of Net Working capital management. The primary
cause of an enterprise’s failure is the poor control management of working capital internally
among components. Thus, the finance manager of an enterprise must be alert to the level of
working capital changes (Brigham, E. F and Houston, J. F. 2003)
From the other point of view, financial management is concerned with raising funds needed to
finance the company’s asset and activities, allocating those scarce funds between competing
uses, and ensuring that those funds are used effectively and efficiently in achieving the
company’s targets. financial management also include some other aspects such as accounting
information system, financial reporting and analysis, fixed asset management, capital structure
management (Horne, V.C.1998).

4
2.2. Overview of Manufacturing Companies
Manufacturing is the production of goods for use or sale using machines, tools and labor. It refers
to a series of human activities, from handcraft to high tech, but mostly applied to industrial
production, in which raw materials are transformed into new products/finished goods on a large
scale (CSA, 2012, pp 2).

Manufacturing activity increased as the governments five year plans diversified the economy by
encouraging agro industrial activity and by substituting domestically produced goods for
imported items in 1957. In 1975, the Derg regime nationalized most of the industries in the
country and it was another factor for the sector to remain at its infancy level by discouraging and
under-utilization of private investors. In 1984/85 manufacturing and handicrafts is getting
encourage and together accounted for 11.4 percent of GDP.

Even if, manufacturing sector in Ethiopia is still in its infancy, its recent growth record has been
good. Growth rates in the sector have been around 10 percent per year in recent years. The share
of manufacturing has remained essentially unchanged at just 5 percent of GDP over the past
decade.

The five-year Growth and Transformation Plan that Ethiopia unveiled in 2010 presents a
government-led effort to achieve the country's ambitious development goals by transforming
agricultural based economy to industry, from which expansion of manufacturing is its major
mission (Fantu Chekol 2001). According to World Bank report (2009), and CSA (2008) In
2013/14 the share of the manufacturing sector to the GDP is 14% and share of manufacturing
companies to the employment is 53% and also it contribute more than 12.8% to the economy.

The following are the manufacturing sector classification according to Central Statistical
Authority (CSA 2012):

 Manufacture of food products and beverages

 Manufacture of tobacco products
 Manufacture of textiles
 Manufacture of wearing apparel
 Tanning and dressing of leather, manufacture of footwear, luggage and hand bags
 Manufacture of wood and off products of wood and cork except furniture
 Manufacture of paper, paper products and printing materials
 Manufacture of chemicals and chemical products
 Manufacture of rubber and plastic products
 Manufacture of other nonmetallic mineral products,
 Manufacture of basic Iron and steel;
 Manufacture of fabricated metal products except machinery and equipment’

5
  Manufacture of machinery and equipment not mentioned elsewhere -Manufacture of
motor vehicle, trailers and semi-trailers -Manufacture of furniture.

2.3. Working Capital and Working Capital Management

2.3.1. Working Capital
[Link]. Definition of working capital
According to Bahttacharya (2009) the concept of working capital was perhaps first evolved by
Karl Marks1867, though in somewhat different form, and the term he used was “variable capital”
meaning outlays for payrolls to advanced workers before the goods they worked on were
complete. This ‘variable capital’ was the wage found remains blocked, in work- in- process
along with other operating expenses until it is released through sale of finished goods. Although
Marx didn’t mention, workers also gave credit to the firm by accepting periodical payment of
wages which founded a portion of work-in-process Guthman & Dougall (1948) defined the
working capital as current asset minus current liabilities. Net working capital represents the
excess of current asset over current liability and in an indicator of the firm’s ability to meet its
short term financial obligation.

[Link]. Importance of Working Capital

Just as working capital has several meanings, firms use it in many ways. The first and most
critical use of working capital is providing the ongoing investment in short term asset that the
company needs to cover its daily expenditures such as payroll, vendor invoices, and inventory
purchases. The business also needs working capital for prepaid business costs such as licenses,
insurance policies or security deposits.
The second purpose of working capital is addressing seasonal or cyclical financial needs. Since
most business doesn’t receive prepayment for selling their goods or services, they need to
finance their purchase of row materials, production and sales of goods prior to receiving
payments from their customers.

Thirdly, working capital is needed to sustain firm’s growth. The firm is expanded not only by
investing in new plants or machinery, working capital is also requires to facilitate sales growth. It
is because as a business growth, it requires larger investment in inventories, accounts receivable,
personnel and other items to increase their sales.

The other use of working capital is to undertake activities, to improve business operations and to
remain competitive, such as activities for product development or exploring new markets. In the
time of high computation, firms are in need of integrating those activities in to operations on a
continuous basis. Consequently, those expenses are more likely to be incurred as small repeated
costs rather than as large infrequent investments. Those ongoing investments, accordingly, must
be addressed through working capital financing (Seidman 2004).

6
2.3.2. Working Capital Management
[Link]. Definition of Working Capital Management
Working capital management refers to all the actions and decisions of the management which
affects the size and effectiveness of working capital. Working capital management requires
special attention in present days when cost of capital is rising and funds are scarce. It has been
generally established that the performance / profitability of a firm largely depends upon the
manner of its working capital management. If a firm is inefficient in managing working capital,
it will not only reduce profitability but may also lead to financial crisis. Both inadequate and
excessive working capital is detrimental for a business concern. The excessive working capital
can result in idle funds which could be used for earning profit while the inadequate working
capital will interrupt the operations and will also impairs profitability (Chowdhary and Amin,
2007). In their studies Chen, Wang, C., M., & Jin, L. (2009) Defined working capital
management as making decision that affect working capital. Also Explained working capital
management as the administration of all aspect of current asset and current liabilities, it includes
the firms’ investment in short term securities, short term assets, inventories and account
receivable.

The working capital meets the short-term financial requirements of a business enterprise. It is a
trading capital, not retained in the business in a particular form for longer than a year. The money
invested in it changes in form and substance during the normal course of business operations.
Just as circulation of blood is very necessary in the human body to maintain life, the flow of
funds is very necessary to maintain business (Arshad 2013).

[Link]. Importance of Working Capital Management

Working capital management is very imperative because it affects the firm’s risk, profitability
and value (Smith 1980). Investment in working capital involves a balance/tradeoff between risk
and profitability because investment decision which leads to increase in profitability will be
inclined to increase risk and vice versa. Efficiency in working capital management is very
important for the manufacturing firms where more than half of the assets are current assets.
Efficiency in managing working capital also increases cash flow to the firms which in turn
increase the growth opportunities for the firms and return to the shareholders (Blinder and
Manccini 1991).

Proper estimation of working capital actually required, is a difficult task for the management
because amount of working capital varies across firms over the periods depending upon the
nature of business, scale of operation, production cycle, credit policy, availability of raw
materials, etc. For this reason efficient amount of funds is necessary to invest permanently in the
form of various current assets. For instance, due to time lag between sale of goods and their
actual realization in cash, adequate amount of working capital is always required to be made
available for maintaining the desired level of sales. A firm can be very profitable if it can

7
translate cash from operations within the same operating cycle, otherwise the firm would need to
borrow to support its continued working capital needs (Cheatham 1989).
Siddiquee and Khan (2009) observed that, firms which are better at managing working capital
are found to be able to make counter cyclical moves to build competitive advantage. They are
also better at generating fund internally and also face lesser trouble while seeking external
sources of financing.
Smith (1979 p.149) contends that the goal of working capital management is to replenish
stocking points in such a way as to minimize the total of all associated cost, and there by enhance
profitability of the organization.
Maintaining high inventory levels can reduce the cost of possible interruption occurred during
the production process or the cost of business loss due to the product scarcity. It can also reduce
supply cost and protect against price fluctuation.
Granting trade credit to customers favors the firm’s scales in various ways. Trade credit can
incentivize customers to acquire merchandise at times of low demand. And helps firm to
strengthen long term relationship with their customers (Smith,M.B & Begmann,E. 1998)
Trade credit received from suppliers is considered as an internal source of financing that
compensates the money tied up in the companies’ inventories and customer receivables. But
there is another opportunity cost associated with early payment discount if available. In fact this
cost may exceed 20 percent, depending on the discount percentage and discount period granted
(Blinder & [Link] 1991). From another aspect, the way Working capital management acts
can have a significance impact on both liquidity and profitability of a company (Shin& Soenen
1998) companies should make a good balance between these two targets.

2.4. Working Capital Policies

Working capital policy can be best described as a strategy which provides the guideline to
manage the current assets and current liabilities in such a way that it reduces the risk of default
(Brian, 2009). The role of working capital management policies on firm performance and the
importance of a tradeoff between liquidity and profitability were investigated by Vishnani and
Shah (2007) they provided two basic reasons behind the tradeoff between profitability and
liquidity. On the one hand if a firm wanted to take higher risk for higher profits, than it reduced
the level of its working capital. On other hand if firm wanted to improve liquidity, it increased
the amount of working capital which puts a negative impact on the profitability of firm.

The Level of Working Capital Policy

Aggressive policy: An aggressive policy with regard to the level of investment in working
capital means that a company chooses to operate with lower levels of inventory, trade receivables
and cash for a given level of activity or sales (Cheatham 1989). According to Gallagher & Joseph

8
(2000) an aggressive policy will increase profitability since less cash will be tied up in current
assets, but it will also increase risk because the difference between short term or liquid assets and
short term liabilities turns very little. Furthermore few finance managers take even more risk by
financing long term asset with short term debts and this approach push the working capital on the
negative side. Managers try to enhance the profitability by paying lesser interest rate but this
approach can be proved very risky if the short term interest rate fluctuates or the cash inflow is
not enough to fulfill the current liabilities.
Such a policy is adopted by the company which is operating in a stable economy and is quite
certain about future cash flows. A company with aggressive working capital policy offers short
credit period to customers, holds minimal inventory and has a small amount of cash in hand. This
policy increases the risk of default because a company might face a lack of resources to meet the
short term liabilities but it also gives a high return as the high return is associated with high risk
(Vishnani& Shah, 2007).
Conservative policy: conservative and more flexible working capital policy for a given level of
turnover would be associated with maintaining a larger cash balance, perhaps even investing in
short-term securities, offering more generous credit terms to customers and holding higher levels
of inventory by using long term debt and equity. Such a policy will give rise to a lower risk of
financial problems or inventory problems at the expense of reducing profitability because long
term debt offers high interest rate which will increase the cost of financing (Cheatham 1989)
Mostly the companies that are operating in an uncertain environment prefer to adopt such a
policy because they are not sure about the future prices, demand and short term interest rate. In
such a situation it is better to have a high level of current assets. E.g. helps to keep the higher
level of inventory in the stock to meet the sudden rise in demand and to avoid the risk of
stoppage in the production. This policy provides the shield against the financial distress created
by the lack of funds to meet the short term liability but as we discussed earlier long term debt
have high interest rate which will increase the cost of financing. Similarly funds tie up in a
business because of generous credit policy of the company also have its opportunity cost. Hence
this policy might reduce the profitability and the cost of following this policy might exceed the
benefits of the policy (Arnold, 2008).
A moderate policy: A moderate policy would trample a middle path between the aggressive and
conservative approaches. So, In order to balance the risk and return these firms are following the
moderate approach. This approach is a mixture of defensive working capital policy and
aggressive working capital policy. In these approach temporary current assets, assets which
appear on the balance sheet for short period will be financed by the short term borrowings and
long term debts are used to finance fixed assets and permanent current asset. Thus the follower of
this approach finds the moderate level of working capital with moderate risk and return
(Siddiquee and Khan 2008).
All three approaches are shows that the working capital policies of a company can be
characterized as aggressive, moderate or conservative only by comparing them with the working

9
capital policies of similar companies. There are no absolute benchmarks of what may be
regarded as aggressive or otherwise, but these characterizations are useful for analyzing the ways
in which individual companies approach the operational problem of working capital
management.

2.5. Liquidity and Profitability

For number of years maintaining liquidity has been one of the prime goals of the firms and
financial managers because, maintaining high or low liquidity affects the profitability of firm in
an adverse manner. The profitability and liquidity, both are important goals for any firm, and to
forego one goal at the cost of other can create serious problems for the firm. Profitability is a
long term goal for any firm because it is required for the survival of the firm and firm will not
continue to exist without profits. On the other hand liquidity is relatively shorter term goal which
needs to be addressed to protect the firm from bankruptcy (Scharf 1984).

Different authors addressed this issue of maintaining a tradeoff between these two conflicting
goals of profitability and liquidity but only gave a general approach to solve the problem. Walker
(1964) stated that increased investment in working capital is associated with decreased risk of
inadequate liquidity, risk of lesser inventory for sales and risk of not granting credit for sales and
production. Similarly if the firm decreased investment in working capital, it will increase the
above mentioned risks. Increased risk also increases profitability of the firm as the decreased
investment in working capital can be used for some productive use. Weston and Brigham (1975)
also discussed this trade off issue and suggested that investment in working capital should be
made till that time marginal return are more than cost of invested capital. And working capital
financing should be used instead of long term financing as long as their use does not increase
firm’s cost of capital. The study conducted by Walker (1964) also encouraged the use of more
working capital assets but emphasized on the risk involved as the major determinant of degree of
working capital investment.
A research by Smith (1980), Raheman & Nasr, (2007), also states the main purpose of any firm
is to maximize profit. But, maintaining liquidity of the firm also is an important objective. The
problem is that increasing profits at the cost of liquidity can bring serious problems to the firm.
Thus, strategy of firm must maintain a balance between these two objectives of the firms.
First as found by Lazaridis and Tryfonidis (2006) companies may enjoy better pricing when they
hold enough cash to purchase from own suppliers and thus they may enhance their profit. So
having enough liquidity also affects the profitability of the firm.
Secondly Deloof (2003) has also proved that by minimizing the amount of funds tied up in
current assets; firms can reduce financing costs and/or increase the funds available for expansion.
Referring to theory of risk and return, investment with more risk will result to more return.
Accordingly, firms with high liquidity of working capital may have low risk then low
profitability. On the contrary, firm that has low liquidity of working capital, facing high risk

10
results to high profitability. The issue here is in managing working capital, firm must take into
consideration all the items in both accounts and try to balance the risk and return.
Therefore the profitability liquidity tradeoff is important because if working capital management
is not given due considerations then the firms are likely to fail and face bankruptcy (Kargar &
Bluementhal 1994). Efficient working capital management involves planning and controlling
current assets and current liabilities in a manner that eliminates the risk of inability to meet due
short term obligations on the one hand and avoid excessive investment in these assets (Eljelly
(2004).
Smith, (1979) emphasized that profitability and liquidity comprised the salient goals of working
capital management. Therefore, in the next portion of this chapter, we present the studies
specifically on the relationship between working capital management and the profitability of a
firm.

2.6. Working Capital Management and Profitability

Profitability can be termed as the rate of return on investment, if there is an unjustifiable over
investment in working capital then, this would negatively affect the rate of return on investment
Vishnani & Shah, (2007). Therefore the basic purpose of managing working capital is
controlling of current financial resources of a firm in such a way that a balance is created
between profitability of the firm and risk associated with that profitability (Ricci & Vito 2000).

As stated by Siddiquee and Khan (2008) it has been observed that, firms which are better at
managing working capital are more profitable. They are also better at generating fund internally
and also face lesser trouble while seeking external sources of financing.
Short-term assets and liabilities are important components of total assets and need to be carefully
analyzed. Management of these short-term assets and liabilities warrants a careful investigation
since the working capital management plays an important role in a firm profitability and risk as
well as its value (Smith, 1980).
Recent works of Deloof, (2003); Howorth and Westhead, (2003) and Afza and Nazir, (2008),
state that firms try to keep an optimal level of working capital that maximizes their value.
As explained on Dupont model indicates by Brealey [Link] (2006), there is a relationship between
working capital and profitability of a firm.

Here ROA can be defined as: *

In this formula, net income per sales is usually called net operating profit margin and sales per
total asset the asset turnover. The total asset includes fixed asset and current asset. As defined
previously, current asset consist of gross working capital, thus by reducing the amount of capital
invested in the working capital, the company can effectively increase their asset turnover ratio,
which intern increase ROA.

11
2.7. Industry Effects on Working Capital
According to Mohammad (2011) Proper estimation of working capital actually required is a
difficult task for the management because amount of working capital varies across industries
over the periods depending upon the nature of industry, scale of operation, production cycle,
credit policy, availability of raw materials, etc. as the need and policies vary heavily from
industry to industry. Weinraub & Visschr (1998) study the different strategy employed by
companies to manage their working capital (aggressive, moderate or conservative) across
different industries, their purpose was to find out industries that tend to have aggressive
investment and financing strategy.

Moyer, Mcguigan and Kretlow (1995) found that working capital consists of a large portion of a
firm’s total investment in assets, 40 percent in manufacturing and 50% - 60% in retailing and
wholesale industries respectively.
The study conducted by Hawawini L. [Link] (1986) studies the investment needed in working
capital per industry. They use the working capital requirement as a measure for the investment in
working capital. They find significant industry difference in working capital needs. For example
airline industry has a negative working capital requirement which means that they actually make
money from their investment in working capital.

2.8. Empirical Review

In addition to the above theoretical review, an attempt is made on other empirical studies to look
into the working capital management and profitability of manufacturing companies in different
countries by different researchers.

Empirical results show that ineffective management of working capital is one of the significant
factors causing industrial sickness. Modern Financial management aims at reducing the level of
current assets without ignoring the risk of stock outs. Efficient management of working capital is
thus an important indicator of sound health of an organization which requires reduction of
unnecessary blocking of capital in order to bring down the cost of financing (Arshad 2013).
Deloof (2003), Surveyed on Belgian Firms to find out whether the working capital management
affects profitability, using correlation and regression tests he found a significant negative
relationship between corporate profitability and number of days accounts receivable, inventories
and accounts payable of Belgian firms. On the basis of these he suggested that manager could
increase corporate profitability by reducing the number of day’s accounts receivable and
inventories to a reasonable minimum. The negative relationship between accounts payable and
profitability is consistent with the view that less profitable firms wait longer to pay their bills.

12
CHAPTER THREE

RESEARCH METHODOLOGY
3.1. Introduction
This chapter presents the strategies, the choice of method, the data collection techniques and the
data analysis technique employed in this study. It as well describes the sampling technique used
as well as the ethical considerations for data collection.

3.2. The Research Design

For this research project descriptive design type of the research will be used because the research
will be conducted in order to describe the existing working capital management of Wolkite Flour
S.C.
3.3. Data Source and Collection Methods
For this study, the researcher will be used both primary and secondary source of data. From
primary method of data collection unstructured interview will be use rather than other method of
data collection with those individuals that are worked on the finance department of the company
in order to overcome some draw backs of secondary data. On the other hand the secondary data
will be collected by reviewing the company annual audited financial statement and audit report.
3.4. Method of Data Analysis
After the relevant data collected from the company financial statement, in order to describe the
real financial performance of the company the researcher will use different accounting tools such
as ratio analysis including liquidity ratio, debt ratio, profitability ratio and asset management
ratio, Horizontal analysis and vertical analysis.
3.5. Methods of Data Presentation
Finally, the analysis will present in the form of tables, percentages and graphs in order to
compare the financial performance of the company in different year.

13
CHAPTER FOUR

TIME AND BUDGET PLAN

4.1. TIME SCHEDULE

No Activity Sep. Oct. Nov. Dec. Jan. Feb.

1 Topic Selection x
2 Preparation of proposal x
3 Collection of useful material x
4 Data Collection x
5 Data Analysis and writing of final x
research
6 Submission of research x
7 Presentation of final research x

4.2. BUDGET PLAN

Item Quantity Per unit (Birr) Total Cost (Birr)

Paper Pack 1 500.00 500.00

Equipment and

Pens 6 5.00 30.00

Pencil 1 1.50 1.50
stationary

Binder 1 50.00 50.00

Total Cost - - 581.50
Transportation - 500 500.00
Internet - - -
Typist 1 500.00 500.00
Print 3 150 450
Personal cost

Total cost - - 1450.00

Contingency - - 203.15
Overall total cost - - 2234.65

14
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17
APPENDIX

WOLKITE UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING & FINANCE
APPENDIX I

WOLKITE FLOUR SHARE COMPANY

BALANCE SHEET
2007-2011
Items 2007 2008 2009 2010 2011

Current asset

Stocks and goods in 16,248.690 22,078,650 30,534,706 43,391,921 49130213

transit

Debtors and 902,121 1,309,383 3,669,611 5,146,703 19902756

prepayments

Cash at bank and 3,058,057 2,898,023 389,738 1,929,478 1544839

on hand

Total current asset 70577808

Fixed assets (net) 8,903,734 8,872,459 11,456,589 12,006,149 73702181

Lease hold land 1,498,495 1,663,369 6544287

Balance 8,903,724 8,872,459 80246468

Total Asset 150824276

Current liabilities

Creditors and 908,617 1,599,109 5,944,985 5,136,886 3858174

accruals

Bank overdraft 7,764,593 7,983,739 9,151,077 26141648

Provision for 790,454 629,287 1,459,911 3,698,261 111181

taxation

Dividend payable 4,778,839 778,243 306,551 -

18
Payable to major 1,242,390 1,242,390 -
stockholders

Term loan –current 1,096,440 3,015,240 7580568

maturity

Lease payable 164,874 329,748 494621

current maturity

Total current 38,,186,192

liability

Long term loan 271,028 794,937 2,742,181 35,324,145

Total liability 73,510,337

Total capital 21,121,264 23,923,010 29,326,010 39,757,676 77,313,939

Total liability and

capital

APPENDIX II

WOLKITE FLOUR SHARE COMPANY

INCOME STATEMENT
2007-2011
Items 2007 2008 2009 2010 2011

Sales 23,220,668 32,561,133 52,211,659 96,457,309 149,130,546

COGS 18,651,896 27,042,911 42,030,490 75,987,460 134,189,737

GP 4,568,772 5,518,222 10,181,169 20,469,849 14,940,809

Other Income 312,965 671,055 581,256 1,211,066 1,976,471

Expenses

Selling and 174,497 407,790 349,224 458,798 769,628

Distribution

Administration 1,297,485 1,771,566 2,092,894 3,278,209 4,168,596

Board Members Fee 36,925 69,125 41,250 76,000 142,000

Interest On Bank 48,213 307,686 533,018 1,042,151 1,774,836

Overdraft

Audit Fee and 26,022 7,979 8,000 9,000 9,000

Consultancy

19
Provision For Stock 791,326

Total Expenses 1,583,142 2,564,146 3,024,386 5,655,484 6,864,061

Net Profit Before Tax 3,298,595 3,625,131 7,738,039 16,025,431 10,053,219

Provision For 989,578 1,094,287 2,335,165 5,593,765 3,036,829

Taxation

Net Income 2,309,017 2530844 5,402,874 10,431,666 7,016,390

20