Determining the optimal working capital to enhance firms’ profitability

Abstract

Seeking the optimal level of cement firms’ working capital in Pakistan, this study examines the impact of working capital on their operating profit. By employing panel least squares estimation, panel fixed effect and panel generalized method of movement, the research finds a significant curvilinear relation between working capital and profitability. Further, it confirms that a positive working capital yields negative profitability, while a negative working capital affects profitability positively. In each method, the optimal level of working capital is derived as the partial derivative of the Working Capital Rate (WCR), with respect to sales. The research also investigates cement firms’ cash level, an important contributor to working capital management efficiency.

Keywords

Working capital profitability optimal cash holding cement firms

Ashfaq Habib received his Master degree in Management Sciences from Muhammad Ali Jinnah University Islamabad, Pakistan in 2011. His major research areas are capital structure, capital budgeting, and portfolio analysis. He has been working as Lecturer in Mohi-Ud-Din Islamic University after that he joined the University of Poonch Rawalakot as a Research Associate. He is currently pursuing the Ph.D degree in Management Sciences at Dongling School of Economics and Management, University of Science and Technology Beijing, China.

Prof. Dr. Xiaoxia Huang received her Ph.D degree in Management Sciences and Engineering from Beijing Institute of Technology, China in 2007. Her major research areas are portfolio analysis, capital budgeting, investment optimization, application of uncertain theory. She is authors of the famous book, Portfolio Analysis: From Probabilistic to Credibilistic and Uncertain Approaches, Berling: Springer-Verlag, 2010. She is currently serving as Professor of Management Science and Engineering in Dongling School of Economics and Management, University of Science and Technology Beijing, China.

1 Introduction

The Pakistan cement industry is playing a vital role in economic development of the country. It contributes public revenues around 30 billion rupees per annum and provides employment opportunities to more than one hundred thousand people. It also provides the raw material to civil engineering and construction projects, which plays an essential role in economic development of the country [1]. Its production increased by 46.41% in 2006 and earned profit to 17.4 billion rupees, which is the first time in the history of Pakistan cement industry. But this increasing trend could not sustain itself over the next years.

The global financial crisis 2008 reverted the increasing trend in Pakistan cement industry. The production decreased by 12.22% and earned only 3.30 billion rupees in 2008. The industry debt increased by 47.94 billion rupees, which was 60% of debt retained by industry in the last five years. The industry is still underperforming and at zero growth rate is recorded in production during 2013-14 [2, 3]. It confronts a number of challenges including the raising energy cost, increasing competition in the international market and low prices of cement in the domestic market.

Pakistan’s soil is rich in white limestone, which is a basic ingredient of cement manufacturing. Cement plants are installed near to rocks of white limestone and enjoying the benefit of low-cost accessibility to the raw material. In such a scenario, cement industry needs to manage operation efficiently to undertake the new challenges and to avail the opportunity of low-cost accessibility of the raw material. It is not only to increase operating profit but also provide a liquidity to run operation efficiently.

Working capital reflects short-term liquidity and measures the operational efficiency of business. It is the difference between current assets and current liabilities. The current assets are cash, marketable securities, account receivables and inventory. These assets are used to assess liquidity position to meet short-term obligations. Short-term obligations are trade debts, short-term debts, and outstanding liabilities etc. [6, 7].

A higher level of working capital creates an opportunity to increase sales by holding large inventories to control input price fluctuation and distributions. It also facilitates to extend trade credit and avails discount to make an early payment. But this requires additional financing, which increases interest expenses and bankruptcy risk [8, 9]. In addition, the excesses cash balance in working capital restricts firms to invest in value enhancing projects in the short run [5 , 10].

Alternatively, a low level of working capital is reducing the financing cost by maintaining a small amount of cash, inventory and trade creditors. But it can also cause a liquidity crisis, shortage of inventories and reduction in trade credit. Managers require a trade-off between liquidity and profitability to run the operations smoothly [11, 12].

The smooth operation strategy needs the efficient management of working capital components (cash, account receivables, inventories, account payables and short-term debt [13, 14]. The efficient working capital management demands to meet short-term obligations and to avoid over-investment in liquidity [5, 15]. Hence, the profitability of firms’ can be enhanced by efficient monitoring of cash, inventories, account receivables and account payables [16, 17].

Cash is a most liquid element of working capital. It directly affects the operational ability of firms’ to meet its short-term financial claims [18, 19]. The firms hold cash to meet the operational expenses that exceed the regular income and to prevent itself against the risk of liquidity shortfall [20]. However, it is not always beneficial to hold too much cash. Cash is a least profitable asset, and investment in cash is costly [21 –23]. The firms tend to invest in less liquid assets to earn a higher rate of return.

Myers [24] offered cash trade-off theory that equalizes costs and benefits of cash holding. The optimal level of cash can be obtained by trading-off among the working capital components to support the operational activities of the business [25, 26]. Therefore, the working capital is used to examine the operational efficiency and cash is performing the most important role to determine the efficiency that eventually influences the profitability of the firms. Thus, the purpose of this study is to examine the impact of working capital on the profitability of cement manufacturing firms in Pakistan and to identify the optimal level of working capital. Further, the study will examine the moderating effect of cash on working capital and profitability. It will guide to overcome the obstacles faced by Pakistani cement firms’ to seek the efficient working capital management.

2 Literature review

2.1 Working capital

Working capital reflects the firms’ liquidity position to meet the short-term financial obligations that arise during the operation of business. The operational risk and returns are generated due to acquiring the inventories from suppliers and collecting the receivables from customers. However, the cash conversion cycle (CCC) has been widely accepted to reflect a measure of risk and returns that are associated with the operation of business [4, 27]. CCC is used to measure the length of time to convert inventory, account receivables, and account payables into cash. For instance, [4 , 28–30] used the cash conversion cycle (CCC) as a proxy of working capital to analyze relationship between working capital and profitability. Theoretically, CCC presents the operational side (inventories, account receivables, account payables) of working capital. In this way past studies, used CCC to analyze the operational side of working capital to measure the operational performance of firms.

The relation between profitability and cash conversion cycle was examined during the period 1996–2000 of Saudi Arabia non-financial listed firms [15]. The research derived a strong negative relation between profitability and cash conversion cycle. The strong negative association was also found in the analysis of Japanese firms [28]. A negative CCC indicates that the firms are processing inventory more quickly, collecting account receivables on-time and delaying the payments to suppliers as much as possible.

Recently, [14] investigated the effect of working capital on profitability in different business cycles during 1990–2008 of Finnish listed firms. The results are consistent with the study [15, 28]. Here the negative CCC indicates that Finnish firms can increase their profitability by managing inventories more efficiently and collecting the account receivables well in time. It states that negative level of CCC needs a lower level of expensive external financing. In contrast, the positive relation was found between CCC and profitability of listed manufacturing firms in Ghana 2005–2009 [30]. The same results were derived in the analysis of Pakistan listed firms [31]. Further, the insignificant relation was found between CCC and profitability of listed firms in Tehran stock exchange during 2006–2009 [29].

A negative level of CCC may also result in reducing operating profit. If the inventory level is reduced too much it can cause an interruption in the production process and delivery problem to customers. The sales may also be decreased due to a shortage of finished goods [32 –35]. Similarly, a large reduction in trade credit may cause a decrease in sales and can damage the relation with valuable customers [33 , 37]. Further, paying vendors after a long payment period and requiring more credit from suppliers result in a reduction in profitability as the firms may fail to avail discount for early payment [33].

According to [6 , 38] inverted U-shape relation exists between profitability and CCC in the analysis of non-financial firms. These studies suggest that at a lower level of working capital firms should increase the investment in working capital in order to increase profitability. However, an increase in working capital can cause a reduction in profitability after a certain point. Therefore, an optimal level of working capital can be found and maintained at a certain point to avoid the negative affects of working capital on profitability.

In the light of above literature, it is observed that no one study fully capture the effects of working capital on profitability. These studies considered the operating aspect of working capital but ignored its financial aspects (cash and short-term debt) that play a pivotal role in maintaining the efficient working capital management. For instance, if the level of cash is increased, the relation between working capital and profitability differs as compared to decrease cash in working capital. Similarly, if the firms have an opportunity to raise short-term debt at a low cost to increase the working capital, the relation between working capital and profitability is changed as compared to raise costly finance from the market.

Further, it has also been studied that effect of working capital on firms’ profitability is changed due to change in characteristics and environment of each industry. The past studies [14 , 28] found a negative relation, while [30, 31] have found a positive relation in different industries in different environments. Therefore, it provides an opportunity to examine operating and financial aspects of working capital on the profitability of Pakistan cement industry. In such a situation, where the cost of raising finance is high, firms’ have an opportunity at the low-cost accessibility of raw material and large demand of cement in the market.

Hypothesis 1: The cement firms’ in Pakistan create inverted-U shape relation between working capital and profitability.

Hypothesis 2: If the working capital of cement firms’ is positive, it will create a negative impact on profitability.

Hypothesis 3: If the working capital of cement firms’ is negative, it will create a positive impact on profitability.

2.2 Cash

Cash holding gets more importance in Pakistan, where fluctuation in prices is very high and has a large energy crisis. Firms might be needed a sufficient amount of cash to run day to day operations of business. However, cash is most liquid and least profitable component of working capital. It is required to maintain cash with the availability of economic conditions and market situation. In favorable economic conditions, it is not suitable to hold extra cash due to higher opportunity cost. While in unfavorable economic conditions firms need to maintain sufficient portion of cash to encounter the liquidity crisis.

Keynes [20] explained the motives of cash holding as transaction motives and precautionary motives. In transaction motives, firms’ maintain liquidity in the form of cash to minimize opportunity cost, reduce expensive external financing, decrease the risk of financial distress and increase flexibility in internal financing [21 , 39]. Simply in transaction motives, firms’ maintain cash to meet operational expenses that exceed their regular income. In precautionary motives, firms’ hold cash to prevent itself against the risk of liquidity shortfall in near future that might be avoided to take value enhancing projects [40, 41]. Thus, both in the transaction and precautionary motives, firms’ need an adequate amount of cash to finance their operation efficiently. However, cash holding is not free of cost. Firms’ pay the cost of cash holding in the shape of opportunity cost, interest expenses and agency cost that negatively affect the operational benefits of cash holding.

Working capital is used to measure the operational efficiency of business. The level of cash holding is dependent upon the management of working capital. A delay in collection of accounts receivables, excess investment in inventories and fast payment of accounts payables are indicating a positive working capital, which shows that firms are poorly generating the cash flow from operation [4, 14]. In such a situation firms’ need sufficient cash balance to finance its operations [12, 41]. The greater cash holding, increases the opportunity and financing costs that adversely affect the profitability of the firms.

In contrast, the firms’ having shorter the account receivables cycle, a higher rate of inventory turnover and delaying the account payables are indicating a negative working capital and lower level of cash is needed to be invested in working capital [6 , 16]. This implies that firms’ are efficiently generating the cash flow from operations. The efficient cash generation from operations needs a lower level of cash holding to pay the short-term debt and trade credit. The lower level of cash holding also reduces interest expenses and opportunity cost in the short run to increase the profitability of the firms. Hence, a positive working capital and a positive cash holding are negatively affecting the firms’ profitability. In contrast, a negative working capital and a positive cash holding are positively affecting the firms’ profitability. So, the cash is playing a moderating role to develop a relation between profitability and working capital.

Hypothesis 4: If cement manufacturing firms’ in Pakistan maintain a positive working capital, the negative relation between working capital and profitability will vary on the level of cash holding.

Hypothesis 5: If cement manufacturing firms’ maintain a negative working capital, the positive relation between working capital and profitability will vary on the level of cash holding.

3 Data and methodology

3.1 Sample

This study uses financial data of Pakistan listed cement manufacturing firms from 2006 to 2014. The data has been extracted from Balance Sheet Analysis of firms compiled by State Bank of Pakistan and websites of listed cement firms. All listed cement manufacturing firms’ are included in the sample, except one firm’s that was declared financial bankruptcy in 2011-2012. The 1% outliers have been converted into average in the entire data set to streamline data for final analysis. The value of Cronbach’s Alpha (0.78) has further confirmed the reliability of data. For the final analysis, this study uses 9 years data, of 20 listed firms, of 180-panel observations of each variable.

3.2 Variables

This research employs the Return on Assets (ROA = net operating income/total assets) as an explained variable to analyze the effect of working capital on operational performance for cement manufacturing firms. The explanatory variables include Working Capital Rate (WCR = working capital/sales), Inventory Rate (INVR = inventory/sales), Accounts Receivable Rate (ARR = accounts receivable/sales) and Accounts Payable Rate (APR = accounts payable/sales). Further, the entire sample is divided into a positive WCR (sum of cash and non-cash assets being more than current debt) and a negative WCR (sum of cash and non-cash assets being less than current debt) to more critically analyze the impact of working capital on profitability. The reason behind this is to examine traditional working capital view that a positive WCR can help to increase the profitability of firms and another view that a positive WCR can cause to decrease the profitability of firms. So it is not suitable to analyze the entire sample mutually, without considering the level of working capital.

Working capital consists of cash assets (cash + cash equivalent – current debt) and non-cash assets (inventory + accounts receivable – accounts payable). The Cash Holding Rate of cash assets (CHR = (cash + cash equivalent – current debt)/total revenue) is used in this study as a proxy for cash holding level. In contrast, the Cash Conversion Rate of non-cash assets (CCR = (inventory + accounts receivable – accounts payable)/total revenue) is used as a proxy for cash conversion cycle. In addition, the interaction term (CHR*WCR) is used both in a positive working capital and a negative working capital to analyze the moderate role of cash in panel Ordinary Least Square. A dummy variable is created with reference to the CHR; (1 = positive CHR) and (0 = negative CHR). The control variables include the Size of Firms’ (FS = log of non-current assets), Leverage (LEV = log of non-current liabilities), Sales Growth (Growth = percentage growth in sales) and Gross Domestic Product (GDP = percentage growth in GDP).

The redundant variable test is applied to check the reliability of variables in the equations. All variables have been found statistically significant during the redundant test. Similarly, multicollinearity in explanatory variables is checked through Tolerance (Toler) and Variance Inflationary Factor (VIF). The values of Toler and VIF are for working capital rate (WCR = 0.57-Toler, 1.11-VIF), firm size (FS = 0.53-Toler, 1.08-VIF), sales growth (Growth = 0.97-Toler, 1.03-VIF), leverage (Lev = 0.82-Toler, 1.14-VIF) and gross domestic product (GDP = 0.80-Toler, 1.12-VIF) respectively. It is seen that they are all greater than 0.5 and less than 2, which indicates that no serious multicollinearity problem exists in explanatory variables.

3.3 Statistical analysis

The research uses the statistical techniques to analyze the relation between working capital and profitability. The Panel Ordinary Least Squares regression method (OLS) in Equation (1) is used to examine the relation between profitability and working capital. The Panel Fixed Effect Method (FEM) and Generalized Method of Movement (GMM) are also applied to reconfirm the results. The FEM is used to remove serial correlate errors in Equation (2). The Hausman test is applied to choose fixed or random effect method. The Cross Section Random Chi.Sq.Statistics (8.8621) under Hausman Test has been found statistically significant. Therefore, FEM is applied instead of the random effectmethod.

Further, GMM is applied to control the endogeneity problem in Equation (3). We run the Breusch-Godfrey Serial Correlation LM Test to check either model is suffering from the endogeneity problem or not. The LM test (Obs*R-Squared 39.22-Prob.Chi-Square 0.0323) is significant at 5% level which indicates that the endogeneity problem is occurring in the model. The endogeneity problem occurs, when one or more explanatory variables correlate with error terms which can be the result of omitted variables or measurement errors. The proper instrument variables are used to deal with the endogeneity problem that correlates with the indogenous independent variables but does not correlate with errors. In GMM, the lag-regression and lag-difference of independent variables can be used as instrument variables to deal with the endogeneity problem. To summarize the following methods are used to examine the relation between ROAand WCR.

1- Panel Ordinary Least Square (OLS)

$ROA = β_{0} + β_{1} * WCR + β_{2} * {WCR}^{2} + β_{3} * FS + β_{4} * Growth + β_{5} * LEV + β_{6} * GDP + ɛ$ (1)

2-Panel Fixed Effect Method (FEM)

${ROA}_{i, t} = β_{0} + β_{1} * {WCR}_{i, t} + β_{2} * WCR β_{i, t}^{2} + β_{3} * {FS}_{i, t} + β_{4} * {Growth}_{i, t} + β_{5} * {LEV}_{i, t} + β_{6} * {GDP}_{i, t} + α_{i} + ɛ_{i, t}$ (2)

3-Panel Generalized Method of Movement (GMM)

${ROA}_{i, t} = β_{0} + β_{1} * {ROA}_{i, t - 1} + β_{2} * {WCR}_{i, t} + β_{3} * {WCR}_{i, t}^{2} + β_{4} * {FS}_{i, t} + β_{5} * {Growth}_{i, t} + β_{6} * {LEV}_{i, t} + β_{7} * {GDP}_{i, t} + α_{i, t} + ɛ_{i, t}$ (3)

$\begin{matrix} Instruments for differenced variables : \\ GMMType : {ROA}_{i, t - 1} \end{matrix}$ $\begin{matrix} Standard : Δ {WCR}_{i, t}, Δ {FS}_{i, t}, Δ {Growth}_{i, t} \\ Δ {LEV}_{i, t} Δ {GDP}_{i, t} \end{matrix}$

4 Results and discussion

4.1 Descriptive statistics

Table 1 presents the descriptive statistics of firms’ a positive working capital group and a negative working capital group from 2006 to 2014. The mean (0.07) and Std. Dev (0.09) of ROA in a positive working capital group has recorded a significant different to the mean (0.01) of ROA in a negative working capital group but Std. Dev (0.11) has found approximately same. The positive WCR group are enjoying the positive WCR (0.16) and positive CHR (0.04) as compared with negative WCR group which holds the negative WCR (–0.72) and negative CHR(–0.36).

The mean value of APR (0.11) and (0.64) is highest among the components of CCR (INVR, ARR, and APR) both in positive and negative working capital groups respectively, which indicates that overall cement firms are availing the opportunity of trade credit. The average sales growth (0.12) in a positive WCR group is recorded a lower than average sales growth is recorded (0.31) in a negative WCR group. The positive WCR group has retained a low percentage of LEV (0.47) to finance their operation as compared with the negative WCR group, which has retained a high percentage of LEV (0.65).

Both positive and negative WCR groups are further divided into sub-groups on the basis of CHR as presented in Table 2. Positive WCR group has divided into sub-groups, positive CHR group, and negative CHR group. But negative WCR group has only maintained the negative CHR group. In other words, all firms’ in negative WCR group are having only negative cash holding rate. In positive WCR group, sub- group positive CHR group has earned higher ROA (0.08), WCR (0.31) and CHR (0.25) as compared to sub-group negative CHR that earned ROA (0.06), WCR (0.06) and CHR (0.10).

The both groups in positive WCR are holding the negative CCR to manage their operations efficiently. In positive WCR, sub-group positive CHR has earned the highest ROA (0.08) when firms’ have positive CHR (0.25), positive WCR (0.31) and negative CCR (–0.05) as compared with the other two groups. In contrast to negative WCR group, sub-group negative CHR has earned ROA (0.01), WCR (–0.72), CCR (–0.36), CHR (–0.36) and Growth (0.31) which are significantly different from sub-groups of positive WCR group.

Table 3 presents the results of Pearson correlation among variables. The significant moderate relation has been found between ROA and WCR (0.50). In WCR components, only the CHR has a positive significant relation (0.51) with ROA, whereas other WCR components, ARR (–0.35), INVR (–0.26), APR (–0.47) have a significant negative relation with ROA. All WCR components are negatively associated with WCR, except CHR (0.68) which has created a positive significant relation with WCR. Further, it is studied that APR (–0.88) has developed a strong negative relation with WCR, whereas INVR (–0.29) developed a weak negative relationwith WCR.

4.2 Statistical analysis

The results of Panel OLS, Panel FEM, and Panel GMM regression analysis are presented in Table 4. The significant positive relation has been found between ROA and WCR in all methods by using equation from (1) to (3). The significant effect explains that a change in working capital brings a change in operating profit of firms. The firms’ can increase the profit by increasing or decreasing in the working capital which creates a U-shape between ROA and WCR. The WCR² square term is used to analyze the effect of WCR on profitability. It measures the curvilinear relation between ROA and WCR as proposed in hypothesis 1. The significant effects of WCR² on ROA in each method show that inverted U-shape relation exists between ROA and WCR which supports the hypothesis 1. The same curvilinear relation is found by [8] in the analysis of UK firms and [38] in the USA listed firms respectively. The partial derivation has been calculated of WCR in term of sales to seek the optimal level of working capital. The Pakistani cement firms’ seek the optimal point, where WCR with respect to sales in OLS is (7.5%), WCR with respect to sales in FEM is (10%) and WCR with respect to sales in GMM is (5.67%).

The LEV (–0.0237) in OLS and LEV (–0.0277) in FEM have a significantly negatively related with ROA, whereas LEV (0.0791) has a significantly positively related with ROA in GMM model. The other control variables (Growth, FS, and GDP) have also developed a significant relation with ROA in each method as presented in Table 4. It indicates that these variables have great influence on the operational performance of firms. Managers need to analyze each variable carefully to design the efficient working capital which ultimately affects the profitability of firms. These results are consistent with previous studies of [38] but contradict to [8]. Further, the WCR² term has a significant effect on ROA, which develops inverted U-shape relation as proposed in hypothesis 1. The same results are derived by [6, 38].

The entire samples have been divided into a positive and negative working capital groups to test the unique relation between firms’ profitability and working capital as proposed in hypotheses 2 and 3. Table 5 presents results of OLS, FEM and GMM analysis of a positive working capital group. The WCR (–0.0893) in OLS, (–0.0894) in FEM and (–0.0641) in GMM have developed a significant negative effect on profitability. The negative effect of WCR on ROA indicates that firms’ are not managing the working capital efficiently by over-investing in inventory, accounts receivable and accounts payable. The over-investment in working capital requires more cash balance and to raise finance from the external market which increases the financing and opportunity costs. The increasing portion of financing and operation costs in positive working capital leads to decrease the profitability of firms. The results support hypothesis 2 that if firms’ have positive working capital, then the working capital is negatively effects the profitability of firms. These results are consistent with the studies of [6, 38].

In contrast, Table 6 presents the effect of a negative working capital group on profitability. The WCR (0.0186) in OLS, (0.0917) in FEM and (0.0297) in GMM have a significant positive effect on profitability. The significant positive effect of WCR on ROA indicates that firms’ are processing inventory more quickly, collecting account receivables on-time and delaying the payments to suppliers as much as possible. The firms’ are efficiently generating the cash flows from operations. In such a situation firms’ need a small amount of cash balance and raise little finance from external market, which reduces its interest expenses and opportunity cost. The decreasing portion of interest expenses and opportunity cost in a negative working capital leads to increase the profitability of firms. It also supports hypothesis 3 that a firms with a negative working capital creates a positive impact on profitability, consistent with the results of [6, 38].

Table 7 presents the moderating role of cash both in the positive and negative working capital groups. The interaction term (WCR×CHR) has been developed in Panel OLS to find the role of cash between ROA and WCR as proposed in hypothesis 4 and 5. The CHR dummy variable has been created (1 = positive cash holding rate) and (0 = negative cash holding rate) to test the hypothesis 4 and 5. In a positive working capital group, interaction term WCR×CHR (–0.1367) has developed a significant negative effect on ROA. It indicates that when working capital is positive if firms’ increase the cash balances, it will enhance the negative effect of WCR on ROA. The results support hypothesis 4 and consistent with the study of [6, 38].

In contrast, in a negative working capital group, the interaction term WCR×CHR (0.0544) has developed a significant positive effect on ROA. It indicates that when working capital is negative if firms’ increase the cash, it will enhance the positive effect of WCR on ROA as proposed in hypothesis 5. The results are contradicted by the study of [38]. The results of both positive and negative working capital groups have confirmed that ROA can be enhanced by decreasing CHR in a positive working capital firms’ and increasing CHR in a negative working capital firms’.

5 Conclusions

This study has examined the influence of working capital on operating performance of cement manufacturing firms’ in Pakistan by employing panel least square estimation, panel fixed effect and panel generalized method of movement. The research has found the significant effects of working capital on operating profit of cement manufacturing firms. The WCR² term has been used to find the curvilinear relation between working capital and profitability. The significant effects of WCR² on ROA in each method shows that U-shape relation exists between working capital and operating profit (hypothesis 1). Holding a positive working capital has created a negative effects on profitability (hypothesis 2) and holding a negative working capital has been created a positive effects on profitability (hypothesis 3). The optimal level of working capital has derived by taking the partial derivation of WCR in each method. The firms seek the optimal point, where WCR with respect to sales in OLS is (7.5%), WCR with respect to sales in FEM is (10%) and WCR with respect to sales in GMM is (5.67%).

Further, the interaction term (WCR×CHR) has been developed to find the moderating effect of cash between ROA and WCR. The interaction term (WCR×CHR) has created significant negative effects on ROA in a positive working capital group (hypothesis 4). It guides that when working capital is positive if the firms increase the cash balances, it will enhance the negative effects of WCR on ROA. In contrast, the interaction term (WCR×CHR) has created significant positive effects on ROA in a negative working capital group (hypothesis 5). It guides that when working capital is negative if the firms increase the cash balances, it will enhance the positive effect of WCR on ROA.

6 Future research

This study has examined the relation between operating profit and working capital of cement manufacturing industry in Pakistan. Although we have collected all the cement manufacturing companies in Pakistan, the sample is still small as compared with other manufacturing industries in Pakistan. The small sample may not be able to represent of other manufacturing sectors in Pakistan. Further, the cement industry is enjoying the low-cost accessibility of raw material and large demand of cement in the market. It gives a competitive margin to finance their operations through trade credit by adopting tight credit policy and receive the raw material at favorable terms and conditions. The future research can be conducted in other manufacturing sectors, where the cost of raw material is high and firms’ face stiff competition to sell the finished products in the market.

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