This study examines the relationship of cash conversion cycle with the size and profitability of the firms in the four specific manufacturing sectors listed at Karachi Stock Exchange named Automobile and Parts, Cement, Chemical, and Food Producers Hence, the results are not generaliseable to non-listed companies but do present valid benchmarks of CCC turnover days for firms in the industrial sectors studied. The data is gathered from the annual reports of 31 sampled firms out of the total firms in the related sectors i.e. 143 covering the period of 2006-2010. The statistical tests which were used in the study for empirical investigation are One-Way ANOVA and Pearson correlation analysis. The lowest mean value of the CCC length is found in the cement industry, with an average of -52.38 days, and the highest mean value of the CCC is found in the Automobiles industry, with an average of 73.72 days. As was expected there is a significant negative correlation between the CCC and the firm size in terms of total assets, and appears a negative correlation between CCC and profitability in terms of return on total assets with the values of -0.415 and -0.131 respectively. The paper is one of the rare studies about the subject conducted in developing countries, and also in Turkey. Secondly, the paper presents industry benchmarks to the firms to evaluate their CCC performance. The study has several implications and is supposed to be very beneficial for the industries, academics and analysts, as it describes the cash management performance of the selected sectors and its findings can help in setting some useful benchmarks in the related sectors.

Key words: – Working Capital Management, liquidity, Profitability, Cash conversion cycle, ANOVA, Pearson Correlation.

Introduction

Working capital management (WCM) and liquidity management hold a significant position among the financial decisions because these affect the firm’s profitability, risk and its market value. Researchers have studied working capital management in different areas and in different ways, as several studies have been conducted on the relationships among the inventory management, account receivables, accounts payable and the cash conversion cycle. Cash conversion cycle ( CCC ) have three main components receivable conversion period, payment deferral period and the inventory conversion period. The firms always attempt to works to seek the most suitable combination of these variables so that the firm’s liquidity is kept intact as well as the firm’s profitability is also ensured at its optimal level. The CCC length relates to the number of days the cash resources are tied up in the working capital components. A larger CCC turnover definitely results in the unprofitable use of the firm’s resources and eventually it can hurt the firm’s profitability. The firms usually set appropriate policies of collection and discounts of the accounts receivables and resultantly these policies have much to do with the firm’s profitability. The firms have to make a very appropriate choice between the CCC length and offering discounts to their customer. On the other side of the credit payments, the firms have to ensure their adequate solvency as well as to delay the time period for the payment towards their creditors and the suppliers for the items and materials purchased on credit.

Liquidity management, which refers to management of current assets and liabilities, plays an important role in the successful management of a firm. If a firm does not manage its liquidity position well, its current assets may not meet its current liabilities. Hence, the firm may have to find external financing due to having difficulty in paying its short term debts. Unfortunately, every firm is not able to find external financing easily, especially as it is in small firm case. In addition, although firms are able find external financing, the cost of borrowing may be expensive, resulting in poorer bottom line. Liquidity of firms can be gauged by cash conversion cycle (CCC) measuring the time lag between cash payments for purchases and collection of accounts and debts receivables from clients. The working capital ratios such as current ratio and quick ratio are useful liquidity indicators of firms; they focus on static balance sheet values (Moss and Stine, 1993) whereas, CCC is a dynamic measure of ongoing liquidity management, as it considers related elements of both balance sheet and income statement along the time dimension (Jose et al., 1996). Measuring an individual firm’s CCC length is vital for its liquidity analysis and improvements, whereas the industry benchmarks are vital for comparative evaluation of its overall CCC performance and explore the viable opportunities for growth in the related sector(Hutchison et al., 2007). Cash or finance is really considered the lifeblood of business and a proper cash management and the firm’s liquid resources is vital to the firm’s profitability, survival and the ultimate growth. One can never expect a smooth working of any business unit unless and until its precious resources are used in an optimal way. The firms which face the WCM management problems and liquidity shortages always find it extremely difficult to cope with the issues relating to their survival and eventual growth. So investigating the optimal combination of the components of WCM is of paramount academic as well as practical importance, and that especially in the context of the developing countries and the small and medium sized enterprises ( SMEs). The meager resources on the disposal of the SMEs compel them to seek external financial assistance and that too is not always available in the required magnitude as the financial markets in the developing countries are not well developed and the lenders as well as the financial institutions are usually found hesitant to finance their needs. So the topic of liquidity management is of great importance in the context of the developing countries like Pakistan.

Defining Cash Conversion Cycle

The CCC measure is basically related to working capital management (Keown et al., 2003; and Bodie and Merton, 2000). It is used as a comprehensive measure of working capital as it shows the time lag between expenditure for the purchases of raw materials and the collection of sales of finished goods (Padachi, 2006). The management of a firm’s short term assets and liabilities is vital to the survival and ultimate growth of firms without which it long term prospects and healthy bottom lines can’t be guaranteed (Jose et al., 1996). The CCC length in days can be simply described in an equation as follows:

CCC length = Stock turnover days + receivables turnover days – payables turnover days

So we can easily understand that managing the cash both on the receivables side and the payable side is very important for the efficient utilization and ensured performance of the firms.

Figure 1: The cash conversion cycle

Adapted from Jordan (2003)

Cash conversion cycle (CCC) can be negative or positive. A positive CCC sho