Sector-wise correlation coefficients between Net Operating Profitability and other variables are presented in Table 7.2. It is observed that in general (overall) Net Operating Profitability is negatively associated with measures of working capital management (Average Collection Period, inventory turnover in days, Average Payment Period, Cash Conversion Cycle and Net Trade Cycle)7. The correlation coefficients for all the measures of working capital management are significant except for Cash Conversion Cycle.
The comparison of results on sectoral basis between different measures of working capital management reveals that Average Collection Period is negatively associated with Net Operating Profitability for all sectors except Sugar & Allied and Textile sector. The negative relationship is not significant only in case of Synthetic Jute and Leather sector. In case of Textile sector, it is showing significant positive relationship with the profitability while in case of Sugar sector it is although positive but not significant.
The strongest negative relationship between NOP and ACP is for the Paper &
Tobacco sector. These results show that collecting receipts from customer in shorter
7 To the best of knowledge, there are no studies to compare the sector-wise results of working capital management and profitability analysis. The analyzed industries in few studies such as Jose et al.,
time period enhances the firm’s profitability. Inventory Turnover in Days (ITID) also has a significant negative association with Net Operating Profitability (NOP). ITID has significant negative relationship with NOP for five sectors and Automobile and Engineering sector is the top one with highest negative relationship. Paper & Tobacco and Energy sector has the significant positive association between NOP and ITID.
In general and for most of the sectors, the results indicate that keeping inventory for a lesser time increase profitability for the firms. Therefore efforts must be towards reducing the time period needed to convert inventory into sales. The results of Average Payment Period (APP) are similar to the above two components of working capital management. There exists negative association between NOP and APP for all the sectors and insignificant only in case of Energy, Food and chemical sector. It indicates that reducing payment time period also increase the profitability which might be due to the reason that less profitable firms wait longer to pay their bills.
The correlation results for Cash Conversion Cycle on sectoral basis reveal that four sectors have negative association between CCC and NOP but significant only in case of two sectors i.e. Automobile & Engineering and Chemical Pharmaceutical &
Fertilizer. This indicates that reducing CCC enhances profitability for firms. The CCC has positive relationship with NOP in case of five sectors but significant only in case of Paper & Tobacco sector. This might be possible because longer Cash Conversion Cycle might also increase profitability because it may leads to increase in sales.
Table 7.2
Sector-wise Correlation Coefficients of NOP and other Variables
Automobile &
**. Correlation is significant at the 0.01 level (2-tailed).
This positive correlation for CCC is also consistent with the view that resources are blocked at different stages of supply chain therefore increasing CCC. The result of correlation between CCC and NOP for different sectors reveals that this relationship is sensitive to industry factors like product type, its durability, production process, capital intensity, marketing channels and competitive forces.
Another alternative measure of working capital management efficiency is the Net Trade Cycle. The correlation coefficients reflect a negative association of NOP for all the sectors except the Textile sector. In most of the sectors the negative correlation is significant at 5% level of significance. The overall result also indicates a significant negative association between NTC and NOP. It implies that if firms are able to reduce the Net Trade Cycle period, it can enhance the profitability for the firms in turn value creation for the shareholders. Shin & Soenen (1998) also confirmed that a shorter NTC is associated with higher profitability.
The gross working capital turnover has significant positive association with NOP for all the sectors except Food and Textile sectors where it is insignificant. The CATAR and CLTAR are included for analyzing the working capital policies followed in different sectors. The variable CATAR has positive relation ship with profitability for all sectors and significant only for Automobile, Cement and Textile sector while the other variable CLTAR has significant negative association with NOP for all sectors except Energy and Food sector. It indicates that most of the sectors are following conservative working capital management policy.
Current Ratio (CR), one of the traditional measures of liquidity has positive association with NOP in most of the sectors. Although, it has negative association with NOP only for energy and Sugar sectors but insignificant. The results indicate that CCC and NTC are measuring liquidity different from more conventional Current Ratio. In general, the understanding about traditional liquidity ratios like Current Ratio is that it has certain deficiencies in measuring working capital management efficiency of firms. One of the deficiencies is that this ratio incorporates those assets which are not readily convertible to cash and also ignore timing of cash conversion.
Financial Debt ratio is included to see the impact of leverage on the profitability. It
indicates that there is significant negative relationship between FDR and NOP for all sectors. It implies that increase in debt utilization by the firms in these sectors will put a negative effect on the profitability for those firms. Other two variables sales growth and natural logarithm of sales show a positive relationship with profitability. In case of LOS which represents size, it is significantly correlated with NOP for all sectors while SG is significant only in case of Sugar sector.
The above correlation analysis suggests that the differences exist between different industries. It suggests that both aggressive and conservative working capital management policies exist for different sectors. However, while interpreting the correlations results care must be exercised because these are not reliable indicators of association because it does not consider the correlation of other explanatory variables (Padachi, 2006). Therefore, we are also applying panel data methodology using fixed effect model in the following discussion.