The Effect of Working Capital Management on Firm's Profitability: Evidence from Istanbul Stock Exchange

The Effect of Working Capital Management on Firm's Profitability: Evidence from Istanbul Stock Exchange

Seda Erdogan (Bogazici University, Turkey)
DOI: 10.4018/978-1-4666-9723-2.ch013
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Working capital management is an extremely essential issue for the healthy conduct of the sustainability of a business. The active and day-to-day nature of the short term business emporium, the ongoing necessity to substitute current assets and in the meantime to liquidate current liabilities clearly demonstrates the significance of working capital management and therefore the essential duty the financial executives carry. While an optimal strategy of working capital management is expected to positively contribute not only to the profitability of a firm but also its value; there is a trade-off between the liquidity level the firm is carrying and its profitability. The direct effect of working capital management on profitability and liquidity of firms clearly demonstrates the significance working capital management has in a firm and consequently the objective of this chapter is to find whether or not working capital management, i.e. cash conversion cycle has an effect on profitability for the publicly listed companies in Turkey using panel regression analysis.
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Both the studies conducted for the Turkish market, as well as the studies conducted for the other markets in the world indicate that there is a significant negative relationship between working capital management often measured in terms of cash conversion cycle and firm performance measured in terms of profitability measures. One of the important papers supporting this conclusion is written by Shin and Soenen in 1998, who studied the relationship between working capital management and profitability of firms, using Net Trade Cycle (NTC) instead of Cash Conversion Cycle to measure working capital management. The difference is that components of CCC are expressed as a percentage of sales in NTC. This study found a strong negative relationship between NTC and corporate profitability for a large sample of listed American firms for the periods between 1975 and 1994.

Key Terms in this Chapter

Receivables Collection Period: Receivables collection period shows how long it takes the customers to pay a company.

Basic Earning Power: Basic earning power shows the profitability of a firm with taking into consideration its EBIT.

Inventory Conversion Period: Inventory conversion period refers to the time elapsed during which a company must invest cash while it converts materials into sale.

Return on Assets: ROA shows how profitable a company is relative to its assets.

Gross Profit Margin: Gross margin demonstrates the percent of total sales revenue that the company withholds after deducting the direct costs associated with the manufacturing of the goods and services by the Company.

Payables Deferral Period: Payables deferral period demonstrates the management’s ability to delay payment to vendor.

Return on Equity: ROE shows how profitable a company is by using the money that has been raised from the company’s shareholders.

Cash Conversion Cycle: The length of time in days it takes for a company to convert resource inputs into cash flows.

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