THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY

SYSTEMS PLUS COLLEGE FOUNDATION

The Effects of Working Capital Management on Profitability of SMEs

in Angeles City

Introduction and Review of Related Literature

The 2017 List of Establishments of the Philippine Statistics Authority (PSA) recorded

a total of 924,721 business enterprises operating in the Philippines. Micro, small and medium

enterprises (MSMEs) account for 99.56% (920,677) of the total establishments, of which

89.59% (828,436) were microenterprises, 9.56% (88,412) were small enterprises, and 0.41%

(3,829) were medium enterprises. Large enterprises made up the remaining 0.44% (4,044).

In addition, small and medium-sized enterprises (SMEs) employ over 70 percent of

the working population, Boh Wai Fong, Philippine Daily Inquirer (2018).

According to PFRS Section 15, Small and medium-sized enterprises are entities with

total assets of between P3 million to P350 million and total liabilities of between P3 million to

P250 million, publish general purpose financial statements for external users that are not in

the process of filing their financial statements for the purpose of issuing any class of

instruments in a public market; and do not have public accountability. In the Philippines,

SMEs are defined as any enterprise with 10 to 199 employees and/or assets valued from P3

million to P100 million, Nikki Natividad (2016).

The recent trends in value added by SMEs in the country and their sales indicate a

growing share. SMEs as a whole have been steadily growing year after year with the overall

industrial growth, as indicated by relevant factors, including the number of establishments and

the number of employees.

Nevertheless, compared to the absolute number of establishments and employment,

SMEs hold relatively small share of value added and sales, less than 30%, thus suggesting
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SYSTEMS PLUS COLLEGE FOUNDATION
their development potential in the country. One of the major issues encountered by managers

in this development journey is not just the procurement of funds but also their meaningful

deployment to generate maximum returns.

Businesses nowadays use a management of assets and liabilities called, Working

Capital Management (WCM) for efficiency and effectivity of the business itself. Working

Capital Management is essentially an accounting strategy with a focus on the maintenance of

a sufficient balance between a company’s current assets and liabilities. An effective working

capital management system helps businesses not only cover their financial obligations but

also boost their earnings. Managing working capital means managing inventories, cash,

accounts payable and accounts receivable. An efficient working capital management system

often uses key performance ratios, such as the working capital ratio, the inventory turnover

ratio and the collection ratio, to help identify areas that require focus in order to maintain

liquidity and profitability.

Working Capital management explicitly impacts both the profitability and level of

desired liquidity of a business. Hence, it may have both negative and positive impact on

firm’s profitability, which in turn, has negative and positive impact on the shareholders’

wealth, Raheman & Nasr (2007). If a firm invests heavily on working capital i.e. more than its

needs, the profits which can be generated by investing these resources in fixed or long term

assets diminishes. Moreover, the firm has to endure the cost of storing inventory for longer

periods as well as the cost of handling excessive inventory, Arnold (2008). It is therefore a

critical issue to know and understand the effects of working capital management and its

influence on firm’s profitability.

THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
SYSTEMS PLUS COLLEGE FOUNDATION
Accordingly, the researchers sought to determine the effects of Working Capital Management

either positive or negative to the profitability of SMEs in Angeles City, Pampanga.

Working Capital Management

Working Capital management refers to choosing the levels of mix of cash, marketable

securities, receivables, inventories and short-term financing. Efficient working capital

management practices involves planning and controlling current assets and current liabilities

so as to eliminate the risk of inability to meet short term obligations as they fall due and avoid

excessive investment in these assets (Eljelly, 2004).

The definition of Working Capital Management is “the administration of the firm’s

current assets and the financing needed to support current assets.” (Van Horne and

Wachowicz, 2008)

Working Capital management should answer some very important questions that

affect the firm’s sustainability and shape its financial strategy, in both short and long term

which are: “how much cash and inventory should we keep in hand? Should we sell on credit

to our customers? How will we obtain any needed short-term financing? If we borrow in the

short term, how and where should we do it.” (Ross, Westerfield and Jordan, 2008)

According to Dr. Ashok Kumar Panigrahi (2012), Working Capital Management

refers to all management decisions and actions that ordinarily influence the size and

effectiveness of the working capital. It focuses attention to the managing of current assets,

current liabilities and the relationships that exist between them.

Profitability

Profitability means ability to make profit from all the business activities of an

organization, company, firm, or an enterprise. It shows how efficiently the management can
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SYSTEMS PLUS COLLEGE FOUNDATION
make profit by using all the resources available in the market. According to Harward &

Upton, “profitability is the ‘the ability of a given investment to earn a return from its use.”

Profitability is an indicator of efficiency; and is regarded as a measure of efficiency and

management guide to greater efficiency. Though, profitability is an important yardstick for

measuring the efficiency, the extent of profitability cannot be taken as a final proof of

efficiency.

According to Dr. Monica Tulsian (2014), Profitability is a relative concept whereas

profit is an absolute connotation. Despite being closely related to and mutually

interdependent, profit and profitability are two different concepts. In other words, in spite of

their generic nature, each one of them has a distinct role in business.

The word 'profitability' is composed of two words, namely; profit and ability. The term profit

has already been discussed at length in detail. The term ability indicates the power of a firm to

earn profits. The ability of an enterprise also denotes its earning power or operating

performance. Also, that the business ability points towards the financial and operational

ability of the business.

Howorth Carole and Westhead Paul (2003) have tried to find out the working capital

management routines of a large random sample of small companies in the UK. Considerable

variability in the take-up of eleven working capital management routines was detected.

Principal components analysis and cluster analysis confirmed the identification of four

distinct “types” of companies with regard to the patents of working capital management.

While the first three types‟ of companies focused upon cash management, stock or debtors

routines respectively, the fourth „type‟ was less likely to take-up any working capital

management routines. The objective of the study is to encourage additional research rather
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SYSTEMS PLUS COLLEGE FOUNDATION
than to provide an exhaustive overview of all the factors associated with the take-up of

working capital management routines by small companies. The results suggest that small

companies focus only on areas of working capital management where they expect to improve

marginal returns.

Chowdhury Anup and Amin Md. Muntasir (2007):- That was the study carried on

pharmaceutical companies listed in Dhanka Stock Exchange. Observation of the study based

on the financial management, according to this major problem found in area of working

capital management. It is true that working capital effects go on business performance and

growth. The main objective of the study is to evaluate working capital practicability and

implication of working capital policy and strategies in the targeted industry. To obtain the

goal, evaluation was made regarding principles, procedures and techniques of stock

management, creditors’ management, and debtors’ management.

Sunday Kehinde James (2011) focuses on effective working capital management

within small and medium scale enterprises (SMEs). Most of the SMEs have little regard for

their working capital position and they don’t even have standard credit policy. They have very

weak financial position, and rely on credit facility to finance their operations. This credit

facility is available from accounts payable most of the time. In conclusion the authors

recommend that for SMEs to survive within the Nigeria economy they must design a standard

credit policy and ensure good financial report and control system. Besides, they must give

adequate awareness to the management of working capital. All this requires systematic

planning for the management of working capital to ensure continuity, growth and solvency

Cheng, Mui Gek (2013) Effect of Working Capital Management on Firms’

Profitability: Empirical Evidence from Malaysia. Masters thesis, INTI International

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SYSTEMS PLUS COLLEGE FOUNDATION
University. Working capital management influence the profitably of the company and

ultimately determine the firm value and the firm value is among the most important criteria

for any shareholders or potential shareholders to decide whether to invest or not to invest.

Inefficiency in managing the working capital will result in insolvency or eventually lead to

bankruptcy. In other words, managers should ponder all the elements that will affect the

working capital management. Consequently, the objective of this research paper is to examine

the effects of working capital management on firms’ profitability in Malaysia and to provide

better justification. The results indicate that there is significant relationship between working

capital management and profitability; therefore, efficient working capital policy can improve

profitability of the company and ultimately shareholders’ wealth.

Rahman Mohammad M. (2011):- Research is based on correlation among working

capital and profitability. To analyze the effectiveness of working capital management of the

selected textile companies. Conclusion of the study found that overall good management in

working capital of selected textile companies and thus most of the companies are profitable

way going on.

Dinesh M. (2008) explicates the concepts of working capital, the different challenges

being faced by the business firms in managing working capital and the strategies to be

adopted for its prudent management. The author concludes with the view that most of the

businesses failed not for want of profit but for lack of cash. The fast growth in production and

sales may cause the business to utilize all of the financial resources seeking growth and

making assets such as inventories, accounts receivable and other assets as more illiquid.
THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
SYSTEMS PLUS COLLEGE FOUNDATION
Statement of the Problem/Research Objectives

This study aims to determine the effects of working capital management on profitability of

SMEs in Angeles City. More specifically, the researchers sought answer to the following

questions:

1. What is the level of working capital management and profitability of SMEs?

2. Is there a significant difference on the level of working capital management between

SMEs when grouped according to:

a. educational attainment

b. capital source

c. years of existence

3. Is there a significant difference on the level of profitability between SMEs when grouped

according to:

a. educational attainment

b. capital source

c. years of existence

4. How may the level of working capital management of SMEs be described in terms of:

a. cash

b. inventory

c. accounts receivable

d. accounts payable

5. Is there a significant relationship between working capital management and profitability

of SMEs?
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SYSTEMS PLUS COLLEGE FOUNDATION
Conceptual Framework

A conceptual framework was framed to serve as the research plot of this study. It

considers the theoretical and conceptual issues surrounding research work and form a

coherent and consistent foundation that will underpin the development and identification of

existing variables (ACCA, 2011). This study seeks to establish The Effects of Working

Capital Management on Profitability of SMEs in Angeles City

Working
Capital Level of
Management Profitability

Figure 1. Conceptual Framework

Figure 1 shows the conceptualization of the independent and dependent variables of the

related study. Working Capital Management served as the independent variable whereas the

level of profitability as a dependent variable. The dependent variable causes an effect on

independent variables.
THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
SYSTEMS PLUS COLLEGE FOUNDATION
Null hypotheses

 There is no significant difference between the:

H1: level of working capital management and educational attainment of the owner.

H2: level of working capital management and capital source of the SME.

H3: level of working capital management and years of existence of the SME.

H4: level of profitability and educational attainment of the owner.

H5: level of profitability and capital source of the SME.

H6: level of profitability and years of existence of the SME.

H7: level of working capital management of SMEs and cash.

H8: level of working capital management of SMEs and inventory.

H9: level of working capital management of SMEs and accounts receivable.

H10: level of working capital management of SMEs and accounts payable.

 H11: There is no significant relationship between working capital management and

profitability.

Significance of the Study

This study was made to determine the impact of Working Capital Management on

companies’ profitability in Angeles City. Thus, this research is conducted to give deeper

understanding on the contribution of Working Capital Management on profitability and

provide additional information and references for relevant research in the future. Furthermore,

this research will benefit:

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THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY

SYSTEMS PLUS COLLEGE FOUNDATION
The SMEs

SMEs are main indicators of a countries’ economic development, contribute to

poverty alleviation in developing countries and they are part of the global market. The

importance of this study will help them understand the effects of working capital management

on profitability so as to enhance growth and success not only in the enterprise itself but also in

the countries’ economy.

The Potential Investors

The study findings will assist them to comprehend the status of the working capital

management practices of entrepreneurs and the interventions that need to be taken up to

achieve the increased performance and hence return for their funding.

The Financial Managers

They will be able to foresee financial challenges and opportunities thus act promptly

and appropriately. This will help them maintain a favorable working capital level that will

make the firm have an improved performance as well as increase in profit which is their main

objectives.

The Government

They can use this knowledge acquired from the economic planners to formulate

policies that promote sound business environment especially during economic instabilities.

The Researchers

The conducted study will give them more insights in the field of Management

Accounting and apply the practices of Working Capital Management in an actual course of

business.
THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
SYSTEMS PLUS COLLEGE FOUNDATION
The Future Researchers

They can use this study to obtain useful information critical to financial management

especially in the working capital management thus are able to develop more robust working 11

capital models.

Scope and Limitations

This study is conducted to find the relationship between working capital management

and profitability of the small and medium enterprises (SMEs). According to PFRS Section 15,

SMEs are entities with total assets of between P3 million to P350 million and total liabilities

of between P3 million to P250 million, publish general purpose financial statements for

external users that are not in the process of filing their financial statements for the purpose of

issuing any class of instruments in a public market; and do not have public accountability.

The respondents are limited to 30 owners, managers or accountants of different SMEs.

Furthermore, the location of study is Angeles City, Pampanga because it is one of the most

civilized cities in our country where there are many businesses.

METHODS

Research Design

The research design that will be used in this study is a survey research design because

it is the most appropriate to answer the questions and the objectives of the study. The

researchers will ask the respondents to rate the factors using 5-point Likert-type scale.

Furthermore, to get the results about the Effects of Working Capital Management on

Profitability of SMEs in Angeles City, the researchers will use________________.

THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
SYSTEMS PLUS COLLEGE FOUNDATION
Participants of the Study

The respondents are from Angeles City, Pampanga because there are numerous Small

Medium Enterprises (SMEs) located in Angeles City and it is also considered as a first class

highly urbanized City. It will be expected that these participants possess the necessary

information to answer the relevant questions for the study. The respondents will ask to answer

a Likert-type scales survey questionnaire. The researchers will choose thirty Merchandising

Businesses as respondents. In each Merchandising Business, the owner, manager or

Accountant of the company will require to answer the questionnaire.

Research Instrument

The researchers will use an instrument which consists of two (2) parts. The first part of

the instrument gathers data about the demographic profile of the respondent in terms of:

a. Educational attainment

b. Source of capital of the business

c. Years of existence of the business

The second part of the instrument gathers data about how the respondent is being efficient in

terms of their management with the following Working Capital Management components:

a. Cash

b. Accounts Receivable

c. Inventory

d. Accounts Payable

The researchers will use the Likert scale frequency distribution as an instrument

to gather data about the level of Working Capital Management in SME’s of Angeles City,
THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY
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Pampanga. There are seven questions each component of Working Capital Management

which will be rated by the respondent according to its corresponding frequency of practicing

the given situation stated with each question. The gathered data will be interpreted to show

the relationship between Working capital management and profitability.

Data Gathering Procedures

The respondents in the study were only limited thus requiring the need to use of

purposive sampling. The researchers will make a letter for the approval to conduct the study.

After the questionnaire was validated by the qualified personnel, the researchers will promptly

handed it out to the owner or manager or the accountant of the SME’s in Angeles City.

Data Processing and Analysis

(This includes sampling techniques and statistical treatment/tools used)