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Working Capital Management and Its Impact on Profitability: A Case of Indian

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 Working Capital Management and Its
Impact on Profitability: A Case of Indian
Oil Corporation Ltd.
Tanushree Sharma* and Utkarsh Rathore**

Management of working capital is a crucial task for every manager in an organization,

because it directly affects the liquidity and profitability of an organization. The present study
investigates the importance of working capital management and its impact on profitability
of Indian Oil Corporation Ltd. (IOCL). A few important ratios have been considered for
highlighting the efficiency of working capital management. Pearson’s simple correlation
coefficient has been applied for measuring the degree of relationship between the working
capital management and profitability. The results revealed that out of eight ratios relating
to working capital management, four ratios, viz., Current Ratio, Current Assets to Total
Assets Ratio, Current Assets to Sales Ratio, and Cash Turnover Ratio, registered positive
association with the selected profitability ratio (ROI), and the remaining ratios like Debtors
Turnover Ratio, Inventory Turnover Ratio, Working Capital Turnover Ratio and Quick Ratio
witnessed a negative association with the selected profitability ratio.

Introduction
Working capital imparts life and strength—profits and solvency—to the business organization.
A company with sufficient working capital is always in a position to take advantage of any
favorable opportunity either to purchase raw materials or to execute a special order or to wait
for a better market position. Further, the adequacy of working capital contributes a lot in
raising the credit-standing of a corporation because of better credit terms, reduced cost of
production on account of receipt of cash discounts, favorable rates of interest on bank loans,
etc.
Importance of working capital management has always been a topic of discussion, and
various previous studies have unanimously accepted its importance in improving the profitability
and resulting improvement in return on investment or capital employed of the company. In
the present scenario of credit crunch, organizations are looking back at their working capital
management to release unnecessary blocking of funds in gross working capital in the form of

* Assistant Professor, NIILM-Centre for Management Studies, Plot No. 53, Knowledge Park-V, Post Office Kuleshra
Near Surajpur, Greater Noida 201306, India; and is the corresponding author. E-mail: tanu24feb@gmail.com
** Jr. Finance Manager, Indian Oil Corporation Ltd., UP State Office-II, E-8.Sector-1, Noida 201301, Uttar
Pradesh, India. E-mail: sidrathore21@gmail.com

Working
© 2013 IUP.
Capital
All Rights
Management
Reserved.
and Its Impact on Profitability: 1
A Case of Indian Oil Corporation Ltd.
investment in inventories or receivables. As the global financial crisis deepens and banks
tighten up on credit, working capital has become a pressing issue.
Management of working capital is a crucial task for every manager in an organization,
because it directly affects the liquidity and profitability of an organization. Ineffective
management of working capital is one of the important factors causing industrial sickness. An
optimal level of working capital is necessary to an organization for survival in the market, and
this study attempts to investigate the importance of working capital management and its
impact on profitability of Indian Oil Corporation Ltd. (IOCL) for the period 2005-2010.

Literature Review
The pioneer work of Shin and Soenen (1998) and the study of Deloof (2003) found a strong
significant relationship between the measures of working capital management and corporate
profitability. Narasimhan and Murty (2001) stressed on the need for many industries to improve
their Return on Capital Employed (ROCE) by focusing on some critical areas such as cost
containment, reducing investment in working capital and improving working capital efficiency.
Though working capital efficiency and working capital management is the concern for all the
business organizations, its importance is more crucial for the success of the small firms. Peel and
Wilson (1996) studied the importance of working capital for small and growing businesses, and
concluded that an efficient working capital management is a vital component of success and
survival. Ghosh and Maji (2003) made an attempt to examine the efficiency of working capital
management during 1992-93 to 2001-02. Ralf and Daniel (2008) and their studies confirmed
that in an average company, decreasing working capital by 30% leads to a 16% increase in after-
tax returns on invested capital, resulting in an increase in return on investment.
The importance of cash flow is not new to the finance literature and so the cash conversion
cycle. The studies of Walker and Petty (1978), Largay and Stickney (1980) and Deakins et al.
(2001) stressed on cash management, as managing cash flow and cash conversion cycle is a
critical component of overall financial management for all firms, especially those that are
capital-constrained and more reliant on short-term sources of finance. Eljelly (2004) elucidated
that efficient liquidity management involves planning and controlling current assets and current
liabilities in such a manner that eliminates the risk of inability to meet the short-term obligations
and avoids excessive investment in these assets.
All the above studies provide a solid base and give an idea regarding the importance of
working capital, working capital management and its components.

Objectives
• To establish a relationship between working capital management and profitability.
• To find out the effects of different components of working capital management on
profitability.
• To study the relationship between the liquidity and profitability of the IOCL.

2 The IUP Journal of Accounting Research & Audit Practices, Vol. XII, No. 3, 2013
 • To draw inferences about the relationship between the working capital management
and profitability of IOCL.

Data and Methodology

The data required for the study, i.e., balance sheet, statement of profit and loss account, etc.,
was collected from the annual report of IOCL for the period 2005 to 2010. The data was also
collected from various other sources like Intranet of IOCL, Internet, books, journals, etc.
For the analysis of data, some important ratios relating to working capital management and
the ratios which are significant to measure profitability have been calculated on the basis of
the data available for the IOCL.
The following ratios have been applied for highlighting the efficiency of working capital
management: Current Ratio (CR), Quick Ratio (QR), Current Assets to Total Assets Ratio
(CATAR), Current Assets to Sales Ratio (CASR), Working Capital Turnover Ratio (WCTR),
Inventory Turnover Ratio (ITR), Debtors Turnover Ratio (DTR), Cash Turnover Ratio (CTR),
and Return on Investment (ROI) to measure the profitability.
For measuring the degree of relationship between the working capital management and
profitability, Pearson’s simple correlation coefficient has been applied. In order to assess the
joint effect of the selected measures of working capital management on the profitability,
multiple regression analysis has been used.

Results and Discussion

The impact of working capital on profitability is measured by computing Karl Pearson’s
correlation coefficients between ROI and the selected measures relating to the working
capital management (Table 1). It is found that:
• The correlation coefficient between ROI and CR is 0.306, which indicates that
there is a positive association between the profitability and CR of the company, and
the correlation coefficient is found to be statistically significant at 1% level. This
implies that there is a significant association between ROI and CR of the company
during the study period.
• The correlation coefficient between ROI and QR is negative (–0.316), which is
found to be statistically significant at 1% level. It also reveals that there is a negative
relationship between ROI and QR.
• The correlation coefficient between ROl and CATAR is 0.76. It implies that there is
a positive correlation between profitability and the ratio of current assets to total
assets. The coefficient is found to be statistically significant at 1% level. It is evident
from these two ratios that the greater the CATAR, the higher the profitability of the
company.
• The coefficient of correlation between ROI and CASR is 0.695, which is also found to
be statistically significant at 1% level. It indicates a higher degree of positive association

Working Capital Management and Its Impact on Profitability: 3

A Case of Indian Oil Corporation Ltd.
 Table 1: Simple Correlation Analysis Between Selected Ratios Relating
to Working Capital Management and Return on Investment of IOCL Ltd.
Particulars 2005-06 2006-07 2007-08 2008-09 2009-10 Correlation
Coefficient

CR 1.42095 1.31479 1.53064 1.25268 1.32707 0.306

QR 0.47542 0.48322 0.64544 0.55306 0.51361 –0.316

WCTR 17.096 23.828 13.242 32.247 18.519 –0.624

CATAR 0.6549 0.63056 0.6909 0.5005 0.62436 0.76

CASR 0.20861 0.180404 0.213986 0.145007 0.220417 0.695

CTR 248.3157 240.6411 302.9868 360.5921 206.122 0.887*

ITR 13.089 14.575 15.452 18.634 14.837 –0.811*

DTR 27.35 32.78 36.63 48.46 46.74 –0.496

ROI (%) 17 22 17 7 20
Note: * indicates significance at 5% level.

between the two variables. Generally, the higher the CASR, the greater the efficiency
of the employment of working capital and larger is the scope of profitability.
• The correlation coefficient between ROI and WCTR is –0.624 which implies that
there is a negative relationship between these two variables. The calculated value of
correlation coefficient is found to be statistically significant at 1% level. It is an
accepted principle that the faster the WCTR, the slower is the relative investment
and greater is the profitability of the company. But the correlation shows, the faster
the WCTR, the lesser the profitability of the company.
• The correlation coefficient between ROI and ITR is negative (–0.811) and is found
to be statistically significant at 5% level. The higher the ITR, the lower is the
IOCL’s profitability. This is because of the fact that IOCL has to obey government
norms to fix the price.
• The correlation coefficient between ROI and DTR is negative (–0.496) and is found
to be statistically significant at 1% level. The study of the relationship between the
profitability (ROI) and the receivables management (DTR) conforms to the generally
accepted rule that the faster the DTR, the lower is the relative investment in receivables
and the higher is the profitability.
• Though we see here that the higher the DTR, the lower would be the profitability, the
study of correlation coefficient between ROI and DTR reveals that the computed
value of correlation coefficient does not conform to this acceptable principle.
• The correlation coefficient between ROI and CTR shows a positive association
(0.887), which is found to be statistically significant at 5% level. The more acceptable

4 The IUP Journal of Accounting Research & Audit Practices, Vol. XII, No. 3, 2013
 principle is that the higher the CTR, the more will be the efficiency of cash
management and the larger will be the scope for improving capital productivity,
and the CTR under study conforms to this accepted principle.
In order to select the independent variables in the analysis of multiple correlation and
multiple regression, the correlation matrix is constructed (Table 2). It is observed that there is
a very high degree of correlation between ITR and CTR (0.817), between ITR and CATAR
(–0.806), between CR and WCTR (–0.883), CATAR and WCTR (–0.952), CASR and WCTR
(–0.945), and CR and CATAR (0.847). This high degree of correlation indicates that there is an
existence of multicolinearity because multicolinearity refers to the existence of high correlation
between the independent variables.
Table 2: Correlation Matrix of IOCL for the Period 2005-06 to 2009-10
Ratio ROI CR QR CATAR CASR WCTR ITR DTR CTR
ROI 1
CR 0.306 1
QR –0.316 0.544 1
CATAR 0.76 0.847* 0.148 1
CASR 0.695 0.688 0.068 0.864* 1
WCTR –0.624 –0.883* –0.253 –0.952** –0.945** 1
ITR –0.811* –0.472 0.452 –0.806* –0.763 0.732 1
DTR –0.496 –0.529 0.302 –0.667 –0.348 0.502 0.782 1
CTR 0.887* –0.079 0.563 –0.565 –0.711 0.518 0.817* 0.33 1
Note: *indicates significance at 5% level; and ** indicates significance at 10% level.

Analysis of Multiple Correlation and Multiple Regression

1. ROI = B0 + B1.ITR + B2.CTR

Table 3: Multiple Regression Results – ITR and CTR

B0 B1 B2
Regression Coefficient 45.245 –0.729 –0.064
Standard Error 14.357 1.512 0.051
Calculated Value of t 3.152 –0.482 –1.259
Significant t 0.088 0.677 0.335
Multiple R = 0.899 R2 = 0.809
Adjusted R2 = 0.618 Standard Error = 3.56778

The combined impact of the selected measures relating to working capital management on
the profitability of the IOCL has been studied here. While fitting the regression equation, ROI
has been taken as the dependent variable and ITR and CTR have been considered as the

Working Capital Management and Its Impact on Profitability: 5

A Case of Indian Oil Corporation Ltd.
independent or explanatory variables (Table 3). The multiple regression equation which has
been fitted in this study is: ROI = B0 + B1.ITR + B2.CTR where B0 is a constant, B1 and B2
are the respective partial regression coefficients.
The detailed results of the multiple correlation coefficient (R), multiple coefficient of
determination (R2) and the regression coefficients of ROI on ITR and CTR show the strength of
relationship between dependent variable (ROI) and all the independent variables (ITR and
CTR) on the profitability of the IOCL during the study period from 2005-06 to 2009-10. It is
observed [the multiple regression equation of ROI = 45.245+ (–0.729) ITR +( –0.064) CTR]
that when ITR is increased by one unit (keeping CTR constant),
ROI = 45.245 + (–0.729) (1) + ( –0.064) (271.73*)
ROI = 27.12
(* the average of CTR taken from Table 1).
Thus, ROI is increased by 22.77 units, and this positive impact of ITR on the profitability
is found to be statistically significant at 1% level.
While for one unit increase in CTR (other independent variable held constant),
ROI = 45.245 + (–0.729) (15.31**) + ( –0.064) (1)
ROI = 34.14
(** the average of ITR taken from Table 2).
The ROI is increased by 34.14 units, and the positive influence of CTR on the profitability
of the company under study is statistically significant at 1% level.
Table 3 shows that the multiple correlation coefficient of ROI on ITR and CTR for the
study period 2005-06 to 2009-10 is 0.899. It reveals that the profitability of the company is
highly influenced by the selected indicators of working capital management. The study of
multiple coefficient of determination (R2) reveals that 80.9% of the total variation in the
profitability of the company is jointly explained by the two independent measures relating to
working capital management.
2. ROI = B0 + B1.ITR + B2.CATAR
Table 4: Multiple Regression Results – ITR and CATAR
B0 B1 B2
Regression Coefficient 25.817 –1.593 –24.476
Standard Error 58.867 1.876 53.450
Calculated Value of t 0.439 –0.849 –0.458
Significant t 0.704 0.485 0.692
Multiple R = 0.831 a
R 2
= 0.690
Adjusted R 2
= 0.380 Standard Error = 4.543645
Note: a Predictors: (Constant), CATAR, ITR.

6 The IUP Journal of Accounting Research & Audit Practices, Vol. XII, No. 3, 2013
When ITR is increased by one unit (keeping CATAR constant),
ROI = 25.817 + (–1.593)(1) + (–24.476)(0.620)
ROI = 9.048
Thus, ROI is increased by 9.048 units, and this positive impact of ITR on the profitability
is found to be statistically significant at 1% level.
While for one unit increase in CATAR (keeping the other independent variable constant),
ROI = 25.817 + (–1.593)(15.317) + (–24.476)(1)
ROI = –23.05
The ROI is reduced by 23.05 units, and the negative influence of CATAR on the profitability
of the company under study is statistically significant at 1% level.
Table 4 shows that the multiple correlation coefficient of ROI on ITR and CATAR is
0.831. It reveals that the profitability of the company is highly influenced by the selected
indicators of working capital management. The study of multiple coefficient of determination
(R2) reveals that 69% of the total variation in the profitability of the company is jointly
explained by the ITR and CATAR.
3. ROI = B0 + B1.CR + B2.WCTR

Table 5: Multiple Regression Results – CR and WCTR

B0 B1 B2
Regression Coefficient 123.437 –58.786 –1.255
Standard Error 77.135 46.759 0.690
Calculated Value of t 1.600 –1.257 –1.819
Significant t 0.251 0.336 0.210
Multiple R = 0.812 a
R 2
= 0.659
Adjusted R 2
= 0.317 Standard Error = 4.767822
Note: a Predictors: (Constant), WCTR, CR.

When CR is increased by one unit (keeping WCTR constant),

ROI = 123.437 + (–58.786)(1) + (–1.255)(20.986)
ROI = 38.31
Thus, ROI is increased by 38.31 units, and this positive impact of CR on the profitability
is found to be statistically significant at 1% and 5% levels.
While for one unit increase in WCTR (keeping the other independent variable constant)
ROI = 123.437 + (–58.786)(1.369) + (–1.255)(1)
ROI = 41.692

Working Capital Management and Its Impact on Profitability: 7

A Case of Indian Oil Corporation Ltd.
 The ROI is increased by 41.692 units, and the positive influence of WCTR on the profitability
of the company is statistically significant at 1% level.
Table 5 shows that the multiple correlation coefficient of ROI on CR and WCTR is 0.812.
It reveals that the profitability of the company is highly influenced by the selected indicators
of working capital management. The study of multiple coefficient of determination (R2) reveals
that 65.9% of the total variation in the profitability of the company is jointly explained by the
CR and WCTR.
4. ROI = B0 + B1.CATAR + B2.WCTR

Table 6: Multiple Regression Results – CATAR and WCTR

B0 B1 B2
Regression Coefficient –89.73 142.972 0.841

Standard Error 85.105 104.01 1.017

Calculated Value of t –1.054 1.375 0.827
Significant t 4.02 0.303 0.495
Multiple R = 0.828a R2 = 0.686
Adjusted R 2
= 0.372 Standard Error = 4.574584

Note: a
Predictors: (Constant), WCTR, CATAR.

When CATAR is increased by one unit (keeping WCTR constant),

ROI = (–89.73) + 142.972(1) + 0.841(20.986)
ROI = 70.891
Thus, ROI is increased by 70.891 units, and this positive impact of CATAR on the profitability
is found to be statistically significant at 1% level.
While for one unit increase in WCTR (keeping the other independent variable constant)
ROI = (–89.73) + 142.972(0.62024) + 0.841(1)
ROI = –0.212
The ROI is decreased by 0.21 units, and the negative influence of WCTR on the profitability
of the company under study is statistically significant at 1% level.
Table 6 shows that the multiple correlation coefficient of ROI on CATAR and WCTR is
0.828. It reveals that the profitability of the company is highly influenced by the selected
indicators of working capital management. The study of multiple coefficient of determination
(R2) reveals that 68.6% of the total variation in the profitability of the company is jointly
explained by the CATAR and WCTR.

8 The IUP Journal of Accounting Research & Audit Practices, Vol. XII, No. 3, 2013
5. ROI = B0 + B1.CASR + B2.WCTR
Table 7: Multiple Regression Results – CASR and WCTR
B0 B1 B2
Regression Coefficient –23.937 182.843 0.244
Standard Error 79.773 248.98 1.210
Calculated value of t –0.300 0.642 0.202
Significant t 0.792 0.597 0.859
Multiple R = 0.702a R2 = 0.493
Adjusted R2 = –0.014 Standard Error = 5.809550
Note: a
Predictors: (Constant), WCTR, CASR

When CASR is increased by one unit (keeping WCTR constant),

ROI = (–23.937) + 182.843(1) + 0.244(20.986)
ROI = 164.02
Thus, ROI is increased by 164.02 units, and this positive impact of CASR on the profitability
is found to be statistically significant at 1% level.
While for one unit increase in WCTR (keeping the other independent variable constant)
ROI = (–23.937) + 182.843(0.1936) + 0.244(1)
ROI = 11.72
The ROI is increased by 11.72 units, and the positive influence of WCTR on the profitability
of the company under study is statistically significant at 1% level.
Table 7 shows that the multiple correlation coefficient of ROI on CASR and WCTR is
0.702. It reveals that the profitability of the company is highly influenced by the selected
indicators of working capital management. The study of multiple coefficient of determination
(R2) reveals that 49.3% of the total variation in the profitability of the company is jointly
explained by WCTR and CASR.
6. ROI = B0 + B1.CR + B2.CATAR
Table 8: Multiple Regression Results – CR and CATAR
B0 B1 B2
Regression Coefficient 15.476 –63.814 142.685
Standard Error 6.872 9.012 13.602
Calculated Value of t 2.252 –7.081 10.490
Significant t 0.153 0.91 0.009
Multiple R = 0.992 a
R 2
= 0.984
Adjusted R 2
= 0.968 Standard Error = 1.037973
Note: a
Predictors: (Constant), CATAR, CR.

Working Capital Management and Its Impact on Profitability: 9

A Case of Indian Oil Corporation Ltd.
When CR is increased by one unit (keeping CATAR constant),
ROI = 15.496 + (–63.814)(1) + 142.685(0.6202)
ROI = 40.175
Thus, ROI is increased by 40.175 units, and this positive impact of CATAR on the
profitability is found to be statistically significant at 1% level.
While for one unit increase in CATAR (keeping the other independent variable constant)
ROI = 15.496 + (–63.814)(1.369) + 142.685(1)
ROI = 70.80
The ROI is increased by 70.80 units, and the positive influence of WCTR on the profitability
of the company under study is statistically significant at 1% level.
Table 8 shows that the multiple correlation coefficient of ROI on CR and CATAR is 0.992.
It reveals that the profitability of the company is highly influenced by the selected indicators
of working capital management. The study of multiple coefficient of determination (R2) reveals
that 98.4% of the total variation in the profitability of the company is jointly explained by the
CR and CATAR.

Conclusion
Out of the selected eight ratios relating to working capital management, four ratios, viz., CR,
CATAR, CASR, and CTR, registered positive association with the selected profitability ratio
(ROI) and the remaining ratios like DTR, ITR, WCTR and QR witnessed negative association
with the selected profitability ratio. Out of these eight selected ratios, only ITR and CTR have
significant association with the profitability ratio. It reveals that the profitability of the company
is highly influenced by the selected indicators of working capital management. The study
reveals that 89.9% of the total variation in the profitability of the company is jointly explained
by CTR and ITR, and 98.4% of the total variation in the profitability of the company is jointly
explained by CR and CATAR. There is a negative influence of CATAR and WCTR on the
profitability of IOCL.

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Reference # 09J-2013-07-05-01

Working Capital Management and Its Impact on Profitability: 11

A Case of Indian Oil Corporation Ltd.
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