MALAWI UNIVERSITY OFBUSINESS AND APPLIED SCIENCES

FACULTY OF COMMERCE
ACCOUNTANCY DEPARTMENT

RESEARCH PROPOSAL

ANALYSING THE RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT

AND THE PROFITABLITY OF CONSTRUCTION COMPANIES

A CASE OF MKAKA CONSTRUCTION COMPANY

SUBMITTED BY : BACW4 GROUP 15

JAMES MAGASO -BAC/21/ME/184
FELLINGS CHIZUMIRA- BAC 21/ME/157
NEWTOWN TAMULA -BAC /22/ME/106
FREEMAN MEMENA – BAC /21/ME/111
ESTHER KAUNDA - BAC/21/ME/102

SUBMITTED ON-
 Table of Contents
CHAPTER ONE: INTRODUCTION.............................................................................................................2
1.0 Introduction.................................................................................................................................2
1.1 Background of the Study.............................................................................................................2
1.1.1 The Concept of Working capital ...........................................................................................2
1.1.2 The Construction industry in Malawi ...................................................................................3
1.2 Problem Statement......................................................................................................................3
1.3 Research Objectives.....................................................................................................................4
1.4 Research Questions.....................................................................................................................4
1.5 Significance of the Study..............................................................................................................5
1.6 Scope and Limitations of the Study.............................................................................................5
1.7 Organization of the Study............................................................................................................5
CHAPTER TWO: LITERATURE REVIEW....................................................................................................2
2.0 Theoretical Review .....................................................................................................................2
2.1 Conceptual framework ...............................................................................................................2
2.2 Empirical review .........................................................................................................................3
2.7 Conclusion...................................................................................................................................5
CHAPTER 3: METHODOLOGY.................................................................................................................7
3.0 Introduction.................................................................................................................................7
3.1 Research Design...........................................................................................................................7
3.2 Study Population and Sampling Techniques................................................................................7
3.3 Data Collection Methods.............................................................................................................8
3.3.2. Questionnaires.....................................................................................................................8
3.3.3. Interviews............................................................................................................................8
3.4 Data Analysis Procedures.........................................................................................................8
3.5 Ethical Considerations.................................................................................................................9
3.6 Conclusion...................................................................................................................................9

References........................................................................................ Error: Reference source not found

CHAPTER ONE

Introduction

Construction industry in Malawi is a crucial aspect of the country’s development as it plays a

significant role in shaping its economic and social landscape.

In the construction industry, working capital management is particularly important due to the
long project cycles, high capital requirements and unpredictable cash flows. Poor working capital
management can lead to cash flow problems, delays in project completion, and ultimately hinder
business profitability (Polewski, 2010). Working capital is defined as the difference between a
company’s current assets and current liabilities (Gitman, 2020) while Working capital
Management is defined as managing current assets and liabilities to ensure the company has
enough liquidity to meet its short term obligations while optimizing operation efficiency
(Horne, 2007) .Profitability of a company can be measured using profitability ratios which
include Gross profit margin, net profit margin, return on net assets and return on capital
employed.

This chapter presents a research proposal that analyses the relationship between working capital
management and profitability of construction companies using Mkaka construction as our case
study. The chapter provides an overview of the research background, problem statement,
research objectives, research questions and the value of the study.

1.1 Background of the study

The concept of Working capital

Capital can be split into two major categories: fixed capital and working capital (Damodaran,
2012), fixed capital is capital that is used for long term investments, for example the purchase of
non-current assets, is a kind of capital that is non- recurring by nature. it normally comes from
shares and debt while working capital is the capital that is needed to fulfil the day-to-day
business needs, working capital comprise current assets and current liabilities, specifically the
components include inventory, receivables, cash, and payables. Working capital measures the
ability of the company to cover its obligations in the short term and long term and demonstrates
its strategy in operation (Houston, 2019). Managing working capital involves managing the
elements of working capital, for example inventory management involves keeping optimal levels
of inventory to avoid losses that come from over holding inventory, keeping low quantities, and
keeping excess inventories. The techniques which can be used to manage inventory include just
in time techniques, ABC analysis and Economic order quantities etc. Receivables management
involves reducing the number of days that customers take to pay the company, the techniques
which can be used to manage receivables include having good credit policies, factoring and
credit insurance etc. Payables management refers to the way a firm manages its payables, which
are amounts owed by a business to its suppliers. Techniques which can be used to manage
payables include cash flow management and forecasting and budgeting etc.

In Managing working capital firms may chose different approaches which have different
implications, the approaches are conservative approach, aggressive and moderate approach.
Conservative approaches of working capital management prioritize maintaining higher levels of
working capital to ensure a safety net for unforeseen events (Gitman, 2020). This involves
holding larger inventories and keeping surplus cash. Aggressive approaches of working capital
management focus on minimizing the amount of working capital tied in the business, this
involves efficient inventory management, prompt collection of receivables and strategic payables
management (Damodaran, 2012). Moderate approaches of working capital are a middle ground
between the conservative and aggressive approaches, it seeks to balance risk and efficiency.
They aim to maintain a reasonable level of working capital while also exploring opportunities for
growth and investment (Gitman, 2020).

The cash conversion cycle is one of the metrics which is used to measure the time it takes for a
company to convert its investments in inventory and other resources into cash flows from sales,
it is also known as the net operating cycle or the cash cycle, the shorter cash cycle, the better, as
it indicates less time that cash is bound in accounts receivables or inventory (Gitman, 2020). To
calculate the cash conversion cycle, we use the formula: CCC =DIO+DSO-DPO, where DIO
means days of inventory outstanding, DSO means day’s sales outstanding and DPO means days
payables outstanding. DSO and DIO are concerned with the inflows while DPO relates to
outflows. Liquidity ratios can also be used to measure working capital, for example current ratio
and quick ratio.
Lastly the effects of managing working capital can be seen in the profitability levels of the
company, so to understand the relationship between the two, profit measures which include gross
profit margin, net profit margin, return on assets and return on capital employed are used, other
supporting ratios like inventory turnover may also be used to support the changes in these two
variables (working capital and profitability)

Construction industry in Malawi

Malawi has a growing construction industry that is essential for infrastructure development,
economic growth, and job creation. However, construction firms in Malawi face various
challenges related to managing working capital efficiently due to factors such as fluctuating
demand, delayed payments, high input costs, and limited access to financing.

The industry has experienced steady growth over the years, with significant increase in the
Construction of infrastructure and housing. The industry is driven by public and private
investments, with the government being the largest investor in infrastructure development. The
public investments involve Government investment in road projects, hospitals, schools, and
government offices etc. while private sector investments have mainly focused on the
construction of residential and commercial buildings. GDP from construction in Malawi
increased to MK 258 118.70 million from 245,532.30 MK Million in 2022. There are currently
eight one registered construction companies in Malawi according to National Construction
industrial council. It is the national construction industrial council that regulates and registers
construction companies in Malawi.

One of the construction companies that has stayed for so long and contributed to the above GDP
figures is Mkaka construction Company Limited which is a multi-disciplined Local Malawian
company established in 1993 and incorporated in 2000, since its inception the company has
strengthened its capacity to undertake various projects including projects in the Civil and
building works. Despite winning several projects, the company has experienced challenges in
maintaining its working capital mainly because of the complex nature of working capital in
construction industry. The company has seen loss of revenues coming from late billings,
insufficient inventory to meet production, late receipts of cash from clients and tight deadlines to
pay suppliers.

1.2 Problem statement.

The construction industry in Malawi is one of the sectors that contribute to the country’s
economic growth. Currently, no studies have been done on the relationship between working
capital management and profitability of construction companies in Malawi, but relative studies
on capital management have been done by some scholars ,for instance Majanga (2015)
conducted a study that looked at the relationship between cash conversion cycle and firm
profitability in Malawi manufacturing sector which he concluded that to achieve profitability, the
liquidity position of the business needs to be improved (Majanga, 2015). Kings Msilimba
Chizimba and Dr Shameen (2024) conducted a study that assessed the impact of cash flow
management on the profitability of SMES in Malawi, a case study of Limbe small, and medium
enterprises.

Past studies have shown that decisions on working capital affect both profitability and liquidity.
Excess of investments in working capital may result in lower profitability and lower investments
may result in poor liquidity. Numerous global studies have investigated the working capital
management relationship with profitability. Mihir mash (2018) “working capital management
and profitability of the construction sector in Bangalore”, which he concluded that both current
assets and current liabilities have impact on profitability in construction companies. Rand
Mahommed Shams Addin Al-Mawsheki (2014), “The relationship between working capital
management and profitability of construction firms in Malaysia” indicated that there is a positive
relationship between working capital and profit. However the relationship between working
capital management and profitability of construction companies in Malawi is still an unexplored
area in the working capital management literature, therefore the main objective is establishing
the relationship between working capital management and profitability of construction
companies, Mkaka Construction Company being the main case study. A number of questions
remain unanswered in this area of study, like for example whether Inventory turnover, debtors’
payment days and creditor’s payment days affect profitability. This research seeks to close this
knowledge gap by determining whether there is a relationship between working capital
management and the profitability of Mkaka Construction Company.

1.3 Research Objectives

Main objective
The main objective of this research is to analyze the relationship between working capital
management and profitability of construction companies in Malawi, a case of Mkaka
Construction Company.
Specific Objectives
1. To evaluate the impact of inventory management on the profitability of construction
companies in Malawi.
2. To analyze the impact of Receivables management on the profitability of construction
companies in Malawi.
3. To evaluate the impact of Trade Payables management on the profitability of construction
companies in Malawi.

1.4 Research questions

1. What is the impact of inventory management on the profitability of construction

companies in Malawi?
2. What is the impact of Receivables management on the profitability of construction
companies in Malawi?
3. How does payables management impact the business profitability of construction
companies in Malawi?

1.4 Value of the study

This study is important because it addresses the gap in literature by analyzing the relationship
between working capital management and profitability of construction companies in Malawi
particularly Mkaka construction limited company.

By analyzing the relationship between working capital management and profitability of

construction companies, Mkaka construction limited company being the main case, the
study will contribute to a better understanding of working capital management practices that
managers in the Mkaka construction companies should strive to implement to ensure the
profitability position of their company is improved.

The findings will not only help the managers in the Mkaka construction company, but also
financial managers in other construction companies will best understand how to develop a
good working capital model, financial policy makers and other stakeholders who are geared
to promote good working capital management processes will also benefit from this study.
Finally, this research will guide future studies on working capital management and
profitability in the construction sector.

Limitation of the study

 CHAPTER TWO
LITERATURE REVIEW

Introduction

This research investigates the relationship between working capital management and profitability
of construction companies using Mkaka Construction Company limited as our case
study .Previous studies related on this subject are discussed. The dependent variable
(profitability) and relevant studies related to the independent variable (working capital) are also
discussed.

Conservative theory of working capital management

Raymond Lev (2010) defined conservative working capital policy as a plan or a strategy to
protect the company against financial distress by holding excess level of current assets. Weston
and Brigham advocated for cautious and conservative approach to working capital management,
they highlighted the importance of balancing liquidity needs with profitability goals. Van Horne
and Wachowicz (2005) discussed the conservative approach to working capital management as a
plan to ensure solvency and financial ability. Richard A. Brealey (2020) said that a higher
current ratio typically indicates a more conservative approach to working management. Deloof
Marc (2020) emphasized the need of a conservative approach to working capital management in
improving firm profitability, his research has shown that a more conservative working capital
management can lead to higher profitability due to reduced financial risk and improved liquidity.
Abdul Raheman and Mohamed Nasr research in 2014 also highlighted the positive relationship
between conservative working capital management and profitability, they argued that a more
conservative approach can lead to a better financial performance by ensuring that the company
has sufficient liquidity to meet its short term obligations without comprosing profitability.
Others authors theories have disputed the notion that a conservative working management policy
can lead to higher profitability , Filbeck , Gregory and Kruger(2005)investigated the impact of
working capital management and profitability and found that a too conservative approach to
working capital management can have negative impact on profitability particularly for smaller
firms . The proponents of the theory above omitted the fact that working capital needs can vary
significantly based on factors such as seasonality, business cycles, industry trends and general
economic conditions and therefore failed to establish an ideal working capital optimal level .

Aggressive theory of Working capital Management

James S Ang (2020) explored the relationship between working capital management practices
and firm performance advocating for a proactive management approach to working capital.
Similarly Jones and Smith (2020) examined the impact of working capital management strategies
on the profitability of construction companies in the UK firms, the results suggested that
construction companies adopting aggressive working capital management practices had higher
profitability levels compared to firms with more conservative approaches. Khan et al (2017)
explored the impact of working capital on the profitability of small and medium –sized
construction companies, the study found that firms following an aggressive working capital
management strategy reported higher profitability margins, indicating that efficient management
of current assets and liabilities can contribute significantly to financial performance in the
construction industry. However conflict exists in this theory, for instance a study by Lee and
Kim (2021) suggested that while aggressive working capital management could lead to cost
savings in the short term, it might negatively impact profitability in the long run due to potential
liquidity constraints and operational inefficiencies.

Moderate theory of Working capital Management

The Moderate theory of working capital management explains that there exists an optimal level
of working capital that maximizes firm profitability (Horne, 2007). According to the theory,
excessively high or low levels of working capital can harm a company’s financial performance.
By effectively managing their working capital, companies can strike a balance between liquidity
and profitability, thus enhancing their overall value. Raheman and Nasr (2007) revealed that an
efficient working capital management strategy positively impacts the profitability of construction
firms, they emphasized the importance of maintaining an optimal level of working capital to
ensure sustained profitability and growth. Sharma and Kumar (2020) highlighted the factors that
determines the amount of working capital that firms in the construction industry should use for
guidance. These factors include project size, payment terms and seasonality on the working
capital needs of construction firms. Zariyawati (2013) concluded that the moderate theories of
working capital management do not incorporate behavioral aspects that can influence working
capital management decisions, human biases, inherent in decision making processes could
impact how managers perceive and respond to working capital challenges, potentially leading to
suboptimal outcomes. Hill (2006) criticized the moderate theory in that it often assumes a static
approach to working capital and ignores the dynamic nature of business and changing market
conditions.

Measurement of Working capital

Anwar (2018) examined the influence of the length of the operation cycle and the turnover of
receivables and inventory on profitability, he concluded that reducing the turnover of both
receivables and inventory leads to a decrease in the operation cycle and an increase in the
company’s profitability. Lazaridis and Tryfonidis (2006) showed a relation between profitability
and the operating cycle , furthering that directors are able generate income for the company by
controlling the operating cycle carefully and keeping every factor of the working capital to the
most appropriate level . Padachi (2006) concluded that excellent working capital control and
policy affect the formulation of a company’s value, the research that Padachi did was done using
statistical methods using the return on total assets ratio. The results showed that focusing heavily
on investments in high capital causes low profitability ratios. Muhammad et al (2016) added that
firms can use working capital management, which is one of the essential determinant to
influence their profitability, the results reveled that there is an association between working
capital elements and profitability .This is defined as the increase in the cash conversion cycle and
influences the profitability negatively, if the company wants to increase profitability the cash
conversion cycle must be shortened. Singh et al (2017) also confirmed that the cash conversion
cycle is related to profitability which indicates that aggressive working capital policies drives
higher profitability because of the shorter conversion cycles.

Conceptual Framework

Empirical review

Filbeck and Kruger (2005) highlighted the importance of efficient working capital management
by analyzing the working capital management policies of 32 non-financial industries in the US.
According to their findings, significant diufferences exist among industries in working capital

CHAPTER THREE

RESEARCH METHODOLOGY

Introduction

Research design

Population

Data collection Techniques

Data analysis

Analytical Model