Profitability Of Listed Pharmaceutical Companies

Published Date: 02 Nov 2017

A Project Work submitted to (Faculty of Management Sciences) in part fulfilment of the requirement for the MBA degree

Muhammad Siddiq

Spring, 2013

Institute of Business & Technology (IBT), Karachi

Acknowledgement

First of all we would thank Almighty ALLAH who has guided us the way for a bright future. We would like to acknowledgement the help provided by our teacher to make this project a success.

Our teacher Dr. Noor Ahmed Memon provided us guidance and learning at every step of the project which helped us, a lot in the questioning, data collection and preparation of report. He always gave full energy and showed willingness in our project.

We are also thankful to our parents and family who accommodated us during those long hours of work in writing Project and all the friends and colleagues who equally encouraged us.

We would also like to appreciate the co-operation we got from our classmates at the institute, which boosted our morale and encouraged us to strive for better results.

DECLARATION

This project work is submitted in the Institute for Business and Technology (IBT) for the degree of MBA.

I, hereby, declare that no portion of the work referred to in this project has been submitted in support of any application for another degree or qualification of this Institute or any other institution of learning.

Muhammad Siddiq, Signatures:________________________

Date: _________________________

Copyright

Copyright in this text rests with the author of the project work. Copies (by any process) of this project work either in full or of extracts may be made only in accordance with the instructions given by the author and lodged in the Institute for Business and Technology (IBT) library. This page must form part of any copies made. Further copies (by any process) of copies made in accordance of such instructions may not be made without instructions (in writing) of this author.

The ownership of any intellectual property rights that may be described in this dissertation is vested with Institute for Business and Technology (IBT), subject to any prior agreement to the contrary, and may not be made available for any use by the third party without written permission of the Institute, which will describe terms and conditions of any such agreement.

Table of Contents

Acknowledgement…………………………………………………………...……..….i

Declaration………………………………………………………………………….......ii

Copyright...............................................................................................................iii

List of Abbreviations…………………………………………………………..............iv

List of Tables………………………………………………………………….………...v

List of Figures……………………………………………………………...………..….vi

Abstract………………………………………………………….……………………...vii

Chapter One: Introduction……………………………...………….………....10

1.0 Introduction……………………………………………….…….............10

1.1 Statement of Research Problem ....…………………….……............10

1.2 Research Objectives ..........................……………….……...............10

1.3 Hypotheses……………….……............................................................10

1.4 Research Work Limitations………………...…..……....………..….....10

Chapter Two: Pharmaceutical Companies and Working Capital

Management........................................................10

2.0 Introduction.....................................................................................10

2.1 Working capital management..........................................…........10

2.2 Working Capital Components/Variables....................…..….......10

2.2 Optimal Level of Cash Conversation Cycle.............…….....10

2.3 Optimal Level of Inventory………………….........…..….......10

2.4 Optimal Level of Accounts Receivable….…..……....…......10

2.4 Optimal Level of Accounts Payable …….…..……....….......10

2.5 Model Specification(Gross Profit)………..........…....……...........10

2.6 Beta (Standardized Regression Coefficients)….........…..……..10

2.7 Financial Ratio..…………………………..…….....…..…...........…..10

2.7.0 Cash Conversation Cycle..……..………..…………….....…..….…..10

2.7.1 Receivable Conversation Period…..………………….....…..….…..10

2.7.2 Payable Conversation period……..……………….....…..…….........10

2.7.3 Inventory Conversation Period...……..……………….....…..……...10

2.7.4 Fixed Financial Assets Ratio.....……..……………….....…..……....10

2.7.4 Financial Debt Ratio.....……..……………….....…..…….................10

2.7.4 Gross Operation Profit....……..……………….....…..……...............10

Chapter Three: Literature Review .................................................18

Chapter Four: Research Methodology................……………....……....54

4.2 Sources of Data..................................……………….....…..…..…..10

4.2 Data Set and Sample Size.................……………….....…..…..…..10

4.1 Descriptive Analysis....................………………………….....……..10

4.0 Multiple Regressions…………………….....…..…….......................10

Chapter Five: Research Analysis..........................……………....…….....54

4.0 Introduction..................………………………………….....…..……..10

Chapter Six: Critical Debate Analysis………………….……..................84

Chapter Seven: Conclusion and Recommendations…………..105

Conclusion…….....................................................................……....…....15

Recommendations………...............................……….....…………....…..12

References………………...…………………………….……………..114

Appendices……………………………......………………….……….............……128

List of Abbreviations

B. A Bachelor of Arts

BPS Basic Pay Scale

BSc Bachelor of Science

CSP Civil Service of Pakistan

CSS Civil Superior Service

GCHQ Government Communication

HR Human Resources

HRD Human Resource Development

HRDNI Human Resource Development Needs

HRM Human Resource Management

Abstract

Under the pressure of increasingly changing economic realities, the organizations have the perforce to utilize their resources, especially the human resources, more effectively as well as efficiently. Meeting this challenge posed by the changing business environment assigns bigger than ever responsibilities to the HR function of the organizations to hone their human resources. However, the contemporary HRD gurus do not look satisfied with the traditional human resource development techniques that mostly comprise off-the-job training programmes. They believe, though off-the-job training itself is an expensive investment, not more than 10% of its expenditures actually result in positive transfer to the job (Geargenson 1982). This worldwide concern among the HRD professionals highlights importance of experiential learning – learning through doing – as an effective HRD intervention and spotlights it as a reply to the scores of unanswered questions posed by the HRD problems that the off-the-job training could not offer. This dissertation, thus, implies the need for awareness among policy makers in Pakistan regarding the importance of learning-through-doing as an effective and efficient mode of HRD to be introduced / promoted amongst the public sector organizations of the country. Its argument tends to concentrate on different dimensions of the introduction and promotion of learning-by-doing in the public sector organizations of Pakistan and sets out to explore how learning can be enhanced therein and made more effective and efficient through making the people learn and develop while still doing their day-to-day routine work.

1.1 Introduction

Money in Hand is nothing but the working capital, this thesis examines the Relationship Between working capital management and profitability, Of Listed pharmaceutical companies in Karachi stock exchange. Working capital refers to a firm’s Current Assets. By "Current" we mean those assets that the firm expects to convert into cash within a year. Current Assets include cash, inventory & accounts receivable. Current Assets are considered liquid because they can be transformed into cash in a relatively short time. Net working capital is the firm’s current assets minus current liabilities.

Short-term assets and liabilities are important components of total assets and needs to be carefully analyzed. Management of these short-term assets and liabilities warrants a careful investigation since the working capital management plays an important role for the firm’s profitability and risk as well as its value. Efficient management of working capital is a fundamental part of the overall corporate strategy to create the shareholders’ value.

Firms try to keep an optimal level of working capital that maximizes their value. A managerial accounting strategy focusing on maintaining effective levels of both components of working capital that is Current Assets & Current Liabilities, on respect to each other. Working capital management ensures a company has a sufficient cash flow in order to meet its short term debt obligations & operating expenses.

The main objective of working capital management is to maintain an optimal balance between each of the working capital components. Business success heavily depends on the ability of financial executives to effectively manage receivables, inventory, and payables. Firms can reduce their financing costs and/or increase the funds available for expansion projects by minimizing the amount of investment tied up in current assets. Most of the financial managers’ time and effort are allocated in bringing non-optimal levels of current assets and liabilities back toward optimal levels. An optimal level of working capital would be the one in which a balance is achieved between risk and efficiency.

It requires continuous monitoring to maintain proper level in various components of working capital i.e. cash receivables, inventory and payables etc.

Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are Ratio Analysis & Management of individual components of working capital.

The way in which working capital is managed can have significant impact on both cash flow and performance of firms. Shortening the cash conversion cycle improves profitability of a firm because the longer the cash conversion cycle the greater the need for expensive external financing. Therefore, by reducing the time that cash are tied up in working capital, a firm can operate more efficiently (Moss and Stine 1993). Cash conversion cycle could be shortened by reducing the inventory conversion period via processing and selling goods more quickly, or by reducing the receivable collection period via speeding up collections, or by lengthening the payable deferral period through slowing down payments to suppliers. On the other hand shortening the cash conversion cycle could harm the firm’s operations and reduces profitability and cash flow. When taking actions to reduce the inventory conversion period, a firm should be

careful to avoid inventory shortages that could cause its customers to buy from competitors; when reducing the receivable collection period a firm should be careful not to lose its good credit customers; and when lengthening the payable deferral period a firm should be careful not to harm its own credit reputation (Basely and Brigham, 2005).

1.2 Research problem

Working capital management is an important issue in any organization. This is because without a proper management of working capital components, it’s difficult for the firm to run its operations smoothly. That is why Brigham and Houston (2003) mentioned that about 60 percent of a typical financial manager’s time is devoted to working capital management.

Hence, the crucial part of managing working capital is maintaining the

Required liquidity in day-to-day operation to ensure firms smooth running and to meet its obligation (Eljelly, 2004). Further, working capital management has been major issue especially in developed countries. As a result, in order to explain the relationship between working capital management and profitability different researches have been carried out in different parts of the world especially in developed countries.

3 Research Objectives:

The purpose of this research is to contribute towards a very important aspect of Financial Management known as Working Capital Management. In order to achieve the objective To establish a relationship between Working Capital Management and Profitability over a period of Five years for 05 Pakistani pharmaceutical companies listed on Karachi Stock Exchange.

To find out the effects of different components of working capital management on profitability.

To establish a relationship between the two objectives of liquidity and profitability of the Pakistani firm.

To find out the relationship between profitability and size of the Pakistani firm.

To find out the relationship between debt used by the Pakistani firm and its profitability.

To draw conclusion about relationship of working capital management and profitability of the Pakistani firms.

3.1 Research Hypothesis

Since the objective of this study is to examine the relationship between profitability and working capital management, the study develop the testable hypothesis {the Null Hypotheses H0 versus the Alternative ones H1}.

H0: Working Capital Management results in optimal balance b/w each of Working Capital components.

H1: High level of Current Assets reduces opportunity cost of funds for investors.

4 Research Work Limitations

Due to limitation of project time duration there are Two aspect of working capital management one is components of working capital management and 2nd is Limited Ratio analysis, the issue of identifying key variables that influence working capital management of KSE listed pharmaceutical company in Pakistan. Selection of variables is influenced by the previous studies on Working Capital Management, those important variables of Working capital management which are given below.

Optimal Level Inventory .

Optimal level Accounts Receivable.

Optimal level Cash Conversion Cycle.

Optimal level Accounts Payable.

Chapter # 2

PHARMACEUTICAL INDUSTRY IN PAKISTAN

Pharmaceutical industry is one of the leading industries of Pakistan & is supposed to be treated as a respectable industry. There are lots of pharmaceutical industries working in Pakistan producing & inventing life saving drugs. It has a high profit margin company & high growth rate depending on the organization’s Research & development R & D. The major portion of company’s budget is allocated for marketing promotion & research & development.

There are 09 pharmaceutical companies are listed in Karachi Stock Exchange & the lists are.

S.NO.

NAME

WEBSITE ADDRESS

POSTAL ADDRESS

1

Abott (Lab)

http;//www.abbott.com.pk/

Opposite Radio Pakistan

Transmission, Hyderabad Road,

Landhi, Karachi.

2

Ferozsons (lab)

http;//www.ferozsons-labs.com/

Attiya Building, 8-Bank Square

Shahrah-e-Quaid-e-Azam, Lahore

3

Glaxo smith & kline

http;//www.gsk.com.pk/

35, Dockyard Road, West Wharf,

Karachi-74000

4

Highnoon

http;//www.highnoon.labs.com/

17.5 km Multan Road, Lahore -

53700

5

Ibl Health Care Ltd

http;//www.searlepak.com/

1st Floor NIC Bldg Abbas Shaheed Rd.

Off Shahra-e-Faisal, KARACHI.

6

Otsuka Pak

http;//www.ostuka.pk/

30-B, Sindhi Muslim Co-operative

Housing Society Karachi-74400

7

Sanofi Aventis

http;//www.sanofiaventis.com.pk

Plot 23, Sector 22, Korangi Industrial

Area, Karachi-74900

8

Searle Pakistan

http;//www.searlepak.com/

1st Floor NIC Bldg Abbas Shaheed Rd.

Off Shahra-e-Faisal, KARACHI.

9

Wyeth Pakistan

http;//www.wyethpakistan.com/

S-33, Hawks Bay Road, S.I.T.E.

Karachi-75730

LATES INFORMATION ABOUT PHARMACEUTICAL COMPANIES EFFECT ON ECONOMY OF PAKISTAN IS MISSING HERE

2.0 Working capital management:

CONCEPTS OF WORKING CAPITAL:

There are two concepts of working capital:

Balance Sheet concepts

Operating Cycle or circular flow concept

BALANCE SHEET CONCEPT:

There are two interpretation of working capital under the balance sheet concept:

Gross Working Capital

Net Working Capital

Gross Working Capital:

The term working capital refers to the Gross working capital and represents the

Amount of funds invested in current assets. There for the gross working capital is the Capital invested in total current assets of the enterprises. Current assets are those assets which are converted into cash within short periods of normally one accounting year. Like Cash in hand and Bank balance Bills Receivable Sundry Debtors Short term Loans and Advances Inventories of Stock.etc.

Net Working Capital:

The term working capital refers to the net working capital. Net working capital is the excess of current assets over current liabilities. Or it may be express by Formula, Which is given below.

Net Working Capital = Current Assets – Current Liabilities.

NET WORKING CAPITAL MAY BE NEGATIVE OR POSITIVE:

When the current assets exceed the current liabilities, the working capital is positive and the negative working capital results when the current liabilities are more than the current assets. Current liabilities are those liabilities which are intended to be paid in the ordinary course of business within a short period of normally one accounting year of the current assets or the income of the business. Current liabilities components are Bills Payable, Sundry Creditors or Account Payable, Accrued or Outstanding Expenses, Short term Loans, Advances Deposits, Dividends Payable and Bank Overdraft.etc.

The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital.

OPERATING CYCLE OR CIRCULATING CASH FORMAT:

Working Capital refers to that part of firm’s capital which is required for financing

Shorts term or current assets such as cash, marketable securities, debtors and

Inventories, Funds thus invested in current assets keep revolving fast and being

Constantly converted into cash and these cash flows out again in exchange for other current assets. Hence it is also known as revolving or circulating capital. The circular flow concept of working capital is based upon this operating or working capital cycle of a firm.

In order to understand the importance of working capital one has to understand the working capital cycle which is described as the core for working capital management. Arnold (2008, p.529-530) said that working capital cycle includes all the major dimensions of business operations. It is quite clear that a bad management of a single account in this cycle might cause a big trouble for the non living entity which might leads to its death. Therefore, the management of working capital and balance between components of working capital is extremely important for the smooth running of business. Similarly, the basic aim of financial management is to maximize the wealth of the share holders and in order to achieve this; it is necessary to generate sufficient sales and profit.

However, sales do not convert in to cash instantly. The time between purchase of

inventory items (raw material or merchandise) for the production and their conversion into cash is known as operating cycle or working capital cycle. Therefore, the following chart shows the framework of firm’s working capital cycle:

Figure 2.1 Working capital cycle;

Working in progress

Finished Goods

Sales

Raw Materials

Creditors

Debtors

Cash

The above working capital cycle reveals that funds invested in operations or activities are re-cycled back into cash. The cycle, of course, takes some time to complete. The longer the period of this conversion the longer is the operating cycle. A standard operating cycle may be for any time period but does not generally exceed a financial year. However, if it were possible to complete the sequence (working capital cycle) instantly, there would be no need for current assets (working capital). But, since it is not possible, the firm is forced to have current assets, because, cash inflows and outflows do not match in the business

Operations, the firm has to keep cash for meeting short term obligations through proper management of working capital components.

Therefore, working capital management deals with the act of planning, organizing and controlling the components of working capital (current asset and liability) like cash, bank balance, inventory, receivables, payables, overdraft and short-term

Loans (Paramasivan and Subramanian, 2009). Weston and Brigham (1977) defined working capital management as it is concerned with the problems that arise in attempting to manage the current asset, current liabilities and the interrelationship that exists between them. Whereas, Smith (1980) noted that working capital management is the administration of the whole aspects of both current assets and current liabilities.

2.1 Working Capital Components/Variables

This study undertakes the issue of identifying key variables that influence working capital management of (KSE) listed pharmaceutical firms in Pakistan. Selection of variables is influenced by the previous studies on Working Capital Management. These variables are:

Optimal Cash Conversion Cycle.

Optimal Inventory Level.

Optimal Accounts Receivable.

Optimal Accounts Payable.

3.5.1. Optimal Cash Conversion Cycle.

The optimal cash conversion cycle is an additive function. It measures the optimal length of inventory conversion period plus the optimal length of receivable collection period less the optimal length of payable deferral period.

Optimal Cash Conversion Cycle Formula:

OCCC =

Inventory Conversion Period + Receivable Conversion Period – Payable

Conversion Period

OCCC =

(Inventory/Cost of Goods Sold)*365 + (Receivables/Sales)*365 –

(Payables/Cost of Goods sold)*365

Optimal Inventory Level:

One of the best-known optimal inventory level approaches is the Economic Order Quantity model (EOQ). The basic idea of this model is plotting the total cost of currying inventory with different inventory quantities.

Inventory carrying costs increase and inventory shortage costs decrease as inventory level increase and we attempt to identify the minimum total cost.

Optimal Accounts Receivable:

Trade credit is an alternative financing choice to the short-term borrowing, trade credit is "free" but short-term borrowing is "costly". When the company extends its trade credit by increasing its accounts payable it will save the cost of short-term borrowing. This means an increase of accounts payable associated with a decrease of short-term borrowing cost or "opportunity cost of short-term borrowing".

When the accounts payable increase some other kind of cost also increase, for example the carrying cost which are the cost of managing and running the payable department increases as the account payable increase. Other cost could also increase when accounts payable increase, for example, the possibility that a company could delay it’s payment to suppliers increase when the company extend its trade credit, this could damage the company’s credit reputation and the company could lose some of the cash discounts offered by suppliers.

Optimal Accounts Payable:

An optimal credit amount could be identified by the points where the incremental cash flows from increased sales stimulated by offering credit to the customers equals the costs of carrying additional investments in account receivables . Therefore, an optimal amount of credit extended could be identified by plotting the total cost of associated with granting a credit with different amounts of credit.

2.2 Model Specification(Gross Profit)

Gross Profit (GP) =

B0 + B1*Fixed Financial Assets + B2*Financial debt + B3*CCCOI + B4*in (Sales)

Beta (Standardized Regression Coefficients):

The beta value is a measure of how strongly each predictor variable influences the criterion variable. The beta is measured in units of standard deviation.

For example, a beta value of 2.5 indicates that a change of one standard deviation in the predictor variable will result in a change of 2.5 standard deviations in the criterion variable. Thus, the higher the beta value the greater the impact of the predictor variable on the criterion variable. When you have only one predictor variable in your model, then beta is equivalent to the correlation coefficient between the predictor and the criterion variable. This equivalence makes sense, as this situation is a correlation between two variables. When you have more than one predictor variable, you cannot compare the contribution of each predictor variable by simply comparing the correlation coefficients. The beta regression coefficient is computed to allow you to make such comparisons and to assess the strength of the relationship between each predictor variable to the criterion variable.

Financial Ratio:

In order to solve the above equation we need to understand some financial ratios.

Cash Conversion Cycle (CCC).

Receivables Conversion Period.

Inventory Conversion Period.

Payables Conversion Period.

Fixed Financial Asset Ratio.

Financial Debt Ratio.

Gross Operating Profit.

Cash Conversation Cycle.

In management accounting, the Cash Conversion Cycle (CCC) measures how long a firm will be deprived of cash if it increases its investment in resources in order to expand customer sales. It is thus a measure of the liquidity risk entailed by growth. However, shortening the CCC creates its own risks:

While a firm could even achieve a negative CCC by collecting from customers before paying suppliers, a policy of strict collections and lax payments is not always sustainable.

Usually a company acquires inventory on credit, which results in accounts payable. A company can also sell products on credit, which results in accounts receivable. Cash, therefore, is not involved until the company pays the accounts payable and collects accounts receivable. So the cash conversion cycle measures the time between outlay of cash and cash recovery.

FORMULA:

CCC = Inventory Conversion Period + Receivable Conversion Period – Payable

Version Period

Receivables Conversion Period.

Days Sales Outstanding is a company's average collection period. A low number of days indicate that the company collects its outstanding receivables quickly. Typically, DSO is calculated monthly. The Days Sales Outstanding (DSO) figure is an index of the relationship between outstanding receivables and sales achieved over a given period. The DSO analysis provides general information about the number of days on average that customers take to pay invoices.

DSO is considered an important tool in measuring liquidity.DSO tends to increase as a company becomes less risk averse. Higher DSO can also be an indication of poor follow up on delinquencies, or higher DSO might be the result of inadequate analysis of applicants for open account credit terms. An increase in DSO can result in cash flow problems, and may result in a decision to increase the creditor company's bad debt reserve.

Days Sales Outstanding, or DSO, is calculated as: Total Outstanding Receivables at the end of the period analyzed divided by Total Credit Sales for the period analyzed (typically 90 or 365 days), times the number of days in the period analyzed.

FORMULA:

ACCOUNTS RECEIVABLE IN DAYS = Average Accounts Receivables

Sales * 365

Inventory Conversion Period:

Days in inventory are an efficiency ratio that measures the average number of days the company holds its inventory before selling it.

FORMULA:

INVENTORY TRUN OVER IN DAYS = AVERAGE INVENTORY

COST OF GOODS SOLD* 365

Payables Conversion Period:

Days payable outstanding (DPO) is an efficiency ratio that measures the average number of days a company takes to pay its suppliers.

FORMULA:

ACCOUNTS PAYABLE IN DAYS = Average Accounts Payable

COST OF GOODS SOLD* 365

3.48 Fixed Financial Asset Ratio:

A measure of how efficiently a business generates sales from its investments. That is, it is the ratio of the amount a company earns in sales to the average value of its fixed assets. Fixed assets are investments that cannot easily be converted into cash, e.g. a factory or computer system, and can be quite expensive. Thus, if a company has a high ratio, this means that its sales have kept pace with or exceeded the amount it has invested in fixed assets, which is a positive sign for the company.

FORMULA:

Fixed Financial Assets ratio = Fixed Assets

Total Assets

Financial Debt Ratio:

A measure of a company's total debt to its total assets. A ratio less than one means that a company has more assets than debt, while a ratio of more than one means the opposite. A debt ratio is a measure of how risky it would be for a bank to extend a loan to a company, with a higher ratio indicating great risk.

A ratio indicating the proportion of debt a company has relative to its assets;

it gives a general idea of the leverage of the company along with the potential risks the company faces in terms of its debt load.

A debt ratio greater than 1 indicates that a company has more debt than assets; a debt ratio less than 1 indicates that a company has more assets than debt. Used in conjunction with other measures of financial health, the debt ratio helps investors determine a company's level of risk.

FORMULA:

Financial Debt Ratio = (Short term loan + Long term loan)

Total Assets

Gross Operating Profit:

Total revenue of a business minus the cost of goods it sold. Gross profit does not include income from incidental sources and also excludes selling and administrative expenses

FORMULA:

Gross operating profit = (Sales – Cost of goods sold)

(Total Assets-Financial Assets)

Literature Review:

Many researchers have studied working capital from different views and in different environments. The following ones were very interesting and useful for our research: (Shin and Soenen, 1998) highlighted that efficient Working Capital Management (WCM) was very important for creating value for the shareholders. The way working capital was managed had a significant impact on both profitability and liquidity. The relationship between the length of Net Trading Cycle, corporate profitability and risk adjusted stock return was examined using

correlation and regression analysis, by industry and capital intensity. They found a strong negative relationship between lengths of the firm’s net trading Cycle and its profitability. In addition, shorter net trade cycles were associated with higher risk adjusted stock returns. (Smith and Begeman 1997) emphasized that those who promoted working capital theory shared that profitability and liquidity comprised the salient goals of working capital management. The problem arose because the maximization of the firm's returns could seriously threaten its

liquidity, and the pursuit of liquidity had a tendency to dilute returns. This article evaluated the association between traditional and alternative working capital measures and return on investment (ROI), specifically in industrial firms listed on the Johannesburg Stock Exchange (JSE). The problem under investigation was to establish whether the more recently developed alternative working capital concepts showed improved association with return on investment to that of traditional working capital ratios or not. Results indicated that there were no significant differences amongst the years with respect to the independent variables. The results of their stepwise regression corroborated that total current liabilities divided by funds flow accounted for most of the variability in Return on Investment (ROI). The statistical test results showed that a traditional working capital leverage ratio, current liabilities divided by funds flow, displayed the

greatest associations with return on investment. Well-known liquidity concepts such as the current and quick ratios registered insignificant associations whilst only one of the newer working capital concepts, the comprehensive liquidity index, indicated significant associations with return on investment.

(Ghosh and Maji, 2003) in this paper made an attempt to examine the efficiency of working capital management of the Indian cement companies during 1992 – 1993 to 2001 – 2002. For measuring the efficiency of working capital management, performance, utilization, and overall efficiency indices were calculated instead of using some common working capital management

ratios. Setting industry norms as target-efficiency levels of the individual firms, this paper also tested the speed of achieving that target level of efficiency by an individual firm during the period of study. Findings of the study indicated that the Indian Cement Industry as a whole did not perform remarkably well during this period.

(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 due short-term obligations and avoids excessive investment in these assets. The relation between profitability and liquidity was examined, as measured by current ratio and cash gap (cash

conversion cycle) on a sample of joint stock companies in Saudi Arabia using correlation and regression analysis. The study found that the cash conversion cycle was of more importance as a measure of liquidity than the current ratio that affects profitability. The size variable was found to have significant effect on profitability at the industry level. The results were stable and had important implications for liquidity management in various Saudi companies. First, it was clear that there was a negative relationship between profitability and liquidity indicators such as current ratio and cash gap in the Saudi sample examined. Second, the study also revealed that there was great variation among industries with respect to the significant measure of liquidity. (Deloof, 2003) discussed that most firms had a large amount of cash invested in working capital. It can therefore be expected that the way in which working capital is managed will have a significant impact on profitability of those firms. Using correlation and regression tests he found a significant negative relationship between gross operating income and the number of days accounts receivable, inventories and accounts payable of Belgian firms. On basis of these results he suggested that managers could create value for their shareholders by reducing the number of

days’ accounts receivable and inventories to a reasonable minimum. The negative relationship between accounts payable and profitability is consistent with the view that less profitable firms wait longer to pay their bills. Filbeck and Krueger (2005) highlighted the importance of efficient working capital management by analyzing the working capital management policies of 32 non-financial industries in USA. According to their findings significant differences exist between industries in working capital practices over time. Moreover, these working capital practices, themselves, change significantly within industries over time. Similar studies are conducted by Gombola and Ketz (1983), Soenen (1993), Maxwell et al. (1998), and Long et al. (1993). However, Weinraub and Visscher (1998) have discussed the issue of aggressive and conservative working capital management policies by using quarterly data for a period of 1984

to 1993 of US firms. Their study looked at ten diverse industry groups to examine the relative relationship between their aggressive/conservative working capital policies. The authors have concluded that the industries had distinctive and significantly different working capital management policies. Moreover, the relative nature of the working capital management policies exhibited remarkable stability over the ten-year study period. The study also showed a high and significant negative correlation between industry asset and liability policies and found that when relatively aggressive working capital asset policies are followed they are balanced by relatively conservative working capital financial policies.

In literature, there is a long debate on the risk/return tradeoff between different working capital policies (Pinches 1991, Brigham and Ehrhardt 2004, Moyer et. al. 2005, Gitman 2005). More aggressive working capital policies are associated with higher return and higher risk while conservative working capital policies are concerned with the lower risk and return (Gardner et al. 1986, Weinraub and Visscher 1998). Working capital management is important because of its effects on the firm’s profitability and risk, and consequently its value (Smith, 1980). Greater the investment in current assets, the lower the risk, but also the lower the profitability obtained. In contradiction, Carpenter & Johnson (1983) provided empirical evidence that there is no linear relationship between the level of current assets and revenue systematic risk of US firms; however, some indications of a possible non-linear relationship were found which were not highly statistically significant. For the first time, Soenen (1993) investigated the relationship between the net trade cycle as a measure of working capital and return on investment in U.S firms. The results of chi-square test indicated a negative relationship between the length of net trade cycle and return on assets.

Furthermore, this inverse relationship between net trade cycle and return on assets was found different across industries depending on the type of industry. A significance relationship for about half of industries studied indicated that results might vary from industry to industry. Another aspect of working capital management has been analyzed by Lamberson (1995) who studied how small firms respond to changes in economic activities by changing their working

capital positions and level of current assets and liabilities. Current ratio, current assets to total assets ratio and inventory to total assets ratio were used as measure of working capital while index of annual average coincident economic indicator was used as a measure of economic activity. Contrary to the expectations, the study found that there is very small relationship between charges in economic conditions and changes in working capital. In order to validate the results found by Soenen (1993) on large sample and with longer time

period, Jose et al. (1996) examined the relationship between aggressive working capital management and profitability of US firms using Cash Conversion Cycle (CCC) as a measure of working capital management where a shorter CCC represents the aggressiveness of working capital management. The results indicated a significant negative relationship between the cash conversion cycle and profitability indicating that more aggressive working capital management

is associated with higher profitability. Shin and Soenen (1998) concluded that reducing the level of current assets to a reasonable extent increases firms’ profitability. Later on, Deloof (2003) analyzed a sample of large Belgian firms during the period 1992-1996 and the results confirmed that Belgian firms can improve their profitability by reducing the number of days accounts receivable are outstanding and reducing inventories. Teruel and Solano (2005) suggested that

managers can create value by reducing their firm’s number of days accounts receivable and inventories. Similarly, shortening the cash conversion cycle also improves the firm’s profitability. In the Pakistani context, Rehman (2006) investigated the impact of working capital management on the profitability of 94 Pakistani firms listed at Islamabad Stock Exchange (ISE) for a period of 1999-2004. He studied the impact of the different variables of working capital management including Average Collection Period, Inventory Turnover in Days, Average Payment Period and Cash Conversion Cycle on the Net Operating Profitability of firms. He concluded that there is a strong negative relationship between above working capital ratios and profitability of firms.

Furthermore, managers can create a positive value for the shareholders by reducing the cash conversion cycle up to an optimal level. Similar studies on working capital and profitability includes Smith and Begemann (1997), Howorth & Westhead (2003), Ghosh & Maji (2004), Eljelly (2004), and Lazaridis and Tryfonidis (2006). From another angle, Chiou and Cheng (2006) have analyzed the determinants of working capital management. The paper explored that how working capital management of a firm is influenced by the different variables like business indicators, industry effect, operating cash flows, growth opportunity for a firm, firm performance and size of firm. The study has provided consistent results of leverage and operating cash flow for both net liquid balance and working capital requirements, however, variables like business indicator, industry effect, growth opportunities, performance of firm, and size of firm were unable to produce consistent conclusions for net liquid balance and working capital requirements of firms.

All the above studies provide us a solid base and give us idea regarding working capital management and its components. They also give us the results and conclusions of those researches already conducted on the same area for different countries and environment from different aspects. On basis of these researches done in different countries, we have developed our own methodology for research.

CHAPTER FOUR;

Research Methodology:

4.0 Sources of Data.

The data for the above mentioned purpose will be collected from secondary sources. Secondary data

sources include:

Karachi Stock Exchange (KSE).

State Bank of Pakistan (SBP).

News Articles.

Companies Web Portal.

Brokerage Houses.

4.1 Data Set and Sample Size.

The data used in this study is acquired from 05 Karachi Stock Exchange (KSE) listed pharmaceuticals companies out of 09 (KSE) listed companies due to easily availability of latest data from their published financials.

4.1 Descriptive Analysis:

To understand and describe relevant aspects of phenomena of cash conversion cycle and provide detailed information about each relevant variable, Mean,

Standard Deviation and F- Statistics have been calculated with help of SPSS.

4.0 Multiple Regressions:

Multiple regression is a statistical technique that allows us to predict someone’s score on one variable on the basis of their scores on several other variables. An example might help. Suppose we were interested in predicting how much an individual enjoys their job. Variables such as salary, extent of academic qualifications, age, sex, number of years in full-time employment and socio economic status might all contribute towards job satisfaction. If we collected data on all of these variables, perhaps by surveying a few hundred members of the public, we would be able to see how many and which of these variables gave rise to the most accurate prediction of job satisfaction. We might find that job satisfaction is most accurately predicted by type of occupation, salary and years in full-time employment, with the other variables not helping us to predict job satisfaction. When using multiple regression in psychology, many researchers use the term "independent variables" to identify those variables that they think will influence some other "dependent variable". We prefer to use the term "predictor variables" for those variables that may be useful in predicting the scores on another variable that we call the "criterion variable". Thus, in our example above, type of occupation, salary and years in full-time employment would emerge as significant predictor variables, which allow us to estimate the criterion variable – how satisfied someone is likely to be with their job. As we have pointed out before, human behavior is inherently noisy and therefore it is not possible to produce totally accurate predictions, but multiple regressions allow us to identify a set of predictor variables which together provide a useful estimate of a participant’s likely score on a criterion variable.

How does multiple regressions relate to correlation & analysis of variance?

Multiple regressions is simply an extension of this principle, where we predict one variable on the basis of several other variables. Having more than one predictor variable is useful when predicting human behavior, as our actions, thoughts and emotions are all likely to be influenced by some combination of several factors. Using multiple regressions we can test theories (or models) about precisely which set of variables is influencing our behavior. On Analysis of Variance, human behavior is rather variable and therefore difficult to predict.

What we are doing in both ANOVA and multiple regressions is seeking to account for the variance in the scores we observe. Thus, in the example above, people might vary greatly in their levels of job satisfaction. Some of this variance will be accounted for by the variables we have identified. For example, we might be able to say that salary accounts for a fairly large percentage of the variance in job satisfaction, and hence it is very useful to know someone’s salary when trying to predict their job satisfaction. You might now be able to see that the ideas here are rather similar to those underlying ANOVA. In ANOVA we are trying to determine how much of the variance is accounted for by our manipulation of the independent variables (relative to the percentage of the variance we cannot account for). In multiple regressions we do not directly manipulate the IVs but instead just measure the naturally occurring levels of the variables and see if this helps us predict the score on the dependent variable (or criterion variable). Thus, ANOVA is actually a rather specific and restricted example of the general approach adopted in multiple regressions. To put this way, in ANOVA we can directly manipulate the factors and measure the resulting change in the dependent variable. In multiple regressions we simply measure the naturally occurring scores on a number of predictor variables and try to establish

which set of the observed variables gives rise to the best prediction of the criterion variable. A current trend in statistics is to emphasize the similarity between multiple regression and ANOVA, and between correlation and the t-test. All of these statistical techniques are basically seeking to do the same thing – explain the variance in the level of one variable on the basis of the level of one or more other variables. These other variables might be manipulated directly in the

case of controlled experiments, or be observed in the case of surveys or observational studies, but the underlying principle is the same.

When should I use multiple regressions?

You can use this statistical technique when exploring linear relationships

between the predictor and criterion variables – that is, when the relationship follows a straight line. (To examine non-linear relationships, special techniques can be used.)

The criterion variable that you are seeking to predict should be measured on a continuous scale (such as interval or ratio scale). There is a separate regression method called logistic regression that can be used for dichotomous dependent variables (not covered here).

The predictor variables that you select should be measured on a ratio, interval, or ordinal scale. A nominal predictor variable is legitimate but only if it is dichotomous, i.e. there are no more that two categories. For example, sex is acceptable (where male is coded as 1 and female as 0) but gender identity (masculine, feminine and androgynous) could not be coded as a single variable. Instead, you would create three different variables each with two categories (masculine/not masculine; feminine/not feminine and androgynous/not androgynous).

Multiple regressions require a large number of observations. The number of cases (participants) must substantially exceed the number of predictor variables you are using in your regression. The absolute minimum is that you have five times as many participants as predictor variables. A more acceptable ratio is 10:1, but some people argue that this should be as high as 40:1 for some statistical selection methods.