The Effect of Working Capital Management on Firm Profitability: Evidence from Selected Wholesale Trade Firms in Addis Ababa, Ethiopia

Abstract

Working capital management has a vital role for success or failure of a firm because of its immediate impact on profitability as well as liquidity. Because of its routine nature of working capital management is the most important one among all issue of financial management. The purpose of this study is to examine the impact of working capital management on profitability of selected large tax payers wholesale firms found in Addis Ababa city. In order to achieve the objectives this study quantitative approaches and explanatory research design were employed. The study was used audited financial statement of six two (62) purposively selected large tax payers wholesale firms for a period of five years (2011-2015) with the total of 310 observations. Accounts receivable period, inventory holding period, account payable period and cash conversion cycle were used as independent variable to measure working capital management. Current assets to total assets ratio and current liabilities to total assets ratio were used to measure working capital investment and financing policy respectively. The dependant variable, firm profitability was measured by return asset. For data analysis the study used descriptive analysis, correlation analysis and a random effects regression model. The result of random effect regression sowed that; there was positive relation between account receivable period and profitability indicating that aggressively collecting receivable adversely affects sample whole sale firms profitability. There was positive relation between inventory holding period and profitability suggesting that maintaining high inventory increase sales. Accounts payable period had significant negative impact on profitability indicate that less profitable firm wait longer periods to pay their obligation. There was significant negative relation between cash conversion cycle and profitability suggesting that sample wholesale firm improve their profitability by shortening the time gap between firm’s actual cash inflows and outflows. There was significant positive relation between current assets to total assets ratio and profitability means that sample wholesale should invest more in working capital than fixed asset in order to get more profit. The study conclude that liberal credit collection, holding high inventory, quick payment of debt and keeping the length of cash conversion cycle to possible minimum level can increase the profitability of a firm.