Determinants of Working Capital Requirement on Manufacturing Firms

Abstract

Working capital investments are essential for daily business operations of an entity. For that matter firms make huge amounts of investments in working capital that enables them to pay recurring obligations. Current asset investments are, however, the least profitable assets of an entity. Thus, in order to maintain the optimum level of working capital required for the daily operation business managers involve in trade-off decisions between profitability and liquidity. In response to this, researchers from developed economies have been striving to investigate the determinants of working capital requirement, since recent years. But, those researches have not considered the issue in underdeveloped economies and there exist a knowledge gap on the literature, with only scanty of studies available in such economies. Therefore in an attempt to fill this research gap, this study investigated the determinants of working capital requirement of 35 large taxpayer manufacturing firms from food and beverage industry of Addis Ababa by employing explanatory research design with quantitative approach. Firms’ financial statements were collected for five years period from 2011 to 2015.Cash conversion cycle, return on asset, operating cash flow, leverage,firm size ,growth rate ,real GDP growth rate and inflation rate were used as an explanatory variables to measure the size or level of working capital requirement, and net working capital deflated by total asset were used as a dependent variable. Data was analyzed with the help of STATA (version 13) and, descriptive and correlation analysis and pooled panel data regression models of cross-sectional and time series data were employed. Results from the analysis revealed that there is statistically significant negative relationship between working capital requirement with leverage, firm size, real GDP growth rate and inflation rate. And there is positive and significant relationship between working capitai requirement with cash conversion cycle. This study recommended that managers of large firms that have an excess leverage should have to pay more attention on minimizing the level of loan at the optimum level and diverting the investment in to profitable long term asset.Finally this study has recommend that managers of those firms should have to pay more attention on shortening the cash conversion cycle by accelerating cash collection and lengthen the payament periodto improve the profitability of those firms.