Relationship between Cash

Conversion Cycle &

Profitability of Cement &
Textile Sector of Pakistan

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

RESEARCH PROPOSAL FOR DISSERTATION

THE RELATIONSHIP BETWEEN CASH CONVERSION CYCLE AND
PROFITABILITY OF CEMENT AND TEXTILE SECTOR OF PAKISTAN

SUBMITTED TO
DIRECTOR
MAM SAJIDA NISAR

SUBMITTED BY
SADIA IQBAL
ROLL NO. 02
MBA 1.5
SESSION 2014-2016
INSTITUTE OF BUSINESS ADMINISTRATION
UNIVERSITY OF THE PUNJAB
LAHORE
NOVEMBER 16, 2015

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Contents
Abstract............................................................................................................................................3
Introduction......................................................................................................................................4
Topic Area....................................................................................................................................4
Research Question........................................................................................................................4
Significance..................................................................................................................................5
Literature Review............................................................................................................................6
Methodology....................................................................................................................................8
Approach......................................................................................................................................8
Variables.......................................................................................................................................8
Hypotheses...................................................................................................................................9
Population & Sample...................................................................................................................9
Data Collection............................................................................................................................9
Data Analysis.............................................................................................................................10
Plan for interpreting results........................................................................................................10
Expected Results............................................................................................................................11
Budget............................................................................................................................................11
References......................................................................................................................................12

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Abstract
The study is aimed at investigating the relationship between Cash Conversion Cycle and the
profitability of the firms. For the purpose of this study, sample of 30 companies shall be drawn
from the cement and textile sectors of Pakistan. Data will be collected from the Income
statements and the Balance sheets of sampled firms over a period of five years from 2010-2014.
Quantitative research design using Descriptive analysis, Pearson correlation coefficient, and ttest will be employed to empirically investigate the relationship between the variables of interest.
Other than the conventional measures of profitability i.e. ROA, study intends to study the
correlation between CCC and Operating profit (EBIT) and Earnings per Share (EPS). It is
expected that the statistical tools will prove that there is a significant and negative relationship
between CCC and the measures of profitability taken for the purpose of this study. The findings
of the study can provide valuable insights to managers to aid the decisions regarding balancing
liquidity and profitability.
Keywords: Cash Conversion Cycle, Profitability, Return on Assets, Earnings per Share,
Operating Profit, Working Capital Management

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Introduction
Topic Area
Working Capital Management is considered to be a very important area for every enterprise,
since it has significant bearing on overall profitability and liquidity (Appuhami, 2008). Cash
Conversion Cycle is one of the dimensions to measure how well a firm is managing its working
capital (Nobanee, Abdullatif, & AlHajjar, 2011).
Besley and Brigham (2007) Defined the Cash Conversion Cycle (CCC) as:
The length of time from the payment for the purchase of raw materials to manufacture a product
until the collection of account receivable associated with the sale of the product.
As the length of the CCC increases, the liquidity position of the firm improves, but more
resources are required to be invested in order to run the operations of business smoothly, and
hence the profitability is adversely affected. CCC can be both positive as well as negative. A
positive CCC indicates the number of days the management of the business must arrange/borrow
funds or resort to its available liquid assets before it gets the collections from its accounts
receivables(s). On the other hand a negative CCC can be regarded as highly beneficial implying
that firm has already received cash from its debtors by the number of days before it has to
discharge its current obligations towards its creditors (Uyar, 2009). It is therefore preferable to
keeps CCC days as low as possible to avoid any liquidity problems or cash bottlenecks (Attari &
Raza, 2012).
Cash Conversion Cycle and Working Capital have a significant impact on the operational as well
as long term returns of companies; however it has been an ignored area of research in Pakistan.
This study aims to contribute to the existing body of knowledge by examining the association
between Cash Conversion Cycle and the Profitability of firms selected from Cement and Textile
sectors of Pakistan.

Research Question
Quite an extensive literature exists regarding working capital management and its impact on the
profitability of firms, but only a few researches have been conducted in Pakistan regarding the
working capital management and still a little is known regarding the association between cash
conversion and firms profitability. The purpose of this study is to fill the gap and contribute to
the literature on the working capital management by analyzing the Relationship between the
length of Cash Conversion Cycle and profitability of the sample firms taken from Cement
and Textile industry of Pakistan.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

The primary research questions of this study are:

Whether there is a significant relationship between Cash Conversion Cycle and the long
term profitability of the firm as measured by EPS?
Whether there is a significant relationship between Cash Conversion Cycle the short term
profitability of the firm as measured by the operating profit?
Whether there is a significant relationship between Cash Conversion Cycle and the
traditional measure of profitability i.e. ROA?

Significance
The study will provide some vital insights to the management of the firms regarding controlling
and planning the receivables, payables and inventory effectively, while balancing the liquidity
and profitability. Moreover it aims at improving the decision making regarding the CCC by
keeping in view its impacts on the corporate returns of the firms. Study can also highlight the
important patterns exhibited by the sample firms in terms of the variables of interest. The study
under consideration provides room for further researches by highlighting the important, ignored
and less emphasized dimensions in the working capital management and profitability. Examining
the profitability in terms of EPS (Earnings per Share) and EBIT (Operating Profit), by keeping
the traditional measure of ROA under focus is the major contribution to the existing body of
knowledge by the study under consideration.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Literature Review
Considerably large amount of literature substantiates the link between Cash Conversion Cycle
and Profitability, and highlights the importance of effective Working Capital Management in
Corporate Returns. The purpose of this section is to analyze the accumulated knowledge in this
area, and identify the gaps and holes in it to conduct further studies.
According to Bhutto, Abbas, ur Rehman, and Shah (2015)literature indicates the presence of two
dimensions of Working Capital Management. One of them assesses the Working Capital
Management on the basis of balance sheet, by taking into account the current assets and current
liabilities. While the other dimension of Working Capital Management is the Cash Conversion
Cycle. A number of other studies support this concept. According to Theodore Farris and
Hutchison (2002), Moss and Stine (1993) and Uyar (2009) Corporate liquidity can be determined
by static or dynamic aspect. As mentioned above the static view is based on the balance sheet,
thus it makes the use of typical ratios like liquidity and working capital management ratios.
These ratios constitute the static aspect, since these have no temporal qualities and measure the
liquidity at a particular point in time. Cash conversion cycle is the dynamic measure of liquidity
since it considers the ongoing liquidity of the firm. The other reason it is preferred over the static
view, is that it incorporates both balance sheet and income statement.
Lyroudi and McCarty (1993) studied the Cash Conversion Cycle in small firms. He applied
Pearson correlational analysis to study the correlation between the Cash Conversion Cycle and
profitability ratios of net profit margin, return on investment and return on equity. He concluded
that CCC was significantly and positively related to all profitability ratios.
Lazaridis and Tryfonidis (2006) investigated the link between corporate profitability and
working capital management on sample of 131 companies listed in the Athens Stock Exchange
(ASE) for the period of 2001-2004. He observed a significant negative relationship between the
two.
Attari and Raza (2012) studied the link of Cash Conversion Cycle with the firms size and
profitability of the 31 companies taken from Automobile and Parts, Cement, Chemical, and Food
Producers sectors, and concluded a significant negative correlation between CCC and size and
profitability. Al-Shubiri and Aburumman (2013) investigated the relationship between cash
conversion cycle and financial characteristics, one of which was profitability, by taking a sample
of companies from 11 industrial sectors of Jordan. Takon (2013) worked on the relationship
between CCC and ROA as a measure of profitability of selected Nigerian quoted firms. The
results of the study proved a negative relationship between ROA and CCC.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Muscettola (2014) analyzed the link between CCC and profitability on the sample of 4,226
manufacturing SMEs of Italy. He found out that by increasing the number of days for account
receivables, and hence cash conversion cycle, the profitability of a firm can be increased.
Upadhyay, Sen, and Smith (2015) investigated the relationship between CCC and Net profit
margin and Operating margin of hospitals in Washington, and concluded an negative
relationship.
As mentioned above, the knowledge base on the relationship between Working Capital
Management and the performance of the firm particularly profitability is quite extensive, yet a
lot needs to be done to answer the remaining questions. There are a number of reasons which
provide evidence for conducting further research in this area.

Most of the studies conducted on WCM focus on the static dimensions (liquidity,
working capital ratios) of the working capital management, which highlights the CCC as
an ignored dimension.
Majority studies examine the relationship between CCC and the profitability of the firm
in terms of ROI, ROA or ROE.

These two points pinpoint two gaps in the literature.

1. The need to use CCC as an indicator of working capital management.
2. The need to consider the relationship between CCC and the profitability measures other
than ROA.
This study aims to address both the deficiencies. It intends to investigate the relationship
between the Cash Conversion Cycle (a dynamic measure of WCM) and the firms long term and
short term profitability (as measured by EPS and EBIT respectively).

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

Methodology
Approach
Quantitative research model will be employed to investigate the hypothesized relationship
between Cash Conversion Cycle and the profitability of the firm. It is a Correlational study as it
focusses on the nature, extent, strength and direction of relationship among variables of interest
without implying that one causes the other. As it is a correlational study, it will be conducted in
non-contrived settings, in the natural environment where the work flows normally. Since the
study intends to establish the relationship between the Cash Conversion Cycle and profitability
of the firms, the unit of analysis of this study is Organizations.

Variables
Studies conducted by Lyroudi and Lazaridis (2000), Richards and Laughlin (1980) and
(Lazaridis and Tryfonidis (2006)) employed CCC as the measure of liquidity and as an
independent variable. Cash Conversion Cycle is measured as a sum of three components i.e.
Average collection period, average age of inventory and average payment period.
CCC = AAI + ACP APP
CCC = OC* APP
*OC = AAI + ACP
Where:
AAI = Average Age of Inventory = 360/Inventory Turnover
ACP = Average Collection Period = 360/Receivable Turnover
APP = Average Payment Turnover = 360/Payables Turnover
The use of profitability as a dependent variable in examining the correlation between CCC and
profitability is established by many researchers (Attari, 2012; Lyroudi, 1993; and Samiloglu and
Demirgunes, 2008). Traditionally, ROA or ROI has been used as the only measures of
profitability (Takon and Manyo, 2013; Lyroudi, 1993). In the recent years however, a few
researchers went further to investigate the relationship between CCC and profitability as
measured by Operating profit margin or EBITDA (Earnings before Interest, Tax, Depreciation
and Amortization) (Muscettola, 2014; Upadhyay, Sen and Smith , 2015). Literature doesnt
provide any evidence regarding the relationship between CCC and EPS as the long term measure
of profitability. It is the gap this study intends to fill.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

For the purpose of this study, Profitability will be measured by three dimensions.
1. Return on Assets (ROA)
Where, ROA = Net Profit after Tax/ Total Assets
2. Operating Profit (EBIT)
Where, EBIT = Sales- Cost of Goods Sold- Operating Expenses
3. Earnings per share (EPS)
Where, EPS = Earnings available for Common Stock/Number of share of common stock
outstanding

Hypotheses
Since the aim of the study is to examine the relationship between CCC and the profitability of
the firm, following are the main hypotheses of this study:
H0: There is no relationship between cash conversion cycle and profitability of firms.
H1: There exists a relationship between cash conversion cycle and the profitability of the
firms.
These major hypotheses can further be broken down on the basis of three different measures of
profitability employed in this study.
H01: There is no relationship between CCC and ROA.
H11: There exists a relationship between CCC and ROA.
H02: There is no relationship between CCC and EBIT.
H12: There exists a relationship between CCC and EBIT.
H03: There is no relationship between CCC and EPS.
H13: There exists a relationship between CCC and EPS.

Population & Sample

To accomplish the objectives of the research, sample will be taken from the textile sector and
cement sector of Pakistan. Simple random sampling will be used for the selection of 15
companies from each sector. Hence, cement and textile sectors serve as the population for this
study. The firms having negative earnings or equity will be excluded from the sample for the
purpose of this study.

Data Collection
For the purpose of this study, data will be collected from the income statements and balance
sheets of the sampled firms for the period of 2010-2014. Collected data will be used to compute

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

10

ROA, EBIT, EPS and the three components of CCC. Since the research is not qualitative, the
data collected will be quantitative, not descriptive. Secondary data collected from the financial
statements will suffice the data needs of the research. There is no need to go for primary methods
of data collection.

Data Analysis
Descriptive analysis will be used to describe the basic features of the data collected from the
financial statements of sampled textile and cement companies (Bhutto et al., 2015). The mean
values of ROA, CCC, EPS and EBIT will be calculated to examine the industry averages.
Pearsons Correlation Coefficient will be employed to investigate the bivariate correlation
between CCC and three measures of profitability(Muturi, Wachira, & Lyria). T-test will also be
used to study the differences in the variables among cement and textile industries(Lyroudi &
McCarty, 1993). Regression analysis will not be appropriate for this study, since it is suitable for
the studies examining the relationship between one dependent variable with one or more
independent variables. It is expected that the analytical tools employed in the study will lead to
this outcome:
Length of Cash Conversion Cycle is negatively related to all profitability measures taken
for the purpose of this study.

Plan for interpreting results

For the purpose of interpretations of results, analytical tools like SPSS will be used. As
mentioned above, a negative relationship is expected between the variables of interest by
employing the statistical techniques.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

11

Expected Results
A number of empirical investigations indicated that there is a significant and negative
relationship between the variables of interest (Manyo, 2013; Shah, 2011; Yousaf, Majid & Yasir,
2014; Upadhyay, Sen and Smith, 2015; Muturi, 2015). The firms having shorter cash conversion
cycles are likely to be more profitable than the firms with longer cash conversion cycles. The
logic behind this proposed relationship lies in the Liquidity Profitability Trade-off Theory.
According to this theory, when a firm tries to strengthen its liquidity position, the opportunity
cost of excess liquidity jeopardizes its profit position. On the other hand if a firm reduces the
amount of liquid assets to increase its profitability, it faces the risk of being technically insolvent.

Budget
Since the study is constrained by time, cost and generalizability. The budget is expected to be
quite meager. Data shall be collected from the secondary sources rather than primary, which will
lead to cost reduction. Moreover, the scope of the study is limited to the extent of Cement and
Textile sector of Pakistan; no extensive statistical and validity tools will be required to ensure
increased generalizability of the study. All the above mentioned factors make it possible to
conduct this study under a low budget.

RELATIONSHIP BETWEEN CASH CONVERSION CYCLE & PROFITABILITY

12

References
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and financial characteristics of industrial sectors: an empirical study.
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management: An empirical study across industries in Thailand. International
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Size and Profitability. International Journal of Academic Research in Business and
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Lyroudi, K., & Lazaridis, Y. (2000). The cash conversion cycle and liquidity analysis of the food
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sample of 4,226 manufacturing SMEs of Italy. International Journal of Business and
Management, 9(5), p25.
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Theodore Farris, M., & Hutchison, P. D. (2002). Cash-to-cash: the new supply chain
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