Effect of WCM on Firm Profitability in Pakistan Textiles
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This research examines the effect of Working Capital Management (WCM) on profitability of firms in the textile sector of Pakistan. I also used cost of production and fixed assets cost as control variable to investigate their effect on profitability of textile companies. I have selected a sample size of 55 textile companies of Pakistan for a period of six years from 2003 to 2008. Regression and coefficient of correlation are used for analysis. The SPSS result R=0.77 shows the strong correlation between the model which helps me understand the relationship between working capital, cost of production, fixed assets and profitability.
This research is focusing on working capital management and its effects on profitability of textile companies in Pakistan. The main objectives are:
- To determine the relationship between the efficiency of Working Capital Management (WCM) and Profitability over a period of 6 years for 55 Textile firms of Pakistan.
- To analyze the relationship between cost of production and profitability of textile companies.
- To find out the effect of fixed assets cost on profitability of textile companies.
- To draw conclusion about the relationship between efficiency of working capital management and profitability of textile firms in Pakistan.
- To suggest some measures for improvement in working capital management of textile sector in Pakistan.
Due to the time frame and choice of the subject there were number of limitation faced by the researcher during the thesis.
The first and the foremost limitation to this research is the shortage of time which created many hurdles in collecting data and completion of report;
Researcher was unable to find many research on his topic within the scenario of Pakistan. So therefore researches were unable to compare its finding with other researches;
Very few studies have been made in relation to Working Capital Management (WCM) especially in the textile sector in Pakistan. Therefore, the present study is a maiden attempt to analyze the relationship between WCM efficiency, cost of production, fixed assets cost and Profit in the textile sector in Pakistan.
Its was very difficult for research to collect financial data of 55 textile companies in a very short span of time allotted to complete the research.
Chapter - 1: INTRODUCTION
1.1 - Textile Sector:
Textile products are a basic human requirement next only to food. Backbone of industrial sector which plays a vital role in the national economy it give support to GDP, exports, employment, foreign exchange earnings, investment and contribution to value added industry by providing employment to largely utilized workforce. So to boost the economy and to reduce the poverty in the country the performance of all industrial sectors is very important and textile sector is one of the major sectors of all developing countries.
1.2 - Performance of Textile Sector in Pakistan:
The performance of textile sector has strong relationship with the cost incurred by textile sector and effective management of net working capital. Pakistan is a developing country which lack in most of the industrial resources same as the case with textile sector in Pakistan we have to import most of the technical machinery used in textile sector from other developed countries which increases the overall cost of textile sector in Pakistan as well as lack of working capital, increase in fuel prices, electricity shortage, high import duties, high cost of debt, taxation and all other factors together bring negativity in the performance of textile sector. However, Pakistan's textile industry has again started to invest in the textile machinery and the imports of textile machinery for the month of February, 2010 were $23.1 million, an increase of 190% as compared to the imports of machinery in February, 2009 of $7.99 million. From July 09 to February 10 the total imports of machinery recorded 3.1% increase, from $158.89 million to $163.844 million for the same period last year. Although the textiles sector cost has increased by purchase of these new machineries but this technology placed the positive impact on performance of textile industries because this not only increase productivity & ultimately profit but also it helps to compete in the international market.
The increased in labor cost is also one of factor effecting the textile sector in Pakistan because the major portion of textile production depends upon the labor used for production purposes due to the lack of technology. As the enhancement of minimum wages for textile sector is announced which proposed increase in minimum wages from Rs.4, 600/= to Rs.6, 000/= per Month (over 30%) for unskilled workers will have a devastating effect on industry. Besides the financial impact will also have to be borne towards payment of gratuity, provident fund, EOBI, social security excluding overtime etc. which if worked out will come to Rs.8, 322. In addition to the above, proportionate increase will also have to be given to the skilled cadre of workers as for instance; an operator will refuse to work at the same rate of salary being paid to a doffer. This will make textile sector survival more difficult in current scenario. The growth of textile sector depends on its productivity and mainly depends on the cost and profitability.
The textile sector is the largest sector of Pakistan's economy which has the major shares in exports of the country but the major financing of this industry depends upon the bank loan. To purchase heavy machineries on cash or to lease them, the textile sector required huge amount of investment and to meet daily expenditures they need net working capital and for all that they have to borrow from bank by paying interest (i.e. cost debt) which increases the overall cost of textile sector in Pakistan. The textile sector of Pakistan is divided in many small firms which have small capital structure most of them are mainly dependent on loans due to unavailability of funds, continuous increase in cost of production. All these factors have a cumulative effect on the cost and profitability of textile sector as the increase in double digit inflation the survival of textile sector become more difficult. Although the textile sector of Pakistan is backed by the government with their greatest interest in textile sector. They have arrange different types of investment policies and funds for textile sector but the improvement in textile sector due to other factors is still less then the requirement.
Importance Of Textile Industry In Pakistan's Economy
1.3 Effect of Working Capital and Other
Factors on Textile Sector:
Working capital management is a very important component of finance because it directly affects the profitability and liquidity of any organization especially in developing countries like Pakistan. It comprises funds invested in Current Assets, which in the ordinary course of business can be turned into cash within a short period without undergoing diminishing in value and without interruption of the organization. Current Liabilities are those which are projected to be paid in the ordinary course of business within a short time. Every company has to make arrangements for adequate funds to meet the day-to-day expenditure apart from investment in Fixed Assets.
However, Pakistan textile sector is on decline just because of the additional cost due to lack of working capital which can have impact of profitability and liquidity and increase in inflation also effect textile's production badly. In this research, I have discussed and analyzed the relationship between the efficiency level of working capital management and profitability of textile sector in Pakistan as it is the major sector which contribute in Pakistan economy and generate foreign revenue by exporting textile products to international markets but the increase in cost, debt and improper management of working capital in this sector make its a declining sector in terms of profitability and liquidity. The textile industries come under the SMEs (Small Medium Enterprises) which does not bear the continuous increase of cost. According to APTMA, textile exports of Pakistan have declined by about 20% in 2008. The industry is bracing for more trouble ahead with continuing crises of electricity and gas, international market access, global economic slowdown, lack of capital and adverse travel advisories.
Chapter - 2: LITERATURE REVIEW
2.1 Concept of Working Capital:
Gross Working Capital: It represents the total current assets and is also referred to as circulating capital because current capital as current assets, are circulating in nature.
Net Working Capital: It is a measure of liquidity and it can be defined in two ways.
The most usually implied definition of net working capital is that it represents the difference between current assets and current liabilities. Some people also define it as excess of current assets over the current liabilities.
It is that portion of the firm's current assets, which is financed by long-term funds.
2.2 Objectives of Working Capital Management:
The main objective is to ensure the maintenance of satisfactory level of working capital in such a way that it is neither inadequate nor excessive. It should not only be sufficient to cover the current liabilities but ensure a reasonable margin of safety also.
To minimize the amount of capital employed in financing the current assets. This also leads to an improvement in the â€œReturn of Capital Employedâ€?.
To manage the current assets in such a way that the marginal return on investment in these assets is not less than the cost of capital acquired to finance them. This will ensure the maximization of the value of the business unit.
To maintain the proper balance between the amount of current assets and the current liabilities in such a way that the firm is always able to meet its financial obligations, whenever due. This will ensure the smooth working of the unit without any production held ups due to paucity of funds.
2.3 Nature & Importance of Working Capital:
Working capital is the most important concepts that a company should understand as how working capital and financing helps them to survive and competitive in business world. Working capital fulfills the short-term financial requirements of any business organization including textile companies especially in developing countries like Pakistan. It is regarded as operating capital needed to meets daily cash requirement of the organization and can not be retained in the business for a longer period of time in a particular form. The money invested in working capital changes its form and substance during the normal course of any business operations and the need and importance for maintaining an adequate working capital in any industry including textile sector can not be neglected in any way. Just as human body can not survive without the circulation of blood in the body, the organization also requires sufficient flow of funds within the organization. If it becomes weak, the business can hardly survive, prosper and generate profit.
In developing countries like Pakistan, working capital starvation is generally accredited as one of the most important reason which causes the decline of any industry. According to Rafuse, (1996), Working capital starvation is generally credited as a major cause if not the major cause of small business failure in many developed and developing countries. There are several problems that create starvation of cash in any business which include poor financial management and improper planning of cash management. Jarvis et al, (1996) said that the cash flow problems of many small businesses are exacerbated by poor financial management and in particular the lack of planning cash requirements. For the financial strength of the business, a company should have and will prefer to have a positive working capital rather than a negative working capital. Some of the best ways to acquire short-term working capital financing are equity, trade credit and short-term loans.
2.4 Determinants of Working Capital:
Working capital management is an indispensable functional area of management. However the large number of factors influences the total working capital requirements of the firm. It may however be added that these factors affect differently to the different units and these keep varying from time to time. In general, the determinants of working capital, which are common to all organizations, can be summarized as under:
Nature and Size of Business
Growth & Expansion
Proper availability of raw materials
2.5 Sources of Working Capital:
The working capital necessary and what constitutes working capital have been analyzed in depth. Now we look out what are the ways we can generate working capital.
Current provisions and non-bank short term borrowings: and
Long term sources i.e., equity share capital, preference share capital and other long term borrowings.
2.6 The Management of Working Capital
According to Van Horne (1977), working capital management is the management of current assets such as cash, marketable securities, receivables, and inventories. Osisioma (1997) described working capital management as the regulation, adjustment, and management of balance between current assets and current liabilities of a firm such that maturing obligations are met, and the fixed assets are properly serviced. In order to manage working capital efficiently, two elements must exist as necessary components and desirable quantities. Osisioma (1997) explained that efficient working capital management must guarantee an adequate relationship between the different components of a organization's working capital so as to make an efficient mix, which will guarantee capital adequacy. Thus, working capital management should ensure that the desirable quantities of each component of the working capital are available for organization. However, the question arises that â€œWhat determines necessary components of an organization's working capital and how much of such necessary components can be considered as adequate or desirable?â€? Each organization working capital's necessary components depend on the type of business and industry. Cash, accounts payables, accounts receivables, marketable securities, inventories, and redeemable futures can be recognized as the common components of firm's working capital. However, the question is to recognize the factors that determine the adequacy of working capital based on growth, size, operating cash flow, etc. The inability to understand the determining factors and measurement of adequate amounts of working capital will lead an organization to bankruptcy.
The altitude of performance levels businesses have traditionally been attributed to many general managerial factors such as manufacturing cost, marketing strategies and operations. Working capital management may have a consequent impact on business survival and growth (Kargar and Blumenthal, 1994). The proper management of working capital is very vital for the financial health of businesses of all sizes. It is often observed that the amounts invested in working capital are high in percentage to the total assets employed. Therefore, it is imperative that these amounts should be used in an efficient and effective manner. However, there is substantiation that manufacturing sector which include textile industry as well are not very good at managing their working capital. Reasons for that are many small businesses suffer from undercapitalization, increase cost of production, increase fixed asset cost and lots of other factors. According to V MARIAPPAN, K CHIDAMBARAM) (2003), Productivity does not only mean the increase in production but it relates to the cost reduction and efficiency in the process of production. Therefore, the importance of exerting tight control over working capital investment, cost of production and cost of fixed assets can not be neglected.
An organization can be highly profitable, but if it fails to translate this into cash from operations within the same operating period, the organization would require borrowing to support its continued working capital requirements. Hence, the dual objectives of profitability and liquidity must be synchronized and one should not impinge on the other for long. Investments by any business in current assets are inevitable to ensure delivery of goods or services to the ultimate customers and a proper management of same should create the desired impact on either profitability or liquidity. If different resources are blocked at the various phases of the supply chain, this will lengthen the cash operating cycle. However, profitability might increase due to increase sales but it may also adversely affect the profitability if the costs tied up in working capital surpass the benefits of carrying more inventories and/or allowing more trade credit to customers. (Padachi, Kesseven, Oct 2006)
2.7 Production Cost & Profit:
Production cost is the cost of materials and labor necessary to produce goods and there are two types of profit that is generated from a business. The first is gross profit which is the difference of the total revenue generated after the sale of each item by the production cost for that item.
Second is net profit which is calculated once the company pays taxes, rent, and other expenses that might come with running and owning the business.
However lack of technology, increase labor and material cost, higher cost of debt and other factors increases production cost and decrease profit but if production increases, businesses are able to purchase more materials at a discounted rate, which can help them to reduce the production cost.
2.8 Textile Sector & Cost of Production:
The relationship of cost of production with profit of any sector is the key element used to evaluate the productivity of that particular sector including textile sector. Productivity is often mixed with increased production. However, higher production does not always mean higher productivity. Higher productivity can be achieved only by better utilization of resources and reduction of cost. So the importance of production cost can not be neglected and is closely related to the increase productivity of industrial sector on any economy. According to the Michael porter of the Harvard University says the competitiveness of any sector is totally depend on the productivity of its industrial sector. Productivity does not only mean the increase in production but it relates to the cost reduction and efficiency in the process of production (V MARIAPPAN, K CHIDAMBARAM) (2003).
The competition from international market has been increased due to the continuous innovation on technology used in the industrial sector of textile which ultimately increases the cost. "The protection from international competition of the earlier semi-insular phase has given rise to high cost manufacturing, which is inhibiting both the expansion of the domestic market and more rapid development of exports" [India, 1985:16].(Aug 29 1989). However, the intense competition in international market leads to the high domestic growth with increased in the level of exports. Productivity is getting drained mainly due to under- utilization of machines, inefficient working, poor machinery maintenance, over- spinning, lack of modernization, power shortage and unhealthy labor and management relations [Gulrajani 1982]. (2003) with reference to above saying the same situation is related to the Pakistan's textile sector the machines used in the textile sector is either underutilized or very old which became the hurdle in productivity of the sector and the labor related with this textile sector is also effected due to strong labor unions in the country which increase cost and decrease productivity and eventually profit of the textile sector.
The government policies related to the investment on technological innovation also effect textile sector Government policies in these sectors, it is argued, have been biased against fresh investments; and import restrictions on capital goods and advanced technology have condemned entire industries to obsolete technologies (1989). The restriction on the imports and other obligations imposed by the Government on the purchase of machinery from outside country force the entire industry to obsolete technologies as well the continuous capital requirement for the expansion of production and other raw material cost force the textile sector to borrow money from bank to inject working capital. One of the most important concepts that a new business owner should know is how working capital and financing helps them survive and grow in a competitive world. The difference between current assets and current liabilities is known as â€œnet working capital (Jonathan Keith Gober). The data of textile sector used in this research shows that most of the companies have negative working capital which means the current liabilities of the textile sector is more than the asset which again increase the cost of the textile sector of Pakistan.
2.9 Textile Sector & Cost of Fixed Assets:
With increasing global competition, the survival of any industry is getting difficult day by day especially in developing countries like Pakistan. Textile sector or any other sector of all developing countries used machineries and fixed assets which are obsolete and outmoded which increases their cost of production and decline productivity, efficiency and profitability. According to V. Mariappan and K. Chidambaram (2003), proper machine utilizations, the effective cost management and quality of material supplies are the three vital factors that determine the operating efficiency of a textile mill.
Developing countries lack in most of the industrial resources same as the case with textile sector in Pakistan we have to import most of the technical machinery and equipment used in textile sector from other developed countries and this increases the overall cost of textile sector in Pakistan. Although the cost of textile sector increases with purchase of new machineries and equipment but this advancement in technology create the positive impact on performance of textile sector because this not only increase productivity, efficiency and profitability but also it helps textile firms to compete in the global market. Increase productivity of the textile sector is not only the outcome of advancement in the level technological development but other factors such as relative cost of labour and equipment, the cost of material, effective management of working capital and other resources also create an impact on it. Thus, higher productivity is not an accident. It is the result of effective planning and the judicious use of resources, V. Mariappan and K. Chidambaram (2003).
Chapter 3: METHODOLOGY
3.1 Statement of Problem:
'What is the impact of working capital, cost of production and fixed assets cost on profitability of textile sector in Pakistan?'
H1: Increase in working capital negatively affect the profitability of textile sector by increase in short term liabilities.
H2: Investment in technological instruments (Fixed Assets) has the positive impact on the profitability of textile sector:
H3: High production cost has a negative impact on the development of textile sector.
3.3 Data Collection:
There are two major sources of data collection use by the researchers for research purposes. They are:
Primary data is used for the first through questionnaires, interviews and service and this is not published anywhere before.
Secondary data is used for the researches which are based on already published in different newspapers, research journals and yearly companies reports.
Chapter 4: STATISTICAL ANALYSIS
In the model summary table he capital â€œRâ€? in this table is coefficient of correlation which is .775 which shows that there is high correlation(relationship) between dependent (net income) and independent variables (fixed assets, working capital and cost of good sold) the second column which shows R Square (coefficient of determination or regression coefficient) which shows that 60% Of variation in net income amount is caused by predictors third column is Adjusted R square 59.7% variation is caused by predictors considering number of observations and the number of predicted variables.
The ANOVA table tests the model acceptability and how model fits the first row which shows regression displays information about the variation accounted for by your model and the second row of Residual shows information about the variation is not accounted by your model the significance value of F is .000 which is less than 0.05 so it means than model is acceptable and the variation explained by the model is not due to chance.
The coefficients table the first row shows constant which is second column of first row -38.373 shows that when all predictors (cogs, working capital and fixed assets) are held to zero the amount of net income is -38.373 and the constant is also significant P<0.05. Then there is fist slope which is cost of good sold it is also significant p<0.05, p=0.000 and t=5.375 which shows that cost of good sold had impact on net income the value of beta for cogs shows 1 million change in cost of good sold will bring 0.052 million change in net income which is not bigger change but at least it will bring change and significant. Then second slope is working capital it is also significant p<0.05, p=0.000 and t=11.333 which shows that working capital had impact on net income the value of â€œtâ€? is also bigger shows healthy variability in net income by working capital the value of beta for cogs shows 1 million change in working capital will bring 0.125 million change in net income. Final variable is fixed assets which is not significant p>0.05, p=0.641 which means that change in fixed assets will not bring any change in net income
On the basis of correlation matrix fixed assets is again rejected of being related to net income R=0.309 which is very low correlation it is also insignificant as shown in coefficient table.
Chapter 5: CONCLUSION &
After evaluating the whole textile sector I reached to a point that cost is greatly affect the productivity, efficiency and profitability of every sector same as the case with textile sector. In Pakistan, the textile sector is considered the most important investment sector which greatly push Gross Domestic Product (GDP) and National Income (NI) of the country. So to study such an important sector these variables help me in evaluating the relationship of cost with the performance of textile sector.
The hypothesis used in conducting this research shows the impact of fixed assets, working capital, cost of production with the net income of the sector my finding shows that there is no impact of fixed asset cost on net income of the textile sector so my hypothesis is rejected which shows that increase in the investment of technology and equipment improve the efficiency and productivity of textile sector.
Secondly, the research contain other variable relationship with the development of textile sector in which the working capital plays an important role my research results clearly shows the impact of working capital with net income because the increase in current assets help this sector to better maintain its current liabilities which ultimately reduces the addition cost incurred by the sector. In Pakistan textile sector needs continuous short term investment which forced the sector to increase it short term debt by borrowing from bank to meet its short term expenses. So the sample size taken in the research shows that both of them are highly correlated but they have inverse relationship increase in working capital decreases the net income as vise a versa. So my hypothesis for the working capital is accepted and it is proved that independent variable is explained by dependent variable.
The third and last variable is the cost of production which incorporate all costs incurred while production of the textile items. It include the prices for all raw materials which are essential for the production process fuel, oil inventories, transportation, cotton prices, yarn prices which bring significant changes in the profitability of textile sector . The hypothesis used for the cost of production shows that there is inverse relationship on cost of production and profitability as cost for producing the textile items is increasing the profitability becomes falling and in result the development of textile sector faced hurdles in growing.
The overall analysis shows that we cannot considered the increase in production only until or unless the cost structure is not clearly defined although the production of textile sector is increased in last few years but simultaneously the cost is increased with greater extend which reduces the profit margins with very less proportion which does not support the economy of Pakistan which has the major share in growth of the Pakistan's economy.
Pakistan is a one of the leading country producing raw yarn, cotton, and fabrics. If we focus on the value added products like garments, hosiery, knitwear and other textile products, the production volume of textiles can be enhanced by tremendously. In this respect top priority should be given to cost reduction, easy availability of working capital and employment creation.
The Government of Pakistan has created a special Textile Board for the promotion of Textile Industry as predicted in Textile Vision 2005 but unfortunately its performance and productivity is still below expectation of the government of Pakistan. So the guess is that government should establish a Ministry of Textile to meet the demand of private sector.Â
Whole economy of Pakistan is suffering due to energy crisis. Therefore, the increase in double digit inflation causes great discrepancy in the production of textile industry which forces most of the textile firms to wind up their business and to set up their business in other countries in our region. Therefore, my suggestion for government is that the government should take concrete steps on priority basis to resolve energy crisis and control inflation in Pakistan.
The government of Pakistan has recently imposed tax of the import of thread from other countries which is severely affecting the productivity and profitability of the textile sector and tremendously increases the cost of production of textile industry. To resolve this issue, the government needs to seriously look into this matter and try to find a solution to it to boost the textile industry in Pakistan.
Government should either set up joint ventures in textile related areas or should provide subsidized credit to textile manufacturers to upgrade their technology and capacity building through â€˜Technology Upgradation Fund'. (TUF). It is also suggested that smaller units of power looms (up to 50 looms) should be upgraded to auto looms and power loom units larger than 50 looms into air jet looms.
At present cost of doing business in Pakistan is higher as compared to the regional countries, which has resulted in bitter competitiveness to Pakistani Products in Foreign Markets. China and India are the bigger competitors of Pakistan. We fear if cost of doing business in Pakistan is not brought at par with other Asian countries, our products would find no place in Market both in terms of quality and price. In the context of future trade, there is an urgent need to bring all the utility charges and levy of taxes down to the minimum level.Â
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