DETERMINANTS OF WORKING CAPITAL “EVIDENCE FROM PRODUCTION AND SERVICE SECTOR OF PAKISTAN”

Purpose: Basic purpose of this study is to explore the factors or determinants of working capital. The effect of this research is threefold as its first aim is to explore the determinants of working capital in the service sector, second is to find the determinant of working capital in the production sector and third is to make a comparison between the findings of both sectors. Research Methodology: Quantitative technique of data collection has been used under explanatory research method and working capital has been taken as dependent variable while return on assets, return on equity, leverage, sales growth, firm size of total assets and firm size of total sales have been taken as independent variables from production and services sector of Pakistan. A sample of 34 companies listed at KSE for 5 years (2007-2011) has been selected with a total observation of 170. Data were collected from balance sheets of these companies from official site of State Bank of Pakistan. Findings: The finding of this research shows that the same selected variables are not a significant predictor of working capital in both sectors. In the service sector, all selected variables are significant predictor or working capital except for short term debt to total assets variable. However, in the production sector, only sales growth and return on assets is a significant predictor of working capital requirement. Unique contribution to theory, practice and policy: In a developing country like in Pakistan, very little work has been done on working capital determinants. In developed countries and other developing countries, enough work has been done in that area, however, not previously study covers the comparison of the diverse sectors to determine working capital. This study will add a new dimension to the existing literature and cover the gaps in existing literature by adding the comparison of diverse nature sectors into the existing literature. Key variable: Working Capital, Determinants of working capital, Profitability, Leverage, Firm size International Journal of Finance and Accounting ISSN 2513-4311X (online) Vol.5 Issue 1, No.5. pp. 67 78, 2020 www.iprjb. org 68 1.0 INTRODUCTION In an enterprise working capital is the availability of net current assets used to run the business operations. It is the disparity of current assets and current liabilities. Due to increase credit risk, financial crises, and low convenience to bank loans it is immense important for organizations to manage the requirement of working capital. (Rehan & Nasir, 2007). Working capital is the financial necessities that are needed to fulfill the day to day operations of an enterprise (Sulemain & Abidi,2012). In financial management, working capital is the most important area as it involves the maturity of less than one-year assets and liabilities. More particularly it affects the profitability and liquidity of the firm. Firms engage in long productions chain usually take time, in that manufacturing process working capital help organizations to manage the disparity occur during the cost of production and revenue generated from sales (Kim & Shin, 2013). Working capital running mode effect principally to liquidity, profitability, and efficiency of an enterprise. It is immense Important to manage the financial needs of a business. These financial needs ultimately affect the profits and liquid assets of the firm. It is important to analyze the short term assets and liability carefully so that the liquidity of the firm could be managed because the management of working capital help to managers to direct the firm’s operations through utilizing available cash for the payment of short term debt, the maturity of long term debt and to manage the day to day process of the enterprise. So, it is necessary for smooth working to maintain an optimal level of working capital for a trade-off between return and risk. The main objective of capital management is to optimize the cash conversion cycle which in turn affects the efficiency of working capital. According to (Mansoori & Muhammad, 2012) if a firm poorly manages its working capital or its working capital is too low, then it may lose many profitable investment opportunities. It is worth important for firms to keep the optimal level of working capital and its management for their endurance ( A b b a d i & A b b a d i , 2 0 1 3 ) . As working capital and its effective management have a greater impact on the profitability of firms so it is worth able for companies to understand what the key drivers, determinants, or component of working capital are. More specifically what variables affect working capital in any company. As companies can minimize risk and pick up the overall performance by understanding the role and drivers of working capital. A firm may adopt an aggressive Working capital management strategy with a low level of current assets as a percentage of total assets or it may use high level of current liabilities as a proportion of total liabilities. Excessive levels of current assets may have negative consequences on the firm’s profitability whereas a low level of current assets may lead to a lower level of liquidity and stock-outs resulting in difficulties in maintaining smooth operations. The main objective of working capital management is to maintain the most advantageous balance between each of the working capital components. As various studies have been done on working capital determinants in both developed and developing countries but in developing countries like in Pakistan no study has been done to understand the determinants of working capital in diverse sectors such as the production and services sector. In present research, the focus is to determine the components in production and services sector and analyze the findings of both sectors to identify whether determinants of working capital are the same in both sectors and not. This research has unique contribution to existing literature both for Pakistan as well as for international markets because it will help business managers to understand what are the determinants of working capital in industries as well as in services sectors which ultimately enable them to boost up their business. International Journal of Finance and Accounting ISSN 2513-4311X (online) Vol.5 Issue 1, No.5. pp. 67 78, 2020 www.iprjb. org 69 Hypothesis H1: There is a relationship between the profitability of firms and their working capital requirements. H2: There is a relationship between the leverage of firms and their working capital requirements. H3: There is a relationship between the size of firms and their working capital requirements. H4: There is r elationship between the growth of firms and their working capital requirements. 2.0 LITERATURE REVIEW The working capital management and profitability in the textile sector in Pakistan has been research by (Bagh et al., 2016) and data is collected from the Karachi stock exchange for a period of 2001 to 2006 in the textile sector. Correlation and regression analysis were practical, and the result of their study shows that there is a strong positive relationship between profitability and cash and cash, accounts receivable, and inventory while there is a negative liaison between profitability and accounts payable. The influence of working capital management components on corporate prosperity in Kenya has been research by (Mathuva, 2015) and a sample of 30 companies listed at Nairobi stock exchange for a period of 1993-2008 has been selected. OLS pooled and fixed regression analysis has been used for test purpose. F i n d i n g s shows that there is a highly significant negative relationship between the cash collection period and profitability. However, there is a highly significant positive relationship between the inventory conversion period and sales and there is a highly significant relationship between cash payment period and profitability. The relationship between working capital management, cost structure, and profitability of Sri Lankan companies has been investigated by (Bandaranayake & Jayasinghe, 2014). For checking that relationship researcher used correlation and regression analysis and take 65 Sri Lankan companies as a sample for 5 years. The result shows that increasing the creditor's payable day’s companies can minimize the length of the working capital cycle. In Palestinian Industrial corporation (Abbadi & Abbadi, 2013) research the determinants of working capital requirement. They took 11 industrial firms from the Palestinian stock exchange for e period of 2004-2011 with 88 observations. The working capital ratio has been selected as the dependent variable and the Cash conversion cycle, operating cash flows, leverage, firm size, profitability, and real GDP have been taken as an independent variable. The result of this study shows that cash conversion cycle, operating cash flow, firm size, return on assets and leverage are the significant predictor of working capital requirement in Palestinian industrial firm whereas Interest rate and GDP has no predictor of working capital determinants. The factors that influence the working capital requirements for the firms in Malaysia, for that intention select 285 companies as a sample for three years from 2006 to 2008 and using structured equation modeling techniques for analysis (Saarani & Shahadan, 2012). The researcher uses the working capital as a dependent variable and growth of the firm, profitability, debt, and size as an independent variable. The effects of working capital management on firm profitability on Swedish companies. CCC, DIO, DPO, and DSO have been taken as an independent variable (Rehn, 2012). A sample of 612 companies has been taken for 9 years. The result of this study shows that International Journal of Finance and Accounting ISSN 2513-4311X (online) Vol.5 Issue 1, No.5. pp. 67 78, 2020 www.iprjb. org 70 there is a significant relationship between working capital management