Working
capital is considered as the life-blood for the business. A business with
favorable amount of working capital is always getting the return on any
favorable opportunity. Working capital is utilized to pay the payroll of the
employees and petty expenses. Every successful business owners do maintain the
right amount of working capital to meet the unanticipated situation. Also firms
work to completely handle the working capital because it shows the efficiency
and strength of the business as it is used to create extra return for stakeholders.
If working capital is low than minimum level then firm may lose the profitable
opportunities and may face the short term liquidity crisis. Amount of working
capital depends upon many factors such as, nature of the business, use of technology,
scale of operations, nature of finished goods, nature of raw materials,
competition and credit policy.

The
management of working capital is one of the most significant parts of financial
management which influence profitability and liquidity of the firm directly. As
it is the difference of current assets and current liabilities. And it is very
important for several reasons. As the total assets of manufacturing companies
comprise of half of current assets. Moreover companies which possess limited
amount of current assets can suffer lack of it and also face hardship in
sustaining continuous operation. (Horne and Wachowicz, 2000)

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Furthermore, the amount of money which is invested
in firm current assets as known as working capital. And the subtraction of
current liabilities from current assets refers to net working capital.
Through proper management of working capital the value of shareholder can be
enhanced. Besides this more profitability and favorable level of working
capital can also be achieved through proper management of current assets and
current liabilities. Moreover bankruptcy of the firm occurs due to lack of
working capital amount. While more amount of working capital reduce the
profitability of the firm because of the involvement of more cash in it.(Chakraborty,
2008)

 

 

As
the management of working capital (WCM) means to manage its proportion of all
components which are necessary for the business good financial position. Firms
which focus on reduction of account receivable follow the severe collection
policies which results in low credit sales and ultimately the profitability of
the firm fall. On the other hand firm profitability can also be affected
through delayed accounts payable because the suppliers will then provide raw
material with inferior quality. Moreover, firms with minimum inventory may
incur shortage that leads to stock out situation which ultimately affect its
sales. Firms who focus on optimum and reasonable proportion of the working
capital components can achieve high profit. For the measurement of working
capital management the cash conversion cycle is frequently used. As it refers
to the interval of time between raw material purchase payment and reception of
finished goods sales.

As
profit maximization is the foremost objective of any firm. While another
objective is protection of liquidity. But a firm may face a severe problem when
it sacrifices the liquidity for the higher profit. Due to this these two
objectives of the firm must be in balance and one of these objectives should
not be sacrifice for another due to their significance. When the firm don’t
concern for the profit then it cannot remain alive and stay for a greater
period in the market. And low concerned for liquidity may lead the firm to
bankruptcy problem. Therefore more importance is given to the management of
working capital because it influences firm’s profitability.

Taking into
account its significance this research study is focus on determining the working
capital management those components which influence profitability of firms in
automobile industry of Pakistan. The following variables are to be use for this
research study, such as average payment period, average collection period,
inventory turnover in days, cash conversion cycle, and Return on assets. The
data for the research study in hand will be collected from those 5 companies of
automobile industry which are listed at Karachi stock exchange during
2008-2012.