International Research Journal of Finance and Economics
ISSN 1450-2887 Issue 49 (2010)
© EuroJournals Publishing, Inc. 2010
The Relationship between Working Capital Management and
Profitability: A Vietnam Case
Huynh Phuong Dong
Faculty of Accounting, Danang University of Economics, Vietnam
Assistant professor at Southern Taiwan University, No.1 NanTai St
Yong Kang City, Tainan County, Taiwan R.O.C
The working capital management plays an important role for success or failure of
firm in business because of its effect on firm’s profitability as well on liquidity. The study
is based on secondary data collected from listed firms in Vietnam stock market for the
period of 2006-2008 with an attempt to investigate the relationship existing between
profitability, the cash conversion cycle and its components for listed firms in Vietnam stock
market. Our finding shows that there is a strong negative relationship between profitability,
measured through gross operating profit, and the cash conversion cycle. This means that as
the cash conversion cycle increases, it will lead to declining of profitability of firm.
Therefore, the managers can create a positive value for the shareholders by handling the
adequate cash conversion cycle and keeping each different component to an optimum level.
Keywords: Corporate Profitability, Working Capital management, Vietnam stock market.
Assets in commercial firm consist of two kinds: fixed assets and current assets. Fixed assets include-
land, building, plant, furniture, etc. Investment in these assets represents that of part of firm’s capital,
which is permanently blocked on a permanent or fixed basis and is also called fixed capital that
generates productive capacity. The form of these assets does not change, in the normal course. In the
contrast, current assets consist of raw materials, work-in-progress, finished goods, bills receivables,
cash, bank balance, etc. These assets are bought for the purpose of production and sales, like raw
material into semi-finished products, semi- finished products into finished products, finished products
into debtors and debtors turned over cash or bills receivables.
The fixed assets are used in increasing production of an organization and the current assets are
utilized in using the fixed assets for day to day working. Therefore, the current assets, called working
capital, may be regarded as the lifeblood of a business enterprise. It refers to that part of the firm’s
capital, which is required for financing short-term.
The management of this working capital is known as working capital management. The basis
objective of working capital management is to manage firm’s current assets and current liabilities, in
International Research Journal of Finance and Economics - Issue 49 (2010)
such a way, that working capital are maintained, at a satisfactory level. The working capital should be
neither more nor less, but just adequate.
Working capital management plays an important role in a firm’s profitability and risk as well as
its value (Smith, 1980). There are a lot of reasons for the importance of working capital management.
For a typical manufacturing firm, the current assets account for over half of its total assets. For a
distribution company, they account for even more. Excessive levels of current assets can easily result
in a firm’s realizing a substandard return on investment. However, Van Horne and Wachowicz (2004)
point out that excessive level of current assets may have a negative effect of a firm’s profitability,
whereas a low level of current assets may lead to lowers of liquidity and stock-outs, resulting in
difficulties in maintaining smooth operations.
Efficient management of working capital plays an important role of overall corporate strategy
in order to create shareholder value. Working capital is regarded as the result of the time lag between
the expenditure for the purchase of raw material and the collection for the sale of the finished good.
The way of working capital management can have a significant impact on both the liquidity and
profitability of the company (Shin and Soenen, 1998). The main purpose of any firm is maximum the
profit. But, maintaining liquidity of the firm also is an important objective. The problem is that
increasing profits at the cost of liquidity can bring serious problems to the firm. Thus, strategy of firm
must be a balance between these two objectives of the firms. Because the importance of profit and
liquidity are the same so, one objective should not be at cost of the other. If we ignore about profit, we
cannot survive for a longer period. Conversely, if we do not care about liquidity, we may face the
problem of insolvency. For these reasons working capital management should be given proper
consideration and will ultimately affect the profitability of the firm.
Working capital management involves planning and controlling current assets and current
liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one
hand and avoid excessive investment in these assets on the other hand( Eljelly,2004). Lamberson
(1995) showed that working capital management has become one of the most important issues in
organization, where many financial managers are finding it difficult to identify the important drivers of
working capital and the optimum level of working capital. As a result, companies can minimize risk
and improve their overall performance if they can understand the role and determinants of working
capital. A firm may choose an aggressive working capital management policy with a low level of
current assets as percentage of total assets, or it may also be used for the financing decisions of the firm
in the form of high level of current liabilities as percentage of total liabilities (Afza and Nazir, 2009).
Keeping an optimal balance among each of the working capital components is the main objective of
working capital management. Business success heavily depends on the ability of the financial
managers to effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2005).
Firms can decrease their financing costs and raise the funds available for expansion projects by
minimizing the amount of investment tied up in current assets. Lamberson (1995) indicated that most
of the financial managers’ time and efforts are consumed in identifying the non-optimal levels of
current assets and liabilities and bringing them to optimal levels. An optimal level of working capital is
a balance between risk and efficiency. It asks continuous monitoring to maintain the optimum level of
various components of working capital, such as cash receivables, inventory and payables (Afza and
Nazir, 2009). A popular measure of working capital management is the cash conversion cycle, which is
defined as the sum of days of sales outstanding (average collection period) and days of sales in
inventory less days of payables outstanding (Keown et al, 2003). The longer this time lag, the larger
the investment in working capital. A longer cash conversion cycle might increase profitability because
it leads to higher sales. However, corporate profitability might also decrease with the cash conversion
cycle, if the costs of higher investment in working capital is higher and rises faster than the benefits of
holding more inventories and granting more inventories and trade credit to customers (Deloof, 2003).
Lastly, working capital management plays an important role in managerial enterprise, it may
impact to success or failure of firm in business because working capital management affect to the
profitability of the firm. The thesis is expected to contribute to better understanding of relationship
International Research Journal of Finance and Economics - Issue 49 (2010)
Result from analysis of relationship between working capital management and profitability on
Vietnam stock market also indicates that there is a negative between number of days accounts receivable,
number of days inventories and profitability. So we claim that managers can increase profitability by
reducing the number of days accounts receivable and inventories. Besides, our research also shows that
more profitability firms wait longer to pay their bills.
However, the period of time for this study is shortly in compare with some of the previous
studies about the relationship between working capital management and profitability (Deloof, 2003,
Shin and Soenen, 1998). So, the sample does not highly stand for population. Moreover, the study only
refers to internal factors but not consider external factors as industry dummy, level of economic
activity (Lazaridis and Tryfonidis, 2006). Future research could further explore in order to overcome
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