Workingworking Capital Management and Firm's Profitability
Working Capital Management and Firm 's Profitability: An Optimal Cash Conversion Cycle
Haitham Nobanee Department of Banking and Finance, The Hashemite University, P.O. Box 150459, Zarqa, 13133, Jordan. E-mail: nobanee@gmail.com
Abstract The traditional link between the cash conversion cycle and the firm 's profitability is that shortening the cash conversion cycle increases firm 's profitability. On the other hand shortening the cash conversion cycle could harm the firm’s operations and reduces profitability. This could happen when taking actions to reduce the inventory conversion period, a firm could face inventory shortages; when reducing the receivable collection period a firm could lose its good credit customers; and when lengthening the payable deferral period a firm could harm it’s own credit reputation. However, identifying optimal levels of inventory, receivables, and payables where total holding and opportunities cost are minimized and recalculating the cash conversion cycle according to these optimal points provides more complete and accurate insights into the efficiency of working capital management. In this regard, we suggest an optimal cash conversion cycle as more accurate and comprehensive measure of working capital management.
Keywords: Working Capital Management; Optimal Cash Conversion Cycle; Cash Conversion Cycle; Receivable Collection Period; Inventory Conversion Period; Payable Deferral Period; Weighted Cash conversion Cycle; Net Trade Cycle JEL classification: G30:G32:L25:O25
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Electronic copy available at: http://ssrn.com/abstract=1471230
Efficiency of working capital management is based on the principle of speeding up cash collections as quickly as possible and slowing down cash disbursements as slowly as possible. This working management principal based on the traditional concepts of operating cycle, cash conversion cycle, weighted cash conversion cycle, and net trade cycle. The operating cycle of a firm is the length of
Haitham Nobanee Department of Banking and Finance, The Hashemite University, P.O. Box 150459, Zarqa, 13133, Jordan. E-mail: nobanee@gmail.com
Abstract The traditional link between the cash conversion cycle and the firm 's profitability is that shortening the cash conversion cycle increases firm 's profitability. On the other hand shortening the cash conversion cycle could harm the firm’s operations and reduces profitability. This could happen when taking actions to reduce the inventory conversion period, a firm could face inventory shortages; when reducing the receivable collection period a firm could lose its good credit customers; and when lengthening the payable deferral period a firm could harm it’s own credit reputation. However, identifying optimal levels of inventory, receivables, and payables where total holding and opportunities cost are minimized and recalculating the cash conversion cycle according to these optimal points provides more complete and accurate insights into the efficiency of working capital management. In this regard, we suggest an optimal cash conversion cycle as more accurate and comprehensive measure of working capital management.
Keywords: Working Capital Management; Optimal Cash Conversion Cycle; Cash Conversion Cycle; Receivable Collection Period; Inventory Conversion Period; Payable Deferral Period; Weighted Cash conversion Cycle; Net Trade Cycle JEL classification: G30:G32:L25:O25
١
Electronic copy available at: http://ssrn.com/abstract=1471230
Efficiency of working capital management is based on the principle of speeding up cash collections as quickly as possible and slowing down cash disbursements as slowly as possible. This working management principal based on the traditional concepts of operating cycle, cash conversion cycle, weighted cash conversion cycle, and net trade cycle. The operating cycle of a firm is the length of
References: Inventory Quantity Source: Ross, Westerfield, and Jordan, 2008, Corporate Finance Fundamentals, Eighth 's Edition, McGraw Hill