Effect of Working Capital Management on Financial Performance of Non Financial Firms Listed in the Nairobi Securities Exchange

Abstract

This study sought to investigate the effect of working capital management on financial performance of nonfinancial firms. Causal research design was employed since variables existed for investigating causation. The population comprised all thirty-nine nonfinancial firms listed at the NSE from 2005 up to 2010 and thirty-six firms reclassified into seven sectors by the NSE were finally utilized. Secondary data was then obtained from financial statements filled at the CMA and NSE libraries as well online company websites. SPSS 16 data analysis tool was employed. Linear regression data analysis technique was used to investigate the effect of efficient working capital management measures that is inventory conversion policy, receivables collection policy, creditors payment policy as well as overall cash conversion cycle (CCC) together with firm specific characteristics that is firm size, leverage and ratio of financial assets to total assets on profitability financial performance measure that is gross operating profit (GOP). Results for whole set of firms shows that both receivables collections policy and cash conversion cycle had a highly significant negative relationship with gross operating profit while firm size, leverage, ratio of financial assets to total assets and inventory conversion policy all had a highly significant positive relationship with gross operating profit. This implies that avoiding stock out would result in increased gross operating profit. Also decrease in number of days it takes to collect cash from customers, hence the cash conversion cycle would lead to an increase in gross operating profit. In order to improve financial performance, firms need to maintain high inventory levels with strict receivables collection policy leading to a shortening of the cash conversion cycle. Results using data in each economic sector indicate that: firm size had a positive relationship with gross operating profit in all sectors except for telecommunication and construction sectors which had a negative relationship between firm size and gross operating profit. Leverage had a positive relationship with gross operating profit in all sectors except for telecommunication sector which had a negative relationship between leverage and gross operating profit. Ratio of financial assets to total assets had a positive relationship with gross operating profit in all sectors except for agriculture, automobile, and energy sectors which had a negative relationship between ratio of financial assets to total assets and gross operating profit. Inventory conversion policy had a positive relationship with gross operating profit in all sectors except where it was excluded. Receivables collections policy had a negative relationship with gross operating profit in all sectors except in the agriculture sector which had a positive relationship between receivables collections policy and gross operating profit. This positive relationship suggests that less profitable firms in the sector will pursue a decrease of their receivable collection days in an attempt to reduce their cash gap in the cash conversion cycle. Payment policy had a negative relationship with gross operating profit in the agriculture and a positive relationship with gross operating profit in Automobile and Construction sectors. This could lead to the conclusion that a less profitable firm in agriculture will wait longer to pay bills, taking advantage of credit period granted by their suppliers. Also, each economic sector had a significantly positive relationship between cash conversion cycle and gross operating profit except for telecommunication and manufacturing sectors which had a negative relationship between cash conversion cycle and gross operating profit. The study recommends that managers of firms operating in different sectors manage their working capital differently so as to maximize firms’ profitability financial performance.