Informative Essay on Literature Review

In intention to discover the relationship between efficient working capital management and firm’s profitability(Shin & Soenen, 1998) used net-trade cycle (NTC) as a measure of working capital management. NTC is basically equal to the CCC whereby all three components are expressed as a percentage of sales. The reason by using NTC because it can be an easy device to estimate for additional financing needs with regard to working capital expressed as a function of the projected sales growth.

This relationship is examined using correlation and regression analysis, by industry and working capital intensity. Using a Compustat sample of 58,985 firm years covering the period 1975-1994, in all cases, they found, a strong negative relation between the length of the firm’s net-trade cycle and its profitability. In addition, shorter NTC are associated with higher risk-adjusted stock returns. In other word, (Shin & Soenen, 1998) suggest that one possible way the firm to create shareholder value is by reducing firm’s NTC.

The study of (Shin & Soenen, 1998) consistent with later study on the same objective that done by (Deloof, 2003) by using sample of 1009 large Belgian non-financial firms for the period of 1992-1996. However, (Deloof, 2003) used trade credit policy and inventory policy are measured by number of days accounts receivable, accounts payable and inventories, and the cash conversion cycle as a comprehensive measure of working capital management. He founds a significant negative relation between gross operating income and the number of days accounts receivable, inventories and accounts payable.

Thus, he suggests that managers can create value for their shareholders by reducing the number of days accounts receivable and inventories to a reasonable minimum. He also suggests that less profitable firms wait longer to pay their bills. In other study, (Lyroudi & Lazaridis, 2000) use food industry Greek to examined the cash conversion cycle (CCC) as a liquidity indicator of the firms and tries to determine its relationship with the current and the quick ratios, with its component variables, and investigates the implications of the CCC in terms of profitability, indebtness and firm size.

The results of their study indicate that there is a significant positive relationship between the cash conversion cycle and the traditional liquidity measures of current and quick ratios. The cash conversion cycle also positively related to the return on assets and the net profit margin but had no linear relationship with the leverage ratios. Conversely, the current and quick ratios had negative relationship with the debt to equity ratio, and a positive one with the times interest earned ratio. Finally, there is no difference between the liquidity ratios of large and small firms