Working Capital Management and Firm Profitability among Banking Institutions in the UK - Research Proposal Example

THE RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT AND FIRM PROFITABILITY AMONG BANKING S IN THE UNITED KINGDOM. Date: The Relationship between Working Capital Management And Firm Profitability Among Banking Institutions In The United Kingdom. Abstract Banking institutions are known to be cash rich entities that use short term liabilities to create long term assets. This puts them at a very delicate position in terms of their business model especially with regards to working capital management. Despite the fact that there has been a lot of research on the effects of working capital on profitability more needs to be done to further elucidate the impact that working capital elements have on the profitability of banking institutions. This particular research proposal aims to investigate the relationship between working capital management and the profitability of publicly listed banking corporations in the London stock exchange. For the purposes of this particular study a group of five diversified banking institutions will be selected and analyzed over a period from 2009 to 2013. The overall purpose of the paper shall be to establish a model that is statistically significant, the other purpose is to explain the need for firm to optimize their level of working capital management by maintaining sufficient liquidity and how that would affect the overall profitability. The results of this particular study are expected to clearly show the statistical significant level of the relationship between various liquidity ratios and profitability ratios as well as elements of the working capital. Introduction In the area of finance the most common areas of study that have been revisited by academics are capital structure and working capital management ( Lazaridis and Tryfonidis, 2006). Working capital management basically involved the ability of a firm to meet its short term financial obligations and long term commitments due and keeping a good balance. In managing working capital there needs to be a balance between not having excess current assets and less than optimal current assets. Having excess could lead to lower returns or profitability as less capital can be put in the core business of firm. Early studies have indicated that the optimal levels of liquidity needed to maximization of profits vary from entity to entity and also depend on industry. In this particular research a more in-depth look shall be investigated on the impact of these phenomena on the banking sector in the United Kingdom through empirical research using historical financial records of banks for a period of five years. This particular area is of great interest to different scholars based on the main objective of the study which over time have been the focus on either maximizing profits or optimizing sales in a given firm. In a study Beasley, Scott and Meyer (1987), the found that working capital ratios were more significant to profitability ratios and the reduction in receivable days greatly increased the liquidity of the firms and hence reduced the risk of dependency on external sources of finance which at times are very expensive to the firm. Working capital management involve short term capital which basically is the resources that companies would use in their daily operations i.e. current assets and current liabilities. Proper working capital management policy needs to always favour the maximization of shareholder value as well as ensuring the well being of a company in the market in terms of liquidity ( Jen-Ren, Li & Han-Wen, 2006). Efficient working capital management is essential for the banking and financial services industry since a huge part of the assets is composed of current assets ( Horne & Wachowitz, 2000). This is because working capital has a direct impact on both the liquidity and the profitability of the firms (Raheman & Nasr, 2007). This delicate balance is critical since if proper attention is not given then banking institutions may be faced with possibility of failure and banckrupty a fact that is not refutable (Filbeck & Krueger, 2005). There have been many studies on working capital management over time by both accounting and financial scholars. This particular study hopes to increase the wealth of knowledge in this particular field by giving relevance to an actual unique market. This is critical because the financial sector in the United Kingdom account for a huge percentage of the economy. Therefore, optimal performance of this institution is critical to the wellbeing of the economy and can cause recession if not well managed as elucidated in the recent global financial crisis of 2007. Literature review Over time there have been previous studies that have looked at the relationship between working capital management (WCM) and firm profitability in different markets. The results have however been varied though a majority of the studies showed a negative correlation between firm profitability and working capital management. The methodology used has also been quite numerous ranging from use of linear regression to panel data regressions. The paragraphs below will look at some of the major studies in that have been done in order to identify and assess the research gap. Almazari (2013) conducted an investigation of the relationship between firm profitability and working capital management in the Saudi cement industry. This study is relevant since the cement industry is quite similar to banking since it requires a high level of working capital and effective working capital management can greatly affect profitability. In his research he analyzed some eight cement manufacturing companies publicly listed on the stock exchange for a period of five years before 2012. In his analysis he used regression analysis and person bivariate correlation to obtain a model to explain the interrelation. The study results indicated that the current ratio was the most significant ratio of liquidity and affected profitability. Other results of the study showed that as sizes of firms increased their ability to be profitable also increased in the cement industry. Another interesting outcome was that increase in debt financing also led to a decrease in profitability as confirmed by a linear regression test that showed a high degree of association between profitability and working capital management (WCM). (Azhagaiah & Muralidharan, 2009) Studied of the Indian paper industry for a period between 1997 to 2005 to investigate the relationship between working capital management efficiency and the earnings before interest and taxes (EBIT). The study found that as accounts payable days had a significant negative relationship with the earnings before interest and tax. This showed that when payments were deployed to suppliers on time the earnings before interest and taxes increased. In conclusion, the authors found that working capital was critical and that players in the industry needed to develop strong working capital management policies that would reduce the cash conversion cycle (CCC). (Agyei & Yeboah, 2011) in their modest research attempted to examine the empirical research between profitability and working capital on non financial firms was applicable to financial entities such as the banks in Ghana. The study was conducted over a period of ten years in which commercial banks in Ghana were analyzed using panel data methodology. The data obtained and using appropriate statistical methods showed that thee there significant positive relationship between bank profitability and the cash operating cycle. Also important is the collection period affected the level of profitability of a firm. The study further states that an observation was made that listed companies performed poorly as compared to unlisted ones. This shows that there is a level of caution among many banks as increasing cash conversion cycles exposed them to higher interest rate risks. (Quayyum, 2011) in this particular paper the researcher investigated the effect of working capital management on the profitability of firms especially within the cement industry that are listed in the Dhaka stock exchange. The analysis covered a a five year period from 2005 to 2009 in which the research concluded that there was a significant level of relationship between the profitability and liquidity ratios given in the working capital components. A special emphasis was found between the cash conversion cycle and the profitability of the firm. This particular finding agrees with the findings of Lazaridis and tryfonidis (2006) and that of Shin and Soenen (1998) among many other studies. The study concluded by validating the initial forecast that there is need for optimal working capital management to ensure profitability and thus cash holding positions need to be set based on projected sales in a particular period of operation. Thus a focus on effective working capital management in terms of cash holding position can greatly affect the profitability of a firm. (Raheman & Nasr, 2007) in their study found that there was a positive relationship between the size of a firm and its profitability. They also found that there was a significant negative relationship between the type of debt used by a firm and its profitability. The overall conclusion found that the working capital control variables had an influence on the profitability ratios of the different firms. The analysis used Pearson’s correlation and regression analysis to highlight the interrelation between the working capital variables and the profitability elements. From the above literature it can be noted that there is still more needed to find out about the relationship between working capital and profitability due to the impact it can have on an entity. It will also help in ensuring a proper understanding in the field of banking in the British market is clearly understood under the most recent historical financial statements obtained from the various published annual reports by listed banking institutions. Objective of study The object of the study shall be to examine the effect of working capital management on the profitability of firms in Britain’ banking sector. To achieve this research shall seek to examine the efficiency of the working capital management practices in the British Banking sector. The research shall also test how the various company have been able to improve the different levels of efficiency in working capital in relation to industry averages. In simple terms the research shall provide a basis for which policy makers, senior banking executive and scholars can base their decisions on how to manage the working capital of the various firms within the British economy. Research Methodology This particular research shall be conducted using secondary data obtained from publish annual reports. These reports can be easily downloaded from the websites and also from the regulators who keeps financial records for all banking institutions due to the importance to an economy. From the financial records various elements shall be highlighted and most importantly the working capital elements such as cash conversion cycle, current ratio, quick ratio and receivable days shall be computed. Additionally, profitability elements such as profit margin return on equity (ROE), Return on Asset (ROA) and Earnings before interest and tax (EBIT) shall be computed. The figures computed shall be analyzed using statistical software such as SPSS to find the correlation between the various elements. The software shall be used to ascertain the reliability and the accurateness of the data before formulating a model to explain the relationships. The SPSS software is preferred due to its ability to analyze a large amount of data and present it is a simplified form for easy understanding. The basic model that shall be studied is as follows Profitability α ( cash conversion cycle, quick ratio, current ratio, collection period, cash to current liabilities). The analysis shall use Pearson’s correlation and regression modeling to come up with a model that will define the relationship between profitability and the working capital in the banking sector of the United Kingdom. Using the data obtained from the financial statements a proper pattern can be obtained that can explain and support the conclusion that would inferred from the model. The regression model will enable the researcher to find a congruence between the various elements being studied and how they compare with other similar studies. The statistical method used also is similar to what most other researched used in their studies and thus would ensure comparability with other peers interested in critiquing the scholarly work done by the author. Ethical Considerations The research shall basically used secondary sources of information that are accessible to the general public and therefore it is expected that there would be no conflict of interest and other ethical considerations to be considered. Previous works cited in the research shall be cited in accordance to the laid down procedures as stipulated by the university. Proposed Workplan Steps in the research plan Deadline for completion Submission of the proposal Week 1 Design of a research plan we week 1 Obtaining the relevant authorizations and permission to use information in the different kinds of analysis and data collections. Week 1& 2 Literature review Week 1,2 &3 Defining the scope of the research, obtaining the accurate sample of companies to satisfy the research objectives. Week 3 Design of a final schedules to be used in statistical analysis Week 4 Actual entering of data,grouping and coding of data into a computer program SPSS Week 4 Design and testing of the SPSS program Week 4 draft analysis of financial qualitative data obtained Week 4&5 Analysis of data Week 6 Report up of findings Week 6 Presentation of the final research thesis to the examiners Week 7 Printing, Binding and filing of copies of the thesis and final presentation of hardcopy research papers Week 8 Reference Agyei, S. K. & Yeboah, B., 2011. Working Capital Management and Profitability of Banks in Ghana. British Journal of Economics, Finance and Management Sciences, 2(2), pp. 1-12. Azhagaiah, R. & Muralidharan, J., 2009. The Relationship Between Working Capital and Managment Efficiency and EBIT. [Online] Available at: http://www.fm-kp.si/zalozba/ISSN/1581-6311/7_061-074.pdf [Accessed 19 October 2014]. Besley, Scott, & Meyer, R.L (1987). An Empirical Investigation of Factors Affecting the Cash Conversion Cycle. Annual Meeting of the Financial Management Association, Las Vegas Nevada Filbeck, G. &Thomas M.K. (2005). An analysis of working capital management results across industries. Mid-American Journal of Business, 20 (2), 11-18. Horne, J.C., & Wachowicz J.M. (2000). Fundamentals of Financial Management . New York, NY: Prentice Hall Publishers Jeng -Ren, C., Li, C., & Han-Wen, W. (2006). The determinants of working capital management. Journal of American Academy of Business, Cambridge, 10(1), 149-155. Lazaridis, I., Tryfonidis, D. (2005). The relationship between working capital management and profitability of listed companies in the Athens Stock Exchange. SSRN.com Quayyum, S. T., 2011. Effects of Working Capital Management and Liquidity: Evidence from th eCement Industry of Bangladesh. Journal of Business and Technology (Dhaka), VI(01), pp. 37-47. Raheman, A. & Nasr, M., 2007. Working Capital Managment and Profitability - a case of Pakistani Firms. International Review of Business Research Papers, March, 3(1), pp. 279-300. Shin, H. H, Soenen, L. (1998). Efficiency of Working Capital Management and Corporate Profitability, Financial Practice and Education , 8(2),37-45 Read More