How capital management enhances firm profitability
Managing working capital plays very significant role in the success of business. This is because it directly affects the profitability of firm and also the liquidity. Current assets, like short term assets are the working capitals. To test the effect of working capital on the profitability, we use panel data methodology. There is a solid relation between the cash and profitability and it can be analyze by correlation and regression analysis. Profitability will increase if the inventory cash and credit sale increases.
In the financial affairs, management of current assets or working capital is the most significant factor. Why is this so? It is because it directly refers to the success of the firm by increasing profitability ratio. Profitability and liquidity are pretty similar. They are just the different sides of the same coin. As the liquidity affects the working capital directly, let us see how it affects the profitability of the firm.
Firm Profitability and liquidity:
The foremost objective of firms is to increase their profitability rate. Along with the maximization in the profitability, liquidity must also be preserve. Many issues can occur if the profit of the firm is increasing at the rate of liquidity. That is why there should be a trade off between the liquidity and profitability. Profitability of an organization should not rely upon the cost of liquidity. Both these factors have same importance, if we are not concern about the profitability we will not survive in the business market. Not even for a short period of time. In addition, this is the same with liquidity. If we take liquidity much slighter, we may face many issues regarding bankruptcy and insolvency. In this situation, working capital should be managed properly, to increase the profitability.
Maximizing the profitability:
Every organization may have different levels of capital that maximize or minimize the profitability. Large inventory can lead to high sales. If the organization have large inventory, the risk level will be reduce automatically. Apart from various components, accounts payable is the major component of working capital. Furthermore, to evaluate the quality of the products, make late payments, it will be the flexible and inexpensive foundation of financing for the organization. Whereas, late payments can be much expensive if the supplier gives discount for timely or early payments. To increase the profitability, longer cash alteration can be helpful as it leads to better sales.
On the other hand, with the cash conversion cycle, profitability of the corporate may also decrease. This is especially so if investment cost rises more quickly than the benefits of granting extra trade credit to the customers or holding additional inventories.
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