How Does Investment in Working Capital Effect the Protability of
Manufacturing Companies at Indonesian Stock Exchange?
Isni Andriana, Yuliani, K. M. Husni Thamrin, and Taufik Saggaff
Universitas Sriwijaya, Palembang, Indonesia
Keywords: Working Capital Investment,Current ratio, Firm Growth, Leverage, Indonesian Stock Exchange
Abstract: Purpose – The purpose of this paper is to investigate the effect of investment in working i.e cash
conversion cycleand control variables i.e. current ratio, firm growth and leverage to firm profitability for
a sample of 51 of manufacturing companies in Indonesian stock exchange. In addition, this paper also
tries to find the break event point of cash conversion cycle and profitability.
Design/methodology/approach – The study is based on secondary financial data obtained from Indonesian
capital market directory from 2014 to 2017.Multiple linier regression was applied to knowthe effect of
cash conversion cycle, current ratio, firm growth and leverage to profitability. Findings – The findings
indicate that cash conversion cycle, current ratio positively influence profitability, meanwhile, firm
growth and leverage do not effect profitability. The results also confirm the inverted U-shape relationship
between cash conversion cycle and profitability. The break event point of cash conversion cycle is 66
days. Originality/value– To best of our knowledge this research is a preliminary attempt contributing to
the literature by providingevidence for an inverted U-shaped relation between working capital investment
and profitability of manufacturing companies at the Indonesian stock exchange. Research limitations –
This research only focuses on manufacturing sector companies. For further research, it is recommended
to observe all companies sectors in the Indonesian stock exchange and add other relevant variables.
Practical implications -The findings have implication for management of manufacturing companies at the
Indonesian stock exchange.to pay attention to investment efficiency in working capital.
1 INTRODUCTION
The establishment of a company certainly wants
to get profitability. The level of corporate profitability
can be caused by investment in working
capital(Bhatia and Srivastava, 2016). Investment in
working capital is represented by the cash conversion
cycle (CCC) which consists of accounts receivable
period (ACP), inventory conversion period (ICP) and
accounts payable period (APP). Cash conversion
cycle is a span of time when companies make cash
outflows and receive cash inflows (Ambarwati,
2010). There is still a debate in financial literature that
the level of corporate profitability is determined by
the level of investment in working capital.
The conservative group argues that the company
must do a little investment in working capital so that
the cash conversion cycle will be shorter. Shorter cash
conversion cycle can improve profitability because it
will reduce investment in inventories and receivables.
Farzinfar and Arani(2012) proved that there was a
negative relationship between the collection period of
accounts receivable and profitability on
pharmaceutical companies in the Iranian stock
exchange. Mohamad (2010) examined the effect of
cash conversion cycle on profitability on the
Malaysian stock exchange. The results concluded that
there was a significant negative relationship between
cash conversion cycle and profitability. Reducing
inventory and receivable investment can reduce
storage and insurance costs and the risk of
uncollectible receivables. If cash conversion cycle
is faster, the company is efficient in using its working
capital and ultimately gives a positive impact on the
optimization of the profitability of the company
(Garcia-Teruel and Martinez-Solano; 2007). The
research that support this view are Mansoori and
Ahmad (2012); Shubita's (2013). Their research
results concludedthat the lower the investment in
working capital, the higher the profitability.
516
Andriana, I., Yuliani, ., Thamrin, K. and Saggaff, T.
How Does Investment in Working Capital Effect the Probability of Manufacturing Companies at Indonesian Stock Exchange?.
DOI: 10.5220/0008442005160524
In Proceedings of the 4th Sriwijaya Economics, Accounting, and Business Conference (SEABC 2018), pages 516-524
ISBN: 978-989-758-387-2
Copyright
c
2019 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved
Meanwhile, traditional groups argue that large
investment in working capital will lead to a longer
cash conversion cycle and increase the profitability
due to increased investment in inventories and
receivables (Tauringana and Afrifa, 2013).High
inventory investment will reduce production
disruption so that it will reduce the chance of loss of
demand.However, increasing investment in accounts
receivable will increase sales because customers are
given more time to pay, which in turn will increase
the profitability. Researchers such as Samiloglo and
Dermirgunes (2008) Attari and Raza (2012); Awad
and Jayyar (2013); Abuzayed (2012);Enqvist et al.,
(2014) supported this view. Their research results
proved that the cash conversion cycle had a positive
effect on the firm profitability.
An interesting issue about the effect of investment
in working capital on profitability is that if
investment in working capital is small, it will cause
the risk of losing sales and disruption to production,
therefore a reduction of investment in working capital
can cause a negative influence on the profitability of
the company (Baños-Caballero et al. , 2012).
Contrary, there is a risk of bankruptcy if the company
invests a large amount of working capital because it
will increase financing expenditure which in turn
gives a negative influence on firm profitability (Pais
and Gama; 2015).Based on the two group views
above, it can be concluded that the effect of
investment in working capital on profitability can be
linear (Tahir and Anuar, 2016), and non-linear
(Singhania and Mehta, 2017). This condition
indicates that there is an optimal investment in
working capital or break-event point of working
capital investment in relation to profitability.
Research on the effect of investment in working
capital on profitability as well as the break-event
point of working capital investment in relation to
profitabilityis still little done by previous researchers,
especially in Indonesia. An interesting phenomenon
is that the manufacturing sector in the Indonesian
stock exchange have a very large investment in
working capital compared to other sectors so that the
efficiency of investment in working capital must be a
serious concern for the management. According to
data from Indonesia stock exchange shows that more
than 50% of total assets of manufacturing companies
are working capital.
Because there are still differences in the results of
previous studies about the effect of investment in
working capital on profitability, linear and non-linear
relationships between working capital investment to
profitability, large investment in working capital of
manufacturing companies in Indonesian stock
exchange, the absence of researchers conducting this
research in the manufacturing sector in Indonesian
Stock Exchange, it is necessary to conduct further
research on how working capital investment affects
the profitability of manufacturing companies in the
Indonesia Stock Exchange 2014 – 2017. This
research also examines the breakeven point of
working capital investment in relation to the
profitability of the manufacturing sector in the
Indonesia Stock Exchange 2014 - 2017.Control
variables consisting of current ratio, firm growth and
leverage are used to reduce the potential bias due to
the omitted variables.
The contribution of this research to the literature
study is to fill the gap by looking at the breakevent
point of investment in working capital n relation to
the firm profitability which is still very little done by
previous researchers, especially in the Indonesian
stock exchange. The results of this study are expected
to provide benefits for academics, practitioners and
strengthen working capital management theories. In
addition, the results of this study are useful for
management in an effort to improve the firm
profitability and alsoprovide benefits external parties
such as investors, creditors, government, suppliers.
2 LITERATURE REVIEW AND
HYPOTHESES DEVELOPMENT
2.1 Risk-Return Trade Off Theory
Working capital management should pay
attention to the trade-off between return and risk,
therefore the company must decide the level of
production. The amount of current assets is highly
dependent on the company's working capital policy
that directs the company whether to use an aggressive
or conservative working capital policy.
2.2 Working Capital Investment Views
Working capital is a short-term asset used in a
company's operations. One of the ways used to
analyze the efficiency of investment in working
capital is to calculate the cash conversion cycle. Cash
conversion cycle describes the amount of working
capital investment of a company. Cash conversion
cycle focuses on the timeframe that occurs when a
company invests working capital and receives cash
back on the investment (Ambarwati, 2010).
The amount of investment in working capital
depends on the length of the working capital cycle. If
How Does Investment in Working Capital Effect the Probability of Manufacturing Companies at Indonesian Stock Exchange?
517
the company has a lot of inventory and a long credit
sale, it will reduce the company's cash and eventually
it will extend the cash conversion cycle. The size of
the investment in working capital can affect the
profitability. There are two views about the effect of
investment in working capital on profitability.
Traditional views argue that if a company makes a
large investment in working capital, it will increase
profitability. The company produces large quantities
of supplies that will reduce total production costs and
ensure the scarcity of goods that consumers want so
that efficiency occurs and meet consumer demand
which ultimately increases profitability. Petersen and
Rajan (1997) revealed that increasing credit sales
would provide increased sales and price incentives for
companies so that they could have a positive impact
on profitability. Awad and Jayyar (2013); Chaklader
and Shrivastava (2013); Martínez-Sola et al (2013);
Bhunia and Das (2015); proved that the increase in
working capital investment represented by the cash
conversion cycle increases the profitability.
Meanwhile the conservative view holds that the
cash conversion cycle which is too long indicates that
the company has a lot of investment in inventories
which will increase warehouse costs, insurance costs
and security costs which in turn will have a negative
impact on profitability. Companies that have large
working capital will pay a high interest rate. This
group believes that small investment in working
capital has a positive impact on the profitability of the
company. According to Shi and Zhang, (2010) the
collection of receivables that are too long will have a
negative impact such as high transaction costs from
changes in receivables to cash back. Literature studies
that support the cash conversion cycle that takes a
long time will have a negative impact on the
company's profitability, namely Lyngstadaas and
Berg, (2016); Ukaegbu (2014); Banos-Caballero et
al., 2013).
The contradiction of the empirical study above
shows that it is not always the relationship of
investment in working capital toprofitability is linier.
Thus investment in working capital should consider
the balance between costs and benefits. If the positive
and negative impacts of working capital investment
on profitability depend on the length of the company's
cash conversion cycle, then this indicates that
profitability will be optimal at the breakeven-point
point of the cash conversion cycle.
2.3 Cash Conversion Cycle and
Profitability
Effective and efficient management of working
capital is very important for the long-term
sustainability growth. If the company lacks working
capital to expand sales and increase production, then
it is likely to lose revenue and profits (Sartono, 2010),
However, the more cash conversion cycle, the longer
the cash collection is embedded in inventories and
receivables, so the possibility of getting cash back
will be longer. If the cash cycle is stalled, the source
of working capital funds for subsequent operating
activities will be hampered, then it can have an impact
on the company's income and profits. Cash
conversion cycle is a measurement of the amount of
investment in working capital. According to
Lyngstadaas and Berg, (2016) the length of the cash
conversion cycle indicated that the company had a lot
of investment in accounts receivable, inventories that
would incur cost costs including warehouse costs,
insurance costs, paying high interest rates and
security costs which would ultimately had a negative
impact on financial performance. A literature study
that supported that if the length of the cash conversion
cycle wouldhave a negative impact on the
profitability are Bhatia and Srivastava, (2016);
Lyngstadaas and Berg, (2016); Pais and Gama,
(2015); Enqvist et al., (2014); Ukaegbu, 2014; Banos-
Caballero et al., 2013); Shubita (2013) and Mansoori
and Muhammad (2012). Based on the theoretical and
empirical studies above, this research hypothesis is:
H1: Cash Conversion Cycle affects profitability.
2.4 Liquidity and Profitability
Liquidity is the ability of a company to fulfill its
short-term obligations (Subramanyam& Wild; 2010).
Liquidity is measured by the amount of current assets
compared to the amount of current debt. Current
assets are used for the company's operational needs in
the short term usually less than one year. The
importance of liquidity can be seen from the
consideration of the impact that comes from the
inability of the company to meet its short-term
obligations. Lack of liquidity will prevent the
company from gaining the opportunity to make a
profit. According to Reeve at al (2012) that a
company that fails to pay its debt in a regulated
manner can experience difficulties in repairing credit.
The lack of available credit can lead to a decrease in
the profitability of the company, or the company can
SEABC 2018 - 4th Sriwijaya Economics, Accounting, and Business Conference
518
become bankrupt. Research conducted by Ganguli,
Santanu K. (2016) proved that liquidity has a negative
effect on the profitability of the company. However,
most of them prove that liquidity has a significant
influence on the profitability of the company, as the
research conducted by Nworji et.al (2014), Boadi,
Antwi, and Lartey (2013), Pratheepan (2014), Zaid,
Ibrahim and Zulqernain (2014). theoretical and
empirical studies above, this research hypothesis is:
H2: Liquidity has a positive effect on profitability
2.5 Firm Growth and Profitability
According to Pande (2011) firm growth can be
represented by the growth of company sales from
year to year. Sales growth is characterized by an
increase in market share which will have an impact
on increasing the firm sales so that it will increase the
firm profitability. Pagano and Schlvardi (2003) stated
that if a firm growth experiences an increase, it gives
an indication that there has been an increase in sales
and finally increase profitability.DarushYazdanfar
(2013), proved that firm growth provided a positive
impact on the profitability of a company. Based on
the theoretical and empirical studies above, this
research hypothesis is:
H3: Firm growth has a positiveeffect on profitability
2.6 Leverage and Profitability
The trade-off theory states that the optimal level
of debt when the balance occurs between the benefits
of debt and the cost of debt (Myers, 1984). Debt
benefits are obtained at a certain level of debt, but
these benefits will decrease after an increase in debt
levels. If the company has more debt, the smaller the
taxable income, but the higher the company's
financial risk. High debt will cause companies to have
higher interest expenses. The high leverage shows
that the company is not solvable, meaning that the
total debt is greater than the total assets. If this goes
on continuously and interest expense increases, it can
reduce profitability (Horne, 2009). The study was
conducted by Charumathi (2012) on insurance
companies in India proved that leverage had a
negative effect on profitability. However, research
conducted by Agiomirgianakis, et.al (2013) proved a
positive relationship between leverage and
profitability. Based on the theoretical and empirical
studies above, this research hypothesis is:
H4: Leverage has a negative effect on
profitability
3 DATA AND METHODOLOGY
The scope of this research is about the effect of
investment in working capital on profitability and the
breakeven point of the investment in working capital
in the manufacturing companiesin Indonesia Stock
Exchange 2014-2017. The data source of this study
came from the financial statements of the
manufacturing campanies companies in the Indonesia
Stock Exchange 2014-2017 which came from the
official web of the Indonesian stock exchange,
namely www. idx.co.id. The type of data used is
secondary data. The population of this study is 150
companies of manufacturing companies in the
Indonesia stock exchange period 2014 – 2017. Based
on the purposive sampling method, the selected
sample is 51 companies. Research variables and
variable measurements are on Table 1.
Table 1: Research Variables and Variable Measurements
Research Variables
Variable Measurements
Inventory conversion period (ICP)
Accounts receivable period (ARP)
Accounts payable period (APP)
Cash Conversion Cycle (CCC)
Quadratic Cash Conversion Cycle (CCC
2
)
ICP = Average inventories× 365/cost of
goods sold
ARP = Average receivables×
365/sales
APP = Average payables × 365/cost of
goods sold
CCC = ICP + ARP – APP
CCC
2
How Does Investment in Working Capital Effect the Probability of Manufacturing Companies at Indonesian Stock Exchange?
519
Return On Assets (ROA)
Current Ratio (CR)
Firm Growth (FG)
Leverage (LEV)
ROA =
Net Income
Total Aset
x 100 %
CR=Total Current Assets /Total
Current Liabilities
FG = (Current year sales /
previous year sales) – 1
LEV = The ratio of total debt to
total assets
The data analysis technique used is multiple
linear regression. The research model is as follows:
Y = β
0
+ β
1
X1
it
+ β
2
X2
2
it + β
3
X3
it
+β
4
X4
it +
β
5
X5
it
+ϵit
(1)
Y = Return on Asset in period t (ROA
it
)
X1 = Cash Conversion Cycle in period t (CCC
it
)
X2
2
= Square of Cash Conversion Cycle in period
t (CCC
2
it)
X3 = Current ratio in period t( CR
it
)
X4 = Firm Growth in period t ( FG
it
)
X5 = Leveragein period t (( L
it
)
Β
0
= Constant
β
1,
β
2,
β
3,
β
4,
β
5
= regression coefficient
ϵit = random disturbance
According to a literature study that the
relationship of investment in working capital to
profitability may be a non-monotonic relationship.
This study refers to Nufazil Ahangar & farooq shah
(2017) research using a quadratic model to test the
relationship. This model is used to see the break-
even point of working capital investment in the
company's profitability by calculating quadratic
cash conversion cycle ( CCC
2
). The Breakeven
point is calculated by defining the CCC variable to
profitability and making the derivative the 0. The
CCC
2
breakeven point formula is: −β1 / 2β2. The
cash conversion cycle and profitability of the
company are expected to be positively related to the
low and negative level of investment in working
capital at a higher level of investment in working
capital. Thus, it is expected that 𝛽1 becomes
positive and 𝛽2 becomes negative.
4 RESEARCH FINDINGS AND
DISCUSSION
Based on the result of classical test assumption,
research model are free from the case of
multicollinearity, heteroskedasticity and
autocorrelation. By using Kolmogorov-Smirnov
test, the result showed that Asymp. Sig is 0.805 so
it can concluded that research data is normal.
Tabel 1: ANOVA
a
Model
Sum of Squares
df
F
Sig.
1
Regression
1618.168
5
8.153
.000
b
Residual
7859.940
198
Total
9478.108
203
Based on these results on table 1 above, it can
be concluded that this regression model can be used
to predict the effect of cash conversion cycle,
current ratio, firm growth and leverage on the
profitability of companies in the manufacturing
sector in the Indonesia Stock Exchange 2014-2017.
The regression result on tabel 2 below shows
that constant value of B is 0.765, B of cash
conversion cycle is 0,008. B of quadratic cash
SEABC 2018 - 4th Sriwijaya Economics, Accounting, and Business Conference
520
conversion cycle is -0,00006, B of current ratio is
0.018, B of firm is growth - 0.005 and B of leverage
is -0.072 These results conclude that the cash
conversion cycle, the quadratic cash conversion
cycle and the current ratio have an influence on the
profitability of the manufacturing companies in
Indonesia Stock Exchange 2014 - 2017 because its
significance is less than 0.05. Meanwhile firm
growth and leverage have no effect on the
profitability of manufacturing companies in
Indonesia Stock Exchange 2014 - 2017 because the
significance value is higher than 0,005 or p>0.05.
Table 2: Regression Cofficient
Model
Unstandardized
Coefficients
t
Sig.
B
Std. Error
1
(Constant)
.765
1.320
.579
.563
CCC
.008
.003
2.813
.005
CCC2
-0,00006
.000
2.134
.034
CR
.018
.005
3.744
.000
FG
-.005
.009
-.581
.562
LEV
-.072
1.258
-.057
.954
Based on the regression results as shown in table
2 above shows that the value of the cash conversion
cycle (CCC) coefficient is positive. The results of this
study indicate that companies can increase working
capital investment because these investments have a
positive impact on profitability of the manufacturing
companies in the Indonesian stock exchange 2014-
2017. Management of manufacturing companies in
the Indonesian stock exchange may make policy to
increase investment in inventories and receivables
because this policy will still have a positive impact on
increasing profitability.
The profitability of manufacturing companies in
the Indonesian Stock Exchange 2014-2017 increased
along with a decrease in the level of investment in the
company's working capital and a decrease in the
profitability of the company in line with the increase
in the level of investment in working capital of the
company. Looking at the direction of the correlation
coefficient, it is indicated that there has been a non-
linear relationship between the cash conversion cycle
and the profitability of the company. The results of
this study provide information to the management of
the manufacturing companies in the Indonesian stock
exchange that at this point the company should pay
attention to the efficiency of investment in working
capital because data from Indonesia stock exchange
shows that manufacturing companies require high
working capital to operate the company. More than
50% of the total asset value of the manufacturing
companies in the Indonesian stock exchange is a
component of working capital. If the company
management does not pay attention to the working
capital investment policy, it can have an adverse
impact on financial performance in this case the
company's profitability. An interesting question is
when the investment in working capital has a
negative impact on profitability.
The Breakeven point is calculated by defining the
cash conversion cycle variable to profitability and
making the derivative the 0. The CCC
2
breakeven
point formula is: −β1 / 2β2. Based on this formula,
the CCC
2
breakeven point value is 66 days. This
breakeven point results explain that if the company
experiences cash conversion cycleover 66 days, the
investment in working capital starts to be inefficient
and will have a negative impact on the profitability.
Given the size of investment in working capital in
the manufacturing companies, the management must
really pay attention to the working capital
management, especially those related to the
components of cash management, securities
management, accounts receivable management and
inventory management because these components
contribute to the amount of working capital
investment. The results of this study also indicate that
the management of manufacturing companies in 2014
- 2017 is quite good because the cash conversion
cycle still has a positive effect on the profitability.
However, the concern of the company is whether the
How Does Investment in Working Capital Effect the Probability of Manufacturing Companies at Indonesian Stock Exchange?
521
66 day time span is not too long even though the
average value of the cash conversion cycle
manufacturing sector in the Indonesia Stock
Exchange 2014 - 2017 is 82 days. To measure the
efficiency of cash conversion cycle time, the
company can usecash conversion cycle information
of manufacturing companies in other countries such
as Malaysia, Singapore as benchmarking, thus the
company can see whether the 66 days cash
conversion cycle C has been optimal and will know
the extent of the three CCC components consisting of
Accounts receivable period (ARP), Inventory
conversion period (ICP) and Accounts payable period
(APP) have made the largest contribution to the cash
conversion cycle. The results of this study support the
research conducted by NufazilAhangar, farooq shah
(2017), but contrary to the results of Mansoori and
Ahmad (2012) and Shubita (2013).
The current ratio has a positive influence on
profitability. The average level of liquidity is 190%
as shown in table. Based on the liquidity value, it can
be indicated that the level of liquidity of the
manufacturing companies in the Indonesia Stock
Exchange 2014-2017 is quite liquid to maintain the
company's short-term obligations. This is evidenced
by the positive influence of the company's liquidity
level on the profitability of the manufacturing
companies inIndonesia stock exchange 2014-2017.
According to the results of previous studies that the
level of liquidity in the manufacturing sector is 190%
can be said to be quite liquid. This good level of
liquidity also reflects that working capital
management such as cash management, accounts
receivable management, inventory management and
efficient debt management can provide acceleration
cash conversion cycle which in turn can help in
meeting the short-term obligations of companies. The
results of this study contradict the research conducted
by Awad and Jayyar (2013), but in line with the
results of research by Al-Nimer et al (2013).
Firm growth does not have an influence on the
profitability of the company. Firm growth of
manufacturing companies in Indonesia Stock
Exchange 2014 – 2017shows a decline in sales This
condition indicates that the average sales trend of
some manufacturing companies during the 2014-
2017 period was negative so that the possibility of not
being able to cover the operational costs of the
company. This condition can cause the firm growth to
be unable to have a positive impact on profitability.
Of the 51firms sample, 24 firm experienced negative
sales changes. The results of this study contradicted
to the research conducted by DarushYazdanfar,
(2013) which proved that firm growth had a positive
impact to profitability.
Leverage does not affect the profitability of the
manufacturing s companies in the Indonesian stock
exchange. According to the trade-off theory that the
policy of increasing debt for companies can have a
positive effect on the company's financial
performance but at some point the composition of
debt no longer has a positive impact and can even
have a negative impact on the profitability. Leverage
is described as a tool to see the extent to which a
company's assets are financed by debt compared to its
own capital. The high leverage can cause a high
corporate burden and if this continues continuously,
the interest expense will increase so that it will reduce
the profitability of the company (Horne, 2009). The
average of capital structure of the manufacturing
companies in Indonesia Stock Exchange 2014 - 2017
is 49%. The results of this study indicate that the
composition of the leverage of the manufacturing
sector companies in the Indonesia Stock Exchange
20014 2017 has reached optimal so that it does not
have an impact on the company's profitability in
accordance with the trade-off theory of capital
structure. The company management should pay
attention to the composition of the current capital
structure. The results of this study contradict the
research conducted by Charumathi (2012) and
Eriotis, et.al (2011).
5 CONCLUSIONS
The conclusions of this research are:
1. Cash conversion cycle has a positive effect
to firm profitability.
2. Current ratio has a positive effect to firm
profitability.
3. Firm growth has no effect to firm
profitability.
4. Leverage has no effect to firm profitability.
5. This breakeven point result of cash
conversion cycle (CCC) is 66 days
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