Aggressive Current Ratio Policy and Corporate Profitability in Bangladesh

Aggressive Current Ratio Policy and Corporate Profitability in Bangladesh

Sharif N. Ahkam

Associate Professor, School of Business, North South University, Dhaka, Bangladesh

Nimita Farzeen Azam,

Lecturer, School of Business, North South University, Dhaka, Bangladesh

Paper to be presented at the Twenty Fourth International Conference of Association for Global Business to be held November 15-17, 2012 at Key Bridge Marriott, Washington, D.C. 

Aggressive Current Ratio Policy and Corporate Profitability in Bangladesh

Sharif N. Ahkam

Associate Professor, School of Business, North South University, Dhaka, Bangladesh

Nimita Farzeen Azam,

Lecturer, School of Business, North South University, Dhaka, Bangladesh

Abstract

In this paper, we investigate the relationship between working capital management and profitability of firms in Bangladesh listed in Dhaka Stock Exchange for the years 2009-2011. The paper finds a negative correlation between current ratio and long-term debt ratio and detects a relatively high current ratio close to the year of listing which decays toward average in a few years. We did not detect any association between the current ratio and industry type and found that when the current ratio falls below 0.9, it appears to be associated with a low return on asset.

Introduction

Investing substantial time in working capital management is an important component of the overall value maximization process for corporate management. However, finance literature grants a lot more attention to capital structure, capital investment valuations, and dividend policies. Defined by the difference between current assets (accounts receivables, cash and cash equivalents, inventories) and current liabilities (accounts payable, short term debts), working capital measures provide us with a snapshot of the ongoing liquidity of the firm. Current assets and current liabilities are essential parts of the firm’s total assets and total liabilities. Proper management of short-term working capital is necessary for firm’s long-term investments. Maintaining working capital ratios, especially the current ratio and quick ratio at a desirable level is often critically important for management and those who provide long-term capital to the firm. Fazzari and Peterson (1993) emphasized the role of working capital as both a source and a use of funds and stated that, in the short run, working capital absorbed