Understanding the Impact of the Average Inventory Period and Cash Conversion Cycle on Firm's Profitability

Abstract

The success of a business is intricately linked to its performance, shaped by corporate strategy and goal attainment. One crucial aspect of this success is the management of inventory and cash conversion cycle, as it directly impacts the company's ability to meet its short-term financial obligations and operate efficiently. Previous research mostly examined the inventory and cash conversion cycle-firm performance link in developed economies, paying less attention to developing economies' dynamics. To address this, this study analysed how inventory and cash conversion cycle affect the profitability of 50 Tanzanian firms from 2011 to 2022. The study used random effect estimate in the regression analysis. Panel data analysis was used, considering variables such as average inventory period, cash conversion cycle, firm size, debt ratio and business growth. The findings showed a significant negative relationship between the Independent variable (Average Inventory Period), the control variable (debts ratio), and firm’s profitability. On the other hand, the findings showed a significant positive relationship between the independent variable (Cash Conversion Cycle), control variables (size of the firm and business growth) and the firm’s profitability.In terms of different sectors, the findings of the study exhibited contrasting outcomes, with certain sectors showing positive relationships, while others displayed negative relationships or insignificant correlations among the variables. Given the inconsistent and significant results observed within specific sectors, it is advisable for Financial Managers to take into account economic order points and industry-specific dynamics when making decisions regarding inventory management and net working capital in order to achieve optimal outcomes.

Keywords: Average Inventory Period, Cash Conversion Cycle, Net Working Capital Management, Firms, Performance and Profitability.

DOI: 10.7176/JESD/15-3-04

Publication date:March 31^st 2024