Cash conversion cycle, its properties and profitability: evidence from listed hotel companies in Sri Lanka

Abstract

The purpose of this study is to examine the relationship between liquidity and profitability of firms at hotels and travels sector in Sri Lanka. Cash conversion cycle (CCC) and its properties namely accounts receivable outstanding days (AROD), accounts payable outstanding days (APOD) and inventory outstanding days (IOD) have been used to explain liquidity management. Profitability is measured through return on asset (ROA), return on equity (ROE), gross profit margin (GPM) and net profit margin (NPM). Analyzing a sample of 26 randomly drawn companies listed in Colombo Stock Exchange (CSE) in hotels and travels sector over three years from 2011 to 2013, the study finds that CCC is positively and significantly related to the profitability. Regression models with AROD, APOD and IOD as predicting variables instead of CCC better explain nearly all profitability measures. This effect of disaggregation is more sensitive when the profitability is measured in terms of net profit margin. Hotels and travels companies can increase profitability by allowing more credit outstanding days and having lower inventory conversion period. Accounts payable outstanding days are found to be insignificantly related to profitability. The findings reveal the effects of aggregation and de-aggregation of CCC in predicting profitability of firms in hotels and travels sector. The study also informs the hoteliers and travels firms about how different components of CCC are to be managed for increased profitability. This investigation is also significant as prior literature on liquidity and profitability nexus in hotels and travels sector is extremely limited. Findings obtained here are useful for hoteliers and policy makers to ensure efficient working capital management at hotel sector in Sri Lanka. Profitability of hotel sector firms in Sri Lanka is investigated in this paper with aggregated and de-aggregated models of cash conversion cycle.