Working Capital Management Analysis
? Working with Working Capital Management Multi-Line Industry Conglomerates Family Firms In GCC Countries Abstract: An efficient Working Capital Management (WCM) has a significant effect toward the creation of a firm’s value.It is a fact that financial managers in the firms used to give concentration on managing long-term financial decisions, specially capital structure, investment decisions, company valuation & dividends decisions.
Only little attention was given to managing the short-term assets and liabilities, managers began to realize the importance of investigating those short-term assets and liabilities since the working capital management has an important role for the firm’s profitability & risk and the overall value of the firm.There is no doubt about the criticality of this issue to firms as holding too much working capital is inefficient and holding too little is dangerous to the organization’s survival.
This study looks at some firms in multi-line industry in GCC country focusing on family owned conglomerates firms, to investigate their methods of managing their working capital and identifies how organizations creates balance in their working capital..
Introduction: Working capital, also known as net working capital, is a financial metric which represents operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.
It is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit. Working capital management is simple and a straightforward concept of ensuring the ability of the organization to fund the difference between the short-term assets and short-term liabilities (Harris 2005). Currently, working capital management became an important issue to all firms; overall, it can minimize companies’ risks and improves firms’ value.
Identifying the 0ptimal value of working capital is not an easy issue; it requires a careful and continuous monitoring of the components of working capital including cash, inventories, receivables and liabilities. Business success heavily depends on the ability of Chief Financial Officers and the Financial Executives to effectively manage the mentioned components of working capital. Through minimizing the investments tied up with current assets, organizations can reduce their financing costs and increase the funds available for any expansion projects.
Some firms adopt an aggressive working capital management policy evidenced in high risk, high return strategies in working capital investment and financing. Other firms may adopt a moderate or matching strategies with low risks and low returns, lower risks and returns is used by companies who adopt a conservative strategy in investing and financing their working capital. Aggressive policies in working capital could be seen clearly in firms maintaining low level of current asset as a ratio of total assets or high level of current liabilities as a percentage of total liabilities.
Maintaining an optimal level of current assets and current liabilities is an important issue to the firms, because excessive level of current assets affects the profitability of the firm, whereas low level of current assets will adversely affects the liquidity and may leads to stock outs leading to poor operations and lost of sales and profits. In this study, I will investigate how firms in Agriculture & Food Industry in the Kingdom of Saudi Arabia manages their working capital. Market Overview:
Two decades ago, the Saudi Government decided to embark and undertakes an ambitious promotion strategy to improve its Agriculture and Food industry as part of its efforts to diversify the structure of its economy and to reduce its dependence on Oil only. Despite the challenges faced the government (water and climate conditions), the government achieved remarkable success over the past two decades by using the fertilizers, latest modern technologies, and other cultivation methods.
The share of this industry was negligible, but after the huge efforts of the government, the share of Agriculture and Food Industry improved to 3. 4% between 1984 and 1985 and rose to 7% in 1995. Literature Review Some earlier work by Gupta (1969) and Gupta & Huefner (1972) and some other researches studies the financial ratios as part of studying the working capital, but only few researchers studies the policies adopted by firms in managing their working capital. In the year 1998, a research was conducted by Herbert J.
Weinraub and Sue Vischer on the polices of a cross-section of ten different industries over ten years period. The results showed that industries do follow significantly different aggressive/conservative working capital policies, and they remain stable relative to each other over extended periods. An interesting research by Nunnm Kenneth (1981) examined why firms use different levels of working capital. His paper dealt with the strategic determinants of working capital (cash, short-term securities, accounts receivables, and inventory) on a product line basis.
In a study conducted by Sathyamoorthi (2002), h focused on effective management of business assets and corporate governance, he concluded that emphasis was given to long term fixed assets whereas working capital has been given only very little attention. Analyzing some selected firms in Botswana between 1993 – 1997, his conclusion was that firms were using the aggressive policy in managing their working capital. Soenen (1993) has conducted for the first time a study to investigate relationship between the net trade cycle as a measure of working capital and return on investment in U.
S . A firms. He showed a negative relationship between the length of net trade cycle and return on assets using chi-square test. Hypotheses: “Aggressive Working Capital Policy” AWCP leads to the capital being minimized in current assets versus long-term assets this may increase the profitability of the firm but will affect the liquidity (Liquidity Risk). In this approach, firms usually utilize higher levels of lower cost short term debt and less long term capital.
An alternative approach places a greater portion of capital in liquid assets, this will improve the liquidity of the firm but sacrifices some profitability, this approach is called “Conservative Working Capital Policy” CWCP. In this approach, firms utilize higher cost capital and postpone the repayment of principal or avoid it entirely by using equity financing. The data set includes current liabilities, current assets, and total assets for four conglomerates firms in GCC multi-line industry for four years from 2004 to 2007.
To study the level and degree of aggressiveness/conservativeness, the following formulas will be used: AWCP = Total Current Assets (TCA) / Total Assets (TA) CWCP = Total Current Liabilities (TCL) / Total assets (TA) In AWCP, lower ratio means more aggressive policy. AWCP is also called Aggressive Investment Policy. In CWCP, higher ratios more aggressive policy. CWCP is also called Aggressive Financing Policy. To study the effects of an effective working capital management on the profitability of the firms in the industry, the profitability measure (return on equity and return on assets) will be used.
The estimated regression models for this are: ROA = a + B1(CR) ROE = a + B1 (CR) ROA = Return on Assets ROE = Return on Equity CR = Current Ratio = Current Assets / Current Liabilities a = intercept Statistical Analysis and Results First, the different working capital management policies are going to be studied, and the relationship between working capital and profitability of the firms will be examined through conducting regression analysis on Return on Assets (ROA) and Return on Equity (ROE).
The data for this purpose has been obtained form the Financial Statements of the firms for 3 years period, from financial year ended 31 December 2005 to financial year ended December 2007. Table 1 Shows the descriptive analysis of the variables. Tables 2 show the correlations between Return on Assets and Current Ration and Table 3 shows the correlations between Return on Equity and the current ratio. It is clear from the table that is weak relationship between Return on Assets and the current ratios of the firms in Agriculture and Food Industry in the Kingdom Of Saudi Arabia.
This also shows the weak relationship between the aggressiveness financing policy for working capital and return on assets. Table 3 indicates that there exist a positive but not strong relationship between Return on Equity and the current rations of the firms in the above mentioned industry. In another word, we can say that firms who have conservative working capital policy (firms which maintain large current assets in relation to total assets) not necessarily have better return on equity. Table 2 Correlations
Return on Assets Current Ratio Pearson Correlation Return on Assets 1. 000 .007 Current Ratio .007 1. 000 Sig. (1-tailed) Return on Assets . .483 Current Ratio .483 . N Return on Assets 42 42 Current Ratio 42 42 Table 3 Correlations Return on Equity Current Ratio Pearson Correlation Return on Equity 1. 000 .008 Current Ratio .008 1. 000 Sig. (1-tailed) Return on Equity . .480 Current Ratio .480 . N Return on Equity 42 42 Current Ratio 42 42 Table 1 Descriptive Statistics Range Minimum Maximum Mean Std.
Deviation Variance Skewness Kurtosis Statistic Statistic Statistic Statistic Std. Error Statistic Statistic Statistic Std. Error Statistic Std. Error Total Income 2905. 77 -46. 47 2859. 30 330. 6283 107. 39131 695. 97521 484381. 490 2. 678 .365 6. 420 .717 Net profit 51348. 23 -309. 23 51039. 00 1341. 8793 1213. 21835 7862. 55356 6. 182E+07 6. 463 .365 41. 837 .717 Earning Per Share 50216. 223 -1. 922E+01 50197. 000 1197. 68098 1195. 106155 7745. 173096 5. 999E+07 6. 481 .365 42. 000 .717 Current Ratio 9. 8 .4 40. 1 2. 893 .9309 6. 0332 36. 399 6. 010 .365 37. 669 .717 Return on Assets 1. 6392 -. 6692 .9700 .174782 .0595976 .3862368 .149 -3. 138E-02 .365 -1. 434E-01 .717 Return on Equity 1. 6770 -. 7490 .9280 .172144 .0626788 .4062048 .165 -2. 315E-01 .365 -1. 926E-01 .717 Market Price 1420 0 1420 240. 21 47. 527 304. 324 92613. 023 2. 216 .369 5. 492 .724 Table 3 Anova Model Sum of Squares df Mean Square F Sig. 1 Regression .000 1 .000 .003 .959a Residual 6. 765 40 .169 Total 6. 765 41 Conclusions:
Firms usually adopt one of three available working capital investment policies, the first is the Moderate or Matching policy where firms try just to match the maturities of short term assets with the maturities of short term liabilities. The second approach is the Conservative approach where the firms permanent current assets, fixed assets or even temporary current assets are financed with long term capital. The last policy for working capital investment is the Aggressive policy where long term liabilities are used to finance long term assets but some of the short term asset financed using short term liabilities.
The relative relationship between the working capital polices (aggressive or conservative) and the Return on Equity & Return on Assets has been examined by investigating the Agriculture and Food Industry in the Kingdom of Saudi Arabia for 3 years period through statistic analysis using the SPSS Statistic Program. The results show a weak relationship between return on assets and the aggressiveness of working capital management, while there exists a positive weak relation between Return on Equity and aggressiveness.
Relaxed or conservative working capital policy maybe appropriate if it leads to greater profit for the firm. References http://blog. receivablesxchange. com/blog/? Tag=credit+crisis http://en. wikipedia. org/wiki/Working_capital www. studyfinance. com/lessons/workcap http://spears. okstate. edu/home/frankpd/legacy/fin3113/Ch16. pdf http://management. ut. ac. ir/fa/hozeh/teachers/MirLohi/ch08. ppt#258,3,Working Capital Concepts http://www. bizresearchpapers. com/Kesseven. pdf http://www. american. edu/TED/SAUDI. HTM