Impact of Working Capital Management Practices on Firm Value
Bandara R.M.S.
Department of Accountancy
Faculty of Commerce & Management Studies
University of Kelaniya
Sri Lanka.
samanb@kln.ac.lk
Weerakoon Banda Y.K.
Department of Finance
Faculty of Management Studies & Commerce
University of Sri Jayewardenepura
Sri Lanka.
weerakoon@sjp.ac.lk
Abstract
This research study investigated the impact of Working Capital Management Practices
(WCMP) on firm value in Sri Lankan companies. Data were gathered from a sample of 74
companies listed in the Colombo Stock Exchange covering seven business sectors for period
of 2005 to 2009.
Firms’ Aggressive Working Capital Management Practice (AWCMP), Moderative Working
Capital Management Practice (MWCMP) and Conservative Working Capital Management
Practice (CWCMP) were used as independent variables. Firm value measured in terms of
Market Value Added (MVA) and Economic value Added (EVA) was employed as dependent
variable in the study. The panel regression analysis was employed.
The results indicate that there is a statistically significant negative relationship between
CWCMP and MVA and it further explains the firms that follow MWCMP yield higher MVA
than the firms with CWCMP. Similarly, it indicates that there is a significant negative
relationship between AWCMP and EVA, providing further evidence that the firms with
AWCMP generate lower EVA than that of the firms with MWCM. Accordingly, the results
conclude that the firms following MWCMP improved both MVA and EVA of the firms in Sri
Lanka.
Key wards: Working Capital Management Practice, Firm Value, Economic Value Added,
Market Value Added, Sri Lanka
Introduction
Corporate financial officers identify Working Capital Management (WCM) 1 as being
important to their firms’ value. Management of short-term assets and liabilities needs a
careful attention since the WCM plays an important role in the determination of the
profitability, liquidity and risk as well as the ultimate objective of firm’s value 2 (Smith,
1980). The greater the investment in current assets leads to the lower risk in terms of settling
short term obligation, while gaining lower profitability because of the inability to invest in
the profitable long-term investments. Efficient management of working capital is a
fundamental part of the overall corporate strategy to create the shareholders’ value.
The main objective of WCM is to maintain an optimal balance between each of the working
capital component. Business success heavily depends on the ability of financial executives to
effectively manage the working capital component of receivables, inventory, and payables
(Filbeck and Krueger, 2005). Working Capital Management Practices (WCMP) is the firm’s
way of
making investment in their current assets which is known as working capital
investment policy and use short-term liabilities to finance firms’ assets which is know as
working capital financing policy. Theoretically, a firm can adopt different working capital
management practices as Aggressive working capital management practice, Moderate
working capital management practice and Conservative working capital management practice
based on its investment and financing strategies.
These different practices affect the
profitability, liquidity, risk, and finally the value of the firm in different ways.
In general, Financial Management is concerned with four broader aspects such as short-term
and long term investment, capital structure and dividend policy. In the short-run, current
assets and liabilities are considered as one of the important components of a firm. A firm can
make investment in the short-term assets comparatively to the long-term assets; maintain a
certain level of liquidity and profitability of the firm as a result of different risk level. Hence,
a firm can use more current liabilities to finance the total assets fully or partly and it will lead
1
WCM is defined as the ability of the organization to fund in to the short term assets and short term liabilities
(Harris, 2005). Working capital management involves planning and controlling current assets and current
liabilities in a manner that eliminates the risk of inability to meet short term obligations on one hand and avoids
excessive investment (Eljelly, 2004).
2
The Firm Value is the present value of the expected future cash flows discounted at the rate of return required
by investors (Robert K, Mark L & Rabhi M.,2008).
to low level of liquidity, high level of risk as well as high level of profitability. It concludes
that excessive levels of current assets may have a negative impact on the firm’s profitability
whereas a low level of current assets may lead to low level of liquidity and stock-outs
resulting in difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2004).
More aggressive working capital policies are associated with higher return and higher risk
while conservative working capital policies are concerned with the lower risk and return
(Gardner et al., 1986 and Weinraub and Visscher, 1998).
Therefore a discussion on managing of working capital is more important for Sri Lankan
companies since we are also in succession in an economic boom. Even though the working
capital management is much important for success of an organization, a very few researches
have been carried out to discuss the organizational working capital management policy in
specific in the Sri Lankan context. In the current research work, attention was given to the
financial statements of listed companies in Sri Lanka. Carrying out research to identify the
impact of working capital policy on firm value of the companies in Sri Lanka.
Through the current study, researchers expect to determine the relationship between Working
Capital Management Practices & the value of the Firm in Sri Lankan organizations.
In the today’s dynamic business environment, survival of the organization is more uncertain
even though the companies are earning profit, unless they can’t meet the short term
obligations. Corporate finance basically deals with three decisions such as capital structure
decisions, capital budgeting decisions, and working capital management decisions. Among
these, working capital management is a very important component of corporate finance since
it affects the profitability and liquidity of a company and finally to its value. It basically deals
with current assets and current liabilities and the way of financing current assets and
liabilities. Efficient working capital management involves planning and controlling current
assets and current liabilities in a manner that eliminates the risk of inability to meet short term
obligations on one hand and avoids excessive investment (Eljelly, 2004). Maintaining
adequate working capital is not just importance in the short term. Sufficient liquidity must be
maintained in order to ensure the survival of the business in the long term as well. Even a
profitable company may fail, if it does not have adequate cash flow to meet its liabilities as
they fall due. On the other hand, one of the main objectives of a firm is to maximize its value.
Therefore, it is important to study how firms should keep the proper investments in current
assets and maintain proper level of current liabilities in an enterprise with maximizing its’
value.
Firm value is more important to have sustainable growth rate for a business leading to attract
prospective investors. Because value of the firm is the form that investors motivate to invest
in the business and increase of value will benefit the firms’ prestige by increasing future
growth. Further, firm value is also important since it affects to achieve the desired
performance and long term survival of the enterprises. Therefore with the current study,
researcher attempted to support for the organizations to keep a healthy WCMP in such a way
to maximize firm value.
According to the literature available, very few researches have been carried out in the area of
WCM in Sri Lanka and no research have been carried out relating to the working capital
management practices and the firm value in specific in the Sri Lankan context. Further, no
researches are available in the literature that has been used EVA and MVA to measure the
firm value with the WCM context? Therefore the researcher expected to study the stability of
working capital management in different business sectors and the impact of those on the firm
value. While the study enhances the WCMP ensuring the maximum utilization of current
assets and current liabilities in Sri Lankan enterprises to achieve ultimate objective of value
creation, it will lead to fill the gap exists.
Further, it will support the policy makers in designing the appropriate level of WCM to
maximize value of the firm continuing their sustainable business growth. And also, new
comers to the different business sectors will be facilitated by providing better understanding
about the behavior and the patterns of the WCMP in different sectors. As a whole, this study
will enhance organization’s understanding about the ability to manage liquidity, risk,
profitability beyond the theoretical framework explanations, and the way in which WCMP
helps to create value for the firm for smooth sustainable operations.
Literature Review
WCM is defined as the ability of the organization to fund into the short term assets and short
term liabilities (Harris, 2005). According to Van Horne (1977), working capital management
is the administration of current assets in the name of cash, marketable securities, receivables,
and inventories. Osisioma (1997) described working capital management as the regulation,
adjustment, and control of balance of current assets and current liabilities of a firm such that
maturing obligations are met, and the fixed assets are properly serviced. Due to lack of proper
plan for working capital requirements and the inability to identify and implement most
suitable Working Capital Management Policy (WCMP), i.e. the firm specific way of making
investment in their current assets which is known as working capital investment policy and
use short term liabilities to finance firms’ assets which is know as working capital financing
policy, firms often experience excess working capital or shortage of working capital, both
leading to destroy its value (Agarwal, 1977).
Haitham N. and Maryam A. (2005) also studied the relationship between working capital
management and firm profitability. The results suggested that managers can increase
profitability of their firms by shortening the cash conversion cycle, the receivable collection
period and the inventory conversion period. The results suggest that managers can also
increase the profitability of their firms by lengthening the payable deferral period. Further it
has been proved by Baum, C. F. et al. (2006) using data from Germany and they examined
the direct effect of non- financial firms’ use of short-term versus long-term liabilities and
stated that non financial firms rely more heavily on short-term liabilities are likely to be more
profitable. According to the study by Baum, C. F. et al.(2007) with a comparison made
between two countries, the US and Germany, with different types of financial systems they
find that German firms that rely more heavily on short-term liabilities are likely to be more
profitable. The link between liability maturity structure and profitability does not appear in
the results from the US sample. It shows that use of more current liabilities is not yielding the
higher level of profitability in US.
Solano (1993) examined the effects of working capital management on the profitability of a
sample of small and medium-sized Spanish firms with the panel data covering the period
1996-2002. The results demonstrate that managers can create value by reducing their firm’s
number of day’s accounts receivable and inventories. Equally, shortening the cash conversion
cycle also improves the firm’s profitability.
WCM is important because of its impact on the firm’s profitability and risk, and consequently
its value (Smith, 1980). Excessive levels of current assets may have a negative effect on the
firm’s profitability whereas a low level of current assets may lead to lower level of liquidity
and stock-outs resulting in difficulties in maintaining smooth operations (Van Horne &
Wachowicz, 2004). Accordingly, Greater the investment in current assets, the lower the risk,
but also the lower the profitability obtained. Filbeck and Krueger (2005) highlighted the
importance of efficient WCM by analyzing the WCMP of 32 non-financial industries in
USA. According to their findings significant differences exist between industries in working
capital practices over time. Moreover, these working capital practices, themselves, change
significantly within industries over time. Similar studies have been conducted by Eljelly
(2004); Ghosh & Maji (2004); Howorth & Westhead (2003); Gombola and Ketz (1983);
Lazaridis and Tryfonidis (2006); Long et al. (1993); Maxwell et al. (1998) and Smith and
Begemann (1997).
Salawu R.O. (2006) investigated fifteen diverse industrial groups over an extended period to
establish the relationship between aggressive and conservative working capital practices. His
results strongly show that the industries had significantly different current asset management
policies. Additionally, the relative industry ranking of the aggressive or conservative asset
policies exhibited remarkable stability over time. It is evident that there is a significant
negative correlation between industry asset and liability policies. Relatively aggressive
working capital asset management seems balanced by relatively conservative working capital
financial management. Furthermore he explains that a firm in deciding its working capital
policies should consider the policies adopted in that particular industry in which it operates
and a firm pursing aggressive working capital investment policy should match it with a
conservative working capital financing policy. This is important to mitigate the risk being
faced under aggressive working capital investment policies by safety involved under
conservative working capital financing policy.
However, Weinraub and Visscher (1998) have discussed the issue of aggressive and
conservative working capital management policies by using quarterly data for a period of
1984 to 1993 of US firms. The researchers have examined ten diverse industry groups to
study the relative relationship between their aggressive/conservative working capital policies
and they have concluded that the industries had distinctive and significantly different working
capital management policies over the time.
Further, Afza and Nazir (2007) investigated the relationship between the aggressive and
conservative working capital policies for seventeen industrial groups and a large sample of
263 public limited companies listed at Karachi Stock Exchange for a period of 1998-2003.
Finally, ordinary least regression analysis found a negative relationship between the
profitability measures of firms and degree of aggressiveness of working capital investment
and financing policies.
Another important study which confirms the results of Afza and Nazir (2007), conducted by
Mian S. and Talaf (2009) have shown that the negative relationship between the Profitability
measures of the firm and the degree of Aggressiveness of working capital management
policies by analyzing the 204 Pakistani firms listed under sixteen industrial groups in the
Karachchi Stock Exchange (KSE). The data was analyzed for the period of 1998-2005. As
the findings it says that firms with more aggressive working capital policy may not be able to
generate more profit proving the negative relationship of WCMP and profitability.
Turning to the empirical literature on WCM practices and the firm value, researcher could not
find any published study of the relationship between WCMP and firm value in specific. Hall,
J. (2001); Ruback and Sesia (2000) and Smith (1980) stated that efficient level of WCM is
one of the drivers for value creation. However, researcher was able to found research that
examines the relationship between WCM and firm profitability as mentioned previously. As
examples, Deloof (2003); Garcia-Teruel and Martinez-Solano (2007); Soenen (1993) and
Shin and Soenen (1998) all showed that the profitability of a firm, measured by either return
on assets or return on equity, is improved as the firm improves its management of its working
capital. While most of such studies suggest that firms that minimize their investment in net
operating capital will maximize their profitability and thereby maximize firm value, this
inference does not necessarily follow (Robert, Mark & Rabhi, 2008).
Theoretically, greater the investment in current assets, the lower the risk, but also the lower
the profitability obtained. In contradiction, Carpenter & Johnson (1983) provided empirical
evidence that there is no linear relationship between the level of current assets and revenue
systematic risk of US firms; however, some indications of a possible non-linear relationship
were found which were not highly statistically significant. So, the link between WCM and
firm value is not simple as the link between WCM and firm profitability discussed.
The study available relating to the Sri Lankan context is the research done by Pandey and
Perera (1997), providing an empirical evidence of WCMP and practices of the private sector
manufacturing companies in Sri Lanka. The information and data for the study were gathered
through questionnaires and interviews with chief financial officers of a sample of
manufacturing companies listed on the Colombo Stock Exchange. They found that most
companies in Sri Lanka have informal working capital policy and company size has an
influence on the overall working capital policy (formal or informal) and approach
(conservative, moderate or aggressive). And also, company profitability has an influence on
the methods of working capital planning and control. According to the study conducted by S.
Morawakage and Lakshan A.M.I (2009) with the companies registered in Colombo Stock
Exchange, results suggest that managers can increase corporate profitability by reducing the
number of inventory turn over days and increasing the creditor’s payable days in order to
minimize the length of the working capital cycle. Increase in creditor’s payable days would
give opportunities to the company for further investments.
Turning to the literature on firm value, a well designed and implemented working capital
management is expected to contribute positively to the creation of a firm’s value. Since the
1990s, strong arguments have been raised in favor of EVA as an accounting measure, mainly
by the Stern Stewart Consulting Company and Associates (Stewart, 1991 and Stern, 1993). A
survey of the available literature on this topic indicates that several studies have concluded
that EVA has a stronger correlation with MVA than the other accounting measures tested.
Supporters of EVA include O’Byrne (1996), Uyemura, Kantor and Pettit (1996) and Grant
(1996). However, after initial strong support for EVA, some criticism of EVA has arisen, and
some research results have been published that indicate as EVA does not explain MVA better
than other measures.
Further, Asogwa (2009) has studied the determinants of shareholder value creation in the
listed banks in Nigerian stock exchange with identifying impact of profitability, dividend
policy, earnings, size of the banks to the value creation. In his study he stated that dividend
policy affects more on value creation than profitability and earnings and bank size do not
affect the value creation in the Nigerian context. But he further explains that unobsevarable
factors such as management quality and strategies are affecting for the value creation in
Nigerian banks.
As the only and first empirical study of the relationship between corporate working capital
management and firm value, as well as the first examination of how financing influences this
relationship, was conducted by Robert, Mark and Rabhi (2008) with U.S. corporations from
1990 through 2004 data. They found that first; a dollar invested in net operating capital is
worth less on average than a dollar held in cash. Second, on average, an additional dollar of
investment in net operating working capital at current levels of such investment reduces firm
value. Third, the evidence that a dollar invested in net operating working capital is worth less
than a dollar is primarily driven by its financing. Fourth, firms with better access to public
capital market, and particularly commercial paper markets, face a lower reduction in value
from financing this investment. Further they have not only shown that WCM is important to
firm value, but also that its financing is a critical determinant of its valuation effects. This
study has used the net present value method to measure the firm value and instead of that
researcher in the study uses the EVA and MVA with the working capital management policy
in specific with the WCM investment and financing practices in different business sectors.
Even though there are prose and cones of using EVA and MVA to measure the firm value, it
has been proved by the literature that EVA and MVA can be used as the better proxy for
measuring the value of the firm.
Methods
Hypotheses
The following hypotheses were formulated in the current study to examine the impact of
WCMP on firm value.
H1: There is negative relationship between the Aggressive Working Capital Management
Practice (AWCMP) and MVA of the companies in Sri Lanka.
H2: There is negative relationship between the Conservative Working Capital Management
Practice (CWCMP) and MVA of the companies in Sri Lanka.
H3:
There is negative relationship between the Aggressiveness of Working Capital
Management Practice (AWCMP) and EVA of the companies in Sri Lanka
H2:
There is negative relationship between the Conservative of Working Capital
Management Practice (CWCMP) and EVA of the companies in Sri Lanka.
Research design
First we identified the WCMP followed by the firms as Investment Policy (IP) and Financing
Policies (FP). The level of the IP and FP is measured by the degree of aggressiveness or the
conservativeness. To measure the degree of aggressiveness/conservativeness of IP, following
formula has been used. This is in consistent with Afza & Nazir, (2007); Weinraub &
Visscher, (1998); Salawu, (2006).
IP
=
Total Current Assets (TCA)
X 100
Total Assets (TA)
Where a lower ratio means a relatively aggressive policy and a higher ratio means a relatively
conservative policy.
To measure the degree of aggressiveness/conservativeness of financing policy, following
formula has been used.
FP =
Total Current Liabilities (TCL)
X 100
Total Assets (TA)
: Where a higher ratio means a relatively aggressive policy and a lower ratio means a
relatively conservative policy.
Based on the Working capital IP and FP followed by the firms, as mentioned above,
researcher adopted the following combinations to identify the WCM practices of the firms in
the study.
a)
AIP with AFP - Aggressive WCMP
If a company is running with an Aggressive Investment Policy (AIP) and Aggressive
Financing Policy (AFP), it is categorized as a company which is having an Aggressive
Working Capital Management Policy (AWCMP).
b)
CIP with CFP- Conservative WCMP
The company which is running with a Conservative Investment Policy (CIP) and
Conservative Financing Policy (CFP) are categorized as a company having Conservative
Working Capital Management Policy (CWCMP).
c)
AIP & CFP or AFP & CIP -Moderate WCMP
The company which is running with an Aggressive investment policy (AIP) with
Conservative finance policy (CFP) and Conservative investment policy (CIP) with
Aggressive finance policy (AFP) is categorized as Moderate Working Capital Management
Policy (MWCMP).
Secondly, measures of EVA and MVA of the selected companies measured. After identifying
the specific WCMP followed by each company in different sectors and measuring the value
of the firms, researcher expects to examine the relationship between WCMP with Economic
Value Added (EVA) and the Market Value Added (MVA).
Market Value Added
Market value says how much management has added to share holder value over the company
and it is the difference between market value of the firm’s stock and the amounts of equity
capital supplied by investors. MVA measures the effect on value of management’s decisions
since the firm’s inception. It is calculated as follows.
MVA = Market Value of Company – Total Operating Capital Invested
Finnegan, (1991) has stated that better picture of the MVA is give as the difference between
the current year MVA and the last year MVA. Therefore, in the current study, the percentage
change in MVA from one year to another year is used to see whether value has been created
or destroyed by the firm. Company creates value when percentage change MVA is grated
than “0”, that is when the market value capital exceeds the capital invested.
Economic value added
EVA is a measure that focuses on firm internal performance over a specific period and it
assesses managerial effectiveness in a given year. By measuring profits, after subtracting the
expected return to shareholders, EVA indicates economic profitability. The EVA measure
was created to address the challenges of companies faced in the area of financial performance
measurement. Creating sustainable improvements in EVA is synonymous with increasing
shareholder wealth.
For the current study, EVA is calculated targeting only the equity shareholders due to
unavailability of the data to calculate the EVA complying with the above formula. Therefore,
researcher uses the EVA contribution only for equity shareholders by deriving the following
formula and it is in consistent with Gregory T. Fraker (2006). Accordingly EVA is calculated
as follows.
EVA = PAT - (Ke x TC)
Where,
PAT= Profit after Tax
TC= Total Capital
Ke = Cost of Equity
Equity capital is provided by the ordinary shareholders. An investor’s expected rate of return
on an investment is equal to the risk free rate plus the market price for the risk that is
assumed with the investment. The relationship between expected return and risk is measured
by comparing a company to the market. The percentage return that a company’s shareholders
require on their investment can be calculated under the assumption that they require both a
return for just investing their money and a return that reflects the risk inherent in investing
specifically into the company. Stated as a formula, which is known as the Capital Asset
Pricing Model (CAPM), the percentage return that a company’s shareholders require is
calculated as follows.
Ke = Risk-Free Rate + Beta Coefficient (Market Risk Premium)
The risk-free rate is the interest rate that can be obtained by investing in an investment with
no risk. Although a truly "risk-free" investment exists only in theory, in practice short-term
government treasury bills, such as three months (91 Days) Treasury bill rate, is used in the
above formula as risk free rate of return.
The beta coefficient is the level of risk inherent by investing in a specific company relative to
investing in the overall stock market. Therefore, it was calculated by using the formula of
Core-variance of company stock price and the market return divided by the Variance of the
market return.
The market risk premium is the risk associated with investing in the stock market as a whole.
It is measured by the year change logarithm of All Share Total Return Index (LnASTRI) and
the risk free rate i.e. 91 days Treasury bill rate.
Ke = RF + ß (Rm- RF)
Ke = 91 Days Treasury bill rate + ß (LnASTRI - 91 Days Treasury bill rate)
Since, EVA is calculated only for equity shareholders, Profit after Tax is calculated after
deducting preference dividends. Total capital of the company is the equity capital and
reserves.
Finally, with all above methods of calculations, researcher proposes to use to put in plain
words to show the design of the research which is to carry out by the researcher through the
following diagram.
Sample and Sampling Procedure
A sample of 74 companies has been selected representing seven different sectors in the
Colombo Stock Exchange (CSE) out of the twenty sectors in the CSE sector categorization.
Researcher did not select bank, financial and insurance sector companies because of the more
regularization of the working capital practices in the industry as a result of inherent
conditions imposed to the financial sector organization. Further, diversified holding sector
was eliminated from the sample due to the group financial statements are available and it may
lead to replication error of data with other sectors. Additionally, since the less number of
companies available in the sectors such as Construction and engineering, Foot ware textiles,
Health care, Information technology, Investment trust, Motors, Oil palms, Power and energy,
Services, Store suppliers and Telecommunication have not been included in to the sample.
The sample companies which covers the fifty percent of the total population is considered for
the study. It was drawn by using the stratified random sampling technique from the 142 listed
companies which are considered for the research selecting seven different sectors in CSE.
Finally researcher possesses the research with 370 observations.
Table 1- Distribution of sample companies listed in CSE according to the Industrial Sectors.
Sector
Number
of Number
of
Companies Available
Companies Selected
Beverage Food and Tobacco (BFT)
18
11
Chemicals and Pharmaceutical (C & P)
09
6
Hotel and Travel (H & T)
33
16
Land and Property (L & P)
22
12
Manufacturing (Manu)
31
15
Plantations (Plant)
18
9
Trading (Trad)
11
5
142
74
Total
Data and Data Collection
With the evidences supported by the literature, most of the researchers have conducted their
researches based on the secondary data from the annual reports polished by the companies.
This study also based on secondary quantitative data and the data is collected for the period
of 5 years starting from 2005 to 2009 using the annual reports published by the above
mentioned companies which have been listed in CSE. Further, the data is obtained from the
magnetic data library and the annual handbook published by CSE.
Data analysis
Data comprises time series natures because it is for five years period and cross sectional
nature because it has 74 companies. Therefore, researcher used panel data from the year 2005
to 2009 representing 74 companies covering seven different sectors in the CSE. Further,
using E-views software package, panel regressions were used with the dummy variables to
examine the impact on WCMP and firm value.
Results and Discussion
Researcher used dummy variables to identify the impact of WCM practices followed by the
firms as Aggressive Working Capital Management Practice (AWCMP), Moderative Working
Capital Management Practice (MWCMP) and Conservative Working Capital Management
Practice (CWCMP) which were derived from the firms’ investment policy, and firms’
financing policy, with value of the firm which is measured by EVA and MVA. Thus, Dummy
1 is used for AWCMP as D1 and Dummy 2 is used for CWCMP as D2. It can be shown as
follows.
Table 2- Dummy variables for WCMP
D1
D2
1
0
Management
Practice 0
1
Management
Practice 0
0
Aggressive Working Capital Management Practice AWCMP
Conservative
Working
Capital
CWCMP
Modarative
Working
Capital
MWCMP
Following models have been used
FV
it
= β0 + β (AWCMP ) + β (CWCMP ) + β (MWCMP ) + εit
1
it
2
it
MVA
= β0 + β (D1 ) + β (D2 ) + εit
EVA
= β0 + β (D1 ) + β (D2 ) + εit
it
it
1
1
it
it
2
2
3
it
Model 1
it
it
Model 2
WCMP and MVA
Table 3- WCMP and MVA
Overall model
Adjusted R2
0.370
F value
3.891
t value
Sig. level
Sign of the Coif.
0.000
D1
D2
(AWCMP)
(CWCMP)
0.712
-4.075
.0.476
.000
Positive
Negative
According to the information provided by model 1 of the impact of the WCMP on value of
the firm by the above table no.3, adjusted R2 value was 0..370 with a f value of 3.89
(p=0.000) stating that nearly 37% of the variation in MVA was explained by WCMP as
AWCMP, CWCMP or MWCMP selected by the firm. It further showed that CWCMP
recorded a negative relationship to MVA (p=0.000) while AWCMP recorded a positive
relationship which was not significant, evidencing that relatively conservative WCMP yields
a relatively low level of MVA. In contrast to that, the firms follow AWCMP impact to have
relatively higher MVA to its base case of MWCMP. In the other words, adopting relatively
AWCMP leads to increase the MVA while CWCMP leads to decrease the MVA relatively to
its MWCMP. Therefore researches first hypothesis is fail to accept and second hypothesis is
failed to reject. Finally it concludes that those firms who move from the CWCMP to
AWCMP increase their MVA.
WCMP and EVA
Table 4- WCMP and EVA
Overall model
Adjusted R2
0.321
F value
3.311
t value
Sig. level
Sign of the Coif.
0.000
D1
D2
(AWCMP)
(CWCMP)
-7.981
-1.322
0.000
0.1871
Negative
Negative
According to regression model no 2, researcher regressed the WCMP as D1 and D2 with
EVA and regression results are summarized in the table no.4. Its’ adjusted R2 value was
0.321 with F value of 3.311 (p=0.000) stating that nearly 32% of the variation in EVA was
explained by the firm’s selection of WCMP as AWCMP, CWCMP or MWCMP. It further
showed that D1 for AWCMP and D2 for CWCMP recorded a negative coefficients to EVA
recording (p=0.000) and (p = 0.1871) respectively. Accordingly, AWCMP was statistically
significant and CWCMP was not significant. It evidenced that AWCMP yield a relatively low
level of EVA compared to the base case of MWCMP. Therefore researcher is fail to reject
hypothesis 3 stated as there is negative relationship between the AWCMP and EVA.
Conclusion
Results provides evidence from the model 1 (Table no.3) on the impact of the WCM practices
on value of the firm, CWCMP demonstrated a negative relationship to MVA (p=0.000) while
AWCMP recorded a positive relationship which was not significant, i.e., explaining that
relatively CWCMP yields a relatively low level of MVA. In the other wards, if any firm is
operating with conservative investment policy3 together with conservative financing policy4,
it decreases the MVA relative to MWCMP firms. In considering all relationships as a whole,
MVA increases when the firm moves from the CWCMP to AWCMP. It further explains that
the firms that maintain higher level of current assets with a lower level of current liabilities
lead to have a lower MVA than the firms which are running with lower level of current
liabilities with lower level of current assets or a higher level of current liabilities with a
higher level of CA.
According to regression model no 2 (Table no.4), showed that D1 for AWCMP and D2 for
CWCMP witnessed negative coefficients to EVA recording (p=0.000) and (p = 0.187)
respectively. Accordingly, AWCMP was significant and CWCMP was not significant. It says
that AWCMP yields a relatively lower level of EVA comparatively the base case of
MWCMP. It can be further explained as, if any firm is operating with aggressive investment
policy5 together with aggressive financing policy6, it decreases the EVA relatively to the
firms that operate with MWCMP. Moreover, it can be concluded that, when the firms are
maintaining lower level of current assets with higher level of current liabilities, it leads to
have a lower level of EVA than the firm’s with lower level of CL coupled with lower level of
CA or higher level of CL coupled with higher level of CA.
Finally the findings of WCM practices as CWCM practice gives a lower level MVA than
MWCM practice while AWCM practice indicates a lower level EVA than MWCM practice.
This finding is complying with the results by Weinraub and Visscher (1998) and Gardner et
al. (1986) as conservative working capital policies are concerned with the lower risk and
return. Even though Weinraub and Visscher (1998) Rehman (2006); Soenen (1993); Jose et al
(1996); Gardner et al (1986) found that aggressive WCMP increases the firm profitability of
the firms, current findings says that the firms who follow AIP together with AFP do not
increase the EVA of the firms.
According to the results which were used to examine the impact of different WCM practices
followed by the firms, CWCMP showed a negative relationship with MVA compared to the
MWCMP. Accordingly, it provided evidence that firms following CWCMP yield lower
MVA than the firms following MWCMP. Furthermore, AWCMP showed a negative
relationship with EVA. It proved that the firms following MWCMP can have higher level of
EVA than the firms with AWCMP.
3
CA/TA ratio is higher than 50%
CL/TA ratio is less than 50%
5
CA/TA ratio is less than 50%
6
CL/TA ratio is higher than 50%
4
Accordingly the firms which are running with the conservative working capital practice can
improve the EVA of the firm. Hence, the firms that maximize internal performance measured
by the EVA, better to use low-level of short term funds to finance their permanent assets.
Additionally, the firms that follow AIP with CFP or CIP with AFP i.e. MWCMP can improve
firms’ MVA as well as EVA.
In the implementation of the above mentioned recommendations to the practice, managers
should be well aware of the current market trends which affect the WCMP and the firm
value. Results were derived from the data gathered for the sample period from 2005 to 2009.
The sample period, especially from 2005 to 2008, had high level of inflation, high interest
rates regime which resulted in high level of cost of capital. However, subsequent to the year
2008/09, i.e. after the war in Sir Lanka, macro economic factors have been changed to have
lower level of interest rate and lower level of cost of capital. Furthermore tax policy with in
the said research period also different from the current situation. Tax rates have been
tremendously decreased by 2011 budget. Furthermore, market competition is also immensely
increasing among the firms in the recent years. As a result, firms are tend to have more credit
periods, more short-term promotions and have to have fast service which directly affects
WCM. Technological development in the market also helps to manage inventory levels
efficiently and finally it provides facilities to have proper level of WCM. New Companies
Act No. 07 of 2007 was introduced in May, 2007 and laid down a new requirement on
distributions to shareholders, namely “solvency test”. One condition in the solvency test is to
have more CA than CL. It regularized the WCM and directly influenced the IP and FP of the
firm.
Therefore, all these macro economic and political variables should be considered in
the implementation of the above mentioned findings.
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