Advanced Research in Economic and Management Sciences (AREMS)
Volume 19, 2014
ISSN: 2322-2360
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The 2014 third Conference on Modern Management Sciences (CMMS 2014)
Aggressive Investment, Financing Policy of working capital with
profitability
Esmaeil amiri
Master Student of Accounting , Shahid Bahonar University of Kerman, Kerman.
Esmaeilamiri303@yahoo.com
Abstract- In this study, Investigate the relationship between Aggressive Investment Policy and
Aggressive Financing Policy of working capital with profitability of Tehran’s stock market were
analyzed. For this purpose statistical society includes 93 firms and also, 1 period of 5 years (20052009).with systematic elimination method were selected. The results indicate that there is no
relationship between(AFB) and (AIP). Also, there is no significant relationship between AIP
with ROA and ROE . Further analysis showed that is no significant relationship between AFP
with ROA and is no significant relationship AFP with ROE.
Keywords; Aggressive, Conservative, working capital, profitability.
1.Introduction
The definition of working capital in accounting literature is current assets minus current debts
and indicates the amount company's investment in cash, marketable securities, Commercial
receivable accounts, Inventories minus current debts. Some author, define working capital as the
sum of the current assets and current debts and expressed their differences as the net working
capital. In other words, net working capital represents that part of the current assets which is
more than the current debts and is protected through long-term loan and equities. Shabahang,
2008).
Today, working capital management which is the resource and current expenditures management
are significant for maximizing shareholders wealth as part of the financial management
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responsibility. Now, the financial management focuses at topics, such as the relationship
between risk and return and maximizing the return against risk. Since the financial management
has the significant impact on organizations improvement and performance and on function
enhancement and their profitability, investment and Financing decisions is the most important
financial decision of a company which is considered as the sub-category of working capital
management.(Nikoomaram et al, 2006)
There are various strategies for working capital which are obtained by modulating current assets
and current debts strategies. In working capital management, according to different conditions,
some appropriate strategies should be selected in order to handle effectively the current assets
and debts of a commercial unit, and the financial needs of the commercial unit provide
properly.As a result, the company shareholder return and the shareholders wealth would be
increased. The total strategies of working capital management would be categorized into three
categories: 1) conservative strategies 2) Aggressive strategies 3) moderate strategies. (Jhankhany
and Parsaeian, (2001), RaymondP(1986)).
2.Theoretical Foundations & Background
The growing importance of working capital in continuation of business unit has led to several
strategies considered for working capital management. Profit units are able to impact the
company liquidity by means of using different strategies with regard to working capital
management. Each of the various strategies has different risk and efficiency. Financial managers
of the companies with regard to conditions prevailing in the company as well as their personality
and individuality would select “daring” or risk strategy and/or “conservative” or risk aversion
strategy.
The liquidity of the company can be influenced by using different strategies in regard to working
capital management. The working capital managers are divided into two categories: conservative
and Aggressive. Conservative strategy in working capital management causes the increase of
liquidity strength excessively. In implementing conservative policies, the risk of the inability of
maturity debts refund has been tried to reach to the lowest level. In this strategy, the manager try
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to keep the large amount of the current assets (whose return rate is low). Hence, companies with
this kind of strategy have risk liquidity and less refund. . Aggressive strategy manager, with the
lowest current asset, try to take maximum advantage from current debts through daring strategy
and manage the company in this way. In implementing this strategy, the liquidity risk would
increase and the company which carries out this strategy often encounters such situation that
cannot pay the debt maturities. On the other hand, because the amount of current asset is at its
lowest level, the rate of the investment refund would be increased (of course, if the company is
not bankrupted). Companies that use risk strategy actually accept a high risk and their refund rate
is so high. Companies can apply various strategies in managing the current assets and debts.By
combining different strategies, a policy can be applied in order to optimize the working capital.
Current Assets Strategy
Having a strategy in managing the working capital requires determining and maintaining a
certain level of each of the current asset andtotal current assets.
Conservative Strategy (in current assets management)
In this kind of strategy, the company tries to keep the liquidity by maintaining the cash and
marketable securities.This is a very low risk strategy. Because having a relatively high liquidity
allows the company to provide the goods inventory sufficiently and sell on credit.
Risk Strategy (in working capital management)
The manager who uses risk strategy always tries to lessen the cash and marketable securities. If
the manager acts daringly, he will attempt to reduce the funds which are invested in products
inventory. A company which has the courage to decrease the cash and securities should accept
the risk of lack of timely payment of debt maturities. Such company may not be able to meet the
customers’ needs and it will run at a loss. For compensating this loss, the company tries to use
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financial resources in order to provide the fixed assets. This strategy means that, the rate of fixed
assets refund is much higher than the rate of cash and marketable securities efficiencies.
The conservative manager tries to lessen the rate of short-term loan in company’s capital
structure. He tries to use long-term loans with floating interest in order to provide current assets.
The manager who is so conservative attempts to use other financial resources (shareholders
capital) instead of taking out such loans. The structure of the company in which this policy is
applied almost consists of two types: debts and equity.
If a manager use risk policy, he tries to maximize the level of short-term loans and supplies the
current assets from these loans. This policy does not mean that the company never uses the longterm loan. Because the fixed assets can be used from long-term loans. (Jhankhany and Parsaeian,
(2001), RaymondP(1986)).
Working capital is a vital part of business investment which is essential for continuous business
operations. It is required by a firm to maintain its liquidity, solvency and profitability
(Pirashanthini et al,2013).
Working capital management is an essential part of the short-term finance of a firm. With an
efficient working capital management, a firm can release capital for more strategic objectives,
reduce the financial costs, and improve profitability. (Taghizadeh et al,2012) studies the
relationship of working capital management on performance of firms Listed in Tehran Stock
Exchange (TSE). Average Collection Period, Inventory Turnover in days, Average Payment
Period, Cash Conversion Cycle, and Net Trading Cycle were used to assess working capital
management, and Net Operating Profitability was used to assess firms' performance.. The results
showed that the increase in Collection Period, Payment Period, and Net Trading will lead
towards the reduction of profitability in the firm. In other words, managers can increase the
profitability of their firms reasonably, by reducing Collection Period, Inventory Turnover, and
Payment Period.
Mohamadi (2009), In study examines the the effect of working capital management on
profitability. The variable used as the profitability measure of companies was the ratio of gross
profit on total assets. Variables used for the measures of capital investment, were Receivables
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Collection Period, inventories turnover, creditors deposit period, and convert cycle of cash fund.
Variables, which were used as control variables, were company size, sale growth, ratio of
financial assets on total assets and financial liabilities to total assets. The result of this research
stated that there is negative relation between companies’ profitability and, and convert cycle of
cash fund. In the other words, managers can increase their companies’ profitability by logical
decreasing Receivables Collection Period, and inventories turnover. The results of this research
relating to creditors deposit period states that he more profitable is the company the less is the
creditor’s cycle.
Malekiniya,(2012). the reviews onthe relationship between working capital policy and
profitability of companies in automobile, pharmaceutical and mineral industries in Tehran Stock
Exchange. The results of this study indicate that there is no direct and significant relationship
between working capital management strategies with earning per share and return on equity, but
there is a direct and significant relation between working capital management strategies and
return on investment but not very strong correlation, and only 6% of the variation in the return on
investment can be justified by the variation in the working capital management strategies.
Zohdi(2011),The reason that most bankruptcy corporations’ does not succeed is the unfavorable
status and improper management of working capital. These corporations have good financial
status in the long run, but because of incompetent working capital, are not able to compete with
other corporations’ and they expelled. Profit units are able to affect corporations’ rate of cash by
applying various policies in relation to working capital management. These strategies can affect
rate of risk and their return. Studied the affect of policies of corporations’ working capital over
the rare of Companies risk. The results of this research reveal that, there is a significant and
positive relationship between the policies of working capital and corporations’ risk. Other
findings of the research show that there is a significant and positive relationship between
corporations’ size and risk.
(Ding et al,2013), with use a panel of over 116,000 Chinese firms over the period 2000–2007 to
analyze the extent to which firms owned by differentagents are able to use working capital to
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mitigate the effects of financing constraints on their fixed capital investment. These findings
indicate that, in the presence of fluctuations in cash flow, firms tend to adjust both their fixed
and working capital investment. Yet, when we differentiate firms into those with a relatively
high and a relatively low working capital to fixed capital ratio, and in the presence of cash flow
shocks, it is only those firms with a high ratio that are able to adjust their working capital
investment. Furthermore, for all but foreign firms, the sensitivity of fixed capital investment to
cash flow is much lower for those firms with high working capital: these may therefore use their
working capital to alleviate the effects of cash flow shocks on their fixed capital investment.To
fully take into account the.
Bei & Wijewardana (2012) to investigates working capital policy (WCP) practices in Sri Lankan
context. For this aim Sample of this investigation consist 155 companies listed in Colombo Stock
Exchange (CSC) from 2002 -2006. The study finding explore the impact of different types of
working capital policy practises are differently affect the firm liquidity, efficiency, profitability
and capacity usage
Nazir & Afza (2007), ) to investigates the traditional relationship between working capital
management policies and a firm’sprofitability. Using the panel data set for the period 1998-2005,
the impact of aggressive working capital investment and financing policies has been evaluated
using return on assets as well as Tobin’s q. The study finds a negative relationship between the
profitability measures of firms and degree of aggressiveness of working capital investment and
financing policies. Theseresults were further validated by examining the impact of aggressive
working capital policieson market measures of profitability, which was not tested before. The
results of Tobin’s q werein line of the accounting measures of profitability and produced almost
similar results for working capital investment policy.
Liquid assets management decisions are very complex. On the one hand, when too much money
is tied up in working capital, the business face higher costs of managing liquid assets with
additional high alternative costs. On the other hand, the higher liquidity assets policy could help
enlarge income from sales. (Michalski 2008).
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ALShubiri (2011), to investigates the Effect of Working Capital Practices on Risk Management
The sample includes 59 industrial firms and 14 banks listed on the Amman Stock Exchange for
the period of 2004-2008. The results indicate a negative relationship between profitability
measures and working capital aggressiveness, investment and financing policy. Firms have
negative returns if they follow an aggressive working capital policy. In general, there is no
statistically significant relationship between the level of current assets and current liabilities on
operating and financial risk in industrial firms. There is some statistically significant evidence to
indicate a relationship between standard deviation of return on investments and working capital
practices in banks.
Pirashanthini et al,(2013), to investigates the relationship between the aggressive working capital
policies and profitability and to identify the impact of working capital policies on profitability
with the samples of twenty Manufacturing companies listed under Colombo stock exchange
(CSE) in Sri Lanka The study found that there is no relationship between the profitability
measures of firms and working capital investment and financing policies. Further, the working
capital aggressive investment and financing policies have no impact on profitability measures of
ROA and ROE.
3.Research Hypotheses:
H1: There is a significant relationship between the Aggressive Investment Policy (of working
capital and profitability.
H2: There is a significant relationship between the Aggressive Financing Policy of working
capital and profitability
H3: There is a significant relationship between Aggressive investment Policy and aggressive
Financing Policy.
4.Measuring the research variables
in this study Variables consists of three sections:
Dependent variable= to calculate the Profitability ratios measure Has been used (ROA) and
(ROE).
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Independent variables=in this research and based on the researches by Afza and Sajid Nazir
(2008) To calculate Aggressive Investment Policy and Aggressive Investment Policy As have
been considered independent variables.
Controlling variables: Variables of firm size, sales growth, asset growth is considered as a control
variable.
Table 1: Calculation of dependent and independent variables
Variable
Symbol
Explanation
Aggressive Investment Policy
AIP
(Total Current Assets)/(Total Assets)
Aggressive Investment Policy
Return on Assets
Return on Equity
Size
Sales growth
AFP
ROA
ROE
Size
SG
(Total Current Liabilities)/(Total Assets)
Net Income / Assets
Net Income/ Equity
ln sale
(current year sales -last year sales)
/ last year sales
5.Methodology:
This study is of applied type as far as goal is concerned and the research method is experimental.
The literature about the research was collected from the theoretical topics of library resources,
scientific databases and local and international papers. In order to assess and analyze the data,
regression method was used. In order to analyze data, EViews software was applied.
6.Sample & Data
The statistical society of this study was selected among the admitted companies to Tehran Stock
Exchange following systematic elimination of banks and insurance companies and financial
mediation and eventually about 93 companies were selected in the cycle of 2005-2009. They had
to possess the following characteristics:
1) The fiscal year of the company had to end on 20 March.
2) The companies should not have had financial changes from 2005 -2009.
3) The companies should have been admitted to Tehran Stock Exchange by the end of fiscal year
2009.
4) The desired data of the research should be available to calculate the test of hypotheses.
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5) They should not have had a stop of transactions for more than 6 months during the study
cycle.
7.Methodology
To test hypotheses 1 and 2, the relationship between profitability and Aggressive Investment
Policy, Aggressive Financing Policy, is used following pattern.
ROA=α+β1 AIP+ β2 Size+β3 SG +ε
Model(1)
ROE =α+β1 AIP+ β2 Size+β3 SG +ε
Model(2)
ROA=α+β1 AFP+ β2 Size+β3 SG +ε
Model(3)
ROE =α+β1 AFP+ β2 Size+β3 SG +ε
Model(4)
The following model is estimated to test hypotheses 3
H0:β1=β2
Model(5)
…….y=α+β1x
H1:β1≠β2
8. Analysis hypotheses
Variables
Mean
Table (2). Descriptive Statistics
Median
Minimum
Maximum
Standard Deviation
ROA
0.333827
0.330128
0.111647
0.566351
0.132857
ROE
0.118991
0.122487
0.061065
0.155393
0.030331
AIP
0.5344
0.53408
0.49365
0.57982
0.0277
AFP
0.624752
0.623179
0.612289
0.643956
0.009678
Size
5.538787
5.546905
5.42491
5.611312
0.062639
SG
2.047422
1.937001
1.545595
3.043925
0.476472
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Table (3). Model(1)
Variables
β0
AIP
SIZE
SG
D.W
Coefficient
16.767
-0.96446
2.69775
33.437
2.28
t-Statistic
1.101816
-0.29299
1.28273
0.42257
Prob.
0.0092
0.8186
0.0000
0.0055
Table (4). Model(2)
Variables
β0
AIP
SIZE
SG
D.W
Coefficient
3.321776
-0.489465
0.51963
2.16378
2.28
t-Statistic
1.134603
-0.772869
1.284233
0.142135
Prob.
0.0099
0.5811
.0000
.0000
Table (5). Model(3)
Variables
β0
AFP
SIZE
SG
(F)
Adj.R
D.W
Coefficient
14.8559
-11.1647
-1.17901
-34.8457
0.039286
0.99
1.72
t-Statistic
22.88813
-13.5753
-9.42109
-8.78221
Prob.
0.0278
0.0468
0.0073
0.0022
Table (6). Model(4)
Variables
Coefficient
t-Statistic
Prob.
β0
1.833145
3.014359
0.2039
AFP
-2.49603
-3.23919
SIZE
-0.04238
-0.36144
0.1906
.0000
SG
2.741551
1.72
0.73746
.0000
D.W
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Table (7). Model(5)
Variables
Coefficient
t-Statistic
Prob.
β0
0.616976
5.729698
0.0106
AIP
0.014551
0.072332
0.9469
(F)
0.005232
D.W
1.52
9.Findings
For the analysis was tested the first hypothesis models 1 and 2. In model (1) The results show
that, is no significant relationship between Aggressive Investment Policy (of working capital) and
profitability (ROA). that the amount of obtained statistics for AIP is more than 5%. Also, the statistics
obtained for the size and sales growth of is less than 5%, This means ,there is a significant relationship
between with profitability, And the 95% confidence level there is not significant relationship between
Aggressive Investment Policy (of working capital) and profitability (ROA).In model (1). In
model 2 was tested the relation between Aggressive Investment Policy (of (working capital) and
ROE . The results show that, is no significant relationship between Aggressive Investment Policy
(of working capital) and profitability (ROE).
To test hypotheses 3, model 4 and 4 are used. In Model 3 the results show, there is a significant
relationship between Aggressive Financing Policy of working capital and profitability (ROA).
amount of obtained statistics for AFP is less than 5%. And between company size and growth sales
with profitability (ROA), is a positive a significant relationship.
In Model 4, is no significant relationship between Aggressive Financing Policy (of working capital)
and profitability (ROE). But, And between company size and growth sales with profitability
(ROE), is a positive a significant relationship.That amount of obtained statistics for AFP is less
than 5%.
To test the third hypothesis is that the relationship between Aggressive Investment Policy and
Aggressive Financing Policy ,the Model 5 is used. The results indicate that there is no
relationship between(AFB) and (AIP). that the amount of obtained statistics for Aggressive
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Investment Policy of more than 5%. and obtained amount for Durbin-Watson statistic 1.52, is
between 2.5 to 1.5, which indicate that there is no auto-correlation between each of the
hypotheses.
10.Conclusions
The working capital managers are divided into two categories: conservative and Aggressive.
Conservative strategy in working capital management causes the increase of liquidity strength
excessively. In implementing conservative policies, the risk of the inability of maturity debts
refund has been tried to reach to the lowest level. Aggressive strategy manager, with the lowest
current asset, try to take maximum advantage from current debts through daring strategy and
manage the company in this way. In this study, Investigate the relationship between Aggressive
Investment Policy , Aggressive Financing Policy and profitability of Tehran’s stock market were
analyzed. For this purpose statistical society includes 93 firms and also, 1 period of 6 years (20042008).with systematic elimination method were selected. The results indicate that there is no
relationship between(AFB) and (AIP). Also, there is no significant relationship between AIP
with ROA and ROE . Further analysis showed that is no significant relationship between AFP
with ROA and no significant relationship AFP with ROE.
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