The Impact of the Crisis on Net Working Capital and Quick Ratio at Top Czech Enterprises

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The Impact of the Crisis on Net Working Capital and Quick Ratio at

Top Czech Enterprises

MAREK HABRNAL Department of Business Economy Faculty of Business Administration University of Economics in Prague

W. Churchilla 4, Prague 3, 136 27 CZECH REPUBLIC [email protected]

Abstract: - This article deals with the results of statistical analysis of liquidity and working capital of the largest Czech companies for the years 2006 up to 2010. The companies were selected according to the Czech Top 100 ranking for the year 2011 (the 100 largest non-financial companies by the total annual sales). The aim is to determine to what extent profitability results worsened during the peak of the economic crisis in the largest companies in comparison with average values for all non-financial companies in the country. At the same time, the development of variability of selected indicators was evaluated.

Key-Words: economic recession, business performance, liquidity ratio, working capital

1 Introduction

The crisis began in 2007 as a financial crisis and naturally grew into an economic one. Reduced availability of capital has reduced demand from vendors (Scholleová, 2012).

In times of economic recession corporate results mostly worsened (CZSO, 2012). This should be reflected also in the deterioration of indicators’ values. The subject of verification is the hypothesis that simultaneously with the decline of values and propensity for risk reduction, the reduction of the ratios variability occurred in companies. The second hypothesis is that the biggest analyzed Czech companies dealt better with the economic development during the years 2006 to 2010 than "average company" in the economy.

Some authors suggest that Czech companies with inefficient financing strategy and with redundant working capital were affected relatively little in the field of working capital. (Scholleová, 2012)

Object of the study are all enterprises which were included in the ranking of the largest Czech Top 100 (Czech Top 100, 2012) in 2011. Of the potential maximum of 100 firms, we eventually managed to obtain usable data for the years 2006 to 2010 for 49 enterprises (Ministry of Justice, 2012). Analyses of the Ministry of Industry and Trade (Ministry of Industry and Trade, 2011) will be then used for the comparison with the "average firm”.

2 Problem Formulation

We have chosen several ratio indicators of financial analysis which evaluate key aspects of financial health of the company. In this article, we will focus on the indicator of quick ratio and the net working capital relative to total sales.

Every company needs a certain capital for performing an activity. Its absolute amount depends on the branch of the activity and on the way how the activity is conducted and the size of the company, of course. Firms use borrowed capital for various reasons, especially in financing operations activities (Habrnal, Scholleová, 2012).

The volume of short-term debt sources used for operation financing as well as the volume of receivables and financial assets depend on the scope of activities of the company (Kislingerová, 2007). And the scope of activities is also reflected in the size of company sales.

The relation among components of working capital, including short term liabilities and short term loans, and the sales can differ among enterprises mutually, nevertheless it should be stable within the company. (Mařík, 2007)

2.1 Quick Ratio

From the category of liquidity indicators was chosen the Quick ratio1, because the values of the indicator

1_{Also known as the "acid-test ratio" or the "quick assets ratio"} (Investopedia.com)

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are not influenced by invetories (Synek, 2011). Inventories respond to business cycle even though with delay. Fluctuation of invetories is also very influenced by various factors independent on macroeconomic situation (production structure, models of supply control, expectations, ...) therefore these factors were excluded from the analysis of liquidity.

And expectations in particular were also of special relevance to production and inventory planning, of Czech enterprises.

“Throughout the observation period, firms are retaining light optimism or conservatism because sales decrease is more dynamic than production decrease where more companies tend to produce more than is eventually sold.” (Scholleová, 2012, ) (1) Quick Ratio = (Current Assets - Inventories) / (Short Term Loans + Short Term Liabilities)

2.2 Ratio of Net Working Capital to Sales

Indicator is chosen in order to asses whether the crisis had an impact also on working capital of the companies or more precisely ratio of working capital to sales. Deteriorated economic situation may have caused:

a) Growth of debts due to customers’ lowered ability to repay,

b) Decrease inshort-term financial asset due to declining profit margin and problems with cash flow in general,

c) Growth of short-term debt sources due to the increased will to pay later,

d) Decrease in short-term debt sources due to declined availability of these sources, e) Change of total company sales.

Therefore, it is hard to estimate in advance, which influences will prevail and how, if the ratio eventually grew or decreased.

(2) NWC = Current Assets - Short Term Loans - Short Term Liabilities

The absolute amount of working capital is intercompany incomparable figure, so we will follow the ratio of NWC to sales.

(3) NWC/Sales ratio = NWC / Sales

In net working capital, invetories is also taken into consideration contrary to quick ration.

3 Problem Solution

To evaluate the results we accept the simplifying assumption that 2007 was the peak of the economic

cycle, the year 2008 was a kind of a turning point and 2009 the peak of the crisis (see Figure 1). In 2010 there was a slight recovery.

Fig.1: GDP in the years of economic recession

Source: Czech Statistical Organization, 2012

If the text speaks of average top enterprises, this means the businesses coming under the Czech Top 100 with value of the indicator between 25 and 75 percentile. If the text speaks of average enterprise, we mean a fictitious company with ratios corresponding to the average of all firms according to MIT.

3.1 NWC / Sales Analysis

In the worst crisis year 2009, the ratio of net working capital to sales slightly decreased.

Overall, we can say that the development of the ratio NWC/Sales was during the whole monitoring period stable between 12,1 a 13,2 %. (see Table 1). Let’s add now the findings of Scholleová which revealed for Czech enterprises stable ratio of net working capital and total assets of 13 to 14 % in years 2009 and 2010.

Much more interesting change was in standard deviation and the range among the top average enterprises.

That may have several reasons, for example:

• some enterprises, obviously, due to perceived risk accumulated working capital and thus increased the ratio to sales.

• Suppliers refused to provide enterprises with supply loan and thus it would lead to increase in ratio NWC / Sales again, nevertheless considering the market position of these companies it is not too probable.

• Enterprises as such stopped providing supply loans and thus decreased the volume of debts.

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Fig. 2: Median, 25th and 75th Percentil, Range

Source: own processing

• Weaker firms lost significant part of liquid assets which was caused by their effort to preserve operation or they had big problems with repayments and thus decreased the ratio of working capital to sales.

According to data of Czech Statistical Office (CZSO, 2012), during the crisis years, the participation of short-term bank loans in the financing of companies significantly decreased. The volume of short-term and middle-term bank loans to nonfinancial firms since 2008 rapidly descended (CNB, 2012).

Fig. 3: Short and Middle Term Bank Loans

Source: Czech National Bank, 2012

Table 1: Variability Characteristics and Mean

Year 2006 2007 2008 2009 2010 Standard deviation (%) 13,6 13,4 15,8 21,0 21,2 Coefficient of variation2 (%) 107,3 101,2 130,1 173,2 162,3 Range (%) 62,0 58,7 79,4 117,3 130,2 2

Coefficient of variation = Standard deviation / Mean

Range between 25th and 75th Percentil (%)

18,9 18,5 18,6 24,6 19,4

Mean (%) 12,7 13,2 12,2 12,1 13,1

On average, Net Working Capital of firms decreases during the crisis and there was no chance to escape from this situation. Certain optimization of financial assets and inventories has already occurred in the early stages of the crisis, short-term loans from banking sector are still difficult to access, and there is no other option than to rely on supplier credits. (Scholleová, 2012)

Nevertheless, the average ratio NWC / Sales in the top Czech companies did not change too. However, the standard deviation and the range among average top enterprises increased.

Fig. 4: Variability Characteristics and Mean

For working capital similarly to liquidity, it holds that optimal value does not lie as high or as low as possible but it is necessary to look for it specifically for each firm. It means that we cannot say whether the indicator has worsened; nevertheless the expectation of decline of variability at this indicator was not confirmed.

The area of working capital is subject of short-term management as well as long term strategy decisions. It offered higher reaction speed, and various companies were likely to use different approaches. Some might admit receivables growth and maintain the amount of working capital, others could reduce the amount of working capital due to certain cost-cutting actions.

According to reseach of University of Economics in Prague (Kislingerová, 2009a, 2009b, 2010) in 2010 38 % of companies admitted problems in obtaining finance for operating activities, and 74 % of the companies during the crisis reduced costs.

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3.2 Quick Ratio Analysis

Since liquidity is relative expression of working capital, we can expect similar results. Quick ratio only eliminates the influence of inventories and thus better reflects the ability of the enterprise in receiving of receivables and paying of payables. After the outbreak of the crisis, many companies have found reserves in working capital, which was often excessive before the crisis. 35 % of companies had liquidity, measured by quick ratio, above 2,2 (Scholleová, 2012).

Fig. 5: Median, 25th and 75th Percentil, Range

Median of quick ratio showed a slight downward trend throughout the period from 2006 up to 2010. But this is not the case of average, which turned to growth already in 2009 (see Fig. 6)

Table 2: Variability Characteristics and Mean

Year 2006 2007 2008 2009 2010 Standard deviation 0,65 0,66 0,78 0,96 0,98 Coefficient of variation (%) 57,8 59,7 71,3 86,5 85,3 Range 3,70 3,96 4,45 5,61 5,71 Range between 25th and 75th Percentil 0,57 0,55 0,67 0,53 0,63 Mean 1,12 1,10 1,10 1,11 1,15

As in the case of the NWC / Sales ratio grew standard deviation of quick ratio. An interesting difference between the two indicators occurred in 2009, when the range of quick ratio for the average top enterprises experienced a minimum, whereas the range of NWC / Sales was at its maximum.

It follows that the average top enterprises in the management of working capital in times of crisis

rather differentiate from each other by the relationship between sales and working capital, but not by the relationship among active and passive components of net working capital. The "average" representative of the Czech Top 100 does not differ from its rivals dramatically in terms of difference between receivables and payables turnover time. Fig. 6: Variability Characteristics and Mean

Before the crisis, 51% of Czech companies use overdraft to cover short-term fluctuations in cash flow (Scholleová, 2012). When a company use overdraft coverage of delay in collecting receivables, the amount of net working capital remain almost the same, on the other hand liquidity ratios usually change.

3.3 Comparison with Average Values of All

Companies

For comparative benchmark we used aggregated data from Ministry of Industry and Trade. Due to the specifics of the methodology was only possible to compare annual changes.

Table 3: NWC / Sales, Quick Ratio, Year-to-Year Changes

Year 2007 2008 2009 2010

TOP: NWC/Sales -11,5 % 4,6 % 52,9 % 1,4 % Avg: NWC/Sales 3,8 % -8,0 % -0,3 % 7,8 % TOP: Quick Ratio -5,7 % 7,3 % 8,2 % 1,5 % Avg: Quick Ratio -1,7 % -0,6 % 1,1 % 3,9 %

It seems that average Czech companies were in terms of working capital and liquidity affected by the crisis more that Czech top companies.

4 Conclusion

The findings of the net working capital and liquidity may be surprising. Although it is impossible to assess whether the slight changes were desirable or

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undesirable direction, increase in variability suggests that in times of crisis there are major differences in working capital management. Overall, negative change does not occur among the Czech top companies.

Comparing the two indicators we have come to believe that the fluctuations among top enterprises closer to median values of the indicators were caused by the development of sales in relation to the net working capital than the relationship of individual items of net working capital.

The crisis has significantly affected the area of working capital. In the first stage of the crisis firms dealt with a rapid response in the operative field Including the production, sale and financing of working capital (Scholleová, 2012).

Later, some of the measures in the area of working capital led only to inflate assets and liabilities. This corresponds with the above findings that differences in the relationship between components of Net Working Capital at top Czech companies were not significant.

The analysis of sample of the biggest Czech companies did not prove a significant change in quick ratio or NWC / Sales ratio throughout the crisis. However, the results showed interesting inter-company differences between Czech top companies. Various companies have opted to respond to the crisis by various measures, which increased inter-company variability of analyzed indicators quick ratio and NWC / Sales ratio.

In the future, we cannot expect a significant improvement. “Professional community and its predictions are definitely not optimistic and residents and businesses cannot expect a period of growth for another so-called post-crisis period, but rather a period of stagnation and decline.” (Scholleová, 2012)

An overall analysis also showed that evaluate companies according to size of sales is tricky. Companies included in the acquired data file are perhaps the largest, but not the best viewed in the evaluation by owners through economic added value. To evaluate actual top companies in the Czech Republic it would be preferable to compile rankings based on economic value added, not just sales.

This article is one of the outputs of the project Analýza uplatňování controllingových nástrojů a vyhodnocení rozdílů v přístupu ke controllingu v době krize a v postkrizovém řízení (Analysis of the

use of controlling tools and the evaluation of different controlling approaches in crisis and after crisis) registered at the University of Economics in Prague under number IGA F3/26/2012.

References:

Books

[1] Brealey, R.A., Myers, S. C., Allen, F., Principle of corporate finance. Mc Graw-Hill/Irvin, New York, 2011.

[2] Kislingerová, E., Hnilica, J., Finanční analýza: krok za krokem. C.H. Beck, Praha, 2008. [3] Kislingerová, E, Manažerské finance, C.H.

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[5] Řezanková, H., Analýza dat z dotazníkových šetření, Professional Publishing, Praha, 2011 [6] Synek, M., Kopkaně, H., Kubálková, M,

Manažerské výpočty a ekonomická analýza. C.H. Beck, Praha, 2009.

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[7] SCHOLLEOVÁ, Hana. The Economic Crisis and Working Capital Management of Companies. Theoretical and Applied Economics [online], 2012, roč. XIX, č. 4(569),

pp. 79–92. ISSN 1844-0029. URL:

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[8] SCHOLLEOVÁ, Hana. České firmy na rozcestí. Hradec Králové 31.01.2012 – 01.02.2012. In: JEDLIČKA, Pavel (ed.). Mezinárodní vědecká konference Hradecké ekonomické dny 2012. Hradec Králové : Gaudeamus, 2012, s. 247–251. ISBN 978-80-7435-171-6.

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[10]Czech Statistical Organization. 2012. Available online 15. 10. 2012 at http://www.czso.cz [11]Czech Top 100. 2012. Available online 15. 10.

2012 at http://www.czechtop100.cz

[12]Ministry of Industry and Trade. 2012. Available online 16. 10. 2012 at http://www.mpo.cz

[13]Ministry of Justice CR. 2012. Available online 10. 10. 2012 at http://portal.justice.cz

[14]Czech National Bank, 2012. Time series system ARAD. Available online 25. 10. 2012 at http://www.cnb.cz

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