Are Working Capital Components and Strategies Significantly Related to Profitability? An Examination of Public Listed Conglomerates in Trinidad and Tobago: 2006 -‐ 2010
Ingrid Andrews1
Abstract
An exploratory study was conducted to determine the relationship between working capital components, working capital management strategies and profitability among two public listed conglomerates in Trinidad and Tobago. Although research on the topic has been done in other countries, no such published research has been done in this country. The independent
variables were inventory turnover period (ITP), average collection period (ACP), average
payment period (APP), and cash conversion Cycle (CCC), working capital ratio (WCR) which was used as a proxy for working capital management strategy or policy. The dependent variable was profitability (P). Data was collected from a purposive sample of secondary, five year annually audited reports of these non-‐financial public listed companies. Two levels of statistics were used to analyse the data. The first was ratio and t-‐tests; followed by the Pearson’s r to determine the correlation between these two sets of variables. Results showed that when the companies were analysed separately the variables showed mixed, and in one case, no level of association. However when analysed jointly, the results showed strong positive associations between all the individual working capital components and profitability, except for average receivables collection period, where there was a statistically weak correlation. Overall, the findings showed a strong negative and significant correlation between working capital management and profitability.
Keywords: Working Capital, Profitability, Conglomerates, Average Collection Period, Inventory Turnover Period, Average Payment Period, Aggressive Working Capital Management Strategy, Conservative Working Capital Management Strategy.
______________________________________________________________________________________________________________________________________ 1Ingrid Andrews graduated from USC in 2013 with the MBA degree. This paper is based on her Thesis.
Introduction
Increased profitability is one of the primary goals of financial managers. Without an
acceptable level of profitability, businesses will find it very difficult, if not impossible, to survive in the long run. Managers are therefore continuously adopting and adapting strategies to improve profitability. A number of studies (Deloof, 2003; Elijelly, 2004; Raheman Nasrim 2007) have supported the above observation. They concluded that effective and efficient
management of an entity’s working capital components was imperative, not only for the sake of maintaining an adequate liquidity position, but also because of the significant implications that this has for the organisation’s profitability, company valuation and shareholders’ value, and ultimately its survivability.
In terms of managing working capital specifically, studies conducted largely in the more
developed and/ or older economies like Belgium, Greece, Pakistan, Spain and India have shown significant relationship between management of working capital and profitability (Deloof, 2003; Lazaridis & Tryfonidis, 2006;Raheman & Nasr, 2007; Garcia-‐Teruel & Martinez-‐Solana, 2007). Notwithstanding the importance of WC management and its effect on profitability (DeLoof, 2003); and its potential for an entity to gain a competitive advantage (Mullins, 2009); no
empirical study has been conducted in Trinidad and Tobago among the three (3) conglomerates nor the sixteen (16) non-‐financial and non-‐banking corporations listed on the Trinidad and Tobago Stock Exchange (TTSE).
Study Objectives
The aim of this study was to examine if individual Working Capital components were
significantly related to profitability among public conglomerates in Trinidad; and to determine if working Capital Management Strategies (Aggressive or Conservative) were significantly related to profitability among these selected companies.
Research Questions and Hypotheses
A number of research questions guided this study. One explored the value of individual WC components of these public conglomerates over the period 2006 – 2010. Another described the types of WC management policy strategies adopted by these conglomerates (Aggressive vs Conservative). The third looked at profitability of the conglomerates; whereas the last
question analysed the relationships between individual WC components, and WC management strategies and profitability.
In addressing the above objectives and research questions two hypotheses were tested. These were:
H1: There is a statistically significant correlation between working capital components and profitability.
H2. There exists a statistically significant correlation between working capital management strategy and profitability.
Literature Review Theory
The main theory which applied to this study was the Working Capital Theory. Working Capital (WC) is a measure of a company’s efficiency and short term financial health. It gives an indication of a company’s ability to finance its short term operating activities from its short term assets. There are three related concepts: Gross Working Capital which comprises of an entity’s total current assets; Net Working Capital, which is its total current assets minus total current liabilities and Operational Working Capital which is a narrower concept that leaves out financial items and concentrates on process or operational related items. . It will therefore be defined as including only Inventories, Accounts Receivable and Accounts Payable.
The amount of profit calculated and the cash/ liquidity accumulated will largely be due to the management of its current assets (which constitute a large part of WC of a business).
Theoretically, net working capital (in this case operational working capital) should ideally have a negative correlation with profitability so that as operational working capital increases
profitability decreases, and vice versa.
Finance theory states that managers should seek to reduce net working capital (and operational working capital) to an optimal level such that financial operations of the firm do not suffer. In so doing, management may adopt an aggressive investment policy strategy which will result in a low level of current assets relative to total assets; or financing policies which result in a high level of current liabilities relative to total assets. The idea here is to collect payments on time
thus leaving little or no debtors’ balances. The creditors are also paid as late as possible allowing the company to use very little of its own funds; both policies allowing the firm to maximise the amount of cash it has with no additional costs of so doing.
A conservative strategy is the converse of the aggressive policy approach; while a moderate strategy approach adopts a middle-‐road policy position.
Studies
A review of studies, over a ten year period, related to profitability and a variety of independent variables have yielded mixed results. DeLoof (2003) completed a five year study that involved a sample of 1009 Belgian firms. Results showed that all the independent variables studied (namely: ACP, ITP, APP and CCC) had a negative correlation with profitability. These findings were interpreted to mean that less profitable firms adopted “aggressive” policies as they took longer to pay off creditors; and that more profitable firms with shorter ACP, were able to take advantage of suppliers’ discounts and thus were able to have higher sales growth and
profitability. He, however, cautioned that the converse was not always true for such firms. Using variables similar to Deloof, while adding others such as fixed financial assets, sales and debt ratios Lazaridis and Tryfondis (2006), examined 131 firms from the Athens Stock Exchange. Their conclusion was that while a negative relationship existed between CCC, ACP ITP, Debt Ratio and P there was a positive relationship between APP and P.
Garcia-‐Teruel and Martinez-‐Solano (2007), investigation of 8800 Spanish SMEs showed results which were consistent with those of Deloof as all their independent variables (ACP, ITP, APP
and CCC) were negatively correlated to P. On the other hand, in investigating 94 Pakistani firms, Raheman and Nasr (2007) showed results that differed from those of Deloof; and Lazaridis and Tryfondis. By scaling up to Pearson’s correlation and regression analysis these researchers found that all WC components (except ACP and CCC), liquidity and debt had negative correlations to P. ACP, CCC and the size of the firm had positive correlations. An analysis of 349 telecommunication equipment firms by Ganesan (2007) yielded mixed results. When P was measured as income to total sales he found negative correlations; but found there were no relationships when P was measured as income to total assets. He further asserted that in this industry CCC tended to be poorly managed and therefore had little effect on profitability. They further suggested that ACP should be shortened to improve P.
A bibliometric study done by Viskarri S., Lukkari E. and Karri T. (2011) showed that research done by Amir Shah and S.M.Sana (2006); and by Dong and Su (2010) agreed with Deloof and others with regard to the negative correlation of CCC and profitability. Yet Shah and Sana also disagreed with them as they found a negative relationship between APP and Profitability. The impact of policies was investigated by Asfar and Nazir (2007). They explored the effect of aggressive and conservative WC policies on P among listed companies on the Karachi Stock Exchange. Using Tobin’s q and regression analysis they found a negative relationship between the degree of aggressiveness and profitability; and that managers should be able to create value if they adopt a conservative approach towards working capital investment and working capital financing policies.
Methodology
Overview: The research objectives, questions and hypotheses were addressed by studying two
conglomerates from among public listed companies in the non-‐financial sector of the Trinidad and Tobago Stock Exchange (TTSE). These businesses were Neal and Massy Holdings Limited (N&M) and ANSA McAL Group of Companies (ANSA). They represent 67% of conglomerates; and 13% of the total non-‐financial and non-‐banking sectors in the Trinidad and Tobago
economy. Even though these companies experienced different beginnings and their operating activities and outcomes were somewhat diverse in nature, they both recognised the need for efficient and ‘tight’ management of working capital. The study focused on the financial operations of public limited liability companies (also referred to as public listed companies) in order to explain the relationships between specified research variables. It was executed through an exploratory, quantitative process. This approach guided the collection and analysis of empirical data and logical conclusions.
Study Variables: The research variables comprised of independent variables; namely Accounts
Receivable Collection Period (ACP), Inventory Turnover Period (ITP), Accounts Payable Payment Period (APP), Cash Conversion Cycle (CCC) and the Working Capital Ratios (WCR). The
dependent variable was Profitability (P).
Population and Sample: The population consisted of all public companies which were listed on
the Trinidad and Tobago Stock Exchange (TTSE) between 2006 and 2010. There were thirty-‐six (36) listed companies which the TTSE stratified into ten (10) categories. These were further grouped as financial, quasi-‐financial and non-‐financial. In order to arrive at an appropriate
sample that was suitable for this type of study only the non-‐financial categories were
considered. To be eligible for inclusion, It was felt that this category (of Conglomerates) would be best suited, given that the success or failure of these companies would have the greatest far reaching impact on the wider economy and on individuals than any of the other groups. There were three (3) conglomerates in this category, namely: Neal & Massy Holdings Ltd., ANSA McAL Group and Grace Kennedy Ltd. Grace Kennedy Ltd was not included for the following reasons: it is a Jamaica based conglomerate whose financial information is quoted in Jamaica dollars. Conversion to TT dollars would therefore have been necessary. The conversion rates for the years researched were not readily available. In addition, the financial reports for the same years were not all available at the time this study was conducted. Thus, based on the inclusion criteria, the sample size was therefore two (2) conglomerates.
Data Collection: The study covered a period of five (5) years of financial data. It thus meant
that there could only be a maximum of ten (10) data values. The data collected were secondary financial records. They were aggregate numeric-‐ratio data, which allowed for easy calculations of differences and comparisons among the data values. The data were obtained from
companies’ annual audited financial reports between 2006 and 2010 which were all publicly available documents. The relevant financial data collected were the Consolidated Statements of Financial Position (Balance Sheet) and the Consolidated Statements of Comprehensive Income (Income Statement).
Data Analysis: Microsoft Excel software was used initially to produce working capital and profitability ratios from the financial data, obtained from the financial reports of the two conglomerates. These ratios included the Inventory Turnover Period (ITP), Average Receivable Collection Period (ACP), Average
Payment Period (APP), Cash Conversion Cycle (CCC), Working Capital Ratio (WCR) and Profitability (P). For further analysis of these ratios, consistent with the positivist philosophy -‐ Microsoft Excel and SPSS software were utilized. These produced exploratory information, as well as bivariate descriptive and inferential statistical analyses.
Results
Frequency Statistics: Table 1 displays the frequency distribution of individual variables for the two conglomerates. These variables were Inventory Turnover (Days); Average Collection Period (Days), Average Payment Period (Days) Cash Conversion Cycle (Days), Profit for the year ($), and Working Capital Ratio (Policy) covering the five year period.
Table 1: Summary of data values of Working Capital Components and Profitability (two decimal points)
Source: Prepared by the Researcher from data from annual financial reports (2006-‐2010). 2006 2007 2008 2009 2010 NEAL & MASSY HOLDINGS ANSA MCAL GROUP NEAL & MASSY HOLDINGS ANSA MCAL GROUP NEAL & MASSY HOLDINGS ANSA MCAL GROUP NEAL & MASSY HOLDINGS ANSA MCAL GROUP NEAL & MASSY HOLDINGS ANSA MCAL GROUP Inventory Turnover (Days) 73.63 126.67 71.83 119.86 84.37 134.2 65.2 115.2 66.32 120.19 Average Collection Period (Days) 52.83 64.68 47.17 62.57 79.91 44.13 67.31 61.35 70.29 60.49 Average Payment Period (Days) 89.92 101.28 74.42 97.29 93.74 108.06 85.81 105.69 87.31 100.28 Cash Conversion Cycle (Days) 36.64 90.07 44.58 85.14 70.54 70.27 46.7 70.86 49.3 80.4 Profit for the year ($) $318,486 579229 $397,935 709762 $504,529 680336 $483,581 690680 $306,066 749053 Working Capital Ratio (Policy) 0.5556 0.3786 0.5262 0.3767 0.4497 0.3702 0.4497 0.3733 0.4802 0.3839
Descriptive Statistics: To further delineate the data, central tendency descriptive techniques
were used. Table 2 displays the mean and standard deviation for each variable, and each company over the study period.
Table 2: Mean and Standard Deviation for Neal & Massy and ANSA McAL
Company N Mean Std. Deviation Inventory Turnover
Period (ITP) (Days)
Neal & Massy ANSA 5 5 72.2700 123.2240 7.64592 7.36976 Average Collection Period (ACP) (Days)
Neal & Massy ANSA 5 5 63.5020 58.6440 13.32691 8.26488
Average Payment Period (APP) (Days)
Neal & Massy ANSA 5 5 86.2400 102.5200 7.26007 4.31997 Cash Conversion Cycle
(CCC) (Days)
Neal & Massy ANSA 5 5 58.5680 79.3480 16.63195 8.71882 Profitability
Profit for Year ($)
Neal & Massy ANSA 5 5 402119.40 681812.00 91326.37748 63060.77717 Working Capital Ratio
(WCMS)
Neal & Massy ANSA 5 5 .4923 .3765 .04725 .00522
Inferential statistics: For more in depth analysis, inferential statistical processes were done
using the SPSS software. These statistics were the Pearson correlation and the t-‐test. The Pearson’s product moment correlation coefficient (PMCC)/ Pearson’s r test calculated the probability of the correlation coefficient occurring only by chance and therefore assessed the
strength and significance of the relationship between each working capital variable and profitability; and then the working capital management policy (aggressive and conservative) and profitability. Table 3 indicates that when N&M was analysed individually, there existed a strong negative relationship between WCR and P (-‐.701), with no level of significance. This suggested that as it adopted a conservative working capital policy (WCR) there was a
corresponding decrease in P, with the converse holding true. This was a first indication of a relationship between WCR and P, and therefore the relevant research question being
addressed. Additionally, there also existed a strong negative correlation between WCR and CCC at a 0.01 significance level. On the other hand ANSA consistently showed moderate to weak correlations between the working capital variables, WCR and profitability.
However, when the conglomerates were analysed as a combined set, some noteworthy findings emerged. There was a strong positive correlation between APP and P at a 0.05
significant level (.762*). This result was consistent with the findings of Lazaridis (2006), and may be explained by the fact that an increased APP allows for a firm to have cash in hand for a longer period of time. This cash in hand can enable increased purchases of inventory resulting in increased sales and possibly ultimately, increased profits. The association between ITP and P was also a strong positive one at a 0.01 level of significance (.874**). Also consistent with the findings of Deloof, Lazaridis, Garcia, et al; was the very strong negative correlation between WCR (which was used as a proxy for the overall WCMS and included, among others, the two ratios mentioned above) and P at a significance level of 0.01 (-‐.909**). It therefore meant that as WCR became more aggressive, P increased; and vice-‐versa.
Table 3: Pearson Correlation Coefficients for N&M and ANSA Individually and Combined
WCR ITP ACP APP CCC P
WCR N&M ANSA Combined 1 1 1 -‐.049 -‐.386 -‐.866** -‐.862 .636 -‐.099 -‐.351 -‐.723 -‐.828** -‐.963** .636 -‐.867** -‐.701 .204 -‐.909** ITP N&M ANSA Combined -‐.049 -‐.386 -‐.866** 1 1 1 .304 -‐.735 -‐.251 .440 .436 .868** .068 -‐.067 .624 .402 -‐.397 .874** ACP N&M ANSA Combined -‐ .862 .636 .099 .304 -‐.735 -‐.251 1 1 1 .730 -‐.728 -‐.019 .886* .688 .454 .472 -‐.163 -‐.090 APP N&M ANSA -‐.351 -‐.723 -‐.828** .440 .436 .868** .730 -‐.728 -‐.019 1 1 1 .377 -‐.817 .589 .140 -‐.137 .762* CCC N&M ANSA Combined -‐.963** .636 -‐.867** -‐.068 -‐.067 .624 .886* .688 .454 .377 -‐.817 .589 1 1 1 .485 -‐.422 .670* P N&M ANSA Combined -‐.701 .204 -‐.909** .402 -‐.397 .874** .472 -‐.163 -‐.090 .140 -‐.137 .762* .485 -‐.422 .670* 1 1 1 ** correlation is significant at the 0.01 level (2-‐tailed)
*correlation is significant at the 0.05 level (2-‐tailed)
The t-‐tests were done in order to determine whether or not the conglomerates were
statistically related. Table 4 shows whether there were any statistically significant differences in the average performances of the companies’ working capital variables. For these results, p<0.05 meant that there were statistical significant differences in the mean/ average
P>0.05; all other variables were significantly different. The results therefore suggested that both conglomerates utilized statistically significant different strategies in managing their WC variables.
Table 4: T-‐test Values for N&M and ANSA McAl
Variable t-‐test df P-‐value
TP -‐10.729 8 <0.05 ACP -‐.693 8 >0.05 APP -‐4.309 8 <0.05 CCC -‐2.474 8 <0.05 Profitability -‐5.635 8 <0.05 WCR 5.44 8 <0.001 Discussion
The analyses above showed that there was some variability and apparent inconsistencies in the outcomes that were generated by the available data. As previously suggested, these apparent variability and inconsistencies may be explained by the fact that the sample size coupled with the relatively short time frame under study may have contributed to the arguably inconclusive results. As was also earlier mentioned, this study adopted a positivist perspective in its approach and therefore the data used and the outcomes generated were objective and logical in linking the theory, addressing the research questions and accepting or rejecting the stated hypotheses.
The main theory which applied to this study was the Working Capital Theory. Theoretically, net working capital (in this case operational working capital) should ideally have a negative
correlation with profitability so that as operational working capital increases profitability decreases, and vice versa. The results from the studied data proved consistent with this theory, showing a strong and significant negative correlation of -‐.909** in the case of the consolidated data; and a relatively strong, though not significant relationship between WCR and Profitability for Neal and Massy.
In response to the research questions of whether there existed a significant relationship between the individual WC components and Profitability, and WCMS (Aggressive vs
Conservative) and Profitability; the evidence can be analysed from two perspectives. Firstly, on an individual company basis, the evidence showed that moderate to very weak associations were seen between the individual components and profitability especially in the case of ANSA. However for N&M, this relationship was observed between WCR and Profitability, thereby positively answering this question in this one instant. Analysing both companies as a whole however, would have also positively answered the question and at the same time proved the hypotheses as acceptable. .
However, of note were the strong correlations which existed among three of the working capital components in the case of N&M. Although this was not one of the initial research questions of the study; the findings of the study revealed a strong and significant negative correlation between CCC and WCR (-‐963**) which would have had meaningful implications for the company and its profitability. As previously explained, a -‐.963** correlation meant that as
the CCC increased, the WCR would have decreased; inferring that because of possible softening of the company’s WC management approach (decreased WCR), the receipt of cash would have slowed, thus lengthening the time taken to convert to available cash for carrying out normal business activities.
When the two companies were examined as one sample unit, all the individual WC components, except for ACP, showed strong positive and significant correlations with
Profitability. This ‘non correlation’ with ACP may be explained by advancing the above point to suggest that, the companies possibly had poor debtors’ collection policies which in turn would have negatively affected ACP. The WCMS, represented as WCR, also strongly negatively correlated with Profitability. This was considered to a very significant relationship. It is important to note that research conducted by others like Mian and Talat (2009) and Asfar and Nazir (2006), also concluded that there is a negative correlation with WCMS and profitability. Based on the result as generated from the Pearson’s correlation test, the (positive) hypothesis was accepted. The test result was consistent with the hypothesis which is that there exists a significant correlation between working capital management approaches and profitability (-‐.909**); a negative and significant level of 0.01.
Implications: The findings of this study have meaningful implications, not only for the two
conglomerates which were investigated, but also for similar corporations, entrepreneurs and their financial decision makers. In addition, researchers who may wish to conduct similar
studies in the Trinidad and Tobago business environment can use these findings to serve as an initial platform from which they could develop more in-‐depth research.
If a firm does not efficiently manage its overall working capital strategy, it can lead to insolvency and unprofitability. While the strong negative correlation between WCMS
(Aggressive vs Conservative) and Profitability, was a positive indicator, and was consistent with findings of Deloof, Lazaridis and others; the positive relationships of the individual components were reason for concern.
Furthermore, as explained earlier, though the positive correlations between ITP, APP, CCC and Profitability, and the weak negative relationship ACP had with Profitability may have generally availed the companies of more cash, thereby causing an increased ITP (especially if not
managed effectively) and increased ACP; this approach was potentially financially dangerous. Increased ITP, which when assessed separately, is not a preferred strategy because of the inevitable increased storage costs and risks of obsolescence and delayed responsiveness to changing customers’ requirements; will however, (at some time), ultimately lead to increased sales, profitability and increased shareholder value. This is therefore a significant balancing act that the firms need to continually monitor and cautiously manage.
These observations also have implications for decision makers in other sectors and
entrepreneurs who may need some empirical evidence about the correlational value of these sets of variables, especially in the context of local companies. This will provide, at least, an initial framework which they can use as a guide to their efficiency in the management of
working capital and ultimately increasing shareholder or owners’ value. Also researchers who may wish to embark on studies of a similar nature in the T&T context, coupled with what was previously discovered by other international researchers can also utilize these findings as a platform from which they can develop, enhance and expand.
Conclusion
Based on the results of the statistical analyses, it can be surmised that:
i. There is a strong negative correlation between the Working Capital Management Strategy (WCMS), measured by Working Capital Ratio (WCR) and Profitability (P), measured as Profit for Year. So that as WCR becomes higher (i.e. more conservative) Profitability will decline and vice versa. Given this result, we can then accept the alternative hypothesis that states that there is a statistically significant relationship between these two variables. In addition, the research question which analyses the relationship between WCMS and P has also been answered in the affirmative. ii. Mixed correlation results have also been observed between the (separate) working
capital components and profitability, and therefore the other research question which analyses the correlation between the individual working capital components to profitability, at this time, cannot be conclusively answered.
As this study is presumably the first of its kind to be done on public listed companies in Trinidad and Tobago, it is suggested that further studies be conducted within each
segment(s) is (are) contributing most to the particular, and ultimately overall, performance of the individual components and thus their impact on profitability. Also recommended, is an investigation of all sixteen (16) non-‐financial, non-‐banking public companies in order to obtain more broad-‐based findings on the relationships between the variables.
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