Effect of working capital management on stock return and profitability (elected glassmaking companies of Iran)

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1 Effect of working capital management on stock return and profitability (elected glassmaking companies of Iran) Abstract AhmadReza Mohamadlua 1 PhD. Ali Kashmari* 2 Working capital management means the balance between the current assets and liabilities, so that this balance can timely meet the needs of components of working capital management. In this study, the effect of working capital management is investigated on return on stock and profitability of elected glassmaking companies. So, four components, including collec period, inventory turnover period, accounts payable period and cash conversion cycle, are considered as the components of working capital management (independent variable) and their effects on return on stock and profitability (dependent variable) is investigated in forms of four quess. The statistical popula of this study is composed of 5 glassmaking companies, including Glass and Gas, Mina glassmaking, Hamadan glass, Takestan glass and Razi glassmaking, that their data had been investigated during 2009 to The results show that collec period and accounts payable period have a significant effect on efficiency and profitability of the mened companies. And also, the inventory turnover and cash conversion cycle have a significant effect on returns on stock. Keywords: working capital management, collec period, inventory turnover period, accounts payable period, cash conversion cycle. 1 - Department of Management,buinzahra Breanch,Islamic Azad University, Buinzahra,Iran. 2 - Ph.D of inancial Economics, Assistante Professor; Department of Management,buinzahra Breanch,Islamic Azad University, Buinzahra,Iran. * Corres ponding author. ( a.kashmari@buiniau.ac.ir). Page 2007

2 Introduc When an enterprise plans its activities, it should maintain the balance between assets, money stock and profitability. Working capital management reflects the policies and decisions applied in current assets and sources of funding, and the proper management of this sector can have a significant impact on the profitability and stock returns. In this study, the main components of working capital management are cash conversion period, collec period, accounts payable period and inventory turnover period that the sum of these elements constitutes the independent variable (Deloof, 2003). According to Skilling, working capital term generally is related to investment in the organiza's current assets, current liability, cash, short-term securities, account receivable and inventory. The main issue in capital management is insuring that those companies have enough cash flow to continue their usual open, so that minimize the risk and inability in finishing their short time duties. In this context, the real ques is that what is the impact of working capital management and its components on profitability and return on stock of glassmaking companies? Sub-quess 1. Does collec period have a significant effect on stock returns and profitability of elected glassmaking companies? 2. Does the inventory turnover period have a significant effect on stock returns and profitability of elected glassmaking companies? 3. Does the accounts payable period have a significant effect on stock returns and profitability of elected glassmaking companies? 4. Does the cash conversion cycle have a significant effect on stock returns and profitability of elected glassmaking companies? Theoretical foundas Working capital management is the of the type, size, amount and composi of sources and uses of working capital in a way that increase stockholders wealth (Reymond P Neveu, 2001). In fact, working capital management is included decisions related to funding to support the current assets of non-profit entities. Working capital management is important in financial health of different business entities. Managers consider various factors to invest in companies in which profitability is one of the most important factors. Working capital management includes an important area of financial management and can have a significant effect on the profitability and of the company (Shin and Soenen, 1998). Working capital meets the short-term financial needs of trade institu. Working capital is a trading capital which not remains more than one year in a company. The cash which is invested in them will be changed during trading open. The need to maintain adequate working capital can hardly be opposed. As the blood circula in human body is very important to maintain the life, cash flow is essential to continue business opens (Kyson, 2006). Working capital policies have some principles and plans including measures concerning current assets and liabilities. Many authors and researchers have pointed to three types of working capital policy: aggressive, moderate and conservative. The main differences of these policies are the net working capital which is equal to the difference between current assets and current liabilities. Conservative strategy in working capital management will increase power so much. In implementa of this policy, it is tried to minimize the risk due to inability to pay the liabilities. The manager of this method tries to maintain the current assets in a high level and in contrast, the manager of working capital tries to utilize Page 2008

3 more from the current liabilities by the least amount of current assets. In implementa of this method, the risk of is very high. In another hand, the return on investment rate will be so high due to the least amount of current assets. However, the equilibrant policy is between boldly and conservative policies, and the manager of capital working tries to use current assets and liabilities in a balanced mode in investment structure, so this policy has risk and average return (Maliki Nia, Asgari, Ghezelbash, 2011). Research history Among oreign Studies, Abdul Rahman and Naser (2007) investigated the relaship between working capital management and liquidity with profitability. In these study, they investigated 94 companies during 1999 to 2004, in which the cash conversion period, inventory period, creditors deposit period, collec period, current, net operating income, company size, financial liability and assets was used. The results, based on regression analysis and Pearson correla, indicates that there is a significant inverse relaship between working capital management and corporate profitability. Troll and Solano (2007) investigated working capital management and its impact on company's profitability. Their investiga took 7 years during 1996 to They found that a decrease in the cash conversion cycle improves the profitability of the company. They stated that the management of working capital is important due to its effect on profitability and company risk and led to the firm's value-crea. Gil et al. (2010) selected a sample of 88 earning listed companies in New York stock exchange, and they investigated the effect of working capital level on profitability, and found that there is a significant relaship between cash conversion cycle and profitability of companies, the profitability of company will be increase by shortening the receivable period. Elmvola (2012) investigated the effect of working capital management policies on the profitability and value of the earning listed companies in Oman stock market during 2001 to 2009, and found that the conservative investment strategy and boldly fiscal policy have a positive and negative effect on the company's profitability and value, respectively. Gill and Beeger (2014) investigated the impact of corporate governance features on the efficiency of working capital management of 180 manufacturing companies of USA during the financial year of 2009 to They applied the size of board, the duality posts of director and the occupa dun of being a director indices to measure the corporate governance. Evidence suggests that some mechanisms of corporate governance play an important role in improving the efficiency of working capital management. Among internal studies, Ardakanian (2009) showed that there is a negative relaship between working capital management and profitability, and profitability will be increased using working capital management boldly strategy, and vice versa. Arefi and Dadras (2010) investigated the importance of basic variables of financial bills in predicting the stock returns using the fundamental analysis strategy, in which 11 factors are considered in calculating the fundamental score of companies, including inventory, accounts receivable, investments, financial leverage changes, liquidity changes, changes in assets cycle, net profit margin, return on assets, changes in return on assets, cash flow and dues. The results of this study showed that the founda score have a significant positive relaship with stock returns at 1 percent. Taghizadeh et al (2011) investigated the relaship between working capital management and performance of companies listed on Tehran Stock Exchange. They chose 50 manufacturing companies during the financial dun of The results showed Page 2009

4 that increased collec cycle, payment period and net exchange cycle reduces the profitability of the company. Methodology The method of analysis in this research is regression panel. The related financial s have been used to determine the relaship between working capital management and return on stock rate, and univariate regression have been used to analyse the data of each variable. These tests were estimated based on panel data. The statistical popula of this study is 5 glassmaking companies listed on the Tehran Stock Exchange, including: Glass and Gas, Mina glassmaking, Hamadan glassmaking, Takestan glassmaking and Razi glass about which complete informa is available. And they have been chose as samples during 2010 to The introduc of study model The model used in this study is a modified model of Abdul Rahman and Mohammadnasr (2007), Gamleyt and Renny (2008) and Bertland and Brink (2013) researches, as follows: StockReturn,Profitability{NPM,ROA,ROCE} CR = Current Ratio: This measures the company's ability to refund the short-time commitments. Which is calculated by dividing current assets to current liabilities. It is better this to be more than one (Reymond P Neveu, 2001). CSR = liquidity : it s a financial and obtained by dividing the cash, cash equivalents and securities, which easily can be converted into cash, to current liabilities (Reymond P Neveu, 2001). Deposit of creditors (APP): it also called accounts payable period and it calculates the dun of accounts payable balance. The managers use this index to plan the payments and to compare the credit condi of other firms sales (Mohammad Mohammadi, 2009). Collec period (ACP): In general, the collec period is a measure to determine the dun of collecting the accounts receivable. To determine the collec period, the daily credit sales are calculated as follows: Equa 1 daily credit sales = annual credit sales / 365 The collec period can be obtained by dividing the accounts receivable to daily credit sale as follows: Equa 2 collec period = Accounts Receivable / daily credit sale Inventory turnover period (ITID): inventory turnover period represents the dun of goods sale, (Reymond P Neveu, 2001). To calculate the inventory turnover period are as follows: irst, we determine the average inventory. There are 3 figures for goods at the end of the year, which are related to the end of last year or the beginning of this year, the inventory of the first six months of the year and the inventory of the end of the year. So, the average of inventory is obtained by the average of the three mened figure: Equa 3 average inventory= (the inventory of the beginning of year + the inventory at the end of the year) /2 After determining the average inventory, the inventory turnover rate is calculated as follows: Equa 4 the inventory turnover rate = average inventory / cost of sold goods Then, the daily inventory turnover is determined as follows: Page 2010

5 Equa 5 inventory turnover period = the inventory turnover rate / 365 Liability payment period (APP): it is the dun to settle the accounts payable. In one method, the approximate amount of one day's purchase is obtained by dividing the total annual purchases to days, then accounts payable balance is divided to it, and it is found that for how many days, the creditors due is not paid (Mark Dellof). Cash conversion cycle (CCC): the dun of the process of converting invested cash of a company into open and profitability is called cash conversion cycle (Mohammadi, 2009). Equa 7 Cash conversion cycle = (payment period - ((collec period + inventory turnover period)) (Pour Heydari, Hoshmand, 2012). NPM: net profit margin is obtained by after-tax profit to net sales, and it shows the profitability of each sale. ROA: Return on assets shows the profit obtained from invested assets (Reymond P Neveu, 2001) and its formula is as follows: Equa 8 ROCE: Return on capital is similar to return on assets, but average of total employed capital is used in the denominator (Reymond p Neveu, 2001, 1989). Equa 9 2. Introduc of model tests In all quess, first, the model is estimated as a panel-variable to choose between fixed and variable test panel, Haussmann test is then used to choose between variable and fixed. Since, Haussmann statistic value is less than 0.05, and the variable assump have been rejected in all quess, so the panel test has been used for estima. Normality tests: data normaliza is the first step in the process of testing the quess. or all quess, the following results are shown using Jarque Bera test, if the P-value is less than 0.05, the assump of normality of data will be rejected. As shown in the below table, all quess are normal. orth ques seco nd subques third subques irst subques Table 1: normality test for panel Third ques Second ques seco seco third irst third irst nd nd sub- sub- sub- subsub- subques ques ques ques ques ques third subques irst ques seco nd subques irst subques test Page 2011

6 Std.de v Skow ness Kurto sis Jarqu e-bera proba bility The of (R 2 ) is between 0.6 and 0.8 in all models, which states that more than 60 percent of the changes of the dependent variable are explained by right variables of the model, so these models have the ability to fit the relaship between dependent and independent variables. In regression analysis, when variables are investigated during a period, the data changes may follow a certain pattern and test is used to assess this pattern. Whatever the value of this test is closer to zero, the correla is positive, and vice versa. In normal mode, if the result of this test is a number between 1 and 4, test variables are correct. As shown in the estima tables of the models, Durbin is between 1 and 3 in all quess. The formula is as follows: = Analysis of data Estima of models related to first ques Table 2 (first sub-ques model estima) P - Value 0 statistic t /0 1/8 0000/ Average Collecting debts of Limer As the results show, the significant level of t-statistics is less than 5% for the main variable of average collecting debts and control variable of current. Therefore, it can be concluded that the collecting debts have a significant effect on return on stock and profitability of glassmaking companies. In another hand, the estimated is negative for average Page 2012

7 collecting debts; it means that the effect of average collecting debts is reverse on the company's profitability. The probability level of the calculated statistic of liquidity is 0.15 which shows the variable is non-significance at 5%. Table 3 (estima of the second sub-ques model) P - Value 0 statistic t /72 2/15 003/ Average Collecting debts of Limer The above table shows that the significant level of t-statistics calculated for the main variable of average collec period and control variable of current and liquidity is less than 5%. Therefore, it can be concluded that there is a significance effect between the collec period and return on assets of glassmaking companies. On the other hand, the estimated of the average collec is close to zero. This means that the period of collec of receivables has a low-impact on returns on asset of glass-making companies. Table 4 (estima of the third sub-ques model) P - Value 0.13 statistic t /0 2/4 022/ Average Collecting debts of Limer Page 2013

8 As the results show, the significant level of t-statistics calculated for the main variable of average collec and control variable of current and liquidity is less than 5% significance level. Therefore, it can be concluded that there is a significance effect between the collec period and return on capital of glass-making companies. On the other hand, the estimated of average collec rate is close to zero. This means that the average collec period has low-impact on return on investment of glass-making companies. The estimated related to the second ques Table 5 (estima model of the first sub-ques) P - Value 0.69 statistic t /0 1/95 000/ Inventory turnover of Limer As the results show, the significance level of t-statistics calculated for the main variable of inventory turnover period is higher than 5%. Hence, the inventory turnover has no significant effect on the profitability (net profit margin) of glassmaking companies. Table 6 (estima of second sub-ques model) P - Value 0 t- statistic /67 1/ Inventory turnover of Limer Page 2014

9 The significance level of T-statistic calculated for the main variable of inventory turnover and control variable of current is less than 5%. Therefore, it can be concluded that the inventory turnover has a significance effect on return on assets of glassmaking companies. On the other hand, the estimated for inventory turnover is negative. This means that the impact of inventory turnover has a reserve impact on the profitability of glassmaking companies. So, the increase of inventory turnover has a negative impact on the return on assets. Also, the significance level of calculated statistic of the liquidity is 0.76, which indicates no significance effect of the variable at 5%. Table 7 (the estima of the third sub-ques model) P - Value 0.07 t- statistic /7 1/74 37/ Inventory turnover of Limer As the results show, the significance level of t-statistics calculated for the main variable of inventory turnover period is higher than 5%. Hence, the impact of inventory turnover on return on capital of glass-making companies is rejected. The estima of model related to the third ques Table 8 (the estima of first sub-ques) P - Value t-statistic /0 2/ Accounts payable of Page 2015

10 000/0 Limer As the results show, the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that the accounts payable has a significance level on profitability (net profit margin) of glass-making companies. On the other hand, the estimated of average collec is close to zero. This means that the accounts payable has a low-impact on profitability (net profit margin) of glassmaking companies. Table 9 (the estima of second sub-ques model) P - Value t-statistic /78 1/ Accounts payable of Limer As the results show, the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that there is a significance level between accounts payables and return on assets of glassmaking companies. The estimated of accounts payable is close to zero. This means that accounts payable has low-impact on return on asset of glass-making companies. Table 10 (the estima of the third sub-ques model) P - Value 0.13 t-statistic /8 1/65 22/ Accounts payable of Limer Page 2016

11 The results show the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that the accounts payable has a significance effect on return on capital of glassmaking companies. On the other hand, the estimated of average collec is close to zero. This means that the accounts payable has low-impact on Return on capital of glassmaking companies. Estima of model related to the fourth ques Table 11 (the estima of first sub-ques model) P - Value t-statistic /73 2/42 000/0 cash Conversion cycle of Limer As the results show, the significance level of t-statistics calculated for the main variable is higher than 5%. As a result, the cash conversion cycle has no significance effect on profitability (net profit margin). Table 12 (the estima of second sub-ques model) P - Value t- statistic /0 85/1 003/ cash Conversion cycle of Limer Page 2017

12 As the results show, the significant level of t-statistics calculated for the main variable is lower than 5%. So, the cash conversion cycle has a significance effect on return on assets, but the calculated is so negligible and around zero. Table 13 (the estima of the third sub-ques model) P - Value t-statistic /0 5/1 223/ cash Conversion cycle of Limer As the results show, the significant level of t-statistics calculated for the main variable is higher than 5%. As a result, the effect of cash conversion cycle on return on investment cannot be verified. Results of the analysis and recommendas In the present study, the influence of four elements, including the collec period, the inventory turnover period, the accounts payable period and the cash conversion cycle, were investigated as components of working capital management, in the form of four ques, on return on stock and profitability of glassmaking companies using regression analysis, the results are as follows. In the first ques, there is a negative significance effect between collec periods on net margin profit of the glassmaking companies. The impact of collec period is accepted on returns on assets and return on applied investment of elected glass-making companies. But regarding to these calculated s, this effect is so negligible. So, we can say that the managers can create a significance relaship between collec periods with net profit margin by reducing the accounts receivable as possible, and then create a positive value and profitability for stockholders by reducing the collec period as possible. This can be achieved by proper management of accounts receivable and effective administn of collec. In second ques, inventory turnover period have a negative significance effect on profitability (return on assets) of glass-making companies. Also, the results reveal the significant effect of inventory turnover period on the return on assets which is negative (reverse). It is indicated that if the inventory turnover period increases, the return on assets will decrease, and vice versa. Also, test results showed that the inventory turnover is significant on the return on investment and it can be used as one of the factors affecting the efficiency. But, the inventory turnover has no significance effect on net profit margin and Page 2018

13 return on employed capital. So, it can be said that managers can increase the return on assets by reducing the inventory turnover period as possible, and improve the desirable profitability. In third ques, the results show that the accounts payable has a positive low-impact on return on assets of glass-making companies. As well as the accounts payable has a low significance and negative relaship with net profit margin and return on used capital in glassmaking companies. In fact, if managers could increase the payment dun of accounts payable using different policies and procedures, the efficiency and profitability of companies will increase. And this will be possible by increasing the dun of refund of commitments. The results of the last ques indicate that cash conversion cycle has a negative significance effect on return on assets. The tests indicate that there is a low significance effect between cash conversion cycle and return on assets of elected glassmaking companies which is negative (inverse), and in fact, it is indicated that increased cash conversion cycle of glassmaking companies reduces the return on assets, but this impact is very low. The effect of cash conversion cycle is not significance on net profit margin and return on investment of the glass-making companies in Tehran Stock Exchange. Therefore, the shorter cash conversion cycle process, the greater efficiency. Page 2019

14 References Mohammad Mohammadi working capital management impact on corporate profitability in the companies listed in Tehran Stock Exchange. Omidpour Haydari Rahmatolah, Hoshmand Zaferanieh Review on experimental studies about working capital management on profitability of the Companies. Raymond pi nouve The financial management. Translate: Ali Jahan khani and Ali Parsaeian. Semat publisher. Mansour Zeranejad, Ibrahim Anvari Applica of compound data in data regression analysis in different sciences with focus on socio-economic sciences. Taghizadeh khanghah et al The investiga of the relaship between working capital management and performance of companies listed in Tehran Stock Exchange. Nahid Maliki Nia, Hossein Asgari Alooj, Azam Ghezelbash The relaship between working capital strategy and profitability criteria of automotive manufacturing companies and minerals in Tehran Stock Exchange. Arefi and Dadras The importance of basic variables of financial statements in predicting return on stocks using fundamental analysis strategy. Deloof, M Does working capital management affect profitability of Belgian firms. Journal of Business inance and Accounting, Vol. 30, pp: Raheman, A. and Nasr, M Working Capital Management and Profitability Case of Pakistani irms. Internaal Review of Business Research Papers, Vol. 3 (2), pp: Samson, A. A.; Mary, J.; Yemisi and Erekpitan, I. O The impact of working capital management on the profitability of small and medium scale enterprises in Nigeria. Research Journal of Business Management, Vol. 3, Iss. 3, p. 8. Teruel, Pedro Juan García and Pedro Martínez Solano" Effects of working capital management on SME profitability". Internaal Journal of Managerial inance.bradford, Vol. 3, Iss. 2, p Shin, H.H and Soenen, L Efficiency of working capital and corporate profitability,inancial Practice and Educa, Vol 8 No 2, pp Shin, H.H and Soenen, L Efficiency of working capital and corporate profitability,inancial Practice and Educa, Vol 8 No 2, pp Kesseven Padachi "Trends in Working Capital Management and its Impact on irms Performance: An Analysis of Mauritian Small Manufacturing irms". Internaal Review of Business Research Papers, Vo.2 No. Pp Teruel, Pedro Juan García and Pedro Martínez Solano" Effects of working capital management on SME profitability". Internaal Journal of Managerial inance.bradford, Vol. 3, Iss. 2, p Raheman, A. and Nasr, M Working Capital Management and Profitability Case of Pakistani irms. Internaal Review of Business Research Papers, Vol. 3 (2), pp: Page 2020