WHAT DETERMINES THE WORKING CAPITAL SIZE OF THAI SMALL CONSTRUCTION FIRMS?

International Journal of Business and Management Studies, CD-ROM. ISSN: 2158-1479 :: 2(1):351 358 (2013) WHAT DETERMINES THE WORKING CAPITAL SIZE OF THAI SMALL CONSTRUCTION FIRMS? Kulkanya Napompech King Mongkut s Institute of Technology, Ladkrabang, Thailand Working capital is vital for firms. Appropriate working capital level enables smooth daily business operation. The objective of this research was to study the factors affecting the working capital size of Thai small construction firms. The sample group consisted of 108 samples from 2007 through 2010. The statistic used was regression. The results of the study revealed that the operating cycle, operating cash flow, debt ratio, and firm size have an impact on the working capital size of Thai small construction firms. Keywords: working capital, construction firms, small firms, Thailand Introduction Working capital is the bloodstream of a business, representing current assets minus current liabilities. This means that the acquisition and use of short-term capital is necessary for all businesses because companies cannot operate without working capital, while without buildings or tools businesses can still operate (Lasher, 2008). Working capital management is important to the net profit of the business (Smith, 1980; Jose, Lancaster, and Stevens, 1996; Shin and Soenen, 1998; Deloof, 2003; Garcia-Teruel, and Martinez-Solano, 2007). Effective working capital management is an important strategy in adding value to owners equity (Shin and Soenen, 1998). An appropriate working capital level enables smooth daily business operations (Mohamad and Saad, 2010); for example, with good working capital management, a business will have sufficient cash to pay debts when they are due. The business will also have sufficient materials for uninterrupted production as well as sufficient products to fulfill customer orders to prevent lost profit, provide credit to customers ( Blinder and Maccini, 1991; Lasher, 2008), and wait for debtors to pay debts. However, if a business invests too heavily in working capital, it will lead to a decrease in business value (Banos-Caballero, Garcia-Teruel, and Martinez-Solano, 2010; Nazir and Afza, 2009; Charitou, Elfani, and Lois, 2010; Eramus, 2010). The solution is to decrease investment in unused working capital and use that amount to invest in profitable business projects (Eramus, 2010). Accordingly, businesses make an effort to maintain an appropriate working capital level to produce the highest profit for the enterprise (Deloof, 2003; Alza and Nazir, 2007). Having an appropriate level of working capital means decreasing working capital to the smallest amount possible while maximizing profit (Ganesan, 2007). Therefore, executives spend time and effort when considering the appropriate levels of current assets and current liabilities by adaptation and adjustment (Lamberson, 1995). Hence, study of the determinants of working capital size is intriguing, especially with small enterprises, because most assets of small 351

352 Kulkanya Napompech businesses are current assets (Peel, Wilson, and Howorth, 2000; Bonos-Caballero, Garcia-Teruel, and Martinez-Solano, 2010). Small enterprises have less liquidity and more cash flow sensitivity. Also, small businesses depend on short-term liability more than big businesses (Peel, Wilson, and Howorth, 2000; Howorth and Westhead, 2003; Bonos-Caballero, Garcia-Teruel, and Martinez-Solano, 2010), have lower bargaining power with trade creditors, and have the capacity to provide credit to customers over a shorter term than big businesses (Bonos-Caballero, Garcia- Teruel, and Martinez-Solano, 2010). Thus far, scant literature has been published on the determinants of working capital size of small construction firms; consequently, the results of this study will serve as interesting content for small business executives and as a contribution to the existing body of knowledge. Literature Review Most literature reviews of working capital management have involved research results related to working capital management as it affects the profit efficiency of the company, studied by using regression statistics. Researchers who have studied these subjects include Wang (2002),who used examples of Japanese and Taiwanese companies; Deloof (2003),who used examples of Belgium companies; Lazaridis and Tryfonidis (2006),who used examples of Greek registered companies: and Abuzayed (2012), who used examples of Jordan listed firms. The outcomes of these studies have been similar: Each has suggested that managers can increase the value of shareholders equity by decreasing the cash cycle. Previous research on the results of working capital management affecting the profit of small companies by Garcia-Teruel and Martinez-Solono (2007), using small and medium-sized enterprise (SME) examples from Spain, revealed that working capital management is important to small businesses and that managers can increase the value of shareholders equity by decreasing inventory levels and collection periods. Banos- Caballero, Garcia-Teruel, and Martinez-Solano (2011) investigated the non-linear relationship between working capital management and the profit efficiency of 1,008 Spanish SMEs from 2002 through 2007. The study revealed a monotonic relationship between the working capital level and the net profit of companies, which indicated that SMEs had an appropriate working capital level that maximized profit of small UK companies. Pertaining to the study of the determinants of working capital management, Chiou, Cheng, and Wu (2006), using the size of working capital to represent working capital management, investigated the company nature and the external factors affecting working capital management of Taiwanese companies through samples of 19,180 firm/quarter data. The results of the study revealed that debt ratio and operating cash flow affected working capital management while business cycle, industrial results, company s growth rate, company s operation results, and company s size had no influence on working capital management. Nazir and Afza (2009) studied the factors determining the size of working capital of 132 companies registered on the Karachi (Pakistan) Stock Exchange during 2004 through 2007. The statistic used was regression. The results of the study revealed that the operating cycle, return on assets, debt ratio, and industry type affected the determination of the size of working capital. Hypotheses Development If a business can manufacture and sell its stock rapidly as well as quickly collect money from sales, such as advanced cash collection or fast debtor collection, the need to maintain working

What Determines the Working Capital Size of Thai Small Construction Firms? 353 capital for operations during the waiting time for the returns on investments will decrease (Brigham and Ehrhardt, 2005). As a consequence, the operating cycle, which derives from manufacturing and sale periods plus debtor collection periods, will probably have a negative relationship with the size of working capital. Having a large amount of operating cash flow indicates that a business has good working capital management(charitou, Elfani, and Lois, 2010; Eljelly, 2004; Raheman, Qayyum, Afza, and Bodla, 2010) that is capable of extending the operations debt payment period and expediting the operations-related debtor collection time, resulting in less need for working capital. Hence, operating cash flow probably has a negative relationship with the size of working capital (Chiou, Cheng, and Wu, 2006). Effective working capital management obviates the need to increase working capital which can lead to external loans. Thus, the debt ratio presumably has a negative relationship with the size of working capital (Chiou, Cheng, and Wu, 2006). Companies that have a high growth rate should need more working capital than those with a low growth rate. When sales increase, enterprises must buy more raw materials for production or more goods for sale, and companies need more accounts receivable from credit sales (Banos- Caballero, Garcia-Teruel, and Martinez-Solano, 2011). Therefore, firm growth should have a positive relationship with working capital size. Any company with good operating results attracts external sources of funds and has more bargaining power over material sellers and customers (Shin and Soenen, 1998). These companies have no need to store cash. Therefore, companies with good operating results demonstrate effectiveness in working capital management and have little excess working capital.accordingly, the returns on investments probably had a negative relationship with the size of the working capital (Charitou, Elfani, and Lois, 2010). Past research about the effect of company size on company financial ratio has revealed that company size affects working capital management (Chan, 1993; Peel and Wilson, 1996; Wu, 2001; Su, 2001) since big companies have higher credit ratings, obtain funds more easily, and have more bargaining power over material sellers and customers than small companies. Small enterprises must offer credit to customers over longer terms to increase selling opportunities (Banos-Caballero, Garcia-Teruel, and Martinez-Solano, 2009); therefore, a healthy amount of working capital must be maintained. One can conclude that the size of the company has a negative relationship with the size of the working capital (Chiou, Cheng, and Wu, 2006). From the aforementioned data, the following hypotheses were formulated: Operating cycle H1a Operating cycle is positively related to working capital size. H1b Operating cycle is negatively related to working capital size. Operating cash flow H2a Operating cash flow is negatively associated with working capital size. H2b Operating cash flow is positively associated with working capital size. Debt H3a Debt is negatively related to working capital size. H3b Debt is positively related to working capital size. Growth of firms H4a Growth of firms is positively related to working capital size. H4b Growth of firms is negatively related to working capital size. Profitability H5a Profitability has a negative link to working capital size.

354 Kulkanya Napompech H5b Profitability has a positive link to working capital size. Size H6a Firm size is negatively related to working capital size. H6b Firm size is positively related to working capital size. Research Methodology Data Collection This research made use of panel data of small businesses in the construction category. Based on guidelines from the Department of Industrial Promotion, Ministry of Industry, Thailand, this research defined small enterprises (industry type) as those with no more than 50 million Baht (or equivalent) in fixed assets value ( 31 Baht is approximately equivalent to 1 $ US). The data were obtained from the Department of Business Development. The sample group consisted of businesses with consecutive operating data from 2007 through 2010. Any enterprises with incomplete variables data or outlier data were removed. Ultimately, the sample group consisted of 108 businesses, equivalent to 472 firm-year observations. Variables This research studied the determinants of working capital size. Following Shulman and Cox (1985), this research defined working capital size (WCS) as (accounts receivable plus inventories) (accounts payables plus accruals). The balance sheets of small businesses that were revealed in the website of the Department of Business Development did not indicate the value of accounts payables or the amount of accruals; therefore, the current liability amount was used to represent the number of both accounts payables and other payables. The size of working capital divided by total assets, which was a dependent variable, represented working capital management. The value of the amount of working capital can be adjusted by total assets to reduce the impacts from the size of the enterprise. Independent variables included operating cycles, operating cash flow, the company s growth rate, debt, returns on assets, and the company s size. The operating cycle (OPC) was generated from the manufacturing period and product sales plus the creditor payment period. Operating cash flow (OPF) derives from adjusting the net profit or net loss of non-cash activities effects and the effects arising from changes in current assets and current liabilities related to operating activities and then dividing by total assets to control the company s size. The sales growth rate (GROWTH) was measured based on changes in annual sales. Business liabilities (DEBT) were measured from total liabilities divided by total assets. The returns on assets (ROA) were measured from the net profit divided by total assets. The size of the business was measured from the log of the assets (Size). This research employed the regression model when examining the determinants of the working capital size of small enterprises. The models used in the research included: WCS it = + 1 OC it + 2 OCF it + 3 Growth it + 4 Debt it + 5 ROA it + 6 Log Size it

What Determines the Working Capital Size of Thai Small Construction Firms? 355 Where WCS = Working capital size deflated by total assets for firm i at year t OC it = Operating cycle in days of firm i at year t OCF it = Operating cash flows deflated by total assets of firm i at year t Debt it = liabilities as measured by debt-to-total assets ratio of firm i at year t Growth it =Sales growth of firm i at year t ROA it = Return on assets of firm i at year t Size it =Log of total assets as proxy for the size for firm i at year t Empirical results Table 1. Descriptive Statistics of the Collected Variables. Variable N Mean Standard Deviation Percentage of current assets to total assets Percentage of current liabilities to total liabilities 432 72.5 23.61 432 84.5 25.23 WCS 432.32 0.88 OC 432.01 148.15 OCF 432.05 0.31 Debt 432 51.0 88.01 Growth 432 15.86 113.42 ROA 432 5.09 15.86 Size 432 6.89 0.41 Table 1 shows that the four-year (2007-2010) means of variables included the size of working capital accounting at.32, the operating cycle at.01 days, the operating cash flow at.05, the debt ratio at 51.0.0, the sales growth rate at 15.86, the returns on assets at 5.09, and the size of the company measured by log of assets at 6.89 In this research, the average assets of small businesses from 2007 through 2010 were in the form of current assets (72.5 %) and the average short-term liabilities for this period accounted for 84.5 % of the total liabilities, consistent with past research suggesting that most assets of small enterprises are in the form of current assets and that current liabilities are the main sources of funds (Peel, Wilson, and Howorth, 2000; Bonos- Caballero, Garcia-Teruel, and Martinez-Solano, 2010).

356 Kulkanya Napompech Results of Study WCS = 0 OC - CF - Debt+.099 size Table 2. Regression Analysis of Determinants of Working Capital Size. Variable Coefficient t-value Sig VIF Constant 0.040.166..869 Operating cycle (OC).001 5.184.000** 1.050 Cash flow (CF) -.114-2.374.018* 1.097 Debt -.920-53.33.000** 1.177 Growth.0 0 1.279.202 1.043 ROA.002 1.547.123 1.276 Size.099 2.846.005* 1.025 N = 432 D-W = 1.971 R Square = 89.1 Adjusted R square = 89.0 F-Value 580.753 Table 2 shows that R 2 has significance with 89.1 %, indicating that the size of the working capital could be well explained by independent variables in the regression model. The results of the study revealed that H1a was supported: The operating cycle had a positive relationship with the size of the working capital with high significance, meaning that if the operating cycle increases, the size of the working capital needs to be increased. The outcome was consistent with the principle that the longer the inventory conversion period, the longer the debtor collection period, and the longer it takes for firms to get their money back, the more working capital the business must maintain. The results of the study supported H2a: Cash flow had a statistically negative relationship with working capital size. This means that companies with good operating cash flows have no need for a large amount of working capital. The outcomes of the study supporting H3a indicated that debt was negatively related to working capital size, meaning that when debts increase, a business must be careful about working capital management to avoid wasting working capital in the inventory or too many trade debtors, both of which result in the need to reduce working capital. The results of the research rejecting H4a and H4b indicated that growth of firms has no relationship with working capital size. The results of the study did not support H5a or H5b. The results showed that profitability has no relationship with working capital size.

What Determines the Working Capital Size of Thai Small Construction Firms? 357 The results of the study rejected H6a, indicating that the size of the business has positive relationship with the size of the working capital. Based on the outcome of the study, there was no collinearity among independent variables, considering the variance inflation factor (VIF) for each independent variable: If the VIF is more than 10, it means that the independent variable has multicollinearity (Stuenmund, 1997). From Table 2, one can see that the maximum VIF was 1.276, which means no multicollinearity. Discussion Businesses make an effort to maintain an appropriate working capital level to produce the highest profit for the enterprise. This is because having too much working capital will decrease the value of the enterprise. However, if a business has too little in working capital, the business will face problems with short-term debt payments, which can create rough daily business operations. Therefore, working capital management is especially important for small businesses. Based on the study of small firms, the current assets of construction enterprises accounted for 72.5 % of the total assets and the current liabilities for 84.5 % of the total assets, which corresponds with past research indicating that small businesses have significant current assets and current liabilities. The enterprises should determine the appropriate size of working capital to balance capital needs and to avoid ineffective working capital management. Similar to the previous studies that used large firms as the samples (Chiou, Cheng, and Wu, 2006; and Nazir and Afza, 2009), this research revealed that the operating cycle, operating cash flow, debt ratio, and firm size determine the working capital size of a small company. References 1. Abuzayed, B. (2012), Working capital management and firm performance in emerging markets: the case of Jordan, International Journal of Managerial Finance, Vol. 8 No. 2, pp. 155-179. 2. Afza, T. and Nazir M. (2007), Is it better to be aggressive or Conservative in managing working capital?, Journal of Quality and Technology, Vol. 3 No. 2, pp. 11-21. 3. Banos-Caballero, S., Garcia-Teruel, P. and Martinez-Solano, P. (2010), Working capital Management in SMEs, Accounting & Finance, Vol. 50 No. 3, pp. 511-527. 4. Banos-Caballero, S., Garcia-Teruel, P. and Martinez-Solano, P. (2011), How does working capital management affect the profitability of Spanish SMEs, Small Business 5. Economics, DOI 10.1007/s11187-011-9317-8. Published online 15 March 2011. 6. Blinder, A. S., and Maccini, L. J. (1991), The resurgence of inventory research: what have We learned?, Journal of Economic Survey, Vol. 5 No. 4, pp. 291-328. 7. Brigham, E., and Ehrhardt, M. (2005). Financial Management: Theory and Practice, 11 th Ed., South- Western, USA. 8. Chan, C. (1993), The study on working capital management of manufacturing business, Unpublished Master s Dissertation, Department of Management Science, Tarn Kang 9. University, Taiwan. 10. Charitou, M., Elfani, M. and Lois, P.(2010), The effect of working capital management on firm s profitability: Empirical evidence from an emerging market, Journal of 11. Business & Economic Research, Vol. 8 No. 12, pp. 63-68. 12. Chiou, J., Cheng, L. and Wu, H. (2006), The determinants of working capital management, Journal of American Academy of Business, Vol. 10 No.1, pp. 149-155.

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