Capital Practices

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Capital Practices

Category : Articles

???A STUDY ON WORKING CAPITAL PRACTICES AND ITS IMPACTS ON ORGANIZATIONAL PERFORMANCES: SRI LANKAN ELECTRICAL COMPANIES PERSPECTIVE???
Introduction

This study provides an evidence of relationship between working capital practices and organizational performances in electrical companies in Sri Lanka. The information and data for the study were gathered through questionnaire and secondary data sources of a sample of electrical companies listed on the Colombo Stock Exchange. Company size has an influence on the overall working capital policy and approach.

Background of the study

Working capital management (WCM) is the management of short-term financing requirements of a firm. This includes maintaining optimum balance of working capital components ??“ receivables, inventory and payables ??“ and using the cash efficiently for day-to-day operations. Optimization of working capital balance means minimizing the working capital requirements and realizing maximum possible revenues. Efficient WCM increases firms??™ free cash flow, which in turn increases the firms??™ growth opportunities and return to shareholders. Even though firms traditionally are focused on long term capital budgeting and capital structure, the recent trend is that many companies across different industries focus on WCM efficiency. The study gives significant evidence for working capital practices and its impacts on the organizational performance.

Many exiting research papers have found that managers spend a considerable time on day-today working of capital decisions since current assets are short-lived investments that are continually being converted into other asset types. As a result, working capital management of a company is a very sensitive area in the field of financial management. It involves the decisions about the amount and composition of current assets and the financing of these assets. The decision-making process on the level of different working capital components has become frequent, repetitive, and time-consuming.

Listed all companies, which are selected by Colombo Stock Exchange institution of Sri Lanka are divided into 16 sectors. Out of 16 sectors, manufacturing sector is also one of them. In the manufacturing sector, four companies are taken for analysis, they are manufacturing electrical goods.
Research problem / Research question

Based on the findings of past researches and through the literature review, the following research question is created for conduct this research study effectively.
???How is working capital practices impact on financial performances of selected electrical companies listed in Colombo Stock Exchange???

This research question is narrow down as follows.

First, to develop an understanding of the determinants of various working capital practices currently used in listed companies of Colombo Stock Exchange: Do managers of these listed companies integrate working capital components in their decision-making processes

Second, to develop a working capital conceptual framework explaining the dynamics of working capital practices of listed companies in Colombo Stock Exchange: How do impact on organizational performances.

Hypotheses

From the aims and objectives of this study and the literature review, the following hypotheses are formulated:

H1:- A higher level of working capital is to result in a lower degree of financial Performance.

H2:- A sufficient level of working capital is to result in a higher degree of financial performance.

Objectives of the study

This study is identified to achieve the following objectives.

? To discover extend to which the working capital help in financial performance of the organization.

? To examine the relationship between these two variables and assess the fit between the outcome in meeting financial performance as working capital increase or decrease.

? To investigate the reasons for the variable relationship.

? To review the existing literature on working capital management to highlight the recent trends.

? To analyze the impact of different factors affecting the working capital on net liquidity balance and working capital requirement.

Significance of the study

The study will attempt to identify the degree to which organizations with working capital level in their financial performance and assess the fit between the outcomes of the two variables. Finding of the study could help organization to make suitable action, instance for maintaining to keep at an optimum level of working capital. Finding of this study could also from further research questions for further investigation, in future, on financial performance in Sri Lankan organization. By developing a conceptual framework, this study will provide a general Working Capital Management framework for researchers, policy makers, professionals and managers to guide future research, reappraise current business practices, and provide basic guidelines for new policies in dynamic business environments.

Scopes of the study

To achieve the objectives outlined, scope of the study and reporting extends to the following areas for an extensive research and analysis:-

? This study mainly focuses on the companies listed in Colombo Stock Exchange.

? This study uses financial data of the CSE for the period from 2004 to 2008.

Limitations of the study

In the circumstances of any event there are many limitations likewise there is no expectations in the report too. It was impossible to get all the data the identified limitations as follows,

? The findings have been generalized for organization, but this study is going to be carried out at selected Listed Electrical Companies in Sri Lanka.

? I am not sure that the information gained be adequate.

? My research is based on the CSE hand book of listed companies in 2008 for last five year.( in 2004 to 2008)

Conceptualization

|A |B |C |
|D |E |F |
|G |H |I |

High

Moderate

Low

Inadequate Sufficient Excessive

Each square of conceptual framework is described as follows:-

A. Inadequate Working Capital and High financial performance.

B. Sufficient Working Capital and High financial performance.

C. Excessive Working Capital and High financial performance.

D. Inadequate Working Capital and Moderate financial performance.

E. Sufficient Working Capital and Moderate financial performance.

F. Excessive Working Capital and Moderate financial performance.

G. Inadequate Working Capital and Low financial performance.

H. Sufficient Working Capital and Low financial performance.

I. Inadequate Working Capital and Low financial performance.

Operationalization

Operationalization of key concept and variables

|Concept |Variables |Indicators |Measures |
|Working Capital |Liquidity |Current ratio |Ratio |
| | |Acid-test ratio |Ratio |
| |Stock |Stock turnover |Days |
| |A/Cs Receivables |Debtor??™s payment |Days |
| | |period | |
| |A/Cs Payables |Creditor??™s turnover |Days |
| | |period | |

|Concept |Variables |Indicators |Measures |
|Financial Performance |Investment |Return on |Percentage |
| | |Investment (ROI) | |
| | |Return on |Percentage |
| | |Equity (ROE) | |
| |Profitability |Gross profit ratio |Percentage |
| | |Net profit ratio |Percentage |
| | |Operating profit |Percentage |
| | |ratio | |
| | |Return on Capital Employed |Percentage |
| | |(ROCE) | |

Review of Literature

The theoretical underpinnings

The working capital meets the short-term financial requirements of a business enterprise. It is a trading capital, not retained in the business in a particular form for longer than a year. The money invested in it changes form and substance during the normal course of business operations. The need for maintaining an adequate working capital can hardly be questioned. Just as circulation of blood is very necessary in the human body to maintain life, the flow of funds is very necessary to maintain business. If it becomes weak, the business can hardly prosper and survive. Working capital starvation is generally credited as a major cause if not the major cause of small business failure in many developed and developing countries (Rafuse, 1996). The success of a firm depends ultimately, on its ability to generate cash receipts in excess of disbursements. The cash flow problems of many small businesses are exacerbated by poor financial management and in particular the lack of planning cash requirements (Jarvis et al, 1996).

Empirical evidences

In the Pakistani context, Rehman (2006) investigated the impact of working capital management on the profitability of 94 Pakistani firms listed at Islamabad Stock Exchange (ISE) for a period of 1999-2004. He studied the impact of the different variables of working capital management including Average Collection Period, Inventory Turnover in Days, Average Payment Period and Cash Conversion Cycle on the Net Operating Profitability of firms. He concluded that there is a strong negative relationship between above working capital ratios and profitability of firms. Furthermore, managers can create a positive value for the shareholders by reducing the cash conversion cycle up to an optimal level. Similar studies on working capital and profitability includes Smith and Begemann (1997), Howorth & Westhead (2003), Ghosh & Maji (2004), Eljelly (2004), and Lazaridis and Tryfonidis (2006).

Afza and Nazir (2007) investigated the relationship between the aggressive/conservative working capital policies for seventeen industrial groups and a large sample of 263 public limited companies listed at Karachi Stock Exchange for a period of 1998-2003. Using ANOVA and LSD test, the study found significant differences among their working capital investment and financing policies across different industries. Moreover, rank order correlation confirmed that these significant differences were remarkably stable over the period of six years of study. Finally, ordinary least regression analysis found a negative relationship between the profitability measures of firms and degree of aggressiveness of working capital investment and financing policies. The current study, following Chiou and Cheng (2006), looks into the various factors those are determining the working capital requirements of non-financial firms in Pakistan.

Smith and Begemann (1997) emphasized that those who promoted working capital theory shared that profitability and liquidity comprised the salient goals of working capital management. The problem arose because the maximization of the firms returns could seriously threaten its liquidity, and the pursuit of liquidity had a tendency to dilute returns. This article evaluated the association between traditional and alternative working capital measures and return on investment (ROI), specifically in industrial firms listed on the Johannesburg Stock Exchange (JSE). The problem under investigation was to establish whether the more recently developed alternative working capital concepts showed improved association with return on investment to that of traditional working capital ratios or not. Results indicated that there were no significant differences amongst the years with respect to the independent variables. The results of their stepwise regression corroborated that total current liabilities divided by funds flow accounted for most of the variability in Return on Investment (ROI). The statistical test results showed that a traditional working capital leverage ratio, current liabilities divided by funds flow, displayed the greatest associations with return on investment. Well known liquidity concepts such as the current and quick ratios registered insignificant associations whilst only one of the newer working capital concepts, the comprehensive liquidity index, indicated significant associations with return on investment.

Ghosh and Maji,(2003) in this paper made an attempt to examine the efficiency of working capital management of the Indian cement companies during 1992 ??“ 1993 to 2001 ??“ 2002. For measuring the efficiency of working capital management, performance, utilization, and overall efficiency indices were calculated instead of using some common working capital management ratios. Setting industry norms as target-efficiency levels of the individual firms, this paper also tested the speed of achieving that target level of efficiency by an individual firm during the period of study. Findings of the study indicated that the Indian Cement Industry as a whole did not perform remarkably well during this period.

Soenen (1993) investigated the relationship between the net trade cycle as a measure of working capital and return on investment in U.S firms. The results of chi-square test indicated a negative relationship between the length of net trade cycle and return on assets. Furthermore, this inverse relationship between net trade cycle and return on assets was found different across industries depending on the type of industry. A significance relationship for about half of industries studied indicated that results might vary from industry to industry. Another aspect of working capital management has been analyzed by Lamberson (1995) who studied how small firms respond to changes in economic activities by changing their working capital positions and level of current assets and liabilities. Current ratio, current assets to total assets ratio and inventory to total assets ratio were used as measure of working capital while index of annual average coincident economic indicator was used as a measure of economic activity. Contrary to the expectations, the study found that there is very small relationship between charges in economic conditions and changes in working capital.

Research design and methods

Type and place of study

This is a descriptive of study impact of working capital on financial Performance of selected listed electrical company in Sri Lanka.

Variables

This study incorporates all the items (current assets and current liabilities) that affect working capital of a firm and they are the independent variables in this study. Financial performance is the dependent variable.

Population and sample

Systematic sampling method is used to select sample, such as listed all companies, which are selected by Colombo Stock Exchange institution of Sri Lanka are divided into 16 sectors. Out of 16 sectors, manufacturing sector is also one of them. In the manufacturing sector following firms are taken for analysis, they are manufacturing electrical goods.

|1 |Abans Electrical Limited (Abans) |
|2 |Associated Electrical Corporation (AEC) |
|3 |ACL Cables Limited (ACL) |
|4 |Regins Lanka Limited (RLL) |

Here the size of the population is 16 (N=16) and size of the sample is 4 (n=4).
Data collection

Secondary data are used from sources such as annual reports and other published information of CSE. (Listed company??™s hand book of the CSE 2008)

For this research purpose, data of the firms are going to be collected. The data such as current assets, current liabilities, net working capital employed of the selected firms will be collected.

Data presentation, data analysis and Statistical techniques

All data will be analyzed by using the SPSS (Statistical Package for Social Sciences 13.0).Descriptive statistics (measures of central tendency, measures of dispersion) and inferential statistical tests like correlations and regression analysis and ANOVA as appropriate, will be used to present findings.

Chapter outline

Chapter 1 provides a brief description of the study. This chapter intends to analyse detailing of the objectives and scopes of the study along with the research problem.

Chapter 2 represents the body of the text covers a detailed review of the available literature on the topic of the working capital practices and its impacts on organizational performances to provide the reader an extensive knowledge on the concept of working capital that exists in electrical companies listed in Colombo Stock Exchange.

Chapter 3 describes research design and methodology and this chapter includes conceptual frame work of the study, operationalization of the key concepts and variables, sampling design, data collection method, hypotheses and tools used in this study.

Chapter 4 presents and interprets the results obtained from the data analysis, commenting on the significance of findings at every stage and testing the hypotheses. It covers all the aspects of data analysis including a description of the data and the preliminary analysis.

Chapter 5 goes to enlighten the reader on the findings of the study and conclusions drawn there from.

Estimation of Timeline

| |Duration of month |
|Activities | |

|Nov

2009 |Dec

2009 |Jan

2010 |Feb |Mar |Apr |May |June |July |Aug | |Planning the research | | | | | | | | | | | |Submit the Research proposal | |[pic] | | | | | | | | | |Complete the

literature review | | | | | | | | | | | |Development of the questionnaire | | | | | | | | | | | |Pilot Testing of the Questionnaire | | | | | | | | | | | |Data collection from secondary sources | | | | | | | | | | | |Coding , Data entry and analysis | | | | | | | | | | | |Report and Presentation Preparation | | | | | | | | | | | |Presentation and Final Report | | | | | | | | | | | |

Final Report

One copy of the final report will be prepared and submitted to the department of accountancy and finance, faculty of business studies, Vavuniya campus of the University of Jaffna by August, 2010.

Bibliography

Anand, M. (2001). ???Working Capital Performance of Corporate India: An empirical survey???, Management and Accounting Research, Vol. 4(4), pp. 35-65.

Burns, R and Walker, J. (1991). ???A Survey of Working Capital Policy Among Small Manufacturing Firms???, The Journal of Small Business Finance 1 (1), pp. 61-74.

Deloof, D. (2003). ???Does Working Capital Management affect Profitability of Belgian Firms??? Journal of Business Finance and Accounting, 30 No 3 and 4, pp. 573 ??“ 587.

Ghosh SK and SG Maji (2004). ???Working Capital Management Efficiency: A Study on the Indian Cement Industry???. The Management Accountant 39(5): 363-372.

Howorth, C., and Westhead, P. (2003). ???The focus of working capital management in UK small firms???. Management Accounting Research 14, pp. 94-111.

Kim, Suk H., Martha Rowland and Seung H. Kim, (1992). ???Working Capital Practices By Japanese Manufacturers in U.S.,??? Financial Practice and Education 2 (1), pp. 89-92.

Lazaridis, I., and Tryfonidis, D. (2006). ???Relationship between Working Capital Management and Profitability of Listed Companies in the Athens Stock Exchange???. Journal of Financial Management and Analysis, 19(1), pp. 26-35.

Maxwell CE, LJ Gitman and SAM Smith (1998). ???Working Capital Management and Financial-Service Consumption Preferences of US and Foreign Firms: A Comparison of 1979 and 1996 Preferences???. Financial Practice and Education 8(2), pp. 46-52.

New Alix Partners (2007), ???Working capital improvement now deemed urgent by half of

CFOs???,[http://www.marketwire.com/pressrelease/Alixpartners-801773.html Accessed on 25 September, 2008].

Padachi, K. (2006). ???Trends in working capital management and its impact on firms??™ performance: an analysis of Mauritian small manufacturing firms???. International Review of Business Research Papers, 2(2), pp.45-58.

Peel, M. L. and Wilson, N. (1996). ???Working capital and financial management practices in small firm sector???. International Small and Business Journal, 14(2), pp.52-68.

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Levels of working capital

Levels of financial performance