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Capital Management And Application In Companies Of Mongolia Finance Essay

This study purpose is to investigate the relationship between working capital management and firm’s profitability using correlation and regression analyses. Using a sample of 169 annual financial statements of 6 different sectors firms listed in the Mongolian Stock Exchange, this study found Mongolian medium sized firms had strong negative relationship between profit and cash conversion cycle. The results suggest that managers can increase profitability of their firms by shortening the cash conversion cycle and inventory conversion period.

INTRODUCTION

1.1 Background

Working capital management is a key element to business success and the number one way to prevent business failure. By implementing strategies such as accounts receivable funding, outsourcing, or inventory management, your business can optimize the return on assets it already possesses. Your company will then be well positioned to handle future growth or economic downturns. So I think working capital plays a significant and major role in the achievement of business growth and it is major factor of management.

The recent trend is that many companies focus on Working Capital Management because it shows result in short term. Efficient WCM increases firms’ free cash flow which is support daily operation. Firms can strengthen their funding capabilities or decrease the source cost reducing source amount they allocate current assets (Mehmet Sen 2009).

Working capital is the total of current assets such as cash, inventory, and receivables that are not being financed by the current liabilities such as accounts payable or short-term credit. It should be sufficient to pay any current liabilities as they come due and cover the financing of daily operations. It is an important indicator of a firm's liquidity. The amount of working capital needs is determined by a number of factors, including the size and type of inventory purchases, and the amount and terms of both its accounts receivable and accounts payable, its bank loans, and the amount of equity the owner has in the business.

1.2 Problem Statement

The current crisis has shown that high levels of debt make medium sized companies vulnerable in economic downturns. Operational performance in companies becomes even more important in weak economic conditions. I see some lack knowledge and experience among Mongolian businessmen and entrepreneurs to operate medium and cooperated business unit. They have some difficulties in financing, investing and allocating funds under the governmental pressure and current market condition. So in this case first step is they need to manage their working capital. But do they manage their working capital? Do they know working capital management can increase their profit?

If you require financing for your business the amount of working capital you will need is more than the difference between current assets and liabilities. A proper level of working capital is a sign of good management. Working capital management is important because of its effects on the firm’s profitability and risk, and consequently its value (Smith, 1980).

There is no exact figure or rule of thumb that will ensure your business has sufficient working capital. Professional advisers have suggested that the value of current assets should be double that of current liabilities, but a 2:1 ratio may not always be sufficient. The amount of working capital your business will require depends on the nature of your business and the assets making up the working capital. Small cash run businesses, those with little or no receivables and small inventories may be able to manage by maintaining a ratio of less than 1:1. Other businesses with substantial debt and a high level of outstanding receivables will need an above average amount of working capital.

Shorter cash conversion cycle could be associated with high profitability because it improves the efficiency of using the working capital. Although the length of cash conversion cycle is an important measure of the efficiency of working capital management, little is known the affect of cash conversion cycle on firm’s profitability.

1.3 Research Purpose

In this research researcher would like to investigate the relationship between working capital management and firm profitability. Also the next aim of this paper is to identify working capital management tools such as current and quick ratios can be different regarding operational size and type.

By reading this paper, researchers and managers will obtain knowledge about how working capital management is important, relationship between operational profit and working capital management, and also working capital management tools are same or not to all sectors of businesses.

LITERATURE REVIEW

2.1 Working capital management efficiency

The importance of working capital management is not new to the finance literature. Over thirty years ago, Largay and Stickney (1980) reported that the then-recent bankruptcy of W.T. Grant, a nationwide chain of department stores, should have been anticipated because the corporation had been running a deficit cash flow from operations for eight of the last ten years of its corporate life. As part of a study of the Fortune 500’s financial management practices, Gilbert and Reichert (1995) find that accounts receivable management models are used in 59 percent of these firms to improve working capital projects, while inventory management models were used in 60 percent of the companies. More recently, Farragher, Kleiman and Sahu (1999) find that 55 percent of firms in the S&P Industrial index complete some form of a cash flow assessment, but did not present insights regarding accounts receivable and inventory management, or the variations of any current asset accounts or liability accounts across industries. Thus, mixed evidence exists concerning the use of working capital management techniques.

Theoretical determination of optimal trade credit limits are the subject of many articles over the years (e.g., Schwartz 1974; Scherr 1996), with scant attention paid to actual accounts receivable management. Across a limited sample, Weinraub and Visscher (1998) observe a tendency of firms with low levels of current ratios to also have low levels of current liabilities. Simultaneously investigating accounts receivable and payable issues, Hill, Sartoris, and Ferguson (1984) find differences in the way payment dates are defined. Payees define the date of payment as the date payment is received, while payors view payment as the postmark date. Additional WCM insight across firms, industries, and time can add to this body of research.

2.2 Result of previous researchers

Some researchers studied the impact of optimum inventory management, shortening the cash conversion cycle while others studied the management of account receivables in optimum way that leads to profit maximization.

The study of Shin and Soenen (1998) is test the effect of cash conversion cycle on the firm’s profitability. In their study they used a large sample of listed American firms covering the period 1975-1994. In intention to discover the relationship between efficient working capital management and firm’s profitability (Shin & Soenen, 1998) used net-trade cycle (NTC) as a measure of working capital management. NTC is basically equal to the CCC whereby all three components are expressed as a percentage of sales. The reason by using NTC because it can be an easy device to estimate for additional financing needs with regard to working capital expressed as a function of the projected sales growth. This relationship is examined using correlation and regression analysis, by industry and working capital intensity. They found, a strong negative relation between the length of the firm's net-trade cycle and its profitability. In addition, shorter NTC are associated with higher risk-adjusted stock returns. In other word, (Shin & Soenen, 1998) suggest that one possible way the firm to create shareholder value is by reducing firm’s NTC.

Deloof (2003) analyzes a sample of large Belgian firms during the period 1992-1996. His results confirm that Belgian firms can improve their profitability by reducing the number of days accounts receivable are outstanding and reducing inventories. Deloof used trade credit policy and inventory policy are measured by number of days accounts receivable, accounts payable and inventories, and the cash conversion cycle as a comprehensive measure of working capital management. He founds a significant negative relation between gross operating income and the number of days accounts receivable, inventories and accounts payable. Thus, he suggests that managers can create value for their shareholders by reducing the number of days accounts receivable and inventories to a reasonable minimum. He also suggests that less profitable firms wait longer to pay their bills.

Besley and Brigham (2005) describes cash conversion cycle as “ the length of time from the payment for the purchase of raw materials to manufacture a product until the collection of account receivable associated with the sale of the product.

Haitham Nobanee and Maryam AlHajjar (2005) are found a significant negative relationship between cash conversion cycle and return on investment, receivable collection period and return on investment, and inventory conversion period and return on investment.

In other study, (Lyroudi & Lazaridis, 2000) use food industry Greek to examined the cash conversion cycle (CCC) as a liquidity indicator of the firms and tries to determine its relationship with the current and the quick ratios, with its component variables, and investigates the implications of the CCC in terms of profitability, indebtness and firm size. The results of their study indicate that there is a significant positive relationship between the cash conversion cycle and the traditional liquidity measures of current and quick ratios. The cash conversion cycle also positively related to the return on assets and the net profit margin but had no linear relationship with the leverage ratios. Conversely, the current and quick ratios had negative relationship with the debt to equity ratio, and a positive one with the times interest earned ratio. Finally, there is no difference between the liquidity ratios of large and small firms.

Elliehausen and Woken (1993), Petersen and Rajan (1997) and Danielson and Scott (2000) show that small and medium-sized US firms use vendor financing when they have run out of debt. Thus, efficient working capital management is particularly important for smaller companies (Peel and Wilson, 1996).

CONCEPTUAL FRAMEWORK

Component of working capital

There are two definitions of working capital (1) Gross working capital (2) Net working capital. Gross working capital (Gross working capital = Total current assets) refers to working capital as the total of current assets, whereas the net working capital refers to working capital as excess of current assets over current liabilities. In other words net working capital refers to current assets financed by long term funds. The net working capital (Net working capital = Current assets – Current liabilities) position of the firm is an important consideration, as this will determine the firm’s profitability and risk. Here the profitability refers to profits after expenses and risk refers to the probability that a firm will become technically insolvent where it will be unable to meet obligations when they become due for payment.

Generally speaking, companies with higher amounts of working capital are better positioned for success because they have the liquid assets that are essential to expand their business operations when required.

Among the most important items of working capital are levels of inventory, accounts receivable, and accounts payable. Working capital can be expressed as a positive or a negative number. When a company has more debts than current assets, it has negative working capital. When current assets outweigh debts, a company has positive working capital.

The requirement for working capital depends on the type of company. Some companies are intrinsically better off than others. Manufacturing companies can incur considerable upfront costs for materials and labor before they receive payment. For much of the time, these companies spend more cash than they generate.

Working capital management

A finance manager has to make an appropriate financing mix, which will limit the risk and increase the profitability. Financing mix refers to the proportion of current assets financed by current liabilities and long term funds. There are two approaches which determine the financing mix (1) Aggressive approach (2) Conservative approach. According to aggressive approach the long term funds are used to finance only the core or fixed portion of current assets (e.g., minimum level of finished goods inventory, raw material etc) and the other portion i.e. temporary and seasonal requirements are financed by short term funds. This is of high risk and high profit financing mix.

According to conservative approach the total current assets are financed from long term sources and short term sources are used only in emergency situation i.e. when there is an unexpected cash outflow. This is of low-risk and low-profit financing mix.

As we observed two methods of financing mix, one method is of high risk high profit and other is of risk low profit. A finance manager has to trade off between these two extremes.

WC management is an integral part of overall corporate management. For proper WC management the financial manager has to perform the following basic functions:

Estimating the WC requirement.

Determining the optimum level of current assets.

Financing of WC needs.

Analysis and control of WC.

WC management decisions are three dimensional in nature i.e. these decisions are usually related to these there sphere or fields.

Profitability, risk and liquidity.

Composition and level of current assets.

Composition and level of current liabilities.

Proper management of working capital gives a firm the assurance that it is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses. If a company’s current assets do not exceed its current liabilities, then it may run into trouble paying back creditors in the short term. A declining working capital ratio over a longer time period could also be a red flag that merits further analysis. For example, it could be that the company’s sales volumes are decreasing and, as a result, its accounts receivable are diminishing.

Working capital management tools

A financial ratio is a relationship that indicates something about a company's activities, such as the ratio between the company's current assets and its current liabilities or between its debtors and its turnover. The basic source of these ratios is the company's profit & loss account and balance sheet that contain all kinds of important information about that company. The ratios really help to bring those details to light and identify the financial strengths and weaknesses of the company. When assessing ratios, it is important that the results are compared with other companies in the same industry and not to be taken in isolation. What may seem like a poor ratio at first glance may well be normal for that industry and, of course, the reverse applies, in that what may seem a good ratio on its own, could be below average for that industry. Financial ratios can be divided such as Liquidity Analysis Ratios, Profitability Analysis Ratios, and Activity Analysis Ratios. The following, easily calculated, ratios are important measures of working capital utilization.

Receivables Ratio (in days) = Debtors * 365/ Sales

Payables Ratio (in days) = Creditors * 365/ Cost of Sales (or Purchases)

Current Ratio = Total Current Assets/ Total Current Liabilities

Quick Ratio = (Total Current Assets - Inventory)/ Total Current

Working Capital Ratio = (Inventory + Receivables - Payables)/ Sales

METHODOLOGY

4.1 Data selection

We selected those companies meeting the following criteria for at least three years from Mongolia;

have fewer than 250 employees

turnover less than $50 million

possess less than $30 million of total assets.

And of course we tried to cover and choose companies from all sectors, all operational types. Data was collected from Mongolian Ministry of Finance and Mongolian Stock Exchange. Companies that meet above requirement are small and medium sized company in Mongolia. We choose 169 companies those are represented wholesales trading, manufacturing, transportation, food, service and mining companies. We categorized in six groups, which are manufacturing (53 companies), service (49 companies), mining (17 companies), farm (13 companies), trading (32 companies), and construction (5companies).

4.2 Variables

In order to analyze the effects of working capital management on the firm’s profitability, we used the gross profit as the dependent variable.

With regards to the independent variables, we measured working capital management by using the number of days accounts receivable, number of days of inventory and number of days accounts payable.

In this respect, number of days accounts receivable (AR) is calculated as 365 x (accounts receivable/sales). This variable represents the average number of days that the firm takes to collect payments from its customers.

We calculated the number of days of inventory (INV) as 365 x (inventories/purchases). This variable reflects the average number of days of stock held by the firm. Longer storage times represent a greater investment in inventory for a particular level of operations.

The number of days accounts payable (AP) reflects the average time it takes firms to pay their suppliers. We calculated this as 365 X (accounts payable/purchases). The higher the value, the longer firms take to settle their payment commitments to their suppliers.

Considering these three periods jointly, we estimated the cash conversion cycle (CCC). This variable is calculated as the number of days accounts receivable plus the number of days of inventory minus the number of days accounts payable. The longer the cash conversion cycle means the greater the net investment in current assets, and hence the greater the need for financing of current assets.

Also we made comparison of ratios and analyzed why different sectors ratios are different from each other. There are many ratios related to analyze of working capital management.

Working Capital Ratio (Current Ratio) indicates whether a company has enough short term assets to cover its short term debt. Anything below 1 indicates negative working capital. While anything over 2 means that the company is not investing excess assets. Most believe that a ratio between 1.2 and 2.0 is sufficient. But companies that have high inventory turns and do business on a cash basis (such as a grocery store) need very little working capital. These types of businesses raise money every time they open their doors, then turn around and plow that money back into inventory to increase sales. Since cash is generated so quickly, managements can simply stockpile the proceeds from their daily sales for a short period of time if a financial crisis arises. Since cash can be raised so quickly, there is no need to have a large amount of working capital available.

Quick ratio indicates whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. The quick ratio is far more strenuous than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets. Calculated by:

Companies with ratios of less than 1 cannot pay their current liabilities and should be looked at with extreme caution. Furthermore, if the quick ratio is much lower than the working capital ratio, it means current assets are highly dependent on inventory.

Shares and participation to other firm are considered as fixed financial assets. The variable we use which is related to financial assets is the following:

Fixed Financial Assets Ratio = Fixed Financial Assets/Total Assets

This variable is used since for many listed companies financial assets comprise a significant part of their total assets. This variable will be used later on in order to obtain an indication how the relationship and participation of one firm to others affects its profitability.

Working capital per dollar of sales is a financial ratio that tells you how much money a company needs to keep on hand to support its operations. Working Capital per Dollar of Sales is equal to Working Capital /Total Sales.

We used some ratios that show companies profitability – return on assets, gross profit and gross profit margin.

DATA ANALYSIS

5.1 Descriptive Statistics

The following table gives the descriptive statistics of the collected variables. The total of observations sums to n = 169. But we used 34 observations to analyze cash conversion cycle and used 169 observations to analyze other ratios because of limited information. On average 59.5% of total assets are fixed assets. Total sales have a mean of 8,310.5 million tugrigs while the median is 1,099.2 million. The credit period granted to their customers ranged at 97 days on average (median 44 days) while they paid their creditors in 186 days on average (median 50 days). Payable period had too much days result because many telecommunication and servicing company was included in my observation. These types of company had very low level of cost of goods sold however large amount of payable had. Inventory takes on average 120 days to be sold (median 94 days). Overall the average cash conversion cycle ranged at 31 days (median 65 days).

Table 1.

Descriptive statistics

Net Sales

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

8,310,578.38

8,149,747.86

10,338,358.64

17,449,077.41

311,491.22

5,131,280.03

970,730.53

Standard Error

1,057,461.70

1,783,346.03

2,158,990.65

5,051,298.43

94,745.77

1,526,854.63

397,967.78

Median

1,099,153.41

1,566,053.15

2,019,773.74

9,234,204.80

175,000.00

261,059.17

576,980.58

Standard Deviation

13,988,903.42

13,345,339.71

15,418,277.20

20,827,036.99

341,610.73

8,637,194.09

974,818.00

Minimum

333.04

2,763.64

7,559.45

282,063.20

9,141.30

333.04

650.00

Maximum

70,113,856.30

67,414,225.76

67,370,060.68

70,113,856.30

991,543.85

28,118,433.22

2,693,710.33

Count

169

53

49

17

13

32

5

Current assets ratio

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

0.404817102

0.35764058

0.336732935

0.45152914

0.673969448

0.46631751

0.319893443

Standard Error

0.020126135

0.026992472

0.034292149

0.047633881

0.075505779

0.059967814

0.092657321

Median

0.389215635

0.392289879

0.312414719

0.441546796

0.809520129

0.399663103

0.28018541

Standard Deviation

0.261639753

0.196508161

0.240045042

0.196399523

0.272239956

0.339229186

0.207188068

Minimum

0.000121747

0.001527344

0.000121747

0.020119008

0.034426781

0.019011075

0.081384209

Maximum

0.986964408

0.790388088

0.932395702

0.86443424

0.927160782

0.986964408

0.649208207

Count

169

53

49

17

13

32

5

Fixed Financial Assets Ratio

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

0.595182898

0.64235942

0.663267065

0.54847086

0.326030552

0.53368249

0.680106557

Standard Error

0.020126135

0.026992472

0.034292149

0.047633881

0.075505779

0.059967814

0.092657321

Median

0.610784365

0.607710121

0.687585281

0.558453204

0.190479871

0.600336897

0.71981459

Standard Deviation

0.261639753

0.196508161

0.240045042

0.196399523

0.272239956

0.339229186

0.207188068

Minimum

0.013035592

0.209611912

0.067604298

0.13556576

0.072839218

0.013035592

0.350791793

Maximum

0.999878253

0.998472656

0.999878253

0.979880992

0.965573219

0.980988925

0.918615791

Count

169

53

49

17

13

32

5

Current ratio

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

25.50066113

2.334732428

2.922041071

4.850049213

3.679822794

121.7580114

3.229200296

Standard Error

22.11901208

0.57066377

1.330128788

2.761849972

1.129624519

116.7330828

1.334159785

Median

1.083272864

0.944214547

1.261572726

0.76362596

1.53629536

1.257409369

1.763312865

Standard Deviation

287.5471571

4.154494957

9.310901514

11.38739916

4.072919127

660.3420357

2.983271973

Minimum

0.000461538

0.003893537

0.000461538

0.020403221

0.119576554

0.051305568

0.614673673

Maximum

3739.167845

18.78552681

64.60110939

45.21519157

11.75837413

3739.167845

8.1107121

Count

169

53

49

17

13

32

5

Quick Ratio

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

25.29452383

2.007787184

2.838508289

4.790517015

3.679822794

121.3703879

3.229200296

Standard Error

22.12002732

0.450404431

1.331144952

2.766919915

1.129624519

116.7458386

1.334159785

Median

0.904998214

0.904998214

1.149784076

0.76362596

1.53629536

0.731521817

1.763312865

Standard Deviation

287.5603551

3.278993752

9.318014664

11.40830307

4.072919127

660.4141932

2.983271973

Minimum

0.000461538

0.003893537

0.000461538

0.018656781

0.119576554

0.051305568

0.614673673

Maximum

3739.167845

16.34796146

64.60110939

45.21519157

11.75837413

3739.167845

8.1107121

Count

169

53

49

17

13

32

5

Working Capital per dollar of sales

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

-11.49801001

-1.477733559

-0.393523722

-23.79838469

0.02298689

-45.04943429

0.058891353

Standard Error

7.500177432

1.444602531

0.372006115

22.90552622

0.97769037

37.51127839

0.152051191

Median

0.053711517

-0.020345177

0.091130063

-0.261721441

0.2214237

0.093348216

0.136573246

Standard Deviation

97.50230661

10.51686518

2.604042806

94.44190402

3.52511278

212.1958346

0.339996799

Minimum

-1194.261286

-64.9501949

-10.26358516

-390.2363635

-8.57641894

-1194.261286

-0.51594573

Maximum

18.84869126

18.84869126

7.142261923

0.39004991

6.20861093

2.672634626

0.349285759

Count

169

53

49

17

13

32

5

Return on Assets (ROA)

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

-3.656883426

0.037999877

0.051612884

-0.33047298

-0.024699411

-19.2583015

-0.07030841

Standard Error

3.649335483

0.165333298

0.055468191

0.304090668

0.074703326

19.27086656

0.144534407

Median

0.036395073

0.030000472

0.062116135

0

0.04172798

0.058929672

0.013196908

Standard Deviation

47.44136127

1.203644581

0.388277337

1.253797945

0.269346673

109.0124834

0.323188759

Minimum

-616.6424554

-2.81683033

-1.41475867

-5.125044704

-0.518303052

-616.642455

-0.63212846

Maximum

7.871520345

7.871520345

0.892125206

0.42178586

0.409055252

2.896179039

0.198516045

Count

169

53

49

17

13

32

5

Gross profit

All

Manufacturing

Service

Mining

Farm

Trading

Construction

Mean

2,176,291.43

1,276,013.46

3,917,528.98

3,927,902.86

122,667.97

1,188,735.01

359,413.20

Standard Error

405,729.28

496,568.33

851,247.28

2,588,605.29

57,422.51

347,816.53

161,153.63

Median

349,887.69

274,324.88

824,350.50

767,121.90

53,919.83

282,207.30

282,164.70

Standard Deviation

5,274,480.66

,615,071.99

5,958,730.98

10,673,093.03

207,039.80

1,967,547.42

360,350.48

Minimum

(14,498,138.40)

(2,080,942.09)

(130,841.08)

(14,498,138.40)

(7,624.75)

(15,036.37)

29,508.05

Maximum

37,768,600.50

23,775,292.48

26,271,704.10

37,768,600.50

726,123.85

8,084,799.46

923,772.27

Count

169

53

49

17

13

32

5

Inventory ratio

All

Manufacturing

Service

Mining

Trading

Mean

119.9888914

201.5712248

99.97400264

115.1454497

111.1574344

Standard Error

17.6586639

70.79001646

25.92288267

25.7075058

25.91357565

Median

93.9966359

104.5550992

76.31581315

119.3667509

78.76682439

Standard Deviation

102.9668198

158.2912889

100.3988929

51.41501159

81.94592138

Minimum

2.467087299

67.7847667

2.467087299

52.83965651

42.26575355

Maximum

410.9863601

410.9863601

388.4526117

169.0086405

282.2505661

Count

34

5

15

4

10

Receivables Ratio

All

Manufacturing

Service

Mining

Trading

Mean

97.18905316

19.3246892

168.5531261

73.70524366

38.46864949

Standard Error

32.60764665

6.349563031

70.37518503

19.02944869

6.968833923

Median

43.9937835

16.12142731

72.68491607

76.33402892

43.9937835

Standard Deviation

190.133619

14.19805457

272.5619196

38.05889738

22.03738783

Minimum

1.148490388

5.833481827

1.148490388

28.10287316

11.00447495

Maximum

853.6074898

39.82040691

853.6074898

114.0500437

67.22215632

Count

34

5

15

4

10

Payables Ratio

All

Manufacturing

Service

Mining

Trading

Mean

186.4924303

15.26306032

326.3784527

75.01765686

106.8679909

Standard Error

62.10363767

5.321420379

131.9082052

31.34425368

34.61926232

Median

50.16483614

9.98990838

56.97533811

61.70898447

57.03820374

Standard Deviation

362.1233237

11.89905771

510.8782821

62.68850737

109.4757199

Minimum

4.725403071

4.725403071

16.13002107

16.25382784

11.97404276

Maximum

1473.77368

33.40969767

1473.77368

160.3988307

320.5402978

Count

34

5

15

4

10

CCC

All

Manufacturing

Service

Mining

Trading

Mean

30.68551424

205.6328537

-57.85132398

113.8330365

42.75809293

Standard Error

68.35912445

71.74515129

148.2483897

50.88201355

46.43254708

Median

65.1220652

103.5981288

-3.43455961

129.2638988

41.29449557

Standard Deviation

398.5987662

160.4270353

574.1635444

101.7640271

146.8326063

Minimum

-1224.436405

65.55542856

-1224.436405

-5.941952232

-207.341123

Maximum

869.5863231

417.0695967

869.5863231

202.7463007

255.5853024

Count

34

5

15

4

10

5.2 Correlation analysis

The following table shows us the correlation between the variables that will be included in my next regression model. We observe that the gross profit is negatively correlated with the variables of number of days accounts receivables, number of days accounts payables and cash conversion cycle. These results are consistent with the view that the shorter the period between production and sale of products the larger firm’s profitability. It is apparent that companies with cash in hand can purchase raw materials from suppliers with better prices. The negative relation between accounts payables and gross profit indicate that more profitable firms delay their payment towards their suppliers-creditors.

 

FA

Net Sales

Gross Profit

INV

AR days

AP days

CCC days

WC per dollar of sales

Net Sales

0.9113

Gross Profit

0.796287

0.849101

INV

-0.114729

-0.23607

-0.166536

AR days

-0.071145

-0.230152

-0.11967

-0.164775

AP days

0.313336

0.301166

0.351421

-0.09859

0.080738

CCC days

-0.177063

-0.384362

-0.254706

0.346352

0.852663

-0.143894

WC per dollar of sales

-0.091712

-0.299894

-0.236616

-0.001079

0.947698

-0.071387

0.908837

ROA

0.349221

0.209387

0.490345

-0.258071

0.609993

0.252549

0.408589

0.535993

5.3 Regression analysis

So far we established a framework of literature and data analysis in order to investigate the impact of working capital management on profitability. In order to shed more light on the relationship of working capital management on firms’ profitability we use regression analysis. In the following proposed models we examine the variable which is profitability against seven variables. The independent variables are fixed assets, the net sales, operating expenses, cash conversion cycle, number of days accounts receivable, number of days of inventory, and number of days accounts payable.

Following is the first regression, where gross profit is regressed against fixed assets, the net sales, cash conversion cycle :

Regression equation:

PROFIT=-1550520.597-0.02343056291*FIXEDASSETS+0.3545675113*SALES+0.2919256252*EXPENSES-383.9024687*CCC

SUMMARY OUTPUT

Regression Statistics

Multiple R

0.70853641

R Square

0.50202384

Adjusted R Square

0.43088439

Standard Error

6251164.06

Observations

34

ANOVA

 

df

SS

MS

F

Regression

6

1,103,051,047,532,660.00

275,762,761,883,166.00

7.056898

Residual

28

1,094,157,460,344,720.00

39,077,052,155,168.60

Total

34

2,197,208,507,877,380.00

 

 

 

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Intercept

-1550520.6

1983397.009

-0.781749992

0.440922

-5613325.141

2512283.95

Fixed assets

-0.0234306

0.158792315

-0.147554766

0.883752

-0.34870187

0.30184074

Net Sales

0.35456751

0.139355912

2.544330604

0.016749

0.06910987

0.64002515

Operating Expenses

0.29192563

0.231012283

1.263680102

0.216765

-0.181281578

0.76513283

CCC

-383.90247

3052.501051

-0.125766531

0.900815

-6636.667339

5868.8624

Durbin-Watson statistics

2.657267

This regression equation shows that there is a negative relationship between cash conversion cycle and profitability which is consistent with the view that a decrease in the cash conversion cycle will generate more profits for a company. The above result is highly significant. This result makes economic sense since if all coefficients were zero then a firm would have negative results i.e Gross Profit = -1550520.6.

The second regression has the dependent variable gross profit and the same independent variables as in the first regression equation. The only difference is the substitution of the cash conversion cycle with the accounts payables. We observed that there is a negative relationship between gross profit and accounts payables. This result is highly significant and does make economic sense, since the longer a firm delays its payments the higher level of working capital levels it reserves and uses in order to increase profitability.

Table 4.

Regression equation:

PROFIT=-2053905.202-0.05708586084*FIXEDASSETS+0.3889212543*SALES+ 0.2766229383*EXPENSES+ 1640.387067*APDAYS

SUMMARY OUTPUT

Regression Statistics

Multiple R

0.710629196

R Square

0.504993854

Adjusted R Square

0.43427869

Standard Error

6232494.674

Observations

34

ANOVA

 

df

SS

MS

F

Significance F

Regression

6

1,109,576,791,922,560.00

277,394,197,980,640.00

7.1412386

0.000427974

Residual

28

1,087,631,715,954,820.00

38,843,989,855,529.40

Total

34

2,197,208,507,877,380.00

 

 

 

 

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Intercept

-2053905.2

2274381.047

-0.903061167

0.3741973

-6712763.52

Fixed assets

-0.05708586

0.176836695

-0.322816827

0.7492323

-0.419319406

Net Sales

0.388921254

0.161331403

2.410697778

0.0227341

0.058448861

Operating Expenses

0.276622938

0.228764412

1.209204423

0.236696

-0.19197971

Payables Ratio

1640.387067

3825.097883

0.42884839

0.671315

-6194.970651

Durbin-Watson statistics

2.700689

In the third equation we use the same variables except the one of accounts payables which we replace with accounts receivables. The results show that there is a positive relationship between gross profit and accounts receivables. As mentioned before on average 59.5% of total assets are fixed assets and 15.8% of total assets are receivables. So therefore comparing with receivables, return on fixed assets are more relative to the gross profit.

Table 5.

Regression equation:

PROFIT=-2069527.656-0.03511536129*FIXEDASSETS+0.3692841222*SALES+ 0.3107818406*EXPENSES+2754.416608*ARDAYS

SUMMARY OUTPUT

Regression Statistics

Multiple R

0.710899309

R Square

0.505377828

Adjusted R Square

0.434717518

Standard Error

6230076.945

Observations

34

ANOVA

 

df

SS

MS

F

Significance F

Regression

6

1,110,420,463,069,910.00

277,605,115,767,479.00

7.152216367

0.000423631

Residual

28

1,086,788,044,807,470.00

38,813,858,743,123.90

Total

34

2,197,208,507,877,380.00

 

 

 

 

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Intercept

-2069527.656

2260172.836

-0.915650176

0.367669427

-6699281.773

2560226.462

Fixed assets

-0.035115361

0.155435017

-0.225916669

0.822907224

-0.353509555

0.283278833

Net Sales

0.369284122

0.13911646

2.654496259

0.01294978

0.084316976

0.654251268

Operating Expenses

0.31078184

0.223808724

1.388604673

0.175901329

-0.147669543

0.769233224

Receivables Days

2754.416608

6071.799796

0.453640881

0.653583846

-9683.101293

15191.93451

Durbin-Watson statistics

2.734022

In the last regression we added number of days for inventory in an attempt to explain gross profit. Although there is negative relationship between gross profit and inventory which can be translated that the longer inventory is tied in the less working capital is available.

Table 6.

Regression equation:

PROFIT=-1491440.123-0.01644371255*FIXEDASSETS+0.3478133363*SALES +0.2986993328*EXPENSES-479.270392*INDAYS

SUMMARY OUTPUT

Regression Statistics

Multiple R

0.708361721

R Square

0.501776327

Adjusted R Square

0.430601517

Standard Error

6252717.387

Observations

34

ANOVA

 

df

SS

MS

F

Significance F

Regression

6

1,102,507,215,586,140.00

275,626,803,896,536.00

7.049914

0.000465993

Residual

28

1,094,701,292,291,240.00

39,096,474,724,687.20

Total

34

2,197,208,507,877,380.00

 

 

 

 

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Intercept

-1491440.123

2650543.163

-0.56269226

0.578122

-6920831.596

3937951.3

Fixed assets

-0.016443713

0.151838596

-0.108297317

0.914532

-0.327470973

0.2945835

Net Sales

0.347813336

0.135109905

2.574299316

0.015624

0.071053245

0.6245734

Operating Expenses

0.298699333

0.223854841

1.334343858

0.192842

-0.159846517

0.7572452

Inventory ratio

-479.2703917

10997.06027

-0.043581683

0.965547

-23005.72689

22047.186

Durbin-Watson statistics

2.659528

Discussion

Previously, lots of researchers have looked at this research with many different ways such as choosing different sectors like SMEs, certain countries’ stock exchange, and specific companies that’s operating in certain areas. Some researcher used a big range of data therefore has eliminated the research result errors. Other researchers collected fewer data depending on the target population and specific industries, however these researchers reached their research goal and received a certain result. The previous researchers mentioned the importance of Cash Conversion Cycle and other elements of Working Capital Management, how it’s very important in terms of increasing companies’ revenue and profit, which means these are have relationship to each other. But they do not research how ratios of working capital management differ by sectors.

Data of medium sized firms, which are listed in Mongolian Stock Exchange, were used in this research. In Mongolian firm’s case, the descriptive statistics results are shown that manufacturing company have longer cash conversion cycle than trading, servicing and mining firms. Manufacturing firms are had a lot of stock comparing to payables they have while trading and servicing firms are had long payable period. From this statistics we can see different sectors are had different ratios. Manufacturing sectors firms are had long inventory period than others but receivables and payables period are shorter than others. Service sectors firms are had high receivables and payables ratio, especially payables ratios are significantly higher than other sectors.

Correlation and regression analysis results are shown same results as other researchers, such as firms’ inventory day, receivables day and cash conversion cycle had negative relation to profit and payables day had positive relationship with profit.

Mongolia is country which has small economics. Also Mongolian firms had very low level of governance and transparency. So it makes difficulties to collect enough information, research data. Therefore this study is based on few data and used financial statements of firms registered in Mongolian Stock exchange. Some firms’ financial statements were unavailable to see current assets information such as inventory, receivable amount. Which mean they issued index of balance sheet by sum not in details.

Conclusion

The purpose of this study is to investigate the relationship between working capital management and firm profitability. The cash conversion cycle is a powerful performance measure for assisting how well a company is managing its working capital. In this study, a significant negative relationship is found between cash conversion cycle and profit, and inventory conversion period and profit. Thus, in purpose to create shareholder value, firm manager should concern on shorten of cash conversion cycle till accomplish optimal level.

All sectors have operational differences. So this research also found working capital management ratios would be different in each sector related to their business type.

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