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MANAGEMENT OF WORKING CAPITAL, PERFORMANCE OF FIRM AND FACTORS OFMACROECONOMIC: IN REFERENCE TO INDIA
Prof. (Dr.) Jayesh Shah
Dean (Research), Renaissance University, Indore
Abstract - This paper investigates the impact of working capital management (WCM) on firm performance among listed Indian manufacturing firms, focusing on the direct and moderating roles of inflation and GDP variables. This study uses the ordinary least squares with robust standard errors to analyze panel data covering the period 2013–2019. Two- stage least squares with robust standard errors is also used to control the endogeneity problem. The results show that the cash conversion cycle (CCC) is negatively related to return on assets and to refined economic value added (REVA). That is, the shorter time the span between expenditure to purchase raw materials and the collection of the receivables for sold goods, the higher the performance. However, when endogeneity problem is controlled for, CCC loses its relationship to REVA. Macroeconomic variables are positively and significantly related to ROA, but only inflation is significantly related to REVA.
Moreover, macroeconomic factors do not moderate the relationship between WCM and firm performance.
Keywords: Working capital management, return on assets, refined economic value-added profitability, cash conversion cycle, macroeconomic factors.
1. INTRODUCTION
The business organization operates in various departments. There are so many techniques and policies are adopted for smooth functioning of business. The WCM plays a pivotal role in the management of Cash receivables and payments to customers. The working capital affects the profitability and liquidity of business. The researcher tries to find out the position of receivable, payables and position of inventories in the Indian concern from the year 2013-19. All the financial activities are based on the decision of the finance manager and this decision plays a very important role in the performance of the concern. (Bhatia &
Srivastava, 2016; Lyngstadaas & Berg, 2016). This study does not give the complete picture. Stewart (1994.p.75) this study shows the changes in the wealth of shareholders more accurately.
The researcher assumes that this research work is justified because India has its unique economic Characteristics. The main indicator of economy is considered high inflation. The Indian economy has witnessed recession for so many years during this recession, corporate asset turnover has increased remarkably and during this time collection from receivables decreased they try to increase the time to sell the goods. The another point is that due to this downturn trend the competition decreases substantially and as a result of this inflow of the cash decreases and the profitability of the concern also come down. One more thing is very important to mention here that increase in the prices of energy puts great pressure on the stocks of the Indian corporate that too creates a serious problem in the availability of the working capital.
One of the biggest limitations of the Indian economy is that it is dependent on the banking sector of the country. The Indian concern arranges their major short term funds requirement from the banks only. So, when a concern has already taken a loan from the bank and until unless this loan is not repaid the bank will not allow releasing more funds.
This situation also increases the importance of the working capital. In India for the short- term financial requirements no other option is available that again make to rely on the banking sector of our country. To overcome from this limitation more effective and efficient working capital management is required.
Over the time the importance of macroeconomics has increased substantially. The country like India the macroeconomic factors play a very important role in financial performance. When we go for the empirical study this also show that also macroeconomic factors for instance- GDP, the inflation rate, the exchange rate, the price of crude oil, and other factors affects the performance of the firm and working capital management.(García- Teruel and Martinez-Solano, 2007; Mathuva, 2010). When we study the material related to
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working capital management the Gross domestic product, inflation rate and financial performance of the firm has got a lot of importance. (e.g., Chiou, Cheng, & Wu, 2006;Deloof, 2003; Enqvist, Graham, &Nikkinen, 2014; Mathuva, 2010; Shi, Zhu, & Yang, 2016).
Through the study of Gross domestic product, we can assess exact macroeconomic condition of our country. The higher gross domestic product is the sign of upward movement which can be accessed through macroeconomic situation. In case of higher gross domestic product firms are in position to increase their profit margin and productivity as well.In the case downturn trend of economy also this factor becomes very important to provide support to the economy. For instance, the situation of depression the average collection period of receivable increases and on the other hand the demand of goods from customers decreases. In this situation the firm always tries to go for the higher level of inventory. As a result of this firms find themselves unable to discharge their current liabilities this affects the financial performance and condition of working capital management. (Golverdi and Mehrabanpour, 2017).
As of now it is evident that financial performance and working capital management is affected by the gross domestic product and inflation. One more question is very relevant from the research point of view that the firm performance and management of working capital management can be moderated with the help of macroeconomics.
2. LITERRATURE REVIEW
2.1. Working Capital Management and Firm Performance
This is the general perception that the profitability and financial performance of the firm is influenced by the working capital management.(Deloof, 2003; Gill, Biger, & Mathur, 2010;
Kabuye, Kato, Akugizibwe, &Bugambiro, 2019; Yazdanfar & Öhman, 2014). The proper management of receivables and payables helps the working capital management to increase the profit margin and cash position of the firms. (Johnson & Soenen, 2003). Apart from this inventory management also affects the profit margin and availability of cash. Gill et al.
(2010) and Abuzayed(2012)found a positive relationship between CCC and gross operating income through this studies (with different methods and sample data) in the United States and Jordan, respectively, to investigate the influence of CCC on gross operating income as a proxy for accounting-based measures of performance. They found a positive relationship between CCC and gross operating income (a proxy for profitability). On the other hand, some of the study shows negative connection between firm performance and working capital management. A study of Yazdanfar and Öhman (2014) has also verified the negative relationship between CCC and ROA (as a proxy for accounting-based measure of performance) in Swedish small and medium-sized enterprises.
The maximum empirical studies indicate that effective working capital management (which minimizes the cash conversion cycle) outcome in better accounting-based performance, on the basis of that the hypothesis can be framed in the following ways: - Hypothesis 1.When we study the Indian manufacturing sector, we find that the negative relationship exists between CCC and ROA (Return on Assets).
Hypothesis 2.Further it is also evident that the negative relationship exists between CCC and modified value added.
2.2. Macroeconomic Factors and Firm Performance
When we talk about various empirical research studies with different methods, we find that they have studied the impact of such factors on the performance of the firm. Broadly it can be said that macroeconomic situation affects the performance of the firm. (Abaidoo &
Kwenin, 2013; Fama, 1981; Issah & Antwi, 2017). According to this study if the prices of the goods are continuously raising that may lead to reduction in the purchasing power of the consumers. As a result of increase in prices the demand of the goods will come down.
Here one thing is very important that if the increase in income is greater than the increase in cost this will affect the performance of the firm positively. From the other angle at the time of inflation borrowers have to borrow money at the inflated rate that may leads increased cost of capital which results the decrease profit of the firm. (Kaminsky, Reinhart,
& Vegh, 2003). On the other hand, Ramadan (2016) has different view on this. He believes that increase in the prices of the goods and services have positive connection EVA.
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Hypothesis 3. There is a very close connection between the inflation and return on assets in the listed Indian manufacturing firms.Hypothesis4. There is a very close connection between rate of inflation and revised economic value added among listed Indian manufacturing firms.
Hypothesis 5. There is a very close connection between gross domestic product and return on assets among listed Indian manufacturing firms.
Hypothesis 6. There is a very close connection between gross domestic product and revised economic value added among listed Indian manufacturing firms.
2.3. Moderating Role of Macroeconomic Factors
The certain factors when remains out of control (for instance, macroeconomic factors) they play a significant role in the planning and decision making of the firm. In a study conducted bail and Khan (2011) they have concluded that in the situation of recession the policies of firm affect and the impact also comes on the working capital of the firm.
Hypothesis 7.In the listed Indian manufacturing firms Inflation reduces the adverse effect of cash conversion cycle on return on assets.
Hypothesis 8. In the listed Indian manufacturing firms Inflation reduces the negative effect of cash conversion cycle on revised economic value added.
Hypothesis 9.In the listed Indian manufacturing firm’s Gross domestic product moderates the negative effects of cash conversion cycle on return on assets.
Hypothesis 10.In the listed Indian manufacturing firm’s Gross domestic product moderates the negative effects of cash conversion cycle on revised economic value added.
3. DESCRIPTION OF SAMPLE AND VARIABLES’ JUSTIFICATION
In this study it is assumed that all the firms are listed on the Indian Stock Exchange. To make this study authentic all the data are derived from the audited books of accounts.
Apart from this the data related to macroeconomics are collected from the World Bank Publication.
Table 1. Industry composition
As concluded by the Afrifa and Tingbani (2018) The Return on Assets of the Indian firms are the higher than the UK firms. The average Refined Economic Value Added of the Indian manufacturing firms is −350,852, this is the sign that Indian firms are not enough capable to create value. The Indian Manufacturing firms which are listed on the Indian Stock Exchange take more time to collect the cash from the receivables; it also indicates that they keep the inventory with them for longer period while on the other hand to discharge the short time borrowings less time is required. This is the indicator of more dependence of business on the external financing. (Maness, 1994). As far as the inflow of cash is concerned in Indian corporate it is 17%, which is greater than that of English firms (10%). The most of the Indian companies are financed their assets through debt that creates the extra burden on the firms. This affects the profitability also.
Table 2. Descriptive result
Variables of research are defined as follows:
The time period between purchase of raw material and collection of receivables determined the Cash Conversion Cycle and that measure the working capital management.
(Gill et al., 2010). These are the important data (Gitman, 1974), and these data can be derived from the audited Balance sheet and Income statement of the firm. (Lyngstadaas &
Berg, 2016). It is measured via three angles i.e., inventory acquisition, receivables collection, and short-term debt payments.
Financial performance of any concern can be measured through various ways.
Research scholars such as Deloof (2003), Gill et al. (2010), and Mathuva (2010) have used net operating income and gross operating income as proxies for profitability. However, such measures are limited to statements of income. Other tools, such as Return on Assets, Return on Earnings, and ROIC, can be employed, because they are more exposed to actual financial condition. As in this study they have taken the help of published Balance Sheets and Income Statements, it is based on the total assets and equity that is why it shows more accurate results of any concern.
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As compare to earlier research work the current work is found more relevant in reference to size of the firm, leverage, Inflow of cash, current asset ratio (CAR), current liabilities ratio (CLR), fixed financial assets to total assets (FFA), firm age and variability of operating net income (VNOI) in order to improve the financial results and avoid the potential problems of endogeneity and omitted correlated variable (OCV) bias. Size is defined as a natural logarithm of total assets (Lyngstadaas & Berg, 2016). Afrifa and Tingbani (2018) showed that cash flow is positively correlated with firm performance, which could interfere with the relationship between firm performance and WCM.4. RESULTS
Table 3 gives the Pearson correlation matrix for the variables. Cash Conversion Cycle, an index for Working Capital Management, is not very much dependent (for the significance investigated at three levels)on the variables (ROA and REVA). This result is very close to results of Sharma and Kumar (2011), according to them they don’t find any relationship between Cash Conversion Cycle and Return on Assets. So, prima facie performance of the firm and Cash Conversion Cycle is not related to each other. While on the other hand, all macroeconomic variables are significantly correlated with ROA, so it can be concluded that macroeconomic factors and performance of the firm which is based on the accounting have the direct relationship. This result is similar to Lyngstadaas and Berg (2016), which depicts the significant relationship between Gross Domestic Product and Return on Assets.
Table 3. Correlations
Therefore mentioned results as depicted in Table 3 gives us only glimpses of Working Capital Management on the firm’s performance. If we want to check the hypothesis then we will have go for some more analyses.
4.1. Results of the Main Analysis
In one hand on the basis of ROA we can study performance of the firm on accounting-based while on the other hand REVA study the performance on the basis of economics. To cover the Working Capital Management, an independent variable Cash Conversion Cycle is selected. Further some fabricated variables are also taken in to the consideration. The variables for size, cash flow, leverage, current assets ratio (CAR), current liabilities ratio (CLR), firm age, firm fixed assets to total assets (FFA), and variability of net operating income (VNOIT) are included in the models as control variables. Further, error term represents the variation of dependent variables that are not described by the exogenous variables in the models.
As to study the impact of macroeconomic factors inflation rate and Gross Domestic Product on the performance of the firm, both were applied independently. Here one thing is very important that to make the study more accurate some of the fabricated factors were omitted from the calculations.
To decide the mediocre role of macroeconomics and to find out the accurate results both were applied separately in various regression models.
The firm model results show that Cash Conversion Cycle is adversely related to return on Assets. This empirical result approves the first hypothesis. It is observed that the credit period is reduced and payments are delayed less inventory were blocked and as a result of that they have achieved the higher profitability. Again this confirmation of the study of the earlier researchers (Lyngstadaas & Berg, 2016; Thakur, 2015; Yazdanfar & Öhman, 2014).
Simultaneously, in flow of cash and size of the cash has a favorable relationship with return on assets, this is the sign of correlation matrix, as it is clear now that when the size of the firm is big, they attract more customers that is why they get the benefit of economies of scale. One more benefit which a firm can get is that when the cash sales increase the bad debts come down and as a result of that profit of the concern also increases. So, when the firm is more leveraged it has to pay high borrowing cost which reduces the profitability of the concern. If a firm maintain the higher level of current assets this always favor the financial performance of the concern.
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In the second model also Cash Conversion Cycle is adversely related with Refined Economic Value Added and this support the second hypothesis. When use of working capital management is effective this will always increase the cash position of the firm and later on it will minimize the cost of capital.On the basis of the outcome of the third model inflation always affects the return on assets and it has positive relation with return on assets this proves the third hypothesis.
Here we will have to understand the inflation always increases the price of the goods and services as result of that the demand reduces. In the case of fourth model, Inflation has a negative and significant influence on refined economic value added, this proves the fourth hypothesis. Inflation mostly increases the expenditure and simultaneously it also increases the cost of capital. This result is to a great extent consistent with Kaminsky et al. (2003), who found a negative and significant relationship between inflation and EVA.
On the basis of the fifth model, it is evident that the Gross Domestic Product has a positive relationship with Return on Assets. This proves the fifth hypothesis. On the basis of this model Gross Domestic Product has the positive impact on the Return on Assets. This result is indicated by the correlation matrix. (Baños-Caballero et al., 2012; Deloof, 2003;
Juan García-Teruel& Martinez-Solano, 2007). So, when the favorable economic condition exists in the market a firm can take the advantage of that situation and increase their profitability. As a result of this the income of the customer also increases that affects the demand positively.
As the seventh, eighth, ninth and tenth models, inflation and GDP do not have moderating effects or any indirect influence on the relationship that CCC has with ROA and REVA, which shows no support for the seventh, eighth, ninth, and tenth hypotheses. The insignificance of the interaction components of inflation and GDP is accounted for by the idea that the India’s inflation rate and economic performance have no significant influence on the Indian manufacturing WCM policies, which was indicated, to a certain extent, by previous studies, such as Yenice (2015), Baños-Caballero et al. (2010), Abbadi and Abbadi (2013) and Nyeadi et al. (2018). This claim also has been empirically examined (un- tabulated results).
5. CONCLUSION
Working Capital Management is a very important component for the smooth functioning of the firm. To manage the current assets and current liabilities this is again a very vital tool for a corporation. The impact of Working Capital Management on the Indian firms is studied from the 2013–2019. In this study the research has tried to understand the role of the macroeconomic factors in the balancing of Working Capital Management and performance of firm. The importance and adverse connection between Cash Conversion Cycle and Return on Assets shows Working Capital Management’s link to a classic example of the risk–return nature of financial decision-making (Yazdanfar & Öhman, 2014); so, it is evident that if a firm is implementing an aggressive strategy it definitely improve the accounting-based performance. So, to obtain this, credit facilities granted to customer should be kept restricted, try to maintain the level of stock minimum and payment period to creditors should be enhanced. In the elementary analysis the relationship between Cash Conversion Cycle and Refined Economic Value Added found negative and significant.
When the contribution of macroeconomic factors is studied it is found that the inflationary trend and Gross Domestic Product has favorable impact on Return on Assets.
As it is now clearly evident that macroeconomic factors have substantial influence on the performance of the firm the planners must consider the importance of macroeconomic factors in to consideration at the time of drafting the policies. For instance, if the firm is working in the condition of high level of Gross Domestic Product, they can adopt the aggressive policies to earn huge amount of profit. While in the case of inflation firm has to face the adverse condition. So, planners must try to frame the policies to minimize the adverse impact through cost management and maintain the optimum level of turnover.
This study is conducted when the inflationary trend was high so it is advisable to all the readers and researchers that it should not be apply in all the situations.
The outcome of this study has theoretical and practical relevance. In this study when we talk about the Working Capital Management, we found that relationship with
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Refined Economic Value Added has strong association with WCM and simultaneously moderating role of the macroeconomic factors. Enhancing the WCM literature and providing an opportunity for future researchers. Through this study we would like to communicate to the future researchers that macroeconomic factors not only affect accounting indicators but also can affect long-term performance indicators.REFERENCE
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