5.2 Data analysis
5.2.1 Model specification
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operations: procuring goods for production or sale, paying suppliers for those goods, selling the goods and collecting from customers. Second, in order to produce a balanced panel, all firms with any missing observations for any variable in the model during the sample period were eliminated
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Cash Conversion Cycle = (Accounts receivable
Sales ˟ 365) + ( Inventory
Cost of Sales ˟ 365 ) – (Accounts payable
Purchases ˟ 365 )
Some firms on the McGregor BFA Library online database do not disclose their cost of sales (probably for competition reasons). Using the CCC substantially reduced the sample size;
therefore it was dropped. This study adopted the gross concept of working capital where all current assets are taken as working capital investment. In addition to increasing the sample size, the gross concept was considered appropriate for a number of reasons. First, most business managers plan their operations using the gross concept, that is, total current assets, because it tells them the amount of assets that are required to sustain operations on a daily basis. Second, the firm has direct control of its working capital investment, current assets.
Strategies to optimise working capital through techniques such as delaying payments to suppliers can be very harmful to the firm. Siefert and Siefert (2008) state that it has been observed that firms that antagonize suppliers by stretching payments risk missing out on innovations, losing capacity and most important, they risk facing supply chain disturbances.
Supply chain disruptions can produce negative stock market reactions such as a drop in the market capitalisation as high as 10% (Siefert and Siefert, 2008). Therefore any working capital optimisation strategy must involve what is directly under the firm’s control. In addition, when a firm adopts a strategy such as delaying payments to suppliers it should be borne in mind that its suppliers could be accelerating collections from customers (that is, the firm) particularly in times of economic crisis. Finally, Etiennot et al. (2012) state that distinguishing between working capital financing and investment helps to understand the key drivers of these decisions.
The working capital investment models used by Gupta (2003) assume a static framework. The present study assumed a dynamic framework; that is it was assumed that firms have a target level of current assets and current liabilities. In dynamic panel data estimation, the lagged dependent variable is also an explanatory variable in the sense of being predetermined.
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The firm’s actual current assets level may not always be at the desired level; therefore the firm takes time to adjust from real to desired levels. Variances between real and desired levels exist because of the difficulties in estimating with certainty the level of sales and the level of current assets required to support the sales.
The literature has shown that firms have or should have a target working capital investment level which maximises profitability; (Deloof, 2003, Filbeck and Krueger, 2005b). The existence of the liquidity-profitability trade-off means that firms should have a working capital level that enables them to balance these conflicting goals. Over-investing in working capital (holding too much liquid assets), results in the firm delivering sub-standard returns. Low working capital levels result in losses (due to stock-outs) and increase the risk of insolvency. As the firm increases (decreases) its working capital investment, carrying costs increase (decrease) while shortage costs decrease (increase). This means that the firm must always counterweight the carrying costs and the shortage costs of investing in working capital. Baños-Caballero et al.
(2009) studied the determinants of working capital management using net trade cycle as the dependent variable and found that firms pursue target working capital levels and take steps to align their current level to their optimal level because the adjustment process involves time and costs. Thus the static framework of understanding the determinants of working capital investment may not fully reflect the dynamics of the firm’s working capital.
TABLE 4: SUMMARY OF THE VARIABLES
Variables Symbol Variables Description
CATA Total current assets to total assets CLTA Total current liabilities to total assets
FIXTA Fixed investment during the year to total assets
RGDP National income as measured using RGDP (at constant prices)
SGR Sales growth rate
PGROWTH Positive sales growth
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NGROWTH Negative sales growth
LEVERAGE Total debt to total assets
MKTPOWER Market power
OCFTA Operating cash flows to total assets
SIZE The natural log of market capitalization and/or total assets as a proxies for size
MTB Market to book ratio
VALUE Tobin’s Q ratio as a proxy for the value of the firm TCTA Trade creditors to total assets
ACCTA Accruals to total assets
SKTA Stock to total assets
CMSTA Cash and marketable securities to total assets TDTA Trade debtors to total assets
STDTA Short-term debt to total assets LTDTA Long-term debt to total assets PURTA Purchases to total assets
OCLTA Spontaneous sources of finance to total assets NDTSTA Non-debt tax shield to total assets
LNAGE Natural logarithm on age
EBITTA Earnings before interest and tax to total assets FIXATA Fixed assets to total assets
INV Fixed investment by firm during year t
ΔW Change in net working capital
K Beginning of the year fixed assets
CF/K Operating cash flow to fixed assets Source: Author’s construction
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5.2.2 THE WORKING CAPITAL INVESTMENT MODEL