of credit within the banking sector translates into adequate access to low-cost credit and satisfaction of demand at the firm level. The results indicate that a large proportion of firms in the private sector do have access to the formal financial sector, primarily through the use of overdrafts. However, most of the finance is clearly being used to meet working capital needs.
With three state-owned banks that do not truly compete with each other and essentially fixed interest rates, there is real rigidity in the financial sector. The main concern with these rates is the lack of variance. Interest-rates do not appear to take into account the varying degrees of risk, represented by the firms in the sample. This reflects the broader problems of the financial sector - by latching onto a 12 percent interest rate "ceiling," and paying depositors 5- 6 percent, the financial sector has settled into lending at a risk-invariant rate of 9 percent while imposing substantial collateral requirements (Internet 6).
As the study above has disclosed the financial sector of Eritrea is not yet developed. It is on the threshold of development. The banks as one part of the financial sector need to revitalise their operations to cope with the ever-changing financial market of the globe.
the risk failing to meet firm's financial obligations. A conservative or relaxed approach is to maintain a larger cash balance and investment in marketable securities that can quickly turned to cash. It is low-risk but usually leads to a reduction in profitability. A moderate approach lies somewhere in between the aggressive and the conservative approaches
Similarly, with the working capital financing policies, a conservative policy is one, which uses long term funds to finance all fixed assets and all permanent current assets, as well as some fluctuating current assets. In contrast, an aggressive policy uses short-term funds to finance all fluctuating current assets and some of the permanent current assets. It is the most risky but offers higher returns. However, the moderate policy is one which attempts to match assets and liability maturities based on the expected lives of these assets being financed.
As was said earlier, it is not clear which working capital policy the firm follows. As to the working capital investment approach, sometimes it looks like an aggressive approach since the firm keeps the current assets level at its minimum. For instance, in 200land 2002 the level of its current assets was limited to 65 percent of the total assets respectively. At times it seems to adopt a conservative approach since the firm increases the level of current assets at its peak.
For example, in 1999 and 2000 the level of current assets was higher, 74 percent and 77 percent respectively. And sometimes, it seems as though it has been inclined to moderate its approach from the fact that the firm keeps the current asset levels not too high and not too low, but moderate. For example in 1998, the current assets level remained as 69 percent, which is a moderate level in relation to the five years period.
Likewise, the firm has envisaged no stated policies concerning the working capital financing.
However, it seemed as though it was more inclined to a conservative financing approach.
Table 3.6 indicates, out of the total financing, on average about 16 percent only is represented as current liabilities. 11 percent in 1998, 13 percent in 1999, 13 percent in 2000, 14 percent in 2001 were short term financing sources. The remaining on average 86 percent had been equity financing. This shows clearly, that the firm's financing policy is more likely to rely on owners' funds, as there is no long-term financing source for working capital needs. However, the short term financing was increased greatly to 23 percent of the total financing in 2002. It
almost doubled in comparison with the previous years. This indicates that the firm may shift to moderate or aggressive financing approaches in the future.
In addition to the questionnaire, the other side of the source document will be used to evaluate the working capital strategies of the firm. In the table below is portrayed the financial statements, which are abridged. The first part of the table consists of some of the profit and loss components and the second part, the balance sheet components.
Table 3.8 Abridged Balance Sheet and Income Statement 1998-2002
Sales (Revenue) Net income
Fixed assets (net) Current assets Total assets Current liabilities Equity capital
Total liabilities & equity
1998 1065469
176982 477697 1083436 1561133 167113 1394020 1561133
1999 1563547
176209 411047 1166746 1577793 207562 1370231 1577793
2000 1495142
206516 359619 1214084 1573703 211666 1362037 1573703
2001 2707655
408370 1025508 1956647 2982155 411748 2570407 2982155
2002 1624124
228264 1281229 2360857 3642086 843415 2798671 3642086 Source: Financial statements of 1998-2002
As is depicted in Table 3.8, the current assets account for about 68 percent of the total assets on average during the study period. This indicates that the level of investment in current assets is very high relative to the fixed assets. In analysing it on annual basis, the current assets can be seen to be 69 percent in 1998, 74 percent in 1999, 77 percent in 2000, 65 percent in 2001 and 2002 of the total assets. This implies that the level of current assets had been kept moderate in the beginning and then progressed to become conservative for the next two consecutive years and turned out to be aggressive by the end of the five years period.
Considering this period separately on a yearly basis, one can see that the working capital investment policies followed by the firm looked like a mix of the three approaches. However, if one observes the level of current assets that is 68 percent vis-a-vis the fixed assets, 32 percent, the firm would be closer to the conservative approach.
Similarly, from the above table one could realize the working capital financing approach of the firm as being more of a conservative one, as the firm's current liabilities represent a very little portion of the total financing amount. Nevertheless, at the end of the five-year period the trend appears to be changing. The short term financing (current liabilities) is increased to 23 percent in 2002, more than double that of 1998's 11 percent. This would be a sign of changing policy from an extremely conservative towards an aggressive financing approach.
3.5.2 LIQUIDITY AND PROFITABILITY RATIOS OF THE FIRM
One way, which helps the financial manger to draw inferences about the liquidity and profitability of a firm, is to compare selected ratios with that of other firms in the same industry and/or to compare different years' ratios within the same firm.
It should be a continuous process. Once ratios have been established for one business, it is important to track them over time and to compare them with the ratios of other comparable businesses or industry sectors. In the table below present various ratios, which can have an influence in working capital management of the firm are presented.
Table 3.9 Liquidity and Profitability Ratios 1998-2002
Current ratio Quick ratio
Receivable turnover Inventory turnover
Total asset turn over (ATO) Average collection period Gross profit margin Profit margin
Return on assets/ Return on invest.
Return on equity (ROE)
1998 6:1 5:1 20times 3times 0.68:1 NA 39%
17%
11%
16%
1999 7:1 4:1 7times 4.5times 0.99:1 NA 28%
11%
11%
16%
2000 6:1 4:1 6times 3times 0.95:1 NA 33%
14%
13%
19%
2001 5:1 3:1 3.5times 3times .091:1 NA
31%
15%
14%
19%
2002 3:1 0.6:1 4times Nil 0.45:1 NA 45%
14%
6%
11%
Source: Financial statements of 1998-2002
The firm's current ratio is on average 5 to 1 in the study period. Current ratio of 5 to 1 means that the firm should be able to stretch its fund as far as 5.00 Nakfa for every 1.00 Nakfa it owes. Less than 1 means that there could be liquidity problems and the firm is under pressure to generate sufficient cash to meet oncoming demands.
The quick ratio is on the average 4 to 1 .This ratio focuses on cash and receivables. It leaves out inventory, as it is not quick to turn into cash. In this ratio 1 to 1 is taken as normal.
The receivable turnover: This takes to an average days to collect monies due to the firm. The firm's turnover was 20 times in 1998, but reduced tremendously to 4 times in 2002. Effective debtor management could minimize the days. One or more large or slow debts can drag out the average days.
The inventory turnover indicates how fast the inventory is turned to the finished product. The greater the turnover, the better will be the efficiency of the firm in production and sales. The firm's average inventory turnover was 3 times (1998-2001) but no turnover of inventory has been seen in 2002.
The Asset turnover (ATO): The firm's ATO was 0.68:1 in 1998, close to 1:1 in the 3 years period (1998-2001) and 0.45 to 1 in 2002. This shows the utilization of assets vis-a-vis total sales of the firm.
The gross profit margin was 35 percent on average during the study period. It was 39 percent in 1998 but it climbed annually in the three consecutive years to reach 45 percent in 2002.
The profit margin of the firm was 14 percent on average. It was 17 percent in 1998, declined to 11 percent in 1999 and maintained 14 percent in the next three years (1998-2002).
The Return on Assets / Return on investment measures the profitability of the firm as a whole in relation to the total assets employed. The firm's ROA/ROI was on average 11 percent during the study period.
Similarly, the Return on Equity (ROE) of the firm was on average 16 percent during the study period. For the first two years it was constant, and it increased by 3 percent each year
over the next two years and lowered by 8 percent in 2002. The reduction might have happened because the Net income after tax (NIAT) has been reduced by almost half during this time.