An optimal level of working capital management would be reached by achieving a balance between liquidity and profitability. In fact, if the company adopts a working capital management policy with an excessive level of current assets, the risk of liquidity may be reduced.
Conversely, the company bears the opportunity cost of funds that may have been invested in long term assets. Though the effect of working capital management on profitability is important, only a few empirical studies have been conducted to observe this relationship. Hence, researchers have almost focused on large companies operating in developed countries. Lessons from these studies are not directly applicable to an emerging market economy like Tunisia [1].
In fact, Tunisian companies are relatively small sized and rely greatly on internal financing, short term debt and trade credit to finance their working capital requirement Saccurato, and Chittenden and al. Particularly, they are characterized by short liquidity and a high level of current assets.
They adopt an informal working capital management which may increase the probability of their default [2]. Even if working capital management concerns all businesses, it is more important for small and medium-sized export companies. In fact, they must be able to face international changes and competition especially in the context of the financial crisis that has spread from and continued to date [3].
Besides, not only the lack of timely and appropriate working capital does present additional costs but also an internal barrier for export activity. Thus, small and medium-sized export companies in Tunisia must pay more attention to manage their working capital. Keeping this in view, this study is the first attempt to identify the impact of working capital management on corporate profitability from a Tunisian dataset.
In addition to this contribution of this paper, the econometric approach is based on panel data analysis to control Tunisian export SMEs in both individual and temporal sides. The paper is organized as follows. Section two briefly provides the literature review and the hypotheses. Section three describes the methodology adopted. Section four exposes the findings. Finally, section five presents the conclusion. It intends to guarantee the sufficient ability of the company to continue its activity and to face operational expenses.
More explicitly, the working capital is the investment required from the time lag between the purchase cost of raw materials and the sale of finished products.
Its management involves accounts receivable and payable, inventories and cash. Thus, the non synchronous nature of flows makes managing working capital essential for understanding liquidity needs. In this section, the literature for the relevant theoretical and empirical research on working capital components inventories, accounts payable and receivable and their effects on corporate profitability is first exposed.
Then, existing literature on the influence of the liquidity on corporate profitability is presented. On the basis of this overview, testable hypotheses are derived. The crucial factor of working capital management concerns the management of inventories, accounts receivable and payable. As stressed by Ganesan , working capital management must provide an efficient mix between working capital components to ensure the capital adequacy of the company. In the sphere of inventory managing, the company aims to hold a minimal acceptable level of inventory with regard to its costs Toomey, , Guariglia and Mateut, Indeed, maintaining a large inventory implies using capital to finance it and to cover different costs transport, insurance, storage, obsolescence, spoilage… Long and al.
However, keeping a low inventory level may lead to lost sales and stock-out Deloof, Thus, inventory flexibility is the crucial dimension in the supply chain management Koste and Malhotra, [4]. Such practice requires an effective coordination between the company and its suppliers, especially in case of an increasing demand. Consequently, inventory flexibility must be observed from an integrative perspective.
Robinson and al. From an empirical view, Deloof points that managers of Belgian firms can enhance profitability and create value for their shareholders by decreasing the period of turning raw materials into cash. Similarly, Gaur and Kesavan propose a model explaining inventory behavior of retailing companies. They found that inventory turnover is negatively associated with gross margins. Recently, Ganesan advocates that short inventories allow American companies operating in telecommunication equipment to rely less on external financial market.
In fact, they may invest daily operation funds in growth projects. Based on trade credit theory, suppliers collect additional information over traditional financing channels. Accordingly, trade credit is a cheaper substitute to bank credit Petersen and Rajan, Besides, by delaying payments to suppliers, the manager allows the firm to beneficiate from a flexible source of financing and a low probability of receiving poor quality materials.
Conversely, trade credit deprives the company of early payment discount which can be considered as an implicit cost. Thus, the company uses credit from suppliers when other financing sources are not available. Furthermore, trade credit may damage the company reputation in case of non payment of the supplier. According to those disadvantages related to lengthening the payable period, Deloof and Lazaridis and Tryfonidis find a negative relationship between profitability and the number of days of accounts payable.
This result is consistent with the view that more profitable companies pay their bills in a short period. Accounts receivable are an important component of the current assets.
As a result, any change in their magnitude can influence the financial viability of the company. Trade credit decision depends on many factors such as: market competition, offered goods or services, price, customer…Moreover, as pointed by Grzergorz , the decision of granting trade credit is a compromise between limiting the risk resulting from untrustworthy buyers and gaining new customers.
A flexible trade credit policy with an interest on receivables may increase sales Long and al. However, such practice can be expensive due to the lock up of money in working capital Guariglia and Mateut, Besides, if the manager chooses to reduce the accounts receivable, he limits sales through credits to customers. Then, this strict collection policy leads to loose purchasers and reduces profits.
In this respect, Pike and Cheng stressed that working capital management looks for creating a high quality accounts receivable portfolio in order to improve corporate value.
Evidence provided by Deloof shows a significant negative relationship between gross operating income and the period that the company takes to receive payment on accounts receivable. Recently, Ganesan supports that long receivable cycle makes telecommunication equipment American companies more dependent on external financing.
Thus, working capital decision is time consuming, intermittent and recurring. Besides, its management depends on information production, transaction costs and available resources and varies across industries Filbeck and al. It involves the planning and the control of current assets and current liabilities. Current assets contain all assets that are converted to cash within a short timely basis.
However, current liabilities include obligations that the company has to pay in a short period of time. The current assets should cover the current liabilities to provide a margin of security. If the company is unable to match properly current assets and current liabilities, it will face financial distress and bankruptcy Zariyawati and al. Liquidity and profitability are the main financial issues for all types of businesses. Smith suggests that the management of working capital affects these two aspects.
Beaumont and Begemann particularly emphasize that understanding the link between profitability and working capital facilitates the comprehension of the relationship between liquidity and profitability.
Indeed, if the company does not have an adequate working capital to sustain sales activity purchase the materials, pay expenses… , it will face problems of insolvency. Referring to the theory of risk and return, more risky investment leads to more return Eugene and Michael, In other words, the decrease of profitability can be explained by the opportunity cost of funds invested in long-term assets Kalcheva and Lins, , Dittmar and Mahrt-Smith, However, excess of liquidity indicates inefficient funds and negatively influences the corporate profitability Cooper, and Vishnani and Shah, Thus, the balance between profitability and liquidity is the dilemma of working capital management.
In assessing the profitability-liquidity trade-off, three basic assumptions are presented by Pramod and Khan :. The company operates in the manufacturing sector the trade cycle is relatively longer than the service cycle. They found that a long cash conversion cycle negatively influences the corporate profitability. They suggest that the company can create shareholder value by reducing their financial needs with regard to liquidity.
The result of Shin and Soenen was consistent with the finding of Deloof who concludes to a negative relationship between gross operating income as a measure of the profitability and the cash conversion cycle. Recently, Eljelly reports a negative relationship between profitability and liquidity. He considers that planning the level of current assets and current liabilities avoids the firm excessive short — lived investments and neutralizes the risk of its incapacity to pay obligations.
H4 : The amount of liquidity generated by Tunisian export SMEs negatively influences their profitability. The theoretical review and studies presented above and synthesized in Table 1 give results and conclusions on working capital management for different countries.
In the next section, the methodology conducted on the same area for Tunisian export SMEs is exposed. Summary of main studies on working capital management. In this section, the companies included in the sample, the variables used and the statistical techniques applied in the investigation are presented.
The quota method is used to make a more representative sample of the population of Tunisian export SMEs. Thus, the distribution of this population by sector of activities was replicated. The sample is composed of export Tunisian SMEs observed from to This period corresponds to a mix of Structural Adjustment Plans [7] and reflects the continuity of economic reforms incentives to exports, subventions to exporting companies….
As shown in Table 2, the panel is mainly composed of limited liability companies The limited corporations represent only S, Asia, Europe and Arabic Maghreb union. Thus, they are considered as small and medium-sized companies [8]. Table 3 shows the distribution of Tunisian export SMEs by industry. Specifically, companies work at the food industry, 96 product construction materials, run textile business, 24 operate in metal industry and 22 have a service activity.
The null hypothesis of the test of homogeneity is verified. Distribution of SMEs by sector of activity and homogeneity test. In order to identify the influence of working capital management on the profitability of Tunisian export SMEs, the following measure of the dependant variable is retained:. GOP it : The corporate profitability is measured by the gross operating profit. It is calculated by subtracting cost of goods sold from total sales and divided by total assets minus financial assets Deloof, Contrary to the use of earnings before interest tax depreciation and amortization Ramachandran and Janakiraman , , the financial activity is separated from operational activity to associate operating results with the operating variables relating to working capital management.
The independent variables included in the study concerning the working capital management are:. A low DSO shows that the company collects its accounts receivable in few days. Companies may improve collection process by offering discounts to customers who reimburse immediately.
This requires a thorough analysis of customer demand patterns, production throughput time and variability, and supplier lead times. These improvements can greatly decrease raw-material and work-in-process inventories, but they require end-to-end process improvements across the value chain from the supplier to the customers.
Does your organization have problems with accounts payable? This could be the result of making payments earlier than necessary or from failing to negotiate payment terms with suppliers. Fast-paying companies are at one end of the spectrum; at the other end are companies that lean on the trade and use unpaid invoices as a source of financing.
Between these two extremes is a more effective, integrated approach to payment renegotiation that takes into account all aspects of the customer-supplier relationship from price and payment terms to delivery time frames and product-acceptance conditions. When renegotiating payment terms, consider the length of your relationship with your suppliers as well as competitive loyalties. High levels of due and overdue receivables could be a result of delayed payment reminders and late dunning, but they could also result from problems with product quality or a failure to meet customer expectations.
By aligning service levels with customer needs in areas such as order lead times and delivery schedules—and tying those service levels to payment terms—companies can improve cash flow and customer service at the same time. Companies should always seek a fair, mutually beneficial, and nonconfrontational solution. Some companies, particularly project-based businesses and manufacturers of large, costly products with lengthy production cycles, have cash flow problems caused by a mismatch in the timing between incurred costs and receipt of customer payments the construction industry is a perfect example.
One way to ensure a steadier flow of cash is to better align incurred costs with customer payments by asking for a down payment and setting up a series of staggered payments to ensure that most receivables have been collected by the time of delivery.
This is a challenge because getting data from multiple legacy systems into a consistent and usable format can be tedious and time-consuming, making it difficult to execute strategy on an ongoing basis. Using ERP systems, organizations are able to disseminate information faster than they would be able to by using more conventional means, such as written reports. The accumulation and use of data are qualities of an effective working capital management system.
Metrics may change year to year as the strategy changes, so make sure that yours are specific to your industry and company. Keep the number of metrics manageable so that you and other financial leaders in your company can communicate them clearly and employees know what to focus on. Five or fewer key metrics are plenty. They should be monitored at all levels within the organization from the executive offices to the employee break room. Posted metrics help keep everyone focused on achieving improvements.
As you can see from this discussion, the reasons to consider a system of working capital improvements are compelling. By analyzing each component of working capital along the value chain, companies can identify and remove the obstacles that slow cash flow. Done right, working capital management generates more cash for growth along with streamlined processes and lower costs. In addition, boards understand that efficient management of working capital can potentially free up cash for other uses that can build shareholder value.
For finance leaders such as you, who are charged with growth and are determined to steer strategy, effective working capital management can provide the cash your organization needs to succeed now and in the future. Working capital management is especially important for small companies with limited financial resources. They may have trouble accessing working capital through debt and equity markets because smaller companie are considered riskier, making it harder for them to secure loans.
In addition, small companies are generally charged higher interest rates compared to large companies. Many small companies are seasonal or cyclical businesses that often require working capital to meet their financial obligations during the off-season. For example, an indoor waterpark or a restaurant with a lot of outdoor seating may do significantly more business during the summer months, resulting in large payouts at the end of the tourist season.
Nevertheless, the company must have enough working capital to buy inventory and cover payroll during the off-season, when revenues are lower. If you work for a small company, a cash flow projection can help you manage your cash so the company can pay its bills on time. As your business grows, it can also help you plan for a large expenditure, such as an equipment purchase or a move to a new location, so that you have the cash on hand when you need it.
Management of working capital includes inventory management and management of accounts receivables and accounts payables. The main objectives of working capital management include maintaining the working capital operating cycle and ensuring its ordered operation, minimizing the cost of capital spent on the working capital, and maximizing the return on current asset investments.
Individuals need to collect the money that they are owed and maintain a certain amount on a daily basis to cover day-to-day expenses, bills, and other regular expenditures. Working capital is a prevalent metric for the efficiency, liquidity and overall health of a company. It is a reflection of the results of various company activities, including revenue collection, debt management, inventory management and payments to suppliers.
This is because it includes inventory, accounts payable and receivable, cash, portions of debt due within the period of a year and other short-term accounts. The needs for working capital vary from industry to industry, and they can even vary among similar companies.
This is due to several factors, including differences in collection and payment policies, the timing of asset purchases, the likelihood of a company writing off some of its past-due accounts receivable , and in some instances, capital-raising efforts a company is undertaking. When a company does not have enough working capital to cover its obligations, financial insolvency can result and lead to legal troubles, liquidation of assets, and potential bankruptcy.
An effective working capital management system helps businesses not only cover their financial obligations but also boost their earnings.
Managing working capital means managing inventories, cash, accounts payable and accounts receivable. An efficient working capital management system often uses key performance ratios, such as the working capital ratio, the inventory turnover ratio and the collection ratio, to help identify areas that require focus in order to maintain liquidity and profitability. Financial Ratios. Financial Statements. Business Essentials. Fundamental Analysis. Actively scan device characteristics for identification.
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