Firms may have an optimal level of working capital that maximizes their .....
heunisse H. and M. Jegers (1994), Elementen van Boekhouden en Analyse van.
joimial of Business Fiiunife if .Aicmmting, 30(.^) & (4), April/May 2003, 0306-686X
Does Working Capital Management Affect Profitability of Belgian Firms? MARC DELOOF*
I. INTRODUCTION
Most firms bave a large amount of cash invested in working capital, as well as substantial amounts of short-term payables as a source of financing. For instance, according to the National Bank of Belgium, in 1997 accounts receivable and inventories were respectively 17% and 10% of total assets of all Belgian nonfinancial firms. Accounts payable were 13% of total assets of these firms. It can be expected tbat the way in which working capital is managed will have a significant impact on the profitability of fit ms. Accordingly, for many firms working capital management (\V(;M) is a very important component of their financial management. Firms may have an optimal level of working capital that maximizes their value. On the one hand, large inventory and a generous tiade credit policy may lead to higher sales. Larger inventory reduces the risk of a stock-out. Trade credit may stimulate sales because it allows customers to assess product quality before paying (Long, Malitz and Ravid, 1993; and Deloof and Jegers, 1996). Because suppliers may have * I hf iiiillinr is from Llit- F;nii!iy ol Applied Economics L FSI.VRL'tJA, L'liivcrsity of .-\mwi-ip. Me is vt'iy gialefiil lo Marc Jegers, Luc Sot-nrn, list- \' • V.I 3
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policy, and not vice verm. An alternative explanation for a negative relation between the tiumber of days accounts payable and profitability could be tbat firms wait too !ong to pay tbeir accounts payab!e. Speeding up paytiieiits to suppliets migbt increase profitability because Belgian firms often receive a substantial discount for prompt payment. However, in Belgian fuiancial statements, discounts received for prompt paytnent sbould be booked as financial iticome, atid .sbould not aflect operating income.
(ii) Regression Analysis
Next, I use regression analysis to investigate the impact of WCM on corporate profitability. Ihe detertninants of corporate profitability are estimated with a fixed effects model. Fixed effects estimation assumes firm specific intercepts, which capture the effects of those variables that are particular to each firm and that are constant over time.^ A disadvantage of fixed effects estimation is that it eliminates anything that is timeinvariant from the model. Variability of income, which is measured by the standard deviation of net operating income over the 1991-1996 period, can therefore not be included in a fixed effects model. I also estimate plain OLS-models, which not only include all variables of the fixed effects tnodel, but also variabihty of income, 4 year dummies and 37 industry dummies, which are based on 2-digit NACE-code. In all regressions, standard errors are calculated using White's correction for heteroscedasticity. The determinants of gross operating income are investigated for all 5,045 firm-year observations. The results can be found in Table ?>. Regression (1) is estimated with fixed effects and includes tiumber of days accounts receivable as a measure of accounts receivable policy. The coefficient of the accounts receivable variable is negative and highly significant, and implies that an increase in the number of days accoitnts receivable by 1 day is associated with a decline in gtoss operating income (divided by total assets minus fitiaticial assets) by 0.048*%. The coefficients of the other variables included in the model are also highly significant. Gross r Bl3ckwcll Piiblishiiig l.cd '.fOfW
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operating income increases with firm size {measured by the natural logarithm of sales), sales growth and fixed financial assets, and decreases with financial debt. In tegtession (2), a significant negative relation is found betweeti gross operating income and number of days inventories (p-value = 0.015). Regression ('i) shows a very significant negative relation between gross operating income and number of days accounts payable. This negative relation confirms the negative correlation between operating income and number of days accoutits payable in Table 2. The cash cotiveision cycle is included in regression (4). "I he coefficient ofthe cash conversion cycle variable is negative, but it is not significantly cfifferent from zero {/?-value = 0.668). That is not a stu prise: gross operating income declines with the tiutiiber of days accounts receivable and inventories, but also with the nutnber of days accounts payable, which is subtracted to calctdate the cash conversion cycle. rhe tesults of regressions (1) to (4) suggest that managers can increase corporate profitability by reducing the number of days accounts receivable and inventories. An explanation for the negative relation between accounts payable and gross operating income is that less profitable firms wait longer to pay their bills. In regressions (5) to (8), the determinants of gross operating income are estimated using plain OLS instead of fixed effects estimation, and include variability of income, 4 year dummies and ;i7 itidttstry dtttnmies as independent variables. OLS estimation does not take into account firm specific differences in profitability. The results are generally consistent with the results of regressions (1) to (4). Gross operating income decreases with niunber of days accounts receivable, inventories and accounts payable. One difference between fixed efFects estimation and OLS estimation is that in regression {8} gross operating income decreases with the cash conversion cycle: the coefficient is highly significant (p-value = 0.000). In regression (4), it was not significant. It is interesting to tiote that the adjusted /?"s of the OLS regressions are much lower than the adjusted 'within' R~s of the fixed effects regressions. The regression models explain a much higher poition ofthe variations in profitability within firms than between firms.'' e Blackwell Publishing? Ltd 2(»):i
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] running a regression on tht- transformed data. Fixed effects estimation explains why the variables differ from their means, hut not why the fnm means diffier from each other. 6 For a number of fn nis in the sample, a large proportion of total assets arc fixed financial assets, which might influence the results. I re-estimated all panel regressions for the firms for which the average fixed financial assets ratio over the 1992-1996 period is below ihe median value (0.034). All OLS regressions were re-estimated for the observations for which the fixed fuiancial assets ratio is below the median value (0.024). The results of all these regressions (not reported) are very similar to the ones reported in the paper.
REFERENCES Deloof, M. and M. Jeger (199fi). 'Irade Oedit. Product Quality, and Intragroup Irade: Some European Evidence". Financial Mana^i-menl, Vol. 25, No. 3, pp. 945-(i8. Emery, G.W. (1984), 'A Pure Financial Explanation for Trade Credit", fournal of Fhianuial and Qiiantilative Analysis, Vol. 9, No. :i pp. 271-85. Eurostat (1985), NACE: General Industrial Classificatum of Economic Aclivilies ivithin tlw European Communities (Brussels, ECSC-EEE-EAEC). Fisman, k. and I. Love (2001). 'Trade Credit. Financial intermediary Development and Industry Clrowtb', Unpublished Manuscript ((Columbia University). Gentry, J.A., R. Vaidyanthan and H.W. Lee (1990), 'A Weighted Cash (^.onversion C^ycle', financial Matiagemevl. Vol. 19, No. I, pp. 90-99. La Porta, R., F. Lopez-de-Silanes, A. Shleifer and R. Vishny (1997), 'Legal Determinants of External Finance", Journal of Finance, Vol. 52, pp. 1131-50. A. Shleifer and R. Vishny (1998), 'Law and Finance, fournal of Political Economy, Vol. lOfi, pp. 1113-55. r Bliiikwfll 1'iibli.shing l.
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Long, M.S., LB. Malitz and S.A. Ravid (1993), T r a d e Credit, Quality Guarantees, and Product Marketability', Fmancial Management, Vol. 22, No. 4, pp. 117-27. PiMersen, M.A. and R.G. Rajan (1997), 'Trade Credit: Theories and Evidence', Rn'ien< of Fuiantial Studies, Vol. 10, No. 3, pp. 6(il-91. Schwartz, R.A. (1974), 'An Kcononiic Model (jf Ttade Cred'il', Joiinuil of Fitiaiina! and Qjiaiitildlive Aria/ysi.s, Vol. 9, No. 4, pp. 64.'i-57. Shin, H.H. atid L. Soenen (199H), 'Efficiency of Working Capital and Corporate Profitability', Finanrinl Praclire and Education, Vol. 8, No. 2, pp. 37-45. Svens.son, K. (1997), 'Trade CJedits in Europe l o d a y : Credit Cultures, Payment Morality and Legal Systems', Unpublished Manuscript (Lund Llniversity). •| heunisse H. and M. Jegers (1994), Elementen van Boekhouden en Analyse van Jaanrkeningen (Brussels, VUBPress).
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