International Research Conference on Management ...

The Eighth International Research Conference on Management and Finance (IRCMF 2013)

International Research Conference on Management and Finance - 2013

December 13, 2013

Conference Proceedings

Faculty of Management & Finance University of Colombo Colombo 03, Sri Lanka

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© Faculty of Management & Finance, University of Colombo December 13, 2013 The views expressed in this publication are those of the authors and do not necessarily reflect the views of the Faculty of Management & Finance, University of Colombo, Sri Lanka Faculty of Management & Finance University of Colombo Colombo 03 Sri Lanka Tel : +94- (0) -11- 5749018 Fax: +94- (0) - 11-2598324 ISBN 978-955-0460-51-9 Conference Co-Chairs

Dr. B. Nishantha

Dr. K. A. S. P. Kaluarachchi Conference Editorial Board Dr. N.U. Amarathunga Ms. S. B. Ranasinghe Conference Proceedings Committee Dr. N.U.Amarathunga Ms. S.B.Ranasinghe Ms. T.M.N.D.Thennakoon Ms. S.U.K.Bandaranayake Ms. R.A.Wimalasinghe Ms. G.Y.Ekanayake Ms.T.H.Alahakoon Ms. I.I.Wijetunga Ms.S.D.K.Wanninayake Assistant to Conference Proceedings Committee

Miss. W. P. Iresha Lakmali Cover Page Designer

Mr. H. H. P. Hettiarachchi Mr. M. C. C. Mahawaththa

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The Eighth International Conference on Management and Finance (IRCMF 2013)

Contents Accounting and Management Information Systems Change of Management Control Systems from the Balanced Scorecard to Budgeting: Case-Study Evidence from a Commercial Bank Kapiyangoda, K. K., Gooneratne, T. N. ………………………………………………………………………….......1 An Initial Quantitative Analysis of the Influential Factors of the Application of A Cost Accounting System (CAS) in Sri Lanka Nagirikandalage, P. ………………………………………………………………………………………………………22 Managing Working Capital: Impact on Performance, Strategies and Barriers in the Manufacturing Sector of Sri Lanka Shermila, T. G. A. and Gunarathne, A. D. N. ……………………………………………………………………33 Enterprise Resource Planning Systems and Change in Accounting Processes: A Case of a Manufacturing Company Thowfeek Z.H. and Jayasiri N.K. …………………..…………………………………………………………….…51 Earnings Management, Accounting Gimmicks and Dummy Giants Vidanage, C. …………………………….…………………………………………………….……………………………74

Business Economics Determinants of the Adoption of Mobile Banking Services in Sri Lanka MaddumaBandara, Y. M. H. P. and De Thabrew, K.T.P. …………….………………………………….90 The Role of Microfinance on Vulnerability Female Headed Women in Jaffna District Rathiranee, Y. ……………………………………………………………………………………………………….……102 Inefficiency Losses of Small-Scale Rice Farms in the Dry-Zone of Sri Lanka: A Parametric Approach Shantha, A.1. and Asan Ali, .G.H. ………………………………………………………….……………..………113 Finance Role of Banks in Financial Inclusion: An Analytical Approach with SpecialReference to India Dekate, M.K. and Pandey, A.V. …………………………………………………………………………….……127 Estimation of Counterfeit Currency Notes in India – Alternative Methodologies Ganesh, C. and Lekshmi. P. ………………………………………………………………………………..….….142 Stock Splits and Liquidity Gunaratna, A.G.D.L.K.., Gunaratne Y.M.C. and Yapa R..D. ..……………………………………………………………………………………………………………….….…………164

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Managing Working Capital: Impact on Performance, Strategies and Barriers in the Manufacturing Sector of Sri Lanka Shermila, T. G. A1 and Gunarathne, A. D. N.2 1

Audit and Assurance division, PricewaterhouseCoopers, Colombo, Sri Lanka of Accounting, Faculty of Management Studies and Commerce, University of Sri Jayewardenepura, Colombo, Sri Lanka ([email protected])

2Department

Abstract The study attempted fill the paucity of research on developing countries on working capital management (WCM) by focusing on the manufacturing companies to identify; the impact of WCM on financial performance, various WCM strategies and barriers that retard efficient WCM. The study adopted a mixed method i.e. both quantitative and qualitative. Primary data were collected by conducting ten semi- structured interviews. Perusing the financial statements (from 2008-2012) of thirty two manufacturing companies listed in the Colombo Stock Exchange secondary data were collected. Quantitative data were analysed using panel data analysis. The interviewees’ responses were analysed thematically. The results suggest corporate profitability can be improved by minimizing the number of inventory turnover days and the length of the cash conversion cycle. The accounts receivable days and accounts payable days indicate no statistically significant relationship with profitability. These companies generally operate on a deficit-credit basis consequently resulting in non-spontaneous sources for financing the trade deficits. These companies focus on managing inventory and receivables in optimizing their WCM. However, they ignore the efficient management of account payables. Corporate complacency, lack of guidance from top management and economic uncertainty are the main barriers for efficient WCM. The companies, therefore, do not reap the due benefits that could be derived from WCM. Thus, the manufacturing companies can enhance corporate profitability by considering WCM as a high priority activity in their business management agenda. Key words: Cash conversion cycle, Corporate profitability, Manufacturing sector, Sri Lanka, Working capital management 1. INTRODUCTION Investors around the world expect some return on their investment by the investments they make in different forms of business organizations. Thus, the management of a company should manage business affairs to create value for the owners. In this value creation process, WCM plays a crucial role (Lazaridis & Tryfonidis, 2006). A well managed working capital policy can create value for the owners while a deprived policy might affect a business negatively and might even cause a financial distress (Afza & Nazir, 2008). Due to the undisputable significance of WCM, researchers all over the world focus on this issue and discuss it in detail in the perspective of many countries Despite the importance of managing working capital globally, most of these studies have focused on the developed countries (Jose et al., 1996; Shin & Soenen, 1998; Summers & Wilson, 33


2000; Wang, 2002; Deloof, 2003). While WCM is of importance to all firms operating in both developed and emerging countries, it is particularly important for the business firms operating in emerging markets (Abuzayed, 2012).Firms operating in emerging markets are small in size compared to the companies in developed markets. These firms in most of the emerging markets/developing markets have limited access to long term capital markets. This situation has compelled them to focus on heavily on owner financing, trade credit and short-term bank loans to finance their needed investment in working capital (Saccurato, 1994). Thus, due to the specific contextual factors prevailing in developing countries the knowledge gained from the studies carried out on developed countries will be of limited application. Despite the importance of WCM to the firms operating in the emerging markets, for example Sri Lanka, the research carried out on this area is limited. Even these limited number of studies carried out have not captured the recent years such as 2007-2012 in which Sri Lanka witnessed a rapid economic growth. Further, they have focused mainly on the secondary data while confining their studies to the relationship between firm’s profitability or value and WCM (Morawakage & Lakshan, 2010; Anandasayanan, et al.,2011; Bandara & Weerakoon Banda, 2011; Lingesiya & Nalini, 2011). Ignited by this paucity of research, the study focused on Sri Lanka which now witnesses a rapid economic expansion in a post war situation (CBSL, 2011). The manufacturing sector, the second largest economic sub sector, plays a crucial role in the Sri Lankan economy in order to enhance the economic growth. Conversely, a manufacturing firm’s current assets account for over half of its total assets. The maintenance of excessive levels of current assets can easily result in a substandard return on a firm’s investment. Therefore, the decision to focus on the manufacturing companies is based on the following two aspects. Firstly, manufacturing companies represent an appropriate sample in order to analyse WCM. Because all of three components in working capital (inventory, account receivable and payable) usually play an important role in the manufacturing sector and comparability of the sample companies will be enhanced. Secondly, most of the previous studies in different countries in relation to this topic have been conducted on manufacturing companies (Deloof, 2003; Raheman & Nasr, 2007) providing better guidance for the study. Given this context, this study attempted to identify the impact of different components of WCM on profitability of organizations, different strategies companies adopt to manage working capital efficiently and the barriers that retard the efficient management of working capital in the listed manufacturing companies in Sri Lanka. The rest of the paper is organized as follows. The Section Two presents the literature review of the study which is then followed by the research methodology in Section Three. The Section Four provides the analysis and finding. The Section Five presents the discussion and the last section provides the conclusions. 34


2. LITERATURE REVIEW The term working capital has received extensive definitions and references (Weston & Brigham, 1977; Smith, 1980; Shin & Soenen, 1998; Paramasivan & Subramanian, 2009). Further, different types of working capital, such as temporary and permanent working capital, have been suggested (Brigham & Houston, 2003; Fabozzi & Peterson, 2003). Grablowsky (1976) and Walker & Petty (1978) showed the importance of managing working capital policies and procedures in overall financial management for all firms. Moreover, working capital is regarded as lifeblood of a firm and its efficient management can ensure the success of the firm while its inefficient management may lead to the bankruptcy of the firm (Padachi et al., 2008).WCM deals with the act of planning, organizing and controlling the components of working capital (current asset and liability) (Weston &Brigham, 1977; Smith, 1980; Paramasivan & Subramanian, 2009). Pioneer study by Mueller (1953) about corporate working capital and liquidity may be considered as the best-known study in this field (Samiloglu & Demirgunes, 2008). It concluded that the term working capital should be coextensive with current assets and it is through working capital that source of liquidity is attained. Hence, WCM have an important impact on the profitability and liquidity of the firm, sometimes creating a dilemma (Smith & Begemann, 1997;Shin & Soenen, 1998; Eljelly, 2004). Smith & Begemann (1997) emphasized that profitability and liquidity comprised the salient goals of working capital management. The problem arose because, the maximization of the firm's returns could seriously threaten its liquidity, and the pursuit of liquidity had a tendency to dilute returns. When determining a WCM policy, a firm has to find a right balance between risk and return. In his regard, a firm can pursue a defensive/hedging, aggressive or conservative working capital policy (Arnold, 2008). Due to the importance of the relationship between profitability and liquidity in WCM, many studies have been carried out in this regard. Shin & Soenen (1998) found a strong negative relationship between the length of the firm's nettrade cycle and its profitability. Similarly, Deloof (2003) found significant negative relationship between gross operating income and the number of days accounts receivable, inventories, and accounts payable among Belgian firms. Raheman & Nasr (2007) also found a strong negative relationship between variables of working capital management and profitability among the Pakistani firms. They found that as the cash conversion cycle increases, it leads to decreasing profitability of the firm and managers can create a positive value for the shareholders by reducing the cash conversion cycle to a possible minimum level. Garcia-Teruel & MartinezSolano (2007) found that shortening the cash conversion cycle also improves the firm's 35


profitability in Spanish firms. Samiloglu & Demirgunes (2008) found accounts receivables period, inventory period and leverage significantly and negatively affect profitability of Turkish manufacturing firms. Falope & Ajilore (2009)found a significant negative relationship between net operating profitability and the average collection period, inventory turnover in days, average payment period and cash conversion cycle for a sample of fifty Nigerian. Similarly, in Nigeria, Mathuva (2010) found a highly significant negative relationship between the accounts collection period and profitability. Contrary to this, Lyroudi & Lazaridis (2000) identified that the cash conversion cycle is positively related to the return on assets and the net profit margin. Mathuva (2010) found a strong positive relationship between the inventory conversion and average payment periods and profitability. Revealing another aspect of this relationship, Wajahat & Hammad (2010) by studying Swedish firms, however, found that managers cannot change the level of profitability by adopting any of the working capital policy i.e. there exist no relationship between working capital policy and profitability. Their findings are in line with Smith & Begemann (1997) who identified that well known liquidity concepts such as the current and quick ratios registered insignificant associations with profitability. Thus, the studies carried out so far reveal inconclusive results regarding the relationship between different components in working capital and firm’s performance. Further, it is not clear what strategies are adopted by the Sri Lankan organizations to manage working capital efficiently and the challenges they encounter in doing so.

3. RESEARCH METHODOLOGY This section describes the research methodology in terms of data collection, hypothesis built up, the variable selected to operationalize the concepts and the strategy to analyse the data. 3.1 Data collection The researchers followed a mixed method, i.e. both quantitative and qualitative, in this study. In order to achieve the first objective of identifying the impact of different components of WCM on profitability of organizations, a quantitative method was adopted. In order to achieve the last two objectives of the study, i.e. to identify various WCM strategies followed and the barriers that retard the efficient WCM, a qualitative approach was used. For this purpose, primary data were gathered through semi structured interviews with ten finance managers. The aim was that the 36


interviewees would be persons who are responsible for WCM of the company and have in depth information of liquidity practices in a company. The interviews took the form of semi-structured interviews, where the researcher used an interview guideline to conduct interviews and had the freedom to ask different questions when the need arose. These interviews lasted thirty minutes to one hour in general. The responses of the interviewees were noted down by the researcher and also audio-recorded at the time of the interview. The secondary data needed for the study were gathered from the audited accounts (i.e. income statement and balance sheet) of the concerned companies. Thus, these data may be considered reliable for the study. The population of the study was all the Public quoted companies in Colombo Stock Exchange (CSE) at 31stJune, 2013.Presently there are 284 companies listed in the Colombo Stock Exchange (CSE, 2013). The sample consisted of 32 listed manufacturing companies among 35 manufacturing companies. The data for 5 years from 2008 to 2012 were considered for this study purpose. The sample selection was justified by their meeting the data availability criteria needed for the study period of 5 years (2008 – 2012). Conducting the study on five-year period would allow comparing changes over time and it would make the results more reliable than using one-year financial data. In addition to the application of those selection criteria, the researchers applied a series of filters. Thus, the researchers have removed the observations of entry items from the balance sheet and profit and loss account exhibiting signs that were contrary to reasonable expectations. Finally, extreme values presented by several variables also have been eliminated from the data set. Based on the prior literature, as outlined in the previous section, the study identified WCMefficiency as the independent variable while profitability as the dependent variable. Inventory turnover days, accounts receivable days, accounts payable days and cash conversion cycle have been identified as indicators of WCMefficiency and gross operating profit and return on assets have been identified as indicators of profitability (Figure 01). Fig. 01 Conceptual framework for the study Independent Variables WCMefficiency  Inventory turnover days  Accounts receivable days  Accounts payable days  Cash conversion cycle

Dependent Variables Profitability  Gross operating profit  Return on total assets

Source: authors 3.2 Hypotheses

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This study aimed to examine the impacts of WCMefficiency on profitability of manufacturing companies listed in the CSE. Based on the prior research and the conceptual framework, several statements of supposition have been made in view of the impacts of WCMefficiency on firms’ profitability. H01: There is a relationship between efficient WCM and profitability. Firms more efficient in managing their working capitals are expected to pose high level of profitability and vice versa. 3.3 Variable choice Firm profitability: The profitability measures that will be used in this study are as follows (refer Eqs. (1) and (2)):

(

(

)( )

( )

)( )

( )

GOP was chosen, because this measurement has been used by influential studies such as Deloof (2003), Lazaridis & Tryfonidis (2006) and Raheman & Nasr (2007). ROA was at first chosen, because the largest part of working capital research uses ROA as the dependent variable, and secondly it’s chosen because with two different dependent variables robustness can be checked. ROA and GOP were chosen as dependent variables, although the sample selected for the study represents several industries, the study does not purely compare profitability ratios but investigating a relationship between profitability and WCM. Further, more attention was given to the regression models using GOP, because this measure is more reliable in studying the effect of WCM on a firm’s profitability. There are several reasons for this higher reliability; the first reason is that it measures only the performance of the operating activities of a firm. This is because the measurement of the gross operating profit, which is sales minus costs of goods sold, excludes taxes, interest costs, depreciation and amortization (Lazaridis & Tryfonidis, 2006 and Gill et al., 2010). The second reason is also based on the fact that this measurement focuses on the operational performance. This is because it excludes the income gained through the financial activities by firms; this is done through the exclusion of fixed financial assets, which are deducted from the total assets.

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Components of Working Capital Management: Accounts Receivable Days (ARD) was used as a proxy for the collection policy of firms while inventory turnover in days (ID) was used as a measure for the inventory policy of firms, and second independent variable. Similarly, Accounts Payable Days (APD) was used as proxy for the payment policy of firms and third independent variable and the last independent variable is cash conversion cycle (CCC) which was used as a comprehensive measure of WCM efficiency. These equations used in the study are given as Eqs. (3) – (6).

(

)

( )

(

)

(

)

(

( )

( )

)

( )

3.4 Analysis strategy The data is expected to be analysed with panel regression analysis, which is deemed a suitable in the context of this research (Deloof, M. 2003; Abuzayed, 2012), . Random effects specification or fixed effects specification in this panel data analysis would be used to analyse ROA and GOP based on the Hausman test results. The sales growth rate, leverage and size of the firm based on asset value would be used as the control variables. These relevant equations are given as Eqs. (7) – (8).

( )

( )

( )

( )

It is expected to have a positive relationship between the efficiency of the WCM and firm’s profitability. The firms that efficiently manage working capital would expect to have a high level of profitability and vice versa.

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4. ANALYSIS AND FINDINGS This section presents the quantitative and qualitative data analysis. It presents the quantitative analysis in terms of descriptive statistics and panel data analysis. 4.1 Descriptive statistics Table 01 shows the descriptive statistics for the 136 observations used in the study except for GOP which has only 130 observations. The inventory is kept for 103 days while taking 46 days to convert account receivables into cash. The companies take 26 days to settle their creditors. This has resulted in one cash cycle being completed in 121days on average. The average GOP is 37% whereas average ROA is 9%. Other than these values, the table also shows the standard deviation, a measure of dispersion of data from the meanand 25th, 50thand 75thcentile values. The 50thcentile value is the median value which shows the central tendency of the data.

Table 01 Descriptive statistics of sample companies Variable*

N

Mean

SD

25thCentile

50thCentile

75thCentile

ID

136

103.121

66.395

64.123

86.566

122.338

ARD

136

46.092

36.271

14.396

43.621

66.173

APD

136

26.846

32.189

4.692

17.856

36.348

CCC

136

121.259

66.372

77.839

110.960

163.497

GOP

130

37.087

32.275

15.017

32.458

47.631

ROA

136

8.8581

23.476

.606

4.694

10.172

Grow

136

16.358

47.527

-3.785

9.016

25.691

Lever

136

115.006

381.436

51.922

87.200

137.953

Size

136

18.308

3.469

14.847

20.053

21.196

Where: ID (Number of days Inventory of firm i for the period t); ARD (Number of days accounts receivables of firm i for the period t); ARD (Number of days accounts receivables of firm i for the period t); APD (Number of days accounts payables of firm i for the period t); GOP (Gross Operating Profit ratio of firm i for the period t)(%); ROA (Return on Assets ratio of firm i for the period t) (%) ; Grow (Sales growth rate of firm i for the period t) %; Lever (Leverage of the firm of firm i for the period t) %; Size (Size of the firm of firm i for the period t) All variables were Winsorized at 1% and 99% centiles to deal with outliers.

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4.2 Pearson’s correlations and regression analysis To examine the association among the variables under consideration, including the relationship between WCMefficiency and profitability, the Pearson’s correlation coefficients were calculated. Table 02 summarizes the correlation matrix with Pearson’s correlation coefficients Table 02: Pearson’s correlation coefficients ID

ARD

APD

ROA

GOP

Grow

Lever

ID

1

ARD

0.173**

APD

0.362*** 0.459***

1

ROA

-0.163*

-0.12

0.086

1

GOP

-0.109

-0.016

-0.129

0.282***

1

Grow

-0.052

-0.13

-0.03

0

0.094

1

Lever

-0.045

-0.066

-0.03

-0.025

0.027

0.14

1

Size

0.000

0.001

0.172**

0.189**

0.124

-0.013

0.023

Size

CCC

1

1 -

CCC

0.814*** 0.519***

0.107

-0.264***

-0.039

-0.092

-0.053

0.074

1

*Significant at .10; **Significant at .05; ***Significant at .01 -

Refer Table 01 note for variable definition

In order to assess the nature of the relationship between the components of working capital and profitability a regression analyses was used. The models used in the analysis were based on the following equations (refer Table 03). Table 03 Models of regression analysis Model

Specification

1 2 3 4 5 Where: represents the respective firm and t denotes the period. Refer the table note of Table 01 for variable definition. Results of the regression analysis can be summarized as follows (refer Table 04).

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Table 04 Results of Panel regression analysis Indep.

Depen.

Variable

Variable

ID

F-value/

Coefficient (β)

Within R2

GOP

-0.137***

0.4109

16.742***

ID

ROA

-0.043

0.0268

4.91

ARD

GOP

0.047

0.3212

11.355***

ARD

ROA

-0.047

0.0217

3.46

APD

GOP

-0.038

0.3196

11.274***

APD

ROA

0.015

0.0248

2.91

Wald

Chi2

ID+ARD+APD

GOP

0.153***/0.074/0.031 0.4265

11.652***

ID+ARD+APD

ROA

-0.055*/-.068/0.085

0.0285

6.69

CCC

GOP

-0.081**

0.3576

13.361***

CCC

ROA

-0.067**

0.0353

7.48

*Significant at .10; **Significant at .05; ***Significant at .01 Refer Table 01 note for variable definition 4.3 Qualitative data analysis The data collected through the interviews were transcribed and electronically logged. The transcriptions were analysed in order to understand the common themes emerged mainly in terms of different WCM strategies and impediments faced. The main themes of WCM strategies are stock management, receivable management, payable management and cash management. The main impediments in managing working capital were identified as corporate complacency, lack of direction from the top management and the economic uncertainty. Further, the findings of the interview were used to buttress the findings of the statistical analysis. 5.

DISCUSSION

This section presents the discussion of the study. Firstly it discusses the findings of the quantitative analysis, i.e. the impact of the different components in WCM on the firm’s performance. Next it discusses the strategies pursued by the manufacturing organizations in managing working capital. Finally, this section discusses the barriers that these companies face in managing their working capital. 5.1 The impact of different components of WCM on profitability of organizations Regression analysis results in Table 4 indicate that if the inventory turnover in days increases it will have a negative impact on the profitability which is measured in terms of GOP. This 42


relationship is consistent with the findings of Deloof (2003); Garcia-Teruel & Martinez-Solano (2007); Raheman & Nasr (2007); Falope & Ajilore (2009); Karaduman,et al., (2011); Morawakage & Lakshan, (2010) and Lingesiya & Nalini (2011). This identified relationship was further substantiated by the interview results. All the manufacturing companies identify inventory as the most critical component in managing working capital because lack of proper inventory management may cause stock-out issues. These manufacturing companies therefore keep inventory to avoid stock-out situations which in turn adversely affect the profitability. According to Lazaridis & Tryfonidis (2006) it could also suggest that in the case of a sudden drop in sales accompanied with a mismanagement of inventory will lead to tying up excess capital at the expense of profitable operations. However, a statistically significant relationship was not identified with ROA and inventory turnover days, although the identified relationship is negative. These findings were similar to the observation of Lazaridis & Tryfonidis (2006) in Greek and Vural et al. (2012) in Turkey. According to the statistical analysis there is no significant relationship between efficient management of accounts receivables and profitability. However, the interview results suggest that most of the listed manufacturing companies increase the accounts receivable in a bid to improve profitability. These manufacturing firms are export oriented and hence face the global competition. It is implied that the firms are better off increasing their number of days accounts receivables based on the profitability of the next year. The reason for this is that larger firms are lending aid to their financially constrained customers and by doing that save a part of their future sales. Sharma and Kumar (2011) argue that there is a positive effect of accounts receivables on a firm’s profitability and is caused by the fact the firms have to grant more trade credit to sustain their competitiveness with their foreign competitors who have superior product and services, in an Indian context. This argument is valid in the Sri Lankan context also as revealed in the interviews despite the fact that it is not being identified in the statistical analysis. The statistical analysis further suggests that there is no significant relationship between accounts payable days and profitability. This finding is similar to the findings of Vural et al. (2012). This is consistent with the interview based findings as most of the firms do not have a well developed policy for efficient management of payables. In managing their payable the focus is on avoiding any late payment fees and any unfavorable fluctuations in the exchange rate movements without a proper analysis of its impact on profitability. However, these findings are quite opposite to the findings of Shin & Soenen (1998), Deloof (2003), Raheman & Nasr (2007), Garcia-Teruel & Martinez-Solano (2007), Falope & Ajilore (2009) and Morawakage & Lakshan 43


(2010) who suggested a positive relationship between account payables and profitability. Thus, the results for the account receivable days and account payable days lead to inconclusive interpretations in the Sri Lankan context and this requires further investigation. As a measure of robustness when inventory turnover days, accounts payable in days and accounts receivable in days taken together. There is a statistically significant relationship only between inventory turnover days and profitability, confirming the previous findings. Finally, the results indicate that the cash conversion cycle is negatively related with profitability of the company as identified by Garcia-Teruel & Martinez-Solano (2007), Falope & Ajilore (2009), Shin & Soenen (1998) and Vural et al. (2012). The results indicate that as the cash conversion cycle increases, profitability of the firm decreases and managers can create a positive value for the shareholders by reducing the cash conversion cycle to a possible minimum level. Thus, the findings of this study too further confirm the existing body of world literature in a Sri Lankan context. 5.2 Different strategies companies adopt to manage working capital efficiently The study also identified several strategies followed by the listed manufacturing companies in managing their working capital. These strategies were identified as stock management strategies, receivable management strategies, payable management strategies and cash management strategies. This section explains these various WCM strategies pursued by the Sri Lankan manufacturing organizations. Stock management strategies are used for the purchase and replacement of inventory. All the responded firms use material requirements planning (MRP) and perpetual inventory control (PIC) as their primary inventory planning technique. They heavily use an Enterprise Resource Planning (ERP) system in this regard. Due to the size and the financial strength of these organizations the use of an ERP/MRP system is possible and stock monitoring and management is entirely carries out through these systems. These organizations, in addition, rely on industry guidelines and economic order quantity (EOQ) techniques in managing their inventories. As highlighted by Lazaridis & Tryfonidis (2006) and Singh & Pandey (2008) managers can create value by keeping inventory at an optimum level, these firms never take ad-hoc decisions on inventory management. Receivable management strategies are another important aspect in WCM among the listed Sri Lankan firms. Many firms grant hefty credit to their customers due to the competition existing among companies having investigated characteristics of their customers. The main 44


characteristics concerned are the capacity, capital, condition and character. Debtors’ payment behavior is monitored through ageing schedule. Collection period and collection experience are used as second important debtors payment monitoring technique. Highlighting these techniques one management accountant said; “On the accounts receivable side we have a lot of initiatives around monitoring key customers and follow up and tracking of payments. We measure our debtors’ collection period very carefully. We work very closely on our relationships with our key, top ten customers.” Despite the availability of well developed systems for inventory and receivable management these firms do not have developed strategies for payables management. The main focus is to settle the dues on time. One manager said; “On the accounts payable side, I don’t think that there’s as much strategy around our payables other than we try to have a lot of visibility into our payables and into our liabilities” Further, the companies avoid late payments to its suppliers to reduce the unfavourable impacts of unnecessary fluctuation in exchange rate as most of them source raw materials from overseas. Despite the relationship with profitability as discussed in the literature, most of the companies maintain less accounts payables than accounts receivables. Accordingly the Sri Lankan manufacturing companies generally operate on a deficit-credit basis, and as a consequence, they depend on non spontaneous sources for financing their trade deficits. This was further proven in the statistical analysis in which the APD was 46 and ARD was 26 resulting in a deficit- credit basis (refer Table 01). As cash management strategies, it was identified that companies engage in short-term investments to gain better return when they have excess liquidity. The motive for investing in the short term is to maintain liquidity as the firms can access funds to meet unexpected investment opportunities or sudden expenses. Further, they consider the security of the investment than the return earned indicating a defensive strategy (Weston & Brigham, 1977; Arnold, 2008; Afza & Nazir, 2009). Two finance managers expressed following views regarding their cash investment strategy. “We are more mindful of the quality of the investments. We are more risk aware because of current market conditions”. “Our cash investment strategy has focused first and foremost on safety, then on liquidity and then on return”. 45


They do not maintain high levels of cash due to the easy availability of bank overdraft facility. Moreover, the banks do not require any compensating balance for extending overdraft facilities so they do not need to deposit extra cash for that purpose. As these firms are large and well reputed, they do not have a problem of borrowing from the bank. Due to this easy availability of overdraft facility, idle cash within companies can be resulted in, but it may sometimes, ensure survival. As highlighted by Paramasivan & Subramanian (2009) WCM is influenced by both internal and external factors. However, the Sri Lankan firms manage their working capital by optimizing internal processes. In optimizing the WCM, although the companies focus on customers and suppliers, they often find it extremely difficult to implement changes. This is mainly due to the lack of negotiating opportunities with foreign suppliers and customers as the company has to accept the world market prices when goods are imported and exported. Thus, the main WCM strategy is the optimization of inventory as it is in the company’s own hands. In general, to assess the performance in WCM, all respondents reported that they compare their past performance with their present achievements, actual with the expected performance and comparing inter-firm benchmarks. Moreover, all respondents also use quick ratio for keeping the eye on liquidity. Inventory and receivable turnover are commonly used for analyzing operational efficiency (Firth, 1976; Brigham & Houston, 2003). 5.3 Barriers that retard the efficient management of working capital The researchers identified the barriers for the efficient management of working capital, as their last objective of the study. Most of the companies are struggling to improve working capital performance, for a variety of reasons, including corporate complacency, lack of clarity/direction from the top management and the uncertainty prevailing in the current economic conditions. Corporate complacency on the success of the existing business can act as a barrier that takes away the attention of the management from working capital. A senior accountant who is responsible for handling working capital mentioned. “Managers at the top need to realise that the real success of the business is based on their ability to keep close control over cash flows, avoiding holding excessive stocks and collecting debts on time” He was of the opinion that due to current economic success of a company, the attention of the management will be diverted to other areas. This lessened attention on WCM, arising due to the 46


corporate complacency, is one of the main impediments for the efficient management of working capital. The loose control, especially in the areas of sending timely invoices, collecting payments on time and following the late payments, is clearly evident in managing collectibles. This situation can negatively affect the profitability of an organization as highlighted by Deloof, (2003); Samiloglu & Demirgunes (2008); Falope & Ajilore (2009); Mathuva (2009). Another hindrance in managing working capital efficiently comes from the top management’s focus on technical matters than attending to the much vital cash flows which is considered as the oxygen that enhances the survival and prosperity of a business (Brealey & Myers, 2003).One Chief Financial Officer stated that lack of knowledge and experience of top level about the business operations constrain the efficient management of working capital of the company. In the Sri Lankan context, Goonasekara (2004), Kulendran (2008) and Subasinghe & Fonseka (2010) have identified the top managers’ awareness of accounting practices plays a crucial role in the adoption of the practice. The findings of this study explain the same situation in terms of working capital. The study further identified that the challenges arising from the turbulent business environment, which is an external factor that decides the working capital requirement of a firm (Paramasivan & Subramanian, 2009), act as another barrier in managing working capital efficiently. “It is always a challenging task for companies to manage their working capital in the current economic downturn with relatively expensive finance and patchy economic growth” said one finance manager. He elaborated this issue as, “High borrowing cost due to interest rate increase and high fluctuations in foreign exchange rate have negative consequences over company’s profitability. These bad implications of economic climate have a direct link with WCM and company faces practical difficulties to manage working capital efficiently to increase the company’s profitability”. These comments indicate that to successfully meet the challenges in WCM in the current economic situation companies should adopt the practices, processes and technologies which increase the understanding of working capital performance among all levels of employees. As emphasized by Arnold (2008,) bad management of a single account in working capital cycle can create big trouble since working capital cycle includes all the major dimensions of business operations. Hence, cooperation among all departments and support from top management is 47


essential to overcome some practical difficulties. Thus, managing working capital should not be restricted to finance department of the company or finance manager’s job role. It should be embedded in the company’s main business strategy to ensure the acceptance of company as a whole. 6. CONCLUSION The study identified that the companies can improve profitability by minimizing the number of inventory turnover days and the length of the cash conversion cycle. It also identified that there is no statistically significant relationship accounts receivables or account payables with profitability. Further, the study identified that firms use MRP and PIC systems as the key techniques of inventory management. They monitor debtors through ageing schedule. However, these firms do not have well developed strategies to manage accounts receivable. Sri Lankan manufacturing companies generally operate on a deficit-credit basis, and as a consequence, they depend on non-spontaneous sources for financing their trade deficits. In order to assess the performance in working capital management, companies carry out variance analysis and interfirm benchmarks. In addition, the study further identified that most of the companies are struggling to improve working capital performance due to corporate complacency, lack of support from the top and current economic downturn. The companies, therefore, do not reap the due benefits that could be derived from WCM. Thus, the manufacturing companies can enhance corporate profitability by considering WCM as a high priority activity in their business management agenda.

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