The relationship origin

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The relationship origin

  1. 1. Southern Taiwan UniversityDepartment of Business Administration (IMBA) Program Master’s Thesis THE RELATIONSHIP BETWEENWORKING CAPITAL MANAGEMENT AND PROFITABILITY: A VIETNAM CASE Graduate student: Huynh Phuong Dong 研究生: 桜橄 Advisor: Assistant Professor Jyh-Tay Su 指導教授: 証扐炮 May, 2010
  2. 2. Acknowledgements I am deeply grateful for the encouragement and support throughout thepreparation of this thesis. I would like to express my deepest acknowledgement to mysupervisor, professor Jyh- Tay Su from the Southern Taiwan University, for his valuableadvice and recommendations. I acknowledge Dr. Tran Phuoc Tru and Mr Nguyen Ba The from Da Nanguniversity of economics for their support with statistical techniques and data analysis. I would like to thank my friends in Southern Taiwan University who havesupported me about material as well spirit in order to finish this thesis. Finally, to my parents and my wife, I wish to extend my loving thanks for theirencouragement. My greatest debt of gratitude is to my wife, Mrs. Le Anh Phe, who waspatiently supporting me during my study in Taiwan. This thesis could not have beenwritten without her daily encouragement. i
  3. 3. Abstract The working capital management plays an important role for success or failureof firm in business because of its effect on firm’s profitability as well on liquidity. Thethesis is based on secondary data collected from listed firms in Vietnam Stock Exchange(VSE) for the period of 2006-2008 with an attempt to investigate the relationshipexisting between profitability, the cash conversion cycle and its components for listedfirms in VSE. The finding shows that there is a strong negative relationship betweenprofitability, measured through gross operating profit, and the cash conversion cycle.This means that as the cash conversion cycle increases, it will lead to declining ofprofitability of firm. Therefore, the managers can create a positive value for theshareholders by handling the adequate cash conversion cycle and keeping eachdifferent component to an optimum level. Keywords: Working Capital Management, Gross operating profitability,Vietnam Stock Exchange. ii
  4. 4. Table of contentsAcknowledgements............................................................................................................ i Abstract ............................................................................................................................. ii Table of contents.............................................................................................................. iii List of tables ..................................................................................................................... v List of figures ................................................................................................................... vi CHAPTER ONE  INTRODUCTION ............................................................................... 1  1.1 Background ............................................................................................................. 1  1.2 Aims of research ..................................................................................................... 3  1.3 Research structure ................................................................................................... 4 CHAPTER TWO  LITERATURE REVIEW ................................................................... 5  2.1 Theory about working capital management and profitability ................................. 5  2.2 Related literature review ......................................................................................... 9 CHAPTER THREE  RESEARCH METHODOLOGY ................................................. 21  3.1 Research design .................................................................................................... 21  3.2 Research method ................................................................................................... 21  3.3 Variable definitions and model development ....................................................... 22  3.3.1 Variable measurement ................................................................................... 22  3.3.1.1 Dependent variable ................................................................................. 22  3.3.1.2 Independent variable ............................................................................... 24  3.3.1.3 Control variable ...................................................................................... 26  3.3.2 Hypotheses ..................................................................................................... 26  3.3.3 Model development ....................................................................................... 28  3.3.3.1 Model classification ................................................................................ 28  3.3.3.2 Model development for this research...................................................... 29  3.4 Data collection methods........................................................................................ 30  3.5 Data transformation .............................................................................................. 31  3.6 Data analysis methods .......................................................................................... 32  3.6.1 Descriptive statistics ...................................................................................... 32  iii
  5. 5. 3.6.2 Correlation analysis ....................................................................................... 32  3.6.3 Multiple Regression analysis ......................................................................... 32 CHAPTER FOUR  RESEARCH RESULTS.................................................................. 33  4.1 Descriptive statistics ............................................................................................. 33  4.2 Correlation analysis .............................................................................................. 35  4.3 Multiple regression analysis ................................................................................. 37 CHAPTER FIVE  CONCLUSIONS AND IMPLICATIONS ........................................ 48  5.1 Conclusions........................................................................................................... 48  5.2 Implications .......................................................................................................... 50  5.3 Limitations of research ......................................................................................... 52 References....................................................................................................................... 53 Appendix......................................................................................................................... 57  Appendix 1: Model 1 .................................................................................................. 57  Appendix 2: Model 2 .................................................................................................. 57  Appendix 3: Model 3 .................................................................................................. 58  Appendix 4: Model 4 .................................................................................................. 58  Appendix 5: Test normal for model 1 ......................................................................... 59  Appendix 6: Test normal for model 2 ......................................................................... 60  Appendix 7: Test normal for Model 3 ........................................................................ 62  Appendix 8: Test normal for model 4 ......................................................................... 63  iv
  6. 6. List of tablesTable 4.1: Descriptive statistics………………………………………………………... 33Table 4.2: Correlation matrix………………………………………………………….. 35Table 4.3: Variables entered/removeb for model 1…………………………………… 37Table 4.4: Model summaryb for model 1…………………...………………………….. 37Table 4.5: ANOVA result for model 1… …………….…….………………………... 38Table 4.6: Result of regression model for mode 1… …….………………..………... 38 bTable 4.7: Variables entered/remove for model 2….…………………….……….…… 39Table 4.8: Model summaryb for model 2……………..…………………….………….. 39Table 4.9: ANOVA result for model 2………..…………..…………….…………….. 39Table 4.10: Result of regression model for mode 2……………………………….…… 40Table 4.11: Variables entered/removeb for model 3…..………..……………………… 40Table 4.12: Model summaryb for model 3…………………..…………………………... 41Table 4.13: ANOVA result for model 3………...……………………………………..... 41Table 4.14: Result of regression model for mode 3..……………………………….…… 41Table 4.15: Variables entered/removeb for model 4…..………..……….……………….. 42Table 4.16: Model summaryb for model 4…….…………….…………………………... 42Table 4.17: ANOVA result for model 4……………....……….………………………... 42Table 4.18: Result of regression model for mode 4……………………………….…… 43Table 5.1: Hypothesis test results………………...……………………………………. 50 v
  7. 7. List of figuresFigure 1.1: Research structure………………………………………………… 4Figure 3.1: The Cash conversion cycle………………………………………. 25Figure 3.2: Analytical model………………………………………………… 30Figure 5.1: The relationship between working capital management and profitability……………………………………………………….. 49 vi
  8. 8. CHAPTER ONE INTRODUCTION1.1 Background Assets in commercial firm consist of two kinds: fixed assets and current assets.Fixed assets include land, building, plant, furniture, etc. Investment in these assetsrepresents that of part of firm’s capital, which is permanently blocked on a permanent orfixed basis and is also called fixed capital that generates productive capacity. The formof these assets does not change, in the normal course. In the contrast, current assetsconsist of raw materials, work-in-progress, finished goods, bills receivable, cash, bankbalance, etc. These assets are bought for the purpose of production and sales, like rawmaterial into semimanufactured products, semimanufactured products into finishedproducts, finished products into debtors and debtors turned over cash or bills receivable. The fixed assets are used in increasing production of an organization and thecurrent assets are utilized in using the fixed assets for day to day working. Therefore,the current assets, called working capital, may be regarded as the lifeblood of a businessenterprise. It refers to that part of the firm’s capital, which is required for financingshort-term. The management of this working capital is known as working capitalmanagement. The basis objective of working capital management is to manage firm’scurrent assets and current liabilities, in such a way, that working capital are maintained,at a satisfactory level. The working capital should be neither more nor less, but justadequate. Working capital management plays an important role in a firm’s profitability andrisk as well as its value (Smith, 1980). There are a lot of reasons for the importance ofworking capital management. For a typical manufacturing firm, the current assetsaccount for over half of its total assets. For a distribution company, they account foreven more. Excessive levels of current assets can easily result in a firm’s realizing asubstandard return on investment. However, Van Horne and Wachowicz (2004) pointout that excessive level of current assets may have a negative effect of a firm’sprofitability, whereas a low level of current assets may lead to lowers of liquidity andstock-outs, resulting in difficulties in maintaining smooth operations. Efficient management of working capital plays an important role of overallcorporate strategy in order to create shareholder value. Working capital is regarded as 1
  9. 9. the result of the time lag between the expenditure for the purchase of raw material andthe collection for the sale of the finished goods. The way of working capitalmanagement can have a significant impact on both the liquidity and profitability of thecompany (Shin and Soenen, 1998). The main purpose of any firm is maximum theprofit. But, maintaining liquidity of the firm also is an important objective. The problemis that increasing profits at the cost of liquidity can bring serious problems to the firm.Thus, strategy of firm must be a balance between these two objectives of the firms.Because the importance of profit and liquidity are the same so, one objective should notbe at cost of the other. If we ignore about profit, we cannot survive for a longer period.Conversely, if we do not care about liquidity, we may face the problem of insolvency.For these reasons working capital management should be given proper considerationand will ultimately affect the profitability of the firm. Working capital management involves planning and controlling current assetsand current liabilities in a manner that eliminates the risk of inability to meet due shortterm obligations on the one hand and avoid excessive investment in these assets on theother hand ( Eljelly, 2004). Lamberson (1995) showed that working capital managementhas become one of the most important issues in organization, where many financialmanagers are finding it difficult to identify the important drivers of working capital andthe optimum level of working capital. As a result, companies can minimize risk andimprove their overall performance if they can understand the role and determinants ofworking capital. A firm may choose an aggressive working capital management policywith a low level of current assets as percentage of total assets, or it may also be used forthe financing decisions of the firm in the form of high level of current liabilities aspercentage of total liabilities (Afza and Nazir, 2009). Keeping an optimal balanceamong each of the working capital components is the main objective of working capitalmanagement. Business success heavily depends on the ability of the financial managersto effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2005).Firms can decrease their financing costs and raise the funds available for expansionprojects by minimizing the amount of investment tied up in current assets. Lamberson(1995) indicated that most of the financial managers’ time and efforts are consumed inidentifying the non-optimal levels of current assets and liabilities and bringing them tooptimal levels. An optimal level of working capital is a balance between risk andefficiency. It asks continuous monitoring to maintain the optimum level of various 2
  10. 10. components of working capital, such as cash, receivables, inventory and payables (Afzaand Nazir, 2009). A popular measure of working capital management is the cashconversion cycle, which is defined as the sum of days of sales outstanding (averagecollection period) and days of sales in inventory less days of payables outstanding(Keown et al, 2003). The longer this time lag, the larger the investment in workingcapital. A longer cash conversion cycle might increase profitability because it leads tohigher sales. However, corporate profitability might also decrease with the cashconversion cycle, if the costs of higher investment in working capital is higher and risesfaster than the benefits of holding more inventories and granting more inventories andtrade credit to customers (Deloof, 2003). Lastly, working capital management plays an important role in managerialenterprise, it may impact to success or failure of firm in business because workingcapital management affect the profitability of the firm. The thesis is expected tocontribute to better understanding of relationship between working capital managementand profitability in order to help managers taking a lot of solutions to create value fortheir shareholders, especially in emerging markets like Vietnam.1.2 Aims of research This research is focusing on working capital management and its effects onprofitability for a sample of Vietnamese firms. The main objectives are: • To investigate a relationship between working capital management and profitability over a period of 3 years for 130 Vietnamese firms listed on Vietnam Stock Exchange. • To find out the effects of different components of working capital management on profitability. • To find out the relationship between profitability and size of Vietnamese firms. • To find out the relationship between debt ratio used by the Vietnamese firms and its profitability. • To draw conclusion about relationship of working capital management and profitability of Vietnamese firms. 3
  11. 11. 1.3 Research structure This thesis is structured into 5 chapters. Chapter 1 introduces the researchincluding introduction, aims of research, structure of the study. Chapter 2 introducesabout literature review including theory about working capital management andprofitability, literature review about the relationship between working capitalmanagement and profitability. Chapter 3 discusses methodology utilized in the research.Chapter 4 analyses the data collected and presents the findings of the research. Chapter5 points out conclusions and the implications of the research findings.Figure 1.1 Research structure INTRODUCTION LITERATURE REVIEW RESEARCH METHODOLOGY RESEARCH RESULTS CONCLUSIONS AND IMPLICATIONS 4
  12. 12. CHAPTER TWO LITERATURE REVIEW2.1 Theory about working capital management andprofitability According to Van Horne and Wachowicz (2004), working capital managementis the administration of current assets in the name of cash, marketable securities,receivables, and inventories. Osisioma(1997) described working capital management asthe regulation, adjustment, and control of the balance of current assets and currentliabilities of a firm such that maturing obligations are met, and the fixed assets areproperly serviced. Smith (1980) showed that the working capital management plays an importantrole in a firm’s profitability and risk as well as its value. Efficient management ofworking capital is very essential in the overall corporate strategy in order to createshareholder value. Firms try to maintain an optimum level of working capital thatmaximizes value for shareholders (Deloof, 2003) According to Harris (2005), working capital management is a simple andstraightforward concept of ensuring the ability of the organization to fund the differencebetween short-term assets and short-term liabilities. However, a ‘total approach’ shouldbe followed which covers all the activities of the company relating to vendors,customers and products (Hall, 2002). In practice, working capital management hasbecome one of the most important issues in organizations, where many financialmanagers are finding it difficult to identify the important drivers of working capital andthe optimum level of working capital (Lamberson, 1995). Consequently, companies canreduce risk and improve their overall performance if they can understand the role anddeterminants of working capital. A firm may apply an aggressive working capitalmanagement policy with a low level of current assets as percentage of total assets, or itmay also be used for the financing decisions of the firm in the form of high level ofcurrent liabilities as percentage of total liabilities (Afza and Nazir, 2009). Excessivelevels of current assets may have a negative effect on a firm’s profitability, whereas alow level of current assets may lead to lower levels of liquidity and stock outs, resultingin difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2004).The main objective of working capital management is to maintain an optimal balanceamong each of the working capital components (Afza and Nazir, 2009). In the light of 5
  13. 13. view, Filbeck and Krueger (2005) stressed business success heavily depends on theability of the financial managers to effectively manage receivables, inventory, andpayables. Firms can reduce their financing costs and/or increase the funds available forexpansion projects by minimizing the amount of investment tied up in current assets(Afza and Nazir, 2009). Most of the financial managers’ time and efforts are consumedin identifying the non-optimal levels of current assets and liabilities and bringing themto optimal levels (Lamberson, 1995). An optimal level of working capital is the one inwhich a balance is achieved between risk and efficiency. It requires continuousmonitoring to maintain the optimum level of various components of working capital,such as cash, receivables, inventory and payables (Afza and Nazir, 2009). Efficient working capital management is an integral component of the overallcorporate strategy to create shareholder value. Working capital is the result of the timelag between the expenditure for the purchase of raw materials and the collection for thesale of the finished products. The continuing flow of cash from suppliers to inventory toaccounts receivable and back into cash is usually referred to as the cash conversioncycle. Smith (1980) firstly signaled the importance of the trade-offs between the dualgoals of working capital management, i.e. liquidity and profitability. In other words,decisions that tend to maximize profitability tend not to maximize the chances ofadequate liquidity. Conversely, focusing almost entirely on liquidity will tend to reducethe potential profitability of the company. A few key performance ratios of a working capital management system are theworking capital ratio, inventory turnover and the collection ratio. Ratio analysis willlead management to identify areas of focus such as inventory management, cashmanagement, accounts receivable and payable management. The component of working capital management includes following contents:Number of days accounts receivable Number of days accounts receivable is a key figure which measures the averageamount of time that a company holds its accounts receivable. It is calculated by thefollowing equation: Number of days accounts receivable = Accounts receivable / sales * 365Number of days inventories Number of days inventories is a key figure which measures the average amountof time that a company holds its inventory. It is calculated by the following equation: 6
  14. 14. Number of days inventories = Inventory / Costs of goods sold * 365Number of days accounts payable Number of days accounts payable is a key figure which measures the averageamount of time that a company holds its accounts payable. It is calculated by thefollowing equation: Number of days accounts payable = Accounts payable / Costs of goods sold * 365Cash conversion cycle The cash conversion cycle is defined as the sum of days of sales outstanding(average collection period) and days of sales in inventory less days of payablesoutstanding (Keown et al, 2003). The cash conversion cycle concept also matches theprinciple of cash management well, i.e. to collect cash as quickly as possible, topostpone cash outflow as long as possible, and to put available cash to the best usewhen we have it. The length of a firm cash conversion cycle depends on the number ofday’s credit it gets from its suppliers, the length of the production process and thenumber of days finished products remain in inventory before they are sold, and finally,the average collection period from the company customers. The length of the cashconversion cycle is instrumental in determining the degree to which the firm must relyon external financing. Accounts payable are a form of spontaneous credit generatedthrough the normal production process of the firm. This spontaneous credit has noexplicit financing charge (interest payments) as long as no penalty is charged for latepayment. Rising sales often present a firm with a serious financing problem because thefirm must finance its operations. The cash conversion cycle is also closely related to theissue of firm valuation. The shorter the cash conversion cycle, the higher the presentvalue of net cash flows generated by the assets and thus, the higher the value of the firm.Likewise, the shorter the cash conversion cycle, that is, the fewer the number of dayscash is tied up in working capital not offset by “free” financing in the form of deferredpayments, the more liquid the condition of the firm. The cash conversion cycle is ameasure for the efficiency of working capital management as it indicates how quicklycurrent assets are converted into cash.Cash conversion cycle = number of days accounts receivable + number of daysinventories – number of days accounts payable 7
  15. 15. Importance of profitability McMahon (1995) indicated that one goal of financial management is tomaximize the owner’s wealth. Thus, profitability is one of the most important objectivesof financial management as well in determining the success or failure of a business. Atthe establishment stage, a business may not be profitable because of investment andexpenses for establishing the business. When the business becomes mature, profits haveto be produced. Thomas and Evanson (2006) indicated that the goal of a business is notonly for the generation of sales, but also for the generation of profits. Profit is especiallyimportant because it is necessary for the survival of a business. Davidson and Dutia(1991) stressed low profitability contributes to under-capitalization problems because itleads to fewer dollars as retained earnings and therefore to a reliance on external capital.Defining and measuring profitability In general, accounting profits are calculated by revenues minus costs. However,the problem of profitability measured by accounting is that they ignore risk (Nguyen,2001). In the economic sense, a firm is profitable only if its profitability is greater thaninvestors can achieve independently in the capital market. Ross et al. (2005) took somemethods to measure profitability including return on sales, return on assets, and returnon equity. • Profit margins are computed by dividing net income by revenue and thus express profits as a percentage of total operating revenue. • Return on assets is the ratio of net income to average total assets, and measures managerial performance. • Return on equity is defined as net income divided by average stockholders’ equity, and shows profit available for stockholders. Cohen (2005) indicated a lot of different ratios to measure profitability of thebusiness. They consisted of asset-earning power, return on the owner’s equity, net profiton sales, and return on investment. • Asset-earning power is determined by the ratio of earnings before interest and tax to total assets. It indicates how much operating profit each dollar of total assets earns. • Return on the owner’s equity is computed by dividing net income by average equity, and shows return that the business received in exchange for investment. 8
  16. 16. • Net profit on sales is determined by the ratio between net income and net sales, and measures the difference between what the business takes in and what it spends in the process of doing business. • Return on investment is simply computed by dividing net profit by total investment. This measure is very useful for measuring profitability.Factors influencing profitability Based on the profitability measures presented by Cohen (2005), it can see thatthe main factors influencing profitability include revenues, cost and capital. Generally,revenue is determined or influenced by marketing, sales management and new productdevelopment, whereas cost and capital are mainly affected the financial managementpractices. Burns (1985) found that there were many different economic factors that couldaffect profitability. Lev (1983) also showed that variability of profit measures over timeis affected by type of product, degree of competition, degree of capital intensity as wellfirm size. Kirchhoff and Kirchhoff (1987) implemented a research in order to examinefamily contributions to productivity and profitability in small businesses. The findingsof the research showed that family members are more productive than other employees.However, in their study family member’s productivity did not increase profitability.Results showed the opposite, as paid family labor increases, profitability decreases. Asfamily member participation increases, wage and salary expense increase as apercentage of revenue, thereby causing profit as a percentage of sales to decline.2.2 Related literature review Working capital is essential for day-to-day operations of a business, and thus itis the life-blood of any business. Working capital management is about the managementof current assets and current liabilities in such a way that a satisfactory level of workingcapital, which maximizes the profits of the firm, is maintained. Inadequacy of workingcapital may lead the firm to insolvency, whereas excessive working capital implies idlefunds which earn no profits. Therefore, efficient management of working capital is anintegral part of the overall corporate strategy to improve corporate profitability. But inreality, controversy persists on the issue whether the working capital of a firm affects itsprofitability or not. Following empirical studies are good literature for establishing therelationship between working capital management and profitability. 9
  17. 17. By carefully monitoring both the timing and magnitude of cash flows, managerscan minimize loan draws or create cash for investment purposes and therefore lessen netinterest expenses. The cash conversion cycle, by reflecting the net time interval betweenactual cash expenditures for the purchase of productive resources and the ultimatecollection of receipts from product sales, provides a valid alternative for measuringcorporate liquidity. The length of the cash conversion cycle is instrumental indetermining the degree to which a firm must rely on external financing. The cashconversion cycle is closely related to issue of firm valuation. Soenen (1993)implemented an empirical to examine the relationship between cash conversion cycleand corporate profitability for 20 different industries during the period 1970-1989. Theresearch shows that there is negative relationship between a firm’s net trade cycle andits profitability measured by the total return on total assets. The results demonstrate thatshorter net trade cycles are most commonly associated with higher profitability whilethe reverse is also true. However, the relationship is not found to be very strong.Analysis at the specific industry level indicates that the inverse association between thenet trade cycle and the profitability of firm is very different, depending on the type ofindustry. The results show that, in most firms in these industries, managing thecorporate cash cycle efficiently has a direct impact on corporate profitability. This studyalso shows that it is of interest for any individual firm to calculate the net trade cycleand to make a comparison with other firms in the same industry. This calculation wouldgive the firm an indication of the efficiency of its working capital management relativeto others in the same industry. Moreover, a firm could verify whether changes inoperating and financial management practices with regard to the management of thedifferent components of working capital had a measurable impact on a profitability offirm. The cash conversion cycle measures the time between cash outlays for resourcesand cash receipts from product sales. The cash conversion cycle is dynamic in the sensethat it combines both balance sheet and income statement data to create a measure witha time dimension. A conservative approach to liquidity management results in a highercash conversion cycle by increasing the inventory period and the accounts receivablesperiod while reducing the accounts payables period. Management of the firm’s cashconversion cycle involves tradeoffs between liquidity and profitability. If the days ininventory are reduced too far, the firm loses sales from customer requiring credit. If the 10
  18. 18. firm increases the days in payable too much, discounts for early payments andflexibility for future are both lost. Jose et al., (1996) made an empirical research toinvestigate the relationship between profitability measures and management of ongoingliquidity needs. The sample for research consisted of 2,718 firms for the twenty-yearperiod from 1974 to 1993. The data are taken from the annual Compustat tapes. Thestudy used correlation, nonparametric and multiple regression procedures on order toevaluate the cross-sectional relationships between profitability measures and the cashconversion cycle. The findings of research shows that more aggressive liquiditymanagement (lower cash conversion cycle) is associated with higher profitability forseveral industries, including natural resources, manufacturing, service, retail andprofessional services. For these industries, there is a statistically significant inverserelationship between cash conversion cycle and profitability and this relationship is notdriven by size. The cross-sectional relationship between cash conversion cycle andprofitability is not significant statistic in the construction industry. The paper alsoindicated that there is a statistically significant negative relationship between cashconversion cycle and profitability disappears when size differences in natural resourcesfirms are controlled. Finally, a statistically significant negative relationship betweencash conversion cycle and profitability is found only when size differences arecontrolled in the financial service industry. Efficient working capital management plays an important role of corporatestrategy to create shareholder value. Working capital is the result of the time lagbetween the expenditure for the purchase of raw materials and the collection for the saleof the finished products. The continuing flow of cash from suppliers to inventory toaccounts receivable and back into cash is usually referred to as the cash conversioncycle (Shin and Soenen, 1998). Working capital management can have a significantimpact on the liquidity as well profitability of the company. Smith (1980) first signaledthe importance of the trade-offs between the dual goals of working capital management,i.e. liquidity and profitability. In other words, decisions that tend to maximizeprofitability tend not to maximize the chances of adequate liquidity. Conversely,focusing almost entirely on liquidity will tend to reduce the potential profitability of thecompany. Shin and Soenen (1998) had implemented an empirical research aboutefficiency of working capital management and corporate profitability. A sample of58,985 firm years covering the period 1975-1994 is used in order to investigate the 11
  19. 19. relationship between firm’s efficiency of working capital management and itsprofitability. Net trade cycle, calculated by (inventory + accounts receivable – accountspayable)*365/sale, is used as an independent variable in the regression model.Profitability, measured by operating income plus depreciation related to total assets(IA), is used as a dependent variable. Current ratio, sales growth, debt ratio are used ascontrol variables. Pearson correlation and regression analysis are utilized for examiningthis relationship. The results provide strong evidence of a negative association betweenthe net trade cycle and corporate profitability. Profitability is also significantlynegatively related to current ratio. In other words, liquidity and profitability are clearlyinversely related. The paper claim that reducing the net trade cycle as a way to enhancethe efficiency of working capital management pays off in terms of increased operatingincome and higher risk adjusted return for the shareholders. Therefore, reducing thefirm’s net trade cycle is one possible way for the firm to create additional shareholdersvalue. In addition, the negative coefficient of debt ratio difference implies that anincrease in leverage is associated with a decline in profitability even though usingoperating profit before interest as a measure of profitability. Deloof (2003) investigated the relationship between working capitalmanagement and corporate profitability for a sample of 1,009 large Belgian non-financial firms for the 1992-1996 periods. The result from analysis showed that therewas a negative relationship between profitability that was measured by gross operatingincome and cash conversion cycle as well number of days accounts receivable andinventories. He suggested that managers can increase corporate profitability by reducingthe number of days accounts receivable and inventories. Less profitable firms waitedlonger to pay their bills. Padachi (2006) had made an attempt to examine the trends in working capitalmanagement and its impact on firms’ performance. This study is based on a sample of58 Mauritian small manufacturing companies. The data has been collected from thefinancial statements of the sample firms having a legal entity and have filed their annualreturn to the Registrar of Companies. The primary purpose of this research is toinvestigate the impact of working capital management on corporate profitability ofMauritian small manufacturing firms. The paper used return on total assets in order tomeasure firm’s profitability as a dependent variable. The reason for choosing thisvariable is the small and medium – size enterprises is characterized by a low fixed assets 12
  20. 20. base and relied to a large extent on accounts payable to fund its gross working capital.Therefore, a comprehensive measure of profitability is best captured by computing thereturn on total assets. Some firms have significant fixed financial assets and were thusexcluded from the calculation of return on total assets. Number of days accountsreceivable, number of days accounts payable, number of days inventories and cashconversion cycle are used as independent variables. The control variable in theregression model consist of total debt to total asset, natural logarithm of sales, currentassets to total assets, current liabilities to total assets and sales to current assets. Resultfrom analysis shows that there is a negative relationship between profitability andnumber of days accounts receivable as well number of days accounts payable. Inaddition, there is also a negative relationship between cash conversion cycle andprofitability. This means that mangers can increase profitability by shortening theirworking capital cycle. Garcia-Teruel and Martínez – Solano (2007) had implemented an empiricalresearch to provide evidence about the effects of working capital management on theprofitability of a sample of small and medium-sized (SEM) Spanish firms. The samplefor this study is 8,872 SMEs covering the period 1996-2002. The objective of thisresearch is to provide evidence about the effects of working capital management onprofitability. Return of assets was used to measure profitability of firms as a dependentvariable. The component of working capital management as number of days accountsreceivable, number of days inventories, number of days accounts payable were used asindependent variables. In order to analyze the effect of working capital management onprofitability of firms, they used correlation and regression analysis. From result ofanalysis, they indicated out that the negative relation between profitability and thenumber of days accounts receivable and number of days inventories could be explainedif less profitable firms incentivize their customers by granting them long paymentdeadlines, or if firms with falling sales and consequently declining profits found theirstock levels rising. Likewise, the negative relation found between profitability andnumber of days accounts payable could be a consequence of firms with more problems,and hence lower profits, delaying their payments. However, they could not confirm thatthe number of days accounts payable affected an SEM’s return on assets, as this relationdid not have significance when they controlled for possible endogeneity problems.Moreover, the study also showed that the relationship between profitability and cash 13
  21. 21. conversion cycle was a negative relationship. Therefore, they suggested that managerscould create value by reducing their cash conversion cycle to a minimum, as far as thatwas reasonable. Working capital management is a very important component of corporatefinance because it directly affects the liquidity and profitability of the company. Withtarget of contributing towards a very important aspect of financial management knownas working capital management, Raheman and Nasr (2007) have implemented anempirical research to investigate the relationship between working capital managementand profitability of Pakistani firms. They utilized the secondary data collected fromfinancial statement of listed firms in Karachi Stock Exchange (KSE) for a period 6 yearsfrom 1999-2004. Net operating profitability was used as a variable while averagecollection period, inventory turnover in days, average payment period and cashconversion cycle were used as independent variables. Current ratio, natural logarithm ofsales, debt ratio and ratio of financial assets to total assets were used as controlvariables. They used correlation model in order to measure the degree of associationbetween different variables under consideration. Regression analysis consisted of twoparts with pooled ordinary least squares and generalized least squares (cross sectionweights) used to estimate the causal relationships between profitability variable,liquidity and other chosen variables. From result of research, they found a significantnegative relationship between net operating profitability and the average collectionperiod, inventory turnover in days, average payment period and cash conversion cycle.They suggested that managers can create value for their shareholders by reducing thenumber of days accounts receivable and inventories to a reasonable minimum. Kaushik (2008) had made an empirical study to examine the influence ofworking capital on the profitability and evaluate the relationship between workingcapital and profitability. The sample chosen for this research was 25 companies in theIndia pharmaceutical industry during the period 1996-97 to 2007-08. Many statisticaltools and techniques had been used for analyzing these data. The ratios relating toworking capital management which had been used in this study are: current ratio,inventory turnover ratio and debtor’s turnover ratio. The profitability measures that hadbeen selected for this study were: profit before interest and tax margin; and return oncapital employed. The degree of relationship between working capital management andprofitability had been assessed through correlation coefficients between the selected 14
  22. 22. measures of working capital management and profitability taking into account theirmagnitudes (i.e., by Pearson’s simple correlation coefficient), ranking of theirmagnitudes (i.e. by Spearman’s rank correlation coefficient), and the nature of theirassociated changes (i.e. by Kendall’s correlation coefficient). Multiple correlation andmultiple regression techniques had been applied in order to recognize influence of theselected measures relating to indicators of working capital management on theprofitability. In order to examine whether the computed values of correlationcoefficients and partial regression coefficients were statistically significant or not, t-testhad been used. The multiple correlation coefficients had been tested by F-test. Thefindings of research show that liquidity management, inventory management and creditmanagement had positive contribution towards improvement of the corporateprofitability. Singh and Pandey (2008) made an attempt to investigate the working capitalcomponents and the impact of working capital management on profitability of Hindalcoindustries limited. The research was based on secondary data collection from annualreports of Hindalco for the study period 1990 to 2007. The ratio analysis, percentagemethod and coefficient of correlation had been used to analyze the data. The researchalso used the regression analysis in order to examine influence of working capitalmanagement to profitability. The findings from this study show that the contribution oflong term source in working capital was below 30% in all the study period. It had alsobeen found that during the study period, except 1994, 1998, 2001, 2004 and 2007, theworking capital of Hindalco had registered an increasing trend. In the regression model,they used current ratio, working capital ratio, inventory turnover ratio, receivablesturnover ratio and working capital to total assets as independent variables. While theprofit before tax to total assets ratios was used as a dependent variable. The regressionresults of the research indicated that current ratio, liquid ratio, receivables turnover ratioand working capital to total assets ratio had statistically significant impact on theprofitability of Hindalco industries limited. Current assets are important components of total assets and need to be carefullymanaged. Smith (1980) claimed that the working capital management played animportant role in a firm’s profitability and risk as well as its value. Efficientmanagement of working capital is very essential in the overall corporate strategy increating shareholder value. Deloof (2003) indicated that firms try to maintain an 15
  23. 23. optimum level of working capital that maximizes that value. The optimum level ofworking capital is examined, to a large extent, by the methods adopted by themanagement. The managers need to maintain optimum level of various component ofworking capital, such as cash, receivables, inventory and payables. Nazir and Afza(2009) had implemented an empirical research to examine the factors that determine theworking capital requirement of the firms. A sample of 132 manufacturing firms from 14industrial groups that were listed on Karachi Stock Exchange between the periods 2004-2007 were taken. In this study, the working capital requirement is used as a dependentvariable while various financial and economical factors, such as operating cycle of thefirm, level of economic activity, leverage, growth of the firm, operating cash flows, firmsize, industry, return on assets and Tobin’s q were used as the determining factors ofworking capital management. The findings of research show that working capitalrequirement, as a dependent variable, was influenced by various economic and financialvariables related to firm. Industry effect was found significantly influencing the workingcapital management practices of non-financial firms operating in different sectors. Thisresearch indicated that there was a positive relationship between operating cycle, wasused to measure the working capital management efficiency of firms, and workingcapital requirement. This means that the higher the days of operating cycle, the moreworking capital would be required by the firm as operative necessity. Tobin’s q ispositively affecting the requirements of working capital of the firms, indicating thatefficient management of working capital was associated with the stock marketperformance of the Karachi Stock Exchange. Moreover, the findings also showed thatleverage of firm, was measured by debt to total assets ratio, was strongly and negativelyrelated to the working capital requirement of a firm, indicating that companies with anincreasing debt to total assets ratio showed lower working capital requirements. Level ofeconomic activity was not found to have any significant effect on working capitalmanagement practices of firms in Pakistan. This was consistent with research ofLamberson (1995) who proved that the response of the firms to change their workingcapital requirements with changes in economic conditions was not significant. Lastly,the research indicated that there was not statistically significant relationship between theworking capital requirement and size of the firm and sales growth. Corporate finance basically deals with three decisions: capital structuredecisions, capital budgeting decisions, and working capital management decisions. 16
  24. 24. Among these, working capital management is a very important component of corporatefinance since it affects the profitability and liquidity of a firm (Appuhami, 2008). Itregards to current assets and current liabilities. There are many reasons for importanceof working capital management that are taken care by financial managers. For one thing,a typical manufacturing firm’s current assets account for over half of its total assets. Fora distribution firm, they account for even more. The maintenance of excessive levels ofcurrents can easily result in a substandard return on a firm’s investment. However,according to Van Horne and Wachowicz (2004) firm with inadequate levels of currentassets may incur shortages and have difficulties in smoothly maintaining day to dayoperating. Basically, the necessary components of an organization’s working capitaldepend on the type of business and industry. Cash, debtors, receivables, inventory,marketable securities, and redeemable futures can be recognized as the component oforganization’s working capital. However, the question is to recognize the factors thatdetermine the adequacy of working capital based on growth, size, operating cash flow,etc. The inability to understand the determining factors and measurement of adequateamounts of working capital will lead an organization to bankruptcy. Departing fromthese reasons, Appuhami (2008) had made an attempt to investigate the impact of firm’scapital expenditure on their working capital management. The research was based onfinancial data; the main source of data was financial statements, such as incomestatements, balance sheets, and cash flow statements of listed companies in the stockexchange in Thailand for the period from 2000 to 2005. Working capital requirementand net liquidity balance were utilized as dependent variables. Capital expenditure,operating expenditure and financial expenditure were used as independent variables.Control variables were utilized in the model including: firm’s operating cash flow,growth of the firm, leverage that measured by total long-term debt capital and dividedby equity. The findings of research showed that firm’s capital expenditure had asignificant impact on working capital management. In addition, the research also foundthat the firm’s operating cash flow, which was recognized as a control variable, had asignificant relationship with working capital management. Working capital management relates to the source and application of short-termcapital. When working capital is improperly managed, allocating more than enough of itwill render management non-efficient and reduce the benefits of short-term investment.On the other hand, if working capital is too low, the firm may miss profitable 17
  25. 25. investment opportunities or suffer short-term liquidity crises, leading to degradation offirm credit, as it cannot respond effectively to temporary capital requirements. Narenderet al., (2008) made a research to investigate the determinants of working capitalmanagement cement industry in India for a period of 10 years. The research used netliquid balance and working capital requirement to assess working capital management,analyzing the influence of firm characteristics, external business factors and industryeffect. The findings of research indicated that size of the firm affected the company’sworking capital management both in the case of net liquid balance and working capitalratio. In the case of working capital ratio, the research found that growth of the firm,operating cash flow, and industry trends in terms of business significantly influence theliquidity management in case of cement industry in India. Efficiency in working capital management is so vital for especially production-firms whose assets are mostly composed of current assets, as it directly affects liquidityand profitability of any firm (Raheman and Nasr, 2007). According to Kargar andBluementhal (1994) bankruptcy may also be likely for firms that put inaccurate workingcapital management procedures into practice, even though their profitability isconstantly positive. Thus, it must be avoided to regress from optimal working capitallevel by bringing the aim of profit maximization in the foreground, or just in directcontradiction, to focus only on liquidity and consequently pass over profitability. Whileexcessive levels of working capital can easily result in a substandard return on assets,inconsiderable amount of it may incur shortages and difficulties in maintaining day today operations. Samiloglu and Demirgunes (2008) made an empirical research toanalyze the effect of working capital management on firm profitability. The sample foranalysis is listed manufacturing firms in Istanbul Stock Exchange (ISE) for the period of1998-2007. The research used return on assets as a dependent variable. While accountsreceivable, inventory period, cash conversion cycle were used as independent variables.Firm size, firm growth, leverage and fixed financial assets were used as controlvariables. Result from research shows that, for the mentioned sample and period,accounts receivables period, inventory period and leverage significantly and negativelyaffect profitability of Turkish manufacturing firms, while firm growth significantly andpositively. However, the research also indicated that cash conversion cycle, size, andfixed financial assets have no statistically significant effect on firm profitability. Theresearch suggested that firm profitability can be increased by shortening accounts 18
  26. 26. receivables and inventory periods. In addition, leverage is another variable affectingfirm profitability negatively. The only variable in the regression model that hassignificantly positive effect on profitability is firm growth. Moss and Stine (1993) stressed that a useful way of assessing the liquidity offirms is with the cash conversion cycle. It measures the time lag between cash paymentsfor purchase of inventories and collection of receivables from customers. Traditionalmeasures of liquidity such as the current ratio and quick ratio are useful liquidityindicators of firms; they focus on static balance sheet values. The cash conversion cycleis a dynamic measure of ongoing liquidity management, since it combines both balancesheet and income statement data to create a measure with a time dimension (Jose et al.,1996). Uyar (2009) had made an empirical research about the relationship of cashconversion cycle with firm size and profitability for corporations listed on the IstanbulStock Exchange. The findings of research show that there is a significant negativecorrelation between the length of cash conversion cycle and the firm size, in terms ofboth net sales and total assets. Hence, the research concluded that smaller firms havelonger cash conversion cycle. This finding is parallel to the finding of the studyconducted by Moss and Stine (1993). Since longer cash conversion cycles are associatedwith smaller firms, this offers a strong incentive for these firms to better manage theircash conversion cycle (Moss and Stine 1993). Moreover, finding of the study alsoshows that there is a significant negative correlation between the length of cashconversion cycle and profitability. The reason for this problem is keeping inventory fora long time, being slow in collecting receivables, and paying debts quickly. Current assets are considered as one of the important components of total assetsof a firm. A firm may be able to reduce the investment in fixed assets by renting orleasing plant and machinery, whereas the same policy cannot be followed for thecomponents of working capital. The high level of current assets may cut down the riskof liquidity associated with the opportunity cost of funds that may have been invested inlong-term assets. Although, the impact of working capital policies on profitability ishighly important, only a few empirical studies have been carried out to examine thisrelationship. Departing from this reason, Afza and Nazir (2009) made an attempt inorder to investigate the potential relationship of aggressive policies with the accountingand market measures of profitability of Pakistani firms. They used a sample of 204Pakistani firms divided into 16 industrial groups by Karachi Stock Exchange for the 19
  27. 27. period 1998-2005. The impact of aggressive working capital investment and thefinancing policies had been examined using panel data regression models betweenworking capital policies and profitability. The findings of research indicated that therewas a negative relationship between the profitability that measures of firms and degreeof aggressiveness of working capital investment and financing policies. From thosefindings, they suggested that managers can create value if they adopted a conservativeapproach towards working capital investment and working capital financing policies. Inaddition, the paper also found that investors gave weight to the stocks of those firms thatadopted an aggressive approach to managing their short-term liabilities. 20
  28. 28. CHAPTER THREE RESEARCHMETHODOLOGY3.1 Research design Zikmund (1997) stressed that descriptive research seeks to determine the answersto who, what, when, where and how questions. The essential difference betweendescriptive and causal studies lies in their objectives (Emory, 1985). If the research isconcerned with finding out who, what, where, when, or how much, then the study isdescriptive. If it is concerned with learning why, that is, how one variable affectsanother, it is causal (Nguyen, 2001). Major research question of this thesis is trying toanswer for how are the relationships between working capital management andprofitability of listed companies on Vietnam Stock Exchange (VSE). This thesis is seeking to explain how working capital management affectsprofitability. Therefore, this thesis is concerned with learning “why”, that is, how“working capital management” variables affect the “profitability variable”. This concernrequired a causal design to identify the cause-and-effect relationships between workingcapital management and profitability of listed companies. Thus, causal research isadequate in order to implement in this thesis.3.2 Research method Based on the methods of data collection, Emory (1985) classified research intotwo types: observation and surveys. However, Zikmund (1997) expands thisclassification into four basic types: surveys, experiments, and observation andsecondary data studies. • Survey is a research technique in which information is gathered from a sample of people by use of a questionnaire (Zikmund, 1997). • Experiment holds the greatest potential for establishing cause-and-effect relationships. The use of experimentation allows investigation of changes in one variable while manipulating other variables under controlled conditions (Zikmund, 1997). • Observation allows the researcher to monitor and record information about subjects without questioning them (Emory, 1985). 21
  29. 29. • Secondary data are data gathered and recorded by someone else prior to the current needs of the researcher (Zikmund, 1997). Secondary data can be used for such things as forecasting sales by constructing models based on past sales figures and through extrapolation. The advantage of secondary data is the savings in time and costs of acquiring information that are generated (Cavana et al., 2001). However, secondary data as the sole source of information have the drawbacks of becoming obsolete and not meeting the specific needs of the particular or setting. In terms of research technique, this thesis uses secondary data because the mainpurpose of this thesis is to investigate the relationship between working capitalmanagement and profitability. Thus, this research uses the audited financial statement oflisted companies on Vietnam Stock Exchange (VSE) to investigate this relationship.3.3 Variable definitions and model development3.3.1 Variable measurement  Variables had to be defined and measured clearly before developing thehypotheses to test these associations. Pedhazur and Schmelkin (1991) defined a variableas any attribute or property in which organisms vary. Dependent and independentvariables are two kinds of variables involve in developing a causal model and testing thehypotheses of association. The dependent variable is the variable of primary interest tothe researcher. The research’s goal is to understand and describe the dependent variable,or to explain its variability or predict it (Cavana et al., 2001). An independent variable isone that influences the dependent variable in either positive or negative (Cavana et al.,2001) Following is a more detail consideration of the dependent and independentvariables, which are defined and utilized in this thesis.3.3.1.1 Dependent variable This thesis examines the impact of working capital management on profitability.Generally, profitability is viewed as a dependent variable. However, profitability is anabstract concept and a latent variable, it cannot be measured directly (Nguyen, 2001) Inorder to overcome this obstacle, researchers often use indicated variables to indirectlymeasure profitability. Nguyen (2001) had reviewed variables that the previous 22
  30. 30. researchers used to measure profitability, such as Burns (1985) measured profitabilityusing three indicated variables: return on total assets, return on net assets and return onequity. Hutchinson et al., (2006) used two indicated variables: return on sales and returnon equity to measure profitability, while Cohen (2005) suggested four variables: assetearning power, return on equity, net profit on sales and return on investment. Generally,depending upon their own purpose, researchers in the literature review used differentindicated variables to measure profitability. However, Nguyen (2001) concluded thatthere were three variables: return on sales (ROS), return on assets (ROA) and return onequity (ROE) were the most popularly used by the researchers and authors such as Rosset al. (2005), Burns (1985) to measure profitability. The empirical research about the relationship between working capitalmanagement and profitability, the previous researches used the following variables tomeasure profitability. • Raheman and Nasr (2007) used net operating profitability (NOP) to measure profitability of firm. It is defined as operating income plus depreciation, and divided by total assets minus financial assets. • Samiloglu and Demirgunes (2008) used return on assets (ROA) to measure profitability when investigating the effect of working capital management on firm profitability. • Singh and Pandey (2008) used the profit before tax to total assets ratios to measure profitability when investigating impact of working capital management on the profitability of Hindalco industries limited. • Deloof (2003) used gross operating income, which is defined as sales minus cash of goods sold, and divided by total assets minus financial assets, in order to measure profitability when examining the effect of working capital management on profitability of Belgian firms. • Lazaridis and Tryfonidis (2006) used gross operating profit to measure profitability. It is calculated by subtracting cost of goods sold from total sales and divided the result with total assets minus financial assets. This thesis uses gross operating profit as a dependent variable. The reason forusing this variable instead of earnings before interest tax depreciation amortization orprofits before or after taxes is because this research wants to associate operating‘success’ or ‘failure’ with an operating ratio and relate this variable with other operating 23
  31. 31. variables (i.e. cash conversion cycle). Moreover, the research wants to exclude the participation of any financial activity from operational activity that might affect overall profitability. Thus, financial assets are subtracted from total assets. This is consistent with the research of Deloof (2003) and Lazaridis and Tryfonidis (2006). Sales - Cost of goods sold Gross operating profitability = Total assets – Financial assets 3.3.1.2 Independent variable The research investigates the relationship between working capital management and profitability, therefore the components of working capital management is used as independent variables. The independent variables used in this research are consistent with the research of Deloof (2003) and Lazaridis and Tryfonidis (2006). • Number of days accounts receivable Number of days accounts receivable represents the average number of days that the firm takes to collect payments from its customers. The higher the value, the higher its investment in accounts receivable (Garcia-Teruel and Martínez - Solano, 2007).Number of days account Average account receivable = x 365 receivable Sales • Number of days accounts payable Number of days accounts payable reflects the average time it takes firms to pay their suppliers. The higher the value, the longer firms take to settle their payment commitments to their suppliers (.Garcia-Teruel and Martínez - Solano, 2007). Average accounts payable Number of days account = x 365 payable Cost of goods sold 24
  32. 32. • Number of days inventories This variable reflects the average number of days of stock held by the firm. Longer storage times represent a greater investment in inventory for a particular level of operations (Garcia-Teruel and Martínez - Solano, 2007) Average inventory Number of days = x 365 inventories Cost of goods sold • Cash conversion cycle The cash conversion cycle measures the time between cash outlays for resources and cash receipts from product sales. The cash conversion cycle is dynamic in the sense that it combines both balance sheet and income statement data to create a measure with a time dimension (Jose et al., 1996). The cash conversion cycle, called cash gap, is the sum of days of sales outstanding (average collection period) and days of sales in inventory less days of payables outstanding (Keown et al, 2003). Figure 3.1 The cash conversion cycle The cash conversion cycleInventory Inventorypurchase sold Number of days Number of days accounts inventories recevable Time Number of days Cash conversion cycle accounts Cash receive payable Operating cycle 25
  33. 33. Number of days Number of Number of Cash conversion = accounts + - cycle days days receivable inventories accounts Cash conversion cycle is likely to be negative as well as positive. A positiveresult indicates the number of days a company must borrow or tie up capital whileawaiting payment from a customer. A negative result indicates the number of days acompany has received cash from sales before it must pay its suppliers (Hutchinson etal., 2007)3.3.1.3 Control variable The research investigates the relationship between working capital managementand profitability. So, the main purpose of this research is to examine how workingcapital management affects profitability. The research will investigate the effect ofpartly of working capital management on profitability in condition the other variables isconstant. The following control variables are used in this research: • The natural logarithm of sale: that is used to measured size of firm ( used by Deloof, 2003 and Lazaridis and Tryfonidis, 2006). • Debt ratio: that is used as proxy for leverage, calculated by dividing total debt by total assets (used by Deloof , 2003 and Lazaridis and Tryfonidis,2006). • Ratio of financial assets to total assets: that is calculated by financial assets dividing by total assets (used by Deloof, 2003 and Lazaridis and Tryfonidis, 2006). 3.3.2 Hypotheses    A hypothesis is a proposition that is empirically testable. It is an empiricalstatement concerned with the relationship among variables (Zikmund, 1997). This thesismakes a set of testable hypotheses that based on previous researches about thisrelationship between working capital management and profitability.Hypothesis 1: There is a negative relationship between number of days accounts receivable andprofitability that is measured by gross operating profit. 26
  34. 34. Deloof (2003) indicated that there was a negative relationship between numberof days accounts receivable and profitability when investigating this relationshipbetween working capital management and profitability of 1,637 firms for period 1991-1996. Similarly, Lazaridis and Tryfonidis (2006) and Raheman and Nasr (2007) alsoshowed that the relationship between number of days accounts receivable andprofitability was negative.Hypothesis 2: There is a positive relationship between number of days accounts payable andprofitability. Deloof (2003) and Raheman and Nasr (2007) indicated that there was a negativerelationship between number of days accounts payable and profitability. However,Lazaridis and Tryfonidis (2006) showed that there was a positive relationship betweenthem.Hypothesis 3: There is a negative relationship between number of days inventories andprofitability. Deloof (2003), Raheman and Nasr (2007) and Lazaridis and Tryfonidis (2006)indicated that there was a negative relationship between number of days inventories andprofitability.Hypothesis 4: There is a negative relationship between cash conversion cycle and profitability. Traditional approach to interaction between cash conversion cycle andprofitability posits that relatively long cash conversion periods tend to decreaseprofitability. Deloof (2003), Raheman and Nasr (2007) and Lazaridis and Tryfonidis(2006) indicated that there was a negative relationship between cash conversion cycleand profitability.Hypothesis 5: There may exist a positive relationship between debt ratio and profitability.Deloof(2003), Raheman and Nasr (2007) and Lazaridis and Tryfonidis (2006) indicatedthat there was a negative relationship between debt ratio and profitability.Hypothesis 6: There may exist a positive relationship between size of firms and profitability. 27
  35. 35. Deloof (2003), Rahemanand Nasr (2007) and Lazaridis and Tryfonidis (2006)indicated that there was a positive relationship between natural logarithm of sales, usedto measure size of firm, and profitability.Hypothesis 7: There may exist negative relationship between ratio of financial assets tototal assets and profitability. Deloof (2003) and Raheman and Nasr (2007) indicated that there was a negativerelationship between financial assets to total assets ratio and profitability. However,Lazaridis and Tryfonidis (2006) showed that there was a positive relationship betweenthem.3.3.3 Model development     3.3.3.1 Model classification Davis (2000) defined a model as any highly formalized representation of atheoretical system, usually designated through the use of symbols. He emphasized theimportance of models to decision-makers as follows: models are extremely importanceto decisions-makers because they form the basis for the development of decisionsupport system. There are a lot of ways in order to categorize models. According to Davis(2000), all useful classification schemes have three elements in common: level ofaggregation, time dimension, and degree of uncertainty in the process being modeled. Based on the basic forms of decision models, Davis (2000) classified modelsinto two types: verbal and mathematical models. Each can be used to transform acomplex real-world process into a more manageable representation of that process. Theverbal model has broad appeal in that it is more easily understood by decision makersbut it is quite difficult to implement, since many implied variables and relationships thataffect the objective are omitted (Davis, 2000). The generalized mathematical model form can symbolically be represented asfollows:OI = f (Ai, B j) whereOI = outcome information or objective from the model to be used by the decision makeror the dependent variableAi= Controllable independent variables in the process being modeled 28
  36. 36. Bj = uncontrollable independent variables influencing the process being modeled, or theenvironment variablesf= functional relationship between the outcome information variable (the dependentvariable) and the independent variables Ai and Bj (Davis, 2000).3.3.3.2 Model development for this research Based on the generalized mathematical model form as indicated by Davis (2000)and the variables defined in subsection 3.2.1, the model of the relationship betweenworking capital management and profitability is developed as follows:  GROSSPRit it = β0 + βiXit + εWhere:GROSSPR it : Gross operating profitability of firm i at time t; i= 1, 2, 3……, 130 firmsβ 0: The intercept of equationβ i: Coefficients of Xit variablesXit: The different independent variables for working capital management of firm i attime tt: Time = 1,2,3 yearsε: The error termSpecifically, when converting the above general least squares model into our specifiedvariables it becomes:GROSSPRit = β 0 + β1 (WCMit)+ β2(DRit) + β3(LOSit) + β4(FATAit) + εWhereWCM: Working capital management, it consists of : - Number of days accounts receivable (AR) - Number of days accounts payable (AP) - Number of days inventories (INV) - Cash conversion cycle (CCC) 29
  37. 37. Figure 3.2: Analytical model LOS: Logarithm of sales FATA: Financial assets to total assets ratio Analytical model for the study Debt ratioEfficient of working capitalmanagement ‐ Number of days accounts receivable Profitability of Ratio of financial ‐ Number of days accounts firms assets to total assets payable ratio ‐ Number of days inventories ‐ Cash conversion cycle Logarithm of sales 3.4 Data collection methods This thesis investigates the relationship between working capital management and profitability in Vietnam Stock Exchange (VSE), so data used for this thesis is secondary data. According to Zikmund (1997), secondary data is defined as data gathered and recorded by someone else prior to the current needs of the researchers. Secondary data are usually historical, already assembled, and do not require access to respondents or subjects. This method has been popularly used by previous researchers in examining the relationship between working capital management and profitability of firms. 30
  38. 38. The data is collected from audited financial statement of listed companies. InVietnam, these financial statements can be obtained from following organizations: • HOCHIMINH STOCK EXCHANGE ( www.hsx.vn) • HANOI STOCK EXCHANGE ( www.hnx.vn) • STATE SECURITIES COMMISSION OF VIETNAM (www.ssc.gov.vn) The reason the research choose this market because there have not been anyresearch about this relationship in Vietnam Stock Exchange (VSE). For the purpose ofresearch, firms in financial sector, banking and finance, insurance, leasing, businessservice, renting, and other service are excluded from the sample. The most recent periodfor this investigating is 2006-2008. Some of the firms are not included in the sample dueto lack information for the certain period. The sample is based on audited financialstatements of 130 firms that listed in VSE. With 130 firms for period of 2006-2008, ithas 390 observations totally.3.5 Data transformation This section examines aspects of data transformation including purpose andmethods of data transformation. Zikmund (1997) defined data transformation as theprocess of changing data’s original form to a format that is more suitable to perform adata analysis that will achieve research objectives. Hence, the purpose of datatransformation is to create a more suitable format for data analysis. This research uses ratios such as: gross operating profitability as a dependentvariable; number of days accounts receivable, number of days accounts payable, numberof days inventories as independent variables and debt ratio, natural logarithm of sales,ratio of financial assets to total assets as control variables. The ratios are not available inaudited financial statement of listed companies. Hence, the process of deriving theseratios required a transformation of raw data into more suitable data for analysis.Computer package (Excel) will help this data transformation easily and quickly. 31
  39. 39. 3.6 Data analysis methods3.6.1 Descriptive statistics  Descriptive analysis refers to the transformation of the raw data into a form thatwill make them easy to understand and interpret. Describing responses or observationsis typically the first form of analysis (Zikmund, 1997). In this thesis, descriptive statistic is used to calculate averages, frequencydistribution, and percentage distribution used as a form of summarizing data. It is usedto describe characteristics of variables in the sample.3.6.2 Correlation analysis  This thesis investigates the relationship between working capital managementand profitability of firms. Therefore, Pearson’s correlation analysis is used to see therelationship between profitability, used as independent variable, and the component ofworking capital management used as independent variables. If efficient working capitalmanagement increases profitability, one should expect a negative relationship betweenthe measures of working capital management and profitability variable. The results ofcorrelation coefficients are presented by standard form of reporting correlation results –correlation matrix.3.6.3 Multiple Regression analysis  Multiple regression analysis is an analysis of association that simultaneouslyinvestigates the effect of two or more independent variables on a single, interval-scaledor ratio-scaled dependent variable (Zikmund, 1997). Departing from shortcoming of Pearson’s correlation is that they do not allowidentifying causes from consequences. While, the main objective of this research is toinvestigates the simultaneous effect of several independent variables (AR, AP, INV,CCC…) on a dependent variable (GROSSPR). Multiple regressions are appropriate tobe selected in this study. 32
  40. 40. CHAPTER FOUR RESEARCH RESULTS 4.1 Descriptive statistics Descriptive analysis shows the average and standard deviation of the different variables in the study. It also presents the minimum and maximum values of the variables which help in getting a total picture about maximum and minimum values a variable can get.Table 4.1 Descriptive Statistics n Minimum Maximum Mean Std. Deviation AR 390 1.92 313.36 51.91 43.62 AP 390 .04 313.91 45.40 43.29 INV 390 .77 315.21 89.46 64.51 CCC 389 -121.70 410.65 96.21 81.75 LOS 390 23.22 30.67 26.61 1.345 DR 390 .04 .92 .44 .22 FATA 390 .00 .84 .12 .15 GROSSPR 390 -.43 3.86 .35 .41 130 Vietnam non- financial firms, 2006-2008 • Number of days accounts receivable (AR)= Average of accounts receivable / Sales* 365 • Number of days accounts payable (AP)= Average of accounts payable / Cost of goods sold *365 • Number of days inventory (INV) = Average of inventory / Cost of goods sold * 365 • Cash conversion cycle (CCC) = AR+ INV- AP • Natural logarithm of sales (LOS) = ln(sale) • Debt ratio (DR)= Total debt/ Total assets • Ratio of financial assets to total assets (FATA) = Financial assets/ Total assets • Gross operating profitability (GROSSPR) = ( Sales – Cost of goods sold)/ (Total assets – Financial assets) Table 1 gives descriptive statistics for 130 Vietnam non-financial firms for a period of three years from 2006 to 2008 and for a total 390 firm -year observations. Looking at this table, we can see that the average value of gross operating profitability 33
  41. 41. is 35.2% of total assets, and standard deviation is 40.7%. This figure means that thevalue of profitability can deviate from mean to both sides by 40.7%. The maximum andminimum values of gross operating profitability are 3.86 and -0.43, respectively.Information from descriptive statistics also indicates that the mean of cash conversioncycle that used as a proxy to measure the efficiency of working capital management is96 days and standard deviation is 82 days. The average of number of days accountsreceivable is 52 days with standard deviation 44 days. Minimum time taken by acompany in order to collect cash from customers is nearly 2 days while the maximumtime for this goal is 313 days. The average time of paying to suppliers is 45 days and thestandard deviation is 43 days. Maximum time taken for firm to pay for their suppliers is314 days while minimum time taken for this purpose is nearly 1day. Moreover, it takesan average 89 days in order to sell inventory with standard deviation of 65 days.Maximum time taken by a firm is 315 days, while minimum time to convert inventoryinto sales is 1 day. Natural logarithm of sales that measure the size of the firm is used as a controlvariable. Figure from Table 1 indicates that the mean of logarithm of sales is 26.61 andstandard deviation is 1.35. The maximum value of logarithm of sales for a firm in a yearis 30.67 while the minimum value is 23.22. Debt ratio is used as a proxy for leverage to check the relationship between debtfinancing and the profitability. It is also used as a control variable. The result ofdescriptive statistics indicates that the average of debt ratio is 44% with standarddeviation of 22%. The maximum debt ratio financing used by a firm is 92% which isunusual because of debt nearly asset. However, it is also possible if the equity of thefirm is nearly zero. While the minimum of debt ratio is 4%, this means that there is acompany that uses a little debt in its operation. Lastly, the ratio of financial assets to total assets is used to check the relationshipbetween the ratio of financial assets to the total assets of Vietnam firms andprofitability. It is also utilized as a control variable. The mean value for this ratio is 12%with a standard deviation of 15%. The maximum value of financial assets to total assetsis 84% and the minimum value for this purpose is nearly 0%. 34
  42. 42. 4.2 Correlation analysis Correlation analysis is used to identify the association between profitability as a dependent variable and other related variables. In this case, the thesis investigate the relationship between profitability of firm that is measured by gross operating profitability and component of working capital management as: number of days accounts receivable, number of days accounts payable, number of days inventories, cash conversion cycle as well other control variables. Table 4.2 Correlation matrix AR AP INV CCC LOS DR FATA GROSSPRAR 1.000 .408** .285** .549** -.279** -.035 -.043 -.223**Sig.(2-tailed) .000 .000 .000 .000 .487 .399 .000N 390 390 390 390 390 390 390 390AP .408** 1.000 .235** -.116* -.138** .157** -.079 .195**Sig.(2-tailed) .000 .000 .022 .006 .002 .118 .000N 390 390 390 390 390 390 390 390INV .285** .235** 1.000 .819** -.198** .043 -.119* -.202**Sig.(2-tailed) .000 .000 .000 .000 .401 .019 .000N 390 390 390 390 390 390 390 390CCC .549** -.116* .819** 1.000 -.236** -.065 -.077 -.383**Sig.(2-tailed) .000 .022 .000 .000 .200 .129 .000N 389 389 389 390 389 389 389 389LOS -.279** -.138** -.198** -.236** 1.000 -.040 -.016 .172**Sig.(2-tailed) .000 .006 .000 .000 .435 .746 .001N 390 390 390 390 390 390 390 390DR -.035 .157** .043 -.065 -.040 1.000 -.271** .231**Sig.(2-tailed) .487 .002 .401 .200 .435 .000 .000N 390 390 390 390 390 390 390 390FATA -.043 -.079 -.119* -.077 -.016 -.271** 1.000 .075Sig.(2-tailed) .399 .118 .019 .129 .746 .000 .140 35
  43. 43. N 390 390 390 390 390 390 390 390GROSSPR -.223** .195** -.202** -.383** .172** .231** .075 1.000Sig.(2-tailed) .000 .000 .000 .000 .001 .000 .140N 390 390 390 390 390 390 390 390 ** Correlation is significant at the 0.01level (2-tailed) *Correlation is significant at the 0.05 level (2-tailed) The first, we have started our analysis of correlation results between the number of days accounts receivable (AR) and gross operating profitability. The result of correlation analysis shows a negative coefficient – 0.223, with p value of 0.000. It shows that there is a high significant at α = 1%. This means that if number of days accounts receivable increase, it will make operating profitability decrease. Correlation result between number of days inventories (INV) and the gross operating profitability also indicate the same type of result. The correlation coefficient is – 0.202 and p value is 0.000. It also shows a high significant at α = 1%. It explains for reason why when the firm takes more time in selling inventory, it will adversely affect its profitability. On the other hand, correlation result between number of days accounts payable (AP) and gross operating profitability is a positive. The correlation coefficient is 0.195 and p value is 0.000. It shows highly significant at α = 1%. This means that the more profitable firms wait longer to pay their bills. The cash conversion cycle that is used as a comprehensive measure of working capital management also has a negative correlation with gross operating profitability with coefficient -0.383 and p value is 0.000. It also shows highly significant at α = 1%. This demonstrates that paying suppliers longer and collecting payments from customers earlier, and keeping products in stock less time, are all associated with an increase in the firm’s profitability. Result from analysis also shows a positive relationship between natural logarithm of sales, used to measure the size of firm, and the gross operating profitability. Its coefficient correlation is 0.172 with p value 0.001. It shows highly significant at α = 1%. This shows that as size of the firm increases, it will increase its profitability and vice versa. To sum, result from analyzing of correlation indicates that there is a negative relationship between cash conversion cycle, number of days accounts receivable, number of days inventories with the profitability of firms are consistent with the research of Deloof (2003) and Raheman and Nasr (2007). However, in their study, he 36

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