Effect of Working Capital Management on Stock Return and Profitability (Elected Glassmaking Companies of Iran)

Special Issue INTERNATIONAL JOURNAL OF HUMANITIES AND February 2016 CULTURAL STUDIES ISSN 2356-5926

Effect of working capital management on stock return and profitability (elected glassmaking companies of Iran)

AhmadReza Mohamadlua1 PhD. Ali Kashmari*2 Abstract

Working capital management means the balance between the current assets and liabilities, so that this balance can timely meet the needs of components of working capital management. In this study, the effect of working capital management is investigated on return on stock and profitability of elected glassmaking companies. So, four components, including collection period, inventory turnover period, accounts payable period and cash conversion cycle, are considered as the components of working capital management (independent variable) and their effects on return on stock and profitability (dependent variable) is investigated in forms of four questions. The statistical population of this study is composed of 5 glassmaking companies, including Glass and Gas, Mina glassmaking, Hamadan glass, Takestan glass and Razi glassmaking, that their data had been investigated during 2009 to 2013. The results show that collection period and accounts payable period have a significant effect on efficiency and profitability of the mentioned companies. And also, the inventory turnover and cash conversion cycle have a significant effect on returns on stock.

Keywords: working capital management, collection period, inventory turnover period, accounts payable period, cash conversion cycle.

1 - Department of Management,buinzahra Breanch,Islamic Azad University, Buinzahra,Iran. 2 - Ph.D of Financial Economics, Assistante Professor; Department of Management,buinzahra Breanch,Islamic Azad University, Buinzahra,Iran. * Corres ponding author. ( e-mail: [email protected]).

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Introduction When an enterprise plans its activities, it should maintain the balance between assets, money stock and profitability. Working capital management reflects the policies and decisions applied in current assets and sources of funding, and the proper management of this sector can have a significant impact on the profitability and stock returns. In this study, the main components of working capital management are cash conversion period, collection period, accounts payable period and inventory turnover period that the sum of these elements constitutes the independent variable (Deloof, 2003). According to Skilling, working capital term generally is related to investment in the organization's current assets, current liability, cash, short-term securities, account receivable and inventory. The main issue in capital management is insuring that those companies have enough cash flow to continue their usual operation, so that minimize the risk and inability in finishing their short time duties. In this context, the real question is that what is the impact of working capital management and its components on profitability and return on stock of glassmaking companies?

Sub-questions 1. Does collection period have a significant effect on stock returns and profitability of elected glassmaking companies? 2. Does the inventory turnover period have a significant effect on stock returns and profitability of elected glassmaking companies? 3. Does the accounts payable period have a significant effect on stock returns and profitability of elected glassmaking companies? 4. Does the cash conversion cycle have a significant effect on stock returns and profitability of elected glassmaking companies?

Theoretical foundations Working capital management is the determination of the type, size, amount and composition of sources and uses of working capital in a way that increase stockholders wealth (Reymond P Neveu, 2001). In fact, working capital management is included decisions related to funding to support the current assets of non-profit entities. Working capital management is important in financial health of different business entities. Managers consider various factors to invest in companies in which profitability is one of the most important factors. Working capital management includes an important area of financial management and can have a significant effect on the profitability and money stock of the company (Shin and Soenen, 1998). Working capital meets the short-term financial needs of trade institution. Working capital is a trading capital which not remains more than one year in a company. The cash which is invested in them will be changed during trading operation. The need to maintain adequate working capital can hardly be opposed. As the blood circulation in human body is very important to maintain the life, cash flow is essential to continue business operations (Kyson, 2006). Working capital policies have some principles and plans including measures concerning current assets and liabilities. Many authors and researchers have pointed to three types of working capital policy: aggressive, moderate and conservative. The main differences of these policies are the net working capital which is equal to the difference between current assets and current liabilities. Conservative strategy in working capital management will increase money stock power so much. In implementation of this policy, it is tried to minimize the risk due to inability to pay the liabilities. The manager of this method tries to maintain the current assets in a high level and in contrast, the manager of working capital tries to utilize

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more from the current liabilities by the least amount of current assets. In implementation of this method, the risk of money stock is very high. In another hand, the return on investment rate will be so high due to the least amount of current assets. However, the equilibrant policy is between boldly and conservative policies, and the manager of capital working tries to use current assets and liabilities in a balanced mode in investment structure, so this policy has risk and average return (Maliki Nia, Asgari, Ghezelbash, 2011).

Research history Among Foreign Studies, Abdul Rahman and Naser (2007) investigated the relationship between working capital management and liquidity with profitability. In these study, they investigated 94 companies during 1999 to 2004, in which the cash conversion period, inventory period, creditors deposit period, collection period, current ratio, net operating income, company size, financial liability and assets ratio was used. The results, based on regression analysis and Pearson correlation coefficient, indicates that there is a significant inverse relationship between working capital management and corporate profitability. Troll and Solano (2007) investigated working capital management and its impact on company's profitability. Their investigation took 7 years during 1996 to 2002. They found that a decrease in the cash conversion cycle improves the profitability of the company. They stated that the management of working capital is important due to its effect on profitability and company risk and led to the firm's value-creation. Gil et al. (2010) selected a sample of 88 earning listed companies in New York stock exchange, and they investigated the effect of working capital level on profitability, and found that there is a significant relationship between cash conversion cycle and profitability of companies, the profitability of company will be increase by shortening the receivable period. Elmvola (2012) investigated the effect of working capital management policies on the profitability and value of the earning listed companies in Oman stock market during 2001 to 2009, and found that the conservative investment strategy and boldly fiscal policy have a positive and negative effect on the company's profitability and value, respectively. Gill and Beeger (2014) investigated the impact of corporate governance features on the efficiency of working capital management of 180 manufacturing companies of USA during the financial year of 2009 to 2011. They applied the size of board, the duality posts of director and the occupation duration of being a director indices to measure the corporate governance. Evidence suggests that some mechanisms of corporate governance play an important role in improving the efficiency of working capital management. Among internal studies, Ardakanian (2009) showed that there is a negative relationship between working capital management and profitability, and profitability will be increased using working capital management boldly strategy, and vice versa. Arefi and Dadras (2010) investigated the importance of basic variables of financial bills in predicting the stock returns using the fundamental analysis strategy, in which 11 factors are considered in calculating the fundamental score of companies, including inventory, accounts receivable, investments, financial leverage changes, liquidity changes, changes in assets cycle, net profit margin, return on assets, changes in return on assets, cash flow and dues. The results of this study showed that the foundation score have a significant positive relationship with stock returns at 1 percent. Taghizadeh et al (2011) investigated the relationship between working capital management and performance of companies listed on Tehran Stock Exchange. They chose 50 manufacturing companies during the financial duration of 2006 – 2009. The results showed

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that increased collection cycle, payment period and net exchange cycle reduces the profitability of the company.

Methodology The method of analysis in this research is regression panel. The related financial ratios have been used to determine the relationship between working capital management and return on stock rate, and univariate regression have been used to analyse the data of each variable. These tests were estimated based on panel data. The statistical population of this study is 5 glassmaking companies listed on the Tehran Stock Exchange, including: Glass and Gas, Mina glassmaking, Hamadan glassmaking, Takestan glassmaking and Razi glass about which complete information is available. And they have been chose as samples during 2010 to 2014. 1- The introduction of study model The model used in this study is a modified model of Abdul Rahman and Mohammadnasr (2007), Gamleyt and Renny (2008) and Bertland and Brink (2013) researches, as follows:

StockReturn,Profitability{NPM,ROA,ROCE} CR = Current Ratio: This ratio measures the company's ability to refund the short-time commitments. Which is calculated by dividing current assets to current liabilities. It is better this ratio to be more than one (Reymond P Neveu, 2001). CSR = liquidity ratio: it’s a financial ratio and obtained by dividing the cash, cash equivalents and securities, which easily can be converted into cash, to current liabilities (Reymond P Neveu, 2001). Deposit of creditors (APP): it also called accounts payable period and it calculates the duration of accounts payable balance. The managers use this index to plan the payments and to compare the credit condition of other firms’ sales (Mohammad Mohammadi, 2009). Collection period (ACP): In general, the collection period is a measure to determine the duration of collecting the accounts receivable. To determine the collection period, the daily credit sales are calculated as follows: Equation 1 daily credit sales = annual credit sales / 365 The collection period can be obtained by dividing the accounts receivable to daily credit sale as follows: Equation 2 collection period = Accounts Receivable / daily credit sale Inventory turnover period (ITID): inventory turnover period represents the duration of goods sale, (Reymond P Neveu, 2001). To calculate the inventory turnover period are as follows: First, we determine the average inventory. There are 3 figures for goods at the end of the year, which are related to the end of last year or the beginning of this year, the inventory of the first six months of the year and the inventory of the end of the year. So, the average of inventory is obtained by the average of the three mentioned figure: Equation 3 average inventory= (the inventory of the beginning of year + the inventory at the end of the year) /2 After determining the average inventory, the inventory turnover rate is calculated as follows: Equation 4 the inventory turnover rate = average inventory / cost of sold goods Then, the daily inventory turnover is determined as follows:

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Equation 5 inventory turnover period = the inventory turnover rate / 365 Liability payment period (APP): it is the duration to settle the accounts payable. In one method, the approximate amount of one day's purchase is obtained by dividing the total annual purchases to days, then accounts payable balance is divided to it, and it is found that for how many days, the creditors due is not paid (Mark Dellof). Cash conversion cycle (CCC): the duration of the process of converting invested cash of a company into operation and profitability is called cash conversion cycle (Mohammadi, 2009). Equation 7 Cash conversion cycle = (payment period - ((collection period + inventory turnover period)) (Pour Heydari, Hoshmand, 2012). NPM: net profit margin is obtained by after-tax profit to net sales ratio, and it shows the profitability of each sale. ROA: Return on assets shows the profit obtained from invested assets (Reymond P Neveu, 2001) and its formula is as follows:

Equation 8

ROCE: Return on capital is similar to return on assets, but average of total employed capital is used in the denominator (Reymond p Neveu, 2001, 1989).

Equation 9

2. Introduction of model tests In all questions, first, the model is estimated as a panel-variable to choose between fixed and variable test panel, Haussmann test is then used to choose between variable and fixed. Since, F Haussmann statistic value is less than 0.05, and the variable assumption have been rejected in all questions, so the panel test has been used for estimation. Normality tests: data normalization is the first step in the process of testing the questions. For all questions, the following results are shown using Jarque Bera test, if the P-value is less than 0.05, the assumption of normality of data will be rejected. As shown in the below table, all questions are normal.

Table 1: normality test for panel Forth question Third question Second question First question seco seco seco seco third First third First third First third First nd nd nd nd sub- sub- sub- sub- sub- sub- sub- sub- sub- sub- sub- sub- test ques ques ques ques ques ques ques ques ques ques ques ques tion tion tion tion tion tion tion tion tion tion tion tion

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0.49 0.49 0.10 0.38 0.03 0.50 0.50 0.03 0.49 0.38 0.03 0.50 Std.de 82 81 65 56 86 09 1 75 83 4 85 09 v - - - - 0.07 0.07 0.43 0.43 - 0.01 0.07 0.43 Skow 0.41 0.41 0.41 0.41 34 212 55 5 0.41 51 31 55 ness 39 01 39 01 2.98 3.13 3.99 3.99 3.99 3.55 3.02 3.13 2.99 3.99 3.55 Kurto 3.56 3 88 38 36 4 74 03 87 32 37 73 sis 1.81 0.73 1.81 1.81 1.81 1.02 1.02 0.09 0.73 0.73 1.81 1.02 Jarqu 9 42 92 86 99 46 44 6 41 2 89 443 e-bera 0.69 0.69 0.40 0.40 0.90 0.59 0.59 0.95 0.69 0.90 0.68 0.59 proba 3 27 26 28 1 9 9 3 27 1 26 91 bility

The coefficient of determination (R2) is between 0.6 and 0.8 in all models, which states that more than 60 percent of the changes of the dependent variable are explained by right variables of the model, so these models have the ability to fit the relationship between dependent and independent variables. In regression analysis, when variables are investigated during a period, the data changes may follow a certain pattern and Durbin-Watson test is used to assess this pattern. Whatever the value of this test is closer to zero, the correlation is positive, and vice versa. In normal mode, if the result of this test is a number between 1 and 4, test variables are correct. As shown in the estimation tables of the models, Durbin Watson is between 1 and 3 in all questions. The formula is as follows:

Analysis of data Estimation of models related to first question

Table 2 (first sub-question model estimation)

P - statistic Variable coefficient Variable name Value t- symbol 0 11.05 528.92 intercept 0 -27.07 -0.0002 Average Collecting debts 0.0002 -4.72 -26.90 Current ratio 0.1527 -1.50 -7.48 money stock ratio coefficient of 65/0 R2 determination 1/8 Dw Durbin-Watson 0000/0 F F Limer

As the results show, the significant level of t-statistics is less than 5% for the main variable of average collecting debts and control variable of current ratio. Therefore, it can be concluded that the collecting debts have a significant effect on return on stock and profitability of glassmaking companies. In another hand, the estimated coefficient is negative for average

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collecting debts; it means that the effect of average collecting debts is reverse on the company's profitability. The probability level of the calculated statistic of liquidity ratio is 0.15 which shows the variable is non-significance at 5%.

Table 3 (estimation of the second sub-question model)

P - statistic Variable Variable coefficient Value t- symbol name

0.000 33.42098 0.08 intercept Average 0.000 10.24511 0.012 Collecting debts 0.000 6.08525 0.002 Current ratio money stock 0.0008 4.129238 0.004 ratio coefficient of 0/72 R2 determination Durbin- 2/15 Dw Watson 003/0 F F Limer

The above table shows that the significant level of t-statistics calculated for the main variable of average collection period and control variable of current ratio and liquidity ratio is less than 5%. Therefore, it can be concluded that there is a significance effect between the collection period and return on assets of glassmaking companies. On the other hand, the estimated coefficient of the average collection is close to zero. This means that the period of collection of receivables has a low-impact on returns on asset of glass-making companies.

Table 4 (estimation of the third sub-question model)

statistic Variable Variable P - Value coefficient t- symbol name

0.13 -1.59 -0.196 intercept Average 0.00 5.37 0.008 Collecting debts 0.00 5.05 0.082 Current ratio money stock 0.00 13.61 0.097 ratio coefficient of 85/0 R2 determination Durbin- 2/4 Dw Watson 022/0 F F Limer

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As the results show, the significant level of t-statistics calculated for the main variable of average collection and control variable of current ratio and liquidity ratio is less than 5% significance level. Therefore, it can be concluded that there is a significance effect between the collection period and return on capital of glass-making companies. On the other hand, the estimated coefficient of average collection rate is close to zero. This means that the average collection period has low-impact on return on investment of glass-making companies. The estimated related to the second question

Table 5 (estimation model of the first sub-question)

P - statistic Variable Variable coefficient Value t- symbol name

0.69 -0.41 -285.77 intercept

0.33 0.99 4.20 Inventory turnover 0.04 -2.21 -5.57 Current ratio money stock 0.27 -1.13 -0.02 ratio coefficient of 77/0 R2 determination 1/95 Dw Durbin-Watson 000/0 F F Limer

As the results show, the significance level of t-statistics calculated for the main variable of inventory turnover period is higher than 5%. Hence, the inventory turnover has no significant effect on the profitability (net profit margin) of glassmaking companies.

Table 6 (estimation of second sub-question model)

P - t- Variable Variable coefficient Value statistic symbol name

0.000 7.1210 0.1188 intercept

0.037 -2.2822 -0.0002 Inventory turnover 0.000 5.2040 0.0014 Current ratio money stock 0.764 -0.3056 0.0004 ratio coefficient of 0/67 R2 determination Durbin- 1/55 Dw Watson 0.002 F F Limer

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The significance level of T-statistic calculated for the main variable of inventory turnover and control variable of current ratio is less than 5%. Therefore, it can be concluded that the inventory turnover has a significance effect on return on assets of glassmaking companies. On the other hand, the estimated coefficient for inventory turnover is negative. This means that the impact of inventory turnover has a reserve impact on the profitability of glassmaking companies. So, the increase of inventory turnover has a negative impact on the return on assets. Also, the significance level of calculated statistic of the liquidity ratio is 0.76, which indicates no significance effect of the variable at 5%.

Table 7 (the estimation of the third sub-question model)

P - t- Variable Variable coefficient Value statistic symbol name

0.07 1.916 0.5019 intercept

0.07 -1.978 -0.0037 Inventory turnover 0.00 23.830 0.0958 Current ratio money stock 0.0915 1.795593 0.057 ratio coefficient of 0/7 R2 determination Durbin- 1/74 Dw Watson 37/0 F F Limer

As the results show, the significance level of t-statistics calculated for the main variable of inventory turnover period is higher than 5%. Hence, the impact of inventory turnover on return on capital of glass-making companies is rejected.

The estimation of model related to the third question

Table 8 (the estimation of first sub-question)

Variable Variable P - Value t-statistic coefficient symbol name

0.00 11.051 528.89 intercept

0.00 -27.081 0.005 Accounts payable 0.16 -1.477 -7.35 Current ratio money stock 0.2906 -1.09305 0.014 ratio coefficient of 85/0 R2 determination 2/55 Dw Durbin-

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Watson 000/0 F F Limer

As the results show, the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that the accounts payable has a significance level on profitability (net profit margin) of glass-making companies. On the other hand, the estimated coefficient of average collection is close to zero. This means that the accounts payable has a low-impact on profitability (net profit margin) of glassmaking companies. Table 9 (the estimation of second sub-question model)

Variable Variable P - Value t-statistic coefficient symbol name

0.00 33.433 0.08 intercept

0.00 10.307 0.12 Accounts payable 0.00 4.122 0.04 Current ratio money stock 0 -52.1667 0.56 ratio coefficient of 0/78 R2 determination Durbin- 1/95 Dw Watson 0.003 F F Limer

As the results show, the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that there is a significance level between accounts payables and return on assets of glassmaking companies. The estimated coefficient of accounts payable is close to zero. This means that accounts payable has low-impact on return on asset of glass-making companies.

Table 10 (the estimation of the third sub-question model)

Variable P - Value t-statistic coefficient Variable name symbol

0.13 -1.590 -0.20 intercept

0.00 5.371 0.08 Accounts payable 0.00 13.607 0.10 Current ratio money stock 0.19 1.37 0.10 ratio coefficient of 0/8 R2 determination 1/65 Dw Durbin-Watson 22/0 F F Limer

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The results show the significance level of t-statistics calculated for the main variable of accounts payable is less than 5%. Therefore, it can be concluded that the accounts payable has a significance effect on return on capital of glassmaking companies. On the other hand, the estimated coefficient of average collection is close to zero. This means that the accounts payable has low-impact on Return on capital of glassmaking companies. Estimation of model related to the fourth question

Table 11 (the estimation of first sub-question model)

Variable P - Value t-statistic coefficient Variable name symbol 0.11 1.680 528.84 intercept cash Conversion 0.11 1.681 0.06 cycle 0.25 -1.206 -7.26 Current ratio money stock 0.11 -1.68 -0.59 ratio coefficient of 0/73 R2 determination 2/42 Dw Durbin-Watson 000/0 F F Limer

As the results show, the significance level of t-statistics calculated for the main variable is higher than 5%. As a result, the cash conversion cycle has no significance effect on profitability (net profit margin).

Table 12 (the estimation of second sub-question model)

t- Variable Variable P - Value coefficient statistic symbol name 0.00 33.444 0.08 intercept cash 0.00 -10.355 0.008 Conversion cycle 0.00 4.117 0.004 Current ratio money stock 0.00 9.69 0.04 ratio coefficient of 7/0 R2 determination Durbin- 85/1 Dw Watson 003/0 F F Limer

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As the results show, the significant level of t-statistics calculated for the main variable is lower than 5%. So, the cash conversion cycle has a significance effect on return on assets, but the calculated coefficient is so negligible and around zero.

Table 13 (the estimation of the third sub-question model)

Variable Variable P - Value t-statistic coefficient symbol name 0.26 -1.161 -0.20 intercept cash 0.14 -1.552 0.07 Conversion cycle 0.03 2.409 0.10 Current ratio money stock 0.14 1.57 0.008 ratio coefficient of 72/0 R2 determination Durbin- 5/1 Dw Watson 223/0 F F Limer

As the results show, the significant level of t-statistics calculated for the main variable is higher than 5%. As a result, the effect of cash conversion cycle on return on investment cannot be verified.

Results of the analysis and recommendations In the present study, the influence of four elements, including the collection period, the inventory turnover period, the accounts payable period and the cash conversion cycle, were investigated as components of working capital management, in the form of four question, on return on stock and profitability of glassmaking companies using regression analysis, the results are as follows. In the first question, there is a negative significance effect between collection periods on net margin profit of the glassmaking companies. The impact of collection period is accepted on returns on assets and return on applied investment of elected glass-making companies. But regarding to these calculated coefficients, this effect is so negligible. So, we can say that the managers can create a significance relationship between collection periods with net profit margin by reducing the accounts receivable as possible, and then create a positive value and profitability for stockholders by reducing the collection period as possible. This can be achieved by proper management of accounts receivable and effective administration of collection. In second question, inventory turnover period have a negative significance effect on profitability (return on assets) of glass-making companies. Also, the results reveal the significant effect of inventory turnover period on the return on assets which is negative (reverse). It is indicated that if the inventory turnover period increases, the return on assets will decrease, and vice versa. Also, test results showed that the inventory turnover is significant on the return on investment and it can be used as one of the factors affecting the efficiency. But, the inventory turnover has no significance effect on net profit margin and

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return on employed capital ratio. So, it can be said that managers can increase the return on assets by reducing the inventory turnover period as possible, and improve the desirable profitability. In third question, the results show that the accounts payable has a positive low-impact on return on assets of glass-making companies. As well as the accounts payable has a low significance and negative relationship with net profit margin and return on used capital in glassmaking companies. In fact, if managers could increase the payment duration of accounts payable using different policies and procedures, the efficiency and profitability of companies will increase. And this will be possible by increasing the duration of refund of commitments. The results of the last question indicate that cash conversion cycle has a negative significance effect on return on assets. The tests indicate that there is a low significance effect between cash conversion cycle and return on assets of elected glassmaking companies which is negative (inverse), and in fact, it is indicated that increased cash conversion cycle of glassmaking companies reduces the return on assets, but this impact is very low. The effect of cash conversion cycle is not significance on net profit margin and return on investment of the glass-making companies in Tehran Stock Exchange. Therefore, the shorter cash conversion cycle process, the greater efficiency.

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