Identification and Estimation of the Role of Internal Micro Level Factors Towards Efficient Working Capital Management A case study based on the experience of manufacturing firms in Pakistan. By Shahid Ali A research thesis submitted to the Department of Management & Social Sciences, Mohammad Ali Jinnah University, Islamabad In partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY IN MANAGEMENT SCIENCES (FINANCE) DEPARTMENT OF MANAGEMENT & SOCIAL SCIENCES MOHAMMAD ALI JINNAH UNIVERSITY ISLAMABAD JANUARY 2012 Identification and Estimation of the Role of Internal Micro Level Factors Towards Efficient Working Capital Management A case study based on the experience of manufacturing firms in Pakistan. By Shahid Ali A research thesis submitted to the Department of Management & Social Sciences, Mohammad Ali Jinnah University, Islamabad In partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY IN MANAGEMENT SCIENCES (FINANCE) DEPARTMENT OF MANAGEMENT & SOCIAL SCIENCES MOHAMMAD ALI JINNAH UNIVERSITY ISLAMABAD JANUARY 2012 Identification and Estimation of the Role of Internal Micro Level Factors Towards Efficient Working Capital Management A case study based on the experience of manufacturing firms in Pakistan. By Shahid Ali (PM073008) Professor Dr. Tudorel Andrei The Bucharest Academy of Economic Studies, Romania Dr. Claudiu Herteliu University of Economic Studies, Romania ______________________________________ Professor Dr. Muhammad Ramzan Akhtar ______________________________________ Dr. Sajid Bashir (Head of Department, Management and Social Sciences) _______________________________________ Dr. Arshad Hassan (Dean, Faculty of Management and Social Sciences) DEPARTMENT OF MANAGEMENT & SOCIAL SCIENCES MOHAMMAD ALI JINNAH UNIVERSITY ISLAMABAD JANUARY 2012 Copyright© 2012 by Mr. Shahid Ali All rights are reserved. No part of the material protected by this copy right notice may be reproduced or utilized in any form or any means, electronic or mechanical, including photocopying, recording or by any information storage and retrieval system, without the permission from the author. (Dean FM&SS) Certificate This is to certify that Mr. Shahid Ali has incorporated all observations, suggestions and comments made by the external evaluators as well as the internal examiners and thesis supervisor. The title of his Thesis is: Identification and Estimation of the Role of Internal Micro Level Factors Towards Efficient Working Capital Management - A case study based on the experience of manufacturing firms in Pakistan. Forwarded for necessary action Dr. Muhammad Ramzan Akhtar (Thesis Supervisor) Table of Contents Table of Contents ....................................................................................................................................... i List of tables .............................................................................................................................................. v Acknowledgement ................................................................................................................................... vi Abstract ................................................................................................................................................... vii CHAPTER 1 ............................................................................................................................................. 1 INTRODUCTION .................................................................................................................................... 1 1.1 Chapter Overview ............................................................................................................................... 1 1.2 Formulation of the topic ...................................................................................................................... 1 1.3 Nature of the Study ............................................................................................................................. 5 1.4 Objectives of the Research Thesis ...................................................................................................... 5 1.5 Study Design of Research ................................................................................................................... 5 1.6 Research Scope, Assumptions and Limitations .................................................................................. 5 CHAPTER 2 ............................................................................................................................................. 7 REVIEW OF LITERATURE ................................................................................................................... 7 2.1 Chapter Overview ............................................................................................................................... 7 2.2 Internal Micro level factors ................................................................................................................. 7 2.2.1 Working Capital Efficiency ............................................................................................................. 7 2.2.2 Credit Policy of a Firm................................................................................................................... 10 2.3.3 Inventory Management .................................................................................................................. 12 2.2.4 Employees' Capability of Decision Making ................................................................................... 15 2.2.5 Payables Management.................................................................................................................... 17 2.2.6 Receivables Management .............................................................................................................. 19 2.2.7 Profitability .................................................................................................................................... 20 2.2.8 Liquidity Needs .............................................................................................................................. 25 2.2.9 Corporate Governance ................................................................................................................... 30 2.3 Micro Level Factors – External to a firm .......................................................................................... 31 2.3.1 Customer Needs ............................................................................................................................. 31 2.3.2 Supplier Covenants ........................................................................................................................ 31 2.3.3 Shareholders’ Wealth ..................................................................................................................... 32 2.3.4 Financing Opportunities and Requirements ................................................................................... 32 2.3.5 Seasonal Needs .............................................................................................................................. 34 i 2.4 Macro Level Factors – Internal to a sector........................................................................................ 36 2.4.1 Industry Effects .............................................................................................................................. 36 2.4.2 Sectoral Differences ....................................................................................................................... 37 2.4.3 Compelling Business Reasons for Firms ....................................................................................... 38 2.5 Macro Level Factors – External to a sector ...................................................................................... 39 2.5.1 Impact of Inflation on Inventory .................................................................................................... 40 2.5.2 Impact of Inflation on Receivables ................................................................................................ 41 2.5.3 Impact of Inflation on Cash Balances ............................................................................................ 41 2.6 Summary of Reviewed Literature ..................................................................................................... 41 METHODOLOGY ................................................................................................................................. 44 3.1 Chapter Overview ............................................................................................................................. 44 3.2 Rationale of Theoretical Models ....................................................................................................... 44 3.3 The Efficiency Quest in Exploratory Sense ...................................................................................... 45 3.3.1 Theoretical Model for Exploring Efficient Firms .......................................................................... 46 3.4 Business Performance and Working Capital Management ............................................................... 46 3.4.1 Theoretical Model for Linking Business Performance with Working Capital Management ......... 47 3.5 Determinants of the Working Capital Requirements of a Firm ........................................................ 47