Asian Journal of Business and Management Sciences ISSN: Vol. 1 No. 2 [ ]

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1 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] THE EFFECT OF WORKING CAPITAL ON PROFITABILITY OF FIRS IN NIGERIA: EVIDENCE FRO GENERAL ETHOD OF OENTS G) rs Aknlo, Olaynka Olufsayo Ph.D) Department of anagement and Accountng Obafem Awolowo Unversty, Ile-Ife E-mal: Ths study was fnanced by the Councl for the Development of Socal Scence Research n Afrca CODESRIA). ABSTRACT The paper nvestgates the effect of workng captal on proftablty of frms n Ngera for the perod 999 to 007. The study adopts the dynamc panel general method of moments n analysng the data. Results of the estmaton show that sales growth, cash converson cycle, account recevables and nventory perod affect frm postvely, whle leverage and account payable affect frm proftablty negatvely. JEL Classfcaton: G30, G3 Key Words: Workng captal management, nventory, proftablty, Ngera, G. INTRODUCTION Workng captal management s an mportant component of corporate fnance because t drectly affects the lqudty and proftablty of the company. Indeed, nteracton between workng captal management practces and proftablty should a major area of research focus. Accordng to Kargar and Bluementhal 994), any frm that put naccurate workng captal management procedures nto practce may lkely face bankruptcy even though ther proftablty s constantly postve. Hence, t must be avoded to recede from optmal workng captal level by brngng the am of proft maxmzaton n the foreground, or just n drect contradcton, to focus only on lqudty and consequently pass over proftablty. In general, excessve levels of workng captal wll result n a substandard return on assets whle nadequate amount of t wll lead to shortages and dffcultes n mantanng day-to-day operatons. oreover, workng captal consttutes an mportant source of captal for small and medum scale enterprses as well as hgh flyng frms. In most developng countres, these categores of frms face lmted access to long term captal markets. To overcome ths constrant, these frms tend to rely more heavly on owner fnancng, trade credt and short term captal bank loanschttenden et al, 998; Saccurato, 994). Hence, workng captal poston of such frms s not only an nternal frm-specfc matter, but also an mportant ndcator of rsk for credtors oyer et al., 99). Frms wth hgh amount of workng captal are able to meet ther short term oblgatons easly thereby decreasng ther default rsk and enhancng ther borrowng capablty. And, as ncrease n borrowng capablty s often perceved as ndcaton of decrease n cost of debt and also n cost of captal), t s possble to state that the effcency n workng captal management affects not just the short term fnancal performance proftablty) but also long-term fnancal performance. Though effcent Socety for Busness Research Promoton 30

2 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] management of the workng captal s crucal for both proftablty and prosperty of any frm, not many studes have been conducted on the ssue n Ngera. Indeed, to the best our knowledge, no known has been conducted on the ssue n Ngera. Hence, the man objectve of ths paper s to fll ths gap n the lterature. Specfcally, the study examnes the effects of workng captal on the proftablty of frms n Ngera. In order to examne ths ssue for 66 frms for the perod, we employed the dynamc panel general ethod of oments G) n ths study. The rest of the paper s organzed as follows: the next secton presents the model and the data descrpton. The thrd secton dscusses the methodology and the fourth secton reports the emprcal fndngs of the study. The last secton concludes the paper.. ODEL SPECIFICATION AND DATA Followng the emprcal lterature, the functonal specfcaton of the relatonshp between proftablty and the workng captal may be specfed as : n o t X t t 3 Where t o = proftablty of frm I at tme t, =,, frms = ntercept = coeffcents of X = error term t = ndependent varables for workng captal of frm at tme t The annual tme seres data are obtaned from 66 frms lsted n the Ngeran Stock Exchange arket for the perod The lsted frms chosen for the study were selected on the bass of data avalablty. 3. ETHODOLOGY Ths paper employs dynamc panel general method of moments. In panel estmaton, nether the Generalsed Least Squares GLS) estmator nor Fxed Effect FE) estmator produces consstent estmates n the presence of dynamcs and endogeneous regressors. The proftablty equaton we estmate has lagged endogeneous regressors as well as unobserved frm fxed effects whch are correlated wth the regressor, hence the orthogonalty condton s not lkely to be met for a GLS or FE estmator to produce consstent estmates. Ths explans the use of G approach. The basc G panel estmators are based on moments of the form, Where g g ) = Z s a T ) = Z ).) p matrx of nstruments for cross-secton, and, ) = Y t X, ))..) In some cases we wll work symmetrcally wth moments where the summaton s taken over perods t nstead of. G estmaton mnmzes the quadratc form: However, as workng captal s not the only factor affectng proftablty, other factors such as sales growth, sze, leverage and economc growth rate were accounted for n the estmated model. Socety for Busness Research Promoton 3

3 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] S) = [ Z )] H [ Z )] = g ) Hg) 3) Wth respect to for a sutably chosen p p weghtng matrx H. Gven estmates of the coeffcent vector, ˆ, an estmate of the coeffcent covarance matrx s computed as, V ˆ ) = GHG) G HHG) G HG) 4) Where s an estmator of dervatve matrx gven by: E g ) g ) ) = E Z ) ) Z ), and G s a T k G) = )...5) In the smple lnear case where closed form as, X t, ) = X t,, we may wrte the coeffcent estmator n ˆ = X H X H X Y = H Wth varance estmator, H ZY 6) V ˆ ) = H H H ZY ) H..7) For AB of the general form: AB = A B 8) The bascs of G estmaton nvolve: ) specfyng the nstruments Z, ) choosng the weghtng matrx H, and 3) determnng an estmator for. It s worth pontng out that the summatons here are taken over ndvduals; we may equvalently wrte the expressons n terms of summatons taken over perods. Ths symmetry wll prove useful n descrbng some of G specfcatons that EVews supports. A wde range of specfcatons may be vewed as specfc cases n the G framework. For example, the smple SLS estmator, usng ordnary estmates of the coeffcent covarance, specfes: H = = ˆ ˆ Substtutng, we have the famlar expressons, ˆ = ˆ.. 9) ˆ ZY ) Socety for Busness Research Promoton 3

4 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] = ZY 30) and, V ˆ ) = ˆ Standard errors that are robust to condtonal or uncondtonal heteroskedastcty and contemporaneous correlaton may be computed by substtutng a new expresson for, T T t Z t ˆ ˆ Z t t t So that we have a whte cross-secton robust coeffcent covarance estmator. Essentally n ths work, we use the Arellano and Bond 99) dynamc panel General ethod of oments G) estmator proposed by Arellano and Bond 99). We have used ths method partly because we do not have reasonable nstruments for the endogeneous regressors that can be excluded from the equatons and partly because t produces consstent estmates n the presence of endogeneous regressors. Arellano and Bond provde a famly of dynamc panel G estmators n the DPD 98 program that allows for one to estmate coeffcents from levels, frst dfference or orthogonal devaton of the varables. In ths study, we estmate the equatons n the frst dfference form. The DPD estmator s gven as: ˆ ˆ X ZA Z X ) X N A N Z y 3 Where s a vector of coeffcent estmates on both exogeneous and endogeneous regressors, X and are the vectors of frst dfferenced regressors and dependent varables y respectvely, Z s a vector of nstruments and A N s a vector used to weght the nstruments. The estmator uses all lagged values of endogeneous and predetermned varables as well as current and lagged values of exogeneous regressors as nstruments n the dfferenced equaton. As an llustraton, for the equaton: y y x ths study used equaton, y,, y, x, x and x 3 y,, x and x as nstruments. For the y 4 serve as vald nstruments. Instruments for other crosssectonal equatons are constructed n the same way. The dynamc panel estmator s a G W equvalent of an effcent three stage least squares 3SLS) estmator. Two estmators are proposed by Arellano and Bond 99). These are one-and two-step estmators. The two-step s the optmal estmator. Thus n ths work, we use the two-step estmator to estmate the coeffcents of the proftablty equaton because t s more effcent than the one-step estmator. 4. EPIRICAL RESULTS We used the DPD estmator to estmate equaton. Table presents the results of the estmaton. Columns and report results usng lagged dependent varable and number of days account recevable as ndependent varables. Columns 3 and 4 uses nventory turnover as ndependent varable. Columns 5 and 6 adopt account payable as measure of workng captal whle columns 7 and 8 uses cash converson cycle as measure of workng captal. Socety for Busness Research Promoton 33

5 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] Table G) Emprcal Effects of Workng Captal anagement on Proftablty Dependent varable Proftablty Regresson odel Dynamc G Prof ) ) ) ) ) ) ) ) Prof-) Sz ) Sgr ) Lev ) Gdp ) 0.08) ) ) ) 9.388) ) 03.75) ) 4.74) -0.84) ) ) ) 0.387) ) ) ) 4.336) 0.70) ) ) ) 0.658) ) ) ) 0.74) ) ) ) ) 3.99) Are ).389) Invt ) 0.886) Pay ) -.567) Ccc ) ) j statstc Instrum ent Rave p-value No of N N No of Obser vaton Note: The fgure n parenthess ndcate t-statstcs Denotes sgnfcance at 0% Denotes sgnfcance at 5% Denotes sgnfcance at % The results show that the coeffcents of lagged dependent varable are postve and sgnfcant at %. Ths suggests that current proft levels are postvely nfluenced by proft level n the prevous year. Sales growth s postvely and sgnfcantly related to proftablty. Sales growth s an ndcator of a frm s busness opportuntes as such t s an mportant factor that allows frms to enjoy mproved proftablty. Leverage s negatvely and sgnfcantly related to proftablty. The negatve relatonshp between leverage and proftablty mght be an ndcaton that frms mantan hgh debt rato to ncrease ther lqudty holdngs so as to decrease the lkelhood of fnancal dstress. Increase lqudty holdng possbly adversely affected the proftablty of the frms. Several prevous studes have found negatve relatonshp between proftablty and leverage see yers 984 and Rajan and Zngales 995). Also, the fndng of negatve relaton between leverage and frm proftablty may be explaned by the suggestons that hghly leveraged frms are boster compettors that wll curtal nvestment yers 003), so ther nsuffcent power of competton may lead to decrease n proftablty. Sze varable s postvely related to Socety for Busness Research Promoton 34

6 Asan Journal of Busness and anagement Scences ISSN: Vol. No. [30-35] proftablty where only frst lags of dependent varable are ncorporated but the coeffcent s not sgnfcant at 5%. The coeffcent of GDP s postve n all the regressons but the coeffcent s not sgnfcant n all the regressons. The non sgnfcance of the economc growth rate mght not be unconnected wth relatvely low economc growth rate experenced durng the study perod. Indeed, as a result of low economc growth and poor nfrastructural facltes, many frms were ether closed down or operated far below capacty durng the study perod. The negatve relaton between proftablty and number of days account payable shows that less proftable frms take longer tme to settle payment to credtors. Hence, when there s a drop n proftablty, less cash s generated from operatons and frms are able to survve by postponng payment to supplers. Also, the postve relaton between nventory perod and proftablty may be the result of ncreasng sales leadng to hgher profts and thus fewer nventores. The postve relaton found between proftablty and number of days nventores possbly shows that reducng the number of days nventory by frms may not ncrease ther proftablty. The results show postve relatonshp between account recevable perod and proftablty. Ths mght be due to the fact that customers do not requre more tme to assess qualty of products they buy from frms wth ncreasng proftablty. The cash converson cycle CCC) has sgnfcant postve effect on proftablty. The postve relaton for CCC s consstent wth the vew that resources are blocked at the dfferent stages of the supply chan, thus prolongng the operatng cycle. Ths possbly ncrease profts as a result of ncrease sales, especally where the costs of ted up captal s lower than the benefts of holdng more nventores and generatng more trade credts to customers. 5. CONCLUSION The paper uses a dynamc panel estmator to examne the mpact of workng captal on proftablty of frms n Ngera over the perod These are the major fndngs. Frst, sales growth s postvely related to frms proftablty. Frms may gan some advantages lke monopoly or barganng power due to growth as a reflecton of economes of scale Kulter and Dermrgunes 007). Second, leverage s negatvely related to proftablty. Thrd, accounts recevable perod and frms proftablty are postvely related. Fourth, cash converson cycle s postvely related to proftablty. REFERENCES Arellano,. and Bond, S. 99), Some Tests of Specfcaton for Panel Data: onte Carlo Evdence and An Applcaton to Employent Equatons, Revew of Economcs Studes 58; Chttenden, F., Poutzours, P. and chaelas, N. 998), Fnancal anagement and Workng Captal Practces n UK SEs, anchester, anchester Busness School. Karger, J. and Blumenthal, R. A. 994), Leverage Impact on Workng Captal n Small Busness, TA Journal 46); Kulter, B. and Demrgunes, K. 007), Determnants of Proftablty n Retalng Frms: An Emprcal Study on ISE Lsted Retalng Frms, Journal of Cukurova Unversty Insttute of Socal Scences 6); oyer R.C., cgugan J.R., and Kretlow W.J. 995), Contemporary Fnancal anagement, west publshng co, Cncnat, Oho. yers, S.C., 984), The captal structure puzzle Journal of Fnance 34; Rajan, R. and Zngales, L. 995), What Do We Know about Captal Structure Some Evdence from Internatonal Data, Journal of Fnance 505); Saccurato, F. 994), The Study of Workng Captal, Busness Credt, January; Socety for Busness Research Promoton 35