ANALYSIS OF WORKING CAPITAL MANAGEMENT OF LEADING COMPANIES IN THE HUNGARIAN DAIRY SECTOR BETWEEN 2008 AND 2012

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1 ANALYSIS OF WORKING CAPITAL MANAGEMENT OF LEADING COMPANIES IN THE HUNGARIAN DAIRY SECTOR BETWEEN 2008 AND Tálas Dorisz University of Debrecen Faculty of Applied Economics and Rural Development Institute of Accounting and Finance, Debrecen, Hungary Abstract: This study analyses trends in the working capital management of those Hungarian dairy companies that feature the highest levels of sales in the domestic market and diversified product structures. In view of the significance of food industry in the national economy, a particularly important question to examine in this context is to see what impacts the economic crisis has had on the business operations of the dominant companies of the sector, what processes it has triggered in working capital management. In, 44 of the 500 companies with the largest amounts of sales were operating in the food processing sector. Within the group of these 44 enterprises, dairy companies had an 11% share. On the other hand, 82% of the total sales of the dairy industry was given by the 15 companies where the individual amounts of registered capital are over HUF 250 million, which reflects a strong sales revenue concentration. Therefore, it has been an interesting aspect to study how in such a concentrated sector the leading companies shape their working capital management, what processes can be observed in this respect. This study has relied on the annual reports, i.e. the balance sheets and profit & loss accounts of the companies for the fiscal period of The research methodology of the analysis is based on the review of financial indicators internationally accepted and used in connection with working capital management. Moreover, the study determines a cash conversion cycle, and in this context the inventory and receivables turnover, as well as the payables turnover. It has been assessed what changes the above-mentioned indicators of the competitors belonging to the target group of analysis have undergone, if there has been a general tendency of changes to be identified. For outstanding values it has been analysed what the large-scale changes could have been caused by. Fundamentally, I have aspired to reveal whether there has been any uniform tendency in the working capital management of the leading dairy companies, and if the improvement of efficiency via the regulation of working capital management is considered as a pronounced element of their corporate strategies. The closing section of this study summarises the conclusions drawn from the data of the analysis conducted, and the major characteristics of the working capital management for the leading companies of the Hungarian dairy industry with diversified product structures are highlighted. Keywords: cash conversion cycle, financial analysis, effectiveness, working capital, industrial organisations, Hungary JEL Classification Codes: M21, L66 948

2 1. Introduction This study has been conceived to analyse the working capital management of those Hungarian, dairy companies that featured the largest amounts of sales and diversified product structures in the period from 2008 until. Such a review of the dairy industry as a sector has been considered to be important due to its significance in the national economy, the high level of market competition and the potential, inherent points of interest the analysis have been expected to unveil. Like in other EU member states, dairy processing companies in Hungary also form a segment of high concentration. Nevertheless, in the Hungarian market, with the relatively large number of companies, the given degree of concentration is somewhat surprising. The comparatively strong bargaining position of processing entities seems to be the reason; that they seem to transact with rather unorganised, defenceless producers. A general tendency is that capacities of milk processors are under-utilised a situation that the companies concerned wish to change in order to increase their sales. This latter aspiration is mostly regarded as means of boosting their profits, whereas acquisitions and mergers are not regarded to be expedient solutions. Therefore, in recent years milk processing companies have focused on increasing their profits as their main objective. Furthermore, product development and the introduction of new forms of packaging have also been targeted by these companies in spite of the fact that the innovation activities of Hungarian milk processing companies generally lag behind those of the competitors (Popp, Potori and Papp, ). The degree of concentration among dairy companies and the sharpness of market competition are also confirmed by the sample of business entities used for the purposes of the study. With reliance on the Opten corporate information database, it has been ascertained that currently in Hungary there are 147 business entities that are involved in the manufacturing of dairy products as their core activity. From among these companies, there are 20 enterprises with capital stock (registered capital) in excess of HUF 100 million, and the capital stock levels of only 15 companies (10% of the sample as a whole!) are over HUF 250 million. When the amounts of capital stocks are assessed in combination with the sales in, it can be ascertained that this 15 companies represent 82% of the sales of the dairy industry in total. Consequently, the assumed high-level market concentration can be regarded as confirmed, and for this reason it is worth analysing the companies of the sector, because due to this strong concentration just a handful of dominant enterprises with outstanding sales make up the majority of operations in the sector. When defining the set of sample companies for this research, in addition to the amounts of registered capitals and sales I also considered that the companies subjected to the analysis should have diversified product structures, because I thought that only companies operating in the same submarkets could be efficiently compared. In terms of the registered capital, there has been only one company where the given criterion, i.e. the value of the registered capital should be over HUF 100 million, was not met. This enterprise is the E company, which has been included in the sample for its large sales ; on the basis of the level of sales, it perfectly matches the other companies forming the sample, as it ranks 5 th among the 8 companies concerned. Although with a smaller amount of registered capital, this company has a major share from the sales of the entire sector, and therefore, in my opinion, it needs to be involved in the sample. Another aspect that justifies its presence in the sample is that the large volumes of sales are accompanied by a diversified product structure, meaning that from milk through yogurts and sour creams to milk desserts the enterprise manufactures everything. For, the combined sales of the companies forming the sample make up nearly 60% of the total sales of the dairy industry, which further confirms the assumed concentration of the domestic dairy industry. 949

3 On the corporate level, the economic crisis of 2008 primarily impacted sales and profitability by deteriorating the effective demand. Therefore, this study has been designed to assess the factors that shaped the working capital management of the 8 leading dairy companies selected for the sample, changes in the cash conversion cycle, as well as the activity ratios that influenced them. Enterprises have various means to achieve increase in sales, and I have wanted to know how the crisis affected the turnover ratios. 2. Literature review and research methodology As an impact of the economic crisis emerging in 2008, the set of funding sources that could be utilised by the actors of economic life became smaller. For this reason, the providers of funds tended to subject the demanders of financing to stricter review. Since the conditions of external funding became much more rigorous, enterprises were to focus on their internal resources to an increasing extent, and therefore it came to be more and more important for them to see their own situation clearly (Fenyves and Tarnóczi, ). Working capital is an essential component of the efficient operation of any enterprise, because the best returns can be fundamentally achieved by avoiding investments in assets that bring small incomes or no earnings at all. Another aspect to be specifically considered is that the cheapest possible assets are worth being used for financing shortterm assets. If an enterprise invests into current assets in suboptimal volumes, and/or these assets are not of the most efficient composition, operation-related risks tend to rise, which can deteriorate the profitability of the company. Because of the difficulties of financing short-term assets and bad decisions in relation to funding, interest expenditures may increase to remarkably high levels, similarly to the financial risks of the enterprise (Gitman, 2002). The study of working capital management in fact embraces the economics of the production process. Its focal points are inventory management, the crediting policy of the enterprise and the management of liquid assets. Besides, it examines the associated funding decisions, and therefore it can be claimed that it concentrates on the economic aspects of production (Ross, Westerfield and Jordan, 2002). The elements of working capital management include current asset financing and management, as well as control over the level of short-term liabilities. The associated decisions determine whether the enterprise can survive in the long term, i.e. they are principal tasks that managers need to handle (Ross, Westerfield and Jordan, 2002). The following table shows the companies involved in the analysis and their sales revenue figures, as well as changes in them from 2008 to. In the order of their sales, the studies companies have been designated as A, B, C, D, E, F, G, H companies. Table 1: Corporate target group of the study (data in HUF 1000) Company Average sales A B C D E F G

4 Company 2008 Average sales H Below, a list is shown of the financial indicators that characterise working capital management, and have been used and described for the purpose of this analysis. Table 2: Analytic framework of the study Financial indicators Inventory turnover Receivables turnover Payables turnover Cash conversion cycle (day) A B C D E F G H A B C D E F G H The inventory turnover has been calculated as the ratio of net sales to the average value of inventories. The average values have been established as the simple arithmetic average of the amounts for the year under review and the previous year. The receivables turnover is in fact the ratio of net sales to the average amount of trade receivables. The average values have been calculated similarly to those for inventories (Katits, 2002). The payables turnover is the ratio of net sales to the average amount of trade payables (Bélyácz, 1999). The average values have been calculated similarly to those for inventories. The cash conversion cycle reflects the number of days that have to be bridged with the application of funding sources due to the given logistic processes, i.e. it quantities the duration between the payment of trade receivables and trade payables (Banomyong, 2005). Its calculation formula: inventory turnover in days + accounts receivable turnover in days accounts payable turnover in days (Ross, Westerfield and Jordan, 2002). From the performed calculations, conclusions have been drawn in relation to the working capital management of leading dairy companies and the processes triggered by the economic crisis, and besides a tendency that can be regarded as general has been described. In this context, the direction of changes from to has been examined. In addition to the assessment of cash conversion cycles, important points of the study have been the inventory and receivables turnover, as well as the payables turnover, as suggested by Nobanee and AlHajjar (). The reason is that in view of the cash conversion cycles the time period elapsing between the payment for base materials and the collection of receivables should be minimised as far as it is possible under the given sectoral conditions so that the funding sources required for bridging the time gaps of the logistic processes could not widen. 3. Results of the research 951

5 Hereunder, the values that have been calculated with the use of the data of annual reports for 2008 as the results of my research are discussed. Changes in these calculated values are presented for the period of in order to establish the direction, tendency of changes. As a result of the calculation of average values, the values of the indicators could be determined as early as from. 35,00 Inventory turnover 30,00 25,00 20,00 15,00 10,00 5,00 0,00 A B C D E F G H Figure 1: Results of the research: changes in the inventory turnover 952

6 Receivables turnover 14,00 12,00 10,00 8,00 6,00 4,00 2,00 0,00 A B C D E F G H Figure 2: Results of the research: changes in the receivables turnover 953

7 Payables turnover 20,00 18,00 16,00 14,00 12,00 10,00 8,00 6,00 4,00 2,00 0,00 A B C D E F G H Figure 3: Results of the research: changes in the payables turnover 954

8 Cash conversion cycle (days) A B C D E F G H -20 Figure 4: Results of the research: changes in the cash conversion cycle In the case of the inventory and receivables turnovers, higher values are regarded to be better, because it means that the inventory period and average collection period is short, i.e. the enterprise produces more efficiently and quickly, shorter times elapse between the purchasing of base materials and the selling of finished products. Besides, it is capable of collecting the receivables earlier, it has a better bargaining position against its customers. At the same time, flexible customer relations can potentially add to sales, and therefore the assessment of the receivables turnover sectoral characteristics and customer demands have to be taken into account, as well. In contrast, the payables turnover is deemed to be more favourable in case the corresponding values are small, because it means that the terms of payables are longer, i.e. suppliers need to be paid later. For cash conversion cycles, short values are more favourable, because the longer the cash conversion cycle of an enterprise is, the larger demand it has for sources of funding. Moreover, it also influences profitability, because the quicker the company can sell its inventories and collect its receivables, the smaller the total value of assets will be with 955

9 unchanged sales, and consequently the higher the profitability of assets as a whole will rise (Ross, Westerfield and Jordan, 2002). In association with the values for the cash conversion cycle, it can be seen that with the exception of the F and G company for all the other enterprises the values were well under the level, which means that almost all the companies involved in the analysis could consistently reduce its cash conversion cycle. The examination of the inventory and receivables turnovers has suggested that this tendency except for the F and G company was accompanied by a massive rise in the receivables turnover, as well as the decrease of the payables turnover, save for the E company. In relation to the changes in the inventory turnovers, it can be observed that for companies wherever the cash conversion cycles dropped with the exception of the H company the efficiency of production improved, i.e. the inventory turnover increased. It means that the enterprises made efforts to better their production efficiencies, aspired to shorten the production process. It is further confirmed by the fact that it did not bring about any general drop in sales, or in other words it does not suggest that the value of inventories would have decreased due to a fallback in the turnover. Besides, enterprises generally made their crediting policies stricter, that is they set shorter terms of payment for their own customers. In addition, they tried to reinforce their bargaining positions against suppliers, and all of them seem to have succeeded in this respect. This tendency is in line with the processes described in the associated literature, because most of the suppliers are milk producers who according to Popp, Potori and Papp () are unorganised and relatively defenceless. In the light of the results, as irrespective of the given tendencies, the G company needs to be highlighted, because all through the analysed interval its cash conversion cycle remained in the negative side. It is a consequence of its receivables turnover being much higher than the payables turnover, which means that the production process and the period from selling until the collection of receivables are funded by the suppliers. It is an uncommon outcome both in the sector and on the level of the national economy; looking at the company s reports, it can be suggested that the reason underlying longer payable periods to suppliers is presumably the high degree of indebtedness, which in turn has emerged due to the large amounts of bank credits owed. This situation can be sustained in the short term, because in view of the given bank credits and overheads the company tries to pay to the suppliers as late as it is possible, and furthermore there is a risk of becoming incapable of settling its debts. Moreover, it is unable to satisfy the special customer demands and conditions of the largest retail chains, and therefore it can lose markets, which may lead to the drop of sales. This latter assumption can be justified by assessing the sales of the enterprise, because between 2008 and the net amount of sales diminished by 36%. It is to be also remembered that the enterprises are not involved solely in price competition in most markets. In addition to prices, they also compete in the field of commercial credits, meaning that any excessively rigorous customer policy may lead to a loss in the market share in case the customers decide that they want to purchase from other enterprises that offer products of similar price-to-value ratios, but follow less strict crediting policies. It would further decrease the sales of the enterprise. From among the companies with positive cash conversion cycles in the sample of the analysis, the F company is the only one whose cash conversion cycle increased- though minimally- between and. In the light of the available data, the underlying reason was the decrease of the inventory and receivables turnovers. As the payables turnover decreased in the period under review, it is obvious that the increase in the cash conversion cycle came from the reduction of the two other turnovers. It means that both the efficiency of the crediting policy and the effectiveness of production weakened, which could not be counter-balanced by the company s delayed payments to its suppliers. In consequence, 956

10 the two options for boosting efficiency are the adoption of more rigorous crediting policy and the improvement of production efficiency. 4. Conclusions This study has been dedicated to the analysis of the working capital management of dairy companies within Hungarian food processing, as these entities are attributed significance in the national economy. The selection of the sample has confirmed the existence of sectoral concentration and a strongly competitive situation. 8 companies have been subjected to comparative analysis with reliance on the indicators used in the domestic and international literature. In the light of the obtained results, the general tendencies to be established is that the companies could reduce their cash conversion cycles in the period from to, which was achieved by the combined effect of rising inventory and receivables turnovers and diminishing payables turnover. Since it was a tendency prevailing at nearly all the companies, they were not to be afraid of any loss of market as a consequence of their adopting more rigorous crediting policies. As a result of the economic crisis, the enterprises turned to internal sources of funding, and started to optimise production processes, similarly to the deviation between the terms of the credits they provided and the terms of the payment of suppliers. This latter time interval could be extended partly owing to the fact also highlighted in the associated literature that Hungarian milk producers were unorganised, and had weak bargaining positions vis-á-vis processors (Popp, Potori and Papp, ). One company shows notable results, because in the case of the G company the cash conversion cycle has been negative, which is caused by the high ratio of indebtedness, since the company has a large volume of bank credits. For this reason, the enterprise tries to defer payments to suppliers as far as it is possible, while it is not absolutely sure that it always has sufficient funds for the payment of debts. At the same time, the proper fulfilment of the conditions of supply to large retail chains as the company s suppliers has also become uncertain, which may lead to a loss of markets. Similarly, overly strict crediting policies can potentially lead to market loss, as it has already been demonstrated in connection with the evaluation of results. Any increase in the inventory turnover suggests improvement in the efficiency of production with respect to the fact that most of the companies realised increasing sales between 2008 and. Consequently, the leading dairy companies involved in the study can be claimed to have had the aspiration to better their efficiencies as a result of the crisis, and almost all of them have been able to meet this effort successfully. To round off these results, a further orientation of research could be the detailed analysis of profitability. The analysis of the cash conversion cycle has pointed out that by cutting this factor the profitability of the enterprise can be improved even if all the other factors remain unchanged. The calculation of the profitability indicators described in the Hungarian and international literature would confirm or disaffirm the applicability of this assumption to Hungarian dairy industry. 957

11 References: Banomyong, R. (2005) Measuring the Cash Conversion Cycle in an International Supply Chain, Annual Logistics Research Network (LRN) Conference Proceedings pp [Online] Available: [13 Apr ]. Bélyácz, I. (1999) Vállalati tőkefinanszírozás, Pécs: Janus Pannonius Egyetemi Kiadó. Fenyves, V. and Tarnóczi, T. () A kockázatkezelésről contorollereknek(2), A Controller, vol. 7, no. 1, January, pp Gitman, L. J. (2002) Principles of Managerial Finance, 10 th edition, New York: Addison Wesley. Katits, E. (2002) Pénzügyi döntések a vállalat életciklusaiban, Budapest: KJK-Kerszöv Jogi és Üzleti Kiadó Kft. Nobanee, H. and AlHajjar, M. () Optimizing Working Capital Management, Internet- SSRN [Online] Available: [28 Dec ]. Popp, J, Potori, N. and Papp, G. () A magyar tejvertikum diagnózisa, Gazdálkodás, vol 54, no. 1, pp Ross, S.A., Westerfield, R.W. and Jordan, B.D.(2002) Fundamentals of Corporate Finance, 6 th edition, New York: The McGraw-Hill Companies. 958