The Relationship between Working Capital Management and Profitability: Empirical Evidence from Morocco

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1 Global Review of Accounting and Finance Vol. 6. No. 1. March 2015 Issue. Pp The Relationship between Working Capital Management and Profitability: Empirical Evidence from Morocco Samir Aguenaou*, Omar Farooq**, Jawad Abrache*** and Manal Brahimi**** This research investigates the relationship between working capital management and profitability of firms using a sample of 43 non-financial firms listed at the Casablanca Stock Exchange for a period of 7 years from 2006 to The profitability measures used in this study as dependent variables are the return on assets (ROA) and the gross operating income (GOI). In addition, as independent variables, the study includes a comprehensive measure of working capital management that is the cash conversion cycle and its components: inventory conversion cycle, average collection period, and payables deferral period. The findings show that there is a statistically significant positive relationship between return on assets and the average collection period. They also show that a statistically negative relationship exists between the gross operating income and both the average collection period and the payables deferral period. An efficient management of these working capital components can have a positive impact on profitability of Moroccan firms. JEL Codes: F34, G21 and G24 1. Introduction Firms require both long-term and short-term financing in order to operate. Companies use long-term financing mostly to invest in fixed assets. A large amount of previous empirical works had studied firms long-term financing. However, as stated by Uyar (2009), it is not easy for any firm, especially the small ones, to have access to external financing. He adds that even if they have access to it, firms would incur high borrowing costs. Working capital represents the short-term financing available to firms and is used by companies in their day-to-day operations. Afeef (2011) asserts that profitability of all sized firms is somehow sensitive to an efficient management of working capital. The three main components of working capital are inventory, account receivables, and account payables. Enqvist, Graham, and Nikkinen (2011) state that the focus on working capital policies becomes very important regarding the current economic downturn and its consequences on firms. Working capital management concerns the management of current assets and current liabilities and is crucial for the success of companies. Managing the working capital is keeping an optimal level of each component in order to enable firms to meet their shortterm obligations and operating expenses. The net trade cycle is a measure of working capital management and it expresses the three main components, inventory, receivables and payables, as a percentage of sales. The net trade cycle shows how many day sales the company has to finance the working capital. *Dr. Samir Aguenaou, School of Business Administration, Al Akhawayn University, Morocco. **Dr. Omar Farooq, American University in Cairo, ***Dr. Jawad Abrache, School of Business Administration, Al Akhawayn University, Morocco. *** Manal Brahimi, School of Business Administration, Al Akhawayn University, Morocco.

2 The operating cycle is also used as a measure of efficient working capital management, but this measure only takes into consideration the financial flows coming from receivables and inventory, disregarding the ones of payables. Gill, Biger, and Mathur (2010) affirm that a popular measure of working capital management is the cash conversion cycle. They define this latter as the time span between the expenditure for the purchases of raw materials and the collection of sales of finished goods. The cash conversion cycle is the most widely used measure of working capital management and takes into account the three main components of working capital in contrast to the operating cycle. Studying working capital is very important since it can affect profitability, risks and liquidity of firms. Firms should understand that there is a tradeoff between profitability and liquidity. Companies have to keep enough cash to be able to meet their short-term obligations but they should not hold too much cash unnecessarily since it would represent opportunity costs for them. Brigham and Ehrhardt (2011, p. 678) state that a firm should minimize the amount of cash it holds for its daily operations but at the same time maintain sufficient cash reserve for unexpected expenses. Thus, each component of working capital should follow a clear policy in order to maximize profitability, because if they are not well managed, they can lead the companies into bankruptcy. First, keeping a large inventory can both have advantages, such as no stock out and higher sales, and disadvantages such as reduced profitability due to the costs incurred by carrying inventory. Second, concerning the account receivables and account payables, if companies collect receivables quickly it can on one hand use the cash for its daily operations but it can lose customers that need longer trade credits. On the other hand, if it takes more time to pay suppliers it could use the cash for its day-to-day operations but could lose suppliers that need to be paid more quickly. Thus, reducing risks has a negative impact on profitability of firms. Garcia-Teruel and Martinez-Solano (2007) state that being too aggressive while investing in inventory and trade credit could negatively impact corporate profitability. Therefore, understanding the relationship between each component of working capital and firms profitability is important in order to find the right policies to follow concerning the management of inventory, account receivables and account payables. Firms should find the optimal level of working capital components that should be maintained in order to maximize profit. This study enables the and understanding of the relationship between working capital management and profitability of non-financial Moroccan companies listed at the Casablanca stock market. As far as we know, there are no previous studies on working capital management done on Morocco and thus, this study helps to compare the Moroccan results with the various previous researches done in other countries. In addition, it helps to define clear policies that should be used in Moroccan firms while managing the components of working capital. The remainder of the paper is organized as follows: Section 2 presents the literature review. Section 3 is about the methodology and the formulation of the hypotheses; it describes the process of data collection and identifies the measurements of all variables included in the study while section 4 discusses its results. The paper concludes with section 5 that also discusses the limitations of the study and suggests certain recommendations for future research. 119

3 2. Literature Review Aguenaou, Farooq, Abrache & Brahimi This section presents various empirical studies investigating the relationship between working capital management and profitability of firms. Those researches are divided into two parts that are first, the empirical studies performed on developed markets and, second, the empirical studies investigating this relationship in emerging markets. 2.1 Empirical Studies on Developed Markets Deloof (2003) works on the relationship between working capital management and corporate profitability using a sample of 1,009 Belgian non-financial firms during the period between 1992 and The author uses as a measure of profitability the gross operating income as a percentage of total assets minus financial assets. Concerning the working capital management measure, the author uses the cash conversion cycle and its three components: inventory conversion cycle, average collection period and payable deferral period. Deloof (2003) adds five control variables to the equations that are size, sales growth, the financial debt ratio and the ratio of fixed financial assets to total assets. The author does not use return on asset as a measure of corporate profitability as for some firms financial assets represent a significant part of total assets. The study uses both correlation and multiple (fixed effect estimation) to investigate this relationship and adds 4 year dummies and 37 industry dummies to the equations. Deloof (2003) affirms fixed effects estimation assumes firm specific intercepts, which capture the effects of those variables that are particular to each firm and that are constant over time. The author s findings show a significant negative relationship between gross operating income and the cash conversion cycle, number of days accounts receivable, inventories and accounts payable of Belgian firms. Deloof (2003) suggests that managers can increase corporate profitability by reducing the number of day s accounts receivable and inventories and that less profitable firms wait longer to pay their bills. García-Teruel and Martínez-Solano (2007) investigate the effects of working capital management on SME profitability using a sample of Spanish firms for the period The authors focus on small and medium sized firms, as short-term financing is more crucial for them since they have fewer alternative sources of external finance available. In order to analyze this relationship the authors use the return on assets as a measure of the firm s profitability. The independent variables used in this study are the number of days accounts receivable, number of days of inventory and number of days accounts payable as well as the cash conversion cycle that combine these three periods. In addition, García-Teruel and Martínez-Solano use the following as control variables: size of the firm, sales growth, and leverage (ratio of debt to liabilities). As the average percentage of financial assets to total assets is only around 4 percent, the authors did not use gross operating income as in the previously presented study of Deloof. Finally, the authors control for the evolution of the economic cycle using the annual GDP growth. The methodology used in this study to investigate this relationship is the correlation and the multiple using four equations one for each independent variable, all including the control variables and the year dummies. This research s findings are the same as Deloof (2003) meaning that there is significant negative relationship between the cash conversion cycle, average collection period, inventory conversion cycle and return on assets. The authors conclude that reducing the trade credit granted to customers and keeping low inventory levels are associated with an increase in corporate profitability. The findings show no significant relationship between payables deferral period and profitability measure. Finally, shortening the cash conversion cycle is shown to have a positive impact on profitability of firms. 120

4 Lazaridis and Tryfonidis (2006) study the relationship between working capital management and profitability using 131 listed companies in the Athens stock exchange (ASE) for the period The authors use cash conversion cycle, number of days in account receivable, number of days in inventory, and number of days in account payable as measures of working capital management. The profitability measure used in this study is the gross operating profit as a percentage of total assets minus financial assets. The authors want to associate operating success or failure with an operating ratio and relate this variable with other operating variables (i.e. cash conversion cycle). The control variables used are firms size, fixed financial asset ratio, and financial debt ratio. Their research findings show a strong negative relationship between profitability and the cash conversion cycle, the average collection period and payable deferral period meaning that reducing number account receivables would increase profitability and that the less profitable firms wait longer to pay their bills. Concerning the inventory conversion period, the study reveals no significant relationship with the profitability measure. The authors conclude that managers could create profits for their companies by handling correctly the cash conversion cycle and keeping each different component (accounts receivables, accounts payables, inventory) to an optimum level. Gill, Biger and Mathur (2010) extend Lazaridis and Tryfonidis s findings concerning the relationship between working capital management and profitability. The authors use a sample of 88 American firms listed on New York Stock Exchange for the period This study uses the same methodology and variables as the study of Lazaridis and Tryfonidis previously presented. However, the findings were different from the ones expected. The results of the indicate that slow collection of accounts receivables is correlated with low profitability (measured using gross operating income) and thus companies can increase profitability by reducing the credit policy used with their customers. In addition, the authors find no statistically significant relationship between average days of accounts payable, average number of days in inventory and profitability. Finally, the authors find a positive relationship between cash conversion cycle and operating profit showing that shortening the cash conversion cycle would have a negative impact on profitability. Enqvist, Graham, and Nikkine (2011) examine the impact of working capital management on firm profitability in different business cycles, using a panel of Finnish listed companies for the years between 1990 and The sample consists of 1,136 firm year observations. Concerning the dependent variables, the authors choose to use both return on assets (considered an overall indicator of profitability), and gross operating income as a percentage of total assets minus financial assets since it measures the operational performance. The independent variables are the inventory conversion period, the average collection period, the payable deferral period, and the cash conversion cycle. The following control variables known to affect firm profitability are included in the models: company size, current ratio, debt ratio, sales growth, and operating income (gross income minus operating expenses minus depreciation). In addition, dummy variables are added to reflect two different states of the economy (recession and prosperous economic state). The study s findings are that there is a statistically significant negative relationship between cash conversion cycle and the measures of profitability (return on assets and gross operating income), which means that companies can increase their profitability by shortening their cash conversion cycle. In addition, the results show a negative and significant relationship between account payable deferral period and the two profitability measures, implying less profitable firms wait longer to pay their bills. Finally, they find that there is a negative and statistically significant relationship between account receivables and profitability as well as between inventories and corporate profitability 121

5 meaning that reducing the number of days in account receivables and in inventory will have a positive impact on corporate profitability. Concerning the economic conditions, they are found to have an influence on the working capital and profitability relationship, as low economic state is found to have negative impact on profitability and that the impact of efficient working capital management increases in economic downturns. The majority of the above literature on the relationship between working capital management and profitability of firms in developed markets (Deloof (2003), García-Teruel and Martínez-Solano (2007), Lazaridis and Tryfonidis (2006), and Enqvist, Graham, and Ikkinen (2011)), find a negative relationship between working capital management (measured through cash conversion cycle) and profitability of firms. In addition, those studies find a negative relationship between the three major components of working capital (number of days accounts receivable, number of days of inventory, and number of days accounts payable) and profitability, except for the case of Spanish companies (García-Teruel and Martínez-Solano (2007) that find an insignificant relationship between number of days accounts payable and profitability. Concerning the other study on American firms (Gill, Biger, and Mathur (2010)), it shows, in contrast, a positive relationship between cash conversion cycle and corporate profitability. In addition, the study finds no significant relationship of number of days of inventory and number of days accounts payable with profitability. The difference in the relationships found in the last study might be explained by the small sample used by the authors as compared to the other studies. Table 1 below summarizes the different studies undertaken in developed countries on the topic of the relationship between working capital management and firms profitability. Table 1: Summary of literature review on developed countries Authors Country # Observations Duration of Study Deloof Belgium (5 years) García- Teruel and Martínez- Solano Lazaridis and Tryfonidis Gill, Biger, and Mathur Enqvist, Graham, and Ikkinen Spain (7 years) Greece (4 years) U.S (3 years) Finland (19 years) Methodology correlation, (fixed-effects estimation) correlation, (univariate and multivariate) correlation, correlation, correlation, Dependent Variable(s) Gross Operating Income Return Asset Gross Operating Profit Gross Operating Income on Return on Asset, Gross Operating Income Independent Variables ICP(-), ACP(-), PDP(-), CCC(- ) ICP(-), ACP(-), PDP(insignific ant), CCC(-) ICP(insignifica nt), ACP(-), PDP(-), CCC(- ) ICP(insignifica nt), ACP(-), PDP(insignific ant), CCC(+) ICP(-), ACP(-), PDP(-), CCC(- ) Control Variables Size, sales growth, financial debt ratio, current ratio, FATA Size, sales growth, financial debt ratio, GDP growth Size, sales growth, financial debt ratio, FATA Size, financial debt ratio, FATA Size, sales growth, current ratio, operating income 2.2 Empirical Studies on Emerging Markets Uyar (2009) investigates the relationship between cash conversion cycle and both firms size and profitability using a sample of 166 corporations listed in the ISE (Istanbul Stock Exchange) for the year The author uses return on assets and return on equity as a 122

6 measure of profitability and net sales and total assets as a measure of the firm s size. The result of this shows a significant negative correlation between the cash conversion cycle (CCC) and size. The author suggests that smaller firms should look for ways to shorten their CCC by shortening inventory period and accounts receivable period, and lengthening accounts payable period. In addition, the results indicate a significant negative correlation between the CCC and the return on assets and an insignificant correlation between the CCC and return on equity. Uyar (2009) concludes that firms with shorter cash conversion cycles are likely to be more profitable than those with longer CCC. This paper also presents an industry benchmarks to the firms to evaluate their CCC according to their industries. However, this study uses a very short period ending with a very low sample size of 166 years observations and does not use. Dong and Su (2010) empirically examine the relationship existing between gross operating profit and cash conversion cycle and its components using a sample of 130 listed firms in Vietnam stock market for the period The authors use as control variables the company size, the debt ratio, and the fixed financial asset ratio. The methodology used in this research is again the correlation and the multiple with fixed effect estimation. The authors use four models including each time one of the following as independent variable: cash conversion cycle, inventory conversion period, average collection period, and payable deferral period. The authors findings show that shortening the cash conversion cycle would increase the firm s profitability. The authors also assert that there is a negative relationship between number of days accounts receivables, number of day s inventories and profitability, and that in Vietnam the more profitable firms wait longer to pay their bills (positive relationship). However, the sampling period in this paper is short (3 years) in comparison with other studies. Sharma and Kumar (2010) empirically examine the effect of working capital on profitability of Indian firms. The authors use a sample of 263 non-financial firms listed at the Bombay Stock (BSE) for the period Following previous studies, the authors use the correlation and multiple to investigate this relationship using return on asset as a dependent variable and profitability measure. The independent variables are the cash conversion cycle and its three components and each of those was incorporated in a different equation. In addition, this study includes as control variables in each equation, the size of the firm, the growth in sales, the firm leverage and the current ratio. The fixed financial ratio was not used in this study because of the lack of data available. The findings show that the number of days in inventory and number of days accounts payable are negatively correlated with a firm s profitability meaning that reducing those periods will increase profitability of Indian firms. In contrast, the number of days in accounts receivables and the cash conversion period are found positively related to corporate profitability. The author explains this difference in the results by the fact that the Indian companies tend to grant longer credit to customers to sustain in their market and respond to the competition. Therefore, increasing the number of days in account receivables has a positive impact on the profitability of Indian firms. However, as the study does not include the fixed financial asset to total asset ratio, we cannot know if the return on asset is a good measure of profitability compared to working capital management since fixed financial asset could have a significant impact on profitability. Hayajneh and Lahcen AitYassine (2011) investigate the relationship between working capital efficiency and profitability of the 53 Jordanian manufacturing firms listed in Amman Exchange Market for the period The dependent variable used in this work is the net operating profit over total asset (measure of profitability) and the independent variables are the cash conversion cycle and its three components. The control variables 123

7 used are the size of the company, the sales growth, the current ratio, and the financial leverage ratio. The authors used both correlation coefficient and to analyze those relationships (four models used, one for each independent variable). The results show a negative significant relationship between average receivables collection period, average conversion inventory period, average payment period and the profitability measure (net operating income). Finally, all models show a positive relationship between size of the firm, growth sales, current ratio and the profitability, and a negative relationship between financial leverage and corporate profitability. Al-Debi'e (2011) investigates the relationship between profitability of Jordanian firms and working capital management measures using a sample of 77 listed on Amman Stock Exchange for the years 2001 to The author uses as dependent variable, representing the profitability of firms, the gross operating income over average total asset, and as independent variables the cash conversion cycle, the receivables conversion period, the inventories conversion period, and the payables deferral period. The control variables used are the size, leverage and annual GDP. This study uses the same methodology as the previous presented study on Jordan and its findings are the same as they reveal a negative relationship between profitability and working capital management measures, meaning that less profitable companies wait longer to sell their products, to collect credit sales, and to pay their supplies of goods and that companies in Jordan pay their suppliers before collecting credit sales. Finally, the authors conclude that industrial firms in Jordan invest heavily in working capital. Afeef (2011) analyze the impact of working capital management on the profitability of Small and Medium Enterprises (SME) in Pakistan. The author uses a sample of 40 nonfinancial companies listed on the Karachi Stock Exchange for the period from 2003 to The dependent variables used in this study are the return on asset and the operating profit to sales, the independent variables are the cash conversion cycle and its three main components, and the control variables used are size, sales growth, financial leverage and current ratio. Using both correlation and multiple, the results of this study show a strong negative relationship of the inventory conversion period and the receivable collection period with the operating profit to sales of small firms. In addition, the shows that payable deferral period and cash conversion cycle have no significant link with the profitability variable. The results show insignificant relationship between all working capital management measure and return on assets. The difference in the results and the insignificant relationships may be due to the small sample size used by the author with only 240 observations. Raheman and Nasr (2007) examine the effect of working capital management on profitability and liquidity of Pakistani firms using both correlation and multiple. They use a sample of 94 firms listed on Karachi stock exchange market for the years between 1999 and The study uses as independent variables the average collection period, inventory turnover in days, average payment period, cash conversion cycle and current ratio (as measures of working capital management) and the net operating profitability as dependent variable (defined as operating income plus depreciation, and divided by total assets minus financial assets). The current ratio, the firm size, the debt ratio and the ratio of financial assets to total assets (FATA) are included as control variables in the models. The findings reveal a strong negative relationship between the working capital management measures and firms profitability. In addition, the study finds a significant negative relationship between liquidity and profitability. These findings join the ones of the previously presented studies as reducing the periods for collecting 124

8 receivables, paying payables, and selling inventory will increase profitability of firms in Pakistan. However, those findings are different from the previous study presented on Pakistan as the sample size, the period under study, and the profitability measure are different. Eljelly (2004) investigates the relationship between liquidity, measured by the cash gap (or cash conversion cycle) and the current ratio, and profitability measured by the net operating income before depreciation deflated by sales. The author uses a sample of 27 joint stock companies in Saudia Arabia for the period The correlation and the multiple are used in this study and the control variables added to the model are two measures of firms size (natural logarithm of sales and of total assets). The result of this study shows that there is a significant negative relationship between profitability and both liquidity measures. In addition, the results reveal that the current ratio is the most important liquidity measure that affects profitability and that size has an influence over profitability essentially in the manufacturing and agriculture sectors. Cash conversion cycle is shown to have less impact on profitability of firms in the laborintensive sectors, such as services. The majority of the above literature on the relationship between working capital management and profitability of firms in emerging markets (Dong & Su (2010), Uyar (2009), Hayajneh and Lahcen AitYassine (2011), Eljelly (2004), Raheman and Nasr (2007), and Al-Debi'e (2011)) find a negative relationship between working capital management (measured through cash conversion cycle) and profitability of firms. In contrast, in the case of Indian firms (Sharma and Kumar, 2010), the study shows a positive relationship between cash conversion cycle, number of days in receivables and profitability. This is explained by the fact that Indian companies grant longer credit to sustain in their market and respond to the competition. Concerning the number of days in inventory and number of days accounts payable, they are found negatively related to profitability for all the above studies except in the case of Vietnam where number of days accounts payable is found positively related to gross operating income.the author explained that the less profitable firms in Vietnam wait longer to pay their bills. Finally, the two studies done on Jordan reveal the same results even with different sample sizes; however, the research on Pakistan show different results essentially regarding cash conversion cycle and payables deferral period. This might be due to the large differences in both the sampling size and period. Table 2 below summarizes the literature review on the relationship between working capital management and profitability in emerging markets. 125

9 Table 2: Summary of literature review on emerging markets Authors Country # Observations Duration of Study Uyar Turkey (1 year) Dong Su and Sharma and Kumar Hayajneh and Lahcen AitYassine Vietnam (3 years) India (9 years) Jordan (7 years) Al-Debi'e Jordan (11 years) Afeef Pakistan (6 years) Raheman and Nasr Eljelly Pakistan (6 years) Saudi Arabia (5 years) Methodology correlation correlation, (fixed-effects estimation) OLS multiple, correlation, OLS multiple, correlation, correlation, correlation, OLS multiple correlation, Dependent Variable(s) Return on Asset, Return on Equity Gross Operating Profit Return Asset on Net Operating Income over Total Asset Gross Operating Income Return on Asset, Operating Profit to Sales Net Operating Profitability (NOP) Net Operating Income before depreciation deflated by sales Independent Variables ROA: CCC(-); ROE: Insignificant ICP(-), ACP(-), PDP(+), CCC(-) ICP(-), ACP(+), PDP(- ), CCC(+) ICP(-), ACP(-), PDP(-), CCC(- ) ICP(-), ACP(-), PDP(-), CCC(- ) ROA: insignificant; OPS: ICP(-), ACP(-), PDP and CCC (insignificant) ICP(-), ACP(-), PDP(-), CCC(- ) Current ratio (- ), CCC(-) Control Variables Size, debt ratio, FATA Size, sales growth, firm leverage, current ratio Size, sales growth, financial leverage, current ratio Size, leverage, growth in annual GDP Size, sales growth, financial leverage, current ratio Size, debt ratio, current ratio, FATA 3. The Methodology and Model 3.1 Hypothesis development The main objective of this study is to investigate the relationship between working capital management measured through cash conversion cycle (CCC) and profitability of firms. The literature review showed a negative relationship among the two variables meaning that shortening the cash conversion cycle would improve corporate profitability. Thus, the first hypothesis of this is a follow: Hypothesis 1: There is a negative relationship between the cash conversion cycle and profitability of Moroccan firms. The other objectives of the study are to examine the relationship between each component of CCC and the profitability measures. The relationship between receivables conversion period, inventory conversion period and profitability are expected to be negative as found in the majority of the previous researches. The payables deferral period is also expected to be negatively related to profitability measures as firms with lower profitability are supposed to wait longer to pay their bills. Therefore, the three hypotheses related to the components of cash conversion cycle in this study are: 126

10 Hypothesis 2: There is a negative relationship between the inventory conversion period and profitability of Moroccan firms. Hypothesis 3: There is a negative relationship between the receivables conversion period and profitability of Moroccan firms. Hypothesis 4: There is a negative relationship between the payables deferral period and profitability of Moroccan firms. 3.2 Data Collection The sample of this study focuses on 43 Moroccan firms listed on Casablanca Stock Exchange (CSE) and covers a period of seven years corresponding to The financial statements of these firms were downloaded from the CSE website and from the website of the CDVM (Moroccan equivalent of the Securities Exchange Commission in the US). There are a total of 76 Moroccan firms listed on the CSE. Following previous studies (Dong and Su (2010), Deloof (2003), and Lazardis and Tryfonidis (2006)) that investigated the impact of working capital management on corporate profitability a total of 20 financial firms were excluded from the sample due to the nature of their activities. In addition, 13 firms were also excluded from the sample because of the lack of data for the period under study. The choice of the study s time period is justified by a major wave of IPOs in the CSE during years The following table gives a list of the 16 represented industries and the number of firms included in each industry. Table 3: Represented industries and the number of firms in each industry Industry Number of firms in the sample Beverages 2 Chemicals 4 Construction & building materials 6 Distributors 7 Engineering & equipment industrial goods 2 Food producers & processors 6 Forestry & paper 1 Leisures and hotels 1 Materials, software & computer services 4 Mining 2 Oil & gas 2 Pharmaceutical industry 2 Real estate 1 Telecommunication 1 Transport 1 Utilities Measurements of Variables Following most similar studies listed in the literature review, a balanced panel data is performed to examine the relationship between working capital management and profitability of Moroccan firms. For instance, Asteriou and Hall (2007) explain that panel data set is formulated by a sample that contains N cross-sectional units [firms] that 127

11 are observed at different T time periods. The panel data model used in this study includes 43 firms and 7 years ( ) and is a balanced panel. This latter is defined as a panel data set where every variable and every firm has the same number of time observations (Asteriou and Hall, 2007). The sample of this study consists of 301 firm year observations. In order to estimate panel data, either the fixed effects or the random effects methods can be used. In this research, the fixed-effects model is used to estimate the panel data set under study, as it is known to be more consistent. Marc Deloof (2003) used the same model in his research; the author stated that using fixed effects estimation helps analyze the effects of those variables that are particular to each firm and that are constant over time Dependent Variables The dependent variables chosen in this study as the measures of firms profitability are the return on assets (ROA) and the gross operating income (GOI) as a percentage of total assets minus financial assets. Padachi (2006) states in his study that it is better to use the return on asset as a measure of profitability as it is related to its asset base. In addition, the ROA had been used in various previous empirical studies such as the ones of García- Teruel and Martínez-Solano (2007), Uyar (2009), Afeef (2011), and Sharma and Kumar (2010). However, as stated by Marc Deloof (2003), when a firm has mainly financial assets on its balance sheet, its operating activities will contribute little to the overall return on assets and thus, in this case, ROA would be a less adequate measure of corporate performance. That is why gross operating income (GOI) is also used as a measure of profitability in this study. The GOI is used in various previous literatures as in the ones of Lazaridis and Tryfonidis (2006), Dong and Su (2010), Deloof (2003), and Gill, Biger, and Mathur (2010). Finally, Enqvist, Graham, and Ikkinen (2011) use both variables as measures of profitability. Those two variables are computed as follow: o ROA = Earnings Before Interest and Taxes / Total Assets o GOI = (Sales - Cost of Goods Sold) / (Total Assets - Financial Assets) Variables of Interest (Independent Variables) The independent variables used in this study are: the cash conversion cycle, that is a comprehensive measure of working capital management, the number of days accounts receivable, the number of days accounts payable, and the number of days in inventory. Brigham and Ehrhardt (2011, p.678) define cash conversion cycle (CCC) as the length of time between the firm s actual cash expenditures to pay for productive resources and its own cash receipts from the sale of products. The cash conversion cycle (CCC) is the most widely used measure of working capital management. It is equal to inventory conversion period (or number of days in inventory) plus average collection period (or number of days accounts receivable) minus payables deferral period (or number of days accounts payable). Brigham and Ehrhardt (2011, p.678) define the inventory conversion period as the average time required to convert materials into finished goods and then to sell those goods, the average collection period as the average length of time required to convert the firm s receivables into cash, that is, to collect cash following a sale, and the payables deferral period as the average length of time between the purchase of materials and labor and the payment of cash for them. The three components of cash conversion cycle are computed as follow: o Inventory conversion period (ICP) = inventory/cost of goods sold*

12 o Average collection period (ACP) = accounts receivables/sales*365 o Payables deferral period (PDP) = accounts payables/cost of goods sold* Control Variables The control variables used in this study are the firms size (measured as the natural logarithm of sales), the sales growth (measured by the percentage change in sale), the financial debt ratio (measured by the ratio of Short Term Loans + Long Term Loans to Total Assets), the current ratio (measured by the ratio of current assets to current liabilities), and the ratio of fixed financial assets to total assets. Fixed financial assets are defined by Deloof (2003) as shares in other (mainly affiliated) firms, intended to contribute to the activities of the firm that holds them, by establishing a lasting and specific relation, and loans that were granted with the same purpose. This control variable is used to check the ratio of fixed financial assets to the total assets of Moroccan firms and see the relationship of the fixed financial assets to profitability of firms. Most of the previous researches, such as the ones of Deloof (2003), Gill, Biger, and Mathur (2010), Afeef (2011), Sharma and Kumar (2010), Enqvist, Graham, and Nikkinen (2011), and Hayajneh and Lahcen AitYassine (2011), used the previous five variables as control variables to investigate the relationship between working capital management and profitability in both developed and emerging markets. Those five control variables are used because of their known impact on corporate profitability. 3.4 Regression Equations This study uses eight models to analyze the relationship between working capital management and profitability of firms. The first four equations use return on assets as dependent variable and one of the four working capital management measures (CCC, ICP, ACP, PDP) as independent variables. In addition, all the equations include five control variables (SIZE, SGROWTH, DR, CR, FATA). Here are presented the four first equations that follow the ones used by García-Teruel and Martínez-Solano in Spain: (1) ROA = ᵦ0 + ᵦ1CCC + ᵦ2SIZE + ᵦ3SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є (2) ROA = ᵦ0 + ᵦ1 ICP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є (3) ROA = ᵦ0 + ᵦ1 ACP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є (4) ROA = ᵦ0 + ᵦ1 PDP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA + є Concerning the last four equations, they are exactly the same as the first ones except that the dependent variable, return on assets, is replaced by the gross operating income used as another profitability measure in this paper. The following equations follow the ones of Deloof (2003) in Belgium. (5) GOI = ᵦ0 + ᵦ1 CCC + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є (6) GOI = ᵦ0 + ᵦ1 ICP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є (7) GOI = ᵦ0 + ᵦ1 ACP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є 129

13 (8) GOI = ᵦ0 + ᵦ1 PDP + ᵦ2 SIZE + ᵦ3 SGROWTH + ᵦ4 DR+ ᵦ5 CR+ ᵦ6 FATA +є Where ROA = return on assets GOI =gross operating income CCC = cash conversion cycle ICP = inventory conversion period ACP = average collection period PDP = payable deferral period SIZE = natural logarithm of sales SGROWTH = Sales Growth DR = debt ratio CR= current ratio FATA= financial assets to total assets ratio ε = error term 4. The Findings This section presents the descriptive statistics first and then provides the results of the different equations. 4.1 Descriptive Statistics Table 4 presents the descriptive statistics of the variables collected for this research. The total number of observations is N = 301. This table shows the minimum, maximum, mean, and standard deviation of all the variables under interest. Table 4: Descriptive Statistics for all the variables under study N Minimum Maximum Mean Std. Deviation ROA 301 -, , , , GOI 301 -, , , , CCC ICP ACP 301, , PDP , Size , , , Salegrowth 301 -, , , , Debtratio 301, , , , Currentratio 301, , , , FATA 301, , , ,10975 The average return on asset (ROA) of the Moroccan firms under study is 11%, with a minimum ROA of -27.6%, a maximum of 284%, and a standard deviation of 18%. The gross operating income (GOI) is on average % of total assets, with a minimum of and a maximum of The GOI s standard deviation is about 49%. Concerning the cash conversion cycle (CCC) of the firms under study, it is on average 87 days. This latter is considerably higher than the one of Belgian firms which is 44.5 days (Deloof, 2003) and the one of the Spanish firms that is 76 days (Garcia-Teruel and Martinez-Solano, 2007). However, the Moroccan average CCC is still lower than the ones of the Jordanian firms of 217 days (Hayajneh and Lahcen AitYassine, 2011), the Indian firms of 450 days (Sharma and Kumar, 2010) and the Greek firms of 189 days (Lazaridis and Tryfonidis, 2006). The average inventory conversion periods of the Moroccan firms shows that inventory takes on average 140 days to be sold. Comparing this average with the ones of other studies in different countries, it is much higher in Morocco than in Jordan 130

14 with 193 days (Hayajneh and Lahcen AitYassine, 2011), but lower than in Vietnam with 88 days (Dong & Su, 2010), and in Pakistan with 118 days (Afeef, 2011). The average collection period s mean of the firms under study is of 123 days which is higher than the one of Jordan firms of 112 days (Hayajneh and Lahcen AitYassine, 2011) and much lower than the one of India which is 471 days (Sharma and Kumar, 2010). It takes on average 176 days for Moroccan firms to pay their purchases, which is again higher than the Jordanian average payable deferral period of 88 days (Hayajneh and Lahcen AitYassine, 2011) and lower than the one of Indian firms that is 683 (Sharma and Kumar, 2010). The average days in account payables and account receivables show that the Moroccan firms under study collect money from customers before paying suppliers for their purchases. Concerning the control variables used to show their impact on profitability, there is an average size of Moroccan firms (computed using the natural logarithm of sales) of 20.61, with a size of for the smallest firm and a natural logarithm of sales of for the largest firms. The average sales growth of the sample is 14.23% with a standard deviation of 70%. The result of descriptive statistics indicates that the average of debt ratio is 40.45% and the standard deviation is 61.97%. The minimum debt ratio is 5.43% meaning that the firm uses a low level of debt and the maximum is 171,7% meaning that this firm uses excessive level of debts in its operations. The average current ratio is 2.37 meaning that the current assets of the Moroccan firms under study are more than two times higher than their liabilities. The current asset of the firm with the lowest current ratio represent 8% of its current liabilities, and the current assets of the firm with the highest current ratio represent about 14 times the level of its current liabilities. Finally, on average 8.12% of total assets of the firms included in the sample are financial assets. The fixed financial asset to total asset ratio has a standard deviation of 10.98%. The correlation matrix (available upon request) shows no severe multicollinearity between the control variables used in this study, hence the need to include them in our equations. 4.2 Regression Analysis This section presents the results of the different s used to examine the relationship between working capital management and profitability of Moroccan firms Profitability Measured by Return on Asset (ROA) Regression equation 1 The first includes cash conversion cycle (CCC) as a comprehensive measure of working capital management (independent variable) and return on asset (ROA) as profitability measure (dependent variable). The results of this are presented in table 5 below. Results show an insignificant negative relationship between CCC and ROA. Most of the previous studies on the impact of working capital management on firms profitability, find a significant negative relationship between cash conversion cycle and return on asset as in Spain (Garcia-Teruel and Martínez-Solano, 2007) and Finland (Enqvist, Graham and Nikkinen 2011). However, few researches find a significant positive relationship between the two variables as in the case of India (Sharma qnd Kumar, 2011). Finally, the study on Pakistani firms finds an insignificant positive relationship between cash conversion cycle and return on assets. There is no evidence that the cash conversion cycle will affect the return on asset of the Moroccan firms included in the sample. 131

15 Table 5: Relationship between Return on Asset and Cash Conversion Cycle ROA coef. t p > t Constant ,056 CCC -0, ,187 SIZE ,041 SGROWTH ,632 DEBTRATIO 0, ,000 CURRENTRATIO -0, ,33 0,741 FATA -0, ,19 0,236 R-sq = Regression equation 2 The second includes inventory conversion cycle as independent variable and return on asset as dependent variable. Table 6 below shows an insignificant negative relationship between the two variables. Most of previous researches find a significant negative relationship between inventory conversion period (ICP) and return on asset (Garcia-Teruel and Martínez-Solano, (2007), Enqvist, Graham, and Nikkinen, (2011), and Sharma and Kumar, (2011). In the case of Pakistan, the relationship between these two variables is found insignificantly negative. Here again, as in the case of Pakistan, there is no evidence of any potential impact of reducing the inventory conversion period on Moroccan firms profitability. Table 6: Relationship between Return on Asset and Inventory Conversion Period ROA coef. t p > t Constant ,057 ICP -0, ,328 SIZE ,042 SGROWTH ,636 DEBTRATIO 0, ,000 CURRENTRATIO -0, ,40 0,688 FATA -0, ,16 0,248 R-sq = Regression equation 3 The third includes average collection period (ACP) as independent variable and return on asset (ROA) as dependent variable. Results presented in table 7 below show a significant negative relationship between the two variables. These findings confirm that there is strong evidence that a better management of the receivables will have an impact on the profitability of Moroccan firms. Sharma and Kumar (2011) find a significant positive relationship between ACP and ROA for Indian firms, and Garcia-Teruel and Martínez-Solano (2007) and Enqvist, Graham, and Nikkinen (2011) find a significant relationship between the two variables for Spanish and Finish firms respectively. 132

16 Table 7: Relationship between Return on Asset and Average Collection Period ROA coef. t p > t Constant ,222 ACP -0, ,004 SIZE ,130 SGROWTH ,584 DEBTRATIO 0, ,000 CURRENTRATIO -0, ,42 0,674 FATA -0, ,335 R-sq = Regression equation 4 The fourth includes payables deferral period (PDP) as independent variable and return on asset (ROA) as dependent variable. Results presented in table 8 below reveal an insignificant negative relationship between the PDP and ROA for Moroccan firms. Comparing this result with previous researches, Garcia-Teruel and Martínez-Solano (2007) and Afeef (2011) find also an insignificant negative relationship between days in account payables (or PDP) and ROA for Spanish and Pakistani firms. Enqvist, Graham and Nikkinen (2011) and Sharma and Kumar (2011) find this time a statistically significant negative relationship between these two variables in Finland and India respectively. Table 8: Relationship between Return on Asset and Payable Deferral Period ROA coef. t p > t Constant ,082 PDP -0, ,197 SIZE ,056 SGROWTH ,636 DEBTRATIO 0, ,000 CURRENTRATIO -0, ,47 0,641 FATA -0, ,09 0,277 R-sq = The R squared found in the first four s using the return on assets are very low ranging from around to There is a strong evidence that a good management of the average collection period will enhance the performance of Moroccan firms listed at the Casablanca stock exchange. Concerning the relationships found between the control variables and the return on asset (ROA), the results reveal a significant positive relationship between size and ROA and between debt ratio and ROA. In addition, the study shows an insignificant negative relationship between sales growth and ROA. For the last two control variables that are current ratio and financial assets to total asset ratio, there is an insignificant negative relationship between ROA and those two variables. 133

17 4.2.2 Profitability Measured by Gross Operating Income (GOI) Regression equation 5 The fifth includes cash conversion cycle (CCC) as independent variable and gross operating income (measure of profitability of firms) as dependent variable. Results presented in table 9 below show an insignificant negative relationship between cash conversion cycle and profitability. This result is similar to the one reached by Deloof (2003) for Belgian firms. Other studies on working capital management and profitability using the same variables find a significant negative relationship between CCC and gross operation income as in Finland (Enqvist, Graham, and Nikkinen (2011)). Gill, Biger, and Mathur (2010) show that there is a significant positive relationship between the CCC and the profitability of US firms. They confirm that managers should handle carefully the CCC to increase their firms profitability. Table 9: Relationship between Gross Operating Income and Cash Conversion Cycle GOI coef. t p > t Constant ,016 CCC 0, ,400 SIZE ,014 SGROWTH ,000 DEBTRATIO ,000 CURRENTRATIO ,029 FATA ,022 R-sq = Regression equation 6 The sixth includes inventory conversion period (ICP) as independent variable and gross operating income (measure of profitability of firms) as dependent variable. Table 10 presents the results of equation 6. They show an insignificant negative relationship between those two variables. Referring to the previous studies, a negative relationship is expected between ICP and gross operating income as in the case of Finish firms (Enqvist, Graham and Nikkinen 2011) and Belgium firms (Deloof, 2003). Reducing the inventory conversion period (ICP) will affect positively the firms profitability. 134

18 Table 10: Relationship between Gross Operating Income and Inventory Conversion Period GOI coef. t p > t Constant ,016 ICP -0, ,485 SIZE ,015 SGROWTH DEBTRATIO ,000 CURRENTRATIO ,025 FATA ,023 R-sq = Regression equation 7 The seventh examines the relationship between the gross operating income and the average collection period. Table 11 documents the results of the equation 7. Findings show a significant negative relationship between average collection period and profitability. The majority of previous researches on the same topic using the same variables confirm this significant negative relationship between average collection period and gross operating income as in Finland (Enqvist, Graham and Nikkinen 2011), Vietnam (Dong and Su, 2010), and Belgium (Deloof, 2003). Table 11: Relationship between Gross Operating Income and Average Collection Period GOI coef. t p > t Constant ,000 ACP -0, ,000 SIZE ,000 SGROWTH ,000 DEBTRATIO ,000 CURRENTRATIO ,018 FATA ,013 R-sq = Regression equation 8 The last investigates the relationship between payables deferral period and gross operating income as a measure of profitability for Moroccan firms. The shows a significant negative relationship between these two variables. Most of the previous studies using these two variables find also a significant negative relationship (Enqvist, Graham, and Nikkinen, (2011) and Deloof, (2003)). However, few others as the case of Vietnam find a significant positive relationship between payables deferral period and gross operating income (Dong and Su, 2010), meaning that the more profitable firms wait longer to pay their bill. 135

19 Table 12: Relationship between Gross Operating Income and Payable Deferral Period GOI coef. t p > t Constant PDP -0, ,004 SIZE ,002 SGROWTH ,000 DEBTRATIO ,000 CURRENTRATIO ,036 FATA ,013 R-sq = The R squared found in the last four s using the gross operating income are relatively high, around This means that 38 % of the change in the dependent variable (GOI) is explained by the changes in the independent variables used in each. Concerning the relationships found between the control variables and the gross operating income (GOI), the results reveal a significant negative relationship between the size of the firm and GOI. Findings also show a significant positive relationship between sales growth, debt ratio, current ratio and financial asset to total asset ratio and GOI. 5. Summary and Conclusions This study provides empirical evidence about the impact of the management of working capital on the profitability of Moroccan firms. The sample includes 43 Moroccan nonfinancial firms listed on Casablanca stock exchange market for the period This balanced panel data set is estimated using the fixed-effect. The independent variables used in this research as measures of working capital management are the cash conversion cycles and its components: inventory conversion period, average collection period, and payables deferral period. Concerning the dependent variables, two profitability measures were used: the return on assets (ROA) and the gross operating income as a percentage of total assets minus financial assets (GOI). The results of the s using return on assets as measure of profitability reveal no significant relationship between the working capital management measures CCC, ICP and PDP and return on assets. The only variable that has a positive and significant relationship with return on assets is the average collection period. Previous studies using return on asset revealed different results than the expected ones, essentially insignificant relationships between working capital components and profitability. The return on asset seems not to be a good measure of profitability of firms in what concerns working capital management as it is not an operational ratio. Gross operating income over total assets minus financial assets might be a better measure as it is related in this case to operational variables. Concerning the s using gross operating income as dependent variable, the results show as expected a negative and significant relationship between average collection period, payables deferral period and GOI. This means that there is strong evidence that the management of the receivables and the payables would impact the profitability of the Moroccan firms included in the sample. Even if some results were 136

20 insignificant, this empirical research shows that Moroccan firms can increase their profitability by correctly handling their cash conversion cycle and by managing to hold an optimal level of inventory. Therefore, an efficient management of working capital components can have a positive impact on Moroccan firms profitability. The major limitations of this study concern the lack of available data that limits the research s scope and reduces the sample size. First, there is a limited number of Moroccan firms that are listed on Casablanca stock exchange. Second, only a small number of years financial statements is provided, which reduces the period under study to only seven years ( ). In addition, data about the variables used in this research (such as CCC, ICP, ACP, PDP ) is not available and needs to be computed from the financial statements of each firm for the seven years. This process is tough and very time consuming. Another limitation to this study is that it does not include an industry-wise of working capital management. Previous empirical studies, as the one of Weinraub and Visscher (1998), show that the way firms deal with working capital management varies across the different industries. Each industry has specific characteristics that have an effect on the way companies invest in working capital policies. Therefore, the relationship between profitability of firms and the management of working capital management is impacted by the industry in which it operates. For example, shortening the cash conversion cycle and its components can be positively related to profitability of firms in one industry and negatively or insignificantly related in another industry. As stated in the data collection part, there are 16 industries represented in this study; however, each industry includes only a small number of firms (refer to table 3) that would not be enough to represent the whole industry. This is the reason why this research does not investigate the relationship between working capital management and profitability for each industry. Further research could use a larger sample once available and investigate the best working capital policies to be followed by firms in different industries. Finally, the impact of the financial crisis (2007) could have been investigated during this study s sampling period as firms would need to use different working capital policies in order to increase their profitability. Further research should investigate the relationship between working capital management and corporate profitability in non-crisis time, during the crisis, and after the crisis. Comparing the different findings would show the relative impact of the crisis on the management of both current asset and current liabilities. In addition, it will help managers know the changes needed during and after economic downturns. Baveld (2012) studied how companies in Netherland can manage their working capital profitably during non-crisis periods and during a crisis period. The author s findings show that the policy used for the account receivables has to be changed during crisis period. This is due to the fact that longer trade credit should be granted to customers in order to help them in the short run, even if the company is taking risks, as it will have a positive impact on the long run (e.g. keep customers for future sales). Concerning the policies of inventory and account payables, the author shows that during periods of crisis firms do not need to alter these policies in order to be profitable. 137

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