IMPACT OF WORKING CAPITAL ON FIRMS PROFITABILITY:

Transcription

1 VIETNAM NATIONAL UNIVERSITY HOCHIMINH CITY INTERNATIONAL UNIVERSITY SCHOOL OF BUSINESS IMPACT OF WORKING CAPITAL ON FIRMS PROFITABILITY: EVIDENCE FROM CONSTRUCTION AND BUILDING - MATERIAL SECTOR OF VIETNAM In Partial Fulfillment of the Requirements of the Degree of BACHELOR OF ARTS in BUSINESS AMINISTRATION Student s name: NGO LE QUAN (BAIU09161) Advisor: DUONG THUY TRAM ANH, MSc. Ho Chi Minh City, Vietnam 2013

2 IMPACT OF WORKING CAPITAL ON FIRMS PROFITABILITY: EVIDENCE FROM CONSTRUCTION AND BUILDING-MATERIAL SECTOR OF VIETNAM APPROVED BY: Advisor APPROVED BY: Committee, MSc. Duong Thuy Tram Anh MSc. Duong Thuy Tram Anh Ph.D Pham Thi Thu Tra MBA Nguyen Thi Thuy Trang Ph.D Ho Diep THESIS COMMITTEE

3 ACKNOWLEDGEMENTS This is a pleasure to express my sincere gratitude to all those who made this thesis possible. First and foremost, I would like to express deepest gratitude to my advisor, Ms. Duong Thuy Tram Anh, MSc. for her dedication and great support to me. Without her, I would not have completed the load of work that the thesis required. She gave me a lot of helpful advices as well as encouragement throughout my time doing this thesis. Moreover, she helped me a lot in improving my knowledge and writing. I really appreciate her great contributions to help me finishing this thesis. Second, I would like to give special thanks to my beloved parents, my sister and my brother. They always support me whenever I have difficulties. Great encouragement and support from them have been an inspiration for me to make great efforts to complete my thesis. Especially, to my cousin Hon Xuyen, who had spent his time helping me and gave me a lot of encouragement to accomplish this study. Also, to my beloved friend, Phuc Nguyen, for encouraging me as well as cheering me up when I encountered difficulties. Thank you very much. Last but not least, I m also grateful to my best friends Ngoc Tuyen, Tuong Vy, Thanh Hien; and my best friends in IU: Thanh Ngan, Diem Chau, Diem Huong, Cao Thu, and Chi Hai. They have been always beside me when I am in need. We gave great supports to each other in our group during the time doing our theses. Thank you for being parts of me during my campus life and later on. iii

4 TABLE OF CONTENTS LIST OF TABLES... viii LIST OF FIGURES... ix ABSTRACT... x CHAPTER I: INTRODUCTION Background Rationale Research questions and objectives Methodology Scope and limitation Implication of the study Organization of the study... 6 CHAPTER II: LITERATURE REVIEW Theoretical review Working Capital Definition Characteristics Working Capital Accounts Measure of Working Capital... 9 iv

5 Working Capital Requirement Working Capital Management and its Components Profitability and Liquidity Profitability Liquidity Relationship between Profitability and Liquidity Relationship between Working Capital and Profitability Review of empirical studies Developing-nation group Developed-nation group Conclusions Construction and Building material sector in Vietnam CHAPTER III: RESEARCH DESIGN AND METHODOLOGY Theoretical Framework The variables Models and Hypotheses Research Methodology Research Design Sampling Design v

6 Target population Sample Data Collection Data Analysis Descriptive Statistics Correlation Test Multiple Linear Regression Analysis CHAPTER IV: DATA ANALYSIS AND DISCUSSIONS Descriptive Statistics Correlation Multiple Linear Regressions Assumptions Heterokedasticity Cross-section weight Hausman Tests for correlated random effect Multicollinearity with Variance Inflation Factor (VIF) Autocorrelation Multiple Linear Regressions Results Result of the hypothesis vi

7 Result of the hypothesis Result of the hypothesis Result of the hypothesis Discussions of the results CHAPTER V: CONCLUSIONS AND RECOMMENDATIONS Conclusions Recommendations Limitations and Suggestions for Further Research LIST OF REFERENCES APPENDIX: RESULTS OF HAUSMAN TEST FOR CORRELATED RANDOM EFFECT vii

8 LIST OF TABLES Table 1: Factors affect Working Capital Requirements Table 2: Variables and their Calculations Table 3: Descriptive Statistics Table 4: Correlation Table 5: Regression Result of Hypothesis Table 6: Regression Result of Hypothesis Table 7: Regression Result of Hypothesis Table 8: Regression Result of Hypothesis Table 9: Result of Hausman Test for Hypothesis Table 10: Result of Hausman Test for Hypothesis Table 11: Result of Hausman Test for Hypothesis Table 12: Result of Hausman Test for Hypothesis viii

9 LIST OF FIGURES Figure 1: Operating Cycle of A Business Figure 2: Type of ownership of companies in Construction and Building material sector in Vietnam Figure 3: Research Models Figure 4: Relationship between ACP and ROA Figure 5: Relationship between ITID and ROA Figure 6: Relationship between APP and ROA Figure 7: Relationship between CCC and ROA Figure 8: Predicting Models and Outcomes ix

10 ABSTRACTS Working capital is an important aspect of corporate profitability that managers of every firm must understand in order to maximize firm s value. The main objective of this study is to investigate the relationship between working capital and firms profitability in the context of Vietnam. The study used Cash Conversion Cycle and its components (Average Collection Period, Inventory Turnover in Days, and Average Payment Period) as measures of working capital and Return on Assets as a measure of profitability. Using panel data methodology for 50 listed companies that manufacture building materials in Construction and Building-material sector of Vietnam for the period, the study has provided empirical evidence that there was a significant positive relationship between Average Collection Period and Return on Assets; there were negative relationships between Inventory Turnover in Days, Average Payment Period, Cash Conversion Cycle and Return on Assets. From these results, managers can increase credit payment to customers or lower the amount of inventories or delay debt payments to maximize firms profit and hence increase firms value. x

11 CHAPTER I INTRODUCTION 1.1 Background In any firms, management of working capital is an important part of corporate finance management. According to Smith (1980), working capital management is a very important factor that affects firm s profitability and risk, and thus affects firm s value. Working capital is defined as the difference between current assets and current liabilities. (Enqvist, Graham, & Nikkinen, 2012). The management of working capital is called working capital management (Huynh & Su, 2010). The objective of managing working capital is to manage current assets and current liabilities of firms. Working capital should be managed to a satisfactory level so that it can be adequate, neither more nor less. Shin and Soenen (1998) mentioned that working capital management can have significant impact on company s liquidity and profitability. As we all know, the main purpose of any firms is to maximize their profit. However, maximizing profit has to come along with maintaining liquidity. Firms have to balance the profitability and the liquidity so that there will be no problems if profit increases at cost of liquidity. According to Lamberson (1995), working capital management has become one of the most important issues in organization, where financial managers find it difficult to identify the importance of working capital and the optimal level of working capital. Thus, firms can maximize their profit as well as minimize risks if the managers understand the importance of working capital and each element of working capital. Keeping an optimal balance among each of the working capital components is the main 1

12 objective of working capital management (Huynh & Su, 2010). An optimum level of working capital is a balance between efficiency and risk, when the components of working capital such as cash receivables, inventories and payable are maintained at the optimum level (Afza & Nazir, 2009). Gitman (1974) proved that cash conversion cycle the time lag between the expenditure for the purchases of raw materials and the collection of sales of finished goods was a key factor of working capital management. Deloof (2003) believed that the longer the time lag, the larger the investment in working capital, and long cash conversion cycle could increase the profitability by leading to higher sales. Meanwhile, Shin and Soenen (1998) concluded that there is a negative relationship between cash conversion cycle and firm s profitability by conducting a study of large-sample listed firms in America for the period. This result showed that managers should reduce cash conversion cycle to a minimum point in order to obtain high firms value. Also, according to Alipour (2011), the efficient policy of working capital is minimizing the time between expenses for buying inventory and the cash receipt resulted of selling it. This study will attempt to investigate the impact of working capital on firms profitability, in the context of Vietnam, for listed companies in Construction and Building-material sector from both Hochiminh Stock Exchange (HOSE) and Hanoi Stock Exchange (HNX). 1.2 Rationale Making financing decisions is very important to firms. Financing decision consists of long term financing decision and short term financing decision. Long-term financing decisions include capital investment decisions, financing decisions, dividend decisions, etc. Short term financing decisions involve in dealing with short term balance of current assets and current liabilities, which will focus on management of cash, inventories, accounts payable and accounts receivable. The management of current assets and current liabilities refers to working capital management. 2

13 Working capital is an important issue that managers of every firm must understand in order to maximize firm s value. Firms will find it is hard to run smoothly and efficiently without proper management of working capital. According to Brigham and Houston (2003), about 60 percent of financial manager s time is spent for management of working capital. Currently, working capital management research has been conducted in Finland (Enqvist et al., 2012), Spain (Teruel-Garcia & Martinez- Solano, 2007), India (Sharma & Kumar, 2011), Iran (Alipour, 2011), Pakistan (Raheman & Nasr, 2007), Belgium (Deloof, 2003), etc. Despites the importance of working capital management, there has been limited working capital study in Vietnam context. Lack of research related to this issue may lead to limitation in increase firms value. Therefore, it is necessary to conduct a study to show that how working capital has impact on firms profitability. From that managers of chosen firms or other firms which are in the same sector can find the solutions to maximize firms profit and thus enhance firms value. Construction and Building-material sector is an important sector of Vietnam; it has a special role in developing economy as well as society, especially in the period of industrialization and modernization of Vietnam. In 2010, this sector accounts for 10.3% of GDP. This sector includes firms that focus mainly on construction activities, and firms that focus on manufacture building material. For the purpose of this research, the researcher only focuses on firms that manufacture building materials. 1.3 Research questions and Objectives The questions that needed to be answered in this study are: To what extent do factors of working capital have impact on firms profitability? How can managers increase firm s value using working capital management? In order to answer these questions, the objectives of this study are set as follows: To examine the relationship between working capital and profitability. 3

14 To provide empirical evidence showing that each component of working capital has effect on firm s profitability for a sample of 50 firms in Construction and Building-material sector of Vietnam. To make suggestions based on the results of findings. To evaluate and compare the results of Vietnam context with previous studies in foreign countries. 1.4 Methodology The Construction and Building-material sector consists of 2 types of companies with different business activities. They are companies that focus on construction activities and companies that manufacture building materials. The total population of the Construction and Building-material sector of HOSE and HNX is 197 companies. (The list of listed companies on HOSE and HNX by industrial classification is on the Web site of VNDIRECT SECURITIES COMPANY This study will focus only on companies that manufacture building materials listed in HOSE and HNX. There are 67 listed companies that manufacture building material; however, only 50 of them have enough requiring information. Therefore, these 50 companies will be chosen to conduct this study. This research will focus on quantitative method. The purpose of using this method is to investigate causal relationship between working capital and firms profitability. In this case, the firms profitability is the effect and the causes are the component elements of working capital. Regression analysis is applied, in which the components of working capital are independent variables and profitability is dependent variable. Firms profitability will be measured by Returns on Assets, which is calculated by taking Net income divided by Total assets. Working capital will be measured by cash conversion cycle. Cash conversion cycle has been defined as the time lag between the expenditure for the purchases of raw materials and the collection of sales of finished 4

15 goods. (Deloof, 2003, p.564). Cash conversion cycle is measured by adding Inventory Turnover in Days to Average Collection Period and then subtracting by Average Payment Period. Inventory Turnover in Days is the average required time to change the materials into product and then sell the goods; Average Collection Period is defined as the average required time for changing the company receivables into cash; and Average Payment Period is the average time between buying materials and using lab our force and cash payment relates to them (Alipour, 2011). The data used for this study is the secondary data collected from the sample of 50 firms that manufacture building-material listed in HOSE and HNX for three years, from 2009 to The data is gathered from companies audited financial reports. After collecting necessary data, it will be analyzed by Eviews software for descriptive statistics, correlation tests, and regression analysis to show important relationships of variables in the study. After that, the findings and the results will be discussed, from which conclusions and recommendations can be drawn. 1.5 Scope and limitation of the study This study is conducted based on the information of the firms that manufacture building-material listed in HOSE and HNX. Since the researcher wants to focus on specific characteristics of working capital of manufacturing firms, this study will only examine 50 firms that manufacture buildingmaterial for three year (from 2009 to 2011), therefore, the result can only be represented for those firms only, it cannot represent the whole Construction and Building-material sector as well as other sectors of Vietnam. Also, lack of literature in Vietnam context and shortage of reference books may narrow the output of the study. 5

16 1.6 Implications of the study The results of this study can help the managers of the chosen firms understand how working capital affects firms profitability. From the result of the study, they can find the best solutions to maximize firms profit, and thus firms value. This work helps contribute to the literature in two ways. First, there is no evidence exists for the case of manufacturing building material firms listed in HOSE and HNX. Second, the result of this study can be the reference for further research on related fields or sectors. 1.7 Organization of the study This study is divided into five main parts, which are placed in five chapters. Chapter I provides reasons for conducting the study, research questions and objectives and structure of the study. Chapter II reviews the definitions, concepts and previous studies related to the topic. In chapter III, theoretical framework, hypotheses, and research models will be presented. Chapter IV provides the process of analyzing the data and then will come up with the findings and discuss them. Chapter V concludes the study and recommends for further studies on related fields. 6

17 CHAPTER II LITERATURE REVIEW This chapter will review the concepts, definitions, and previous research that related to the topic. Also, this chapter presents how theory and empirical evidence are related to each other. 2.1 Theoretical review Working Capital Definition. Working capital is a type of short term financing decision, and it refers to the difference between current assets and current liabilities. Arnold (2008) defined working capital as it includes stocks of materials, fuels, semi-finished goods including work-in-progress and finished goods and by-products; cash in hand and bank and the algebraic sum of various creditor as represented by outstanding factory payments e.g. rent, wages, interests and dividends, purchase of goods and services; short-term loans and advances and sundry debtors comprising amounts due to the factory on account of sale of goods and services and advances towards tax payments. In short, working capital can be understood as the changes of assets from one form to another. For example, from beginning with cash, changing to raw materials, and then converting into work-inprogress and finished goods, sale of finished products and finally ending with realization of cash from debtors (Weston and Brigham, 1977). Working capital is often used to evaluate a company s ability to meet currently maturing debts. It is useful for a company to make monthly or other period-to-period comparisons (Warren and Reeve, 2006). 7

18 According to Sharma (2009), for the purpose of definition, there are two concepts of working capital: Gross concept and Net concept. In term of Gross concept, working capital is the investment in circulating assets, or in inventory and accounts receivable comprising the operating cycle of a manufacturing firm. The investment in assets comprising gross operating cycle is called current assets. Current assets are assets which in normal course of operations are meant to be converted into cash within a period not exceeding one year. Likewise, current liabilities are commitments which require cash settlements in the ordinary course of business within a year. On the other hand, in term of Net concept, working capital is the difference between current assets (resources in cash or readily convertible into cash) and current liabilities (organizational commitments for which cash will soon be required) Characteristic. Sharma (2009) discussed the characteristics of working capital as it has short life span. Usually, life of current assets such as cash, accounts receivable, accounts payable are short (within a year or less than a year). This short life span depends upon the operating cycle of the firm (time taken by various activities such as procurement of materials, production process, sales and collection of bills, etc.) The greater the time duration of operating cycle is, the longer life current assets gets. Moreover, working capital is transformable, which means the process of transforming current asset into other forms of asset. Cash is utilized to procure raw materials, raw materials are transform to work-in-process and finished goods, and finished goods are sold or credit to create accounts receivable, and when cash is collected, accounts receivable are converted back into cash. These forms of assets are inter-related. Therefore, a decision of one form of asset may have impact on other forms of current asset. As a result, when analyzing working capital, all of these forms of assets must be taken into account. 8

19 A significant characteristic of working capital is short-term focus. The entire work from procurement to management is usually happened one year. Therefore, present value of money is unnecessary for analyzing working capital. One of the major purposes of working capital management is to provide liquidity for the business all the time in the way that neither the risk is very high nor the return on investment should fall. Since current asset keeps on changing, maintaining liquidity becomes a difficult task for managers Working Capital Accounts. Sagner (2010) described working capital accounts include cash accounts and short-term investments (cash on hand and in banks accounts, and any short-term investments that are expected to be turned into cash within a year); accounts receivable (credit sales when the customer is expected to pay by a future date on date of invoice); inventory (raw materials, work-in-process, and finished goods); accounts payable (the amounts owed to creditors for purchases); and other working capital accounts (prepaid expenses and accrued expenses) Measure of Working Capital. Sagner (2010) described the following ratios in order to measure working capital: Activity utilization. Activity utilization ratios indicate how efficiently the business is using its assets. These are the ratios of some working capital accounts: o Accounts receivable: Receivable turnover = credits sale accounts receivable Receivable turnover describe the relationship between sales and accounts receivable. It is desirable to base the average on monthly balances, which allows for seasonal changes in sales (Warren and Reeve, 2006) Average collection period (ACP) = accounts receivable daily credit sales 9

20 The ACP is an estimate of the length of time (in days) the accounts receivable have been outstanding. o Inventory: Inventory turnover = cost of goods sold inventory Each business or each department within a business has a reasonable turnover rate. A turnover lower than this rate could mean that inventory is not managed properly (Warren and Reeve, 2006). Inventory turnover in days (IDID) = 365 days inventory turnover Accounts payables. The ratio average payment period, or average day s payable measures the length of time it takes the company to pay its own suppliers (Clayman, Fridson, & Troughton, 2012) Average payment period (APP) = accounts payable purc ase 365days Operating cycle and cash conversion cycle Another way to measure working capital is by using operating cycle. The operating cycle analyzes accounts receivable, inventory, and accounts payable in terms of days (Sharma, 2009). Operating cycle is the average time between purchasing or acquiring inventory and receiving cash proceeds from sales of finished goods. In other words, operating cycle is the time period which elapses between the point of cash is spent on the production of a product, and the cash collection from customers. An operating cycle of a business begins with purchasing of raw materials and the payment is not done immediately. This leads to the creation of accounts payable. The raw materials are converted into work-in-progress and finished goods and then sold. The time lag between the purchase of raw materials and the sale of finished goods is inventory period. When products are sold on account, there exists a time lag between the 10

21 sale of finished goods and the collection of cash on sale, which is called accounts receivable period. The figure below will illustrate an operating cycle of a business. Figure 1: Operating cycle of a business (Source: Sharma, 2009) Operating cycle = number of days of inventory + number of days of receivable (Clayman et al., 2012) A shortage of operating cycle is that it does not take everything into account, because the available cash flow is increasing by deferring payment to suppliers. This deferral is considered in net operating cycle, or cash conversion cycle, which is calculated as follow: Cash conversion cycle (CCC) = number of days of inventory + number of days of receivables number of days of payables (Clayman et al., 2012) 11

22 The shorter the cycles, the greater a company s cash-generating ability and the less its need for liquid assets or outside finance Working capital requirement. According to Sharma (2009), the investment on operating cycle is called working capital requirements. Working capital requirement is financed by short-term bank loan because of lower cost of financing and the flexibility in accommodating the fluctuating nature of net current assets. The smaller the working capital requirement, the smaller is the total financing requirement, and the stronger is the financial base of the company. Clayman et al. (2012) showed the factors that can affect working capital requirements: Table 1: Factors affect working capital requirements Internal factors Company size and growth rates Organizational structure Sophistication of working capital management Borrowing and investing positions/activities/capacities External factors Banking services Interest rates New technologies and new products The economy Competitors (Source: Clayman, Fridson, & Troughton, 2012) Working capital management and its components. The management of working capital is working capital management. Working capital management is a simple concept to ensure the ability of the organization to fund the difference between the short term assets and short term liabilities (Harris, 2005). It is one of the most important issues in any firms where managers have to struggle to identify the drivers of working capital and an appropriate level of working capital (Lamberson, 1995). Working capital management is important because of these reasons. First, the management of current assets involves the largest portion of financial manager s time; second, Working capital is 12

23 a requirement to be concerned; hence, it is impossible to avoid an investment in current assets; finally, there exists a close relationship between sales growth and the level of current assets and current liabilities (Sharma, 2009). Management of working capital involves management of each account of working capital. Sharma (2009) discussed each of them as follow. The first thing is management of Cash. Cash is the most liquid form of current assets. Other forms of cash include cash equivalents or short-term investments. It is important to have a well-plan and maintained budgeting system in order to manage cash efficiently. Good cash management requires regular cash-forecasts, which must be based on information provided by managers for the amounts timing of capital and operating expenditures. Managers must make decisions on how much cash should be available on the bank account of the company, and how much should be deposit on term deposit at various available time. In short, cash is a central component of working capital; hence, the more efficient payment and collection practices are, the better the business s level of working capital can be enhanced. Second, management of Inventory is an important thing in working capital management. Inventory makes up more than 40% of a firm s current assets and kept in many forms such as raw materials, work-in-progress, and finished goods. In order to manage inventory efficiently, managers must understand some issues such as what is the reasonable level of inventory in relation to sales, what is the inventory turnover rate, what should be done to increase or decrease inventory, etc. Inventory management is an important aspect of working capital management because inventories do not earn revenues themselves. Holding too much or too little inventory incurs costs such as carrying costs, ordering costs, and stock out costs. Next, it is necessary to manage Accounts receivable. In order to manage and control debtors effectively, appropriate policies to cover the choice of customers, the way 13

24 which sales are made, trading terms, the sales of invoicing systems, the mean of settlement, and the overdue accounts collection system should be established. Managers must understand what is amount of accounts receivable related to sales, how rapidly can accounts receivable converted into cash, how to speed up collections. Furthermore, management of working capital also involves management of Accounts payable. Firm s managers must maintain the level of payables and cash outflow in accordance with firm s policy, and ensure no interruption to any manufacturing processes or operation activities at the same time. They have to make sure that information of accounts payable is up-to-date in terms of invoices received, invoices awaited, and payment made. Finally, management of other accounts is also necessary. These include accrued expenses and prepaid expenses. For accrued expenses, it is necessary to have timely plan to ensure the liabilities are paid on time. Because of inter-relation among these accounts, they cannot be viewed separately. Effective management of all these accounts of working capital can have powerful influence on the success or failure of a business Profitability and liquidity Profitability. The ability of a business to earn income is called profitability. This ability depends on the effectiveness and efficiency of its operation as well as the resources available to it (Warren and Reeve, 2006). Ross, Westerfield, & Jordan (2010) discussed the three measures as the best known and most widely used of all financial ratios as follow: Profit margin. Profit margin = Net income Sales 14

25 Return on assets (ROA). ROA = Net income Total assets Return on equity (ROE). This is a measure of how the stockholders fared during the year ROE = Net income Total equity Liquidity. Liquidity refers to the speed and ease with which an asset can be converted into cash. Liquidity has two dimensions: ease of conversion versus loss of value. A highly liquid asset is one that can be quickly sold without significant loss of value. In contrast, an illiquid asset is one that cannot be converted into cash quickly without a substantial price reduction. Currents assets are relatively liquid and include cash and assets that are expected to be converted into cash over the next 12 months. Liquidity is valuable. The more liquid a business is, the less likely it is to experience financial distress. However, liquid assets are less profitable to hold, thus, there is a tradeoff between the advantages of liquidity and potential profits (Ross et al., 2010). Liquidity can be measured by current ratio or quick ratio Relationship between profitability and liquidity. The primary goal of any firm is to increase shareholders value, in other words, to maximize its profit. A firm wants to profitable; it should also be liquid at the same time (Sharma, 2009). Managers have to strike a balance between profitability and liquidity (Eljelly, 2004). Liquidity means the firm has to have adequate cash to pay its bill, also, firm has to reserve cash for unexpected problems or emergencies. Meanwhile, profitability requires firm should be utilized as to yield the highest return. As a result, liquidity and profitability are conflicted terms and have negative relationship with each other Relationship between working capital and profitability. Sagner (2010) believed that any change to working capital components directly impacts profit. Too 15

26 much working capital denotes idle funds that will earn no profit. First, high level of inventory will demand more costs, but low level of inventory can be not enough to supply when necessary; in that case, firms have to resort to external borrowing with high costs. In addition, too much inventory can be dangerous for firms when products price decrease in the market. Second, lack of funds resulting from late collecting of debts may bring inefficiency to the operating as well as investments activities of firms. These activities will affect firms profitability directly. The reasons above have shown that there is a relationship between working capital and profitability. The next part will examine how previous studies have proved that this relationship had been existed. 2.2 Review of empirical studies This section will review previous studies that relate to impact of working capital on firms profitability. Many studies about this issue in different environments have been conducted, which can be divided into two groups: group of developing nations, and group of developed nations. The main difference between these two groups is the sample size. Researchers of developing-nation group tended to chose small sample while those who are from developed-nation group chose larger sample. Because of the different level of economy, developed nations may have more listed companies in stock exchange than developing nations. In fact, large sample can help the researchers obtain more accurate results. In this case, despite the difference in sample size between two groups, results of finding show a relationship between working capital and profitability Developing-nation group. The majority research found out that there was a negative relationship between working capital and profitability. However, there are some differences between results of these findings. 16

27 Raheman and Nasr (2007) conducted a research with a sample of 94 Pakistani firms listed in Karachi Stock Exchange (KSE) for periods to study the effects of different variables of working capital management (average collection period, inventories turnover in days, average payment period) on net operating profit. The results showed that there was a negative relationship between variables of working capital management and profitability. Also, they claimed that the size of the firm and profitability had positive relationship. For the same context of Pakistani firms listed in KSE, Afza and Nazir (2009) attempted to investigate the relationship between working capital management policies and corporate profitability. With a sample of 204 nonfinancial firms from 1998 to 2005, using panel data regression models and return on assets as well as Tobin s Q as measurements of profitability, they found a negative relationship between profitability and aggressiveness degree of working capital investment and financing policies across different industries. In the context of a country from Africa, Falope and Alijore (2009) used a sample of 50 non-financial firms listed in Nigerian Stock Exchange from 1996 to They found a significant negative relationship between net operating profitability and cash conversion cycle and its components. Nevertheless, the study showed that there were no significant variations in the impact of working capital management between large and small firms. Mathuva (2009) tested the effects of working capital on corporate profitability in Kenya, with the focus on 30 listed firms of Nairobi Stock Exchange. Besides Pearson and Spearman s correlations, the author used the fixed effect regression models to conduct his study. Mathuva found that there was a significant negative relationship between average collection period and profitability; whereas there was positive relationship between profitability and inventories conversion period and average payment period. 17

28 From the viewpoint of India, Sharma and Kumar (2011) examined the effect of working capital on profitability of 263 non-financial firms listed in Bombay Stock Exchange from 2000 to Using Ordinary Least Square multiple regression, the study showed some similarity and differences with other studies in the past. First, profitability had a significant negative relationship with number of days accounts payable and number of days of inventories. Second, number of days of accounts receivable and profitability had a positive relationship with each other. Third, there was a positive relationship between working capital management (measured by cash conversion cycle) and profitability of Indian firms, which meant, shortening of cash conversion cycle would negatively affect Indian corporate profitability. The main differences between Sharma and Kumar (2011) s study and other studies was the positive relationship between days of accounts receivable and profitability; and the positive relationship between cash conversion cycle and profitability. To explain for these differences, they used the specific situations of firms as well as economic environment of India. Also from India, Ghosh and Maji (2003) made an attempt to examine the efficiency of working capital management of the Indian cement companies during to In order to measure the efficiency of working capital management, they used performance index, utilization index, and overall efficiency index. They tested the speed of achieving target efficiency level of individual firms (from which industry norms set as) during this period. Findings showed that some of the sample firms had successfully improved their efficiency during these years. For a sample of 72 small-to medium sized enterprises (SMEs) in Turkey, Karadagli (2012) conducted a study about effect of working capital on profitability of Turkish SMEs. Despite using the same measure for working capital with other previous studies (cash conversion cycle), the main difference between this study with other previous studies on this issue is that Karadagli (2012) used one more proxy for estimating working capital: net trade cycle. Karadagli also examined whether managers could use 18

29 net trade cycle instead of cash conversion cycle to measure working capital. The author concluded that an increase in cash conversion cycle and net trade cycle would improve firm performance in terms of operating income and stock market return for Turkish SMEs, meanwhile, for bigger companies, a decrease in cash conversion cycle and net trade cycle would enhance profitability. Moreover, the author suggested managers could use net trade cycle instead of cash conversion cycle confidentially Developed-nation group. Studies about relationship between working capital and firm s profitability have been conducted in some developed nations in Europe and America such as Belgium, Finland, Cyprus, Greece, the United States of America, etc. In order to test the relationship between working capital management and corporate profitability, Deloof (2003) conducted a study using a sample of 1,009 large Belgium non-financial firms from 1992 to He measured profitability by gross operating income and working capital by cash conversion cycle. Using Pearson correlation and regression tests, he found that there was negative relation between gross operating income and each component of cash conversion cycle. Based on those results, he suggested that managers can reduce number of days accounts receivable and inventories to increase corporate profitability. Shin and Soenen (1998) investigated the relationship between net-trade cycle (which was used to measure the efficiency of working capital management) and corporate profitability. Basically, net-trade cycle is equal to cash conversion cycle but a difference between net trade cycle and cash conversion cycle is all three components are shown as percentage of sales. With a sample of 58,985 firms in America from 1975 to 1994, they found a negative relationship between the length of firms net-trade cycle and their profitability, using correlation and regression with industry and working capital intensity. 19

30 Therefore, according to Shin and Soenen (1998), in order to create shareholders value, firms net-trade cycle must be reduced. Lazaridis and Tryfonidis (2006) conducted a cross sectional study of the relationship between working capital management and corporate profitability with a sample of 131 companies listed in Athens Stock Exchange for the period of They found significant relationship between profitability (which was measure by gross operating profit) and cash conversion cycle and its components. With the results of finding, they claimed that managers should handle the cash conversion cycle correctly and keep each different of its component to an optimum value to create value for shareholders. In order to extend the findings of Lazaridis and Tryfonidis (2006) regarding the relationship between working capital and corporate profitability, for the context of America, Gill, Biger, and Mathur (2010) conducted a study of 88 firms listed in New York Stock Exchange from 2005 to They found out that there existed a negative relationship between average days of accounts receivable and profitability measured by gross operating profit. This result was consistent with the findings of Lazaridis and Tryfonidis (2006). However, the main thing that made this study differ from Lazaridis and Tryfonidis (2006) s as well as most studies was the positive relationship between cash conversion cycle and gross operating profit. From this result, they suggest that firms can decrease accounts receivable to reduce the cash gap in cash conversion cycle. Charitou, Elfani, and Lois (2010) hypothesized that working capital management lead to improved profitability. To provide empirical evidence for the hypotheses, they used a data set consisted of 43 non-financial firms listed in the Cyprus Stock Exchange (CSE) from 1998 to Cyprus was as an emerging market of Europe, where CSE considered one of the most volatile exchanges worldwide. By applying 20

31 multivariate regression analysis, they proved that cash conversion cycle and its components were associated with corporate profitability. Another study about this issue was conducted by Garcia-Teruel and Martinez- Solano (2007), using a panel of 8,872 SMEs in Spain from 1996 to Using panel data methodology, they tested the effects of working capital management on SME profitability. Instead of measuring profitability by gross operating income like other studies, they used return on assets as a proxy for measuring profitability. They found that there were significant negative relationship between SME s profitability and the numbers of days of accounts receivable and numbers of days of inventory. The results of the study confirmed that working capital played an important role in value generation of SMEs. They also suggested that managers can create value for firms by reducing cash conversion cycle as minimum level. 2.3 Conclusions Theoretically, working capital and profitability are inter-related. In reality, the majority of empirical studies have proved that there is a relationship between working capital and firms profitability. Although some researchers used different proxies for measuring profitability (Deloof (2003), Gill et al. (2010), Alipour (2011), Lazaridis and Tryfonidis (2006) used Gross operating profit, whereas Garcia-Teruel and Martinez- Solano (2007), Charitou et al. (2010), Sharma and Kumar (2011) used Return on asset; Raheman and Nasr (2007) and Falope and Alijore (2009) used net operating profit), most of the researchers found a relationship between working capital and profitability. Following these previous studies, this study will investigate the relationship between working capital and firms profitability for the context of Construction and Building material sector in Vietnam. 21

32 2.4 Construction and Building-material sector in Vietnam Construction and Building-material sector of Vietnam is an important sector, which contributes 10.3% to GDP (in 2010) ( Every year, there are more than 10,000 of construction projects that are under construction, many of them are core projects of Vietnam. This helps contribute to development of infrastructure, economic, and society of the country. According to Industry Classification Benchmark (ICB), Construction and Building material sector belongs to Industrials group. This sector consists of firms that manufacture building material (cement, steel, brick, etc.) and firms that build construction. In 2010, Vietnam has about 36,000 enterprises in this sector, with 1.38 million employees. 0.5% 1.6% 97.9% State Owned Private Owned FDI Figure 2: Type of ownership of companies in Construction and Building material sector in Vietnam The number of 36,000 enterprises consists of 1.6% State Owned enterprises (576 enterprises), 97.9% (35,244 enterprises) owned by Private and 0.5% (1,800 enterprises) FDI. 22

33 There are two main reasons for the development and the importance of this sector towards Vietnam. First, Vietnam is a developing country; therefore, Vietnam has a high demand in building schools, hospitals, houses, factories, etc. as well as maintaining roads, bridges, ports, etc. Second, Vietnam has many mineral resources that can be used as raw material for manufacture. In order to reduce transporting cost, firms that manufacture building material are often placed their factories near the resources. In recent years, frozen of real estates in Vietnam has caused some difficulties for firms in this sector. Besides, the increase in the price of raw materials, fuels, electricity is also a reason for declining of profit of these firms. Nevertheless, the severe competition between domestic products and foreign products has made firms in this sector facing difficulties than ever. However, firms can totally overcome these difficulties if they have short-term as well as long-term strategies to ensure sustainability. Firms can look for ways to have their products consumed, to reduce inventory and to save costs. From that reducing products selling price. In addition, the Government also has some policies that help these firms survive by reducing VAT input and output, reducing lending rates, reducing importing of building material, etc. Despites the frozen real estates, some firms in Construction and Building material sector are not affected much. Some manufacturing firms try to focus on highstandard market with new materials, or environmental friendly materials. Other construction firms and manufacturing firms try to focus on small constructions such as residents houses, or houses for low-income employees. For firms in this sector, it is necessary to have adequate strategies to maintain working capital in ways that firms can generate profit. Unlike firms in Foods and Beverages sector or Pharmaceutics sector, firms that manufacture building material tend to extend payment period for their customers. In Vietnam, 23

34 people often have their constructions built first, after finishing the constructions; they will pay for construction firms and material firms. Because of this, firms in this sector tend to increase credit period to their customers. Also, building materials have longer expiry dates; therefore, firms will have longer days of inventory than other manufacturing firms. 24

35 CHAPTER III RESEARCH DESIGN AND METHODOLOGY This chapter will present theoretical framework of the study, from that, research methodology will be designed and applied to answer the research questions and to achieve research objectives. 3.1 Theoretical framework Cavana, Delahaye, and Sekeran (2011) defined the theoretical framework as the foundation that the research based on. Theoretical framework elaborates the relationship among variables, explains the theory underlying these relations, and describes the nature and direction of the relationship. After having enough foundation from literature review, theoretical framework will provide logical base for developing hypotheses The variables. Following the study of Garcia-Teruel and Martinez-Solano (2007), this study will measure the firms profitability by Returns on assets (ROA). Padachi (2006) believed that ROA is a better measure of profitability since it relates the profitability of the company to the asset base. Besides, ROA is not affected by whether the assets are financed primarily by creditors or stockholders (Warren and Reeve, 2006). ROA is considered as a dependent variable. 25

36 In order to measure working capital, Cash conversion cycle (CCC) and its components: Average collection period (ACP), Inventory turnover in days (ITID), and Average payment period (APP) will be used as they have been used in many previous studies. Most of researchers have used CCC as they evaluated it a useful tool for measuring working capital: Deloof (2003), Garcia-Teruel and Martinez-Solano (2007), Sharma and Kumar (2011), Enqvist et al. (2012), etc. CCC and its components will be independent variables. Besides independent variables and dependent variable, it is necessary to take some control variables into account. In this study, control variables include other factors that can affect profitability. They are company size and sales growth. Company size is the natural logarithm of sales; sales growth is calculated by taking this year s sales minus previous year s sales and divided by previous year s sales (Deloof, 2003). Naturally, company which has more sales will have more profitability. Another control variable that should be taken into account is debt ratio, which is also known as leverage. Leverage refers to the extent to which a firm relies on debt. The more debt financing a firm uses in its capital structure, the less profitability firm has. Therefore, debt ratio can have impact on profitability as well. The variables used for the study are listed in the table below 26

37 Table 2: Variables and their calculations Type of variable Name of variable Abbreviation Calculation Dependent Return on Assets ROA Average collection period ACP Net income Total assets Accounts receivable x 365 Sales Independent Inventory turnover in days Average payment period Cash conversion cycle ITID APP CCC Inventories x 365 Cost of goods sold Accounts payable x 365 Purcases ACP + ITID - APP Firm s size SZ Ln(Sales) Control Sales growth GRW Sales t Sales t 1 Sales t 1 Debt ratio DR Total liabilities Total Assets Models and hypotheses. Having all the required variables and following previous studies, especially those of Deloof (2003) and Garcia-Teruel and Martinez- Solano (2007), the research models and hypotheses are developed with descriptions as follow: 27

38 Hypothesis 1 Hypothesis 2 ACP Negative ROA ITID Negative ROA Hypothesis 3 APP Negative ROA Hypothesis 4 CCC Negative ROA Figure 3: Research Models (The control variables are not appeared in the models because the researcher wants to keep the models simple, control variables will be added in regression equations.) Hypothesis 1: There is a significant negative relationship between ACP and ROA. ROA it =β 0 + β 1 (ACP it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it Hypothesis 2: There is a significant negative relationship between ITID and ROA. ROA it =β 0 + β 1 (ITID it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it Hypothesis 3: There is a significant negative relationship between APP and ROA. ROA it =β 0 + β 1 (APP it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε i Hypothesis 4: There is a significant negative relationship between working capital that is measured by CCC and ROA. 28

39 ROA it =β 0 + β 1 (CCC it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it In which: β 1, β 4 : Regression model coefficient β 0 : a constant, the value of dependent variable when all values of independent and control variables are zero. ε: the error term, normally distributed about the mean of 0. (For the purposes of computation, the ε is assumed to be 0.) it: Firm i at time t ɳ i : (unobservable heterogeneity) measure particular characteristics of each firm 3.2 Research Methodology Research Design. This study will employ quantitative approach, where hypotheses are built up based on theoretical framework and data is collected to test the hypotheses. According to Cooper and Schindler (2006), quantitative approach usually measures consumer behavior, knowledge, opinions, or attitudes. Quantitative approach is often used theory testing, requiring that the researcher maintain a distance from the research so as not to bias the results. The study will focus only on Construction and Building-material sector of Vietnam for the period in order to examine the impact of working capital on firms profitability. The researcher uses panel data methodology since the data consists of both time-series and cross-sectional dimensions. Using panel data methodology will help the researcher identifies and measures effects that are simply not detectable in pure timeseries data or pure cross-sections data. Besides, in panel data methodology, many variables will be measure accurately at micro level and biases from aggregation over firms are eliminated (Brooks, 2008). 29

40 This is a causal study in which causal relationship between working capital management and firms profitability is investigated. In this study, the firms profitability is the effect and the cause is working capital. Four models will be tested to support the hypotheses, from which conclusions and recommendations will be drawn Sampling design Target Population. In this study, the target population is 197 companies in Construction and Building-material sector of Vietnam that listed in HNX and HOSE. The listed companies are classified into Construction and Building-material sector by Industry Classification Benchmark (ICB). The list of companies is achieved from the Website of VNDIRECT Securities Company. ( Construction and Building-material sector includes firms that manufacture building materials and firms that perform construction or building services. The study focuses on some specific characteristics of manufacturing firms such as inventory (for manufacturing firms, the process of transferring raw materials into finished goods is longer than other firms), accounts payable, accounts receivable (these types of accounts are also different between different types of firms). Therefore, to obtain the purpose of this study, only firms that manufacture building materials are chosen is a tough year for Construction and Building-material sector, since real estates is facing many difficulties and becoming frozen. Real estate has a direct relationship with Construction and Building material sector. Firms that manufacture building materials are suppliers for firms that build constructions, and firms that build constructions are the one that perform building services for firms in real estates. When real estates become frozen, firms in Construction and Building material sectors will be affected. When choosing the period 2009 to 2011, the researcher wants to investigate with the nearest period to obtain accuracy of the situation. Because of difficulties that 30

41 firms in this sector faced in 2012, the researcher will not include the year 2012 in the study Sample. Totally, there are 197 firms from Construction and Building material sector that listed in HNX and HOSE. 197 firms consist of 67 firms that manufacture building material and 130 firms that perform construction or building services. As mentioned above, only 67 firms that manufacture building material are chosen for the study. However, because some firms do not have enough necessary audited financial reports, these firms will be excluded. Finally, only 50 firms that have enough requiring information for the study; therefore, the sample consists of 50 firms for 3 year from 2009 to There are 150 observations in total Data Collection. From the annual audited financial report of each chosen company, the necessary data is obtained. These include the data that used for calculating variables: Accounts Receivable, Sales, Inventory, Cost of goods sold, Accounts Payable, Total Debt, Total Liabilities, Total Assets, and Net Income. After taking the amount of the data, it is recorded in a spreadsheet Data Analysis. After collecting enough data, it will be analyze by Eviews software following these procedures: Descriptive Statistics. This process will help transforming raw data into a form to provide information that describes a set of factors in a situation. This step provides frequencies, measure of central tendency and dispersion Correlation Test. This study will apply Pearson s Product Moment Coefficient r to help indentify the magnitude and direction of relationship. The coefficient r symbolizes its estimates of linear association based on sampling data. The magnitude is the degree to which variables move in unison or opposition. The 31

42 coefficient s sign signifies the direction of the relationship, whether it is a positive, a negative, or a neutral relationship (Cooper and Schindler, 2006) Multiple Linear Regression Analysis. This step is to examine the relationship among variables, especially the relationship between a dependent variable and one or more independent variables. The study will apply multiple linear regression analysis to investigate the relationship between ROA and ACP, ITID, APP, and CCC. For multiple linear regression analysis, it is necessary to make some assumptions so as to obtain the accuracy when testing the models. Assumptions will be discussed later on Chapter IV. 32

43 CHAPTER IV DATA ANALYSIS AND DISCUSSIONS This chapter will provide empirical evidence to support the hypotheses as well as how the hypotheses consistent with theories and previous studies results. After removing the outliers which may affect the results, the sample of 50 companies now has 43 companies within 3 years (from 2009 to 2011) with 129 observations in total. 4.1 Descriptive Statistics This process will help transforming raw data into a form to provide information that describes a set of factors in a situation. This step provides frequencies, measure of central tendency and dispersion. Table 3: Descriptive Statistics ROA ACP ITID APP CCC DR GRW SZ Mean Median Maximum Minimum Std. Dev (Source: Eviews output) 33

44 Based on the results, it can be seen that the mean of ROA is around 6.7%, and it has a high standard deviation of 6.1%. Different profitability of each firm is the cause of ROA s high standard deviation. On average, the average collection period is around 85 days, the average payment period is 53 days, and number of days of inventory turnover is 102. Combining these three elements, the average cash conversion cycle is about 134 days. The debt ratio fluctuates in a small range, from to 0.875, and the standard deviation is The average of firm s growth rate is with a high standard deviation (0.457). This growth rate depends on firm s sales of current year and firm s previous sales. Therefore, difference in purchasing activities is the cause of high standard deviation. Lastly, the average of firm s size is around and the standard deviation is Correlation This study will apply Pearson s Product Moment Coefficient r in order to help indentify the magnitude and direction of relationship. Considering three-year period jointly, results from the correlation table show that ACP and APP have significant negative relationships with ROA. These relationships are presented at significant level (pvalue < 0.01). Although these relationships are not quite strong (r = -0.19, r = respectively), they are consistent with hypothesis 1 and 3. 34

45 Table 4: Correlation 35

46 Considering the relationships among independent variables, there exist relationships between CCC and ACP (nearly 0.64) and ITID (nearly 0.85), or between DR and SZ (around 0.44). This problem may be caused by multicollinearity. Therefore, further calculations relating to this problem must be taken into account. 4.3 Multiple Linear Regressions Assumptions Heterokedasticity. Heterokedasticity happens in panel data when there is a change in variation in a short period. In order to avoid heterokedasticity, the researcher will employ Generalized Least Square (GLS) with cross section weights Cross section weight. For GLS regression with cross section weights, the common intercept was calculated for all variables and assigned a weight (Gill et al., 2010). A weighted least square will be obtained by first dividing the weight series by its mean, and then multiplying all of the data for each observation by the scaled weight series. The scaling of the weight series is a normalization. It has no effect on the parameter results, but it makes the weighted residuals more comparable to the unweighted residuals Hausman Tests for correlated random effect. In panel data methodology, researchers have to determine whether there is fixed effect or random effect in the models. Results from Hausman Test show that the null hypothesis (H0: there are random effects of the cross sections) is rejected at p-value less significance value of (Results of Hausman Test for correlated random effect can be seen on Appendices). Hence, the multiple regressions for four models will apply fixed effects for cross section. This study will not focus on the changes of variables through time dimension, therefore, for time period, there will be no effect Multicollinearity with Variance Inflation Factor (VIF). In multiple regression, multicollinearity occurs when the independent variables are correlated with 36

47 each other. In order to measure the ill effect of multicollinearity, Variance Inflation Factor (VIF) is calculated as follow: VIF(X h ) = 1 1 R 2 2 Where R is the R 2 value obtained for the regression of X, as dependent variable, on other X variables on the original equation aimed at predicting Y. When the VIF is greater than 5, there are some degree of multicollinearity exists with respect to the variables (Aczel and Sounderpandian, 2009). In another way, when the VIF is lower than 5, there is no multicollinearity. results. The results of VIF for each regression are shown together with the regression Autocorrelation. An autocorrelation is a correlation of the values of a variable with values of the same variable lagged one or more time periods back. In order to detect if there exists autocorrelation (that is, regression errors are uncorrelated any lag), Durbin-Watson test is applied. The Durbin-Watson test will provide evidence of the existence of a first-order autocorrelation (Aczel and Sounderpandian, 2009). As a rule of thumb, any Durbin-Watson statistics that lower than 2 show positive serial autocorrelation. An ideal value of Durbin-Watson statistics is 2, which means errors are not correlated. Besides, any values that fluctuate from 1.75 to 2.5 are acceptable Multiple linear regression results Result of the hypothesis1 Hypothesis 1: There is a significant negative relationship between ACP and ROA H1: ROA it =β 0 + β 1 (ACP it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it 37

48 ROA ACP Figure 4: Relationship between ACP and ROA From the figure, it can be seen that ACP and ROA have a negative relationship. When ACP increases, ROA will decrease. This is appropriate with the correlation result. However, the figure merely estimates the relationship between ACP and ROA without considering other factors that can affect ROA. Therefore, it is necessary to estimate the result of multiple regression to obtain the accuracy of the model. 38

49 Table 5: Regression result of hypothesis 1 ROA = E-05*ACP *DR *GRW *SZ + [CX=F] Variable Coefficient Std. Error t-statistic Prob. VIF C ACP 5.01E E DR GRW SZ Weighted Statistics R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Sum squared resid F-statistic Durbin-Watson stat Prob(F-statistic) (Source: Eviews output) Results from the test show that there is a relationship between ACP and ROA at p-value of 0.02, which is less than significance level of However, the coefficient term of ACP is 5.01E-0.5, which mean the relationship between ACP and ROA is positive. An increase of ACP in one day will increase the ROA by 0.005%. This result contradicts to the predictions and result of correlation. Naturally, the sooner firms collected debt from their buyers, the fewer amounts in accounts receivable, and the easier firms can afford their debts or investments. Average collection period and profitability in this result show a positive relationship, which differs from theory and previous studies. It 39

50 can be implied that managers of these firms can increase their firms value by increasing credit period granted for customers. DR and SZ have a negative significant relationship with ROA, whereas GRW presents a positive relationship with ROA. As DR decreases, ROA will increase. This result is appropriate with the theory that the less money blocked in current assets, the more profitability firms get. Also, as GRW measured by current year s sales and previous year s sales, it can be seen that any firms with high growth rate find it easier to generate profit. R-square is around 0.91, which means that 91% of the variation in ROA is explained by the combination of an independent variable (ACP) and three control variables (DR, GRW, and SZ). The adjusted R-square (0.94) is closed to the unadjusted measure. It can be concluded that the regression model fits the data very well. All of the VIFs in this regression are lower than 5, which mean there is not multicollinearity. Durbin-Watson statistics is about 2.64; hence, autocorrelation problem does not exist Results of the hypothesis2 Hypothesis 2: There is a significant negative relationship between ITID and ROA H2: ROA it =β 0 + β 1 (ITID it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it 40

51 ROA ITID Figure 5: Relationship between ITID and ROA The figure presents the negative relationship between ITID and ROA. When ITID increases, ROA will decrease. 41

52 Table 6: Regression result for hypothesis 2 ROA = E-05*ITID *DR *GRW *SZ + [CX=F] Variable Coefficient Std. Error t-statistic Prob. VIF C ITID -7.67E E DR GRW SZ Weighted Statistics R-squared Mean dependent var Adjusted R- squared S.D. dependent var S.E. of regression Sum squared resid F-statistic Durbin-Watson stat Prob(F-statistic) (Source: Eviews output) From the regression analysis above, it can be seen that there exists a relationship between ITID and ROA. Since the p-value less than significance level (0.00 < 0.05) and the coefficient of ITID is -7.67E-05, it can be concluded that there exists a significant negative relationship between ITID and ROA. When ITID increases by one day, ROA will decrease %. This result is consistent with the hypothesis 2. Furthermore, DR presents a negative relationship whereas GRW presents a significant relationship with ROA. 42

53 ROA Since ITID has a significant negative relationship with ROA, managers of firms that are being studied can increase firms profit by shortening the days of inventory turnover. R-square is around 0.966, implying that 96.6% of the variation of ROA is explained by ITID, DR, GRW, and SZ. Again, VIFs for this regression are lower than 5 and Durbin-Watson statistics is higher than 2, indicating that there are not multicollinearity as well as autocorrelation Results of the hypothesis3 Hypothesis 3: There is a significant negative relationship between APP and ROA H3: ROA it =β 0 + β 1 (APP it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε i APP Figure 6: Relationship between APP and ROA The figure illustrates a negative relationship between APP and ROA. As APP gets higher, ROA will be lower. 43

54 Table 7: Regression result of hypothesis 3 ROA = *APP *DR *GRW *SZ + [CX=F] Variable Coefficient Std. Error t-statistic Prob. VIF C APP E DR GRW SZ Weighted Statistics R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Sum squared resid F-statistic Durbin-Watson stat Prob(F-statistic) (Source: Eviews output) Regression result shows that p-value of t-test for APP is , which is less than significance level of 0.05, implies the APP and ROA have a relationship with each other. The negative sign of the coefficient ( ) confirms the negative relationship between APP and ROA. When APP increases by one day, ROA will decrease by 0.029%. Also, like the results from the first and the second multiple regression, DR shows a significant negative relationship whereas GRW shows a significant positive relationship with ROA. VIFs calculated for this regression is lower than 5, showing the absence of multicollinearity. Also, the Durbin-Watson statistics is 2.69, indicating no positive 44

55 ROA autocorrelation. Lastly, R-square is which can explain that 95.5% of the variation of ROA is affected by the combination of ACP, DR, GRW, and SZ. Result from this regression is appropriate with hypothesis 3. From this result, it can be understood that the more days that firms delay to pay to their suppliers, the less profitability firms have Results of the hypothesis 4 Hypothesis 4: There is a significant negative relation between CCC and ROA H4: ROA it =β 0 + β 1 (CCC it ) + β 2 (SZ it ) + β 3 (GRW it ) + β 4 (DR it ) + ɳ i + ε it CCC Figure 7: Relationship between CCC and ROA ROA The figure shows a negative relationship between CCC and ROA. However, this relationship is not strong since the slope of the regression line is small. 45

56 Table 8: Regression result of hypothesis 4 ROA = E-05*CCC *DR *GRW *SZ + [CX=F] Variable Coefficient Std. Error t-statistic Prob. VIF C CCC -1.33E E DR GRW SZ Weighted Statistics R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Sum squared resid F-statistic Durbin-Watson stat Prob(F-statistic) (Soure: Eviews output) In order to test the relationship between working capital and profitability, the independent variable used for this regression is CCC, which will measure working capital as a whole. Together with other control variables (DR, GRW, and SZ), regression result shows that CCC has a negative impact on ROA (the coefficient is -1.33E-05). However, this relationship is not significant because the p-value is higher than significance level of 0.05 (0.605>0.05). The VIFs and Durbin-Watson statistic show that there are no multicollinearity as well as autocorrelation. As mentioned earlier, CCC is equal to ACP plus ITID and subtracts APP. ACP has a positive relationship with ROA, whereas ITID and APP have negative 46

57 relationship with ROA. Because APP is subtracted when calculating CCC, it cannot be inferred that when APP has a negative relationship with ROA, CCC will have negative relationship with ROA, too. Comparing the absolute value of the coefficient of ACP and ITID, it can be seen that ITID has greater coefficient than ACP s (7.67E-05 > 5.01E-05), therefore, ITID will have greater impact on ROA rather than ACP. From that, when ITID has a negative relationship with ROA, it can be inferred that CCC will have a negative relationship with ROA. Besides, results from this test show a significant negative relationship between DR and ROA, and a significant positive relationship between GRW and ROA; which are consistent with the results from three tests above Discussions of the results. From the regression results, it is necessary to have discussions to see how good the results are in Vietnam context as well as to perform comparisons between the results from these findings with other previous studies. First, there exist a significant positive relationship between ACP and ROA. This result, however, is in contrast with theory. As firms can collect their debts soon, they will have more money on hands, which will help firms maintain their operating activities or enhance investment activities. Nevertheless, this result is different from those of previous studies. Deloof (2003), Mathuva (2009), Raheman and Nasr (2007), Garcia- Teruel and Martinez-Solano (2007) have proved that there is a significant negative relationship between ACP and ROA. Despites those differences, result of this finding shows a similarity with result of Sharma and Kumar (2011). In Vietnam, thanks to the Doi Moi Policy, more and more companies from foreign countries decided to invest into Vietnam as this is an interesting new market. Competitions between domestic firms and foreign firms are tough than ever; they happen in most of industry sectors of Vietnam such as Foods and Beverages, Pharmaceutics, Consuming Goods, etc. And Construction and building material sector is not an exception. According to a report from Steel subset, the world s steel price is reduced rapidly, around 100 USD per ton. Moreover, steel that 47

58 produced in China has very low price and it still reduced at 15% to 20%. This makes domestic steel producers face a lot of difficulties when cheaper price of Chinese steel attracts more customers. Therefore, to sustain in this market as well as to respond to this competition, steel producers in Vietnam have to grant longer credit to their customers. In order to increase profitability, managers in these firms must increase credit period to customers. Second, for the context of construction and building material sector of Vietnam, ITID has a significant negative impact on ROA. This result is consistent with the theory that the longer inventories stored in warehouses, the more expenses firms have to bear such as insurance expense, storage costs, property taxes and other related expenses. These expenses will reduce funds that can be used elsewhere to improve operations; hence improve profitability. In addition, too many inventories also increase the risk of losses since the price declines or obsolescence of the inventory. Comparably, the result in this finding is similar to other previous findings of some researchers such as Deloof (2003), Raheman and Nasr (2007), Garcia-Teruel and Martinez-Solano (2007), Falope and Alijore (2009), etc. Overall, most of researchers who study the relationship between ITID and profitability (measured by ROA, Gross Operating Profit) proved that there exists a significant negative relationship between these two variables. Because of the difficulties of purchasing building materials, firms in Construction and building material sector of Vietnam have to find the best solution the obtain sustainability. For SMC Joint Stock Company, keeping inventories at an adequate amount is one of the strategies to maintain and increase profit ( For SMC as well as other companies that producing steel, keeping an appropriate amount of inventory will reduce the risk of losing when steel s price declined. Tao Nguyen from Vicem Hoang Thach Company confirmed that the profitability of the company is not much affected by frozen real estate. Currently, there is not inventory being kept and purchasing activity is doing fine. In contrasts, for some firms, they are facing troubles because of 48

59 producing too much products but the products cannot be sold, that leads to high inventory being kept. Furthermore, these firms do not focus on improving technology or reducing selling price, which make it hard to sell the products in the competitive market when products from foreign countries, especially China, are imported to Vietnam with very low price. Third, there exist a significant negative relationship between APP and ROA. This result is appropriate with the theory as well as some previous studies. Profitability depends on the number of days firms need to pay their suppliers. As a matter of fact, any firms that have more profitability would pay their creditors sooner than those have less profitability. Padachi (2006) believed that when profitability decreases, less cash will be generated from operations, and by delaying payment to creditors, firms are able to survive. This negative relationship is consistent with Deloof (2003) s view that less profitability firms tend to wait longer to pay their bills. Other researchers also proved that there exist a negative relationship between APP and profitability such as Sharma and Kumar (2011), Falope and Alijore (2009), Enqvist et al. (2012). This happens not only for other contexts but also for Vietnam in general and for Construction and building material sector in specific. Generally, 2009 was still a tough year for Vietnam since it was impact by the inflation in 2008, firms would have low profitability. Overall, when comparing APP between 2009 and 2010 of some firms, more firms tend to have higher APP in 2009 and the lower in Firms delaying payment to creditors so as to get cash reserved for other activities. Finally, the fourth regression result specifies that there is a negative relationship between CCC and ROA. This result is consistent with the theory that the lower CCC, the higher profitability. Theoretically, it is suggested that shortening the CCC will add to the profitability of a company. Previous research also added empirical evidences to support the theory. Deloof (2003), Raheman and Nasr (2007), Falope and Alijore (2009), Lazaridis and Tryfonidis (2006), etc. found out that CCC had a significant negative relationship with corporate profitability. They suggested that in order to increase 49

60 firms value, CCC should be reduced at a minimum value so that profitability will increase. In contrast to this result, Gill et al. (2010) found out that CCC had a significant positive relationship with profitability measured by Gross Operating Profit. They concluded that firms should reduce the ACP in order to reduce the gap in CCC. Also, Sharma and Kumar (2011) found the same result with Gill et al. (2010). For the result of hypothesis 4 in this study, it is implied that firms can shorten CCC to increase profitability. 50

61 CHAPTER V CONCLUSIONS AND RECOMMENDATIONS This chapter will provide conclusions of the study, from those recommendations will be made. Also, this chapter includes limitations and suggestions for further research. 5.1 Conclusions Results from previous chapter have shown that there are some similarities as well as differences between the predicting models and the outcomes. These are presented in figure below: ACP (-) ACP (+) ITID (-) ROA ITID (-) ROA APP (-) APP (-) CCC (-) CCC (-) Predictions Outcomes Figure 8: Predicting Models and Outcomes 51

62 Results from ITID, APP, and CCC are consistent with the hypothesis 2, 3, and 4 respectively, that is these variables have significant negative relationship with ROA, except the case of CCC that the relationship is not significant. On the other hand, result from ACP is different from prediction that ACP has a significant positive relationship with ROA, not negative relationship as prediction. Results from the tests as well as the literature review have helped the researcher come up with the conclusion that working capital and its components has great impact on firms profitability, for the context of Construction and Building material sector of Vietnam. The negative relationship between each of ITID, APP, CCC and profitability found in the study are consistent with previous studies of some researchers such as Deloof (2003), Raheman and Nasr (2007), Falope and Alijore (2009). The positive relationship between ACP and ROA is similar from the result of Sharma and Kumar (2011). The study also adds to existing literature about the impact of working capital on firm s profitability. Working capital is an important part of corporate finance. Being managers of any firms, they have to understand how working capital has impact on firms profitability, from that they can find the best solutions to increase firms value. 5.2 Recommendations Based on the conclusions that provided, some recommendations are made to help managers of firms that are being studied increase firms profitability, from that firms can increase their value. For the purpose of reducing of Cash conversion cycle to increase profitability, managers can consider the following ways. First, managers can increase credit period to customers. Longer credit period granted to customers can help firms attract more customers and therefore increase firms profitability. 52

63 Second, keeping inventory at an adequate amount is also a way to help firms increase profitability. Keeping too much inventory will make firms afford more costs, but too little inventory may not be enough to supply when needed. Hence, managers must balance the level of inventory so that firms can obtain the optimum value. Third, managers can slower companies payments by delaying or making debts payment longer, from that there will be more cash reserved that can be used to enhance companies operating activities or other activities. 5.3 Limitations and suggestions for further research Although there are some significant findings, this study contains some limitations that may affect the outcomes. First, the sample is small, which may cause less reliability. Second, the researcher only focuses on one sector of industry of Vietnam (Construction and Building-material sector), hence, the results of findings are only applicable for this sector. Also, lack of literature review in Vietnam context may narrow the outputs of the study. Based on this study, further research should be conducted to help gain better understanding about the impact of working capital on firms profitability. Researchers in the future of the same topic may focus on two or more sectors of the economy and compare the results, or they can use different proxies to measure the variables. For example, researchers can use Gross Operating Profit as a measure of profitability. Moreover, further research can be conducted between small firms and large firms to see if there are any differences between working capital and profitability of small firms and large firms in the context of Vietnam as well as worldwide. 53

64 LIST OF REFERENCES Aczel, A. D., & Sounderpandian, J. Complete Business Statistics. 7 th Edition. New York, NY: McGraw-Hill/Irwin. Alipour, M. (2011). Working Capital Management and Corporate Profitability: Evidence from Iran. World Applied Sciences Journal, 12(7), Afza, T., & Nazir, M. (2009). Impact of Aggressive Working Capital Management Policy on Firms Profitability. The IUP Journal of Applied Finance, 15(8), Arnold, G. (2008). Corporate Financial Management. Location: Pearson education limited. Brooks, C. (2008). Introductory Econometrics for finance. 2 nd Cambridge University Press. Edition. Cambridge: Canava, R. Y., Delahaye, B. L., & Sekaran, U. (2001). Applied Business Research: Qualitative and Quantitative Methods. Australia: John Wiley & Son Australia, Ltd. Charitou, M. S., Elfani, M., & Lois. P. (2010). The Effect of Working Capital Management on Firm s Profitability: Empirical Evidence from An Emerging Market. Journal of Business & Economics Research, 8(12): Clayman, M. R., Fridson, M. S., & Troughton, G. H. (2012). Corporate Finance: A Practical Approach. 2 nd Edition. Hoboken, NJ, USA: Wiley. Cooper, D. R., & Schindler, P. S. (2006). Business Research Methods. 9 th Edition. New York, NY: McGraw-Hill/Irwin. Deloof, M. (2003). Does Working Capital Management affect Profitability of Belgian firms. Journal of Business, Finance and Accounting, 30,

65 Eljelly, A. (2004). Liquidity Profitability Tradeoff: An Empirical Investigation in An Emerging Market. International Journal of Commerce and Management, 14(2): Enqvist, J., Graham, M., & Nikkinen, J. (2012). The Impact of Working Capital Management on Firm Profitability in Different Business Cycles: Evidence from Finland. (Master dissertation). Retrieved from Social Science Research Network. ( ). Falope, O. I., & Alijore, O. T. (2009). Working Capital Management and Corporate Profitability: Evidence from panel data analysis of selected quoted companies in Nigeria. Research Journal of Business Management, 3, Garcia-Teruel, P. J., & Martinez-Solano, P. (2007). Effect of Working Capital Management on SME Profitability. International Journal of Managerial Finance, 3(2), Gill, A., Biger, N., & Mathur, N. (2010). The Relationship between Working Capital Management and Profitability: Evidence from the United States. Business and Econometrics Journal, 2010, pp Ghosh, S. K., & Maji, S. G. (2003). Working Capital Management Efficiency: A study of the Indian cement industry. Management and Accountant, 39(5), Gitman, L. J. (1999). Principles of managerial finance. 7 th Edition. New York, NY: Addison Wesley. Harris, A. (2005). Working Capital Management: Difficult, but Rewarding. Financial Executive, 21(4),

66 Huynh, P. D., & Su, J. (2010). The Relationship between Working Capital Management and Profitability: A Vietnam Case. International Research Journal of Finance and Economics, 49, Karadagli, E. C. (2012). The Effect of Working Capital Management on the Profitability of Turkish SMEs. British Journal of Economics, Finance and Management Sciences, 5(2): Lamberson, M. (1995). Changes of Working Capital of Small Firms in Relation to Changes in Economic Activity. Journal of Business, 10(2), Lazaridis, I., & Tryfonidis, D. (2006). Relationship between Working Capital Management and Profitability of listed companies in the Athens Stock Exchange. Journal of Financial Management and Analysis, 19(1), Mathuva, D. (2009). The Influence of Working Capital Management components on Corporate Profitability: A survey on Kenyan listed firms. Research Journal of Business Management, 3:1-11. Padachi, K. (2006). Trends in Working Capital Management and Its Impact on Firms Performance: An analysis of Mauritian small manufacturing firms. International Review of Business Research Paper, 2(2): Raheman, A., & Nasr, M. (2007). Working Capital Management and Profitability: A case of Pakistani firms. International Review of Business Research Paper, 3(1), Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2010). Fundamentals of Corporate Finance: Alternate Edition. 9 th Edition. New York, NY: McGraw-Hill/Irwin. Sagner, J. (2010). Essentials of Working Capital Management. Australia: John Wiley & Son Australia, Ltd. 56

67 Sharma, A. K., & Kumar, S. (2011). Effect of Working Capital Management on Firm Profitability: Empirical evidence from India. Global Business Review, 12(1), doi: / Sharma, D. (2009). Working Capital Management: A Conceptual Approach. Mumbai, IND: Global Media. Shin, H. H., & Soenen, L. (1998). Efficiency of Working Capital Management and Corporate Profitability. Financial Practice and Education, 8(2), Smith, K. V., Profitability and Liquidity tradeoff in Working Capital Management. Reading on the Management of working capital. New York, NY, St. Paul: West Publishing Company. Warren C. S., & Reeve, J. M. (2007). Financial and Managerial Accounting. 9 th Edition. New York, NY: McGraw-Hill/Irwin. Weston, J. F., & Brigham, E. F. (1977). Essentials of managerial finance. Illinois, IL: The Dryden Press. 57

68 APPENDIX RESULTS OF HAUSMAN TESTS FOR CORRELATED RANDOM EFFECT Hypothesis 1: Table 9: Result of Hausman test for hypothesis 1 Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob. Cross-section random (Source: Eviews output) Hypothesis 2: Table 10: Result of Hausman test for hypothesis 2 Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob. Cross-section random (Source: Eviews output) 58

69 Hypothesis 3: Table 11: Result of Hausman test for hypothesis 3 Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob. Cross-section random (Source: Eviews output) Hypothesis 4: Table 12: Result of Hausman test for hypothesis 4 Test Summary Chi-Sq. Statistic Chi-Sq. d.f. Prob. Cross-section random (Source: Eviews output) Since p-value of 4 tests are higher than significance level of 0.05 (0.6458, , , and 0.76 respectively), H0 is accepted (H0: There are not random effects). Therefore, the multiple regression will apply fixed effect in cross-section for four hypotheses. 59