Impact of Working Capital Management Practices on Firm Value

Transcription

1 Impact of Working Capital Management Practices on Firm Value Bandara R.M.S. Department of Accountancy Faculty of Commerce & Management Studies University of Kelaniya Sri Lanka. Weerakoon Banda Y.K. Department of Finance Faculty of Management Studies & Commerce University of Sri Jayewardenepura Sri Lanka. Abstract This research study investigated the impact of Working Capital Management Practices (WCMP) on firm value in Sri Lankan companies. Data were gathered from a sample of 74 companies listed in the Colombo Stock Exchange covering seven business sectors for period of 2005 to Firms Aggressive Working Capital Management Practice (AWCMP), Moderative Working Capital Management Practice (MWCMP) and Conservative Working Capital Management Practice (CWCMP) were used as independent variables. Firm value measured in terms of Market Value Added (MVA) and Economic value Added (EVA) was employed as dependent variable in the study. The panel regression analysis was employed. The results indicate that there is a statistically significant negative relationship between CWCMP and MVA and it further explains the firms that follow MWCMP yield higher MVA than the firms with CWCMP. Similarly, it indicates that there is a significant negative relationship between AWCMP and EVA, providing further evidence that the firms with AWCMP generate lower EVA than that of the firms with MWCM. Accordingly, the results conclude that the firms following MWCMP improved both MVA and EVA of the firms in Sri Lanka. 1

2 Key wards: Working Capital Management Practice, Firm Value, Economic Value Added, Market Value Added, Sri Lanka Introduction Corporate financial officers identify Working Capital Management (WCM) 1 as being important to their firms value. Management of short-term assets and liabilities needs a careful attention since the WCM plays an important role in the determination of the profitability, liquidity and risk as well as the ultimate objective of firm s value 2 (Smith, 1980). The greater the investment in current assets leads to the lower risk in terms of settling short term obligation, while gaining lower profitability because of the inability to invest in the profitable long-term investments. Efficient management of working capital is a fundamental part of the overall corporate strategy to create the shareholders value. The main objective of WCM is to maintain an optimal balance between each of the working capital component. Business success heavily depends on the ability of financial executives to effectively manage the working capital component of receivables, inventory, and payables (Filbeck and Krueger, 2005). Working Capital Management Practices (WCMP) is the firm s way of making investment in their current assets which is known as working capital investment policy and use short-term liabilities to finance firms assets which is know as working capital financing policy. Theoretically, a firm can adopt different working capital management practices as Aggressive working capital management practice, Moderate working capital management practice and Conservative working capital management practice based on its investment and financing strategies. These different practices affect the profitability, liquidity, risk, and finally the value of the firm in different ways. In general, Financial Management is concerned with four broader aspects such as short-term and long term investment, capital structure and dividend policy. In the short-run, current assets and liabilities are considered as one of the important components of a firm. A firm can make investment in the short-term assets comparatively to the long-term assets; maintain a certain level of liquidity and profitability of the firm as a result of different risk level. Hence, a firm can use more current liabilities to finance the total assets fully or partly and it will lead to low level of liquidity, high level of risk as well as high level of profitability. It concludes 1 WCM is defined as the ability of the organization to fund in to the short term assets and short term liabilities (Harris, 2005). Working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet short term obligations on one hand and avoids excessive investment (Eljelly, 2004). 2 The Firm Value is the present value of the expected future cash flows discounted at the rate of return required by investors (Robert K, Mark L & Rabhi M.,2008). 2

3 that excessive levels of current assets may have a negative impact on the firm s profitability whereas a low level of current assets may lead to low level of liquidity and stock-outs resulting in difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2004). More aggressive working capital policies are associated with higher return and higher risk while conservative working capital policies are concerned with the lower risk and return (Gardner et al., 1986 and Weinraub and Visscher, 1998). Therefore a discussion on managing of working capital is more important for Sri Lankan companies since we are also in succession in an economic boom. Even though the working capital management is much important for success of an organization, a very few researches have been carried out to discuss the organizational working capital management policy in specific in the Sri Lankan context. In the current research work, attention was given to the financial statements of listed companies in Sri Lanka. Carrying out research to identify the impact of working capital policy on firm value of the companies in Sri Lanka. Through the current study, researchers expect to determine the relationship between Working Capital Management Practices & the value of the Firm in Sri Lankan organizations. In the today s dynamic business environment, survival of the organization is more uncertain even though the companies are earning profit, unless they can t meet the short term obligations. Corporate finance basically deals with three decisions such as capital structure decisions, capital budgeting decisions, and working capital management decisions. Among these, working capital management is a very important component of corporate finance since it affects the profitability and liquidity of a company and finally to its value. It basically deals with current assets and current liabilities and the way of financing current assets and liabilities. Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet short term obligations on one hand and avoids excessive investment (Eljelly, 2004). Maintaining adequate working capital is not just importance in the short term. Sufficient liquidity must be maintained in order to ensure the survival of the business in the long term as well. Even a profitable company may fail, if it does not have adequate cash flow to meet its liabilities as they fall due. On the other hand, one of the main objectives of a firm is to maximize its value. Therefore, it is important to study how firms should keep the proper investments in current assets and maintain proper level of current liabilities in an enterprise with maximizing its value. Firm value is more important to have sustainable growth rate for a business leading to attract prospective investors. Because value of the firm is the form that investors motivate to invest 3

4 in the business and increase of value will benefit the firms prestige by increasing future growth. Further, firm value is also important since it affects to achieve the desired performance and long term survival of the enterprises. Therefore with the current study, researcher attempted to support for the organizations to keep a healthy WCMP in such a way to maximize firm value. According to the literature available, very few researches have been carried out in the area of WCM in Sri Lanka and no research have been carried out relating to the working capital management practices and the firm value in specific in the Sri Lankan context. Further, no researches are available in the literature that has been used EVA and MVA to measure the firm value with the WCM context? Therefore the researcher expected to study the stability of working capital management in different business sectors and the impact of those on the firm value. While the study enhances the WCMP ensuring the maximum utilization of current assets and current liabilities in Sri Lankan enterprises to achieve ultimate objective of value creation, it will lead to fill the gap exists. Further, it will support the policy makers in designing the appropriate level of WCM to maximize value of the firm continuing their sustainable business growth. And also, new comers to the different business sectors will be facilitated by providing better understanding about the behavior and the patterns of the WCMP in different sectors. As a whole, this study will enhance organization s understanding about the ability to manage liquidity, risk, profitability beyond the theoretical framework explanations, and the way in which WCMP helps to create value for the firm for smooth sustainable operations. Literature Review WCM is defined as the ability of the organization to fund into the short term assets and short term liabilities (Harris, 2005). According to Van Horne (1977), working capital management is the administration of current assets in the name of cash, marketable securities, receivables, and inventories. Osisioma (1997) described working capital management as the regulation, adjustment, and control of balance of current assets and current liabilities of a firm such that maturing obligations are met, and the fixed assets are properly serviced. Due to lack of proper plan for working capital requirements and the inability to identify and implement most suitable Working Capital Management Policy (WCMP), i.e. the firm specific way of making investment in their current assets which is known as working capital investment policy and use short term liabilities to finance firms assets which is know as working capital financing 4

5 policy, firms often experience excess working capital or shortage of working capital, both leading to destroy its value (Agarwal, 1977). Haitham N. and Maryam A. (2005) also studied the relationship between working capital management and firm profitability. The results suggested that managers can increase profitability of their firms by shortening the cash conversion cycle, the receivable collection period and the inventory conversion period. The results suggest that managers can also increase the profitability of their firms by lengthening the payable deferral period. Further it has been proved by Baum, C. F. et al. (2006) using data from Germany and they examined the direct effect of non- financial firms use of short-term versus long-term liabilities and stated that non financial firms rely more heavily on short-term liabilities are likely to be more profitable. According to the study by Baum, C. F. et al.(2007) with a comparison made between two countries, the US and Germany, with different types of financial systems they find that German firms that rely more heavily on short-term liabilities are likely to be more profitable. The link between liability maturity structure and profitability does not appear in the results from the US sample. It shows that use of more current liabilities is not yielding the higher level of profitability in US. Solano (1993) examined the effects of working capital management on the profitability of a sample of small and medium-sized Spanish firms with the panel data covering the period The results demonstrate that managers can create value by reducing their firm s number of day s accounts receivable and inventories. Equally, shortening the cash conversion cycle also improves the firm s profitability. WCM is important because of its impact on the firm s profitability and risk, and consequently its value (Smith, 1980). Excessive levels of current assets may have a negative effect on the firm s profitability whereas a low level of current assets may lead to lower level of liquidity and stock-outs resulting in difficulties in maintaining smooth operations (Van Horne & Wachowicz, 2004). Accordingly, Greater the investment in current assets, the lower the risk, but also the lower the profitability obtained. Filbeck and Krueger (2005) highlighted the importance of efficient WCM by analyzing the WCMP of 32 non-financial industries in USA. According to their findings significant differences exist between industries in working capital practices over time. Moreover, these working capital practices, themselves, change significantly within industries over time. Similar studies have been conducted by Eljelly (2004); Ghosh & Maji (2004); Howorth & Westhead (2003); Gombola and Ketz (1983); Lazaridis and Tryfonidis (2006); Long et al. (1993); Maxwell et al. (1998) and Smith and Begemann (1997). 5

6 Salawu R.O. (2006) investigated fifteen diverse industrial groups over an extended period to establish the relationship between aggressive and conservative working capital practices. His results strongly show that the industries had significantly different current asset management policies. Additionally, the relative industry ranking of the aggressive or conservative asset policies exhibited remarkable stability over time. It is evident that there is a significant negative correlation between industry asset and liability policies. Relatively aggressive working capital asset management seems balanced by relatively conservative working capital financial management. Furthermore he explains that a firm in deciding its working capital policies should consider the policies adopted in that particular industry in which it operates and a firm pursing aggressive working capital investment policy should match it with a conservative working capital financing policy. This is important to mitigate the risk being faced under aggressive working capital investment policies by safety involved under conservative working capital financing policy. However, Weinraub and Visscher (1998) have discussed the issue of aggressive and conservative working capital management policies by using quarterly data for a period of 1984 to 1993 of US firms. The researchers have examined ten diverse industry groups to study the relative relationship between their aggressive/conservative working capital policies and they have concluded that the industries had distinctive and significantly different working capital management policies over the time. Further, Afza and Nazir (2007) investigated the relationship between the aggressive and conservative working capital policies for seventeen industrial groups and a large sample of 263 public limited companies listed at Karachi Stock Exchange for a period of Finally, ordinary least regression analysis found a negative relationship between the profitability measures of firms and degree of aggressiveness of working capital investment and financing policies. Another important study which confirms the results of Afza and Nazir (2007), conducted by Mian S. and Talaf (2009) have shown that the negative relationship between the Profitability measures of the firm and the degree of Aggressiveness of working capital management policies by analyzing the 204 Pakistani firms listed under sixteen industrial groups in the Karachchi Stock Exchange (KSE). The data was analyzed for the period of As the findings it says that firms with more aggressive working capital policy may not be able to generate more profit proving the negative relationship of WCMP and profitability. Turning to the empirical literature on WCM practices and the firm value, researcher could not find any published study of the relationship between WCMP and firm value in specific. Hall, 6

7 J. (2001); Ruback and Sesia (2000) and Smith (1980) stated that efficient level of WCM is one of the drivers for value creation. However, researcher was able to found research that examines the relationship between WCM and firm profitability as mentioned previously. As examples, Deloof (2003); Garcia-Teruel and Martinez-Solano (2007); Soenen (1993) and Shin and Soenen (1998) all showed that the profitability of a firm, measured by either return on assets or return on equity, is improved as the firm improves its management of its working capital. While most of such studies suggest that firms that minimize their investment in net operating capital will maximize their profitability and thereby maximize firm value, this inference does not necessarily follow (Robert, Mark & Rabhi, 2008). Theoretically, greater the investment in current assets, the lower the risk, but also the lower the profitability obtained. In contradiction, Carpenter & Johnson (1983) provided empirical evidence that there is no linear relationship between the level of current assets and revenue systematic risk of US firms; however, some indications of a possible non-linear relationship were found which were not highly statistically significant. So, the link between WCM and firm value is not simple as the link between WCM and firm profitability discussed. The study available relating to the Sri Lankan context is the research done by Pandey and Perera (1997), providing an empirical evidence of WCMP and practices of the private sector manufacturing companies in Sri Lanka. The information and data for the study were gathered through questionnaires and interviews with chief financial officers of a sample of manufacturing companies listed on the Colombo Stock Exchange. They found that most companies in Sri Lanka have informal working capital policy and company size has an influence on the overall working capital policy (formal or informal) and approach (conservative, moderate or aggressive). And also, company profitability has an influence on the methods of working capital planning and control. According to the study conducted by S. Morawakage and Lakshan A.M.I (2009) with the companies registered in Colombo Stock Exchange, results suggest that managers can increase corporate profitability by reducing the number of inventory turn over days and increasing the creditor s payable days in order to minimize the length of the working capital cycle. Increase in creditor s payable days would give opportunities to the company for further investments. Turning to the literature on firm value, a well designed and implemented working capital management is expected to contribute positively to the creation of a firm s value. Since the 1990s, strong arguments have been raised in favor of EVA as an accounting measure, mainly by the Stern Stewart Consulting Company and Associates (Stewart, 1991 and Stern, 1993). A survey of the available literature on this topic indicates that several studies have concluded 7

8 that EVA has a stronger correlation with MVA than the other accounting measures tested. Supporters of EVA include O Byrne (1996), Uyemura, Kantor and Pettit (1996) and Grant (1996). However, after initial strong support for EVA, some criticism of EVA has arisen, and some research results have been published that indicate as EVA does not explain MVA better than other measures. Further, Asogwa (2009) has studied the determinants of shareholder value creation in the listed banks in Nigerian stock exchange with identifying impact of profitability, dividend policy, earnings, size of the banks to the value creation. In his study he stated that dividend policy affects more on value creation than profitability and earnings and bank size do not affect the value creation in the Nigerian context. But he further explains that unobsevarable factors such as management quality and strategies are affecting for the value creation in Nigerian banks. As the only and first empirical study of the relationship between corporate working capital management and firm value, as well as the first examination of how financing influences this relationship, was conducted by Robert, Mark and Rabhi (2008) with U.S. corporations from 1990 through 2004 data. They found that first; a dollar invested in net operating capital is worth less on average than a dollar held in cash. Second, on average, an additional dollar of investment in net operating working capital at current levels of such investment reduces firm value. Third, the evidence that a dollar invested in net operating working capital is worth less than a dollar is primarily driven by its financing. Fourth, firms with better access to public capital market, and particularly commercial paper markets, face a lower reduction in value from financing this investment. Further they have not only shown that WCM is important to firm value, but also that its financing is a critical determinant of its valuation effects. This study has used the net present value method to measure the firm value and instead of that researcher in the study uses the EVA and MVA with the working capital management policy in specific with the WCM investment and financing practices in different business sectors. Even though there are prose and cones of using EVA and MVA to measure the firm value, it has been proved by the literature that EVA and MVA can be used as the better proxy for measuring the value of the firm. Methods Hypotheses The following hypotheses were formulated in the current study to examine the impact of WCMP on firm value. 8

9 H 1 : There is negative relationship between the Aggressive Working Capital Management Practice (AWCMP) and MVA of the companies in Sri Lanka. H 2 : There is negative relationship between the Conservative Working Capital Management Practice (CWCMP) and MVA of the companies in Sri Lanka. H 3 : There is negative relationship between the Aggressiveness of Working Capital Management Practice (AWCMP) and EVA of the companies in Sri Lanka H 2 : There is negative relationship between the Conservative of Working Capital Management Practice (CWCMP) and EVA of the companies in Sri Lanka. Research design First we identified the WCMP followed by the firms as Investment Policy (IP) and Financing Policies (FP). The level of the IP and FP is measured by the degree of aggressiveness or the conservativeness. To measure the degree of aggressiveness/conservativeness of IP, following formula has been used. This is in consistent with Afza & Nazir, (2007); Weinraub & Visscher, (1998); Salawu, (2006). IP = Total Current Assets (TCA) X 100 Total Assets (TA) Where a lower ratio means a relatively aggressive policy and a higher ratio means a relatively conservative policy. To measure the degree of aggressiveness/conservativeness of financing policy, following formula has been used. FP = Total Current Liabilities (TCL) X 100 Total Assets (TA) : Where a higher ratio means a relatively aggressive policy and a lower ratio means a relatively conservative policy. Based on the Working capital IP and FP followed by the firms, as mentioned above, researcher adopted the following combinations to identify the WCM practices of the firms in the study. a) AIP with AFP - Aggressive WCMP 9

10 If a company is running with an Aggressive Investment Policy (AIP) and Aggressive Financing Policy (AFP), it is categorized as a company which is having an Aggressive Working Capital Management Policy (AWCMP). b) CIP with CFP- Conservative WCMP The company which is running with a Conservative Investment Policy (CIP) and Conservative Financing Policy (CFP) are categorized as a company having Conservative Working Capital Management Policy (CWCMP). c) AIP & CFP or AFP & CIP -Moderate WCMP The company which is running with an Aggressive investment policy (AIP) with Conservative finance policy (CFP) and Conservative investment policy (CIP) with Aggressive finance policy (AFP) is categorized as Moderate Working Capital Management Policy (MWCMP). Secondly, measures of EVA and MVA of the selected companies measured. After identifying the specific WCMP followed by each company in different sectors and measuring the value of the firms, researcher expects to examine the relationship between WCMP with Economic Value Added (EVA) and the Market Value Added (MVA). Market Value Added Market value says how much management has added to share holder value over the company and it is the difference between market value of the firm s stock and the amounts of equity capital supplied by investors. MVA measures the effect on value of management s decisions since the firm s inception. It is calculated as follows. MVA = Market Value of Company Total Operating Capital Invested Finnegan, (1991) has stated that better picture of the MVA is give as the difference between the current year MVA and the last year MVA. Therefore, in the current study, the percentage change in MVA from one year to another year is used to see whether value has been created or destroyed by the firm. Company creates value when percentage change MVA is grated than 0, that is when the market value capital exceeds the capital invested. 10

11 Economic value added ICBI 2011 EVA is a measure that focuses on firm internal performance over a specific period and it assesses managerial effectiveness in a given year. By measuring profits, after subtracting the expected return to shareholders, EVA indicates economic profitability. The EVA measure was created to address the challenges of companies faced in the area of financial performance measurement. Creating sustainable improvements in EVA is synonymous with increasing shareholder wealth. For the current study, EVA is calculated targeting only the equity shareholders due to unavailability of the data to calculate the EVA complying with the above formula. Therefore, researcher uses the EVA contribution only for equity shareholders by deriving the following formula and it is in consistent with Gregory T. Fraker (2006). Accordingly EVA is calculated as follows. EVA = PAT - (Ke x TC) Where, PAT= Profit after Tax TC= Total Capital Ke = Cost of Equity Equity capital is provided by the ordinary shareholders. An investor s expected rate of return on an investment is equal to the risk free rate plus the market price for the risk that is assumed with the investment. The relationship between expected return and risk is measured by comparing a company to the market. The percentage return that a company s shareholders require on their investment can be calculated under the assumption that they require both a return for just investing their money and a return that reflects the risk inherent in investing specifically into the company. Stated as a formula, which is known as the Capital Asset Pricing Model (CAPM), the percentage return that a company s shareholders require is calculated as follows. Ke = Risk-Free Rate + Beta Coefficient (Market Risk Premium) The risk-free rate is the interest rate that can be obtained by investing in an investment with no risk. Although a truly "risk-free" investment exists only in theory, in practice short-term government treasury bills, such as three months (91 Days) Treasury bill rate, is used in the above formula as risk free rate of return. 11

12 The beta coefficient is the level of risk inherent by investing in a specific company relative to investing in the overall stock market. Therefore, it was calculated by using the formula of Core-variance of company stock price and the market return divided by the Variance of the market return. The market risk premium is the risk associated with investing in the stock market as a whole. It is measured by the year change logarithm of All Share Total Return Index (LnASTRI) and the risk free rate i.e. 91 days Treasury bill rate. K e = R F + ß (Rm- R F ) Ke = 91 Days Treasury bill rate + ß (LnASTRI - 91 Days Treasury bill rate) Since, EVA is calculated only for equity shareholders, Profit after Tax is calculated after deducting preference dividends. Total capital of the company is the equity capital and reserves. Finally, with all above methods of calculations, researcher proposes to use to put in plain words to show the design of the research which is to carry out by the researcher through the following diagram. Sample and Sampling Procedure A sample of 74 companies has been selected representing seven different sectors in the Colombo Stock Exchange (CSE) out of the twenty sectors in the CSE sector categorization. Researcher did not select bank, financial and insurance sector companies because of the more regularization of the working capital practices in the industry as a result of inherent conditions imposed to the financial sector organization. Further, diversified holding sector was eliminated from the sample due to the group financial statements are available and it may lead to replication error of data with other sectors. Additionally, since the less number of companies available in the sectors such as Construction and engineering, Foot ware textiles, Health care, Information technology, Investment trust, Motors, Oil palms, Power and energy, Services, Store suppliers and Telecommunication have not been included in to the sample. The sample companies which covers the fifty percent of the total population is considered for the study. It was drawn by using the stratified random sampling technique from the 142 listed companies which are considered for the research selecting seven different sectors in CSE. Finally researcher possesses the research with 370 observations. 12

13 Table 1- Distribution of sample companies listed in CSE according to the Industrial Sectors. Sector Number of Companies Available Beverage Food and Tobacco (BFT) Chemicals and Pharmaceutical (C & P) 09 6 Hotel and Travel (H & T) Land and Property (L & P) Manufacturing (Manu) Plantations (Plant) 18 9 Trading (Trad) 11 5 Total Number Companies Selected of Data and Data Collection With the evidences supported by the literature, most of the researchers have conducted their researches based on the secondary data from the annual reports polished by the companies. This study also based on secondary quantitative data and the data is collected for the period of 5 years starting from 2005 to 2009 using the annual reports published by the above mentioned companies which have been listed in CSE. Further, the data is obtained from the magnetic data library and the annual handbook published by CSE. Data analysis Data comprises time series natures because it is for five years period and cross sectional nature because it has 74 companies. Therefore, researcher used panel data from the year 2005 to 2009 representing 74 companies covering seven different sectors in the CSE. Further, using E-views software package, panel regressions were used with the dummy variables to examine the impact on WCMP and firm value. Results and Discussion Researcher used dummy variables to identify the impact of WCM practices followed by the firms as Aggressive Working Capital Management Practice (AWCMP), Moderative Working Capital Management Practice (MWCMP) and Conservative Working Capital Management Practice (CWCMP) which were derived from the firms investment policy, and firms financing policy, with value of the firm which is measured by EVA and MVA. Thus, Dummy 13

14 1 is used for AWCMP as D1 and Dummy 2 is used for CWCMP as D2. It can be shown as follows. Table 2- Dummy variables for WCMP D1 D2 Aggressive Working Capital Management Practice AWCMP 1 0 Conservative Working Capital Management Practice 0 1 CWCMP Modarative Working Capital Management Practice 0 0 MWCMP Following models have been used FV it = β 0 + β 1 (AWCMP it ) + β 2 (CWCMP it ) + β 3 (MWCMP it ) + ε it MVA it EVA it = β 0 + β 1 (D1 it ) + β 2 (D2 it ) + ε it = β 0 + β 1 (D1 it ) + β 2 (D2 it ) + ε it Model 1 Model 2 WCMP and MVA Table 3- WCMP and MVA Overall model D1 (AWCMP) D2 (CWCMP) Adjusted R F value t value Sig. level Sign of the Coif. Positive Negative According to the information provided by model 1 of the impact of the WCMP on value of the firm by the above table no.3, adjusted R 2 value was with a f value of 3.89 (p=0.000) stating that nearly 37% of the variation in MVA was explained by WCMP as AWCMP, CWCMP or MWCMP selected by the firm. It further showed that CWCMP recorded a negative relationship to MVA (p=0.000) while AWCMP recorded a positive 14

15 relationship which was not significant, evidencing that relatively conservative WCMP yields a relatively low level of MVA. In contrast to that, the firms follow AWCMP impact to have relatively higher MVA to its base case of MWCMP. In the other words, adopting relatively AWCMP leads to increase the MVA while CWCMP leads to decrease the MVA relatively to its MWCMP. Therefore researches first hypothesis is fail to accept and second hypothesis is failed to reject. Finally it concludes that those firms who move from the CWCMP to AWCMP increase their MVA. WCMP and EVA Table 4- WCMP and EVA Overall model D1 (AWCMP) D2 (CWCMP) Adjusted R F value t value Sig. level Sign of the Coif. Negative Negative According to regression model no 2, researcher regressed the WCMP as D1 and D2 with EVA and regression results are summarized in the table no.4. Its adjusted R 2 value was with F value of (p=0.000) stating that nearly 32% of the variation in EVA was explained by the firm s selection of WCMP as AWCMP, CWCMP or MWCMP. It further showed that D1 for AWCMP and D2 for CWCMP recorded a negative coefficients to EVA recording (p=0.000) and (p = ) respectively. Accordingly, AWCMP was statistically significant and CWCMP was not significant. It evidenced that AWCMP yield a relatively low level of EVA compared to the base case of MWCMP. Therefore researcher is fail to reject hypothesis 3 stated as there is negative relationship between the AWCMP and EVA. Conclusion Results provides evidence from the model 1 (Table no.3) on the impact of the WCM practices on value of the firm, CWCMP demonstrated a negative relationship to MVA (p=0.000) while AWCMP recorded a positive relationship which was not significant, i.e., explaining that relatively CWCMP yields a relatively low level of MVA. In the other wards, if any firm is 15

16 operating with conservative investment policy 3 together with conservative financing policy 4, it decreases the MVA relative to MWCMP firms. In considering all relationships as a whole, MVA increases when the firm moves from the CWCMP to AWCMP. It further explains that the firms that maintain higher level of current assets with a lower level of current liabilities lead to have a lower MVA than the firms which are running with lower level of current liabilities with lower level of current assets or a higher level of current liabilities with a higher level of CA. According to regression model no 2 (Table no.4), showed that D1 for AWCMP and D2 for CWCMP witnessed negative coefficients to EVA recording (p=0.000) and (p = 0.187) respectively. Accordingly, AWCMP was significant and CWCMP was not significant. It says that AWCMP yields a relatively lower level of EVA comparatively the base case of MWCMP. It can be further explained as, if any firm is operating with aggressive investment policy 5 together with aggressive financing policy 6, it decreases the EVA relatively to the firms that operate with MWCMP. Moreover, it can be concluded that, when the firms are maintaining lower level of current assets with higher level of current liabilities, it leads to have a lower level of EVA than the firm s with lower level of CL coupled with lower level of CA or higher level of CL coupled with higher level of CA. Finally the findings of WCM practices as CWCM practice gives a lower level MVA than MWCM practice while AWCM practice indicates a lower level EVA than MWCM practice. This finding is complying with the results by Weinraub and Visscher (1998) and Gardner et al. (1986) as conservative working capital policies are concerned with the lower risk and return. Even though Weinraub and Visscher (1998) Rehman (2006); Soenen (1993); Jose et al (1996); Gardner et al (1986) found that aggressive WCMP increases the firm profitability of the firms, current findings says that the firms who follow AIP together with AFP do not increase the EVA of the firms. According to the results which were used to examine the impact of different WCM practices followed by the firms, CWCMP showed a negative relationship with MVA compared to the MWCMP. Accordingly, it provided evidence that firms following CWCMP yield lower MVA than the firms following MWCMP. Furthermore, AWCMP showed a negative relationship with EVA. It proved that the firms following MWCMP can have higher level of EVA than the firms with AWCMP. 3 CA/TA ratio is higher than 50% 4 CL/TA ratio is less than 50% 5 CA/TA ratio is less than 50% 6 CL/TA ratio is higher than 50% 16

17 Accordingly the firms which are running with the conservative working capital practice can improve the EVA of the firm. Hence, the firms that maximize internal performance measured by the EVA, better to use low-level of short term funds to finance their permanent assets. Additionally, the firms that follow AIP with CFP or CIP with AFP i.e. MWCMP can improve firms MVA as well as EVA. In the implementation of the above mentioned recommendations to the practice, managers should be well aware of the current market trends which affect the WCMP and the firm value. Results were derived from the data gathered for the sample period from 2005 to The sample period, especially from 2005 to 2008, had high level of inflation, high interest rates regime which resulted in high level of cost of capital. However, subsequent to the year 2008/09, i.e. after the war in Sir Lanka, macro economic factors have been changed to have lower level of interest rate and lower level of cost of capital. Furthermore tax policy with in the said research period also different from the current situation. Tax rates have been tremendously decreased by 2011 budget. Furthermore, market competition is also immensely increasing among the firms in the recent years. As a result, firms are tend to have more credit periods, more short-term promotions and have to have fast service which directly affects WCM. Technological development in the market also helps to manage inventory levels efficiently and finally it provides facilities to have proper level of WCM. New Companies Act No. 07 of 2007 was introduced in May, 2007 and laid down a new requirement on distributions to shareholders, namely solvency test. One condition in the solvency test is to have more CA than CL. It regularized the WCM and directly influenced the IP and FP of the firm. Therefore, all these macro economic and political variables should be considered in the implementation of the above mentioned findings. References Afza, T. & Nazir, M. S. (2007). Working Capital Management Policies of Firms: Empirical Evidence from Pakistan. Presented at 9th South Asian Management Forum (SAMF) on February 24-25, North South University, Dhaka, Bangladesh. Agarwal, N. K. (1977). Management of working capital. Phd. diss., Delhi School of Economics. Asogwa, R. C. (2009). Measuring the determinant of value creation for publicly listed banks in Nigeria: A Random effect profit (REP) model analysis. African review of money, banking and finance, 23(2),

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