Studying the effects of using different strategies of working capital management on accruals quality of working capital

Studying the effects of using different strategies of working capital management on accruals quality of working capital Mehdi Saleki 1,,Farhad Shahveisi* 3, Babak Jamshidinavid 4 1 Department of Accounting, College of Humanities, Kermanshah Science and Research Branch, Islamic Azad University, Kermanshah, Iran Department of Accounting, College of Humanities, Kermanshah Branch, Islamic Azad University, Kermanshah, Iran 3 Department of Accounting, Faculty of social Science, Razi University, Kermanshah, Iran *Corresponding auditor: Email: F.shahveisi@razi.ac.ir 4 Department of Accounting, College of Humanities, Kermanshah Branch, Islamic Azad University, Kermanshah, Iran ABSTRACT Increasing role of working capital in continuation of entities activities has caused in defining different strategies for managing working capital so that businesses can manage liquidity and provide long-term benefits for the business unit by the use of various strategies related to working capital management. The aim of this study is to determine the effects of differences in working capital strategies type on the quality of accruals. The statistical population of this study has consisted of all firms listed in Tehran Stock Exchange and in order to test the research hypotheses data collected from the 183 companies selected using systematic methods from 6 to 13 has been used. In order to analysis data, correlation and logistic regression have been used. The research results show that all the strategies defined in terms of working capital management affect on the quality of accruals working capital but the type and impact direction of these strategies are different. Keyword:Aggressive strategy of working capital management, Moderate strategy of working capital management, Conservative strategy of working capital management, Quality of Accruals, Accruals working capital INTRODUCTION Nowadays the capital markets play a critical role in the economies of countries so that attention to these markets and its decision making fundamentals are essential. One of the effective key elements on decision making in this market is the financial statements of the companys particularly, income statement. Income statement contains one of the key variables in the economic decisions namely net incomewhich represents the performance of an economic unit during the financial period and it is one of the items which are interested by a wide range of financial statement users. The basic issue in applying net profit in economic decision making is that the accrual accounting system is used for measuring this variable. But what makes inefficient use of this system is that profit calculated by this system may be affected by estimations accounting and will result in the profit which is different from actual performance of the business unit.although accruals play an important role in the financial reporting process and reducetiming problems and lack of hidden adaptation in cash figuresbut its reliability and usefulness is doubtful because managers are able to manipulate the figures given being the subjective nature of those and adjust reported earnings in accordance with GAAP and to their liking [4].Accruals quality can be influenced by working capital strategies which are used by management. Working capital management is one of the important structutal issues in financial management. It is an indicating of policies and decisions which are applied in working capital section in order to change in current assets and short term financing. Controlling working capital management, correctly can affect on company s profitiability. Working capital managemement is classified to current assets and current liabilities where their balancing is very important so that decision making about one of them affects on another. Different strategies are dominant on working capital management of an entitity which are derived from combining assets and debts strategies. Managers in managing businesses are classified to 544

two groups; risk aversion or risk lover. Working capital managers can classified in the same way. They use two approachs of current liabilities and current assets for managing working capital. In the conservative strategy, managers try to keep their liquidity by holding cash and cash equivalent assets. This strategy has a low of risk because in the one hand, liquidity allows that company pays liabilities in due date. In the other hand due to the maintenance of large amount of funds, the risk of customers losing and bankruptcy is very low but, company return is aslo low. In an aggressive strategy (current assets management), the of funds, marketable securities and investment in inventory is at minimum. This approach is very risky so that the risk of the customer's losing and insolvency is very much. In contrast, company s return will increase dut to purchase fixed assets and high operating turnover. In the Conservative strategy (Current liabilities management) manager tries to minimize the amount of short-term loans and to use long-term loans which have floating interest current assets in order to provide current assets. Sometimes instead of getting these loans, manager use other sources of capital such as equity. A company that minimizes the short-term loans will reduce the bankruptcy and insolvency risks. Also, using of long-term loans and equity rather than short-term loans will increase the costs of capital and finally will reduce the rate of shareholders return. In an aggressive strategy approach (in current liabilities management) manager tries to maximize the short-term loan and to provide current assets from these loans. If a company's short-term loans are increased the default risk will increase. When the market is facing with a shortage of money and credit, to obtain short term loans is not easily available and its cost will go up. The policy that manager exerts company's working capital management may be based on current assets and liabilities. If a company adopts an aggressive strategy about current assets and adopts a conservative strategy about current liabilities, company overall policy is balanced and risk and return policy are balanced. If the company adopts an aggressive strategy about current assets and current liabilities, to adopt a conservative strategy company overall policy is aggressive and risk and return will increase. So depending on the manager s risk tolerance, combination of net working capital components varies. Given that risky managers are also compared with conservative managers hold low of cash, so they need to external financing when funds are needed. The aim of this study is to identify the effects of using different strategies of working capital management (strategy aggressive, moderate and conservative) accruals quality of working capital and to find the answer of following questions: - Are there the motivation in brave managers to reduce financing costsby improving the accrual quality and increasing the information content of accounting reports and reducing information asymmetry? - Is the working capital strategy is effective on management motivation in enhancing the quality of working capital accruals? - Due to the potential for manipulation and also nearness to the market value of in items constituting the working capital is not the same, does the quality of accruals is affected by net composition of working capital? Theoretical framework and literature review Due to the company's financial statements are prepared based on the accrual accounting thus the major part of the financial statements accruals such as Inventories involve working capital accruals which are effective on the balance sheet and income statement. Accruals report in the financial statements is based on estimations that are affectedby management's judgment. For the reason that the turnover of current assets and liabilities arehigher than turnover of long-term assets and liabilities, the quality of working capital accruals is more effective on decision making of financial statements users and appropriateness of the items constituting working capital is affected by strategies which are used by management. Betweendone researches within Iran, the research that examines the relationship and influence strategies of working capital on accruals quality was not found. So in this part, those studies that have used working capital sterategis or accruals quality variables have been mentioned. Hassanpour (9) in oeder to examine the impact of working capital sterategies on the stock returns of companies listed in Tehran Stock Exchange divided the general strategies of working capital management into three categories: conservative, aggressive and moderate. The results have indicated that the average return was significantly different in the different strategies and aggressive strategy has maximum return between other sterateies in total industries. Caisson Padachy (6) examined the trend of working capital management and its impact on the performance of companies in different industries. He concluded that in Printing and publishing and paper making industry major changes have been occurred and choosing different methods can have important effects on company s profitability. Rahman and Naser (7) investigated the relationship between the working capital management and liquidity and concluded that there is a significant negative relationship cash 545

conversion cycle and its components, including inventory turnover, the settlement period of creditors and receivables collection period and company profitability. Garcia (11) in a study has investigated the relationship between profitability and working capital management and he has concluded that companies can increase the profitability of the company by maintaining the optimal (time period) of the cash conversion cycle and its components including the receivables collection period, inventory turnover and settlement period of creditors. Gazi et al. (11) in a research examined the effect on working capital management on corporate profitability and found that Maintaining the desired (time period) of the cash conversion cycle and its components, including the receivables collection period, inventory turnover and settlement period of creditors will increase the profitability of the company. Research hypotheses Hypothesis 1: Applying aggressive strategy of working capital management influences on the accruals quality of working capital significantly. Hypothesis : Applying moderatestrategy of working capital management influences on the accruals quality of working capital significantly. Hypothesis 3: Applying conservative strategy of working capital management influences on the accruals quality of working capital significantly. Research methodoogy The statistical pupolation of this research encompasses all of the companies listed in Tehran Stock Exchange (TSE). In order to select companies to test the research hypotheses the systematic elimination with respect to the following restrictions is used which finally 183 companies were remained: 1.The company must be a member of the Tehran Stock Exchange at the beginning of 6.The company financial year ends of March each year. 3. During the study period, interrupted of their stock trading not be longer than 6 months. 4. Company doesn t belong to investment industry. Table1: How to select sample ccompanies discribtion The statistical population members at end of 1 Filter1- companies that have been listed in TSE after 6 and have been delisted before 1. Filter- companies that their financial years have not been March, after applying filter1. Filter3- companies that classified in investment industry, after applying filters 1,. Filter4- companies that interrupted of their stock trading has been more than 6 mounts, after applying filters1,, 3. Filter5- companies that their needed information have not been avalible, after applying filters 1,, 3, 4. Total of deleted companies Total of companies studied number 176 73 49 33 Number 534 351 183 Present study is a descriptive-survey correlational research and is an applied research in terms ofobject. All needed information of research literature have been collected from books, and specialized and public journals and articles from the Internet, and data needed to test research hypotheses have been collected by referring to the Tehran Stock Exchange, annual financial statements,explanatory notes of the companies listed in Tehran Stock Exchange, reports of board, and software summarized financial information such asrah-ovard-e-novin 1 for 8 years period (5-1) and have beenstored in an informational database such as Excel in order to 1 A common database for Tehran Stock Exchange calculate the variables.to assess the presence of the relationship, according to measuring of variables, the Pearson correlation test has been used and in order to measure the effect of each independent variable on the dependent variable separately step by step regression analysis by the least squares method at significant 95%, the coefficient of determination (R ), adjusted coefficient of determination have been used. If the p-value be more than 5%, hypothesis has been accepted, otherwise hypothesis has been rejected. Also, in order to analysis statistical data E-views and SPSS softwares have been used. The independent variable of research consists of three strategies of working capital management, which are defined as follows: 546

Conservative strategy: in which the ratio of net working capital and liquidity power is too high. Aggressive strategy; in which unlike conservative strategy, company current assets is at the lowest possible and instead of debt is at the highest possible. Moderate Strategy which is between conservative strategy and aggressive strategy and the of current assets and liabilities is at highest or lowest possible. Mentioned strategies are qualitative variables and their analysis was conducted as a quantitative variable. They are defined in terms of current ratio; quick ratio and current debt ratio are defined then are compared with the industry average and are interpreted as follows: 1. If the current and quick ratios are both higher than the industry average: -Current debt ratio is above the industry average, indicating a moderate strategy. -Current debt ratio equal or less than the industry average represents a conservative strategy..if the current and quick ratios are both lower than the industry average: - Current debt ratio below the industry average shows a moderate strategy. -Current debt ratio equal or more than the industry average represents aaggressive strategy. 3.If one of; current or quickratio equalsindustry average and other than is higher than the industry average: -Current debt ratio is above the industry average showing a moderate strategy. -Current debt ratio equal or less than the industry average represents a conservative strategy. The "upper", "lower" and "equal" industry average have been shown below: Upper: higher than average, with a distance of more than 5% deviation from the mean Equal: more or less than average, with a distance of less than 5% deviation from the mean. Lower: less than average, with a distance of more than 5% deviation from the mean The purpose of this classification in comparison with the state divided into two more or less than average, increasing accuracy and resolution strategies for states close to the industry average (Shahveisi and Soltanzadeh, 11).Also, the current ratio is current assets divided by current liabilities and quick ratio is current assets less inventurydivided by current liabilities and current liabilities ratio is current liabilities divided total assets.the dependent variable in this study is accruals quality which is measured by Dicho and Decho model (). This model is obtained by regressing current accruals on operating cash flows previous, current and future periods. The model assumes that, accruals with high quality is ultimately reflected in cash flowshowever, the accruals that have not been properly estimatedareassociated with cash flows weakly.it isexpected who Managers know business environmentbetter than others and are more aware of the risks,estimate accruals with higher accuracy (Jakson, 11). Dicho and Decho model () is as follows: TCA = β + β CFO + β CFO + β CFO + ε Where TCA is change in accruals of working capital which is calculated as follow: TCA = Δ (CA CL C) Where CA is current assets, CL is current liabilities, C is cash and CFO is operating cash flow. All variables in the regression model have been divided by the book value of assets at the beginning of the period. Residuals of the regression model reflect the of accruals that are not explained by the cash flows and are indicative of the quality of accruals. So thatin above model the highstandard deviation ofresidual is an indicative of low quality accruals (Dastgir and Rastgar, 1). Research findings This study has been conducted over a period of 8 years and companies (183 companies per each year) have been examined.main variables of researchare working capital strategies and quality of accruals and a wide range of variables has been used to calculate the variables based on spicified formula (Dicho and Decho model). Descriptive statistics of variables are presented as follows: Current ratio Quick ratio Current liabilities Accounting profit Market value of equity Table: Descriptive statistics of intermediate variables number Minimum Maximum Average.3.1.6-74976 115411*1 5 7. 7.1.76 35446. 833883*1 8.431.9.56 59779.6 583737 51.15 Standard deviation.933.849.83 77634.57 98663*1 7 547

Dividend(DPS) Stock price Stock return Current asset Current liabilities Cash Change in accruals of working capital Operating cash flow. 387 -.79 11366 1851 18-88937 159917-75 319 6.1 7434799 93987 97935 3889694 477135 479.743 4494.711.38 79.9 55654.1 3436.57-944.11975 771338.973 887.4 4895.764.854 8453776.67 9778.71 51453.43 15689.944 83551.459 Million Rials (Iran currency) Also, in this research the two main variables have been studied namely; working capital strategies which are qualitative variables and the other accruals quality of working capital which is a quantitative variable. Descriptive statistics of these variables are shown in table 3: Accruals quality of working capital Table3: Descriptive statistics of quality of accruals Number Minimum Maximum average 171.98 151897 5148.414 Standard deviation 9951.1 Also to test the normality of the variables Jarquobera test is used. In this test if the significance of the test be more than.5, indicating the normality of the data: H : variable i is normally distributed. H 1: variable i is not normally distributed. The results presented in Table 4 showing the normality of the data because, P- value or significance of research variable is greater than.5 Table4: results of variable normality number Jarquo-bera Accruals quality of working.174 capital P-value. result normal H: aggressive strategy of working capital management does not affect on accruals quality of working capital management, significantly. H1: aggressive strategy of working capital management affects on accruals quality of working capital management, significantly. To test this hypothesis, the correlation coefficient between aggressive strategy and quality of accruals is calculated as follows: Testing research hypotheses Hypothesis 1 In this hypothesis, the effect of aggressive strategy of working capital management on accruals quality of working capital has been tested. To do this the null hypothesis and its alternativehypothesis have been defined as follows: Table5: result of testing hypothesis 1 Quality of accruals Correlation R Adjased R MSE coefficient -.58.3.3 7.54541 1 5 Durbin- Watson 1.855 As shown in above table, the correlation coefficient between two variables is -.58 which demonstrates a correlation between aggressive strategy and accruals quality The R and adjusted R are.3. In order to test the significance of the correlation coefficient between aggressive strategy and working capital accruals quality t-test has been used. If the significance of the t-test (P-Value) be less than.5, it can be concluded that the correlation between two variables is significant. Linear regression is used to t-test but in order to use linear regression, is needed that errors be always independent. In order to examine the errors independence Durbin-watson statistic has been 548

used and the following hypotheses have been tested: H : Errors are not independent H 1: Errors are independent. If the Durbin-Watson statistic be between 1.5-.5, H1 is accepted and it is concluded that errors are independent. Because tha Durbin-Watson is 1.855 which is between 1.5-.5 so, can be concluded that the errors are independent and regression can be used. The regression model in which the independent variable (X1) represents the aggressive strategy of working capital management and the dependent variable (Y) represents the quality of accruals is as follow: As 1 represents the intercept and 1 represents the regression coefficient between independent variable and the dependent variable. If the significance be less than.5, H is rejected and H1 is accepted. According to Table 7 can be seen that the value of the regression coefficient between aggressive strategy and quality of accruals is -8978.183 and its significant is.37 which is less than.5, so with respect to significant H 1 is confirmmed statistically and the first hypothsis is accepted. In this table, intercept also has been tested. Since the significant is less than.5 it can be concluded that the intercept is not zero and in writing regression equition is used. Intercept( ) Aggressive sterategy ( ) Table 6: coafficients of hypothesis 1 Coafficients T test Significant Hypothesis 168556.94 6.9. : 1 : -8978.183.9.37 1 Result H H 1 By the use of above table, simple linear regression model between aggressive strategy and accrual quality is: Y 168556.94 8978.183X Model coaficient of determination is.3 means that using above medel.3% of changes can be described. Also, in order to suitability presnted model, ANOVA test has been used and following hupothsis are tested: 1 H : linear regression model in not significant. H 1 : linear regression model in significant. If signifivant be less than.5, indicating alternative hypothesis is confirmed and linear regression model is significant. As is seen in table 7, significant is.37 which is less than.5. So, regression model presented is significant with significance 95%. Table7: ANOVA analysis of hypothesis1 Source of changes F statistic Average of Squares Degree of freedom Sum of squares Significant 489 1 9 1 489 1 9 Error 4.375 5689 1 8 186 7316 1 1.37 Total 187 7341 1 1 Testing hypothesis Hypothesis : moderate strategy of working capital management affects on accrual quality, significantly. Null hypothesis and alternative hypothesis are defined as follows:. H : moderate strategy of working capital management does not affect on accrual quality of working capital, significantly. H 1 : moderate strategy of working capital management affects on accrual quality of working capital, significantly Table8: result of testing hypothesis Quality of accruals Correlation R Adjased R MSE coefficient -.1.. 7.55535 1 5 Durbin- Watson 1.848 549

As is seen in table 7, the coaficient correlation between two variables is -.1 which indicating preasence relationship between moderate strategy of working capital and accual quality of working capital. R and adjusted R are.. In order to test the significance of the correlation coefficient between aggressive strategy and working capital accruals quality t-test has been used. If the significance of the t-test (P-Value) be less than.5, it can be concluded that the correlation between two variables is significant. Linear regression is used to t-test but in order to use linear regression, is needed that errors be always independent. In order to examine the errors independence Durbin-watson statistic has been used. Because the value of Durbin-Watson satatistic is 1.848 which is between 1.5-.5 so, can be concluded that the errors are independent and regression can be used. The regression model in which the independent variable (X) represents the moderate strategy of working capital management and the dependent variable (Y) represents the quality of accruals is as follow: Y X As represents the intercept and represents the regression coefficient between independent variable and the dependent variable. If the significance be less than.5, it can be concluded that correlation coaficient between two variables is significant thus H is rejected and H 1 is accepted. According to Table 1 can be seen that the value of the regression coefficient between moderate strategy and quality of accruals is -77.5 and its significant is.958 which is more than.5, so with respect to significant H1 is rejected statistically and the hypothsis is rejected. Intercept( ) Moderate sterategy ( ) Table 9: coafficients of hypothesis Coafficients T test Significant Hypothesis 3936.66 8.654. : 1 : -77.5.53.958 1 Result H H 1 Testing hypothesis 3 Hypothesis 3: Conservative strategy of working capital management affects on the accruals quality of working capital. To test this hypothesis at first, null hypothesis and alternative hypothesis must be defined: H : Conservative strategy of working capital management does not affect on the accruals quality of working capital, significantly. H1: Conservative strategy of working capital management affects on the accruals quality of working capital, significantly. Table1: result of testing hypothesis 3 Quality of accruals Correlation R Adjased R MSE coefficient.6.4.3 7.541968 1 5 Durbin- Watson 1.855 As is shown in table 9, the coaficient correlation between two variables is.6 which indicating preasence relationship between conservative strategy of working capital and accual quality of working capital. In order to test the significance of the correlation coefficient between variables t- test has been used. If the significance be less than.5, it can be concluded that the correlation between variables is significant. Linear regression is used to t-test but in order to use linear regression, is needed that errors be always independent. In order to examine the errors independence Durbin-watson statistic has been used. The value of Durbin-Watson satatistic is 1.855 which is between 1.5-.5. So it can be concluded that the errors are independent and regression can be used. The regression model in which the independent variable (X 3) represents the conservative strategy of working capital management and the dependent variable (Y) represents the quality of accruals is as follow: Y 3 3 X 3 As 3 represents the intercept and 3 represents the regression coefficient between independent variable and the dependent variable. If the 55

significance be less than.5 indicating that correlation coaficient between variables is significant thus H is rejected and H 1 is accepted. In Table 1 can be seen that the value of the regression coefficient between conservative strategy and quality of accruals is 9188.1 and its significant is.33 which is less than.5. So with respect to significant, H1 is confirmmed statistically and the hypothsis 3 is accepted. In this table, intercept also has been tested. Since the significant is less than.5 it can be concluded that the intercept is not zero and in writing regression equition is used. Intercept( ) Conservative sterategy ( ) Table 11: coafficients of hypothesis 3 Coafficients T test Significant Hypothesis 4991.86 8.91. : 1 : 9188.1.138.33 1 Result H H 1 By using above table, simple linear regression model between conservative strategy and accrual quality is: Y 4991.86 9188.1 X 3 Model coaficient of determination is.4. It means using above medel.4% of changes can be described. In following, in order to suitability presnted model, ANOVA test has been used and following hupothsis are tested: H: linear regression model in not significant. H1: linear regression model in significant. If signifivant be less than.5, indicating alternative hypothesis is confirmed and linear regression model is significant. As is seen in table 1, significant is.33 which is less than.5. Thus, regression model presented is significant with significance 95%. Table1: ANOVA analysis of hypothesis3 Source of changes F statistic Average of Squares Degree of freedom Sum of squares Significant 6 1 1 1 6 1 1 Error 4.571 7315 1 11 186 5688 1 8.37 Total 7341 1 11 187 Table 13: Summarization of research finding Hypothesis Relation Result 1 Aggressive strategy of working capital affects on accruals Negative quality of working capital, significantly. Moderate strategy of working capital affects on accruals - Rejected quality of working capital, significantly. 3 Conservative strategy of working capital affects on accruals quality of working capital, significantly. Positive Conclusion Working capital management represents the optimal combination of working capital items namely current liabilities and current assets so that maximizes stockholders s wealth and comprises important section of planning short financing. The increasing importance of working capital in continuation business units activities has cuased in forming different strategies such as aggressive strategy, conservative strategy or combination of them for working capital management, so that strategy used for working capital can affect on the quantity of company liquidity. Each strategy characterizes different return and risk. Financial managers must choice a suitable 551

strategy for managing company working capital with respect to different internal and external factors, and risk and return so that results in creasing return, liquidity, solvency and finally business activities continuation. In this study, the effect of working capital strategies on the accruals quality of working capital has been examined. Working capital strategies have been defined in terms of current ratio, quick ratio and combination of those for every company, yearly. Research findings show as much as conservative in working capital management increases, the quality of accruals will increase and companies which use aggressive strategy of working capital in comparesion with companies which use conservative strategy spend more sources for long term investments and keep less volume of current assets. Refrences [] Shahveisi, F, yousefi, N, Soltanzadeh, M. R (1), Studying the effect of working capital strategies on operational, financial and compound leverage in accepted companies of Tehran Stock Exchange. Master thesis, Islamic Azad University, Kermanshah Branch. [3] Talebi, M (8), Evaluation of working capital management position in Iranian Companies. PHD Thesis, University of Tehran. [4]Arab maziar yazdi, M, Mashayekhi, B, Rafiei, A(5). The content of cash and accrual flows in Iranian capital market, Journal of accounting and auditing researchs. [5] Mehrani, K, Wafisani. J, Hasani, A(11). The relation between debt contracts and firm size with conservatism in accepted companies in Tehran Stock exchange, Journal of accounting and auditing researchs. [6] Shiwa, H(7). Examining the effect of working capital strategies on stock returns. Quarterly Financial Accounting, 1.1-19. [7] Dastgir, M, Rastgar, M(11). Examining the relation between earnings quality, accruals and stock return with quality of accruals, Journal of financial accounting Researchs, year3, No. 1. [8] Mohammadi, A (7). The effect of working capital management on profitability of accepted companies in Tehran Stock Exchange, Journal of Researcher Management. [9] Nikoomaram, H, Rahnamaye Roodposhti, F, heibati, F (1). Fundamentals of managerial finance, Termeh Publication. [1] YaghoobneZhad, Vakilifard, Babaei (9). Relation between working capital management and profitability in accepted companies in Tehran Stock Exchange, Journal of financial engineering and portfolio management. [11]Jackson. B, (11), Does accounting quality enhance the timelines of price discovery? Research interaction forum. [1] J.Garcia.(11). The Impact of Working Capital Management upon Companies Profitability: Evidence from European Companies,fep working papers. n. pp438. [13] KessevenPadachi,(6). "Trends in Working Capital Management and its Impact on Firms Performance: An Analysis of Mauritian Small Manufacturing Firms" International Review of Business Research Papers Vo. No.., Pp. 45-58. [14] Qazi, Amir Shah, Abbas, Nadeem. Impact of working capital on firms profitability, African Journal of Business Management Vol. 5 (7), pp. 115-111, 9 November, 11. [15] Raheman and Nasr, (7) Working Capital Management And Profitability-Case Of Pakistan Firms International Review of Business Research Papers,Vol.3, pp.79 3. 55