1-1 Introduction
The purpose of this chapter is to present the background of the research problem and how to create research question. The delimitation’s, research gap and the expected role that the study can bring will be tested in the later part of the chapter.
1-2 Nature of the problem
Actually, most of the recent finance researchers have generally focused on large size companies deep understanding of long-term financial decisions, which include investments types, the capital source of fund, earnings dividends or corporation assessment decisions. On the other hand, short-term assets and liabilities are very important elements of total assets and must to be carefully examined. Managing of these short-term assets and liabilities needs a deep understanding, where those factors affecting directly the working capital management which play a critical role in an enterprise’s cost-effectiveness and risk as well as its value (Smith, 1980).
Effective management of working capital policy is very significant in the whole enterprise policy that leads to raising enterprise total value. Enterprises trying most of the time for keeping an ideal level of working capital that maximizes enterprise value (Deloof, 2003; Howorth and Westhead, 2003; and Afza and Nazir, 2007). from a different point of view, from the perspective of a Chief Financial Officer (CFO), working capital management is a very clear and direct concept of ensuring the capability of the enterprise to finance the difference between short-term assets and short-term liabilities (Harris, 2005).
In fact, working capital management has become one of the most critical problems in enterprises, but the difficult situation comes from that many financial managers are unable to find easy the critical determinants of working capital and the optimal level of working capital (Lamberson, 1995). As a result, enterprises can manage the whole performance risk by decrease risk and increase their overall performance if they can recognize the role and determinants of working capital.
An enterprise may follow an aggressive working capital management policy with a low percentage of total current assets as a portion of the sum of assets, or it may also be applied by depending on raising spontaneous finance choices of the enterprise in the style of a high level of current liabilities as a proportion of total liabilities. High levels of current assets may lead to making negative effect on an enterprise ’s profitability, on the other hand, a low level of current assets will causing to creating lower levels of liquidity and may raising the probability of inventory outs, raising problems in keeping smooth and stable operations (Van Horne,Wachowicz, 2004).
The main goal of effective working capital management is to have a stable balance among each element of the working capital components. Enterprises success totally depends on the success of the financial directors to efficiently manage the most three elements of enterprise operation receivables, inventory, and payables (Filbeck and Krueger, 2005). Enterprise can follow the quick steps that will bring fast results by decreasing their financing expenses and/or raising the finance viable for expansion projects by reducing the amount of money engaged in current assets. The problem comes from that Most of the financial directors’ time and hard efforts are spent in determining the optimal levels of non-long assets and liabilities once they think they found it they try to optimize them to optimal levels (Lamberson, 1995). But they should take into consideration that the ideal level of working capital is the one in which a balance is achieved between risk and efficiency.
We should understand that It needs a continuous process of identifying to keeping the optimal level of several elements of working capital, for example, cash, receivables, inventory, and payables. Totally, current assets are considered as one of the most critical components of total assets of an enterprise. To understand how it is very important an enterprise may easy be able to decline its investment in fixed assets by selecting another style of finance like renting or leasing plant and machinery, but Unfortunately same policy cannot be applied to the components of working capital. Some enterprise may depend on keeping a high level of current assets in order to decrease the risk of liquidity but this will raise the question about the opportunity cost of funds that may have been invested in long-term assets. The current study will explore the numerous determinants of working capital management.
1-3 Significance of the Study
Actually Working capital management has been an attention of many studies but recently more attentions are specifically in the segment of SMEs, ever since these enterprises facing problems in access to finance and normally do not reach the long-term funding for the causes of credibility and through capital markets (SEC regulations etc). as a result, the small and medium-sized enterprises solve the problem of access to finance by using general short-term capital funds generally suppliers credit, because it is supposed to be cheaper and more obtainable.
An additional important source of finance for small and medium enterprises is reserved capital, but this is very changeable because of it subject on the fact that enterprise manages to generate a capital surplus in earlier years. So these decisions and relevant management activities are taken by an enterprise management give us an important indicator for efficient handling of current assets. Commonly positive working capital usually gives indicator for efficient Working Capital Management. We can say that the goal of working capital is to balance between costs and benefits and maintain the optimum level of cash, raw materials, and goods.
If we look in depth at previous studies we will find that that “poor” or “careless” financial management is a most significant cause of failures among small enterprise (Smith 1973).A number of the most significant internal problems small enterprise want to stand on are inadequate capital, cash flows management, and inventory control. The clear fact that show that more than 20% of failures were as a result of written off debts or poor receivable management (Padachi, 2006).
We can see that in developed countries such as US, Canada, England, it has long been stable that effective management of working capital playing very important role for success and survival of small businesses (Deloof, 2003).In the latest financial crisis and the downfall that come after since 2008 have carried more attention and focusing on the investment that enterprises build in short-term assets and the capitals used with a maturity of less one year which represent the key portion of items on an enterprise balance sheet.
To add more evidence for important of working capital management One group of researchers concluded that efficient management of working capital is critical role for enterprises during the growing economic periods (Lo,2005) and when its managed strategically its leading to increase competitive position and profitability of the enterprise. Others put additional emphasis that improving working capital management is reasonably important for companies to withstand the influence of economic instability (Reason2008). This adds more evidence of the importance of short-term working capital management in enterprises all over the world and encouraged researcher’s attention.
On the other hand, Small and medium Enterprises play very important role in the development process of any country. They are a significant and stable source of employment creation and output growth in the developing countries as well as in the developed countries (Norton.E 1991).
In Egypt small and medium enterprise play a critical role in employment creation, poverty reduction, improving income distribution, industrial development, rural development and export growth.
Most small and medium enterprises depend on significantly on the internal source of capital for running their business operation and when their internal capitals are incomplete they have to look for outside source of finance where access is limited as we mention before. As a result, the probability for increasing or even living becomes limited. A further study by Bolten (1971) shown that working capital problems can be experienced by any enterprise as a normal internal problem of finance but it is usually small businesses which have most problems especially during their startup phase. This paper explores how working capital management and its components are managed in Small Medium Enterprises in Egypt
1-4 Research Objectives
From the problem background, we have recognized a clear shortage of studies within the area of Small Medium Enterprises working capital management in Egypt and in specific different working capital policies and the influence this can have towards the enterprise performance. This study examines the determinates of Working Capital Management in an organizational context, specifically Egyptian companies. Even though Many types of research of Working Capital Management have been accomplished in many countries around the world, the Understanding of Working Capital Management performs in an organizational background has neither been sufficiently Recognized nor understood.
1-5 Research purpose and Questions
The purpose of this research is to investigate the determinate working capital requirements of the Egyptian SMEs over the time span 2011-2014. By testing this relationship, we intend to investigate the determinates of working capital policy. Secondly, we want to test the theory behind the risk/return trade-off and see if risk increases with an aggressive policy. That will lead us to answer the following questions: –
1. Determine the factors affecting the working capital requirement.
2. Determine the factors affecting the behavior of cash conversion cycle.
3. Determine the effect of independent factors that explain the working capital requirement on working capital management efficiency.
4. Determine the effect of independent factors that explain the behavior of cash conversion cycle on working capital management efficiency.
5. Provide recommendations that helping Egyptian SMEs enhancing the efficiency of working capital management.
1-6 Research variables
Dependent variables
1- working capital requirement ( WCR )
The study observes the determinants of the working capital requirements of an enterprise. Working Capital Requirements (WCR_TA) were included as a dependent variable, as used by Shulman and Cox (1985), as a measure of working capital management (cash and equivalents + marketable securities + inventories + accounts receivables) – (accounts payables + other payables). Working capital requirements are deflated by total assets to control the size effect
2- Cash Conversion Cycle (CCC)
Cash Conversion Cycle (CCC) as a measure of working capital management, where a shorter CCC represents the aggressiveness of working capital management measured by the following Cash Conversion Cycle = Inventory days + Accounts Receivables days – Accounts Payable day
Independent Variable Measures:
1- Operating cash flows deflated by total assets (OCF_TA)
the cash flows generated from the routine operations of the enterprise and obtained directly from the cash flow statement as well as deflated by total assets. The high value of this ratio shows that the enterprise main operation generating enough cash this also decreasing operation risk.
2- Size
The Size ratios generally measure the enterprise dimensions about the age i.e. for how many years’ enterprise start business also measuring enterprise size and annual growth this dimensions are very important because it is affecting the decision related to policy of managing current assets and liability, the paper uses the following Natural log of total assets as proxy for the size for enterprise
3- Sales Growth
The growth ratios generally measure the enterprise dimensions about the age i.e. for how many years’ enterprise start business by annual growth, the paper uses the following current year sales subtracted last year sales divided by last year sales for the growth for enterprise
4- Return on assets (ROA)
As mentioned previous, most of the studies used to clarify the level of efficiency of working capital management concentrated on profitability as a significant factor. It is claimed that efficient working capital management results in low CCC and this would lead to speedy accessibility of cash flows and, hence, improved profitability
Dividing the net income of the enterprise by the total assets. This ratio indicates the ability of the enterprise to generate profit relative to assets .it’s measure the enterprise management efficiency of using assets. The high value of this ratio shows that the enterprise is efficient in the management of its assets and able to producing optimal use.
5- Leverage
The leverage/gearing ratio reflects the ratio of enterprise assets financed by liabilities. Dividing total debt to total assets ratio for the enterprises Small leverage ratio may show that the company produces high cash flows to finance upcoming expansion (expansion can be also financed by additional shares issued). Opposing to this, an enterprise reporting high leverage ratio may show that this enterprise produces low cash flows to finance its expansion. Therefore, it depends on outside borrowings.
6- Industry
Businesses working in different segments tend to have different capital structures, different operations, different products, different markets, different customers and different credit policies. All of these factors impact corporate working capital management. Therefore, it is reasonable to say that working capital management is influenced by industry category.
D1 = 1 if the enterprise belongs to trading sector and 0 if the enterprise belongs to another sector
D2 = 1 if the enterprise belongs to manufacturing sector and 0 if the enterprise belongs to another sector
D3 = 1 if the enterprise belongs to service sector and 0 if the enterprise belongs to other sectors
D1 = 1 if the enterprise belongs to agriculture sector and 0 if the enterprise belongs to other sectors
1-7 Research hypothesis
In order to achieve the study goals testing the accuracy of the following hypothesis
H1: There is a significant statistical relationship between working capital requirements and enterprise’s profitability.
H2: There is a significant statistical relationship between working capital requirements and enterprise’s size
H3: There is a significant statistical relationship between working capital requirements and enterprise’s cash flows
H4: There is a significant statistical relationship between working capital requirements and enterprise’s sales growth
H5: There is a significant statistical relationship between working capital requirements and enterprise’s level of leverage
H6: There is a significant statistical relationship between working capital requirements and industry type of the enterprise
H7: All the research independent variables have a joint significant statistical impact on working capital requirements.
H8: There is a significant statistical relationship between cash conversion cycle and enterprise’s profitability.
H9: There is a significant statistical relationship between cash conversion cycle and enterprise’s size
H10: There is a significant statistical relationship between cash conversion cycle and enterprise’s cash flows
H11: There is a significant statistical relationship between cash conversion cycle and enterprise’s sales growth
H12: There is a significant statistical relationship between cash conversion cycle and enterprise’s level of leverage
H13: There is a significant statistical relationship between cash conversion cycle and industry type of the enterprise
H14: All the research independent variables have a joint significant statistical impact on cash conversion cycle.
1-4 Research models
The first model
WCRi,t = α + β1 OCFi,t + β2 SIZEi,t + β3 ROAi,t + β4 LEVi,t + β5 GROWTHi,t + β6 INDSi,t + εit
The second model
CCCi,t = α + β1 OCFi,t + β2 SIZEi,t + β3 ROAi,t + β4 LEVi,t + β5 GROWTHi,t + β6 INDSi,t + εit
Where: –
I Enterprises of sample
T time= 1, 2…. 7 (from year 2011 to 2014),
α intercept of the regression
β1, β2, β3, β4, and β5 coefficients on each respective explanatory variables
WCR Working capital requirement for enterprise i at corresponding time t.
CCC Cash Conversation Cycle for enterprise i at corresponding time t.
OCF Operating Cash Flow for enterprise i at corresponding time t.
Size Natural logarithm of sales. for enterprise i at corresponding time t.
ROA Return on asset – for enterprise i at corresponding time t.
LEV Leverage for enterprise i at corresponding time t.
GROWTH 1-year growth of sales. for enterprise i at corresponding time t.
INDS Industry type: 1 trading, 2 Manufacturing, 3 service, 4 agriculture
εit is the error term of the regression – for enterprise i at time
1-9 Research limitations
The study is restricted to the determinates of working capital management of Small and medium enterprises in Egypt. The total sample size of the study is 300 Small and medium enterprises and the study took four years’ data from the year 2011 – 2014. The study covers only Small and medium enterprises in National bank of Egypt portfolio.
1-10 Research methodology
1-10.1 Data source and collection procedure
this study depending on the use of a secondary source of data. The secondary data was collected from audited financial statements of selected small and medium enterprises. These data include audited balance sheet and the income statement showing annual financial statements of the sampled enterprises. The data was collected for a period of four years. The period of the data collection was from the years 2011 to 2014.
Variables Required data Source
Net working capital total assets
NWC/total assets Cash, accounts receivable inventory, account payable, accrued expenses , total assets Financial statements
Cash conversion cycle
CCC Account receivable day on hand , inventory days on hands , accountable days on hands , total assets Financial statements
Operating cash flow /total assets
OCF/TA Operating cash flow , total assets Financial statements
Size Total assets Financial statements
Return on assets
ROA Net profit , total assets Financial statements
Leverage
LEV Liabilities , total assets Financial statements
Growth
GROWTH Cuuent years revenues , last year revenues Financial statements
Industry
INDS Sectors type Financial statements
1-4.1.1 Data analysis
collected data are reorganized, modified and calculated so that become complete data that is needed for this study. Next, these collected data are analyzed by using E-views. The last step is interpreting the result of E-view version 9’s output.
1-4.1.2 Statistical tests
1-4.1.2.1 Descriptive statistics
mean and standard deviation of the variables used in the study. In addition, it shows the
minimum and maximum values of each respective variable which essentially gives an
indication of how wide ranging each respective variable can be.
1-4.1.2.2 Checking problems of measuring tests
Test type purpose
Sharpiro – wilk Normal distribution for study variables
Correlation matrix Test for Multi collinearity
Panel unit roots tests dfffs
Diagnostic Analysis examine whether the sample is consistent with these assumptions:
1) The model is correctly specified
2) There is no relationship between independent variables (No multi collinearity).
3) There is no relationship among the error term at the period t and the error term at
period before t (No Serial correlation problem)
4) The error term is constant across the number of observations (Homoscedasticity).
5) The error term is normally distributed.
The Hausman test selection criteria (Random vs. Fixed effect model)
Diagnostic tests are robust statistical tests carried out to verify if the data used have met the
assumptions underlying the ordinary least squares regression and where possible to remove problems associated with panel data
The Jarque-Bera Testing for normality
reusch-Godfrey Serial Correlation LM Test Testing for serial correlation to detect
autocorrelation problem
Glesjer Test, Breusch-Pagan-Goldfrey Test Heteroscedasticity
1-5 Research Gap and Contribution
Most of the last preceding research that has been conducted within the area of working capital management has focused on large corporate and not much on what effects the small enterprises. These studies have mostly studied the type of the relation that working capital has with the profitability of corporate which is commonly measured by net income. There have not been many types of research done on discovering the determinates of working capital policies of the small and medium enterprise. We have found insufficient studies that are investigating the factors that affecting working capital management in small and medium enterprises segment so there is an obvious research gap. In addition, none of the studies we have found examine the determinates of working capital for Egyptians small and medium enterprises. The consequences of this research will be a support for both researchers and finance managers in the following ways:
Firstly, many previous studies have convinced that there is a relationship between the working capital management and the accounting profitability of corporates. Our study will, however, attention on determinates of working capital management for the small and medium enterprise.
Secondly, we try to explain a problem for the finance manager of a business to recognize what optimal level of working capital that is enough.
Thirdly, as a scientific contribution, this research can help further with the definition of the diverse working capital policies in defining at what levels one can be considered aggressive or defensive. Moreover, in regards to this at this time, there is not any inclusive or fine determined size of the concept of working capital policies so we aim to be descriptive in this approach in order to try investigates some different methods. This might help for coming studies in accomplishment an improved method to in how to quantify the working capital policies more correctly. To conclude, the study can help to determine the working capital policy of the small and medium enterprise.