Tài liệu Working capital requirement and profitability

International Research Journal of Finance and Economics ISSN 1450-2887 Issue 146 March, 2016 http://www.internationalresearchjournaloffinanceandeconomics.com Working Capital Requirement and Profitability: Evidence from Seafood Processing Enterprises in the Khanh Hoa Province of Vietnam Nguyen Thanh Cuong Corresponding Author, Faculty of Accounting and Finance Nha Trang University, VietNam E-mail: [email protected] Nguyen Thi Hong Nhung Faculty of Accounting and Finance, Nha Trang University, Viet Nam E-mail: [email protected] Abstract Investment decisions in working capital is crucial for any business organization. The purpose of this research is examining the relationship between working capital requirement and firm’s profitability. A sample of 38 seafood processing enterprises in Khanh Hoa province of Vietnam for a period of 9 years from 2006 to 2014 was selected. Panel data methodology was employed and Generalized Method of Moments (GMM) was used as estimation technique. The results show that there is an inverted U-shaped relation between investment in working capital and firm's profitability. This finding implies that there exists an optimal level of investment in working capital in order to maximize a firm's profitability. Specifically, companies should not invest more than 32% of working capital to total assets. To ensure and enhance the corporates’ profitability, optimal investment range of working capital should be below 32%. In addition, study results also showed that promoting revenue growth, improving asset efficiency and using reasonable financial leverage can increase firm's profitability. From this results, the article proposes some policies implications for seafood processing enterprises in Khanh Hoa province of Vietnam in making investment decisions on working capital reasonably in order to maximize a firm's profitability. Keywords: Working Capital Requirement, Investment in working capital, Profitability JEL code: G31, G32 1. Introduction Making financing decisions is very important to firms. Investment decisions on working capital involve in dealing with short term balance of current assets and current liabilities. The management of current assets and current liabilities refers to working capital management. Working capital management is a very important factor that affects firm’s profitability and risk, and thus affects firm’s value (Shin and Soenen, 1998). On the other hand, according to Brigham and Houston (2011), about 60 percent of financial manager’s time is spent for management of working capital. Thus, companies can maximize profit and minimize risk if managers understand the importance of working capital management. In acknowledgement of this importance, most previous studies in different countries have International Research Journal of Finance and Economics - Issue 146 (2016) 93 focused primarily on how investment in working capital affects a firm’s performance (e.g., Shin and Soenen, 1998; Deloof, 2003; Lazaridis and Tryfonidis, 2006; Nobanee et al., 2009; Mohamad and Saad, 2010; Gill et al., 2010; Dong and Su, 2010; Vijayakumar, 2011; Garcia, 2011; Mansoori and Muhammad, 2012; Napompech, 2012; Ukaegbu, 2014; Baños-Caballero et al., 2014; among others). Khanh Hoa province of Vietnam has many outstanding advantages to develop seafood processing industry. This is one of the major export sectors of Khanh Hoa province. In the current trend of integration, one of the problems posed to Khanh Hoa seafood processing enterprises is that how to managing working capital to improve the company performance, contributing to increase corporate’s value. To solve this problem, companies need to know the effect of working capital management on firm’s profitability. Therefore, it is necessary to conduct a study to show that how working capital requirement has impacted on firms’ profitability. This research focused on the relationship between working capital requirement and firms’ profitability to help Khanh Hoa seafood processing enterprises in building working capital investment policies timely consistent to improve corporate performance, contributing to increasing corporate’s value. This paper is divided into five sections. The next section reviews the previous literature and develops testable hypotheses. In section 3, we describe our empirical model and data. The fourth section presents the results of the empirical analysis. Finally, we summarize our findings and suggest some implications in the last section. 2. Literature Review and Hypotheses Investment decisions on working capital will focus on management of cash, inventories, accounts payable and accounts receivable. Until now, researches on the relationship between investment in working capital and company performance have been done many in international and Viet Nam. The results of previous studies formed the different views about this relationship. Shin and Soenen (1998) used Net Trade Cycle (NTC) as a measure of working capital management. They discovered a negative relation between NTC and corporate’s profitability for a sample of US firms in the period of 1975-1994. This result showed that managers should reduce cash conversion cycle to a minimum point in order to obtain higher firms’ value. Lazaridis and Tryfonidis (2006) used cash conversion cycle (CCC) as a measure of working capital management for a sample of companies listed on Athens stock market in the period of 2001-2004 and have also found a negative relationship between CCC and the gross profit margin. With the results of finding, they claimed that managers should handle the cash conversion cycle correctly and keep each different of its component to an optimum value to create value for shareholders. Garcia (2011) in Europe, Ukaegbu (2014) in Africa, Nobanee et al. (2009) in Japan, Mohamad and Saad (2010) in Malaysia, Vijayakumar (2011) in India, Mansoori and Muhammad (2012) in Singapore, Napompech (2012) in Thailan, Dong and Su (2010) in VietNam also found the similar relationship between cash conversion cycle and profitability of the company. In contrast, the second point is that the more companies invest in working capital, the more revenue increases, the time of payment is shorter and, therefore, that may increase the enterprises’ value (Deloof, 2003). Similarly, Gill et al. (2010) studied the relationship between working capital management and profitability of 88 US firms listed on the New York Stock Exchange from 2005-2007 and also found a positive relationship between cash conversion cycle and profitability. Recently, a third opinion is that there exists a optimal level of working capital investment balance between costs and benefits in order to maximize the enterprise’s value. Specifically,BañosCaballero et al. (2014) used Net Trade Cycle (NTC) as a measure of working capital management. They confirm a large and statistically significant inverted U-shaped relation between corporate performance and working capital for a sample comprises non-financial quoted firms from the United Kingdom in the period of 2001–2007. Based on the empirical evidence on these, this paper aims to examine whether there exists the optimal threshold between the level of investment in working capital and profitability of seafood 94 International Research Journal of Finance and Economics - Issue 146 (2016) processing enterprises in Khanh Hoa province of Vietnam or not. Therefore, the hypothesis posed in this study is: "there exists an optimal level of investment in working capital for the seafood processing enterprises in Khanh Hoa province of Vietnam". 3. Empirical Model and Data 3.1. Specification of the Model and Estimation Methods Based on the estimated model of Baños-Caballero et al. (2014), to test the hypothesis, we regress corporate profitability against working capital requirement (WCR) and its square (WCR2). Additional variables are also presented in the profitability regression model to control for other potential influences on the firm's profitability. Therefore, this study estimates the following model: + + + , , = , + , + , + , + , + , + where , is the variable representing the profitability of firm i in year t. WCRi,t is the variable representing working capital requirement of firm i in year t. TDTAi,t, SIZEi,t, SGi,t, ROAi,t, which are the control variables may affect the profitability, represents capital structure, firm size, growth opportunities and return on assets of firm i in year t. The parameter λt is a time dummy variable that aims to capture the influence of economic factors that may also affect corporate performance but which companies cannot control. ηi is the unobservable heterogeneity or the firm's unobservable individual effect, so we can control for the particular characteristics of each firm. Finally, εi,t is assumed to be independent and standard distributed (εi,t ~ iid (0, σ2)). To test the hypothesis, we estimated our models using the two-step generalized method of moments (GMM) estimator based on Arellano and Bond (1991), which allows us to control for endogeneity by using instruments. To determine the appropriate nature of the instrumental variables or test the limits of endogenous in the model, the test of Hansen and Sargan was used in this study. At the same time, we used the Arellano-Bond test to check the phenomenon of autocorrelation for residuals. Besides, we also used a formal test to ensure that the multicollinearity problem is not present in our analyses. Specifically, we calculated the variance inflation factor (VIF) for each independent variable in our models. 3.2. Data and Measurement Variables To proceed with estimating the impact of investments in working capital to the profitability of Khanh Hoa seafood processing companies, we used secondary data collected from financial statements of 38 Khanh Hoa seafood processing enterprises in the period of 2006-2014. Period unit to determine the value of variables is year, the total number of observations used in the model is 342. In this study we only used book value to measure the variables. The market value is not used because most Khanh Hoa seafood processing companies is now unlisted. The variables in the model are measured as follows: Corporate profitability (ROE): There are many indicators measuring the profitability of firm as Tobin's Q, EVA, ROE, ... However, in this paper, we can not be calculated in market value. Therefore, we used ROE represents corporate profitability. This measure is in line with Ross et al. (2008), Cuong (2014), ... !" $ "% "$& = '(!") Working capital requirement (WCR): Unlike Baños-Caballero et al. (2014), we used indicators working capital requirement to total assets representing investments in working capital of enterprises. This measure is in line with Chiou et al. (2006), Azeem and Marsap (2015). ( %*" $++%"+ − -!$.!/!"!%+ = "$/ $++%"+ According to research results of Baños-Caballero et al. (2014), capital structure(TDTA), firm size (SIZE), growth opportunities (SG), return on assets (ROA) are control variables that affect International Research Journal of Finance and Economics - Issue 146 (2016) 95 corporate profitability. Unlike Baños-Caballero et al. (2014), in this study, the control variables is measured as follow: = - 0$ !"ℎ2 " "$/ $++%"+ "$/ /!$.!/!"!%+ = "$/ $++%"+ 3 %4%*(% "ℎ% )%$ $ "% − %4%*(% "ℎ% )%$ .% %5 = %4%*(% "ℎ% )%$ .% % !" .% % !*"% %+" $*6 "$&%+ = "$/ $++%"+ The measurement way of control variables in this study is accordance with previous studies. Such as Deloof (2003), Chiou et al. (2006), Cuong (2014), ... 4. Empirical Results and Discussion 4.1. Descriptive Statistics Table 1 presents the descriptive statistics for all variables, which used in this research. All these variables are calculated based on the formula in Section 3.2 and on the basis of the financial information collected from balance sheets and annual business outcome reports of 38 Khanh Hoa seafood processing enterprises during 2006–2014 periods. The total number of observations is 342 firm-years. Table 1: Descriptive Statistics Mean Median Std. Dev. Minimum Maximum CV ROE 0.044 0.032 0.241 -1.544 0.993 5.432 WCR 0.118 0.087 0.251 -0.796 0.853 2.128 TDTA 0.609 0.640 0.229 0.006 0.988 0.375 SIZE 23.952 23.947 1.699 19.564 28.569 0.071 SG 0.180 0.061 0.798 -0.992 6.665 4.429 ROA 0.054 0.043 0.091 -0.324 0.620 1.679 Notes: Std. Dev. denotes standard deviation. For the coefficient of variation (CV), the higher the number indicates the larger the dispersion of the variable, and the lower the number of CV, the smaller the dispersion of the variable. Statistical results described in Table 1 show, the average ROE of Khanh Hoa seafood processing companies is 0.044, that means each VNĐ in equity that corporate used in business has brought 0.044 profit after tax per year. This shows that the profitability of Khanh Hoa seafood processing companies is relatively low. The median value, standard deviation, minimum value, maximum value and variation coefficient of ROE are 0.032, 0.241, -1.544, 0.993 and 5.432 respectively. Average WCR is 0.118, that means the rate between working capital requirement to average total assets is 11.8%. The median value, standard deviation, minimum value, maximum value and variation coefficient of WCR are 0.087, 0.251, -0.796, 0.853 and 2.128 respectively. The statistical parameters of the control variables (TDTA, SIZE, SG, ROA) are presented in detail on Table 1. Descriptive statistical analysis shows that the variation coefficients of ROE, WCR, SG and ROA are high. This implies that the profitability of equity, the ratio of working capital requirement to total assets, revenue growth and return on assets in Khanh Hoa seafood processing enterprises have strong fluctuations . 4.2. Correlation Analysis Phenomenon of multicollinearity is a problem often encountered in the estimation of multiple regression model. If multicollinearity exists that will makes the estimated results inaccurate.To test the existence of multicollinearity in regression model, variance inflation factor (VIF) is used. If the value 96 International Research Journal of Finance and Economics - Issue 146 (2016) of variance inflation factor exceeds 10, it indicates there is serious multicollinearity (Studenmund, 2011).The results in Table 2 shows that the magnification factor variance factorization (VIF) of the independent variables in the model are less than 1.6. Thus, we can conclude that there is no multicollinearity problem in the model. Table 2: Correlation matrix and VIF factors ROE WCR TDTA SIZE SG ROA VIF ROE 1.000 WCR ***0.291 1.000 1.57 TDTA ***-0.190 ***-0.568 1.000 1.51 SIZE 0.043 -0.098 ***0.211 1.000 1.07 SG 0.093 0.072 -0.085 0.072 1.000 1.02 ROA ***0.752 ***0.341 ***-0.208 0.077 0.031 1.000 1.15 Notes: ***, ** and * indicate significance of 1%, 5% and 10% respectively. VIF is calculated by 1/(1-R²), with R² stated in the regression model result using STATA. 4.3. Results of Regression Table 3 presents the regression results of the impact of working capital requirement on profitability of Khanh Hoa seafood processing enterprises according to GMM estimation method. Table 3: The relation of ROE with the working capital requirement Independent variables Coef. t-Stat. WCR 0.194 5.95 WCR2 -0.302 -8.99 TDTA 0.223 9.20 SIZE -0.037 -12.80 SG 0.019 5.52 ROA 1.986 41.48 Number of observations 266 Arellano-Bond test on autocorrelation (m2): z = -1.54 ; Pr > z = 0.124 Sargan and Hansen test on the validity of model: Sargan test: χ2(27) = 31.36 ; Prob > χ2 = 0.256 Hansen test: χ2 (27) = 30.02 ; Prob > χ2 = 0.313 Notes: ***, ** and * indicate significance of 1%, 5% and 10% respectively. Sig. 0.000*** 0.000*** 0.000*** 0.000*** 0.000*** 0.000*** Results in Table 3 shows that all the variables in the model are statistically significant at 1%. On the other hand, results of Hansen and Sargan test on the validity of the model shows that the value of Prob > χ2 are greater than 10%, meaning that the model has validity. In addition, the results of Arellano-Bond test for autocorrelation at level 2 (m2) shows the value Pr > z greater than 10%, meaning that there is no chain correlation phenomena of grade 2 in the model. Thus, all the results estimated by GMM are significant. From the results of Table 3, Figure 1 simulates the relationship between working capital requirement and profitability of Khanh Hoa seafood processingenterprises. In Table 3, the estimated coefficients of WCR is 0.194 (β1 > 0) and that of WCR2 is -0.302 (β2<0), both of them are statistically significant at 1%, implying that the relationship between the working capital requirement and profitability is non-linear and inverted U-shaped form as shown in Figure 1. According to this result, maximum ROE value is at point WCR by 32%, implying that the optimal level of working capital investment for Khanh Hoa seafood processingenterprises is 32%. This result implies that the excess working capital investment can reduce the profitability. This result supports our hypothesis and is in accordance with the study of Baños-Caballero et al. (2014). International Research Journal of Finance and Economics - Issue 146 (2016) 97 Figure 1: 1 The relation of ROE with the working capital requirement For control variables in the model, the estimated results showed that the estimated coefficient of TDTA is 0.223 statistical significance significance at 1%, implying that the increase in debt may increase profitability for companies. This result is consistent with theory ofModigliani ofModigliani and Miller (1963)and (1963) the results of experimental studies of Baños-Caballero Baños Caballero et al. (2014). (2014). However, However, according to research results of Cuong (2014), (2014), to ensure and enhance the value of enterprises, the optimal range of TDTA in south central seafood processingenterprises, including enterprises in Khanh Hoa should be lower than 57.39%. On the other hand, the estimated coefficient of SIZE is -0.037, 0.037, statistically significant significant at 1%, implying that the expansion of asset size is not the solution to improve the profitability of Khanh Hoa seafood processingenterprises. This result is consistent with the findings of Baños-Caballero Baños Caballero et al. (2014).. However, the estimated coefficient SG is of 0.019, statistically significant at 1%, implying that the revenue growth growth will contribute to improving the profitability of Khanh Hoa seafood processingcompanies. This result is consistent with the findings of Baños-Caballero Baños Caballero et al. (2014). (2014) In addition, the estimated coefficients of ROA is 1.986, statistical significance at 1%, indicating improving asset efficiency will contribute to improving the profitability profitabil of Khanh Hoa seafood processingcompanies. These results are entirely consistent with the current reality of the companies. 5. Conclusions and Implications Investment decisions in working capital is very important for all businesses because there is a strong influence on corporates’ profitability, profitability, and therefore it affects the enterprises’ value. This study applies GMM estimation method on a sample of 38 Khanh Hoa seafood processingenterprises in period 20062006 2014 to investigate the relationship between between working capital requirement and corporates’ profitability. profitability We found a reverse U-shaped U shaped relationship between investment in working capital and corporates’ profitability. In addition, this study provides new evidence that there exists an optimal level of profitability. investment nvestment in working capital at 32%, while the investment in working capital is more than 32% that will reduce the corporate profitability of enterprises. This result supports the hypothesis set out and the findings of previous authors. For control variables, variables, according to experimental results, boosting revenue growth and improving asset efficiency can contribute to increase corporates’ profitability. profitability. However, the expansion of asset size may reduce corporates’ profitability. profitability. At the same time, firms need to use u financial leverage to improve corporate profitability, profitability, but it should not exceed 57.39%. From these results, some policies implications for Khanh Hoa seafood processing businesses in making investment decisions in working capital. First, companies should not invest more than 32% of working capital to total assets. To ensure and enhance the corporates’ profitability, profitability, optimal investment range of working capital should be below 32%. Second, if companies currently have higher working 98 International Research Journal of Finance and Economics - Issue 146 (2016) capital investment rates than 32%, managers should set an investment target of working capital, and then gradually move toward the goal for maximizing profitability. Third, the managers of firms which has proportion of investing in working capital currently lower than 32%, should plan to invest more to improve the profitability of enterprises. Finally, in relation to the management of working capital, the managers should have policies for revenue growth, manage and use assets more efficiently, increase financial leverage in a reasonable manner to contribute to improve and enhance the profitability of corporate. Financial statements of most unlisted Seafood Processing Enterprises in Khanh Hoa province of Vietnam are not audited. 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