ABSTRACT
There is ongoing conversation among researchers and practitioners on the role working capital variables play in determining the profitability of firms. The findings of previous research works have proven to be far from conclusive, having shown that the role of working capital management can, at best, be context specific. This means that there is the need to examine the relationship between working capital management and profitability in different contexts. While extant literature has shown research on this relationship, studies in Ghana have not considered what the differences will be for/in this relationship for local and foreign firms. The purpose of this study was, thus, to determine the relationship between working capital management and firm profitability in Ghana using data on the Ghana Stock Exchange (GSE) listed non-financial firms and compare the results for local and foreign firms. The study used the fixed effects technique to estimate a model on a panel of eighteen (18) firms from the period 2003 to 2016.
The study found a positive relationship between Account Payables Period (APP) and Return on Assets (ROA) for all samples, that is, the full sample and the local and foreign sub-samples. This relationship was however only significant for the foreign sample. The relationship between the Inventory Conversion Period (ICP) and ROA was found to be negative for all samples. These relationships were not statistically significant. The results for Receivable Collection Period (RCP) differed from one sample to another. Whilst it was positive in the foreign and local samples, it was negative in the full sample. It was, however, statistically significant only in the local sample. Finally, the results also show that Cash Conversion Cycle (CCC) has a negative relationship with ROA for all samples.
These results led to the following conclusions: First, working capital management has limited effects in determining the profitability of the listed firms that were sampled for this study. Secondly, good working capital management has a more beneficial effect on the profitability of foreign firms than on local firms. Thirdly, the only working capital variable that can be said to be able to improve profitability of local firms is the receivables collection period. Finally, the study concludes that the working capital management practices that work for local firms listed on the GSE do not yield the same results as for their foreign counterparts. It is recommended that foreign firms should negotiate for more lenient and flexible trade credit periods with their creditors. Local firms, on the other hand, should restrict the trade credit period allowed to their customers. Foreign firms should also aim at achieving overall shorter operating cycles in order to achieve the optimum level of profitability. Local firms should pursue firm growth in order to enhance their profitability
CHAPTER ONE INTRODUCTION
Background to the Study
Working Capital (WC) is the excess of a firm’s current assets over its current liabilities (Sagan, 1955). A firm’s asset can be defined as the benefits that are due to the firm as a result of events, such as contractual obligations and sale of goods, that occurred in the past and from which the firm is expected to obtain benefits in the future (International Accounting Standards Board [IASB], 2010). Assets also include resources that the firm controls as a result of past events that it expects to derive benefits from in the future. Some of these benefits that accrue from assets may be realised within one year, while others may be accrued in more than one year. The assets that these short-term benefits relate to are known as current assets and these are the assets considered as working capital. On the other hand, liabilities are regarded as the obligations that have arisen due to past events and are expected to result in an outflow of resources from the firm to another entity. Those liabilities that are due within a year from the end of the accounting period are referred to as current liabilities and these are important for working capital. The difference between these two items (i.e. total current assets and total current liabilities) is what is termed working capital or net current assets. Finance practitioners regularly review the balance of working capital to ensure that their firm stays afloat and is able to settle its obligations in due time. The processes involved in ensuring that the firm stays afloat and liquid at all times is what practitioners term Working Capital Management (WCM). Thus, Working Capital Management consists of matching a firm’s short-term assets and liabilities as they fall due. Firms that fail to manage their working capital well will inevitably become insolvent. Hence, efficient management of working capital is essential for the survival of firms in the long run (Bagchi,
Chakrabarti, & Basu Roy, 2012). It is partly because of this that working capital management is considered a critical part of the financial management of firms, together with capital budgeting and capital structure (Ansah, 2011; Deloof, 2003b; Edmunds, 1983; Kesimli & Gunay, 2011; Malik & Bukhari, 2014; Shubita, 2013).
Statement of the Problem
Researchers have studied various aspects of working capital and have attempted to explain how they affect the firm’s varied objectives (Aregbeyen, 2013; Goel, Bansal, & Sharma, 2015; Kiarie, 2013; Viskari, Lind, Kärri, & Schupp, 2012). One area that existing studies have mainly focussed on is the role Working Capital Management plays in improving the performance of firms in the non-financial sectors.
In the context of Ghana, there are few studies that have examined the WC-performance relationship. These studies have focussed on manufacturing firms (Korankye & Adarquah, 2013; Kwaku & Mawutor, 2014), SMEs (Agyei-Mensah, 2012; Attom, 2016) and listed firms (Agyemang & Asiedu, 2013; Fiador, 2016; Korankye & Adarquah, 2013; Kwaku & Mawutor, 2014). Notwithstanding the existence of these studies, it appears little is known, if any, about the differences in the relationship between the effects of WCM and performance of local and foreign firms. This is considered to be an interesting comparison for a number of reasons (Barine, 2012; Belt & Smith, 1991; Khoury, Smith, & MacKay, 1999; Moradi, Salehi, & Arianpoor, 2012).
First, foreign firms are generally bigger, and they have access to relatively cheaper funds, both in the local market and in their home country. Moreover, many of the firms have strong parent companies that support them in difficult times, and this has the potential of making them more
tolerant to risk (Anginer, Cerutti, & PerÃa, 2014; Jinjarak, 2007). Also, these firms are usually able to access trade credit more easily due to the perception that they are more creditworthy or ethical (Sweeney, Arnold, & Pierce, 2010). Foreign firms, however, also have exposure to currency and political risks which may adversely affect their bottom line (Cooper, 1984; GarcÃa- Canal & Guillén, 2008; Sarno & Valente, 2005).
Local firms, on the other hand, have lower capital and so, are usually smaller and participate in the low end of their industries (Domeher, Frimpong, & Mreku, 2014; Kayanula & Quartey, 2000). They are usually owned by families (mainly individuals in the context of Ghana) who rely extensively on their networks for trade credit (Tetteh & Frempong, 2007). They usually do not have access to formal forms of finance options because they do not keep organised (or complete) accounts and hence, struggle to access funds from the formal financial system (Nkuah, Tanyeh, & Gaeten, 2013; Ricky-Okine, Amankwaa, & Owusu, 2015; Schicks, 2011). In addition, local firms are perceived to be more likely to default and this compounds their limited access to financing options; when they have access, it comes with tougher conditions than for foreign firms (Abor, Biekpe, Emerging, Aug, and Taylor, 2007; Domeher , Frimpong, and Mreku., 2014; Kayanula & Quartey, 2000; Schicks, 2011).
These differences have important implications for Working Capital Management. First of all, firms that have limited access to financing will pay higher cost for finance, partly because poor record keeping means that there is no documented track record for many local firms. High cost of financing will have to be managed, and this is a Working Capital Management function. For foreign firms, political and currency risks will require pragmatic action to control, which are functions of working capital and treasury management. It is against this background that this study contributes to the WC-Performance literature by examining the differences between
foreign and local firms with a focus on non-financial firms that are listed on the Ghana Stock Exchange (GSE). Moreover, Ghana is a country which has a significant diversity of foreign firms that have thrived in Ghana for many years; this provides a good basis for comparing these foreign firms with the indigenous firms.
Purpose of the Research
The purpose of this study was to determine the relationship between WCM and profitability of firms listed on the GSE and to ascertain if this relationship differs among local and foreign firms.
Objectives of the Study
The objectives of the study are:
- To determine the effect of WCM on firm profitability of GSE listed non-financial firms.
- To determine the difference between the effects of WCM on firm profitability for local and foreign listed non-financial firms.
Research Questions
The study seeks to address the following questions:
- What is the effect of WCM on firm profitability among GSE listed firms?
- What is the difference between the effects of WCM on local and foreign listed non- financial firms’ profitability?
