The Explanatory Of Variables

Published Date: 02 Nov 2017

Chapter 3

Methodology

The purpose of this study is to identify the impacts of working capital management on profitability with reference to listed companies in Mauritius. This chapter provides details about the selected companies included in the sample, the variables used and the statistical techniques applied in the investigation.

3.2 Research Design

3.2.1 Quantitative and Qualitative research

Quantitative research measures variables with some precision using numerical scales. In short, it gathers data in numerical form which can be put into categories or measured in units of measurement.  This type of data can be used to construct graphs and tables of raw data. On the other hand, qualitative research refers to direct observation of behavior or transcripts of unstructured interviews with informants. Besides, qualitative research gathers information that is not in numerical form including open-ended questionnaires, unstructured interviews and unstructured observations.  This study is based on quantitative data.

3.2.2 Sample

The sample consists of 20 listed companies operating in diverse activities and for which data was available for a six year period, covering the accounting period of 2007 to 2011. The data used in this research was acquired from the Stock Exchange of Mauritius (SEM). The reason why we chose only listed firms is primarily due to the reliability and availability of the financial statements. Furthermore, data was also collected from Registered of companies of Mauritius due to unavailability of annual reports on stock exchange.

3.2.3 Population

Out of 50 listed firms, only 20 companies listed on the SEM were selected for the sample of the study. Others were ignored due to lack of information during that particular period and the activities undertaken by these companies were different. Moreover, insurance and investment companies were also excluded from the sample. The targeted population of 20 listed firms on the stock exchange of Mauritius is as follows:

Table : List of selected listed companies

Forges Tardieu Limited

Livestock Feed Limited

Les Moulins de la Concorde Ltee

ENL Limited

Ciel Textile Limited

Sun Resorts Limited

Ireland Blyth Limited

New Mauritius Hotels Limited

Omnicane Limited

Quality Beverages Limited

Lux Island Resorts Limited

The Medical & Surgical Centre ltd

Medine Limited

Chemco Limited

Air Mauritius Limited

Gamma Civic Limited

Innodis Limited

Bychemex Limited

Air Mauritius Limited

United Basalt Products Limited

3.2.3 Data Collection Procedure

The main source of data used in this study are from secondary data from annual reports of selected companies including income statements, cash flow statements and statements of company position. Data relating to the sales, receivables, payables, inventory, and operating income are processed manually. The selected data was supplemented through personal unstructured interview of senior personnel of accounts department. Moreover, the main information and data have been collected from head office. Secondary data is used for this study because data from such source is accurate, free from bias and provides opportunity for replication.

3.3 The explanatory of variables

The independent, dependent and control variables are explained in this section which will be used in the analysis. Furthermore, the reasons for the choice of these variables are also explained. The independent variable represents the value that is manipulated whereas the dependent variable represents the result of the independent variables which are manipulated. On the other hand, the control variables represent the variables that influence these values.

3.3.1 Dependent variables

Profitability is the dependent variable and it will be measured by the Return on Assets (ROTA). Besides, ROTA is defined as profit before interest and tax divided by total assets. The reason for choosing this variable is that the ROTA represents the ratio of how much a firm has earned on its asset base (Melicher and Leach, 2009). ROTA has been used as dependent variable by Garcia-Teruel and Martinez-Solano (2007), Karaduman et al (2004), Padachi (2006), Enqvist et al (2011) and, Sharma and Kumar (2011). Thus, the ROTA will also be used in this study as dependent variable because according to the net profit in relation to the company asset base is a good way to measure the extent of returns on investments made in the company.

3.3.2 Independent variables

3.3.2.1 Cash Conversion Cycle (CCC)

The CCC will also be used to measure the profitability. The reason to choose the CCC is because, according to Garcia-Tereul and Martinez- Solano (2007), the decision of how much to invest in customer and inventory accounts, and how much credit to accept from suppliers are reflected in the CCC. This measure is determined by the following equation:

CCC = Accounts Receivables(Days) + Inventory(Days) – Accounts Payable(Days)

Moreover, Melicher and Leach (2009) define the CCC as the amount of time taken to buy materials and produce a finished good (the inventory-to-sale conversion period) plus the time needed to collect sales made on credit (sales-to-cash conversion period) minus the time taken to pay suppliers to pay for purchases on credit (the purchase-to-payment conversion period).

3.3.2.2 Accounts Receivable Collection Period (AR)

The AR indicates how long it takes for a company to collect their money from their customers. It can be calculated by:

Receivables Collection Period (Days) = Receivables / Sales * 365

3.3.2.3 Inventory Turnover (INV)

The inventory collection period or inventory conversion period indicates the time of a product between entering the firm as raw materials, and the moment of selling the product. It is calculated by the following formula:

Inventory Turnover (Days) = Inventory / Cost of sales * 365

3.3.2.4 Accounts Payables (AP)

AP measures the length of time that the company takes in order to pay its suppliers. It is further calculated by the following ratio:

Average Payment period (Days) = Payables / Cost of sales * 365

3.4 Control variables

The profitability of a firm is the control variables which are: the firm size, the financial debt ratio and the real Gross Domestic Product.

3.4.1 Firm Size (LOS)

The LOS is considered as a control variable because large companies have bargaining power and consequently, they receive favorable extended credit terms from suppliers. On the other hand, smaller companies may be required to pay their suppliers immediately. Another way where the size of a firm can make a difference is that large companies can purchase large quantities of goods. The firm size will be determined by the natural logarithm of sales. Researchers who have used this variable as control variable are: Deloof, 2003; Padachi, 2006; Lazaridis and Tryfonidis (2006); Dong and Su (2010).

3.4.2 Financial Debt Ratio (LEV)

Financial Debt Ratio (leverage) shows how much firm’s assets are financed through external debt. In case, the financial charges resulting from external financing is greater than the earnings before interest and taxes then, the firm can suffer from great losses. This ratio will be calculated as follows:

Short term Loans + long term loans / Total assets

Studies in which this control variable is used include: Deloof, 2003; Lazaridis and Tryfonidis (2006); Dong and Su, 2010. This variable is used in this study because companies take debt from financial institutions and at specific times the firms have to pay the debt with interests.

3.5 Hypotheses

Based on the previous studies done by researchers in which they determine how the working capital components in firms affect the profitability, the following hypotheses are identified:

Hypothesis H1: The relation between profitability and the average receivables collection period is negative.

This hypothesis affirms that the more credit the company extends to its customers the less profit the company will make and vice versa. Lazaridis et al (2006) concluded in their study that firms with low profits tend to decrease their accounts receivables in order to minimize the cash gap in the cash conversion cycle.

Hypothesis H2: The relation between profitability and the inventory collection period is negative.

This hypothesis denotes that the profitability of a firm will decrease if the firm invests more in, the inventories. Lazaridis and Tryfonidis (2006) found a negative relationship between number of day’s inventory and profitability and they elucidate that if too much capital is tied to inventories in times of low sales, the profitability of the firm will be affected.

Hypothesis H3: The relation between profitability and the average payment period is positive.

This hypothesis states that if the company lengthens the time to pay its suppliers the more profit it will make. According to Deloof (2003) accounts payable is used as a short term source of finance. The company can assess the quality of the products bought. However, with the late payment of the products the firm may miss the opportunity to gain from early payment discounts.

Hypothesis H4: The relation between profitability and the length of the cash conversion cycle is negative.

This hypothesis implies that the longer the cash conversion cycle will be the less profit the company will have. The shorter the cash conversion cycle is, the higher the profit the company will generate. Gill et al (2010) states that a long conversion cycle can increase the profitability because of the higher sales accomplished. On the other hand, the profitability can reduce due to the cash conversion cycle when the investments in working capital is higher than the benefits attained from holding more inventories and extending more trade credit to customers.

3.6 Analysis of the study

In this dissertation, descriptive statistics will be calculated through the statistical software STATA in order to determine the means, standard deviation, minimum and maximum values of the variables used in the study. In addition, the Pearson correlation analysis will also be used in order to determine the relationships between the variables of the study. Furthermore, regression analysis will also be conducted in order to find out the impact of working capital management on the profitability of firms.

3.7 Conclusion

The next chapter refers to data analysis consisting of descriptive statistics, the Pearson correlation analysis and regression analysis of the sample.