Abstract
Working capital is an important component in financial decision of the company. An optimal working capital management is reached through a trade off between profitability and liquidity. This study aims to provide empirical evidence about the effects of working capital management on profitability of panel sample of 386 small and medium Tunisian exporting companies observed from 2001 to 2008.
The coefficient results of fixed and random effects models provide negative relationship between corporate profitability and the different working capital components. This reveals that Tunisian exporting SMEs should shorten their cash conversion cycle by reducing the number of days accounts receivables and inventories to increase their profitability. Besides, the export dimension (measured by export intensity and number of foreign markets) and the size of the company positively influence its profitability. Then, economics of scale of larger companies and their export performance lead to enhance their profitability.
Key words: Working capital management - Corporate profitability - Panel data- Tunisian exporting SMEs.
Introduction
The Tunisian capital market appears to be relatively little developed and SMEs suffer from credit rationing (Bellouma and al., 2009). Particularly, they are characterized by short liquidity and a high level of current assets. Besides, they generally adopt an informal working capital management which may increase the probability of their default. Beaver (1986) argues that "the firm is viewed as a reservoir of liquid assets … The solvency of the firm can be defined in terms of the probability that the reservoir will be exhausted, at which point the firm will be unable to pay its obligations as they mature" (p. 80). Therefore, the companies need to maintain a larger reservoir to respond rapidly and properly to unexpected changes in the environment (interest rates, raw material prices…). More precisely, they have to control and monitor their working capital to guarantee their short-run solvency and survival. The study of Larsen and Lewis (2007) suggests that the main reasons of SMEs failure are short-term liquidity problems and insufficient working capital.
Traditionally, the corporate finance literature has studied long-term financial decisions (investments, capital structure, dividends…). However, management of short-term assets and liabilities deserves a careful analysis since the working capital management has an important effect on the firm's profitability (Smith, 1980).
A small empirical study has been conducted to observe this relationship. All the existing papers use data from the US (Filbeck and Kreuger, 2005) and Europe (Deloof 2003; Lazaridis and Tryfonidis, 2006 and Uyar, 2009). Hence, researchers have almost focused on large companies operating in developed countries. Lessons from these studies are not directly applicable to an emerging market economy like Tunisia. In fact, companies are relatively small sized and rely greatly on internal financing, short term debt and trade credit to finance their working capital requirement (Saccurato, 1994 and Chittenden and al., 1998).
Even if working capital management concerns all businesses, it is more important for small and medium sized exporting companies. In fact, they must be able to face international changes and competition especially in the context of the financial crisis that has spread from 2007 and continued to date [1] . Besides, not only the lack of timely and appropriate working capital does present additional costs but also an internal barrier for export activity. Thus, small and medium Tunisian exporting companies must pay more attention to manage their working capital. Keeping this in view, this study is the first attempt to identify the impact of working capital management on corporate profitability from a Tunisian dataset. In addition to this contribution of our paper, the econometric approach is based on panel data analysis to control Tunisian exporting SMEs in both individual and temporal sides.
The paper is organized as follows. Section two briefly provides the literature review and presents the hypotheses. Section three describes the methodology adopted. Section four exposes the findings. Finally, section five concerns the conclusion.
Literature review and derivation of hypotheses
Working capital management is the management of company's short-term assets and short term liabilities (Deloof, 2003). It intends to guarantee the sufficient ability of the company to continue its activity and to face operational expenses. Indeed, if the company cannot maintain a suitable level of working capital, it is expected to become insolvent. More explicitly, the working capital is the investment required from the time lag between the purchase cost of raw materials and the sale of finished products. Its management involves accounts receivable and payable, inventories and cash. Thus, the non synchronous nature of flows makes managing working capital essential for understanding liquidity needs.
In this section, the literature for the relevant theoretical and empirical research on working capital components (inventories, accounts payable and receivable) and their effects on corporate profitability is first exposed. Then, existing literature on liquidity and its influence on profitability is presented. On the basis of this overview, testable hypotheses are derived.
II.1. The interaction between working capital management components: The vector of enhancing profitability
The crucial factor of working capital management concerns the management of inventories, accounts receivable and payable. In other words, the main decision in managing working capital is how these components will be arranged. As stressed by Ganesan (2007), working capital management must provide an efficient mix between working capital components to ensure the capital adequacy of the company.
Inventory and corporate profitability
In the sphere of inventory managing, the company aims at holding a minimal acceptable level of inventory with regard to its costs (Toomey, 2000). Thus, this decision is a compromise between reducing risk by keeping large inventory and limiting the related costs (Guariglia and Mateut, 2006). Indeed, maintaining large inventory means using capital to finance it and to cover different costs (transport, insurance, storage, obsolescence, spoilage ...) (Long and al., 1993; Deloof and Jegers, 1996).
However, keeping a low inventory level may lead to lost sales and stock-out (Deloof, 2003). Robinson and al., (1986) argue that inadequate inventory planning is the major source of SME failure since the incapacity to send required goods to customer handicaps the company's long-run viability.
The supply chain encompasses activities of planning and supervising raw materials, components and finished products from suppliers to final customers (Giunipero and al., 2008). Inventory flexibility is the crucial dimension in supply chain management (Koste and Malhotra, 1999) [2] . It reflects the ability of the company to include customer demand fluctuation on time and quantity into the planning cycles. Such practice requires an effective coordination between the company and its suppliers, especially in case of an increasing demand. Consequently, inventory flexibility must be observed from an integrative perspective.
In addition, the company's level of inventory depends on the sector of activity. In fact, Uyar (2009) suggests that retail and wholesale companies store inventory for short period compared to manufacturing one.
From an empirical view, Deloof (2003) points that managers of Belgian firms can enhance profitability and create value for their shareholders by decreasing the period of turning raw materials into cash. Similarly, Gaur and Kesavan (2006) propose a model explaining inventory behavior among retailing companies. They found that inventory turnover is negatively associated with gross margins. Recently, Ganesan (2007) advocates that short inventory allows telecommunication equipment American companies' to rely less on external financial market. In fact, they may invest daily operation funds in growth projects.
This discussion yields the following hypothesis:
H1: More profitable Tunisian exporting SMEs maintain low level of inventory.
Accounts payables and corporate profitability
Based on trade credit theory, suppliers collect additional information over traditional financing channels. Accordingly, trade credit is a cheaper substitute to bank credit (Petersen and Rajan, 1994). Besides, by delaying payments to suppliers, the manager allows the firm to beneficiate from a flexible source of financing and a low probability of receiving poor quality materials.
Conversely, trade credit deprives the company of early payment discount which can be considered as an implicit cost. Thus, the company uses credit from suppliers when other financing sources are not available. Furthermore, trade credit may damage the company reputation in case of non payment of the supplier. According to those disadvantages related to lengthening the payable period, Deloof (2003) and Lazaridis and Tryfonidis (2006) find a negative relationship between profitability and the number of days accounts payable. This result is consistent with the view that more profitable companies pay their bills in a short period.
This discussion yields the following hypothesis:
H2: Less profitable Tunisian export SMEs wait longer to pay their suppliers.
Accounts receivables and corporate profitability
Receivables from customers are important components of the current assets. As a result, any change in their magnitude can influence the financial viability of a company. The firm's decision concerning trade credit depends on many factors such as: market competition, offered goods or services, price, customer... Moreover, as pointed by Grzergorz (2008), the decision of granting trade credit is a compromise between limiting the risk resulting from untrustworthy buyers and gaining new customers. Therefore, it is imperative for the company to consider the customer's capabilities in trade credit decision.
A flexible trade credit policy with an interest on receivables may increase sales (Long and al., 1993; Deloof and Jegers, 1996). However, such practice can be expensive due to the lock up of money in working capital (Guariglia and Mateut, 2006). Besides, if the manager chooses to reduce the accounts receivables, he limits sales by credits to customers. Then, this strict collection policy may lead to loose purchasers and reduces profits. In this respect, Pike and Chang (2001) stressed that working capital management looks for creating a high quality accounts receivable portfolio in order to improve corporate value.
Evidence provided by Deloof (2003) shows a significant negative relationship between gross operating income and the period a company takes to receive payment on accounts receivable. Recently, Ganesan (2007) supports that long receivable cycle makes telecommunication equipment American companies' more dependant on external financing.
This discussion yields the following hypothesis:
H3: Less profitable Tunisian exporting SMEs take longer period to receive payment from customers.
II.2. Liquidity and profitability: the dilemma in working capital management
Apart from the efficient mix between working capital components, the fundamental role of working capital management is maintaining the company's liquidity in day-to-day operation. Thus, working capital decision is time consuming, intermittent and recurring. Besides, its management depends on information production, transaction costs and resources available and varies across industries (Filbeck and al., 2007). It involves the planning and the control of current assets and current liabilities.
Current assets contain all assets that are converted to cash within a short timely basis. The company's liquidity depends on the operating cash flows generated by those assets and not their value (Rahman and Nasr, 2007). However, current liabilities include obligations that the company has to pay in a short period of time.
If the company is unable to match properly current assets and current liabilities, it will face financial distress and bankruptcy (Zariyawati and al., 2009). The current assets should cover the current liabilities to provide a margin of security.
Liquidity and profitability are the main financial issues in corporate activity. Smith (1980) suggests that the management of working capital affects these two aspects. Beaumont and Begemann (1997) particularly emphasize that understanding the link between profitability and working capital facilitates the comprehension of the relationship between liquidity and profitability.
On the one hand, if the company does not have adequate working capital to sustain sales activity (purchase the materials, pay expenses…), it will face problems of insolvency. Referring to the theory of risk and return, investment with more risk leads to more return (Eugene and Ehrhardt, 2008). Put differently, low liquidity would decrease the company's risk and profitability simultaneously.
On the other hand, excess of liquidity indicates inefficient funds and influences negatively the corporate profitability (Cooper, 2003 and Vishnani and Shah, 2007). Besides, increasing profits may be at the expense of liquidity (Kalcheva and Lins, 2007, Dittmar and Mahrt-Smith, 2007). In fact, higher investment in current assets may lead to lower risk of liquidity and lower profitability, as well. In other words, the decrease of profitability can be explained by the opportunity cost of funds invested in long-term assets. Thus, the trade-off between profitability and liquidity is the dilemma of working capital management. In assessing the profitability-liquidity trade-off, three basic assumptions are presented by Pramod and Khan (2007):
The company operates in the manufacturing sector (the trade cycle is relatively longer than the service cycle).
Fixed assets are more profitable than current assets;
Long-term funds are more expensive than short-term funds.
To find out the relationship between efficient working capital management and company's profitability, Shin and Soenen (1998) used the cash conversion cycle as a measure of the length of time between the purchase of raw materials and the collection of accounts receivable. They found that a long cash conversion cycle influences negatively the corporate profitability. They suggest that the company can create shareholder value by reducing their financial needs with regard to liquidity.
The result of Shin and Soenen (1998) was consistent with the finding of Deloof (2003) who concludes to a negative relationship between gross operating income as a measure of the profitability and the cash conversion cycle. Recently, Eljelly (2004) reports a negative relationship between profitability and liquidity. He considers that planning the level of current assets and current liabilities avoids the firm excessive short - lived investments and neutralizes the risk of incapacity to pay obligations.
This discussion yields the following hypothesis:
H4: The amount of liquidity generated by Tunisian exporting SMEs influences negatively their profitability.
The theoretical review and studies presented above and synthesized in Table 1 give us results and conclusions on working capital management for different countries. In the next section, the methodology conducted on the same area for Tunisian exporting small and medium companies is exposed.
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Methodology
The purpose of this study is to identify the effect of working capital management on profitability with reference to Tunisian exporting SMEs [3] . In this section, the companies included in the sample, the variables used and the statistical techniques applied in the investigation are presented.
III.1. Data collection and sample characteristics
The data were collected from Tunisian Export Promotion Center (CEPEX) [4] and are based on financial statements of Tunisian exporting small and medium companies operating in different economic sectors. The yearly data of good sales' costs, receivables, payables, inventories, and operating incomes are extracted from the financial states and have been manually entered into the database of STATA software.
To make a more representative sample of the population of Tunisian exporting SMEs, the quota method is used. In fact, in selecting our sample, we replicate the same distribution by sector of activity of the small and medium Tunisian exporting companies' population. The sample is composed of 386 SMEs observed from 2001 to 2008. This period corresponds to a mix of Structural Adjustment Plans [5] and reflects the continuity of economic reforms (incentives to exports, subventions to exporting companies….) and policies likely to promote exports and to consolidate the share of Tunisia on foreign markets.
As shown in Table 2, the panel is mainly composed of limited liability companies (67.8%). The limited corporations represent only 32.2%. 20.2% of companies in the sample export over 50% of their products towards four foreign markets (U.S, Asia, Europe and Arabic Maghreb union) [6] . 53.2% employ less than 50 workers. Thus, they are considered as small and medium companies. In fact, as reported by Di Tommasso and al., (2001) "a wide consensus among national officials seems to exist on a non-official definition of SMEs as those enterprises employing between 10 and 100 workers. This definition, however, is not stated clearly, nor it appears in any official document" (P. 44).
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Table 3 shows the distribution of Tunisian exporting SMEs by industry. Specifically, 136 companies work at the food industry, 96 product construction materials, 104 run textile business, 24 metal industry and 22 operate in the service sector. The test of homogeneity allowed us to retain the null hypothesis that the population and the sample have homogeneous distribution among the five sectors of activity at the confidence level of 95%.
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III.2. Variables of the analysis
In order to identify the influence of working capital management on the profitability of Tunisian exporting small and medium companies, we retain the following measure as dependant variable:
GOPit: The corporate profitability is measured by the gross operating profit. It is calculated by subtracting cost of goods sold from total sales and divided by total assets minus financial assets (Deloof, 2003). Contrary to the use of earnings before interest tax depreciation and amortization like Ramachandran and Janakiraman (2009), the financial activity is separated from operational activity to associate operating results with the operating variables relating to working capital management.
The independent variables included in the study concerning the working capital management are:
DSOit: The collection policy is reflected by the days sales outstanding and measured by [accounts receivable x 365]/sales. A low DSO shows that the company collects its accounts receivable in few days. A high DSO means that a company sells its product to customers by credit (Petersen and Rajan, 1997).
Companies may improve collection process by offering discounts to customers who reimburse immediately. Alternatively, they may charge interest for the one who pays later. As noted by Pike and Cheng (2003), a high quality portfolio of accounts receivable has significant implications for corporate value. In fact, the increase of accounts receivables implies management expenses and additional working capital, both of them decrease the value of the company.
DIOit: The inventory policy reflected by the days inventory outstanding is measured as [inventories x 365]/cost of sales. When the company maintains a moderate level of inventories it can respond to higher demand. This can be improved by the inventory monitoring process and depends on the synchronization between raw materials delivery by suppliers and the need in the production process (Deloof, 2003). Thus the low level of inventories will have a positive effect on profitability since it will liberate working capital resources to be invested in the business cycle (Lazaridis and Tryfonidis, 2006).
DPOit: The payment policy is measured by the day's payable outstanding. It's calculated as [accounts payable x 365]/purchases. Generally, delaying reimbursement to suppliers helps the company in releasing additional resources and enhancing working capital management (Uyar, 2009). However, prompt payment of suppliers allows the company to receive a significant discount (Deloof, 2003).
CCCit: The Cash Conversion Cycle is a comprehensive measure of working capital and a dynamic view of liquidity. It presents "the time lags between expenditure for the purchases of raw materials and the collection of sales of finished goods" (Padachi, 2006, p. 49).
In the literature, many definitions of cash conversion cycles are used. For instance, Bodie and Merton (2000) consider "the number of days between the date the firm must start to pay cash to its suppliers and the date it begins to receive cash from its customers" (P. 89). Eljelly (2004) defines the cash gap as "the length of time between actual cash expenditures on productive resources and actual cash receipts from the sale of products or services" (P. 50). In this study, the measure of Keown and al. (2003), Deloof (2003) and Uyar (2009) is used. These authors express cash conversion cycle with the following equation:
A positive cash conversion cycle indicates the number of days a company must waiting the payment from its customer. However, a negative result shows the number of days a company has before paying its suppliers (Hutchison and al., 2007). A shorter CCC reflects an efficient cash flow management.
The export dimension is considered through these variables:
EXPRit: The number of years of export activity provides an approximation of the accumulated knowledge in export transactions, methods and techniques. As the company matures, it may build its capabilities to compete in the international market. However, younger companies may be more flexible and proactive in facing foreign customers (Lefebvre and Lefebvre, 2001). We expect that Tunisian exporting SMEs exhibit a low profitability during the first years of export activity.
MARKTit: The number of market is an ordinal variable. It takes the value 1 if the company exports to one foreign market, 2 if it exports to two markets, 3 if it exports to three markets and 4 if it exports to four markets. The companies retained in the sample export principally to US, Asia, Europe and Arabic Maghreb union. They use many techniques in selecting export target markets such as systematic and formalized international market research activities, visits of foreign markets before entry, exploitation of published information about differentiating foreign markets…(Yip and al., 2000). When the Tunisian exporting SME is able to enter more markets it may export a large share of its products and then enhance its profitability.
INTSTYit: The intensity of export is defined as the ratio of export sales over total turnover. Two dimensions of firm level export performance have been used: export propensity and export intensity. Export propensity is more prominent in the literature [7] . It is defined as whether or not a company is an exporter. As noted by Helpman and al. (2008), this is explained by considering export intensity and export propensity decisions are simultaneously taken by the company. Export intensity indicates the participation of the company in foreign markets (Lu and Beamish, 2006). Thus, the higher the level of export intensity, the more Tunisian exporting SMEs are efficient.
The others dependent variables related to the characteristics of Tunisian exporting SMEs are:
CRit: The current ratio is calculated by the ratio of current assets on current liabilities. Working capital management implies the determination of the amount and the composition of current assets and their financing. A high current ratio signifies an important investment in current assets which represents a low return on investment (Vishnani and Shah, 2007).
SIZEit: The size of the company is measured by the log of sales in million Tunisian dinars (TND) (1USD = 1.3169 TND). Financial and organizational constraints faced by small companies may restrict their available resources to invest in working capital management (Howorth and al., 2003). Thus, larger companies are more able to reduce cash gaps which may enhance their profitability (Raheman and Nasr, 2007).
DRit: The debt ratio is measured by the ratio of the sum of short and long term loans on total assets. It presents the proportion of company's debt relatively to its assets. It gives an idea about the leverage of the company and its potential risks. A high level of debt ratio indicates low financial health of the company and its inability to rely on its internal funds (Bellouma and al., 2005). Therefore, company with important debt ratio is expected to have low level of profitability (Raheman and Nasr, 2007).
SECTRit: The sector is a dummy variable with five modalities: Sectr it 1 = equal to 1 if the company belongs to the food industry and 0 otherwise, Sectr it 2= 1 if it operates in construction sector and 0 otherwise, Sectr it 3 = 1 if it has metal trade and 0 otherwise, Sectr it 1 = 4 if it work in textile industry and 0 otherwise and Sectr it 1 = 5 if it provides a service and 0 otherwise (this modality is eliminated from the estimation because it represents the reference modality). These sectors can influence the company decision concerning working capital management and practices. In fact, the current assets of a distribution company are very important compared to the manufacturing company (Deloof, 2003). Besides, the economic environment (the production factors, the production process, supply and demand, taxes, interest rate…) influence differently the profitability of the company according to the sector in which it operates.
III.3. Data analysis and results
To understand the relevant aspects of working capital management, a descriptive analysis is conducted. Table 4 reports the average, the standard deviation, the minimum and maximum values of the variables included in the study.
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The mean value of gross operating profitability is 13.8%. For the sample at hand, the value of the profitability can deviate from the mean by 1.3%. The minimum gross operating profitability is 10.51% while the maximum is 17.75%. As we observe, all the companies under studies have a positive profitability. Thus, it seems interesting to see whether this characteristic is due to the working capital management practices. Besides, the positive profitability is explained by the concern of the Tunisian government to improve the institutional environment and the business support for exporting companies.
The cash conversion cycle appears sometimes negative and sometimes positive (the minimum is -52 days and the maximum is 397 days). To be efficient, the company must have the lowest cash conversion cycle and if possible a negative one. A positive result shows the number of days a company must wait to be paid by its customers. A negative result indicates the number of days a company has before paying its suppliers. Thus, exporters may spend ample time and effort to search partners in the target market. They have to build relationships in foreign markets and to reinforce them.
In the sample, small and medium Tunisian exporting companies collect their cash from receivables after an average of 100 days with standard deviation of 41 days and a minimum of 16 days. Besides, they pay their purchases after an average of 98 with a deviation of 38 days and a minimum of 26 days. They take an average 79 days to convert inventory into sales with a deviation of 21 days and a minimum of 32 days. As observed, the companies in the sample follow a flexible collecting policy in order to capture foreign customers. However, they are unable to postpone payment to suppliers due to their small and medium size. In fact, the mean value of the company size is 0.88 with a standard deviation of 0.49. The minimum value is -0.41 and the maximum value is 2.33.
The average current ratio of Tunisian companies is 0.22 and divert from this mean value to both sides by 0.006. The lowest current ratio for a company is 0.04 times. The average of debt ratio is 38.28% with a standard deviation of 13.5%. The minimum level of debt is 10% which explains the incapacity of small and medium Tunisian exporting company to access to external financing. This result can also reflect its repugnance to rely on bank credit since it is in general a family business.
When considering the export dimensions, it is noted that on average the companies included in the sample have considerable export intensity. In fact, they sell 32.21% of their output overseas. Summary statistics on export markets shows that an exporter has access to two countries only. Finally, the companies have, on average, an important length of export experience (8.667 years) with a minimum of two years which reflects their knowledge regarding exporting activities.
After presenting the descriptive statistics of the variables considered in the analysis, these variables are subjected to correlation measurement. Pearson's correlation analysis allows the identification of the relationship between working capital management and profitability.
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Table 5 illustrates that there is a negative relationship between gross operating profitability and the cash conversion cycle (-0.0382). This is consistent with the idea that the insufficient level of liquidity makes the export company unable to cover the costs supported. In this context, any liquidity shock on the foreign market will influence the exporting company abilities to face competition. Thus, the decrease of the time lag between purchases expenses and sales collection enhances the company's profitability.
Pearson correlation result indicates that cash flows locked in stock may adversely affect profitability (-0.0408). By considering this finding, we conclude that Tunisian exporting SMEs can improve their profitability by reducing the period of selling their inventory. Exporting companies bear additional costs due to transport costs, foreign regulations or adoption of products. Therefore, these costs are one reason for maintaining an adequate stock to cover the eventual demand. Indeed, as pointed by Bougheas and al., (2009) corporate profitability might increase if the benefits of keeping low level of inventory rise faster than related costs. This result is coherent with the positive link between day's inventory outstanding and the cash conversion cycle (0.4353). In other words, export companies that turn their input to sales slowly have a long inventory cycle. Thus, they must cover this cycle by additional funds which explain the deterioration of their profitability.
In addition to that, Pearson's correlation presents a positive relationship between the day's sales outstanding and the cash conversion cycle (0.5927). This means that small and medium Tunisian exporting companies offer to their customers more time to assess the quality of their products because of the competitive international environment. Thus, spending more time to collect cash will increase the time of working capital.
The debt ratio appears positively linked to the profitability which suggests that levered companies are more efficient. Indeed, to get access to external credit companies acquire a healthy financial situation. The monitoring exerted by stakeholders may improve the efficiency of the companies due to their capacity of collecting information and minimizing adverse selection and moral hazard problems (Bellouma and Omri, 2008). Besides, facilities provided by Tunisian commercial banks help exporters suffering from internal liquidity to fulfill orders.
The increase of the company's size improves the profitability of the company. This may be explained by the information opacity of small companies and their informal management. Thus, large exporters are able to stabilize cash flow problems and to grow competitively in the foreign market.
From the export dimension view, the current export intensity of a company is significantly correlated with its past export experience. Indeed, the increase in the years of experience a company has in offshore markets enhances its reputation and leads to enlarge the share of its export sales. Finally, it is worth noting that all the working capital components are negatively related to export intensity. This negative correlation shows that turning inventories into a cash flow requires usually many steps related to the type of industry (storage, manufacturing and distribution). Those steps lead to a long cash conversion cycle and may handicap the transactions of the company and the level of its sales.
In order to capture the impact of working capital management on the profitability of small and medium Tunisian exporting companies, a regression analysis on panel data is used. Contrary to cross section or time series data, panel data allows us to detect dynamics effects of working capital management on profitability. The model applied for each sector is as follows:
GOPit = αi + £i WCit + jδi CCj it + fÏi EDf it + εit (1)
Where: GOPit: Gross Operating Profitability of company i at time t;
αi: The intercept of equation
WC it :The working capital Management variable of company i at time t. We introduce the four variables (DPO, DSO, DIO and CCC) one by one in order to identify their effects on corporate profitability.
£i: : Coefficient of the working capital management variable
CCj it :The variables related to the company's characteristics (j: size, dr…)
jδi : Coefficient of the company's characteristics variables
fEDit: The variables related to the export dimensions (f: MARKT, INTNSTY…)
fÏi: Coefficient of the export dimensions variables
i = 1, 2, …, 386
t : Time = 2001…..2008
ε : The error term= ui + wt + wit (ui: is the individual effect, vt: is the temporal effect and wit: is a composed effect).
We transform equation (1) into a vector form:
GOPit = αi + β'i Xit + εit (2)
Where β'i = (£i, jδi, fÏi) and Xit= (WC it, CCj it, f EDit)
Before estimating the model, the homogeneity or heterogeneity of the data is checked. Economically, we verify if the model is perfectly identical to all companies, or inversely, each one has its own specificities. Econometrically, we test the equality of the coefficients of the model studied.
In order to distinguish between these four cases and validate the use of panel structure, the following procedure presented by Hsiao (1986) should be employed:
First step, the null hypothesis of equal constants and coefficients (perfectly homogeneous structure) is tested:
The classical Fischer test [8] is used. The results of the test are:
If H01 is accepted, the pooled model is perfectly homogenous:
GOPit = α + β' Xit + εit (3)
If the null hypothesis H01 is rejected, the second stage (the heterogeneity comes from coefficients) has to be checked.
Let F1 the statistic associated to H01
Where SSR1,c is sum of squared residuals of the constraint model (3) and SSR is sum of squared residuals of equation (2). If calculated F1 statistic is higher than theoretical value, the null hypothesis of homogeneity is rejected.
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STATA directly provides the p-value of the test. The results obtained in Table 6 show that p-value of the data is higher than critical value of 5%. Then, the null hypothesis of homogeneity is rejected. This means that constants are not identical for all companies. In other words, the small and medium Tunisian exporting companies react differently in enhancing their profitability. By rejecting the null hypothesis H01, we may check if the heterogeneity comes from coefficients βi. Particularly, in this second stage of the process of Hsiao (1986), we test:
The statistic [9] F2 calculated in Table 6 indicates that the null hypothesis H02 may be accepted. Thus, the panel structure can be adopted. Particularly, we have to identify whether if there is a correlation between the dependant variable (GOP) and the individual effect of each company ui. In case of correlation, a fixed effect model is more appropriate to generate consistent estimation by the within group estimator. Otherwise, random effect model is used to obtain efficient estimators by means of generalized least squares (Greene, 2003). The generally accepted strategy of choosing between fixed and random effects is running a Hausman test (1978) under the null hypothesis E (αi/xit) =0. If the null hypothesis is rejected, the effects are considered fixed. However, if it is accepted, the effects are random.
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As illustrated in Table 7, fixed effect model is more appropriate when considering data of food industry, construction and metal retail (when DPO is the exogenous variable). However, the random effect model is adopted to estimate the other regressions related to metal retail (when DSO, DIO and CCC are the exogenous variables), textile and service sectors.
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By introducing the working capital components one by one, it is noted that days inventory outstanding are negatively linked to the corporate profitability (significance at level 1%). The result indicates that maintaining a low level of inventory improves the profitability of small and medium Tunisian exporting companies working in food industry, construction, metal retail and textile. This finding is consistent with the first hypothesis. Thus, a supply chain with a high level of stocks is in position to decrease the corporate profitability.
Particularly, the small and medium Tunisian exporting companies have to conciliate between inventory costs and response time to their customer in order to face foreign environment. In this study, the results show that regardless of the particular nature of each sector, inventories must be handled at a minimum level to be effectively and efficiently managed. In other words, given the volatile nature of foreign demand, small and medium Tunisian exporting companies must continually be alert to unpredictable difficulties.
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From the results of the regressions presented in Table 8 and 11, it is noted that longer days payables outstanding negatively affect the corporate profitability which is consistent with the second hypothesis. The models are statically significant when considering food industry and textile (significance at level 10%, 1% respectively).
The relationship between accounts payables and profitability can be explained by the fact that most profitable companies reimburse their bills quickly. Thus, they may take advantage from the early payment discount. So, unprofitable small and medium exporting Tunisian companies postpone payment to suppliers since they generate less cash from their operation.
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As shown by all the regressions, number of day's sales outstanding is negatively linked to the profitability of companies as expected by the third hypothesis. This result indicates that managers can improve profitability by decreasing the credit period granted to their customers. This finding is inconsistent with the predictions of trade-credit theory and implies that companies offer shorter trade credit as an instrument to boost profitability. In fact, when small and medium Tunisian exporting companies transform their sales into cash in a short period, they may enhance their profitability. In others words, high quality accounts receivable portfolio improves the corporate value of the company. Thus, the small and medium Tunisian exporting companies have to assess the foreign market by collecting sufficient information about the behavior of the customers. Indeed, export sales differ from domestic ones because of transactions with foreign agents, transport expenses and insurance costs.
The above discussion treats the three components of working capital one by one. In order to have a more precise idea about working capital management and its effect on corporate profit, it is interesting to consider them jointly. That's the cash conversion cycle is included as an independent variable which measures the level of the liquidity. This variable is negatively related to the profitability of companies operating in food industry, construction, metal retail and textile with the significance level of 1%. Thus, shorter cash conversion cycle might increase profitability because it implies a higher liquidity. The result is incoherent with the fourth hypothesis but it is driven by the strict receivable and inventory policies of Tunisian SMEs. More precisely, the aggressive working capital management resulting from limiting the cash conversion cycle and hence the time that cash is tied up in working capital improves company's profitability. From this finding, efficient working capital management relies on speeding up liquidity collections as quickly as possible and maintaining inventory short as possible.
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Regarding the other variables included in the study, debt ratio is positively related to the corporate profitability in food industry, construction, metal retail and textile sectors. Thus, this result holds that profitable small and medium Tunisian exporting companies use debt to save taxes by deducing interest costs. Therefore, the leverage level can be used like a signalizing tool to expect the financial health of the companies. Indeed, the increase of the debt ratio may reflect the capacity of the company to contract credits. Also, it may be informative about the efficient use of the credit granted.
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Moreover, all the regressions show that larger companies have an important gross operating profitability with a very high level of significance (1%). Larger companies can take advantage from economies of scale, experience and reputation and thus improve their performance. More precisely, a larger size company is able to adopt suitable export structure with the requirements of international trade by reducing costs.
Concerning the export dimension, both export intensity and number of foreign market seem to have positive effect on corporate profitability. The Tunisian Government initiative through ground level knowledge of overseas markets is detected to be very important for small and medium companies in food industry, metal retail, construction and textile sectors (coefficients with significance level of 1%). More precisely, the Tunisian governmental institutions intervene at the company level to facilitate exporter's entry to new foreign markets. The exporter has to target the best foreign market and to focus on specific opportunities. Consequently, Tunisian exporting SMEs may enter a foreign market after evaluating regulatory problems, standards, cultural sensitivities, distribution channels, pricing, competitors, transportation, insurance or stocking costs.
Particularly, the high export intensity may be related to the negotiation ability of Tunisian exporting SMEs with foreign customers. Therefore, if we relate the positive impact of export intensity with the collection policy, we note that the capacity of the Tunisian exporting SMEs in limiting days sales outstanding increase the share of export and boost the profitability. Globally, the positive relationship between the export performance (measured by the export intensity and number of markets) and profitability let us propose that companies in emerging economies like Tunisia have to sell goods overseas in order to respect international norms and managerial rules as a strategy to improve their performance.
Conclusion
The aim of this study was to identify the factors related to working capital management that enhance corporate profitability. Most Tunisian SMEs have large amounts of cash invested in working capital. Consequently, the way in which working capital management is handled influences the corporate profitability. Working capital management allows all the types of companies to buy the goods and services they require to maintain their transactions. However, in foreign markets, exporting SMEs face additional risks and must cautiously manage their current assets and liabilities. Different theories guided this research. In fact, the trade credit theory was retained to highlight the advantages and disadvantages of delaying payments to suppliers. Also, the theory of risk and return was considered to explain the trade-off between liquidity and profitability.
The empirical study was based on a sample of 386 small and medium Tunisian exporting companies observed from 2001 to 2008. We found a negative relationship between gross operating profitability and days sales outstanding, days inventory outstanding, days payables outstanding and cash conversion cycle. The results of fixed and random effects model suggest that Tunisian exporting SMEs must reduce the number of days accounts receivables and inventories to improve their profitability. In fact, it seems more interesting to finance growth strategies with the additional funds instead of investing them in inventory or receivables. The negative correlation between days payables outstanding and profitability is consistent with the view that less profitable companies postpone the payments of their bills than more profitable ones. Thus, the first category of companies neutralizes the risk of incapacity to meet obligations but at the same time may verify the quality of the products received.
The three components of a company's working capital management influence each other and corporate profitability. This idea is confirmed by the negative effect of cash conversion cycle on the profitability of small and medium Tunisian exporting companies. This shows that longer cash conversion cycle will hurt company's profitability since low liquidity affects its risk.
In addition to these factors, we found that export intensity and number of foreign markets positively influence the corporate profitability. The role played by those export measures in the success of the company is clearly identified. Therefore, Tunisian exporting SMEs that wish to enhance their profitability and international competitiveness would be well advised to get adequate working capital. In fact, working capital management influences the sales of the company, its inventory and its purchases.
On basis of this work, we offer a modest step toward addressing the gap in the literature relating the impact of working capital management on corporate profitability. However, a big number of small and medium Tunisian exporting companies are characterized by their informal management system. Thus, the nature and the role of social interactions between suppliers and buyers should be captured by means of more detailed variables. Besides, different cultural aspects may be introduced in order to enhance export transactions and working capital management.
