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Academy of Accounting and Financial Studies JournalVolume 23, Issue 2, 2019WORKING CAPITAL MANAGEMENT AND FINANCIALPERFORMANCE: EVIDENCE FROM LISTED FOODAND BEVERAGE COMPANIES IN SOUTH AFRICANdonwabile Zimasa Mabandla, University of South AfricaPatricia Lindelwa Makoni, University of South AfricaABSTRACTThis study aimed to investigate the nexus between working capital management and thefinancial performance of firms. We used a sample of 12 listed food and beverage companies inSouth Africa during the period 2007 to 2016. This study collected secondary data from the iressMcGregor databases for the Johannesburg Stock Exchange (JSE) listed companies. Usingvarious econometric techniques, we found a positive relationship between the inventoryconversion period (ICP) and profitability of firms. In addition, the study found a negativerelationship between the average collection period (ACP) and profitability. Furthermore, thestudy found a positive relationship between the average payment period (APP) and profitability.The findings of this article suggest that financial managers of firms need to adopt aggressiveworking capital management policies in order to create shareholder wealth through enhancingthe financial performance of the firm.Keywords: Working Capital Management, Profitability, Return on Assets, Financial Performance.INTRODUCTIONThe management of short-term assets and short-term liabilities available to a company forfinancing the daily operations of the business is gaining incremental interest (Karankye &Adarquah, 2013). It is vital to managing working capital well, as it has a generous influence onthe financial performance of a company (Deloof, 2003). Failing to manage working capitalefficiently may lead to the failure of the business.The most commonly used measure of short-term assets and liabilities is the cashconversion cycle (CCC). It refers to the time span between the expenditure on the acquisition ofthe raw materials and the collection from the sales of accomplished goods (Charituo et al., 2012;Omesa et al., 2013). We used CCC elements such as inventory conversion period (ICP), averagecollection period (ACP) and average payment period (APP) as proxies of working capitalmanagement, consistent with the above-mentioned studies. Deloof (2003) claimed that the longerthe time lag, the more the investment in short-term assets and short-term liabilities, and anextensive CCC might increase profitability as it leads to more sales. Yet, Deloof (2003) foundthat profitability might weaken with the CCC if the cost of greater investment in working capitalimproved quicker than the benefits of holding more inventories or giving customers more tradecredits.Financial performance measurement on the other hand mostly focuses on the types offinancial ratios attained from the financial statements of companies. These measures comprise ofprofitability ratios, liquidity ratios, activity ratios and debt ratios (Ismaila, 2011). We usedprofitability as a proxy for financial performance, specifically, return on assets (ROA). Padachi11528-2635-23-2-356

Academy of Accounting and Financial Studies JournalVolume 23, Issue 2, 2019(2006) defined ROA as the ratio of earnings before taxes gauged to total assets, and narrates acompany’s profitability to its assets base.It is essential to manage short-term assets and liabilities adequately as it has a directimpact on both profitability and liquidity of the company (Deloof, 2003). Mathuva (2010)asserted that if a company has substantial sales due to a lenient credit policy, this eventuallyimproves the cash cycle. Hence, an extensive CCC, in this case, may result in a growth in thecompany’s profitability. Yet, the traditional view of the association between the CCC andprofitability is that a longer cycle can damage the profitability of the company (Deloof, 2003).There are many studies that have been conducted internationally on the relationship betweenworking capital management and financial performance (Gill et al., 2010; Afrifa et al., 2014;Atlaf & Shan, 2017; Shivastava et al., 2017 & Singhania & Mehta, 2017).While a significant number of studies have been conducted on working capitalmanagement and financial performance internationally, and in East and West African countries,there is a dearth of studies that considered this relationship in Southern Africa, and particularly inSouth Africa. The purpose of this study is therefore to investigate the relationship betweenworking capital management and the financial performance of listed food and beveragecompanies in South Africa, as they trade in fast moving consumer goods (FMCG) and perishablegoods. It is important to management working capital efficiently as this has a direct effect onboth liquidity and profitability of the company (Deloof, 2003). Mavutha (2010) argues that if acompany has significant sales owing to a soft credit policy, this ultimately increases the cashcycle. Thus, a long CCC in this regard may lead to an increase in the company’s profitability.However, the traditional view of the relationship between the CCC and profitability is that alonger cycle can harm the profitability of the company (Deloof, 2003). On this basis, it isimportant for financial managers of these companies to manage short-term assets and liabilitiesproperly with the aim of enhancing their company’s financial performance, to avoid sufferingfinancial losses emanating from spoilt goods, a problem generic to the sector. At the same time,financial managers are constantly battling between pursuing the wealth maximisation objectiveof the firm vis-à-vis the profit maximisation objective.This study contributes to the existing empirical literature on the relationship betweenworking capital management and the financial performance of firms, specifically those engagedin the trade of fast moving consumer goods, using data drawn from listed food and beverages inSouth Africa specifically, as the working capital management policies of these FMCGs differsvastly from those of other economic sectors such as retail or mining. These South Africancompanies are deemed important given their significant role in the economy of the country asfood and beverage manufacturers and processors, at a time when the country is undergoingradical economic transformation which could threaten the sector and food security. The FMCGs’ability to provide basic necessities such as food at reasonable costs to both them and the endconsumer, requires the financial managers to do so effectively and efficiently while also ensuringfinancial sustainability of the companies. Our study hence validates some of the findings ofearlier empirical work. The rest of this article is structured as follows: the next section presents areview of the existing literature on the relationship between working capital management andfinancial performance of firms. This is followed by the methodology in which we detail oureconometric model. The results are presented and subsequently discussed, and the paper windsup with a conclusion and recommendations.21528-2635-23-2-356

Academy of Accounting and Financial Studies JournalVolume 23, Issue 2, 2019LITERATURE REVIEWThe assertion that the management of short-term assets and short-term liabilities has aninfluence on the company’s profitability and risk is gaining considerable attention (BanosCaballero et al., 2012). In pioneering research, Smith (1980), suggested that managing short-termassets and liabilities is essential since it has an impact on companies’ profitability and risk, andeventually the value. In the process of managing a firm, an asset-liability mismatch may ariseleading to an increase in profitability in the short run, but endangering liquidity. Theories onworking capital management were intensely discussed by Gitman & Zutter (2014) when theyhighlighted the risk and return trade-offs inherent in different working capital strategies.Excessive working capital results in cash being tied up in accumulated inventory potentiallyleading to waste and theft, complacency of management efficiency and consequent loss ofprofits. On the other hand, inadequate working capital leads to stagnated growth, increasedoperating inefficiencies, and thus reduced profitability. (Pandey, 2005). Precisely, a greateraggressive working capital strategy that has low investment in working capital is related with ahigher return and risk; whereas a conservative strategy which deals with high investment inworking capital has lower return and risk (Gitman & Zutter, 2014). Overall, shortening the cashconversion cycle could improve profitability.Gill et al. (2010) examined the relationship between working capital management andprofitability using a sample of 88 American companies listed on the New York Stock Exchangeover the period 2005 to 2007. They used CCC to measure working capital management and grossoperating profit (GOP) to measure profitability. Their study found a positive and significantrelationship between CCC elements and profitability: the greater the CCC, the greater theprofitability of the company (Gill et al., 2010). They concluded that if companies manage theirworking capital properly, profitability could increase.On the other hand, Afrifa et al. (2014) investigated the working capital management andcompany performance relationship using a sample of 1128 listed small medium enterprises(SMEs) in the United Kingdom over the period 2007 to 2014. They used a panel data regressionanalysis to analyse data. CCC components such as inventory holding period (IHP), accountsreceivable period (ARP) and accounts payable period (APP) were used to measure workingcapital, while Tobin’s q ratio (QRATIO) was used to measure performance. They found aconcave relationship between the QRATIO and IHP, ARP and APP, respectively.Altaf & Shah (2017) examined the relationship between working capital management,company performance and financial constraints using a sample of 437 non-financial Indiancompanies. They used the two-step generalised method of moments (GMM) technique to analysedata. Their paper found an inverted U-shape relationship between working capital managementand company performance. Furthermore, they also asserted that the firms that are likely to beextra financially constrained have inferior optimal working capital levels.Shrivastava et al. (2017) conducted a study on the impact of working capital onprofitability in Indian corporate entities during the period 2003 to 2012. The classical panel dataand Bayesian techniques were used to analyse data. The findings of their study indicate that alonger CCC has a negative influence on profitability. They argue that financial accuracyindicators play a significant role in determining profitability. Furthermore, Shrivastava et al.(2017) revealed that larger companies seem to be more profitable and significant as per theBayesian approach.Similary et al. (2017) investigated the working capital management link using a sampleof different listed non-financial companies in emerging Asian countries. ROA was used to31528-2635-23-2-356

Academy of Accounting and Financial Studies JournalVolume 23, Issue 2, 2019measure profitability while the CCC was used to measure working capital management. Theyused the panel data model to control for the endogeneity problem. Singhinia & Mehta (2017)found that lower levels of working capital are positively associated with high profitability forcompanies in countries like India, Sri Lanka, Indonesia, Malaysia and Singapore. On the otherhand, for companies in China, Pakistan, Bangladesh, Hong Kong and South Korea, a higher levelof working capital is positively associated with profitability. Furthermore, Singhia & Mehta(2017) found that companies in countries like Thailand, Taiwan and Vietnam do not embrace a Ushape or an inverted U shaped link between working capital and profitability. For instance, theresults of their study revealed that profitability is positively linked to working capital for Taiwanand Vietnam, but is negative for Thailand.In Africa, most research on working capital management and profitability has beenconducted in West and East African countries, with relatively few studies done in SouthernAfrica. Uremadu et al. (2012) conducted a study on the effect of working capital and liquidity onlisted corporates’ profitability in Nigeria over the period 2005 to 2006. They found a positiverelationship between the inventory conversion period, debtor’s collection period and return onassets. In addition, the study also found a negative relationship between the cash conversionperiod and the ROA (profitability).Korankye & Adarquah (2013) conducted a study on working capital management and itsimpact on profitability in Ghana between 2004 and 2011. They employed the working capitalcycle (WCC) to measure profitability and gross operating profit (GOP) to measure profitability.Their study concluded a negative but significant influence between working capital andprofitability. In addition, their study also found a negative relationship between individualelements of the cash conversion cycle; inventory turnover period, APP and profitability.Furthermore, their study revealed a significant negative relationship between leverage andprofitability, while liquidity measures of interest cover and the current ratio yielded significantlypositive relationships with profitability.Kasozi (2017) studied the effect of working capital management on profitability using asample of 69 listed manufacturing firms in South Africa during the period 2007 to 2016. Hisstudy found that ACP and APP have negative but significant effects on profitability as proxiedby the return on assets. In addition, Kasozi (2017) also found that a number of days in inventory,as proxy of working capital management, has a positive significant effect on profitability.Emerging trends from the review of earlier scholarly work reveals that althoughnumerous studies on the relationship between