Impact Of Working Capital Management On Corporate Value And Profitability Before And After Financial Crisis: A Case Study Of J. Sainsbury

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Abstract

The central objective of this research is to provide an empirical evidence pertaining to the impact of working capital management on corporate value and profitability of a retail company listed in the UK stock exchange. The company of choice in this study is J. Sainsbury plc, a large grocery retailer located in London. In general, the 2008-09 global financial crisis had little, non-beneficial effect on the industry average of grocery retailing in the United Kingdom because of the decreasing margins of returns on stakeholder’s funds and return on the capital invested. Nonetheless, it is noted that the margin for return in total assets, together with earnings prior to interest and tax and the net profit increased regardless of the financial crisis (Yan & Pei 2009, p.309). Averagely, the impact was minimal when the grocery retailers were considered cumulatively as opposed to when treated individually, owing to the resulting synergy effect of high margins of leading retailers: Tesco, ASDA, and J. Sainsbury (Deloitte 2010, p.5).

Corporate financial data of J. Sainsbury have been gathered and analysed using variables of return on assets ratio together with return on invested capital ratio to evaluate the profitability of the company. Further, variable of Tobin Q ratio has been used to measure the market value along with variables of cash conversion cycle, current assets to total assets ratio, current ratio, current liabilities to total assets ratio, as well as total debt to total assets ratio, generally, as working capital management criteria. This study shows that there exists a significant relationship between the WCM and profitability of J. Sainsbury. However, there is no significant relationship with the market value of the retail company. In addition, results indicate that the management of J. Sainsbury can increase their profitability by reducing cash conversion cycle, as well as total debts to total assets ratio.

Table of Contents

Abstract 2

Table of Contents. 4

1.0       Chapter One. 7

1.1 Introduction.. 7

1.2 Background Information of the Study. 8

1.3 Research Questions. 12

1.4 Aims and Objectives of the Study. 12

1.5 Methodological Approach.. 13

1.6 Layout of the Remaining Parts of the Study. 14

1.7 Conclusion.. 14

Chapter Two. 15

Literature Review on WCM and Firm’s Value. 15

2.1 Introduction.. 15

2.2 Theoretical and Analytical Frameworks. 15

2.2.1 Working Capital 15

2.2.2 Concepts of Working Capital 16

2.2.3 Importance of Working Capital 16

2.2.4 Analytical Framework. 18

2.3 Review of Academic Literature on Working Capital Management and Firm’s Value. 21

2.4 Empirical Findings on Working Capital Management in Relation to Corporate Profitability  26

2.5 Analysis of Academic Literature on Working Capital Management 31

2.4) Important issues that are relevant to your investigation. 32

2.5 Conclusion.. 32

Chapter Three. 34

Case Study of Working Capital Management in the UK Retail Industry. 34

3.1 Introduction.. 34

3.2 WCM in the UK J. Sainsbury. 34

3.3 Brief History of J. Sainsbury Plc. 37

3.4 Impact of WCM on Profitability, Firms Value, and Performance. 38

3.5 Managerial Approaches and Techniques for enhancing WCM.. 40

3.5 Internal and External Factors that affect the WCM.. 42

3.6 Conclusion.. 44

Chapter 4. 46

4.1 Introduction.. 46

4.3 Appropriateness of Qualitative methodology. 47

4.4 Data Collection Methods for the Study. 48

4.4.1 Secondary Data Collection Sources. 48

4.4.2 Case Study Approach.. 48

4.4.3 Primary Data Collection.. 49

4.5. Enhancing Validity of Methodological Approach.. 49

4.6 Analytical Framework. 49

Chapter Five. 53

5.1 Introduction.. 53

5.2 Analysis. 55

Chapter Six. 56

6.1 Introduction.. 56

6.2 General Summary of the Study. 56

6.3 Policy Recommendations. 60

6.4 Contribution of the Study. 60

6.5 Limitations of the study and areas of further research.. 60

6.6 Concluding Remark. 61

Bibliography. 62

Appendix. 70

 

 

Impact of Working Capital Management on Corporate Value and Profitability before and after Financial Crisis: A Case Study of J. Sainsbury

  • Chapter One

1.1 Introduction

Literally, any problem engulfing any area of a firm is disastrous on its survival. However, a problem engulfing a firm’s finance area makes it more vulnerable. Fortunately, finance literature has given it sufficient coverage. Firms spends much time managing working capital and in the period of recession managing working capital is challenging as cash flow prediction is hard and also availability of credit is limited. Working capital management is concerned with the management of short term assets and liabilities including cash and cash equivalents, accounts receivables and accounts payable. The approach that firm adopts in managing working capital can impact its ability to generate profit (Shin and Soenen, 1998). The corporate world today demands higher profit to survive in greater competition; however, it is tough when the operational cost such as prices, energy, inflation, interest rate and technology is changing and high.

For a retail company managing working capital is as prominent as for other sector companies. Retail companies heavily depend upon the daily operating activities and in this instance the importance of working capital holds a prominent place in order to increase profit and evade bankruptcy. In economic downturn, when the commodity prices increase, currency fluctuations and other factors can have prominent effect in working capital management. Largay and Stickney (1980) in their research of the bankruptcy case of a large retail store in the year 1980 showed poor cash flow from their operation to be the main reason behind the bankruptcy. Mathur (2003) also emphasized on the importance of working capital management and determined the flexibility of it in context of ability to change with the rise and fall in seasonal demands of the product or service, and with the rise and fall in economic and market conditions The study interest of this paper is to explore the effect of the working capital management, WCM, on corporate value and profitability before and after financial crisis. Different case studies will be used to identify work capital management, countermeasures used to alleviate working deficits, and cause-effect of relationships between working capital management policies on firm performance and profitability and characteristics, market evaluation, and shareholder wealth.

In this chapter, there is an introduction of case studies—literature review—bearing evidence from different countries which has various economic situations and the cause-effect relationship between working capital management and the countries’ firms. Relevant research questions on the issue I am investigating are set; a description of the aims of the study; a provision of the methodological approach and main topics to be covered in the rest of the chapters; and a conclusion addressing the discussions of the chapter and a leading line for the next chapter’s main theme.

1.2 Background Information of the Study

Firms are fraught with activities and much effort and time goes to managing capital. However, the flurry increases during the onset of recessions in managing work capital as a result of unpredictable cash flow and limitation of the available credit. In firms, working capital management is a crucial part in financial management (Economic Survey of Pakistan, 2006-07). Working capital management is concerned with and not limited to making decisions on various views regarding investing cash, maintenance of inventories to various ranges, and the management of accounts, both receivables and payable (Zahra & Azam 2012). It’s only through the maintenance of working capital to adequate levels that firms are able to realize their current obligations (Mona, 2012). If a firm can’t manage its working capital efficiently, it can’t survive in a world that is highly competitive as the working capital is related to not only the firm’s liquidity, but also its profitability (Alam et al. 2011). Thus, the fate of the firm’s survival lies in the working capital management. However, even with better working capital management, it is becoming a nightmare for the firms as operational costs increase as a result of soaring prices and interest rates, recessions, and a technological gale that is changing at an unprecedented rate.

In the wake of the 2008 economic meltdown, firms were compelled to review their short term investment decisions. That notwithstanding, during recessions—there is a limitation to the capital and credit accessed—firms are faced with challenges of managing working capital. So as to immunize themselves against the effects of economic meltdown, firms should improve the level of management of their working capital (Zahra & Azam, 2012). In the UK, the retail sector contributes significantly to its economy as it accounts for 8% of the GDP and as recently as up to 2007, UK had an economic growth that was not only strong, but also sustainable. The Small and Medium Scale (SME) organizations are the driving force behind a country’s growth and development and in the U.S, the account for at least 60% of its GDP; in the U.S., the majority of the accomplishments made were through SMEs, for instance, Microsoft Disk Operating System that facilitated approximately 80% of the world’s PCs, co-developed by Bill Gates in the 1980s to operate. However, they are the most susceptible to poor financial management, more so, managing working capital so as to get maximum profitability (Sunday 2011).

Padachi (2006) shares the opinion that compared to big organizations, the rate of business failure is higher in small business and UK and US studies reveal that the main cause is poor financial management, notably, poor management of working capital.  Research was conducted in SMEs and big organizations in UK, US and Belgium to assist the firms practice better ways of working capital management. Surprisingly, there are firms in some countries notably those that are developing, that give scant credence to financial management. A perfect example is Mauritius whereby firms there completely ignore that area of management.

Most small to average sized firms, for instance, Jordanian, tend to rely excessively on short term loans, notably, where the bond market is not well developed, thus, working capital should be efficiently managed through effective investment methods and financing policies (Mona, 2012). Instead of taking such an unnecessary risk—such as depicted by Mauritius firms that completely ignore the management of working capital in their management practices—that can determine the failure or the success of the organization;  a firm should practice “short term warranties on time if it has high amount of working capital” as it will lead to a higher “capacity of receivable loan in company and to decrease in the risk of non-payment of the debts, so efficiency in working capital management affects” not only on the “short term financial performance (profitability), but also long term performance (maximum firm value)” (Zahra & Azam 2012).

Some firms are seeing the importance of improving their working capital management such as those located in the Asian continent. An example is that of Telekom Malaysia’s, a large business that is listed among Malaysian companies; it was being faced with problems of slow payments after the economic turbulence and to cap it all, great competition from business competitors that offered competitive rates thereby crippling its cash collection processes (Dong &  Su 2010). However, even though at a slow rate, there are gradually improving their practices on working cash management, an act that will cushion them against economic turbulence. To sum up it all, improving the working capital management in a firm is vital in that it does “immunize corporations from financial upheaval “ and can also be “managed strategically to improve competitive position and profitability, also, the wider perspectives of it contributes to the greater  opportunities to create wealth” (Duran, Roudaki & Radford 2008).

A research was conducted on the profitability of pharmaceutical firms of the Tehran’s stock exchange from 2005-09 by Farzinfar and Ghadirian (2012); it revealed that payables and receivables “conversion periods and gross operating profit” showed a considerable negative relationship. Also, Zahra and Azam (2012) conducted a research on the connection between the management of working capital and corporate performance. To evaluate working capital management, they used net liquidity balance; and evaluated corporate performance by using factors among others, proceeds on total assets, owner’s equity proceeds, market value, and book value. Research hypothesis was tested and analyzed using the financial reports from 56 firms registered in the Tehran Stock Exchange; also, used a model and a method, regression and correlation respectively (Zahra & Azam 2012; Mahdi, Mahdi, & Arash 2012). It was found out that corporate performance related positively with the working capital management.

It is evident that much of research concentrates on the practice, determinants and the impact of working capital on corporate performance in firms (Eljelly 2004). Unfortunately, research on the significance of working capital management of a retail market both before and after the crisis has largely been ignored.

1.3 Research Questions

The primary question is: How does J Sainsbury manage working capital? Three secondary questions are constructed to assist in replying the primary question:

Is the profitability and market value of J Sainsbury affected by working capital management before and after the financial crisis?

What measures did J Sainsbury take to manage working capital during crisis?

What are the policy recommendations for effective management of the working capital?

1.4 Aims and Objectives of the Study

The purpose of this study is to analyse the impacts that working capital and profitability before and after the recent financial turbulence have on J Sainsbury, UK’s retail company. In the wake of economic meltdown, firms got a challenge in reviewing their working capital management practices and learning the causing factors and effects, such as cash conversion cycle and cash and inventory management, which are crucial in profit stabilization and avoiding liquidation. Making a critical analysis and investigation of the working capital management is a sure way of understanding this concept (Eljelly 2004).

The aim of the study is to conduct an investigation on the working capital management of J Sainsbury. This is achieved through a trend analysis of the working capital in relation to the profitability. The following are the study objectives:

  • An examination of the impact that working capital on corporate profitability and market value made on J Sainsbury before and after the financial turbulence.
  • A description of the measures on working capital management J Sainsbury practiced during the crisis period.
  • Give recommendations on the areas that J Sainsbury need to improve in working capital management policies.

1.5 Methodological Approach

The effect of working capital management on corporate profitability and market value of J Sainsbury uses the following hypothesis— qualitative analysis. The qualitative data collected will be analyzed using SPSS or Ms Excel computer software and will be presented by use of various types of charts: bar, column, histogram, and pie charts. For data analysis, see Chapter Four. The significance of these is in helping come up with recommendations for J Sainsbury on how to improve management of working capital. Data will be collected using secondary sources from official figures, from J Sainsbury’s case study, also, from a primary data approach J Sainsbury’s website and publications such as 2006-2012 annual reports, and the Internet (Filbeck and Krueger, 2005).

Case studies of the retail industry bearing evidence from various firms will be analyzed to unearth the reasons failure and lessons learnt in working capital management approaches.

1.6 Layout of the Remaining Parts of the Study

In total, the research contains six chapters. The following is the layout of the rest parts of the study, i.e., chapter two to six.

  • Chapter Two: A literature review on the management of working capital; and reviews based on both past and present trends and perspectives on retail market.
  • Chapter Three: An analysis of the working capital management; an example of J Sainsbury behaviour before and after the financial turbulence is analysed.
  • Chapter Four: A discussion of the methodology, analysis, and justification.
  • Chapter Five: Results, further analysis, and interpretation.
  • Chapter Six: Summary of the results and recommendations for improving working capital management.

1.7 Conclusion

The motive and objective of the research are discussed. There is a provision of information on the background of working capital management and its significance to the retail market (Deloof 2003). Chapter two will offer further literature review on working capital management and will address issues and point out the risks associated with it during the period of economic turbulence.

Chapter Two

Literature Review on WCM and Firm’s Value

2.1 Introduction

The importance of working capital management has been redefined by the current liquidity turbulence.  Literally, the level of efficacy of working capital management determines the fate of firms—its inefficacy can spell the end of a firm— as it’s connected to a firm’s liquidity and profitability (Alam et al 2011). Managing working capital is a quick and direct way of ascertaining that a firm is able to fund the disparity existing between short term assets and liabilities (Azam & Haider 2011). In this chapter, there will be a discussion of various case studies researched on the topic and views of various authors regarding the impact of working capital management on profitability and value before and after crisis.

2.2 Theoretical and Analytical Frameworks

  • Theoretical Framework: Working Capital Management and Firm’s Value.
  • Theoretical Framework: Working Capital Management and Financial Crisis.
  • Theoretical Framework: Working Capital Management in relation to Corporate Profitability.
  • Analysis Framework: Academic Literature on Working Capital Management.

 

2.2.1 Working Capital

Working capital management refers to the situation or challenges that arise when managing current assets, current liabilities, and relationship between them (Pandey 2005).

Current assets refer to assets that can undergo liquidation into cash within one year without any depreciation in value. Such assets are cash, securities, account receivables, and inventory. In contrast, fixed assets are permanently held with the business, such as land, machinery, and buildings (Porwal 2001).

Current liabilities are debt obligations that have not been paid within a single accounting period. These are accounts payable, bills, overdrafts, and any outstanding expenses (Porwal 2001). Long–term liabilities refer to debts that can be repaid over a longer duration of time in contrast to the single accounting period. Examples are share capital, long-term loans, etc (Fink 2001).

2.2.2 Concepts of Working Capital

Working Capital takes two concepts: gross working capital that is the total investment in current assets; while the net working capital is the difference between current assets and current liabilities (Pandey 2005).Therefore, both play roles in working capital management.

Gross working capital helps in analysing ways in which investment in current assets of a firm and method of refinancing the current assets (Porwal 2001). On the other hand, net working capital shows the liquidity position and reflects on how long-term financing should be done.

2.2.3 Importance of Working Capital

The efficient and productive management of an organization’s working capital is crucial as it aims at ensuring the assets available to a company have a higher purchasing power as well as maximizing the total return on investment or ROI that the enterprise accrues. The individual or department necessary for the management of an organization’s working capital directly affects the success of the enterprises’ operations regardless of which field or industry it operates in. it is the responsibility of these managing entities to ensure that the organization constantly has adequate levels of working capital in order to continue with its various business processes (Gill, Biger  &  Mathur, 2010). This process is not a once off one and has to be constantly carried out since there are many factors or variables that are constantly changing in the business’ environment and therefore the manager has to constantly adapt to these changes in order to keep the current asset value at adequate levels. The current assets of an organization are the backbone of the enterprise as they are related closely to the organization’s daily activities (Teruel & Martinez, 2007). In the case where these assets are mismanaged, the business will not be able to operate and this results in its failure.

Mismanagement of these assets has been stated as the major cause of businesses’ failure. The enterprises’ working capital is the lifeblood of a business and the current assets and liabilities flow around in a cyclic manner. This means that the organization must ensure that its current assets are used efficiently and correctly so as to ensure that this flow is not disrupted and that the liabilities it has do not outgrow the current assets and cash available to cater to them (Lazaridis and Tryfonidis, 2006). If such a scenario is allowed to happen then the business will not be able to continue with its day to day operations and this will result in eminent failure of the business. If the working capital of an organization is managed well however, the business will be able to ensure that all its operations continue without any hitches as well as maximizing on its ROI or return on investment (Maness and Zietlow, 2004). Another advantage of proper management of working capital is that it translates into a good credit rating for the business and this means that suppliers, financial institutions and other entities that have business transactions with the organization will find it easier to give credit services or products to the organization because they will have more confidence that the money or other assets that they have provided to the organization will be paid back, a good credit rating may also translate into discounts and other incentives for the organization.

The management of the current assets also enables the business to keep up to par with the technological and scientific changes that occur within its field of operations. This puts the company in a good position to increase its profitability as it can now use the newly acquired technologies or innovations to improve its various business processes (Maness and Zietlow, 2004). This adoption of technology is directly tied and influenced by the levels of working capital available to the organization and therefore means that in order for the company to improve its profitability the management of the current assets should be carried out well.

2.2.4 Analytical Framework

Management accounting is attributed to be quite significant for business leaders while making decision. These business leaders rate management accounting to be quite useful source of data while making vital choices. The information acquired may offer an extensive insight on the processes and projects of the company as data is created for precise objective and stated user (Gill, Biger, & Mathur, 2010). This is vital for J Sainsbury in trailing its effort of ‘recovery to growth’ objective.

It is just singly if the data is operated in the correct manner that the right decision will be acquired. The information has to be convenient when it is considered for major management choices. These management accounting has to uphold its decision making tendency and prioritize certain aspects. Of consideration is the management of working capital, precisely the organization of the inventory

This section looks to assess the relationship between the working capital management and the organizations’ profitability (Izadinia & Taki, 2010). The management of working capital is a quite significant aspect in the corporate financial organization as it is directly impacts the profitability of an organization. The management of working capital is attributed to the organization of present assets and liabilities.

An organization may have an ideal standard of working capital which optimizes their worth. Huge inventories and credit policy may lead to great sales. The great inventory similarly leads to the threat of stock-out (Deloof, 2003). The trade credit may motivate sales considering that it permits an organization to acquire product quality prior to being paid. Another aspect of the working capital is that the accounts payable. Taking too long to pay accounts payable to the distributors makes it possible for the companies to acquire quality goods and may be cheap and dynamic basis of funding (Gill, Biger, and Mathur, 2010). Similarly, the delay of the payables may be expensive if a company is accorded discount for the prior payment. With the same measure, an acquired accounts receivables may result to cash coming in for the organization.

A common form of working capital management is the cash transformation tendency, which is the time interval between the expenses for what is bought in terms of raw materials and the acquired sales of manufactured products.  A lengthier cash transformation may lead to greater profitability as it leads to massive sales. Though, the corporate profitability may decline with the cash transformation tendency, if the charges of greater investment in working capital increase quicker than the advantages of holding additional inventories as well as granting additional trade credit to clients.

The inventory turnover ratio and receivables turnover ratios accords us information about J Sainsbury performance in the sale of inventory and where later there is cashing of the receivable. These are important pointers of the manner a business is organizing and controlling its working capital.

  1. Sainsbury is gradually having an excellent turnover ratio. This shows that the company is in possession of the most favorable inventory size and the products are quite fast. Additionally, the receivables’ turnover ratio has constantly been in the range of 3-5 that does not show a quite working and efficient management of the receivables. The organization ought to acquire its receivables on a regular basis and advance the ratio.

The stocks turnover has gone on to improve. This portrays that the method that was applied so as to elevate the supply chain has brought about efficiency. There has similarly been an extension and further transformation in the depots which has improved operations (Gill, Biger & Mathur, 2010). They are now able to manage 50m cases at an equal charge. The opening of a distribution base is intended to bring about an increase additional sales.

The ratio of the working capital using the sales is not that strong (Mobeen et al., 2011). While in regards to the trade credit, the level acquired is better considering that the retail grocery does not have goods to issue out until it becomes a franchise base. This is considering that additional credits acquired from distributors. The credit period by the debtors brings forth a working negotiation with the distributors. They are hence able to make good use of their finances.

2.3 Review of Academic Literature on Working Capital Management and Firm’s Value.

Based on the opinion of financial officials in many firms, managing working capital is synonymous with the value of their firms (Robert, Mark & Rabih, 2011). Cash conversion cycle—should not be confused with cash management, instead, it’s how the firm manages its net operating working capital—may be the oldest concept applied in integrated working capital. Cash conversion cycle is the time prolonged between expenditure and collection of raw materials and sale of completed goods respectively (Myers, 2000). Financial officials in firms see the management of net operating working capital as a factor that can be used to determine firm value; unfortunately, research has largely ignored the connection between the two as there aren’t publications on the area Kmart and Wal-Mart were faced with cash conversion cycle issues for 61 days and 40 days respectively. Roughly, Kmart was under a situation that required $ 198.3 more million annually in its financing expenditures; at last, it became bankrupt and the reason for this was directed to poor management practices of its working capital (Robert, Marc, & Rabih 2011).

In their research on U.S corporations for the period between 1990 and 2004, they got various observations to support the importance of working capital management to the firm value. They observed that investing a dollar on the net operating capital decreased its value compared to that got on cash; they also observed that the firm value was reduced where an extra dollar was invested in the firm’s net operating working capital (Robert, Mark & Rabih, 2011). Using economic value added and market value added to find out the firm value has its own challenges and advantages, however, literature has proved and endorsed economic value added and market value added “as the better proxy for measuring the value of the firm” (Bandara, & Weerakoon, 2011).

A firm’s profitability, whether gauged by assets returns or equity returns got, is directly proportional to improvement of a firm’s working capital management (Kieschnick, LaPlante & Moussawi, 2011) carried out an empirical study by studying the impacts that investments had on the net operating work capital. They used a dependent variable to represent the excess returns of a stock in a period of 12 months. Their model looked like some sort of a price equation because there is a relation of excess stock returns to the factors that determine stockholders’ cash flows.

Banda et. al (2011) carried out a research to find out the effects that various working capital management practices had on firm value of Sri Lankan corporations. They used a sample of 74 firms registered in the Colombo Stock Exchange for the period between 2005 and 2009. The variables that were used by the researchers were one, three dimensions of working capital management namely aggressive practice, moderate practice, and conservative practice the other variable was from a value added perspective, market value added and economic value added. They found out that conservative working capital management related negatively with market added value, thus, firms that practiced a moderate working capital management were better advantaged in terms of market value added compared to the latter. Likewise, they found out that aggressive working capital management practice had a considerable negative connection to the firm’s economic value added, thus, such firms are at a disadvantage from an economic value added perspective compared to their counterparts that practiced a moderate working capital management. To sum up it all, there is a surety that working capital management can make a positive contribution to the boosting of the firm’s value provided there is a proper design and implementation.

In the retail industry sector, perhaps, there is no study that explicitly explains describe the significance of working capital management in the creation of firm value better than Howorth and Westhead (2003). The two researchers carried out a research to find out the effects that various working capital management practices had on UK’s small firms. They observed that in UK, there were four kinds of firms namely those that are centered on cash management practices, on inventory management practices, on revenue management routines, and lastly, those that would give scant credence to any practice of working capital management.

The first category, firms that are centered on cash management practices. The researchers found out that the firms under this category exhibited three common characteristics: they were significantly large, were still young, and much of their financing was external. The second category, were firms that were centered on inventory management practices because their financing from external sources was less. The third category, firms that were very much centered on their revenue management practices (Mohammadi, 2009). The firms in this category, and those in the first, were found out to have the highest levels of financial skills. Moreover, they found out that they had the lowest level of operations that were seasonal. The first and the third, had the the lowest growth rates compared to the others. Also, the first, second, and third categories were found out to have the lowest levels of external financing. Lastly, the firms that had less propensity of employing any working capital management practice. The firms in this category possessed compared to the firms in the other categories. The firms under this category were seen to have the shortest cash conversion cycle among the group, thus, having the least requirement for working capital management (Howorth & Westhead, 2003; Viskari, Lukkari, & Karri 2011).

Empirical Findings on Working Capital Management and Financial Crisis

Working capital management gets great attention from the firm officials. The attention is even greater during periods of recessions when the firms are uncertain on the cash flows. The financial turbulence that rocked the world in 2007 had a great impact on the world’s economy, and both the financial and corporate sectors had premium liquidity put on them (Emilio et al., 2010).

CFO Research Services carried out an electronic survey in August 2010. The objective of the organization was to find out the impact of the global economic meltdown on the working capital requirements of the U.S firms (RBS, 2011). The firms’ financial officials were asked a number of questions regarding the effects that the global recession had on working capital management as the economy started recovering. It was found out that the firms’ financial officials used conservative working capital management practices, also, used conservative ways to run their businesses in the wake of the recession. Asked the lessons got from the economic meltdown, a significant number, approximately one-third, concurred that they were extra careful in managing their working capital, more cautious in their spending, and conserve cash as much as possible (RBS, 2011).

The retail industry plays a crucial role in the world’s economies and the welfare of the retail industry is a determinant of the wider economy. During the global recession that hit the world in 2008 to 2009, UK’s retail sector was one of the sectors that the recession had a heavy toll on. This is because the retail investment was faced with an acute downturn and the retail construction decreased enormously; also, was faced with credit turbulence, the spending of the consumers was depressed, lack of finance, and a risk aversion by the investors. Another challenge that awaited the UK retail industry was in 2010. For instance, data figures show that in 2010, a volume of 10% in the decrease of the retail construction was projected. That was only the tip of the iceberg because between 2007 and 2009, there was a 22% decrease on the volume of retail construction (Langdon 2010).

Despite the numerous studies that have carried out, there can be a challenge of pointing out which are the effects of financial and a recession that is normal. This is because at times, financial crises and recessions can occur concurrently (Rezazadeh & Heydarian, 2010). Yet, considerable amount of evidence point out that both the financial crises and other recessions linked to them have not only a negative impact, but may also have a long-term impact on the economy’s supply capacity (Benito, Neiss, Price, Simon, & Rachel, 2010). Nevertheless, Emilio et al., (2010) conducted a study on the effects of working capital on business cycle emphasizing on the great impact that the recent credit had on the practices of UK firms. The researchers calibrated a standard DSGE model, based on flexible-price, to study the significance of working capital components in order to learn the impacts that working capital had on macroeconomic variables. They found out that financial intermediation shocks like those witnessed in the 2007 and 2008 period had negative impacts on the welfare of the economy. Similarly, the researchers used the DSGE model to study how financial crisis like the one that that rocked the UK in 2007/2009 took the advantage of the working capital to affect its economy. They observed that the presence of flexible world prices notwithstanding, an interruption of the credit supply would significantly affect the economy.

2.4 Empirical Findings on Working Capital Management in Relation to Corporate Profitability

Based on the opinion of financial officials in many firms, managing working capital is synonymous with the value of their firms (Robert, Mark & Rabih, 2011). Cash conversion cycle—should not be confused with cash management, instead, it’s how the firm manages its net operating working capital—may be the oldest concept applied in integrated working capital. Cash conversion cycle is the time prolonged between expenditure and collection of raw materials and sale of completed goods respectively (Myers, 2000). Financial officials in firms see the management of net operating working capital as a factor that can be used to determine firm value; unfortunately, research has largely ignored the connection between the two as there aren’t publications on the area Kmart and Wal-Mart were faced with cash conversion cycle issues for 61 days and 40 days respectively. Roughly, Kmart was under a situation that required $ 198.3 more million annually in its financing expenditures; at last, it became bankrupt and the reason for this was directed to poor management practices of its working capital (Robert, Marc, & Rabih 2011).

In their research on U.S corporations for the period between 1990 and 2004, they got various observations to support the importance of working capital management to the firm value. They observed that investing a dollar on the net operating capital decreased its value compared to that got on cash; they also observed that the firm value was reduced where an extra dollar was invested in the firm’s net operating working capital (Robert, Mark & Rabih, 2011). Using economic value added and market value added to find out the firm value has its own challenges and advantages, however, literature has proved and endorsed economic value added and market value added “as the better proxy for measuring the value of the firm” (Bandara, & Weerakoon, 2011).

A firm’s profitability, whether gauged by assets returns or equity returns got, is directly proportional to improvement of a firm’s working capital management (Kieschnick, LaPlante & Moussawi, 2011) carried out an empirical study by studying the impacts that investments had on the net operating work capital. They used a dependent variable to represent the excess returns of a stock in a period of 12 months. Their model looked like some sort of a price equation because there is a relation of excess stock returns to the factors that determine stockholders’ cash flows.

Banda et. al (2011) carried out a research to find out the effects that various working capital management practices had on firm value of Sri Lankan corporations. They used a sample of 74 firms registered in the Colombo Stock Exchange for the period between 2005 and 2009. The variables that were used by the researchers were one, three dimensions of working capital management namely aggressive practice, moderate practice, and conservative practice the other variable was from a value added perspective, market value added and economic value added. They found out that conservative working capital management related negatively with market added value, thus, firms that practiced a moderate working capital management were better advantaged in terms of market value added compared to the latter. Likewise, they found out that aggressive working capital management practice had a considerable negative connection to the firm’s economic value added, thus, such firms are at a disadvantage from an economic value added perspective compared to their counterparts that practiced a moderate working capital management. To sum up it all, there is a surety that working capital management can make a positive contribution to the boosting of the firm’s value provided there is a proper design and implementation.

In the retail industry sector, perhaps, there is no study that explicitly explains describe the significance of working capital management in the creation of firm value better than Howorth and Westhead (2003). The two researchers carried out a research to find out the effects that various working capital management practices had on UK’s small firms. They observed that in UK, there were four kinds of firms namely those that are centered on cash management practices, on inventory management practices, on revenue management routines, and lastly, those that would give scant credence to any practice of working capital management.

The first category, firms that are centered on cash management practices. The researchers found out that the firms under this category exhibited three common characteristics: they were significantly large, were still young, and much of their financing was external. The second category, were firms that were centered on inventory management practices because their financing from external sources was less. The third category, firms that were very much centered on their revenue management practices (Mohammadi, 2009). The firms in this category, and those in the first, were found out to have the highest levels of financial skills. Moreover, they found out that they had the lowest level of operations that were seasonal. The first and the third, had the lowest growth rates compared to the others. Also, the first, second, and third categories were found out to have the lowest levels of external financing. Lastly, the firms that had less propensity of employing any working capital management practice. The firms in this category possessed compared to the firms in the other categories. The firms under this category were seen to have the shortest cash conversion cycle among the group, thus, having the least requirement for working capital management (Howorth & Westhead, 2003; Viskari, Lukkari, & Karri 2011).

Empirical Findings on Working Capital Management and Financial Crisis

Working capital management gets great attention from the firm officials. The attention is even greater during periods of recessions when the firms are uncertain on the cash flows. The financial turbulence that rocked the world in 2007 had a great impact on the world’s economy, and both the financial and corporate sectors had premium liquidity put on them (Emilio et al., 2010).

CFO Research Services carried out an electronic survey in August 2010. The objective of the organization was to find out the impact of the global economic meltdown on the working capital requirements of the U.S firms (RBS, 2011). The firms’ financial officials were asked a number of questions regarding the effects that the global recession had on working capital management as the economy started recovering. It was found out that the firms’ financial officials used conservative working capital management practices, also, used conservative ways to run their businesses in the wake of the recession. Asked the lessons got from the economic meltdown, a significant number, approximately one-third, concurred that they were extra careful in managing their working capital, more cautious in their spending, and conserve cash as much as possible (RBS, 2011).

The retail industry plays a crucial role in the world’s economies and the welfare of the retail industry is a determinant of the wider economy. During the global recession that hit the world in 2008 to 2009, UK’s retail sector was one of the sectors that the recession had a heavy toll on. This is because the retail investment was faced with an acute downturn and the retail construction decreased enormously; also, was faced with credit turbulence, the spending of the consumers was depressed, lack of finance, and a risk aversion by the investors. Another challenge that awaited the UK retail industry was in 2010. For instance, data figures show that in 2010, a volume of 10% in the decrease of the retail construction was projected. That was only the tip of the iceberg because between 2007 and 2009, there was a 22% decrease on the volume of retail construction (Langdon 2010).

Despite the numerous studies that have carried out, there can be a challenge of pointing out which are the effects of financial and a recession that is normal. This is because at times, financial crises and recessions can occur concurrently (Rezazadeh & Heydarian, 2010). Yet, considerable amount of evidence point out that both the financial crises and other recessions linked to them have not only a negative impact, but may also have a long-term impact on the economy’s supply capacity (Benito, Neiss, Price, Simon, & Rachel, 2010). Nevertheless, Emilio et al., (2010) conducted a study on the effects of working capital on business cycle emphasizing on the great impact that the recent credit had on the practices of UK firms. The researchers calibrated a standard DSGE model, based on flexible-price, to study the significance of working capital components in order to learn the impacts that working capital had on macroeconomic variables. They found out that financial intermediation shocks like those witnessed in the 2007 and 2008 period had negative impacts on the welfare of the economy. Similarly, the researchers used the DSGE model to study how financial crisis like the one that that rocked the UK in 2007/2009 took the advantage of the working capital to affect its economy. They observed that the presence of flexible world prices notwithstanding, an interruption of the credit supply would significantly affect the economy.

2.5 Analysis of Academic Literature on Working Capital Management

Much of the financial research carried out deals with the management of working capital, and in finance literature, it has not be new to it. Working capital management is the backbone of the field of financial management. Its significance is to help understand and maintain an optimal range of the working capital constituents (Azam, & Heider 2011; Kieschnik, LaPlante, & Moussawi, 2011 p.18; Kumar, 2001).The significance of working capital management is based on two reasons; one of the reasons is that the current assets get a significant part of the total investment, and the second, changes in sales lead to changes in the level of both current assets and liabilities.

Perhaps one of the oldest firms to be featured in a case study with the objective of showing the significance of working capital management is W.T. Grant. In their study, the researchers observed that the firm’s pending bankruptcy in the 1970s could be seen as for the last decade, it was facing cash flow problems. There are firms that have got lots of cash investment in working capital. However, the impact on the firms lay on the practice used in the working capital management (Van Horne and Wachowicz, 2000). The fate of a firm is dependent on the way the financial officials of the firm deal with the receivables, inventory, and payables (Filbeck & Krueger, 2005). Through the reduction of the funds that have stalled on the current assets, firms can be in a position to either decrease its financial expenses or increase the present funds for development.

A firm mismanaging its working capital is courting the loss of its profits and subsequently, its downfall. Nowadays, firms are becoming creative in the way they manage their working capital (Pawlina. & Renneboog 2005). For instance, firms are realizing the significance of the Six Sigma Methodology and giving it a special attention. This is because the methodology is increasingly and reliably becoming a sure way to find and ascertain effective running of all fields of the firm. Despite the application of different practices, such as the Six Sigma Methodology by a firm, nevertheless, the way it manages its working capital needs must be optimal.

2.4) Important issues that are relevant to your investigation.

The following are the important issues that are relevant to my investigation. One of them is that all the participants in the research will participate on their own voluntary and won’t be coerced against their free will. All the information involving the participants will be treated with confidentiality. The participants will not be put in situations that put them in harm’s way.

2.5 Conclusion

 

In conclusion, this chapter conducts a literature review on the significance of working capital management on firm’s value, effect on a firm during financial crisis, and its relation to corporate profitability. Research shows that working capital management is a good determinant of firm value, working capital management practice determines the survival of a company during financial crisis, and that working capital management has a positive and significant correlation with a firm’s profitability. This chapter has covered the impacts of working capital management in different contexts. In the next chapter, three, there is a description of the impacts of working capital management on a firm, and how the firm conducts its working capital management practices.

Chapter Three

Case Study of Working Capital Management in the UK Retail Industry

3.1 Introduction

In this chapter, justification of why the research investigates working capital management of J. Sainsbury plc in the United Kingdom and a brief history of the company of choice follow by a thorough assessment of approach and techniques currently practiced by the managers of J. Sainsbury plc in the effort to enhance their WCM. Thereafter, there shall be a discussion on the impacts of working capital management on performance firm’s value and profitability. the research will also incorporate both the internal and external factors that affect the working capital management of J. Sainsbury plc.

3.2 WCM in the UK J. Sainsbury

Working capital management is one of the key determinants of a company’s market value because of its effects on profitability. Similarly, WCM is extremely essential from the perspective of a company’s sustainability. In this respect, it is important for an organization to strive for a balance between its profitability and risk as related to managing working capital. Gross working capital essentially refers to the overall investment in current assets of a company (Eljelly 2004). However, net working capital – current assets less current liabilities – is most applicable in the perspective of working capital management. Working capital management thus reflects the decisions relating to the working capital together with short-term financing and entails managing the relationship between a company’s current assets and current liabilities. In general, therefore, the manner in which a firm manages its working capital has significant effects on its profitability, meaning that working capital management calls for a trade-off between risk and profitability (Eljelly 2004).

 

Figure 1: Elements of Working Capital management

(Meir et al 2005)

 

Working capital management is the focal point of this investigation because it has a significant impact on profitability and liquidity of J. Sainsbury (Augustin 201). Traditionally, it has been the practice of J. Sainsbury – in the effort to take a greater risk for greater profits and losses – to reduce the size of its respective working capital as related to its sales volume. Similarly, when geared at improving liquidity, the company often increases the amount of its working capital. Nonetheless, this practice is likely to reduce the sales volume and, in turn, the profitability of the retail company (Wrigley & Lowe 2002). In this respect, J. Sainsbury has battled with striking a balance between profitability and liquidity. The major effects of different variables of working capital are the average collection period of the so called receivable days; the payable days or average payment period, inventory turnover in days; quick ratio; current ratio; cash conversion cycle on the net operating profitability of J. Sainsbury (Augustin 2011).

Figure 2: Cash conversion cycle at J. Sainsbury plc

(Brigham & Houston 2009)

Working capital management is, therefore, a key area of concern for J. Sainsbury plc. The aim of working capital management is to lower the cash conversion cycle, as well as the amount of capital represented in the net current assets (Weisel, Harm & Bradley 2003). There is a minimization of time between the capital outflow and the inflow of cash together with the process cost and quality through working capital management. Achievement of the goals is through proper coordination of order to cash, purchase to pay and sales (Augustin 2011, p.8). As a leading retail company in the UK, J. Sainsbury gives relatively high priority to sales because they realize it is the most significant process to release capital that is tied up in the net current assets. The company understands that it allows itself to have a high proportion of current assets as compared to its major rivals, less liquidity, reliance on short term debt and volatile cash flows, because these risks failure in working capital management, which would be costly for the firm.

Like all other retail firms in the United Kingdom and the corporate world at large, J. Sainsbury plc faces the paradox and dilemma that characterizes working capital management. This is because retaining high working capital is overly inefficient on the one hand, whilst holds rather little working capital that is dangerous to the continued survival of the company, on the other hand (Izadinia & Taki 2010). Excess stock is a waste to a retail giant like J. Sainsbury plc in the sense that cash tied up in stock is less utilized effectively, which results in much warehousing or storage costs, and there is a greater risk of stock being lost in a result of damage and obsolescence. On the other hand, J. Sainsbury plc cannot entertain too little stock because it risks grounding its activities, lose significant amounts of income, as well as cause undesired discomfort to its customers (Augustin 2011). In light of this, J. Sainsbury plc is always striving to have as little money held up in working capital as possible.

3.3 Brief History of J. Sainsbury Plc

  1. Sainsbury plc traces its roots to 1869 when John James and Mary Ann Sainsbury founded it in London (Zentes et al. 2011). The company first gained its reputation for dealing in high quality products offered at relatively low prices. However, the food retailer’s strategy of selling high quality products at premium prices found its niche in 1882 when it became embraced in more affluent regions of London. Faced with stiff competition from companies like Liptons, J. Sainsbury expanded threefold in the last decade of the 19th century. It then grew to status of the largest grocery retailer in the UK by 1922.

Over the years, the company grew tremendously and attained public status in the 1970s, becoming the biggest ever flotation on the London Stock Exchange in 1973 under the leadership of John Sainsbury. The company has steadily diversified its product range, and it was the first ever company in the market to have its own branded wines. By March 2004, J. Sainsbury plc boasted 583 supermarkets in operation throughout the UK and beyond. In August 2004, the company purchased the Jacksons giving J. Sainsbury over 250 convenience stores, though under different brand names, operating as distinct business under the existing management.

At present, J. Sainsbury plc is the third largest chain of supermarkets found in the United Kingdom (behind Tesco and Asda respectively) with its market share put at 16.5% (Zentes et al. 2011). The group currently operates a total of 537supermarkets and 335 convenience stores. In addition, it runs the Sainsbury’s Bank, Sainsbury’s on.............


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