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Journal of African Business

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Determinants of Working Capital Requirements in Selected Quoted Companies in Nigeria

Olayinka Olufisayo Akinlo
a a

Department of Management and Accounting, Obafemi Awolowo University, Ile-Ife, Nigeria

Version of record first published: 04 Apr 2012.

To cite this article: Olayinka Olufisayo Akinlo (2012): Determinants of Working Capital Requirements in Selected Quoted Companies in Nigeria, Journal of African Business, 13:1, 40-50 To link to this article: http://dx.doi.org/10.1080/15228916.2012.657951

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Journal of African Business, 13(1), 4050, 2012 Copyright # Taylor & Francis Group, LLC ISSN: 1522-8916 print=1522-9076 online DOI: 10.1080/15228916.2012.657951

Determinants of Working Capital Requirements in Selected Quoted Companies in Nigeria

Olayinka Olusayo Akinlo
Department of Management and Accounting, Obafemi Awolowo University, Ile-Ife, Nigeria

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In this article, the author investigates the determinants of working capital requirements of 66 rms in Nigeria using panel data for the period 19972007. The results suggest that sales growth, rms operating cycle, economic activity, size, and permanent working capital are rm specic characteristics that positively drive working capital policy. Leverage, however, is inversely related to working capital requirements. Essentially, the results imply that traditional valuation methods used to quantify the efciency of corporate working capital policy may be suspect as increased investments in operating working capital may be necessitated by increased business uncertainties. In general, the ndings suggest that some of the insights from modern nance theory are potable to Nigeria.

Key words:

determinants, Nigeria, panel, working capital

INTRODUCTION The importance of working capital among rms cannot be overemphasized. It constitutes a major external source of capital for small and medium-sized and highgrowth rms. Working capital position of rms is not only an internal rmspecic matter but also an important indicator of risk of creditors (Moyer, McGuigan, & Kretlow, 1995). Working capital is important because of its effects on the rms protability and risk and, consequently, its value (Smith, 1980). Excessive levels of current assets can easily result in a rm realizing a substantial return on investment. However, inadequate working capital not only impairs the rms protability but also results in production interruptions and inefciencies and sales disruptions.1
This study was nanced by the Council for the Development of Social Science Research in Africa (CODESRIA). The author would like to thank two anonymous referees and the editor of the journal for valuable comments and suggestions. All remaining errors are the authors responsibility. Address correspondence to Olayinka Olusayo Akinlo, Department of Management and Accounting, Obafemi Awolowo University, Ile-Ife, Nigeria. E-mail: yakinlo@oauife.edu.ng

Indeed, the signicant decline of corporate performance during the late 1990s nancial crisis has brought to fore the need for rms, especially in developing industrialized countries, to pay more attention to working capital management. The nancial crisis has shown clearly that improving working capital management is very important for rms to withstand the impacts of economic turbulence (Reason, 2008). Moreover, efcient working capital management is essential for rms during the booming economic periods (Lo, 2005), for the reason that working capital management is related to all aspect of managing current assets and current liabilities. Working capital management is not only to immunize rms from nancial crisis but can be managed strategically to enhance competitive position and protability. In short, investigating the determinants of working capital management in general provides valuable information that can be utilized in formulating an effective working capital strategy to improve protability. However, to date, a large number of studies on working capital management have been focused on rms in developed and industrialized economies. Only few studies have been devoted to rms in developing countries. Indeed, to the best of our

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knowledge, no known study has been focused on working capital management in the case of Nigeria. The dearth of research on determinants of working capital requirement might not be unconnected with the lack of rm-level data in most developing countries. However, there is need to ll this gap. Hence, the main objective of the study is to examine the determinants of working capital management of some selected rms in Nigeria. It is expected that the outcome of this study will be of great use for corporate managers and other stakeholders to understand the impact of forces that inuence working capital requirements. The rest of the study is organized as follows: the next section presents the literature review. The third section provides the sample and data description. The fourth section discusses the methodology and the fth section reports the empirical ndings of the study. The last section concludes the article.

LITERATURE REVIEW Theoretical Issues A large number of theoretical and empirical studies have been conducted on small and medium-sized rms in Sub-Saharan Africa. Some of these include OwusuFrimpong and Martins (2010), Acquaah and AppiahNkrumah (2011), Babatunde and Laoye (2011), and Anderson (2011). However, most of these studies have not focused on determinants of working capital.2 In general, a large number of factors, each having different importance, inuence working capital needs of rms. However, the importance of factors tends to change for a rm over time. This explains why an analysis of relevant factors should be made in order to determine total investment in working capital. Theoretically, several factors have been identied in the corporate nance literature (Ramamoorthy, 1976). These include the nature of the business, market and demand conditions, technology and management policy, credit policy, availability of credit from suppliers, operating efciency, and price level changes. The nature of the business is a major determinant of working capital need of a rm. Retail stores will need to carry large stocks of a variety of goods to satisfy varied and continuous demands of their customers; likewise, trading and nancial rms will require a large sum of money to be invested in working capital. In the same way, some manufacturing businesses and construction rms will need to invest substantially on working capital and a nominal amount in xed assets. In contrast, public utilities will have limited need for working capital but have to invest substantially in xed assets. As pointed by Pandey (2006), the working capital requirements of

public utilities in general, will be low because they may have only cash sales and supply services, not products. Hence, no funds will be tied up in debtors and stocks (inventories). As has been pointed out in the literature, the working capital requirements of most manufacturing companies will likely fall between the two extreme requirements of trading rms and public utilities. Therefore, manufacturing rms will need to make adequate investment in current assets depending upon the total assets structure and other variables. Another important factor is sales. Theoretically, it is difcult to ascertain precisely the nature of the relationship between sales volume and working capital needs. A rm that is growing might need to invest in xed assets to be able to sustain growing production and sales. This will, no doubt, result in increase investment in current assets to support enlarged scale of operations. However, sales are function of demand conditions. More often than not, large numbers of rms do experience seasonal and cyclical uctuations in the demand for their services and products. These business variations have been argued to affect the working capital requirement, especially the temporary working capital requirement of the rm. In the period of economic boom, a rms investment in inventories and debtors will increase because sales will increase. Moreover, in the period of boom, rms might need to make additional investment in xed assets so as to increase their productive capacity. This action of the rm will entail increasing their level of working capital. The reverse is the case when there is a decline in the economy. In the period of slump, sales will fall and thus the levels of inventories and debtors. Consequently, rms will curtail short-term borrowings and hence their requirements of funds for working capital. As noted in Pandey (2006), apart from the fact that seasonal uctuations affect working capital requirement, they also create production problems for the rm. In the periods of peak demand, increasing production may be expensive for the rm. In the same way, rms may face more expensive production during the slack period as they may have to maintain a large workforce and physical facilities without adequate production and sales (Pandey, 2006). In order to utilize its resources to the fullest, a rm might adopt the policy of level production, irrespective of seasonal changes. However, adoption of such a policy will entail accumulation of inventories during the off season and their quick disposal during the peak season. The increasing level of inventories during the slack season will require increasing funds tied up in the working capital for some months. One other factor is the technology and manufacturing policy of rms. Each rm has a manufacturing cycle, which is also known as the inventory conversion cycle. The cycle starts when the rm purchases raw materials,

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uses the raw materials, and turns them into nished goods. The manufacturing cycle can be long or short. If it is long, the rms working capital requirement will be large, whereas the opposite is the case if it is short. For example, a rm that produces soaps, sweets, cakes, etc. may have a cycle that last for few hours, but for a rm producing cars, the cycle could last weeks or months. By implication, a long manufacturing cycle will bring about a larger tie-up of funds in inventories. In order to reduce the working capital requirement and shorten the manufacturing cycle, the rm must search for improved technology that will ensure prompt completion of the nished product. However, for this to be achieved there is need for proper planning and coordination at all levels of activity. This will ensure that there are no delays that can result in accumulation of work-inprogress and a waste of time. Manufacturing rms that need a lot of investment in working capital usually have a policy of asking for advance payments from their customers in order to minimize the amount they will invest in working capital, whereas nonmanufacturing rms, especially service and nancial enterprises, do not have a manufacturing cycle. Moreover, to resolve the working capital problems due to seasonal changes in demand for the rms product, there is a need to maintain a steady production policy. This type of policy causes inventories to accumulate during off-season periods and this will expose the rm to greater inventory costs and risks,3 although there are rms that operate a variable production policy due to the high costs and risks of maintaining a constant production schedule. This implies varying production schedules with changes in demand. Firms whose manufacturing capability can accommodate more than one product usually solve their working capital problems by manufacturing the original product during its increasing demand, and during the off-season they produce other products in order to utilize physical resources and working force. This shows that production policy varies from rm to rm depending on the peculiarities of each rm. Another factor is the issue of credit policy. Each rm, depending on the industry in which it is located, usually has credit policies that should be followed. A rm can shape its own credit policy within the constraint of the industry norms and practices and it is advisable that a rm should use its discretion in granting credit terms to customers. Hence, a rm should not maintain a liberal credit policy without a prior knowledge of the creditworthiness of customers because there may be problem of collecting the money later. Another issue tied with credit policy is the issue of collection periods. Where a rm has slack collection procedures there is a chance of increasing the rms bad debt. Therefore, rms should evaluate the creditworthiness of their customers

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before granting them credit and endeavor to avoid high collection periods because a lot of funds will be tied up in debtors. One thing that reduces the working capital need of a rm is the availability of credit from its suppliers. This nances the rms inventories and also reduces the cash conversion cycle. Where a rm is unable to have credit from the suppliers but has favorable bank credit (i.e., the interest rate is at a reasonable cost), the difculty of nancing its inventories and debtors is removed because the working capital policy of the rm will be greatly inuenced. Moreover, there is need for every rm to utilize its resources efciently and effectively in order to increase protability and reduce the pressure on working capital requirement. The resources are materials, labor, and overhead. Last, every rm is expected to think past its present state, especially anticipating changes that could occur in the nearest future. In a nation like Nigeria where prices of commodities are always skyrocketing, a rm depending on the industry in which it operates should know that as price level increases, the working capital requirement will increase except where the rm is able to change the prices of its products immediately. Some rms may not be affected by this price level change because of their industry. Empirical Evidence on the Determinants of Working Capital Some empirical studies have been conducted to identify the determinants of working capital management in the developed countries. However, in developing countries, Nigeria inclusive, not very many studies have been conducted on the subject matter. In this subsection, we provide a summary of the ndings of the few existing empirical studies on the determinants of working capital management. Nunn (1981) used the PIMS database to examine why some product lines have low working capital requirements, while other product lines have high working capital requirements. The results based on factor analysis, identied factors associated with production, sales, competitive position, and industry. Hawawini, Viallet, and Vora (1986) examined the inuence of a rms industry on its working capital management. The study was based on 1181 U.S. rms over the period 1960 to 1979. The results showed that there was a substantial industry effect on rm working capital management practices that is stable over time. The main conclusion from Nunn (1981) and Hawawini et al. (1986) was that sales growth and industry practices were important factors inuencing a rms investment in working capital. Prior research on business indicator and nancial ratios revealed that business exerted an inuence on

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the nancial ratios of a company (Horrigan, 1965; Liu, 1985; Luo, 1984; Su, 2001; Zhou, 1995). Apart from business indicator, another important factor that has been found to affect the working capital policies of a company is uncertainty of the wider economic environment (Merville & Tavis, 1973). Different industries respond differently to the impact of economic environment due to the different natures of their operations. Shulman and Cox (1985) indicated that current ratio and quick ratio are used to evaluate a rms capability to pay debts from the perspective of liquidity with no consideration of the going concern of the company, while net working capital integrating operational and nancial strategy is not a suitable indicator of liquidity. In predicting the nancial crisis of a company, Shulman and Cox (1985) classify net working capital into working capital requirement (WCR) and net liquid balance (NLB) to evaluate the management of working capital and capability of raising and allocating capital, respectively. They found NLB better than traditional indicators in terms of predicting nancial crisis and the liquidity of a company. Hawawini et al. (1986) believed that evaluations based on NLB and WCR were better than any based on traditional indicators. Looking at the work of Kieschnick, LaPlante, and Moussawa (2006) on the determinants and consequences of corporate working capital, they looked at the factors that inuence a rms working capital using the cash conversion cycle (CCC) against the NTC used by Shin and Soenen (1998). Like Hawawini et al. (1986), they believe that industry practices are signicant determinants of a rms working capital practices. Chiou and Cheng (2006), in their article on the determinants of working capital, investigated the relation of business indicator and management of shortterm capital from the perspective of a rms working capital, which traditionally is rated by current ratio, quick ratio, and net working capital. They used the NLB and WCR as measures of a companys working capital in analyzing the inuence of rm characteristics, outside business factors, and industry effect. Their results showed that debt ratio and operating cash ow evaluated by both WCR and NLB exert inuence on working capital. Specically, Kim, Mauer, and Sherman (1998) analyzed the determinants of liquidity holdings for a sample of U.S. companies. They developed a model of optimal corporate investment in liquid assets based on a cost-benet trade-off between the holdings of liquid assets and the benets of minimizing the need to fund protable future investment opportunities with costly external nancing. They found those rms facing higher costs of external nancing, having more volatile earnings, and with relatively lower returns on assets hold signicantly larger liquid assets.

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In the same way, Opler, Pinkowitz, Stulz, and Williamson (1999), in their study based on U.S. rms, found that small rms and rms with strong growth opportunities and riskier cash ows hold larger amounts of cash. The study by Pinkowitz and Williamson (2001) examined the cash holdings of rms from United States, Germany, and Japan. The results obtained by Pinkowitz and Williamson were similar to the Opler et al. (1999) ndings. However, in addition to Opler et al. (1999), they found that the monopoly power of banks had a signicant impact on cash balance. Ozkan and Ozkan (2004) examined the empirical determinants of cash holdings for a sample of U.K. rms. The results revealed that managerial ownership played an important role in determining corporate cash holdings in the United Kingdom. The results showed that board composition and the presence of ultimate controllers do not have a signicant impact on cash holdings. Nazir and Afza (2008) examined the various factors that determine working capital requirements for 204 manufacturing rms for the period 1999 to 2006 in Pakistan. The results based on panel OLS estimation found that operating cycle, leverage, return on assets (ROA), and Tobins q are the internal factors that signicantly inuence working capital. The results also showed that working capital management practices are also related to industry and that different industries are following different working capital requirements. Kim et al. (1998) and Opler et al. (1999) estimate the determinants of cash holdings. The summaries of the two studies are consistentcash varies inversely with size and leverage but varies directly with the degree of asymmetric information and cash ow volatility. These ndings support the transactions, precautionary, and speculative motives for holding cash developed by Keynes. The only difference in their works is that Kim et al. (1998) report a signicant negative relation between cash and cash ow, while Opler et al. (1999) estimate a direct relation between the cash and cash ow. Sample Characteristics and Sources of Data The study utilized data obtained from 66 purposively selected rms from the 100 listed nonnancial rms on the Nigerian Stock Exchange (NSE). The quoted companies covered in this study are dispersed over many states in the country However, many of them have their headquarters located in Lagos State; this is as a result of the fact that Lagos is the commercial nerve center of the country. Most of the data used in this study were sourced from the annual reports and statement of accounts of the selected rms, obtained from the headquarters of the companies and from the NSE ofce in Ibadan, Oyo state. Only rms listed before 1999 and still

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in operation through the end of the 2007 nancial year were chosen. The study only involved rms that were listed in the stock market as information on the unlisted companies are not readily available. Indeed, the management of most unlisted rms was not always ready to divulge information on their companies.4 The sample of rms cut across 15 sectors of the NSE classication: automobile and tire, breweries, building materials, chemical and paints, computer and ofce equipment, conglomerates, construction, food beverages and tobacco, healthcare, industrial=domestic products, machinery, packaging, petroleum, printing and publishing, and real estate.5

The dependent variable is the working capital. For this study, working capital was measured in two ways. The rst measure is WCR dened as the difference between current assets less current liabilities. The second measure is called the CCC. The variable CCC is measured as the sum of number of days accounts receivable and the number of days inventories minus the number of days accounts payable.7 However, to reduce the inuence of rm size, both measures of working capital were deated by total assets. The time-varying independent variables that were included in the model are sales growth, operating cycle, rm size, and leverage. Thus, specifying the model explicitly, we have: WCRit a0 a1 SGRit a2 OPC a3 SIZit a4 RATAit a5 LEVit a6it GDP a8 CONVj ; t eit . . . 2 Equation 2 states that working capital requirements measured as difference between working current assets less current liabilities (WCR) and CCC is a function of sales growth, operating cycle, rm size, proportion of a rms assets accounted for by xed assets (RATA), leverage (LEV), and business indicator measured as the growth rate of the level of economic activity (GDP) and control for permanent working capital requirements (CONV) measured as minimum working capital ratio (MWC) or average working capital ratio (AWC).8 Sales growth (SGR) is calculated as annual percentage change in growth given as [Salest salest 1]= salest 1. Operating cycle (OPC) is the sum of days in inventory and days in accounts receivable. Firm size (SIZ) is the natural logarithms of sales deated by total assets. RATA is the ratio of xed nancial assets to total assets. Fixed nancial assets are shares in other rms (mainly afliated) rms, intended to contribute to the activities of the rms that holds them and loans that are granted with the same purpose. LEV is measured as the ratio of total debt to net assets. Net assets are net xed assets plus net current assets, where net current assets are current assets minus current liabilities excluding interest-bearing short-term debt for working capital. Net assets equal capital employed because capital employed includes total debt and net worth. Gross domestic product growth rate (GDP) is dened as the annual growth rate of GDP. CONV is control for permanent working capital requirements and is measured in two ways: MWC and AWC. The MWC is each rms minimum working capital requirements divided by the rms average total assets. The AWC is each rms working capital requirements divided by average total assets.9

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METHODOLOGY In examining the determinants of working capital requirements of rms in Nigeria, the study employs panel data procedures as the sample contains data across rms and over time. In the estimation, three estimation models were adopted, namely, pooled OLS, xed effects, and random effects. The use of pooled OLS is anchored on the assumption that there are no group or individual effects among the rms. However, as panel contains observation on the same crosssectional units over several time periods, there are most likely to be cross-sectional effects on each rm or on a set of group of rms. To take care of this problem, we use other estimation techniques: xed effects and random effects. Fixed effect approach takes into consideration the individuality of each rm or cross-sectional unit included in the sample by allowing the intercept to vary for each rm while assuming that the slope coefcients are constant across rms. Random effects, on the other hand, assume that the individual or group effects are uncorrelated with other explanatory variables and can be formulated. Model Specication The general model specication is represented by the following equation: WCRit a0 a0 Xit bi Zit eit i 1; . . . ; n t 1; . . . ; Ti 1 where X is a vector of time-varying independent variables and Z is the vector of the control variables. a0 is a rm-specic intercept representing unobservable individual characteristics,6 and eit is a white noise error term for rm i at time t. In this equation, it is considered that the error term is distributed independently and identically in a manner that the variance is equal to zero.

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EMPIRICAL RESULTS Descriptive Statistics Table 1 provides further information on the series employed in our study. The working capital requirements variable has a mean of 1,913,137 naira, which is highest in 2007 and at its minimum in 2001. The positive and high values of working capital requirement indicate that companies are maintaining a relatively loose policy regarding their working capital management. In the prosperous period of high economic growth rate and high sales growth rate, the working capital ratio is quite high compared to other years. The cash conversion cycle used as a proxy to check the efciency in managing working capital is on average 95 days and standard deviation is 127 days. Firms receive payment against sales after an average of 53 days and standard deviation is 62 days. Firms wait an average of 46 days to pay their purchases with standard deviation of 187 days. It takes an average of 93 days to sell inventory with standard deviation of 74 days. The statistics in Table 1 show that prot was highest between 2001 and 2003 but dropped below sample average between 2004 and 2006. It, however, increased above sample average in 2007. Firm size is increasing with the passage of time. Leverage tends to be relatively stable over the years. However, it recorded extraordinary increase in 2002. Sales growth falls below the sample mean over the period 1999 to 2003. However, the reverse was the case between 2004 and 2007; sales growth far exceeded the sample mean during this period. This might possibly reect the increase in the price of oil that led to increase revenue in the latter period of 1999 to 2007. Increased oil revenue might have positively affected consumers demand and, thus, rms production.

REGRESSION RESULTS The results for the determinants of working capital requirement (WCR and CCC) using pooled OLS and xed-effects panel methods respectively are presented here.10 Each econometric methodology is used to estimate three variations of Equation 2. Model 1 is the base model of estimated Equation 2. Model 2 controls for permanent working capital via the minimum WCR ratio, and model 3 controls for permanent component of WCR using the AWC requirements ratio. In the same way, Equation 4 is the base model and estimated Equation 2 using panel xed-effects methodology. Also, adopting panel xed-effects approach, models 5 and 6 control for permanent WCR via minimum and AWC ratios, respectively. Pooled OLS Results The results of the pooled OLS as shown in Table 2 are quite satisfactory. The adjusted R2 for the models ranges from .917 to .959. This simply suggests that the independent variable explain 92% of the variation in the dependent variable. The high adjusted R2 shows the independent variables explain most of the crosssectional variation in working capital management. In other words, there is no problem of omitted variable. Moreover, many of the coefcients are signicant and conformed to a priori expectation. The F-statistic is signicant for all the models. The information criteria used (Schwarz and Akaike) are as reported in Table 1. The Durbin-Watson statistic reported is obtained by computing the rst-order residual correlation on the stacked set of residuals.11,12 The reported intercept for the xed-effects models is the average value of the xed effects.13

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TABLE 1 Descriptive Statistics Results (means by year) WCR Means S.D. means by year 1999 2000 2001 2002 2003 2004 2005 2006 2007 1,913,147 4,756,876 1,055,266 980,399.3 887,944.5 1,316,234 1,791,749 1,739,611 2,603,620 2,856,524 3,986,972 PROF 8.188 16.177 7.473 6.571 11.081 10.955 11.017 5.573 6.088 6.397 8.533 LEV 4.237 26.925 2.844 3.185 3.234 12.433 3.579 3.890 3.740 2.504 2.723 SGR 2,119,588 5,994,663 1,011,445 889,749.3 1,863,673 1,752,251 1,890,106 3,085,239 3,280,462 2,721,408 2,581,963 RATA 0.403 0.534 0.347 0.471 0.366 0.393 0.385 0.516 0.383 0.384 0.383 SIZ 6.393 0.873 6.134 6.201 6.288 6.326 6.404 6.465 6.508 6.572 6.641 PAY 45.549 187.463 54.267 70.766 60.271 60.525 22.392 3.360 49.776 40.887 47.693 CCC 94.596 127.283 114.046 88.928 86.580 109.187 121.403 78.114 78.723 88.564 85.567 ARE 52.770 61.781 58.917 54.828 48.718 56.815 56.286 52.608 47.948 48.136 50.665 INVT 93.058 74.615 109.396 104.866 98.132 112.897 87.509 80.265 80.551 81.315 82.595 MWC 5.015 5.728 2.789 2.871 3.047 3.967 4.644 4.871 5.989 7.378 9.580 AWC 0.310 0.213 0.310 0.310 0.310 0.310 0.310 0.310 0.310 0.308 0.310 N 594

Note. The denition and measurements of all the variables in Table 1 is as given in Appendix 2. The SGR reported is the means of the difference between current and last years sales. The nonratio variables are expressed in millions of naira except WCR.

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O. O. AKINLO TABLE 2 Empirical Results of the Determinants of Working Capital Pooled OLS Without Control 1 18.501 (23.784) 0.019 (1.373) 1.140 (19.622) 13.383 (48.859) 0.003 (0.096) 0.090 (3.149) 0.088 (3.434) 0.917 1.520 761.681 1.452 0.724 410 Without Control 2 13.595 (24.485) 0.017 (1.021) 0.881 (19.795) 13.655 55.400 0.104 (4.958) 0.099 (5.366) 0.180 (7.842) 0.474 (15.473) 0.959 0.826 1380.94 0.748 0.529 410 Without Control 3 18.581 (25.442) 0.035 (2.032) 1.060 (20.416) 13.262 (42.513) 0.054 (2.202) 0.113 (4.722) 0.100 (3.104) 1.057 (8.878) 0.929 1.384 766.782 1.305 0.867 410 Without Control 4 22.377 (9.539) 0.004 (0.194) 1.012 (12.985) 16.770 (11.451) 0.063 (1.782) 0.066 (1.906) 0.020 (0.503) 0.963 1.646 129.761 0.963 1.550 410 Fixed Effect Without Control 5 11.998 (169.700) 9.55E05 (1.040) 0.001 (1.071) 0.047 (1.170) 0.0004 (0.830) 0.0001 (0.802) 0.0003 (0.787) 0.999 (1373.874) 0.965 6.152 327601.4 6.847 1.653 410 Without Control 6 20.323 (8.816) 2.43E05 (0.001) 1.015 (12.917) 17.267 (11.705) 0.061 (1.667) 0.061 (1.760) 0.041 (1.014) 7.557 (2.503) 0.956 1.655 128.369 0.962 1.556 410

WCR C SGR OPC SIZ RATA LEV

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GDP MWC AWC Adjusted R2 Schwarz criterion F-statistic Akaike Durbin-Watson statistic No. of observations

Note. The gures in parentheses indicate t-statistics. Signicance at 10%. Signicance at 5%. Signicance at 1%.

The results show a positive relationship between sales growth and working capital in models 1 and 3. However, the coefcient of sales growth is negative in model 2 but not signicant. Using model 3 as a lead, the result shows that increased sales growth leads to increased working capital requirements. A 1% increase in sales growth will lead to .035 increases in working capital requirements. The coefcient of operating cycle (OPC) used to measure working capital management efciency of rms is positive and statistically signicant at 1% level of signicance in the three models. This means the higher the days of operating cycle, the higher the working capital that would be required by rm as operative necessity. The implication of this is that if rms want to reduce its investment in working capital in order to capitalize some protable projects, the operating cycle needs to be optimized. For each model, working capital requirement varies directly with size and the estimated coefcients have statistical signicance at the 1% level. This corroborates the view that larger rms have more nancing alternatives available; hence, these rms more easily afford investments in working capital requirements. The

result supports nding by Almeida, Campello, and Weishbach (2004), who found that larger rms are less nancially constrained rms and hold less cash than smaller rms. The results show that leverage is strongly and negatively related to the working capital requirement of the rm. The estimated coefcients have statistical signicance at the 1% level. This indicates that with a rising debttototal assets ratio, the rms are supposed to pay more attention to efcient management of working capital to avoid much capital being tied up in account receivables and inventories. Hence, rms with an increasing debttototal assets ratio (high leverage) show lower working capital requirements. This indeed supports the pecking order theory. As expected, the controls (minimum and average working capital) both have signicant positive effect on working capital requirements. Their coefcients are signicant at 1% level in each equation. This result supports the view that rms must maintain a minimum level of net operating working capital. The measure of business indicator (growth rate of economic activity) has signicant negative effect on

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working capital requirement in almost all the models except in pooled OLS without control. However, the variable is majorly signicant when CCC is used as measure of working capital. This seems to conform to a priori expectation. As earlier pointed out, uctuation of general economic activity in the long run is expected to be negatively related to working capital. It is not easy for a rm to raise money during the period of economic uctuations, when cash supply is relatively tight. Hence, to retain capital for daily operations, working capital requirement must be kept at a higher level, and business indicator is expected to be negatively proportional to working capital. Moreover, in the period of economic uctuations, the expansion of a company may not be as smooth as expected, with possibly longer time periods for collecting accounts receivable or possibly expended inventories due to decline in sales. Hence, a relatively high net volume of working capital requirements may occur. Over, the study period, the Nigerian economy did not witness signicant progress in terms of economic growth. The only sector that experienced boom during the study period was the nancial sector. Unfortunately, the boom in the nancial sector did not lter into the productive sector, especially the manufacturing sector. Banks were not ready to extend credit to the manufacturing sector. The result was the collapse of manufacturing rms during the study period. Fixed Effects Results The results of the xed effects are presented in Table 2 (models 4, 5, and 6). Overall, the results from the xed-effects models are to a reasonable extent consistent with the pooled results. However, there were minor differences in the two results.14 These minor differences were not unexpected as the OLS estimation does not take into consideration rm specic differences in working capital requirements. Examining the results from the xed-effects models, this study found that the signicance levels of most of the coefcients dropped as compared to the pooled OLS. It was discovered from the results of xed effects that operating cost, size, leverage, and minimum working capital are statistically signicant and retain the same sign as for the pooled results. This is particularly true with models 4 and 5. Hence, one can safely conclude that the results of both pooled OLS and xed effects are to a reasonable extent similar. All the signicant variables have the same sign and their magnitudes very close.

study estimated Equation 2 using cash conversion cycle (CCC) as a measure of working capital management. The results are as shown in Table 3. The pooled OLS results without and with controls are as shown in Equations 13 of Table 2 while the results from xed-effects method without and with controls are as shown in Equations 46, respectively, in Table 2. Just as in the case of the rst measure of working capital (WCR), the models performed well. The adjusted R2 for the equation are very high ranging from 74% to 99.2%. The F-statistics for all the models are highly signicant. The coefcients of many of the independent variables are also signicant. Overall, the results from the two measures of working capital are quite consistent. However, few minor areas of differences are discernible. The coefcient units of operating costs, leverage, GDP, and MWC are statistically signicant and retain the same sign as for pooled results when we use actual working capital of the rms. The coefcient of sales growth obtained using CCC as measure of working capital management tallies with that obtained using actual working capital except in model 1 (the base model) as against positive sign. The result from the xed-effects models using CCC as proxy for working capital are in every respect consistent with that obtained using the difference between current assets and liabilities as a measure of working capital. The signs are the same for all the variables and their magnitudes are quite close. The only area of difference is the coefcient of size, which comes out negative when CCC is used as a proxy for working capital. However, this result is unexpected because CCC actually measures the efciency of working capital management by rms. This simply means that the larger the rm size, the shorter the CCC, or the smaller the rm size, the longer the CCC. This suggests that the smaller rms should look for ways to shorten their CCC. This result indeed corroborates the nding from the correlation analysis. The coefcient for RATA with CCC as dependent variable has a negative sign in both models 1 and 3 compared to a positive sign obtained when the difference between current assets and current liabilities (WCR) is used. However, the coefcient of RATA when CCC is adopted as working capital is not signicant (in both models 1 and 3). Thus, conclusive inference cannot be drawn from it. However, in the two measures of working capital, the coefcient of RATA is positive and signicant in model 2. This simply suggests that as xed to total assets for a rms increases, the working capital also increases.

ROBUSTNESS CHECK As a way of checking the robustness of this analysis on the determinants of working capital requirement, the

CONCLUDING REMARKS In general, working capital management is very important because of its effects on the rms protability and

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O. O. AKINLO TABLE 3 Empirical Results of the Determinants of Working Capital Pooled OLS Without Control 1 2.011 (3.597) 0.004 (0.317) 1.282 (31.014) 0.324 (1.302) 0.055 (1.485) 0.098 (3.414) 0.057 (3.282) 0.744 1.243 199.229 1.175 0.557 410 Pooled OLS With Control 2 2.833 (5.075) 0.038 (2.466) 0.999 (35.153) 0.138 (0.612) 0.049 (3.025) 0.107 (6.519) 0.187 (7.256) 0.445 (12.999) 0.877 0.525 416.684 0.447 0.486 410 Pooled OLS With Control 3 2.047 (3.557) 0.012 (0.697) 1.194 (29.190) 0.446 (1.771) 0.003 (0.116) 0.122 (4.743) 0.069 (3.071) 1.106 (8.547) 0.795 1.034 227.575 0.956 0.723 410 Fixed Effects Without Control 4 5.618 (2.185) 0.005 (0.313) 1.217 (23.738) 2.714 (1.614) 0.049 (1.791) 0.068 (2.091) 0.060 (1.244) 0.884 1.202 46.405 0.516 1.405 410 Fixed Effects With Control 5 26.055 (36.850) 0.001 (0.100) 0.160 (4.733) 0.009 (0.820) 0.002 (0.363) 0.002 (0.363) 0.027 (1.946) 0.881 (40.698) 0.992 1.473 738.483 2.169 1.577 410 Fixed Effects With Control 6 3.531 (1.484) 0.001 (0.077) 1.221 (22.983) 3.218 (1.864) 0.047 (1.646) 0.064 (1.960) 0.081 (1.678) 7.642 (2.677) 0.885 1.207 46.121 0.511 1.416 410

CCC C SGR OPC SIZ RATA LEV GDP

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MWC AWC Adjusted R2 Schwarz criterion F-statistic Akaike Durbin-Watson statistic No. of observations

Note. The gure in parentheses indicates t-statistics. Signicance at 10%. Signicance at 5%. Signicance at 1%.

risk, and thus its value (Smith, 1980). However, it has attracted less attention of researchers and practitioners in developing countries like Nigeria. Therefore, this current study uses both internal and external factors to explore the determinants of working capital requirements of rms in Nigeria. We use operating cycle, leverage, proportion of rms assets accounted for by xed assets, sales growth, and permanent and minimum working capital as internal rmrelated factors and level of economic activity as external macroeconomic variable. We have found that sales growth, size, permanent working capital requirements, and rms operating cycle are primary drivers of working capital requirement. Leverage is signicantly negatively related to working capital requirement, while the level of economic activity is signicantly and positively related to working capital requirement, indicating that a rm will raise its debt ratio when its short-term capital is depleted. These results are quite consistent with earlier studies by Alfa and Nazir (2008), Chiou and Cheng (2006), and Wu (2001), among others. Although a few of the ndings seem to conict with some earlier studies on the issue, the development may be attributed to the evolving market of Nigeria. The reasons for this

contradiction should therefore constitute an area of future research. Finally, disaggregating the sectors into distinct common group should equally be explored in subsequent research to ascertain if the same sets of factors determine their working capital requirements. NOTES
1. Several studies have articulated theoretically the various dangers that are associated with excessive and inadequate working capital in any rm (for details, see Ramamorthy [1976], Pandey [2006], Blinder & Maccini [1991], and others). 2. Some other studies that have examined the characteristics, determinants, and performance of rms in Sub-Saharan African countries include Damoense-Azevedo and Jordaan (2011), Kyeroboah-Coleman and Amidu (2008), Dane (2008), and Wirston and Dadzie (2007). 3. However, it needs be pointed out that several ingenious inventory management approaches have been devised in modern times by rms to attenuate the problem of inventory accumulation. These include just-in-time approach, outsourcing approach, and computerized inventory control systems. 4. Financial institutions such as banks, insurance companies, etc. were purposively excluded from the sample due to the format used in reporting their balance sheets and the different components of working capital such as stock that are missing from the balance sheet. This makes their capital structure signicantly different from those of nonnancial rms.

WORKING CAPITAL REQUIREMENTS IN SELECTED QUOTED NIGERIAN COMPANIES 5. The number of rms in each of the 15 sectors selected for the study is shown in Appendix 1. 6. The intercept ao is for the general specication for the pooled data. It needs be pointed out that one can choose between alternative o. In the case of no intercept (i.e., identical intercept specication for a o a . However, for xed effect where different for all pool members): a intercepts are estimated for each pool member, ao ai. Finally, for random sheets where intercepts are treated as random variables across (a it) 0. i, a i a 0 a pool members: a 7. The denition and measurement of number of days account receivable, account payable, the number of days inventories, and other variables in the regression are given in Appendix 2. 8. Firms generally maintain a minimum or permanent level of working capital to support operations since it is not likely that sales will drop to zero. Hence, the current level of working capital should be an increasing function of minimum or permanent working capital. Subsequently, we control for permanent working capital requirements by adding proxies for the variables in Equation 1. 9. All the variables in this study and their measurements are largely adopted from existing literature. 10. Both xed effects and random effects specications of the models were estimated but the Hausman (1978) test conducted showed xed effects as the preferred model. This explains why we have reported the results for random effect estimation. The Hausman (1978) test is used to determine which estimation model xed effects or random effects best explain ones estimations. 11. In general, the values of Durbin-Watson statistic for pooled OLS and xed effects show that the problem of autocorrelation tends to reduce with the use of xed-effects approach. However, we may not be able to make conclusive inference on this as the data point is rather short. 12. We tried to reestimate the equation by incorporating an autoregressive root or lagged value of the dependent variable each; however, we only observed marginal increase in the value of the Durbin-Watson statistics for pooled OLS and xed effects estimation. P ^i , is computed as ^ 13. Generally, the intercept a ai t N i i is the mean where  yi represents mean of the dependent variable, x of the nonconstant regressors, bFE is the xed effect parameters, and N is the cross-sectional units. 14. Essentially, the minor differences in the results from pooled OLS and xed effects could be seen in the sign of sales growth, business indicator measured as GDP growth rate, and ratio of xed assets to total rms assets that changed from positive to negative. However, except for RATA, the coefcients were not signicant in most cases and thus a rm conclusion could not be based on them.
0 bFE  yi x

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Appendix 1 Selected Firms by Sectors No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Total Industrial Sector Automobile and Tyre Breweries Building Chemical and paints Conglomerates Construction Computer and ofce equipment Food and beverages Health Industrial=domestic Machinery=marketing Petroleum Packaging Printing and publishing Real estate No. of Firms 3 3 3 6 8 4 3 7 6 7 1 7 3 3 1 66

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Appendix 2 Denition and Measurement of Variables

Sales growth (SGR): Sales growth is calculated as annual percentage change in growth. This is calculated as [Salest salest 1]=salest 1. Ratio of xed nancial assets to total assets (RATA): This is the ratio of xed nancial assets to total assets. Fixed nancial assets are shares in other rms (mainly afliated) rms, intended to contribute to the activities of the rms that holds them and loans that are granted with the same purpose. Firm size (SIZ): This is dened as the natural logarithms of sales. Leverage (LEV): This is measured as the ratio of total debt to net assets. Net assets are net xed assets plus net current assets. Where net current assets are current assets minus current liabilities excluding interest-bearing short-term debt for working capital. Net assets equals capital employed because capital employed includes total debt and net worth. Gross domestic product growth tate (GDP): Growth rate of gross domestic product measures as the annual growth rate. Minimum working capital (MWC) ratio: This variable is dened as each rms minimum working capital requirements divided by the rms average total assets. Average working capital (AWC) ratio: This variable is calculated by taking the average of each rms working capital requirements and scaling it by the rms average total assets. Account receivables (ARE): The number of days account receivables (ARE) is calculated as (accounts receivables=sales) 365. This variable represents the average number of days that the rm takes to collect payments from its customers. The higher the value, the higher its investment in account receivable. Account payable (PAY): The number of days accounts payable (PAY) reect the average time it takes rms to pay their suppliers. This is calculated as (account payable=purchases) 365. The higher the value, the longer rms take to settle their payment commitments to their supplier. Inventory turnover days (INVT): the number of days of inventory (INVT) is calculated as (inventories=purchases) 365. This variable reects the average number of days of stock held by the rm. Longer storage times represent a greater investment in inventory for a particular level of operations. Operating cycle (OPC): This is the sum of days in inventory and days in accounts receivable. Working capital requirement (WCR): this is dened as working liquid assets less working liquid liabilities. This WCR (account receivables inventories) (accounts payables other payable). Cash conversion cycle (CCC): this variable is calculated as the number of days account receivable plus the number of days of inventory minus the number of days accounts payable. The longer the CCC, the greater the net investment in current assets, and hence the greater the need for nancing of current assets.