mungai john mwangi final project.pdf
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THE RELATIONSHIP BETWEEN WORKING CAPITAL
MANAGEMENT AND FINANCIAL PERFOMANCE OF PRIVATE
HOSPITALS IN KENYA
BY: MUNGAI, JOHN MWANGI
Research Project Presented in Partial Fulfillment of the Requirements for
the Award of the Degree in Master of Business Administration
(University of Nairobi)
Nov, 2013
DECLARATION
I declare that this research project is my original work and has not been presented for
a degree in any other University.
Signed………………………………. Date………………………………
Mungai John Mwangi D61/62841/2010
This research project has been submitted for examinationwith my approval as the
University supervisor.
Signed……………………………… Date…………………………….
Supervisor: Mr. J. Barasa
Department of Finance and Accounting
School of Business, University of Nairobi
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ACKNOWLEDGEMENT
I wish to acknowledge, with gratitude, the contributions of my supervisor, Mr. Joseph
Barasa, without whom my work would have been an impossible task. His
overwhelming support, guidance and advice were extremely encouraging.
I give my special thanks to my classmate BedanNdegwa and my good friend Anthony
Amos Musundi. Their encouragement and moral support proved very crucial.
I am grateful to my family members, especially my wife Irene and my elder brother,
Paul Mbugua for encouraging me to pursue further studies
My appreciation also goes to all the private hospitals that provided me with the
requisite data.
Finally, I give thanks to the Almighty God through whom all blessings flow.
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DEDICATION
I dedicate this project to my wife Irene Wacera Mwangi and my daughter
FavourMwende Mwangi. They were inspirational and supportive in this venture.
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ABSTRACT
The study looked into the effect of working capital management on the profitability of
private hospitals in Kenya. The data analysis was carried on 10 private hospitals for a
period of 10 years between 2003 and 2012. The relationship of average collection
period, inventory conversion period and average payment period with return on assets
employed was analyzed in this study. The studyapplied correlation analysis and group
wise weighted least squares regression analysis to identify the effects of these
variables on profitability. The correlation analysis shows that the hospitals’
profitability is influenced by the variables relating to working capital. There is a
positive relationship between profitability and Average collection period and
inventory conversion period. Average payment period shows a negative relationship
with profitability.
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TABLE OF CONTENTS
DECLARATION ........................................................................................................... I
ACKNOWLEDGEMENT............................................................................................ II
DEDICATION ............................................................................................................ III
ABSTRACT ................................................................................................................ IV
ABBREVIATIONS .................................................................................................... VI
CHAPTER ONE ............................................................................................................ 1
INTRODUCTION ......................................................................................................... 1
1.1 BACKGROUND OF THE STUDY ................................................................................................................ 1 1.2 STATEMENT OF THE PROBLEM ............................................................................................................... 5 1.3 OBJECTIVE OF THE STUDY ...................................................................................................................... 7 1.4 VALUE OF THE STUDY ........................................................................................................................... 8
CHAPTER TWO........................................................................................................... 9
LITERATURE REVIEW ............................................................................................. 9
2.1 INTRODUCTION ...................................................................................................................................... 9 2.2 THEORIES OF WORKING CAPITAL MANAGEMENT .................................................................................. 9 2.3 WORKING CAPITAL MANAGEMENT PRACTICES ................................................................................... 10 2.4 REVIEW OF EMPIRICAL STUDIES .......................................................................................................... 14 2.5 CONCLUSION ....................................................................................................................................... 19
CHAPTER THREE .................................................................................................... 21
RESEARCH METHODOLOGY ............................................................................... 21
3.1 INTRODUCTION .................................................................................................................................... 21 3.2 RESEARCH DESIGN .............................................................................................................................. 21 3.3 POPULATION OF THE STUDY ................................................................................................................. 21 3.4 SAMPLE DESIGN ................................................................................................................................... 22 3.5 DATA COLLECTION .............................................................................................................................. 22 3.6 DATA ANALYSIS .................................................................................................................................. 22
CHAPTER FOUR ................................................................................................. 24 DATA ANALYSIS, FINDINGS AND DISCUSSIONS ........................................ 24
4.1 INTRODUCTION .................................................................................................................................... 24 4.2 INVENTORY CONVERSION PERIOD AND PROFITABILITY ........................................................................ 25 4.3 AVERAGE COLLECTION PERIOD AND PROFITABILITY ........................................................................... 25 4.4 AVERAGE PAYMENT PERIOD AND PROFITABILITY ................................................................................ 25 4.5 OVERALL LIQUIDITY AND PROFITABILITY ........................................................................................... 26
CHAPTER FIVE ......................................................................................................... 27
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS................................ 27
5.1 INTRODUCTION .................................................................................................................................... 27 5.2 SUMMARY AND CONCLUSIONS ............................................................................................................. 27 5.3 RECOMMENDATIONS ........................................................................................................................... 28 5.4 LIMITATIONS OF THE STUDY ................................................................................................................ 28 5.4 SUGGESTIONS FOR FURTHER RESEARCH .............................................................................................. 29
REFERENCES ............................................................................................................ 30
APPENDIX .................................................................................................................. 37
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ABBREVIATIONS
ANOVA Analysis of Variance
CCC Cash Conversion Cycle
KSE Karachi Stock Exchange
LSD Least Significant Difference
NGOs Non-Governmental Organizations
NHIF National Hospital Insurance Fund
VAT Value Added Tax
WCM Working Capital management
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Efficiency in working capital management is so vital for firms whose assets are
mostly composed of current assets (Horne and Wachowitz, 1998) as it directly affects
liquidity and profitability of any firm (Raheman and Nasr, 2007). According to
Kargar and Bluementhal (1994) bankruptcy may also be likely for firms that put
inaccurate working capital management procedures into practice, even though their
profitability is constantly positive. While excessive levels of working capital can
easily result in lower profitability, inconsiderable amount of it may incur shortages
and difficulties in maintaining day-to-day operations.
1.1.1 Working Capital Management
Working capital management involves the relationship between a firm's short-term
assets and its short-term liabilities. The goal of working capital management is to
ensure that a firm is able to continue its operations and that it has sufficient ability to
satisfy both maturing short-term debt and upcoming operational expenses. The
management of working capital involves managing inventories, accounts receivable
and payable, and cash.
Liquidity, as a function of current assets and current liabilities, is an important factor
in determining working capital policies and indicates firm’s capability of generating
cash in case of need. Current, acid-test and cash ratios as traditional measures of
liquidity are incompetent and static balance sheet based measures that cannot provide
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detailed and accurate information about working capital management effectiveness
(Finnerty, 1993; Jose et al., 1996).
Drawing attention to limitations of traditional liquidity ratios, Hager (1976), Richards
and Laughlin (1980), Emery (1984a), Kamath (1989), Gentry et al. (1990), Schilling
(1996) and Boer (1999) have insisted on using ongoing liquidity measures in working
capital management. Ongoing liquidity refers to the inflows and outflows of cash
through the firm as the product acquisition, production, sales, payment and collection
process takes place over time. As the firm’s ongoing liquidity is a function of its cash
(conversion) cycle (Pinches, 1992), it will be more appropriate and accurate to
evaluate effectiveness of working capital management by cash conversion cycle,
rather than traditional liquidity measures.
Cash conversion cycle as a part of operating cycle is an ongoing liquidity measure
developed by Gitman (1974). Closely related with operating cycle, cash conversion
cycle is, in brief, the part of operating cycle financed by the firm itself (McLaney,
1997) and is simply calculated by adding inventory period to accounts receivables
period and then subtracting accounts payables period from it. It focuses on the length
of time between the acquisition of raw materials and other inputs and the inflow of
cash from the sale of goods (Arnold, 1998). The shorter this cycle, the fewer
resources the firm needs to tie up.
Studies regarding working capital are mostly related with improving models to
determine optimal liquidity and cash balance, rather than analyzing underlying
reasons of relationships between liquidity, working capital management practices and
profitability.Pioneer studies of Baumol (1952) about an inventory management model
and of Miller (1966) about a cash management model may be considered as the best-
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known studies in working capital management. This model informs managers about
problems related with working capital management practices. Later on, Johnson and
Aggarwal (1998), similarly, have developed a cash management model focusing on
cash flows and argued that cash collection and cash payment processes should have to
be handled independently.
1.1.2 Financial Performance
Financial performance is a subjective measure of how well a firm can use assets from
its primary mode of business and generate revenues. This term is also used as a
general measure of a firm's overall financial health over a given period of time, and
can be used to compare similar firms across the same industry or to compare
industries or sectors in aggregation. These results are reflected in the firm's return on
investment, return on assets, value added, etc.One of the most fundamental facts about
businesses is that the operating performance of the firm shapes its financial
structure.It is also true that the financial situation of the firm can also determine its
operating performance.The financial statements are therefore important diagnostic
tools for the informed manager.
1.1.3 Relationship between working capital management and financial
perfomance
In a study by Kamath (1989) about working capital management practices in retailing
firms, it has been concluded that there is a reverse relationship between cash
conversion cycle and profitability. The results of a more detailed study by Soenen
(1993) have shown that, in case of overlooking industrial differences, there does not
exist any statistically constant relationship between cash conversion cycle and
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profitability. However, in case of considering industrial differences, the relationship
between the mentioned variables has shown dissimilarities across industries as
positive in some industries and negative in others. In another study of Shin and
Soenen (1998), a sample consisting of American manufacturing firms for the period
of 1974-1995 has been analyzed and a statistically negative relationship between cash
conversion cycle and profitability has been confirmed.
1.1.4 Private Hospitals in Kenya
Increased financial pressures on hospitals have elevated the importance of working
capital management, that is, the management of current assets and current liabilities,
for hospitals' profitability. Efficient working capital management allows hospitals to
reduce their holdings of current assets, such as inventory and accounts receivable,
which earn no interest income and require financing with short-term debt. The
resulting cash inflows can be reinvested in interest-bearing financial instruments or
used to reduce short-term borrowing, thus improving the profitability of the
organization.
A study by Kenya National Bureau of Statistics conducted in 2012 revealed that for
every 100,000 people in Kenya, there are 19 Doctors, 2 dentists, 8 pharmacists, 3
Bachelor of Science nurses and 83 a total of registered nurses. Most of these health
care personnel are based in major cities, mainly Nairobi and Mombasa with virtually
no staff in the remote areas.(Kenya Facts and figures 2012.) Health services and
programmes in Kenya are financed from three main sources: the government, the
private sector and Non-Governmental Organizations (NGOs).
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According to the Kenya Human Development Report (1999), government financing
of health expenditure is about 60 percent of what is required to provide minimum
health services, therefore implying that healthcare delivery in Kenya is under-funded.
This is accentuated by inefficiency of the system, including lack of cost-effectiveness
in service delivery. According to Obonyo et al (1997) the government finances 50
percent, private payments (insurance and out of pockets) finances 42 percent and
donors, NGOs, missions and other institutions finance 6 percent of recurrent
healthcare costs.
1.2 Statement of the Problem
The importance of WCM is not new to the finance literature and the review of prior
literature reveals that there exists a significant relationship between financial
performance and working capital management by using different variable selection
for analysis. Studies done in most companies have revealed varying degrees of
negative relationship between working capital management and financial performance
of companies. The study done by Raheman& Nasr, (2007) on a sample of 94
Pakistani firms listed on Karachi Stock Exchange for a period of 6 years from 1999 –
2004, demonstrate a strong negative relationship exists between variables of the
working capital management represents by liquidity and debt with profitability of the
firm.
Afza and Nazir (2007) through cross-sectional regression models on working capital
policies, profitability and risk of the firms, found a negative relationship between the
profitability measures of firms and degree of aggressiveness on working capital
investment and financing policies while Padachi (2006) found that high investment in
inventories and receivables is associated with lower profitability similar to most
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recent study by Christopher and Kamalavalli, (2009), which focus on 14 corporate
hospitals in India for the period 1996-97 to 2005-06.
Similar studies done locally in Kenya have revealed relatively similar results. Biwott,
(2011) found a significant negative relationship between net operating profitability
and the average collection period for a sample of Kenyan firms listed on Nairobi stock
Exchange. Other studies done by Caffaso (2011), Kamula (2011), Kweri (2011),
Mutungi (2010) and Bett (2009) have yielded similar results.
However factors affecting working capital management are varied and quite a number
of them including nature of the Industry, demand of Industry, nature of the Business
and Production Cycle are industry specific. There are studies that have been done in
particular industries and context that have yielded different results. Ganesan, (2007)
found evidence that even though “day’s working capital” is negatively related to the
profitability, it was not significantly impacting the profitability of firms in
telecommunication equipment industry.
Additionally, Chowdhury and Amin (2007) had found positive correlations between
WCM with financial performance of the Pharmaceutical industry in Bangladesh.
Whereas, Narware (2004) in his empirical study on Indian National Fertilizer Limited,
for 1990-91 to 1999-2000 signify that working capital management and profitability
of the Company disclosed both negative and positive association. He also found
evidence that increase in the profitability of a company was less than the proportion to
decrease in working capital.
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Such industry variations cannot be wished away and will require studies to be
conducted in virtually all different industries in their varying context. Although the
issue on Working Capital has been widely studied, largely missing from literature is
the focus on health sector and specifically on Hospitals in Kenya. Hospitals in Kenya
are in significantly different industry setting compared to industries where studies
have already been done locally. They are equally in significantly different context to
other hospitals where studies have already been done elsewhere in the world.
Kweri, (2011) has noted that different industries and lines of business will have
different working capital requirements because of differing operating or business
characteristics across industries recommending similar studies to be done in different
industries and sectors.
The researcher believes there might be differences on the relationship between
working capital management and financial performance. Hospitals manage significant
amount of working capital in inventory and accounts receivable and it would be
interesting to study how this impacts on their performance. This research therefore
aims to fill this research gap by answering one question:
What is the relationship between working capital management and the financial
performance of Private Hospitals in Kenya?
1.3 Objective of the study
The objective of this study will be to examine the relationship between working
capital management and financial perfomance of private hospitals in Kenya
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1.4 Value of the Study
The findings from this study will contribute to the body of knowledge by identifying
how private Hospitals in Kenya manage their working capital and the impact it has
on the profitability. This research will provide a general framework to other
researchers, policy makers and professionals to guide future researches, appraise
current business practices, and provide basic guidelines for policy makers in
businessenvironment in Kenya.
The results of this study would provide better insights to hospital administrators on
how to create efficient working capital management policies that have ability to
maximize firm’s profitability.
This study will be beneficial to private hospital clients since a better management of
working capital my lead to lower operating costs by hospitals. Some of these hospitals
may choose to share the accrued benefit with their clients.
The benefits of this study will be beneficial also to the government policy makers.
They will find it useful to benchmark with private hospitals and learn lessons on how
to manage working capital.
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
The nature of many businesses may cause seasonal variations in a firm’s current
assets. Working capital management approaches differ in terms of how the firm
finances these seasonal variations in current assets. Three common ways of dealing
with such seasonal variations are the maturity-matching, conservative, and aggressive
approaches.
2.2 Theories of Working Capital Management
2.2.1 Maturity-matching approach
Stohs and Maurer (1996) or Morris (1976) argue that a firm can face risk of not
having sufficient cash in case the maturity of the debt had shorter than the maturity of
the assets or even vice versa in case the maturity of the debt was greater than asset
maturity (the cash flow from assets necessary for the debt repayment terminates).
The firm finances long-term assets (fixed assets and all permanent current assets) with
long-term sources of funds (long-term debt and equity). By matching its seasonal
variations in current assets with current liabilities of the same maturity, the firm
essentially hedges against changes in short-term interest rates.The firm essentially
hedges against unexpected changes in short-term interest rates. If short-term interest
rates increase, the increases in the return earned on an equal amount of short-term
current assets should offset the increased cost of short-term funds.
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2.2.2 Conservative approach
The firm finances long-term assets, all permanent current assets, and some temporary
current assets with long-term sources of funds. This approach relies more heavily on
long-term financing than do the other approaches. The firm uses more long-term
financing and less short-term financing to finance current assets and is therefore less
vulnerable to increases in short-term rates than under the other approaches. If short-
term interest rates rise, the firm has fewer short-term sources that it will need to
refinance at the higher rates.
2.2.3 Aggressive approach
The firm finances all temporary current assets and some of its permanent current
assets with short-term sources of financing (Heyman et. Al., 2008). This approach
relies more heavily on short-term financing than do the other approaches. Under the
aggressive approach, increases in short-term interest rates will require the firm to
refinance more current assets at the new higher rates. The firm could be in jeopardy of
being shut off by suppliers.
2.3 Working Capital Management Practices
2.3.1 Cash Management Practices
The squeeze on cash and credit is threatening the survival of many businesses all over
the world, as it is considered the source of company’s working assets and the
liabilities orcollectively referred to as working capital,Noriza B. M., Nor E.A. (2010)
Proper cash management practices stems from creation of a realisticcash flow budget
that charts finances for both the short term (30-60 days) and longer term (1-2 years).
Redouble efforts to collect outstanding payments owed to the company. Bill promptly
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and accurately. The faster one mails an invoice, the faster one will be paid. If
deliveries do not automatically trigger an invoice, establish a set billing schedule,
preferably weekly. Businesses should also include a payment due date. Offer small
discounts for prompt payment. Closely monitor and prioritize all cash disbursements.
Contact creditors (vendors, lenders, and landlords) and attempt to negotiate mutually
satisfactory arrangements that will enable the business to weather its cash shortage
(provided it is a temporary one). In some cases, you may be able to arrange better
payment terms from suppliers or banks. Better credit terms translate into borrowing
money interest free. Assess other areas where operational expenses may be cut
without permanently disabling the business.
2.3.2 Accounts receivable Management Practices
Padachi (2006) found out that high investment ininventories and receivables is
associated with lower profitability. The foundation behind account receivables is the
policies and procedures for sales. The overall objective pursued is to reduce accounts
receivable. One should consider whether to have a credit policy, who and how to
evaluate a customer for credit. Additionally, one needs to establish sales terms. A
system must be in place to track accounts receivables. This will include balance
forwards, listing of all open invoices, and generation of monthly statements to
customers. Aging of receivables will be used to collect overdue accounts. One must
act quickly to collect overdue accounts. The significant factors here are terms of
payment, invoicing, credit control and cash management among other factors. The
reduction in terms of payment and effective collection procedures improves cash
flows. The Reduction in losses on receivables through systematic credit control
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increases profitability, while reduction in personnel costs through more efficient credit
control and collection equally increases profitability.
2.3.3 Invetory management practices
According to Lazaridis andTryfonidis (2006), Inventory, when managed in proper
ways will facilitate a profit maximization and enhancement of companies growth.
Review inventory periodically and revise stocking patterns and norms. Inventory is
dependent upon the demand as well as the supply chain delivery time. Firms should
not follow one stocking policy for all items. while some items may have a longer
lead-time thus affecting the inventory holding, the demand pattern and the hit
frequency in terms of past data may show up differently for each of the inventory
items. Get into detailed inventory planning - one size does not fit all. understand the
inventory types and the specific characteristics of the items you are carrying, then
build the inventory stocking parameters taking into account the unique characteristics
of the particular inventory. Getting into the detailed understanding will help one
identify the inventory-stocking norm required to manage these characteristics to
ensure optimum efficiency. The solution quite often may not be to carry stocks, rather
it may involve setting up the customer service standard for such items and specifying
a delivery time depending upon the frequency of demand. Quite a few items often
have shelf life and hence require separate norms and focus to manage such items.
Study demand pattern, movement patterns and cycles to build suitable inventory
norms for different categories of inventory. Companies which are into retail segments
and dealing with huge inventories in terms of number of parts as well as value will
neccessarily need to ensure they practice review of inventory list and clean up
operations on ongoing basis. It helps to periodically study the past data and
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extrapolate the same to identify slow moving and obsolete items. The dead stocks
should be flushed out and active catalogue items should be made available. Lower
inventories and lower replenishment increases operating cash flow, lower write-offs
and scrapping costs through reduction in excess and obsolete inventories increases
profitability while lower space costs through the reduction in warehouse space needed
improves profitability.
2.3.4 Accounts Payable Management Practices
Crucial decisions need to be made not only in managing cash, account receivables and
inventories, but also in management of account payables (Lamberson, 1995).The
objective of credit mangement practices is to attain longer credit terms from suppliers
while optimising on available terms of discounts. Paying bills is an integral part of
any business, no matter what field one is in. A solid accounts payable policy can not
only lead to improved cash flow but also to better relationships with vendors,
suppliers and other creditors. The most important account payable practice is to make
sure one is not paying more than the absolutely necessary like in the form of late fees,
unnecessary interest charges, lost discounts for quick payment and other penalties.
This means one needs to know exactly how much is due to each creditor and when at
any given time. A good way to go about doing this is to keep all the due dates and
amounts owed in a central location instead of constantly relying on a myriad of paper
bills. Most small businesses can easily meet this challenge with a simple
spreadsheet.At many levels, a good accounts payable policy is also good public
relations policy. It is important to keep a line of communication open with all your
creditors. If a bad cash flow problem arises which will cause you to be late on your
bills, letting your creditors know in advance is almost always appreciated. Many may
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be willing to make alternate arrangements with you, especially if they know you have
a good payment history and a temporary hardship.
2.4 Review of Empirical Studies
Working capital management (WCM) has become one of the most important issues in
the organizations where many financial executives strive to identify the basic working
capital drivers and the appropriate level of working capital (Lamberson, 1995). There
is much evidence in the financial literature that present the importance of WCM.
Working capital management efficiency plays a very significant and vital role in the
performance of firms whose major part of assets is composed of current assets.
Therefore, the level of Working Capital must be properly determined and allocated to
various segments, effectively controlled and regularly reviewed in order to have
adequate and efficient flow of working capital.
The cash conversion cycle had been widely used as a major component represents
working capital. One of the earlier studies done by Jose, Lancaster and Stevens(1996)
for the twenty-year period from 1974 through 1993 of 2,718 firms offers strong
evidence that aggressive working-capital policies indicated by shorter cash conversion
cycle enhance profitability.
Lazaridis and Tryfonidis (2006) also investigated relationship between working
capital management and corporate profitability for the firms listed in Athens Stock
Exchange for a sample of 131 listed companies. The researcher used the company
financials from 2001-2004 for the study. The results of the study of regression
analysis showed that there was a statistically significant relationship between gross
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operating profit, a measure of profitability and the cash conversion cycle. He
suggested that by optimizing the cash conversion cycle the managers could create
value for the shareholders. Results of empirical analysis show that there is statistical
evidence for a strong relationship between the firm’s profitability and its WCM
efficiency.
Zariyawati, Annuar, and Rahim, (2009), investigated the relationship between
working capital management and profitability of the firm. Researchers have used cash
conversion cycle as a measure of working capital management. This study has used a
panel data of 1628 firm year for a period of 1996 to 2006. The coefficient results of
pooled regression analysis provide a strong negative significant relationship between
cash conversion cycle and profitability of the firms. It is revealed that by reducing
cash conversion cycle firm’sprofitability can be increased.
Raheman and Nasr (2007) also investigated relationship between cash conversion
cycle and its components by taking a sample of 94 firms listed on Karachi Stock
Exchange for a period of six years from 1999-2004. He investigated that cash
conversion cycle is negatively related to net operating profit which is a measure of
profitability. Similar relationship was observed for average collection period,
inventory turnover in days, and average payment period.
Eljelly (2004) empirically investigated the relationship between profitability and
liquidity for a sample firms in Saudi Arabia. Researcher took cash gap and current
ratio as a measure of liquidity. Using correlation and regression analysis a negative
relationship was investigated between liquidity and profitability, where current ratio
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was taken as measure of liquidity. At company level it was observed that cash gap
(cash conversion cycle) is more important as measure of liquidity than the current
ratio as measure of liquidity that affects profitability.At industry level it was observed
that size have significant effect on profitability.
Padachi (2006) investigated the working capital management practices for the
manufacturing firms in Mauritius by taking a sample of 58 small firms. Researcher
examined the trends in working capital management and its impact on performance.
Regression results observed negative relationship between inventories and receivables
with profitability. The study has also shown a positive relationship between various
working capital components and profitability. An increasing trend was observed in the
short-term component of working capital financing.
Garcia and Martinez (2007) examined effect of working capital management on
profitability for small and medium size Spanish firms first time. Using panel data
authors revealed that there is a negative relationship between inventories and days’
account outstanding and profitability. The authors further concluded that by managing
working capital such that the cash conversion cycle is reasonably minimum, the
managers can create value for SMEs.
Moss and Stine (1993) revealed that firm size was a factor in the length of the Cash
Conversion Cycle (CCC) and the study indicated that larger firms have shorter CCC.
Further the study revealed that when the CCC was compared to the current and quick
ratios, a significant positive relationship was found. While Jose et al. (1996) examined
the relationship between aggressive working capital management and profitability of
17
US firms using Cash Conversion Cycle (CCC) as a measure of working capital
management where a shorter CCC represents the aggressiveness of working capital
management. The results indicated a significant negative relationship between the
cash conversion cycle and profitability indicating that more aggressive working
capital management is associated with higher profitability.
However the study undertaken based on the data from CFO magazine on the rankings
of firms on WCM efficiency reveals that the measures of WCM efficiency vary across
different industries. The study also gives significant evidence that issues of WCM are
different for different industries and firms from different industry sectors adopt
different approaches to working capital management. Firms follow an appropriate
working capital management approach that is favorable to their industry. Firms in an
industry that has less competition would focus on minimizing the receivable to
increase the cash flow. For firms in industry where there are large numbers of
suppliers of materials, the focus would be on maximizing the payable.
Filbeck and Krueger (2005) highlighted the importance of efficient working capital
management by analyzing the working capital management policies of 32 non-
financial industries in the US. According to their findings, significant differences exist
among industries in working capital practices overtime. Moreover, these working
capital practices, themselves, change significantly within industries overtime.
Afza and Nazir (2007) investigated the relationship between the aggressive and
conservative working capital policies for 17 industrial groups and a large sample of
263 public limited companies listed on Karachi Stock Exchange (KSE) using cross-
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sectional data for the period 1998-2003. Using Analysis of Variance (ANOVA) and
Least Significant Difference (LSD) test, the study found significant differences
among their working capital investment and financing policies across different
industries. Moreover, rank order correlation confirmed that these significant
differences were remarkably stable over the six-year study period. Finally, ordinary
least regression analysis found a negative relationship between the profitability
measures of firms and the degree of aggressiveness of working capital investment and
financing policies.
Finally, Afza and Nazir (2009) made an attempt in order to investigate the traditional
relationship between working capital management policies and a firm’s profitability
for a sample of 204 non-financial firms listed on Karachi Stock Exchange (KSE) for
the period 1998-2005.The study found significant different among their working
capital requirements and financing policies across different industries. Moreover,
regression result found a negative relationship between the profitability of firms and
degree of aggressiveness of working capital investment and financing policies. They
suggested that managers could crease value if they adopt a conservative approach
towards working capital investment and working capital financing policies.
Chiou and Cheng (2006) analyzed the determinants of working capital management
and explored that how working capital management of a firm was influenced by the
different variables like business indicators, industry effect, operating cash flows,
growth opportunity for a firm, firm performance and size of firm. The study has
depicted consistent results of leverage and operating cash flow for both net liquid
balance and working capital requirements while variables like business indicator,
19
industry effect, growth opportunities, performance of firm, and size of firm were
unable to produce consistent conclusions for net liquid balance and working capital
requirements of firms.
2.5 Conclusion
Several studies have already been conducted on the relationship between working
capital management and financial performance of organizations. Most of the studies
outside Kenya have concluded that there exists a negative relationship between
working capital management and financial performance of companies. Similar studies
done locally in Kenya have revealed relatively similar results as concluded by Biwott
(2011) Caffaso (2011), Kamula (2011), Kweri (2011), Mutungi (2010) and Bett
(2009).
However, further studies have revealed that factors affecting working capital
management are varied and quite a number of them including nature of the Industry,
demand of Industry, nature of the Business and Production Cycle are industry
specific. There are studies that have been done in particular industries and context that
have yielded different results. Ganesan (2007) analyzing the working capital
management efficiency of firms from telecommunication equipment industry found
evidence that even though “day’s working capital” is negatively related to the
profitability, it was not significantly impacting the profitability of firms in
telecommunication equipment industry. Chowdhury and Amin (2007) also found
positive correlations in their work Whereas, Narware (2004) in his empirical study on
Indian National Fertilizer Limited, for 1990-91 to 1999-2000 signify that working
capital management and profitability of the Company disclosed both negative and
20
positive association. He also found evidence that increase in the profitability of a
company was less than the proportion to decrease in working capital.
These industry variations reveal research gaps inviting more work to be done in
industries that have not been subjected to research. As earlier noted, the issue on
Working Capital has been widely studied. However, largely missing from literature is
the focus on health sector and specifically on Hospitals in Kenya that are in
significantly different industry setting compared to industries where studies have
already been done locally. They are equally in significantly different context to other
hospitals where studies have already been done elsewhere in the world. Indeed,
Biwott (2011), Caffasso (2011) and Kweri (2011) have recommended similar studies
to be done in different industries and sectors. This study therefore seeks to fill this
research gap by seeking to find out the relationship between working capital
management and financial performance of hospitals in Kenya.
21
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 Introduction
This chapter will discuss the research design that the proposed study took place.
Population from which the study was conducted is defined together with the sample
size and how it was determined. Finally, the chapter discusses the data collection
techniques and how this data was analyzed and interpreted.
3.2 Research Design
The research design for this study is a cross-sectional causal study in which financial
data was gathered from the financial statements for the period 2003 to 2012 . A causal
relationship exists when one variable causes a change in another variable. These types
of relationships are investigated by experimental research in order to determine if
changes in one variable actually result in changes in another variable.
3.3 Population of the study
Population can be defined as a collection or set of interest items in
research and it represents a group that you wish to infer or draw conclusion
regarding your findings from a sample selected inthat population. The population
for the study consisted of all the 125 private hospitals listed in the NHIF accreditation
list under category C.
22
3.4 sample design
Kothari (2008) defines Sample size as the number of items to be selected from the
universe to constitute a sample. It was not easy to collect data from the entire list
due to various constraints mainly time and financial. Since all hospitals in Kenya
operate largely under similar economic conditions, and due to financial and time
constraints, the sample constituted 10 private hospitalsin Nairobi selected randomly
from private hospitals within Nairobi City.This sample represents 21% of private
hospitals in Nairobi and 8% of the entire population countrywide.
3.5 Data collection
Secondary data was obtained from the published financial statements and
management accounts of individualfor the period 2003 to 2012.
3.6 Data Analysis
The researcher conducted a regression analysis to establish the extent of relationship
between working capital management and financial performance. The study applied
the following multi-linear regression model;
ROA=β0+β1ACP +β2ICP +β3APP +εt
Where ROA= Return on Assets
β0= Constant
ACP=Average collection period
ICP= Inventory conversion period
APP=Average payment period
εt= Error term
23
The correlation co-eficient and co-efficient of determination derived were used used
to measure the strength of the relationship at 5% level of significance.
24
CHAPTER FOUR
DATA ANALYSIS, FINDINGS AND DISCUSSIONS
4.1 Introduction
This chapter covers data analysis and findings of the research. The data is summarized
and presented in table form. Secondary data was obtained from the published
financial statements and management accounts of individual private hospitals. The
collected data has been analyzed and interpreted in line with the aim of the study that
is to determine whether or not there is a relationship between working capital
management and the profitability of private hospitals. Analysis was done using
correlation and regression analysis.
Table 1: Correlation matrix
ROA ICP ACP APP CCC
ROA 1
ICP 0.71891856 1
ACP 0.331437358 -0.19985869 1
APP -0.851568514
-
0.829610007 0.120973256 1
CCC 0.950682465 0.815708919 0.326791147 -0.861557687 1
Table 2: Regression matrix
Variable Intercept
ICP ACP APP
ROA 0.159391871
0.001001898
0.002432543
-0.00369681
Table 3: Regression statistics
Model R R Square Adjusted R square Std error of estimate 1 0.993649485
0.9873393
0.98100895
0.006115192
25
Predictors: Average collection period, Inventory conversion period, Average
payment period
Dependent Variable: Return on Assets
4.2 Inventory conversion period and profitability
The study sought to establish what relationship exists between Inventory conversion
period and profitability. The research findings indicated that there exists a positive
relationship between Inventory conversion period and profitability. The positive
relationship between Inventory conversion period and profitability suggests that long
inventory conversion period leads the hospitals to a higher level of profitability and
vice versa.
4.3 Average collection period and profitability
The study sought to establish relationship between Average collection period and
profitability. The research findings indicated that there is a positive relationship
between average collection period and profitability. This relationship between average
collection period and profitability means that as the average collection period
increases, the hospitals’ level of profitability increases and vice versa.
4.4 Average payment period and profitability
The research findings indicated that there is a negative relationship between Average
payment period and profitability. Arunkumar and Ramanan (2013) found that
creditors’ days show a significant negative relationship with return on assets. The
negative relationship between Average payment period and profitability suggests that
26
long Average payment period leads the hospitals to a low level of profitability and
vice versa.
4.5 Overall Liquidity and profitability
The study found that there is positive relationship between profitability and hospitals’
overall liquidity. The return on assets is positively correlated to both inventory
conversion period and average collection period while it is negatively correlated to
average payment period. This suggests that a longer cash conversion cycle will lead to
higher return on assets while lower cash conversion cycle will result in lower profits.
27
CHAPTER FIVE
SUMMARY, CONCLUSIONSAND RECOMMENDATIONS
5.1 Introduction
This chapter summarizes the findings and makes conclusions based on the specific
objective of this study i.e. to determine whether or not there is a relationship between
the working capital management of private hospitals and their profitability. It also
includes the study recommendations for improvement, limitations of the study and
further research.
5.2 Summary and conclusions
It was noted that profits have a positive relationship with working capital
management. This implies that profitability increases with increase in inventory and
average accounts payable while decreasing with increasing average accounts payable.
However, as per deloof (2003) argument it cannot be ruled out that relationship
between WCM and profitability is to some extent a consequence of profitability
affecting WCM, and not vice versa. Indeed, the most plausible explanation for the
negative relation between accounts payable and profitability is that less profitable
firms wait longer to pay their bills. A negative relation between inventory and
profitability can be caused by declining sales, leading to lower profits and more
inventories.
Finance based models explaining trade credit (Schwartz, 1974) argue that firms able
to obtain funds at a low cost will offer trade credit to firms facing higher financing
costs. Emery (1984) sees trade credit as a more profitable short term investment than
marketable securities. These models imply that higher profits should lead to more
28
accounts receivable, because firms with higher profits have more cash to lend to
customers. This is confirmed by Deloof and jegers (1996), who find that Belgian
firms with a shortage of cash reduce investment in accounts receivable.
5.3 Recommendations
On the basis of findings of this project work, we conclude that profitability can be
improved in a number of ways. It acknowledges the many factors at play which
influence profitability depending on which industry the firm is in. These factors vary
in degree of influence on profitability. However, management must continue to
manage their working capital in a more efficient way as this will always affect
profitability if not managed efficiently. Constant efforts should be made to reduce on
the amount of inventories. They must also increase their debtors’ collection efforts
while negotiating for higher credit periods with their creditors. Managers can create
value for their shareholders by reducing the number of days for accounts receivables
5.4 Limitations of the Study
Private hospitals remain a closed up sector with very little financial regulation and
disclosure requirements. As such, the private hospital management did not want to
disclose their information for fear of the unknown. This made it difficult in
collecting secondary data. Management appeared suspicious when asked for
financial information lest it is used against them later on. Others were just slow in
providing data and by the close of data collection period; they had not provided the
required information.
29
5.4 Suggestions for further Research
The study was a survey of the private hospitals in Kenya and I recommend that
further studies should be carried out in sectors and industries not yet researched to
provide the uniqueness of each industry. Further on, a research should be done to
determine why there is a positive relationship between working capital
management and profitability of private hospitals. There is need to research
further and find out what brings about this kind of relationship.
30
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37
APPENDIX Table 1: SUMMARY OUTPUT
Regression Statistics Multiple R 0.962930791 R Square 0.927235709 Adjusted R Square 0.924961825
Standard Error 0.021073389 Observations 100 Table 2: ANOVA
df SS MS F Significance F Regression 3 0.543265172 0.181088391 407.7761545 1.78841E-54 Residual 96 0.042632423 0.000444088 Total 99 0.585897595 Table 3: Regression co-efficients
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Intercept 0.159391871 0.021331646 7.472085079 3.65736E-11 0.117048889 0.201734853 ICP 0.001001898 0.000269021 3.724235652 0.000330595 0.000467896 0.001535901 ACP 0.002432543 0.000149167 16.30756257 2.04021E-29 0.00213645 0.002728637 APP -0.00369681 0.000243113 -15.20616003 2.62724E-27 -0.004179384 -0.003214235
38
Correlation matrix ROA ICP ACP APP CCC
ROA 1 ICP 0.71891856 1 ACP 0.33143736 -0.19985869 1 APP -0.85156851 -0.82961001 0.12097326 1 CCC 0.95068247 0.81570892 0.32679115 -0.86155769 1
39
Input Data
ROA ICP ACP APP CCC (0.07) 9.42 22.87 59.85 (27.56)
0.04 29.62 20.99 58.25 (7.64)
0.06 29.67 34.13 60.22 3.59 0.08 30.11 30.88 58.52 2.48
0.07 33.30 47.98 71.01 10.27
0.08 37.77 58.84 65.14 31.47
0.07 19.87 54.92 58.12 16.66 0.07 16.17 53.25 63.04 6.37 0.05 16.96 50.58 63.91 3.63
0.05 17.02 42.62 59.28 0.35
0.02 44.29 3.69 41.22 6.75 0.11 47.34 18.31 37.35 28.30
0.11 49.13 16.45 35.66 29.93
0.14 51.68 28.04 33.08 46.64
0.17 48.68 35.19 30.59 53.28 0.20 46.26 41.00 28.19 59.07
0.21 47.55 41.07 27.70 60.93
0.22 47.34 43.11 26.82 63.64
0.23 47.17 44.78 26.10 65.84 0.24 47.01 46.16 25.51 67.66 0.02 5.19 18.72 56.14 (32.24)
0.03 16.10 16.83 54.54 (21.60)
0.05 17.22 30.97 57.30 (9.11) 0.07 19.46 28.21 56.06 (8.39)
0.07 25.89 46.11 69.27 2.73
0.07 31.53 57.27 63.61 25.20
0.07 14.30 53.59 56.81 11.09 0.07 12.63 52.13 61.96 2.80
0.05 13.89 49.65 63.02 0.52
0.05 14.38 41.78 58.49 (2.33)
0.07 9.40 22.85 59.83 (27.58) 0.04 29.56 20.97 58.23 (7.70) 0.06 29.62 34.12 60.20 3.53
0.08 30.07 30.87 58.50 2.44
0.07 33.27 47.97 71.00 10.24 0.08 37.75 58.83 65.13 31.44
0.07 19.84 54.91 58.11 16.64
0.07 16.15 53.24 63.04 6.36
0.05 16.95 50.57 63.90 3.61 0.05 17.01 42.61 59.28 0.34
0.02 9.42 22.87 59.85 (27.56)
0.04 29.62 20.99 58.25 (7.64)
0.06 29.67 34.13 60.22 3.59 0.08 30.11 30.88 58.52 2.48 0.07 33.30 47.98 71.01 10.27
0.08 37.77 58.84 65.14 31.47
40
0.07 19.87 54.92 58.12 16.66 0.07 16.17 53.25 63.04 6.37
0.05 16.96 50.58 63.91 3.63
0.05 17.02 42.62 59.28 0.35
0.13 51.48 3.71 44.59 10.61 0.16 55.75 25.46 37.76 43.45
0.16 57.38 21.36 35.34 43.40
0.17 60.51 35.43 32.05 63.90
0.19 54.17 42.58 29.20 67.55 0.22 49.83 48.33 26.56 71.60 0.23 51.27 47.53 26.17 72.63
0.24 50.60 49.12 25.34 74.38
0.25 50.06 50.38 24.69 75.75 0.25 49.61 51.39 24.16 76.85
0.03 44.68 3.69 41.43 6.94
0.12 47.83 18.81 37.38 29.26
0.12 49.65 16.82 35.64 30.83 0.14 52.26 28.62 33.00 47.88
0.17 49.07 35.80 30.47 54.40
0.20 46.53 41.62 28.05 60.10
0.21 47.84 41.63 27.56 61.90 0.22 47.60 43.64 26.69 64.55 0.23 47.40 45.28 25.98 66.70
0.24 47.23 46.63 25.39 68.47
0.02 43.82 3.23 40.81 6.23 0.12 47.83 18.81 37.38 29.26
0.12 49.65 16.82 35.64 30.83
0.14 52.26 28.62 33.00 47.88
0.17 49.07 35.80 30.47 54.40 0.20 46.53 41.62 28.05 60.10
0.21 47.84 41.63 27.56 61.90
0.22 47.60 43.64 26.69 64.55
0.23 47.40 45.28 25.98 66.70 0.24 47.23 46.63 25.39 68.47 0.02 43.84 3.26 40.84 6.26
0.11 46.94 17.98 37.04 27.88
0.11 48.77 16.17 35.40 29.55 0.14 51.35 27.82 32.86 46.30
0.17 48.40 35.01 30.40 53.00
0.20 46.01 40.85 28.03 58.83
0.21 47.32 40.93 27.55 60.70 0.22 47.13 42.99 26.69 63.43
0.23 46.97 44.67 25.99 65.65
0.24 46.83 46.06 25.40 67.49
0.02 44.13 3.54 41.09 6.58 0.11 47.20 18.20 37.24 28.15 0.11 49.01 16.36 35.57 29.80
0.14 51.56 27.96 33.00 46.52
41
0.17 48.58 35.12 30.52 53.18 0.20 46.18 40.95 28.13 58.99
0.21 47.47 41.02 27.65 60.85
0.22 47.27 43.07 26.77 63.57
0.23 47.10 44.74 26.06 65.77 0.24 46.95 46.12 25.47 67.60