Management of working capital by listed South African retail companies

Abstract

The working capital management of a firm has a strong influence on the firm’s profitability and liquidity. The retail industry is vital to the South African economy; hence, if poor working capital management influences a firm’s profitability negatively, it will have a negative impact on the economy. Overinvestment in current assets affects profitability adversely, due to costs such as storage and inventory insurance costs. It is therefore important to find a balance between profitability and liquidity. The purpose of this study is to investigate the effect of working capital management on the profitability of a firm. This study investigated the operations of South African retail firms listed on the Johannesburg Securities Exchange (JSE) over a period of nine years (2004–2012). The sample consisted of 18 retail firms listed on the JSE during that time. The sample was divided into sub-sectors, namely clothing (four firms), food (three firms), furniture (one firm) and other retailing firms (nine firms). The working capital management of the firms was measured by means of calculating the cash conversion cycle (CCC), which measured the time that the firm’s cash was tied up in its operations. Profitability was measured using four variables: return on equity (ROE), return on assets (ROA), gross profit margin (GPM) and economic value added (EVA). The results of this study indicated that South African retail firms reduce their CCC by reducing their selling prices and/or cost prices, causing profitability to increase. The reduction in the CCC can be accomplished by reducing average age of inventory (AAI) and average age of receivables (AAR), and increasing average age of payables (AAP). A reduction of AAI seems to have the most statistically significant impact on a firm’s profitability, and appears to be a useful strategy, given the importance of inventory management to a retail firm. By contrast, a reduction in AAR does not have as high an impact on profitability. If the AAP increases, only the GPM increases, none of the other profitability measures do. It can therefore be concluded that South African retail firms should manage their CCC by focusing on inventory management and by reducing the AAI to a minimum. Decreasing their AAI will improve their profitability. A limitation of the study was that only 18 South African retail firms were listed on the JSE during the period under review, resulting in a small data sample. The data samples for three out of the five sub-sectors were very small (food, furniture and clothing) and statistically significant results could not be obtained; therefore only the results of the total sample and for other retailing firms were included in the results. The study covered a period of nine years, but if the period had been extended, the sample of 18 firms would not have been reduced, due to some firms not being listed on the JSE for the entire period (2004–2012). Searches of prior studies on Google Scholar and the University of Pretoria Library’s database indicated that there have been few prior studies on working capital management in a South African context, and none that focus specifically on the retail industry. The study aimed at providing insight into the management of working capital in the retail sector by measuring the effect of strategies used on profitability, identifying areas that could be improved as well as apparently successful management techniques.