WORKING CAPITAL MANAGEMENT EFFICIENCY IN INDIA: AN EMPIRICAL ANALYSIS

Abstract

The global financial turbulence affected the business and increased the demand for efficiency, efficacy and productivity (Kumar and Vincent, 2011). Aftermath of deregulation, globalisation of economies, strong presence of capital market and global financial instability have created opportunities as well as many challenges in front of Indian firms to sustain its performance and competitiveness. Sound economic growth of any developing economy in general and success of any firm in specific depends on efficient handling of limited resources. A large and critical portion of a firm’s resources is in the form of short term capital or working capital and it is thus crucial for firms to be efficient in managing working capital. The motivation of this study is to perform a robust performance evaluation of working capital management (WCM) efficiency in Indian firms. The study aims to examine the efficiency of working capital management in Indian firms in the current scenario and analyse the trends. To achieve these objectives this study develops a new measure of WCM efficiency using frontier analysis technique ‘Data Envelopment Analysis’. It also aims to explore the firm-specific and macro-economic variables that influence the efficiency of working capital management. Moreover, the objective of the study is also to examine the extent of influence of working capital management efficiency on accounting and market performance of firms. In addition, the study separately analyses the cash holding pattern and its impact, because of its uniqueness in comparison to other liquid assets. This study follows a systematic approach to achieve its objectives and tries to link each step of analysis to the next one. In the first stage, the study adopts a non-parametric frontier technique called Data Envelopment Analysis (DEA) to estimate efficiency of working capital management in Indian manufacturing firms and examines the efficiency scores obtained using this new technique. It compares the new DEA based WCM efficiency measure with the traditional measures and examines its advantages. The new measure is found to be an improvement over the traditional measures because of it benefits of having no mathematical fallacy, higher scale of measurement, capability of benchmarking analysis and ability to be flexible. The efficiency scores indicated that the average WCM efficiency is around 40%, and that there is a vast difference betweenmaximum and minimum efficiencies. This shows that in all industries, there are firms which are extremely inefficient in managing working capital. This stage also analyses the trend in WCM efficiency over the ten year period (2004-2013) using both traditional measures viz. cash conversion cycle and net trade cycle along with new DEA based efficiency measure. Graphical and statistical analysis is carried out to understand the pattern of WCM efficiency and to examine whether the efficiency has undergone any change over the study period. Results suggest that though each industry has its own accepted norm for working capital levels and maintain its position relative to other industries, however the efficiency level is not constant across the years. The trend analysis indicated that efficiency levels of working capital management do vary with time which might be the result of several firm-specific and macro-economic factors. In second stage of the analysis, present study examines the influence of various firm-specific and macroeconomic variables on the WCM efficiency of firms. The traditional WCM efficiency measures and new DEA measure are employed and both graphical and statistical analysis is carried out to analyse the effect of various variables. Analysis is carried out separately for each industryand the results from all the measures and industries are combined to identify the variables with significant influence. It is observed that age of firm,cash holdings, investments in fixed assets,return on assets and sales growth have positive effect on the WCM efficiency. On the other handleverage and size of firms were found to have negative influence. The study also found that the macroeconomic variables had inconsistent effect on WCM efficiency and thus their influence remains inconclusive. Malmquist Productivity index (MPI) and its components pure efficiency, scale efficiency and technology change (as given by Färe et al.(1994) are used to examine the change in WCM efficiency of Indian manufacturing firms over the study period. The trend in pure and scale efficiency changes along with technology change is analysed over the ten years. It is found that the cumulative efficiency change has increased considerably in the ten years but most of this change has been due to change in technology. The analysis indicated that during the study period pure efficiency has almost doubled while the scale efficiency has improved only slightly. Moreover the influence of change in various firm specific and macroeconomic factors on MPI, pure efficiency and scale efficiency change are analysed using both graphical and statistical analysis. The relationships obtained were almost similar to those obtained previously (analysis of WCM efficiency determinants) and thus confirmed the earlier results.In the final stage of WCM analysis the relationship between WCM efficiency and performance of firm is explored. Again both traditional measures (CCC and NTC) and the new DEA based measure are used to examine the effect of WCM efficiency on firm performance. Firm performance is measured using a variety of measures including accounting based, valuation based and wealth creation measures. Each performance measure is used in combination with each of the three WCM efficiency measure (CCC, NTC and DEA based measure) for robust analysis. It is found that many of the performance measures were positively related to the WCM efficiency which suggest that improvement in the efficiency of liquidity management tends to improve the financial performance of firms. Accounting performance measure: return on sales, market performance/valuation measure Tobin’s Q, wealth creation measure market value added (MVA)exhibited positive relationship with WCM efficiency measures This suggested that increase in WCM efficiency is valued by the investors and that the improvement in the efficiency of working capital management improves the overall functioning of firms and hence it leads to creation of value/wealth. Overall it can be inferred that an increase in the WCM efficiency is an essential ingredient for improvement in the performance of firm. In the last section of this study, a different aspect of working capital management i.e. cash holding pattern is analysed. The study found that mean cash holding level in Indian firms was much lower than the values reported in developed countries. The study analysed the movement in the cash holding of firms and investigates whether the pecking order theory or trade-off theory is more applicable with respect to cash holdings in the Indian scenario. The results are more or less in agreement with trade-off theory and it was observed that cash holdings have mean reversion property i.e. as the cash holdings deviate from a target level, firms try to reverse the change and bring the holding back to the desired level. Based on past studies, the study modelled optimal/target cash holdings using various firm-specific variables and found that in general the deviation from the target is around 50% of its value in the previous year, indicating that firms move towards the target and reduce the gap in subsequent years. The study examines the impact of change in cash holdings on the market performance of the firm. The results suggested that a positive change in cash holdings did have a positive effect on stock returns i.e. the investors attach more value with a firm that has more cash. However, beyond a level, any increase in cash holdings (increase in excess cash) is considered unnecessary hoarding and the value of the firm starts declining. The study examines the WCM efficiency of Indian manufacturing firms in an entirely new perspective. Valuable insights and analysis opportunities provided by the proposed new DEAbased WCM efficiency measure will aid financial managers, analysts and other stakeholders to better evaluate and benchmark firms’ liquidity management. The findings of this study will help financial and operational managers to make better decisions in order to achieve the target of maximizing shareholder wealth through proper liquidity management.