CASE STUDY OF WORKING CAPITAL MANAGEMENT
3.1 Introduction
In this chapter, I will first justify why I am investigating Working Capital Management of J. Sainsbury plc in the United Kingdom. Then I shall give a brief history of the history of my company of choice. This shall be followed by a thorough assessment of approach and techniques currently practiced by the managers of J. Sainsbury plc in the effort to enhance their WCM. Thereafter, there shall be a discussion on the impacts of Working Capital Management on performance, firm’s value and profitability. I shall also incorporate both the internal and external factors that affect the working capital management of J. Sainsbury plc.
3.2 WCM in the UK J. Sainsbury
Working Capital Management is one of the key determinants of a company’s market value because of its effects on profitability. Similarly, WCM is extremely essential from the perspective of a company’s sustainability. In this respect, it is important for an organization to strike a balance between its profitability and risk as relates to managing working capital. Gross working capital essentially refers to the overall investment in current assets of a company (Eljelly, 2004). However, net working capital – current assets less current liabilities – is most applicable in the perspective of working capital management. Working capital management thus reflects the decisions relating to the working capital together with short-term financing and entails managing the relationship between a company’s current assets and current liabilities. In general, therefore, the manner in which a firm manages its working capital has significant effects on its profitability meaning that working capital management calls for a tradeoff between risk and profitability (Eljelly, 2004).
Figure 1: Elements of Working Capital management
(Meir et al 2005)
Working Capital Management is the focal point of this investigation because it has a significant impact on profitability and liquidity of J. Sainsbury (Augustin, 2011). Traditionally, it has been the practice of J. Sainsbury – in the effort to take a greater risk for greater profits and losses- to reduce the size of its respective working capital as related to its sales volume. Similarly, when geared at improving liquidity, the company often increases the amount of its working capital. Nonetheless, this practice is likely to reduce the sales volume and in turn the profitability of the retail company (Wrigley & Lowe 2002). In this respect, J. Sainsbury has battled with striking a balance between profitability and liquidity. The major effects of different variables of working capital are the Average collection period of the so called receivable days; the payable days or average payment period, inventory turnover in days; quick ratio; current ratio; cash conversion cycle on the net operating profitability of J. Sainsbury (Augustin, 2011).
Figure 2: Cash conversion cycle at J. Sainsbury plc
(Brigham & Houston 2009)
Working capital management is therefore a key area of concern for J. Sainsbury plc. The aim of working capital management is to lower the cash conversion cycle as well as the amount of capital represented in the net current assets (Harm & Bradley 2003). There is minimization of time between the capital outflow and the inflow of cash together with the process cost and quality through working capital management. Achievement of the goals is through proper coordination of order to cash, purchase to pay and sales (Augustin, 2011). As a leading retail company in the UK, J. Sainsbury gives relatively high priority to sales because they realize it is the most significant process to release capital that is tied up in the net current assets. The company understands that it allow itself to have high proportion of current assets as compared to its major rivals, neither less liquidity, reliance on short term debt and volatile cash flows because this risks failure in working capital management which would be costly for the firm.
Like all other retail firms in the United Kingdom and the corporate world at large, J. Sainsbury plc faces the paradox and dilemma that characterizes working capital management. This is especially because retaining high working capital in overly inefficient on one hand, whilst hold rather little working capital is dangerous to the continued survival of the company on the other hand (Izadinia & Taki, 2010). Excess stock is a waste to a retail giant like J. Sainsbury plc in the sense that cash tied up in stock is less utilized effectively, results in much warehousing or storage costs, and there is greater risk of stock being lost as a result of damage and obsolescence. On the other hand, J. Sainsbury plc cannot entertain too little stock because it risks grounding its activities, lose significant amounts of income as well as cause undesired discomfort to its customers (Augustin, 2011). In light of this, J. Sainsbury plc is always striving to have as little money held up in working capital as possible.
3.3 Brief History of J. Sainsbury Plc
J. Sainsbury plc traces its roots to 1869 when John James and Mary Ann Sainsbury founded it in London (Zentes et al., 2011). The company first gained its reputation for dealing in high quality products offered at relatively low prices. However, the food retailer’s strategy of selling high quality products at premium prices found its niche in 1882 when it became embraced in more affluent regions of London. Faced with stiff competition from companies like Liptons, J. Sainsbury expanded threefold in the last decade of the 17th century. It then grew to status of the largest grocery retailer in the UK by 1922.
Over the years, the company grew tremendously and attained public status in the 1970s, becoming the biggest ever flotation on the London Stock Exchange in 1973 under the leadership of John Sainsbury. The company has steadily diversified its product range and it was the first ever company in the market to have its own branded wines. By March 2004, J. Sainsbury plc boasted of 583 supermarkets in operation throughout the UK and beyond. In August 2004, the company purchased the Jacksons giving J. Sainsbury over 250 convenience stores, though under different brand names, operating as distinct business under the existing management.
At present, J. Sainsbury plc is the third largest chain of supermarkets found in the United Kingdom (behind Tesco and Asda respectively) with its market share put at 16.5% (Zentes et al., 2011). The group currently operates a total of 537supermarkets and 335 convenience stores. In additions it runs the Sainsbury’s Bank, Sainsbury’s online internet shopping services and in excess of 1000 stores throughout the UK. The competitive edge that Sainsbury holds against its larger rivals is based on a higher quality grocery offering. Since September 2011, the company has adopted a new slogan, “Live Well For Less”.
3.4 Impact of WCM on Profitability, Firms Value and Performance
Working capital management (WCM) has a significant impact on the profitability of the food retail J. Sainsbury and thus serves as one of the key determinants of the company’s value (Augustin, 2011). The company strives to manage its working capital management so as to attain balance between profitability and financial stability. The financial management of J. Sainsbury thus constantly struggles in avoiding both over-capitalization and inadequate working capital (Wang, 2002). This is for the simple reason that too much working capital would impinge on the profitability of the retail company. Failure to manage this would lead J. Sainsbury plc to accumulate higher interest rate burden which in turn would compromise its net profitability (Mobeen et al., 2011). On the other hand, inadequate working capital at J. Sainsbury plc would result into liquidity issues along with overtrading which implies that there would rapid expansion without adequate working capital at the disposal of the grocery retail company. Overtrading has negative implications on the profitability of J. Sainsbury Company because cash will be afforded much greater priority as compared to profitability.
Over the years (before and after the financial crisis), J. Sainsbury plc has handled well its working capital requirements resulting in high profitability. This is because relatively less profit earned in cash has had to be directed to meeting the working capital needs of the retail company (Gitman, 2009).
Figure 3: J. Sainsbury plc Summary Income Statement 52 weeks to 17 March 2012
Source: (J. Sainsbury 2012)
3.5 Managerial Approaches and Techniques for enhancing WCM
In the wake of the Global Financial crisis, large retailers like J. Sainsbury plc have found increasingly expensive and difficult to access credit. This is especially because prior to the financial crisis the company heavily depended on easily available loan facilities and overdraft in order to finance its trading activities In the effort to stay afloat in the otherwise competitive market, the management of J. Sainsbury plc has undertaken a number of approaches and techniques to improve the overall management of the company’s working capital management (Vishnani and Bhupesh, 2007). Efficiency of the working capital management is assessed by in terms of inventory, current liabilities turnover cycles, accounts receivable, cash conversion cycle, together with obtained rates of return drawn from non-financial liabilities (Bhattacharya, 2009). Generally, the management of J. Sainsbury plc has laid much emphasis on trade and supply chain finance because WCM is their funding strategy. In addition, the company’s management is making efforts to improve its process management along with efficiency within their business treasuries by connecting trade finance, cash management as well as foreign exchange.
J. Sainsbury applies the middle-of-the-road approach in terms of working capital policy. This implies that the company applies the matching principle, where long term or permanent assets are financed using permanent or long-term sources while short term assets are financed by short-term source. In addition, permanent levels of current liabilities and current assets are regarded as long-term liabilities and long-term assets respectively.
The management of J. Sainsbury plc attaches special importance to liquidity, where access to capital is paramount to the company and their trading partners. As a result, the company has found trade finance structures as an alternative option (Brigham and Houston, 2009).
The other approaches or techniques that the management of J. Sainsbury plc has employed to enhance their WCM are advanced trade and cash management systems. To this effect, the company has employed a combined strategy of its own and bank proprietary platforms. As such, J. Sainsbury is able to identify and aggregate its cash across the entire organization, and settle trade payments to its suppliers in more effective ways, and in so doing unlock its working capital (Gill et al., 2010). In the same vein, the company as a buyer is able to utilize supply chain finance (SCF) techniques in improving its cash flow without necessary destabilizing its suppliers. J. Sainsbury plc has signed up to a SCF program that is supported by its banking partner so as to strengthen strategic supplier relationships by through enabling their key suppliers to receive payments expeditiously. This is because the suppliers of the company are able to cash their invoices early enough at competitively priced discounts without having to interfere with the supplier’s receivable days.
3.5 Internal and External Factors that affect the WCM
Like all other large grocery retail stores in the United Kingdom, the profitability of J. Sainsbury plc is a product of the inevitable interplay between internal and environmental (external) factors. The company faces significant strategic issues in both its internal and external environment which include: the deterioration of the UK economy, the uncertain future of both natural and organic segments of the UK grocery industry, and the rising cost of food (Charitou et al., 2010). In addition, J. Sainsbury plc faces increased competition from other major players in the industry such as Tesco.
In general, therefore, the management of working capital at J. Sainsbury plc is influenced by both external and internal factors as represented in the table below
:
Table 1: External and Internal factors affecting WCM
1. External Factors Factor influencing WCM
a. Macro level factors i. Politics
ii. Business & economic environment
iii. Between industries effect
iv. Legislation
b. Micro level factors i. Customer requirements/needs
ii. Financing methods/requirements
iii. Technology
iv. Supplier collaboration/covenants
v. Competitors effect
vi. Shareholders wealth
2. Internal Factors Factors influencing WCM
a. Macro level factors i. Management system/practice/method
ii. Organizational behavior
iii. Investment policy
iv. Management financial capability (knowledge)
v. Operation management/ supply chainmanagement
vi. Upstream collaboration/outsourcing
b. Micro level factors i. Inventory management
ii. Employees financial capability (knowledge)
iii. Credit policy/Collection management
iv. Payable management
The managers of the retail company constantly grabble with the challenge of reaching decisions and taking actions not only in line with the procedural requirements of the UK government, but also to meet the needs and wants of the customers. The performance of the grocery store is afforded particular special interest by the UK population because food is everyone’s concern. The grocery sector is also afforded greater attention by the UK media, which increases pressure on market leaders like J. Sainsbury plc to enhance its working capital management at all times. In addition, J. Sainsbury plc as a retail firm with greater reliance on efficient working capital is affected by government policy pertaining to how to charge interest on overdue invoices (Raheman et al., 2010). In the same vein, the retailer has to align its actions in response to the actions of its key competitors in the grocery industry. In general, the management of J. Sainsbury plc must constantly address both long-term and short-term tasks that are strategic, tactical and operational in nature with significant effect on working capital management. Though grocery retailing in the UK is a ‘self service industry’, J. Sainsbury plc is affected by the constant change of the “rules of the game.”
3.6 Conclusion
This chapter presented a case study on the working capital of the J. Sainsbury plc, the third largest grocery retailer in the United Kingdom at the moment. It was established that working capital management is at the core of the J. Sainsbury’s business because it has greater impact on the profitability, firm’s value and overall performance of the company. It was further established that J. Sainsbury is a household name in the grocery retailing industry owing to its long history in operation and providing high quality products at relatively low prices. In addition, the chapter reflected on the many external and internal factors that affect the working capital management at J. Sainsbury plc.
The next chapter, Chapter 4, will discuss the Research Methodology of this paper. There shall be explanation of the differences between quantitative and qualitative research methods, along with their respective appropriateness. There shall also be an explanation of data collection methods of this study (both primary and secondary data collection sources) together with reasons for employing case study approach. The explanation will entail ethical issues and administration of your data collection.
CHAPTER FOUR
METHODOLOGY
4.1 Introduction
For researcher to pursue it is prominent to know the appropriate method. The right method applied determines the effectiveness of the findings. Kaplan (1973) states research methodology as an approach of defining the techniques used for research which give maximum level of knowledge and information by not limiting itself using only different techniques.
Kothari (2004) stated that research methodology as a systematic process of solving research problem; evaluation of selected techniques’ and understanding of what research methodology indicate and means. He argues and views research methodology beyond the research methods and considers it as a part of it and defines it as the behavior and instruments used in selecting and building appropriate research technique. Further, emphases on proper understanding of the assumption and criteria of various techniques as the research problem nature vary.
Cohen, Manison, & Morrison (2007) defined research methodology as “abstraction of reality, especially through mathematical models and quantitative analysis for the purpose of comparison.” Hence, it is a procedure which describes, explains and predicts for generating, collecting and evaluating data. Lehaney and Vinten (1994) termed methodology as the process of formulating hypothesis which eventually becomes theories or scientific methodology, the ways in which techniques are selected to solve an issue, the process of selecting appropriate variable for a model and a consecutive planning of events. In each discipline, a separate and unique knowledge is applied and with this help research is conducted. In financial environment, many researches have contributed a distinctive knowledge with aid of established disciplines such as natural science, social science which signifies a requirement of proper research methodology to carry out a research.
Lechyd (2001) mentions six types of research methodology namely experimental, survey, ethnographic, ideal-type, action-learning and ground theory research. Amaratunga et. al. (2002) describes two main fundamental approach of research as logical positivism and phenomenological. Positivism approach uses quantitative method which helps to undertake research analysis by testing hypothesis and gives simplest way of analysis whereas phenomenological approach uses qualitative method which helps understand and explain a particular phenomenon mostly by human experience rather than considering external causes and fundamental laws. The hypotheses are well generated in this case as opposed to positivism approach.
4.2 Differences between Quantitative and Qualitative methods of research
Quantitative methodology seeks to thoroughly inquire into a given identified problem on the basis of testing a theory, measured with numbers, and then analysis done using statistical techniques. On the other hand, qualitative methodology focuses on the importance of the observations made in the course of the research rather than the raw numbers themselves. It is concerned with describing meaning, as opposed to drawing statistical inferences.
The differences between qualitative and quantitative research methodologies relate to the assumptions that underlie the individual approaches (Diriwächter & Valsiner, 2006). In quantitative methods, reality is highly objective and independent of the researcher. However, in qualitative approach, there exist multiple realities to any given situation relating to the researcher, subjects being investigated and the audience or the reader interpreting the presented results. The researcher using quantitative approach assumes a distant and independent position of the research subject while limited distance and close interaction is maintained when using qualitative approach. On the contrary, qualitative methods are primarily founded on inductive forms of logic, where levels of interest stem from subjects (informants) as opposed to being noted as a priori by the researcher. In addition, the objective of quantitative approach is to develop relevant generalizations that enrich the theory enabling the researcher to predict, explain and comprehend given phenomenon. The goal in qualitative approach is to unearth theories or patters that assist in explaining phenomenon of interest.
Furthermore, the values of the researcher do not influence the research in any way whatsoever when quantitative methods are used in a study. On the contrary, qualitative research is value-laden translating that the values of the researcher become part of or interfere with the research itself (Diriwächter & Valsiner, 2006). Similarly, the basis of quantitative research is primarily on deductive forms of theories and logic and cause-effect order is employed to test hypothesis. In light of this, it is important to identify and comprehend the research methodology of the study because the fact that the research approach have significant influence on the questions asked, the methods to be chosen, the statistical analyses employed, the inferences reached, and the ultimate objective of the study.
Anderson (2006) differentiates both methods as following
a. He describes qualitative method as subjective phenomenon compare to quantitative method which is more objective phenomenon. Moreover, qualitative method research in the process develops theories while in quantitative method theories are tested in order to analyze.
b. Also, other distinctive is quantitative method focus is short and narrow whereas qualitative method focus is complex and extensive. In terms of findings quantitative method is measurable whereas qualitative is explanatory.
c. Report presented in quantitative are generally tested by statistical analysis while contrarily, report in qualitative are more narrative, individual and interpretation of ideas and experience.
d. Hypotheses are formulated in quantitative method while in qualitative research questions are formulated. Further, quantitative methods are highly controlled while qualitative method comprises flexible approach. Also, quantitative method sample sizes are of great importance while in qualitative it is not.
4.3 Appropriateness of Qualitative methodology
Compared to Quantitative approach, the Qualitative methodology is appropriate in investigating the impact of WCM of the profitability and corporate value of J. Sainsbury plc. This is because a well-designed and conducted qualitative research using the case study approach would be able to fill the explanatory gaps that quantitative techniques would be suboptimal or even inapplicable. In my view, quantitative approaches are overly positivistic and obsessed with numbers which do not necessarily reflect the true picture of the question at hand (Diriwächter & Valsiner, 2006).
4.4 Data Collection Methods for the Study
This study used the document analysis method to collect data. As such, the required data relating to the impact of WCM on corporate value and profitability of J. Sainsbury plc during and after the financial crisis have been retrieved from the company’s annual financial statements 2006-2012 as posted on the Internet.
4.4.1 Secondary Data Collection Sources
Zikmud (1997) defines secondary data are those which have already been collected and through processed the statically process. Secondary data are mostly used for case study or survey strategy research and it is useful method as it saves enormous time and cost and large of number of data can be studied. Moreover, more focus on interpretation and analysis rather than spending more time collecting raw data (Saunder, Lewis & Thornhill, 2007).
Additional information for this study was retrieved from data collected earlier by earlier researchers such as official statistics, routine accounts by the company, and administrative records (Mohammadi, 2009). The secondary data used relate to procedure of assessment of working capital management from business reference books, academic journals and prior expert analysis.
4.4.2 Case Study Approach
In compliance with the statistical tool, there are various measurement tools which give accurate analysis and used suitably according to nature of the research. Various techniques such as correlation analysis, factor analysis, cluster analysis, multidimensional scale analysis, and canonical correlation analysis are used to find the relationship of research issues. It undertakes only one variable without making a distinction between dependent and independent variables. Contrarily techniques such as regression, path analysis, t-test, analysis of variance methods are appropriate when research is to find the relationship between two or more variable and also referred as dependence technique (Velde, Jansen & Anderson, 2004)
The Case Study approach enables the researcher to explore a single phenomenon or entity limited by time and activity and to collect detailed information through a number of data collection procedures over a given period of time (Kaddumi & Ramadan, 2012). This is the research method of choice for this study because it enables us to better understand the impact of working capital management on the profitability of J. Sainsbury besides strengthening previous research on the same subject. Using the case study, I am able to challenge common theoretical assumptions relating to working capital management.
4.4.3 Primary Data Approach
The primary data are which are collected afresh and for the first time, and thus happen to be original in character. It generally provides larger number of data and more information; however, time and cost are major constraint (Polonsky and Waller, 2011). In my research, data will be collected from interviews with staff and academics expert. Also, another limitation of this source is the corporate desire to keep privacy; hence it is difficult to acquire primary data in this instance. Thus, secondary data serves as the best alternative for my research. The Primary data for this study was collected from the company profile of J. Sainsbury plc on its Website, annual financial reports (2006-2012) as posted on the Internet.
4.5. Enhancing Validity of Methodological Approach
Yin (1994) stated case study approach is applicable in the case of determining question such as ‘who’, ‘where’, ‘what’ ‘how’ and ‘why.’ Basically case studies include the steps of designing, conducting, analyzing and recommending & implication. Ragin & Becker (1992) describes it as a case analysis as a motive of investigating both similar enough and separate enough to understand more when comparing with the instances of same general phenomenon.
Noor (2008) defines case studies as the analysis of single unit which can be an event, entity or an individual. It investigates a particular phenomenon from real life provided with various sources of evidences and enables to understand the complex real life activities. It is particularly used when the particular unit of analysis is necessary to study in depth and cases which provides rich information. Further, he describes two major attributes of using case studies; one major benefit is it enables to understand the complex nature and grasp essential factors of organizational activity in fast changing environment and another benefit is it allows broader generalization in a form of relying and supporting to various findings. Yin finds three types of case studies such as descriptive, exploratory and explanatory case studies.
Case study strategies are mostly useful unlike other strategies. A survey strategy aims to produce generalization about population by collecting information from samples which is generally used in large study; experimental strategy focuses on connection between the variables which is time consuming and costly and are non -opinion based whereas action research strategies are useful to solve a problematic situation (Thomas, 2004).
A case study is an empirical inquiry in which focus is laid on a contemporary issue within its real-life context and parameters between the phenomenon and its related context are not necessarily evident. It procedural characteristics include several variables of interest, varied sources of evidence, together with theoretical proposition to offer guidance in the collection and analysis of data (Mohammadi, 2009).
In this study, the contemporary phenomenon in question is the extent that WCM impacts on productivity of J. Sainsbury, the third largest grocery retailer in the UK at present. A number of data sources have been used in investigating the subject question – both primary and secondary data sources. The design is a single case study that uses qualitative approach.
4.6 Analytical Framework
Analytical auditing procedures are done by studying and comparing relationships between both financial and nonfinancial information. In this respect, there are varied ranges of analytical procedures which include:
• Comparisons – e.g., between the current and previous year account balances
• Ratio analysis – e.g., calculations of inventory turnover or times interest earned ratios.
• Reasonableness tests – e.g., estimation of a given balance and making comparisons between these estimates to the actual balance (Huddleston et al., 2004).
• Regression analysis – e.g., statistical estimation of the payroll expense on the basis of the number of employees, average rate of pay, as well as the number of hours worked.
In this study, Regression and correlation are used to test the hypothesis or questions so as to ascertain the impact of working capital management on corporate value and profitability before and after financial crisis. In this study, therefore, the regression model is presented as:
In this study, to investigation the impact of working capital management on corporate value and profitability of J. Sainsbury plc, a number of variables would be used:
Tobin Q ratios (TQ), the dependent variables is employed as a measure of market value, return on assets ratio (ROA), return on invested capital (ROIC) as a measure of profitability of company and independent variables, cash conversion cycle (CCC), the current ratio (CR), current assets to total assets ratio (CATAR), current liabilities to total assets ratio (CLTAR) and total debts to total assets ratio (DTAR) also is used as working capital management measures. This study uses the following regression model to test hypotheses 1 to 3, 1 to 3 models have been implemented respectively:
(1) TQit = β0 + β1CCCit + β2CACLRit + β3CATARit + β4CLTARit+ β5 DTARit+ ε
(2) ROAit = β0 + β1CCCit + β2CACLRit + β3CATARit + β4CLTARit+ β5 DTARit+ ε
(3) ROICit = β0 + β1CCCit + β2CACLRit + β3CATARit + β4CLTARit+ β5 DTARit+ ε
In these models:
TQit = market value of firm i for time period t
ROAit = return on assets of firm i for time period t
ROICit = return on invested capital of firm i for time period t
CCCit = cash conversion cycle of firm i for time period t
CACLRit = current assets to current liabilities ratio of firm i for time period t
CATARit = current assets to total assets ratio of firm i for time period t
CLTARit = current liabilities to total assets ratio of firm i for time period t
DTARit = total debt to total assets ratio of firm i for time period t
ε = error term of the model.
Variable Method
Dependent variables
Tobin Q (market value of equity + book value of liability)/ total asset
Return on asset earnings before interest and taxes/ total asset
Return on invested capital net profit/ total capital
Total capital consist number of shares in the end of each year multiplied by nominal value of per share.
The independent variables
Cash conversion cycle
days sales in inventory (DSI) + days sales outstanding (DSO) + days payables outstanding (DPO)
DSI= inventory of goods and materials/ (cost of goods sold/ 360)
DSO= business accounts and notes receivables/ (net sales/ 360)
DPO= business accounts and notes payables/ (cost of goods sold/ 360)
Current Assets to Current Liabilities Ratio
current assets/ current liabilities
Current Assets to Total Assets Ratio
current assets/ total assets
Current Liabilities to Total Assets Ratio
current liabilities/ total assets
Total Debt to Total Assets Ratio total debts/ total assets
Reference:
Meier, M., Sinzig, W., & Mertens, P. 2005. Enterprise Management with SAP SEMTM/ Business Analytics. New York: Springer.
