ABSTRACT
The central objective of this research is to provide empirical evidence pertaining to the impact of working capital management on corporate value and profitability of a retail company listed in the UK stock exchange. The company of choice in this study is J. Sainsbury plc, a large grocery retailer located in London. In general, the 2008-09 global financial crisis had little non-beneficial effect on the industry average of grocery retailing in the United Kingdom because of the decreasing margins of returns on stakeholder’s funds and return on the capital invested. Nonetheless, it is noted that the margin for return in total assets, together with earnings prior to interest and tax and the net profit increased regardless of financial crisis (Yan & Pei 2009, p.309). Averagely, the impact was minimal when the grocery retailers were considered cumulatively as opposed to when treated individually owing to the resulting synergy effect of high margins of leading retailers Tesco, ASDA and J. Sainsbury (Deloitte 2010, p.5).
Corporate financial data of J. Sainsbury has been gathered and analyzed using variables of return on assets ration together with return on invested capital ratio to evaluate the profitability of the company. Further, variable of Tobin Q ratio has been used to measure the market value along with variables of cash conversion cycle, current assets to total assets ratio, current ratio, current liabilities to total assets ratio as well as total debt to total assets ratio generally as working capital management criteria. This study shows that there exist significant relationship between the WCM and profitability of J. Sainsbury. However, there is no significant relationship with the market value of the retail company. In addition, results indicate that the management of J. Sainsbury can increase their profitability by reducing cash conversion cycle as well as total debts to total assets ratio.
Chapter Three
Case Study of Working Capital Management in the UK Retail Industry
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.
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 strive 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, p.45). 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, p.163).
Figure 1: Elements of Working Capital management
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, p.6). 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, p.12). 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, 7).
Figure 2: Cash conversion cycle at J. Sainsbury plc
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. 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, p.8). 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, p.345). 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, p.10). In light of this, J. Sainsbury plc is always striving to have as little money held up in working capital as possible.
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, p.355). 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 (Hermann et al 2010, . 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 (Ahlert et al 2010, p.299). 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, p. 356). 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 (Harris & Ogbona 2001, p.165). Since September 2011, the company has adopted a new slogan, “Live Well For Less”.
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, 7). 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. 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 2011, p.196). 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 profits earned in cash have had to be directed to meeting the working capital needs of the retail company (Gitman 2009, p.98).
Figure 3: J. Sainsbury plc Summary income statement 52 weeks to 17 March 2012
Source: (J. Sainsbury plc 2012, p.1) http://annualreport2012.j-sainsbury.co.uk/financial-review/
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. 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, p.481). 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 sources (Seth 2001, p.236). 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 & Houston 2009, p.494).
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 2010, p.46). 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.
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, 165). 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 chain management
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 2010, p.247). 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.”
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 (Geuens 2003, p.246). 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 4
4.1) Introduction
This study integrates case study approach to investigate the Impact of working capital management on corporate value and profitability of J. Sainsbury plc before and after the financial crisis.
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 (Alexander & Doherty 2010, p.932). 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. 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 (Sands & Ferraro 2010, p.572). 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. 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 (Patton 2001, p.474).
4.3) Appropriateness of Qualitative methodology
Qualitative approach is very important to a researcher in the sense that it provides the researcher with relatively more insight into the study context. Clarity of purpose and presumptions are the core considerations in a study when using qualitative approach.
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 (Patton 2001, p.480). 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.
Research Approach
All researches are governed by a couple of approaches – inductive and deductive approaches. In using the deductive approach, the investigator comes up with a theory and hypothesis and then crafts a research strategy by which to test the hypothesis. It gives allegiance to the “top down” path: ‘theory – hypothesis – observation –confirmation.’ Deductive reasoning typically progresses from the more general aspects to the more specific in which available facts are employed to reach logical conclusions.
On the contrary, the inductive approach aligns to the “bottom up” path: ‘observation-pattern – tentative – hypothesis – theory.’ Here the researcher gathers date for the purpose of building theories and hypothesis relevant to the study question (Wertz et al 2011, p.362).
In this research, the inductive approach is employed owing to the aspect that theories are built from observations along with the use of intuitive conception drawn about the subject matter with pieces of information from mailed questionnaires and corporate documents integrated to give the outcome.
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
Additional information for this study is retrieved from data collected earlier by earlier researchers such as official statistics, routine accounts by the company, and administrative records. The secondary data used relate to procedure of assessment of working capital management from business reference books, academic journals and prior expert analysis. In order to make sure that the information gathered is coherent, the study has utilized information from varied online gateways and database, online journals, reference texts together with corporate documents from which the financial analysis has been done (Wiebe et al 2009, p.754).
4.4.2) Case Study Approach
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. It entails use of varied sources of data such s documents, interviews, archival records, participant observations, direct observations along with physical artifacts (Patton 2001, p.453). This is the research method of choice for this study because the bulk of the information will be drawn from financial statements and other relevant corporate documents ranging from years 2006 to 2012 for J. Sainsbury plc. Documentary analysis is very significant for such financial subjects because the sources of information/data are exceptionally vast and readily lend themselves to comparison with other like sources so as to prove their authenticity. Data or information can be collected from any document such as records, letters, and journals.
4.4.3) Primary Data Approach
There are a number of methods of primary data collection methods. These include directly administered or mailed questionnaires, personal interviews, telephone interviews, focus groups, electronic mail surveys, and internet survey. For the purposes of this study, the primary data is gathered through interviews, questionnaires and from annual financial reports (2006-2012) as posted on the company profile of J. Sainsbury plc on its Website.
Interviews
Personal interviews are conducted with the financial managers of J. Sainsbury. This provides in-depth and comprehensive data/information relation to the research question. The interviews entail investigators seeking detailed information or posing questions to the respondents of this study (Wiebe et al 2009, p.778). Conducting interviews for this research will not be too expensive because the single company under investigation and thus minimal transport costs unlike in the case of multiple companies.
Questionnaires
Mailed questionnaires are the primary data collection technique for this particular study. To a larger extent, this method shall be able to gather the needed information because of its structure. There will be up to 4 questionnaires investigating the state of J. Sainsbury prior and after the financial crisis, and mainly the effect of working capital management on the company’s profitability and corporate value during these periods.
4.5) Enhancing Validity of Methodological Approach
Validity means the degree to which the study measures its objectives. This research infers validity generalization. Evidence drawn from a number of studies show point to the aspect that working capital management has had significant positive effect on the corporate value and profitability of J. Sainsbury before the financial crisis. However, the economic troubles that hit the markets in the wake of the financial crisis compromised the positive effect of WCM and in turn the corporate value and profitability of the grocery retailer. This can explain why J. Sainsbury plc has lost its previous market leader stature in 2009 to Tesco and ASDA respectively (Jones et al 2011, p.941).
Justification of the Research Methodology
The research covers the period between 2006 and 2012. It is paramount to use earlier works of different commentators and corporate documents in assessing the effect of WCM on the corporate value and profitability of J. Sainsbury plc. Thus, the study focused on data and information obtained from the documentary analysis and mailed questionnaires.
Research Ethics
In any research, ethics are ideally the core principles that inform morality pertaining to the general conduct of the study. This research has employed some three approaches identified for handling ethical issues: the deontological approach, ethical skepticism, and the utilitarianism approach.
i) The deontological approach – this dictates that ethics should be governed through some set of universal codes e.g. certain inherently unethical actions should be avoided at all costs.
ii) Ethical skepticism – this alludes to an individual’s conscience relating to an ethical decision. Consequently, the researcher ought to do what s/he believes is right and thus refrain from anything unethical, wrong or immoral.
iii) The utilitarianism approach – this perceives ethics as product of the potential benefits which may come from a research study as weighted against their potential costs. If the benefits outweigh the costs, then the decision is to the effect that the research is ethically acceptable.
In designing the questionnaire to be mailed to respondents, sufficient information concerning the objective of the research is provided and confidentiality and privacy of the participants was afforded the care it deserves. In addition, the questionnaires are mailed to enable the participants complete them freely without undue incitement (coaxing) or threats whatsoever.
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, p.218).
• 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 consists the 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
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