PGBM82 Finance and Management Research Dissertation - ASDA

Working capital indicates an effective way in which the company is managing its business and act as the true indicator of the good management as the top performers of working capital seems to be outperformed in comparison to their peers across the other indicators. Most of the retailers in UK had embarked on development of the optimization programmes on the working capital as it wrestle with the way fro providing an appropriate availability without an increase in the inventory substantially. Overall this sector has resulted an improvement in its working capital as many of the company emphasized on improving the demand forecasting and an agility of its supply chain as the e-commerce demands are more accurately available. On the other hand there seen a spread within the performance of the firms with respect to working capital between the bottom and the top performers in the sector (Samiloglu and Akgün, 2016). With across £ 84 billion of the working capital has been identifies in retail sector and still more opportunity is available.

The present report shows the comparison of different retail segment firms that are Tesco, Morrisons, Sainsbury and ASDA. Furthermore, the study reflects the relationship between the management of the working capital with that of the profitability of the company. Moreover, it highlights the different factors of the working capital that has a direct and a great impact on the profitability of an enterprise.

Aims and objectives

Aim

The aim behind conducting present study is to analyse the impact of working capital management on firm's profit with regards to Tesco, Sainsbury, Morrison's and ASDA.

Objectives

• To develop understanding about the concept of working capital and factors affecting it.
• To identify theories and models associated with working capital management (WCM).
• To assess the extent to which WCM has an impact on organizational profitability.
• To recommend prominent WCM strategies to the firms operating in UK retail sector.

Research questions

Q.1 What is the meaning of working capital management and its components?

Q.2 What are the main models and theories associated with WCM?

Q.3 To what extent does WCM influence or impact the operating profit margins of the retail sector company?

Rationale

The reason behind conducting this study is to identify impact of managing the working capital towards the profitability and the revenue of the companies. It is seen as the most important and the current issue in the retail sector firms as without managing the working capital in an effective way, firm cannot survive or cannot function its routine operations adequately. This in turn directly affects the production cycle, sales and the profitability of the company as negative working capital shows that current liabilities of the company is higher than current assets and this signifies a need of additional capital in the business for running the daily operations efficiently (Obradovich, 2019). Therefore, it is very critical for the firm to maintain optimum and balanced working capital in the business as too high and too low working capital impacts the profit margins of the corporation to a larger extent. It is stated as the major issue as there are several factors attached to the WCM which directly affects the profitability of an enterprise adversely. In addition to this, retail firms in UK does not adopted for appropriate strategies for maintaining their liquidity and short term cash position (Boisjoly and et.al., 2020). The study has been made for recommending effective strategies that needs to be adopted by the firm for the purpose of improving its working capital by the increasing the current assets over the current liabilities. Researcher has used quantitative method in assessing the effect of the working capital on net profit of the company.

Significance

The findings generated from this study could redound to benefits society by considering the research problem relating to the working capital management. This study is counted as meaningful for all the readers, other scholars who are looking for the similar research problem and topic. Through this study, universities and colleges can take a detailed knowledge about the WCM and its effect on the firm's performance (Ramiah and et.al., 2016). This study also act as useful for all the retail sector organizations that is Tesco, ASDA, Sainsbury and Morrisons in knowing their working capital performance and can make an effective comparison of their performance with the other competitors so that necessary steps could be taken for achieving competitive edge in the overall industry.

Structure

Chapter 1- Introduction

In the first chapter the study highlights the research problem and the topic in accordance to the problem. Further, it includes framing of the appropriate research aims and objectives in accordance to the research topic. Moreover, this chapter reflects the research questions in relation to the working capital and also throws a deeper insights towards the rationale that is the reason for conducting the study and the significance that involves the usefulness of the study that means the other people or an investigators who can make use of this study.

Chapter 2- Literature review

In the next chapter, the study has made a detailed review of the research problem that relates to an impact of WCM on profitability of the corporations. The review is made on the basis of the objectives framed that means first it focuses on understanding the concept of the working capital and its importance in the business. Thereafter it depicts the appropriate theories and the models that shows the ways in which working capital needs to managed. Along with this the report has also reviewed an extent to which working capital affects the profitability performance and also provides for recommendation of the strategies that the company needs to adopt for improving its working capital.

Chapter 3- Research methodology

In this section, several methods are been highlighted that has been adopted by the researcher for conducting the study more accurately and reliably. An investigator has used quantitative research technique by collecting the numerical facts through secondary research that is by reviewing the articles, journals, books and the data from the official website of the firm. Moreover, the researcher has make use of deductive approach and positivism philosophy as it best suits to the quantitative elements of the research report. Scholar has also made use of SPSS for analysing the data in terms of the data analysis technique.

Chapter 4- Data analysis and findings

After application of the research methods, the researcher has made use of the statistical techniques that correlation and SPSS in order to generate the findings. Theses statistical tool will be used for studying the relationship between the working capital and the profitability of an organization. Through this it has been analysed that with the change in one variable that is working capital, up-to what extent the other variable changes that is profitability.

Chapter 5- Conclusion and Recommendation

In the last chapter, the summary of overall study has been made where the findings attained from the application of the tools and reviewing of the secondary sources are been presented. It represents the analysis of the findings that are been inferred with respect to the influence of the working capital on the profit margins of the firm. Moreover, this chapter also provides for the appropriate recommendations to the company which is having a low working capital and lower profitability so that it could follow and create the strategies and the plan accordingly. By this way the firm can improve its performance within the overall market or industry and this in turn helps the company in attaining growing success.

CHAPTER 2: LITERATURE REVIEW

The literature review section will assimilate the past research work that has been done by different author and researchers in the field of working capital and its impact on profitability. In this section, the different views of the author regarding different themes will be evaluated and the positive or negative aspect that they have presented will be analysed.

Theme 1: The concept of working capital and the factors affecting it.

The authors, Baker, Kumar, Colombage and Singh (2017), have defined working capital as that financial tool used in the contemporary businesses through which the circulating capital in a business is ascertained. The authors state the concept of working capital can be defined as the net difference between the current assets and current liabilities of a company. The authors state that it is a narrower definition and on a broader scale it can just be defined as the current assets that a company has in its possession at a given point of time. In this paper authors have further clarified that based on different types of business and the variety of tasks that they engage in, the working capital requirement is also different for such business. Therefore, there are certain factors that affect the manner in which the working capital levels that are to be maintained in the company are ascertained.

The authors, Haron and Nomran (2016), in their research paper have further classified that the working capital can be either positive or negative. When the current assets of the company are in surplus over the current liabilities of the company, it often tends to create a positive working capital and thus the company is deemed to be in a profitable scenario while they are experiencing the positive working capital. The author have further stated that when the balance of current liabilities in the company increases over the current assets in a company, then the working capital is termed as negative and this can be a highly negative situation for any company. The risk exposure of the business increases drastically when they are experiencing negative working capitals in their company and therefore the authors recommend that this scenario should be avoided in most cases.

However, another research paper by Alarussi and Alhaderi (2018), argues that there are certain business types where the negative working capital is actually beneficial for the organization and this is mainly due to the type of business that they are doing. When the operating cycle of the company does not gets affected by the negative working capital, then this tends to create a profitable situation. The authors give here example of Walmart which has the business habit of buying goods on credit and then selling them in exchange for cash. The instant inventory turnover helps them in analysing the profits immediately thus increasing the profitability of the company rather than affecting it negatively.

To further develop on the concept of working capital and the factors that are affecting it, the research paper presented by Ramiah, Zhao, Moosa and Graham (2016), can be used to substantiate the research. The authors have elucidated about the factors that have a significant impact on the working capital of an organization. They have expanded on the points that the length of the operating cycle is a major point where the duration of the operating cycle which is usually for one financial year in majority of the companies helps in determining that what will be the working capital requirement of the business based on the time period. Another factor is the nature of the business that they have undertaken and the scale at which the business is being carried out. The authors explain the point stating that when the business is of wholesale nature, then the working capital requirement will be more as compared to the retail shop. Similarly, manufacturing company would require more working capital because of the increased number of work activities thus affecting the decision.

Another research paper published by Shah (2016), can be used to state that the business cycle fluctuations is another contributing factor where there might be boom in the market or it might be on recession and the working capital needs to be adjusted accordingly. Technology used in the business, seasonal factors affecting operational activity, competition level in the market, raw material availability are some of the other factors that might affect the overall decision-making regarding the working capita that is to be maintained in the businesses.

However, the authors, Wang, Zhu and Liu (2017), have argued in their research paper that only a consideration of these factors on the working capital is not sufficient, it is necessary that these are all integrated together and a correct balance is estimated which is neither excessive in nature and nor it is redundant or insufficient for the organizational activities. The authors highlight the disadvantages of the excessive working capital in the organization presenting that extra working capital shows redundancy in the organization where the funds are being kept idle. The opportunity cost on such idle funds that could have ben utilized in other activities of business is a double loss making situation for the company or organization. Additionally, they have stated that excess working capital can also lead to the increased inventory accumulation and thus increased inventory risk exposure of the company as well. In the next half of their research paper, the authors have again expanded on the disadvantages of having inadequate or less working capital in the organization than the requirement. They have stated that the business might not be able to meet its short term liabilities and obligations timely when the funds are insufficient. Another major point about which they argued was that there might be chances that the firm, due to insufficient balance might not be able to exploit the favourable position or opportunities that can arise in the market suddenly. This can affect the profitability where the firms might not be able to take immediate actions and encash the opportunities that have such arisen.

The authors, Çelik, Bilen and Bilen (2016), have added another interesting point while discussing the concept of working capital stating that the retail stores have a separate set of factors that define their working capital requirement and similarly, technological company might have another set of factors impacting their requirement for working capital in the company. They have presented that in retail sector the requirement for the working capital is higher because their operating cycles are usually longer. Larger companies and multinational retail stores stock tonnes of inventory and this storing of inventory requires maintenance and investment. Higher level of working capital ensures that companies are able to meet up any expenses that might arise immediately as the realization of such inventory into sales is a slower process and a time-consuming process. For the retailers, as the authors have presented, the major factor is the seasonal factor where holiday seasons, festival seasons etc. impact their sale and the working capital requirement. The Çelik, Bilen and Bilen (2016) also stated that in retail sector, through the income is realized late, the expenses become due regularly and for meeting such expenses, it is necessary to maintain a higher working capital and when the seasonal factor is active, the requirement becomes even higher, therefore, their working capital requirement is higher.

Further, the Çelik, Bilen and Bilen (2016), made comparison between the retail and technology sectors where the working capital requirement in the retail sector was illustrated upon by the authors. Authors have argues that the working capital requirement of the tech companies is much lower as compared to that of the retail sector companies due to the fact that the industry is more dependent on the constantly changing trends and therefore, a huge amount is not segregated into the working capital segment. Also, the work is more online and in the form of software thus reducing the physical space and resources required. Therefore, the authors emphasize the point that the working capital requirement varies on the basis of industry types, the way it operates, etc. and importance should be on the industry type rather than some designated factors.

Another research paper, that is presented by the authors, authors, has highlighted that it is a common practice for the retail industries to maintain a negative working capital balance and this occurs due to their operating method. Retail organizations usually implement strategies like promotional discounts, stock clearance sale etc., that help in realizing the cash quicker and the inventory gets cleared quickly. This amount is then again invested in the stocking of the inventory at a larger level thus increasing the amount that is being spent on the inventory levels. Therefore, despite so many negative consequences of maintaining a negative working capital, it actually affects the retail industry in a positive way. But researcher have also argued that this must not always be the case because ultimately it can also impact the goodwill of the business thus affecting their business operations. Therefore, the retail sectors need to be extremely analytical in designating a correct working capital estimation in their companies so that it can be linked with the company in a positive way.

Theme 2: Working capital management and theories and models associated to it.

With reference to Obradovich (2019), WCM tools that are used by the managers of the business helps in effectively managing the working capital. Techniques like intersection of the holding cost and the shortage cost, cash budgeting, JIT, working capital financing, Economic order quantity are been applied for managing all the factors of the working capital. Companies that are high performing understands company and the specific drivers regarding an industry behind each and every element of the operative working capital and emphasizing on optimising the most promising ones. During such process, an entity has to consider an overall value chain for revealing root causes of tie-ding up the cash and taking into consideration all the interdependencies between respective elements. Boisjoly Conine Jr and McDonald IV (2020), highlighted that it should apply for a holistic approach within which they does not randomly reduces the cost but consider all the trade-offs with the cost and the capital employed in optimising value of the company. With an application of the appropriate levers of every component, obstacles that the slow cash could be removed and an entire process of the company could be improved.

An enterprise could be endowed with the assets and be seen as profitable but due to the shortage of the liquidity it could not convert its assets into the cash. Positive WC is needed for ensuring that the company is been able to continue their operations and that it had an adequate funds for satisfying both upcoming operational expenses and the maturing short term debts. Managing the working capital includes inventory management, managing payable, cash and the receivable.

Boțoc and Anton (2017), indicated that the theory in relation to working capital states that on case if the working capital is been managed in accordance to the prescriptive theory then it would expect that business need to make investment in the working capital. There are various models with regards to managing the working capital such as operating cycle, inventory model, stochastic model, Baumol's model, probability model etc. The operating cycle states that higher cash turnover reflects lower requirements for the cash because optimum need of the cash by firm is been identified by dividing firm's annual expenditures by that of the cash turnover rate. Further, Inventory model is been used by an organization which is counted as the working capital model through which inventory could be managed in an effective way and facilitates useful conceptual foundation for the problem of cash management. With respect to this model, carrying or holding cost of maintaining the cash is been balanced against a fixed cost in transferring the marketable securities to the cash. However, in case there present the shortage of the cash, the marketable securities are been liquidated or the fresh borrowings could be made. Both requires the procurement cost that is inclusive of the fixed cost in relation with transaction. Further, in addition to the running cost, portion of general foxed cost is also involved. Similarly, when an enterprise holds too much of the cash balance, it might incur borrowing cost and the opportunity cost.

In opinion of Talreja, Ahmed and Ali, (2018), moreover, stochastic model is also an important model that need to be adopted by the company in managing its working capital effectively. This model states that where an uncertainty in relation to the payment of the cash is very large that is a future is not known, EOQ model might not be applicable. In order to identify an optimum behaviour, other types of the models must be utilised by assuming that demand for the cash is seen as stochastic and not known in advance. Theory of control could be applicable where the balances of cash fluctuates on a wider basis. Under this manager need to set the control limits in such a way that when the cash reaches to an upper limit, transfer of the cash to the marketable securities is been consummated, in a situation if it hits the lower limit of the transfer from the marketable securities towards the cash is been triggered. Setting up the control limits depends on fixed cost attached with the securities transactions and an opportunity cost in holding the cash. This model provides for an answer in relation to minimum and the maximum balance of the cash so that suitable decisions regarding spending of the cash could be made.

Simon Sawandi and Ali Abdul-Hamid (2019), determine the other model is the probability model where the probability distributions are been used for the range of the possible outcomes and an optimum cash balance that might be ascertained accordingly. Baumol's Model is also a main model that could be applied by the firm in managing the working capital which is seen as the same as an EOQ model of an inventory management. The main objective of this model is assessing balance of the income foregone on the cash held against a transaction cost in converting the cash into the marketable securities by an entity. It is the model that depicts, for reducing a holding cost, minimum balance of the cash might be maintained by a company.

It has been reflected by the Orobia Padachi and Munene (2016), that an entity can procure or acquire the cash by disposing some of the marketable securities at anytime it needs the cash. The company must bear the transaction cost and it would be trying for minimising transaction. This type of the limitation might be overcome through maintaining the higher value of the cash against a higher value of the holding at a same time. Therefore, the firm should consider both transaction and the holding cost. It is not needed for mentioning that optimum level of the cash balance might be attained through controlling both holding and the transaction cost so that it could minimise the holding cost by the firm. It is also seen that the cash received through disposing of the marketable securities would be utilised in a way that cost of transaction must optimally balance with that of the holding cash by firm.

Moreover, apart from the models there are different theory relating to management of the working capital that could be used by an entity such as cash conversion cycle (CCC), Transaction cost Economics etc. CCC theory represents an interaction between elements of the working capital and cash flow within an enterprise that could be used for determining an amount of the cash required for any of the sales level. It acts as the part of an operating cycle theory that is been computed by summing up inventory period to the period of accounts receivables and thereafter subtracting the accounts payable from that. The focus of the theory is mainly on length of the time between an procurement of the raw material and the other inputs & cash inflows received from sale of the finished goods which represents number of the operational days for which the financing is required. This theory is seen as the comprehensive measure of the working capital because it reflects a time lag between an expenditure for purchasing raw material and sales collection of the finished goods.

As per Lopatta Böttcher and Jaeschke (2018), shorter CCC indicates very fewer resources are needed by firm. However, the Longer CCC shows higher value of an investment within the working capital. This longer cycle leads to increase in the sales that in turn results to the higher profitability. On the other side Altaf and Shah, (2018) argued that it is significant for an entity for shortening CCC because managers could create a value for its shareholders by way of reducing cycle to the reasonable minimum.

Dufour Luu and Teller (2018) ascertained that optimum level of an inventory must be determined on the basis of the trade-off between the costs and the benefits that is associated with inventory level. For being competitive, an entity has to decrease its costs and this could be accomplished by keeping cost of the stocking inventory to the reasonable. Net trade cycle is the another theory that takes into account all the three elements of CCC that are been articulated as the sales percentage, this makes net trade cycle more and more easier for calculating and in making less difficult comparing with CCC and the weighted CCC.

Theme 3: To ascertain the impact of WCM on organizational profitability.

In view of the Singhania and Mehta, (2017) it has been represented that working capital management is counted as important for maintaining the performance of the firm. As WCM directly impact the firm's profitability, it explicitly affects both liquidity and the desired level of the profitability in the business. Managing the working capital plays a vital or critical role in recovering financial performance of an entity as along with working capital, firms could obtain benefit of an opportunities. Decisions regarding working capital and the short term financing is been referred as the management of the working capital. Working capital is considered as the best mixture or blend of the current assets and the current liabilities that in turn heighten value of the shareholders. The main purpose of the working capital management is attaining optimal balance between the mechanism of the short term capital.

As per Mbawuni Mbawuni and Nimako (2016), it has analysed that managing working capital has turned as one of the most essential and current issue for most of the companies in UK so managers are mainly striving for recognizing problems of the working capital and seeking for framing the most suitable policy in order to negotiate with such problems that has been arises due to the mismanagement of Working capital. For the purpose of reaching towards successful and the smooth operations within the work environment, an entity need to considered effective management of the working capital as it acts as the most valuable and the suitable factor for the firm.

Azeez Abubakar and Olamide (2016) stated that WCM has a direct or negative correlation with the profitability and the liquidity of the company. It is very crucial for achieving success as if the firm manages its working capital in an effective and efficient manner, it could be able to meet its short term requirements and can take advantage of the short term opportunities that leads to increased profitability. The foremost and the chief purpose of every financial manager is to attain increased sales volume and the profitability of the company. For achieving this goals, it is important to look for efficient WCM because it has a great impact on the liquidity and the profitability of an enterprise.

Afrifa (2016), reflected that, the firm which makes more and more investment in the current assets is counted as more liquid as compared to the firm that do not makes investment. This reduces the liquidity risk of the firm at the time of decreasing an overall return rate, because return of the current assets is seen as lesser than the return generated from the other kinds of the assets. However. Lower amount of the investment in the working capital is been expressed as the aggressive policy that represents higher return in consideration with the higher level of risk. More investment made by the company in working capital shows conservative policy that depicts lower risk and the lower return.

Effective management of the working capital is considered as essential for the firm's survival, continuity of their activities, maintenance of the profitability and the liquidity. With reference to an impact of the working capital on profitability of an enterprise is stated as contributing on determining of the investment level in the working capital of the different firms. Identifying distribution among elements of working capital, optimum use of the scarce resources, supply of the resources and the sustainability of the future investments with an application of the working capital that would increase profitability.

In accordance to Mishra (2019), its is presented that managing the working capital efficiently plays most important role in an entire corporate strategy for the purpose of increasing value of the shareholders. It could be done by determining a composition and a level of an investment on the current assets, sources, level and the mix of the current debts. Specifically an efficient management of the working capital enables the firm in reacting genuinely and quickly to an unexpected changes in the economic environment and in gaining a competitive advantage over rivals. Maintaining adequate and efficient WCM, firm primarily aims at ensuring maintenance of the optimum balance between the risk and the profitability. Such objective could be reached through constant monitoring towards an element of the working capital like accounts receivable, accounts payable and an inventory. The success of the company highly depends on an effective skills of the financial managers.

Dalci and et.al. (2019), presented that the relationship in between the current liabilities and the current assets identifies liquidity position of the company. However, it has been pointed out by Masadeh Khasawneh and AL Salamat (2018), that excess or too high level of the current assets might be having a negative impact on the profitability of the firm while lower level of the current assets might leads to the lower level of the liquidity and the inventory outs resulted in the difficulties in managing the operations smoothly. It does not provided for an accurate view of the corporate liquidity as components of the working capital have a different liquidity level as like some elements have the financial essence with higher liquidity. The other components contains non-financial essence with the lower

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