THE CASH CONVERSION CYCLE AND PERFORMANCES OF CONSUMER PRODUGTS IN MALAYSIA

Nur Shafiqah Binti Tukino

Bachelor of Finance (Honours) 2012

0' Pusat Khidmat MakJumat Akademik UNlVERSm MALAYSIA SARAWAK

THE CASH CONVERSION CYCLE AND PERFORMANCES OF CONSUMER PRODUCTS IN MALAYSIA

P.KHIDMAT MAKLUMAT AKADEMIK

111111111 fliIIII" 11111 1000245047

NUR SHAFIQAH BINTI TUKINO 24624

This project is submitted in partial fulfillment of

the requirement for the degree of Bachelor of Finance with Honours

(Finance)

Faculty of Economics aJld Business UNIVERSITI MALAYSIA SARA W AK

2010

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1

Statement of Originality

The work described in this Final Year Project, entitled

The Cash Conversion Cycle and Performances of Consumer Products in

Malaysia I

is to the best of the author's knowledge that of the author except where due reference is

made .

.'

7/k­'LotL-J~e 1011­

(Date submitted) (Student's signature)

Nur Shafiqah Binti Tukino

24624

...

I

ABSTRACT

THE CASH CONVERSION CYCLE AND PERFORMANCES OF CONSUMER

PRODUCTS IN MALAYSIA

By

Nur Shafiqah Binti Tukino

The purpose of this research is to explore the relationship between the firm's Cash

Conversion Cycle with its profitability, size and cash flow. The collected data of this study

was obtained from the DataStream ofthe consumer products listed on Bursa Malaysia for the

period from 2006 to 2010. They were 119 finns - data collected after deleted non-applicable

items. The researcher utilized Simple Linear Regression and Spearman's Correlation

Analyses for empirical investigation on the hypotheses. These results in regression analysis

provide a strong negative significant relatioQ.Ship between Cash Conversion Cycle and firm's

size and firm's cash flow. Nevertheless, the relationship between Cash Conversion Cycle and

firm's profitability showed no significant relationship between the two variables measured.

Thus, this reveals that the increasing of independent variables (Net sales, Total assets, Cash

& short tenn investment) results to lower Cash Conversion Cycle. Hence, in purpose to create

shareholder value, the managing director sho~dd emphasize and concern on generating

ultimate firm's siZe and firm's cash flow as to experience well perfonnance in Cash

Conversion Cycle.

ABSTRAK

KITARAN PENUKARAN TUNAl DAN PERSEMBAHAN PRODUK PENGGUNA DI

MALAYSIA

Oleh

Nur Shafiqah Binti Tukino

Tujuan kajian ini adalah untuk meneroka hubungan antara kitaran penukaran tunai

fU'ma dengan keuntungan, saiz dan ali ran tunai. Data yang dikumpul dalam kajian ini didapati

daripada DataStream bagi sektor produk pengguna yang tersenarai di Bursa Malaysia dari

tahun 2006 hingga 2010 setelah menyisihkan data yang tidak lengkap, 119 fmna - data telah

dikumpul dan digunakan. Penyelidik menggunakan Regresi Linear Mudah dan Analisis

Korelasi Spearman untuk siasatan empirikaL Keputusan analisis regresi menunjukkan

hubungan negatif yang signiflkan di antara kitaran penukaran tunai dengan saiz flrma dan

firma aliran tunai yang kukuh.Oleh itu, ini menunjukkan bahawa peningkatan pembolehubah

tak bersandar Uualan bersih, .Tumlah aset, Tunai & pelaburan jangka pendek) menyebabkan

penurunan kitaran penukaran aliran tunai. Oleh itu, bagi tujuan untuk mewujudkan nilai

pemegang saham, pengarah urusan perlu memberi perhatian dan penekanan tentang menjana

saiz firma dan tunai firma yang optimum bagi mencapai prestasi yang baik dalam kitaran

penukaran tunai.

ACKNOWLEDGEMENT

This research project would not have been possible without the support of many

people. The researcher wishes to express her gratitude to her supervisor, Puan Salawati Binti

Sahari who was abundantly helpful and offered invaluable assistance, support and guidance.

The researcher would also like to convey thanks to the Faculty of Economics and Business for

providing the financial means and laboratory facilities. Also, the researcher would like to

thank Ahmad Hafiz Bin Rozlan for his insightful suggestions and help. Words are inadequate

in offering my thanks to Shafizza Binti Sahdan for her encouragement in carrying out the

research. Finally, yet importantly, the researcher wishes to express her love and gratitude to

her beloved families for their understanding & endless love, through the duration of her

studies.

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Pusat Khidmat MakluRllt Akademik VNlVERSm MALAYSIA SARAWAK

TABLE OF CONTENTS

LIST OF FIGURES IX

LIST OF TABLES X

CHAPTER ONE: INTRODUCTION

1.0 Preamble

1.1 Problem Statement 4

1.2 Research Objectives 5

1.2.1 General Objectives 5

1.2.2 Specific Objectives 5

1.3 Research Significant 5

1.4 Scope of Study 6

CHAPTER TWO: LITERATURE REVIEW

2.0 Introduction 7

2.1 Cash Conversion Cycle 7

2.2 The Relationship Between CCC and Firm's Profitability 11

2.3 The Relationship Between CCC and Firm's Size 17.'2.4 The Relationship Between CC<; and Firm's Cash Flow 19

CHAPTERTHREE:METHODO~OGY

3.0 Introduction 22

3.1 Theoretical Framework 22

3.1.1 The CCC and Firm's Profitability 23

3.1.2 The CCC and Firm's Size 23

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3.1.3 The CCC and Firm's Cash Flow 24

3.2 Data Measurement d' 24

3.3 Research Design 25

3.3.1 Sample Size 25

3.3.2 Data Collection 25

3.3 .3 Data Analyses 26

3.4 Research Hypotheses 28

CHAPTER FOUR: FINDINGS AND DISCUSSIONS

4.0 Introduction 29

4.1 Demographic Proftle 29

4.2 The Analyses 0 f CCC and I ts Independent Variables

(Profitability, Size and Cash Flow) 37

4.2.2 Normality Test 37

4.2.3 Spearman's Correlation Analyses 38

4.2.3.1 The Relationship between CCC and Firm's Profitability 40

4.2.3.2 The Relationship between CCC and Firm's

Size 41

4.2.3.3 The Relationship between CCC and Firm's

Cash Flow 44

., 4.2.4 Regression Analyses 45

4.2.4.1 The CCC and Firm's Profitability 47

4.2.4.2 The CCC and Firm's Cash Flow 48

4.2.4.3 The CCC and Firm's Size 49

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CHAPTER FIVE: CONCLUSION

505.0 Introduction

5.1 Concluding Remarks 50

5.2 Recommendations 52

5.3 Limitation of the study 52

535.4 Future Research

54REFERENCES

APPENDIX 1: Table of Regression Tests

APPENDIX 2: Final Year Project Semester 1 Session 201112012 Time Frame

APPENDIX 3: Final Year Project Semester 2 Session 201112012 Time Frame

APPENDIX 4: List ofConsumer Products Listed in KLSE: Sample for this study

APPENDIX 5: Slide Presentations

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PAGELIST OF FIGURES

Figure 1: The Independent Variables and Dependent Variable 22

Figure 2: Mean (Net Sales) 30

Figure 3: Mean (Total Assets) 31

Figure 4: Mean (Cash & Short Term Investment) 32

34Figure 5: Mean (ROA)

35Figure 6: Mean (ROE)

Figure 7: Mean (Cash Conversion Cycle) 36

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LIST OF TABLES PAGE

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Table 1: Definition ofCCC by Various Researchers 8

Table 2: The Cash Conversion Cycle 9

Table 3: The Variables Measurement 24

Table 4: Mean (Net Sales) 30

Table 5: Mean (Total Assets) 31

Table 6: Mean (Cash & Short Term Investment) 32

Table 7: Mean (ROA) 33

Table 8: Mean (ROE) 35

Table 9: Mean (Cash Conversion Cycle) 36

Table 10: Tests ofNormality 37

Table 11: Rules of thumb: Spearman's Correlation Analyses 39

Table 12: Correlations between Cash Conversion Cycle and ROA 40

Table 13: Correlations between Cash Conversion Cycle and ROE 41

Table 14: Correlations between Cash Conversion Cycle and Net Sales 42

Table 15: Correlations between Cash Conversion Cycle and Total Assets 43

Table 16: Correlations between Cash Conversion Cycle and

44Cash & Short Term Investment

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47 Table 17: Model Surnmaryb (Net Sales and CCC)

d'

Table 18: Model Surnmaryb (Total Assets and CCC) 48

Table 19: Model Surnmaryb (Cash & Short Tenn Investment and CCC) 48

Table 20: Model Surnmaryb (ROA and CCC) 49

Table 21: Model Surnmaryb (ROE and CCC) 49

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CHAPfERONE

INTRODUCTION

1.0 Preamble

First and foremost, in Investopedia (2011) do explain about the Cash

Conversion Cycle. It is when a company acquires inventory on credit, the accounts

payable is announced. Besides that, a company also sell merchandise on credit which

results in accounts receivable. Therefore, cash is not involved until the company

pays the accounts payable and collects accounts receivable. Thus, the Cash

Conversion Cycle measures the time between outlay ofcash and cash recovery. This

Cash Conversion Cycle is essential for retailers and others businesses because it

shows how effective and quickly a firm can convert its products into cash through

sales. [ndeed, the shorter the cycle, the less time capital is tied up in the business

process, and thus the better for the company's·bottom line.

According to Eugene F. Brigham and Joel F. Houston (2007) in the book of

Essentials of Financial Management, pp 512, mentioned that all firms follow a

"working capital cycle" in which they purchase or produce inventory, hold it for a

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time, and eventually sell it and receive cash. This process is also known as the Cash

Conversion Cycle.

According to Lyroudi and Lazaridis (2000), the interest in working capital

management has increased during the last two decades and both academics and

financial officers are showing more interest in working capital management. Apart

from that based on Ruback and Sesia (2000) Dell and Wal-Mart declare that their

working capital management practices are an important source of their competitive

advantage. An advantage about the essential of the efficiency of a corporation's

working capital management is given by Shin and Soenen (1998).

They point out that Wal-Mart and Kmart had similar capital structures in

1994, but Kmart had a Cash Conversion Cycle of roughly 61 days while Wal-Mart

had a Cash Conversion Cycle of 40 days. The probably reason is according to

Moussawi et ai, 2006 Kmart faced an additional $198.3 million per year in financing

expenses. Such evidence demonstrates that Kmart's poor management of its working

capital contributed to its bankruptcy. Therefore, efficiency of working capital

management is based on the principle of speeding up collections as much as possible

and slowing down disbursements as much as possible. This working management

principle is introduced by Richards and Laughlin (1980) which is based on the

. traditional concepts of the Cash Conversion Cycle. It is a powerful performance

measure for assisting how well a company is managing its working capital. Gentry et

al. (1990) argue that a short Cash Conversion Cycle is indirectly related to firm's

value. A short Cash Conversion Cycle indicates that the firm is collecting the

receivables as quickly as possible and delaying the 3 payments to suppliers as much

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as possible. This leads to relatively high net present value ofcash flow and relatively

high firm value. " However, Cash Conversion Cycle definitions are not constant. For example,

Stewart (1995) defmes a Cash Conversion Cycle as to describe the average period of

time needed to tum a dollar invested in raw materials into a dollar collected from a

customer. Other than that, Besley and Brigham (2005) describe a Cash Conversion

Cycle as the average length of time from the payment for the purchase of raw

materials to until the collection of receivables associated with the sale of the product.

A shorter Cash Conversion Cycle could be worked with high profitability

because it improves the efficiency of using the working capital. A short Cash

Conversion Cycle indicates that the firm handles and processes inventory more

quickly, collects cash from receivables more quickly and slows down cash payments

to suppliers. As a result, this incre~es the efficiency of internal operations of a firm

and results in higher profitability, higher net present value of cash flows, and higher

market value of a firm referred to Gentry et ai, 1990. In a solution, the Cash

Conversion Cycle can be shortened by reducing the time that cash is tied up in

working capital. This could happen by shortening the inventory conversion period

via quicker processing and seBing goods to customers, or by shortening the

receivable collection period via speeding up collections, or by lengthening the

payable deferral period via slowing down payments to suppliers.

On the other hand, shortening the Cash Conversion Cycle could harm the

flfOl'S operations and lead to poor performance. Reducing the inventory conversion

period could increase the shortage cost and make the company's lose its good credit

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customers, and lengthening the payable period could damage the fum's credit

reputation.

As the whole defmition, the Cash Conversion Cycle is a useful way of

assessing the liquidity of a firm, especially for small companies that are usually

operated with fewer fmancial resources, compared to larger companies that have

better access to both money and capital markets. Shortening the Cash Conversion

Cycle could be one important source of fmancing for small fums.

The purpose of this paper, therefore, is to investigate the relation between the

length of Cash Conversion Cycle and profitability for 595 samples firms' years

covering the period 2006-2010 for consumer product's listed on the Kuala Lumpur,

to examine the relation between the length of the Cash Conversion Cycle and firm

sizes and to identify the relation between the length of the Cash Conversion Cycle

and cash flow .

The rest ofthe paper is organized along the following lines. The next chapter

discusses the existing literature review. Chapter three reviews the methodology used

in this study, section four discusses the findings, section five reviews the discussion,

and finally section six concludes the paper.

1.1 Problem Statement

The consumer products sectors are facing the difficulties in achieving an

efficient Cash Conversion Cycle. This is due to the changes in profitability, firm's

size and firm's cash flow. Literally, if the firm's profitability is lower the Cash

Conversion Cycle might be longer because a fum is slow in collecting cash from

receivables. Next, the smaller firms have longer Cash Conversion Cycle by Moss

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Pusat Khidmat Maklumat Akademik VNIVERSITI MALAYSIA SARAWAK

and Stine (1993). Finally, according to Schilling (1996) mentioned that if the

minimum liquidity required increases it will lengthen the Cash Conversion Cycle.

1.2 Research Objectives

1.2.1 General Objective

It is to identify the determinants which affect the relationship between

the implementation of Cash Conversion Cycle towards the firm's

performance.

1.2.2 Specific Objectives

I To clarify the relationship between Cash Conversion Cycle and

profitability.

II To examine the rel~tionship between Cash Conversion Cycle and

firm's size.

III To identify the relationship between Cash Conversion Cycle and

firm's cash flow.

1.3 Research Significant

This 'research is benefit for the young ~ntrepreneur whom is interested to set

up a new business in Consumer Products sector. Apart from that, the local \ ,

companies may refer to the data provided in this research as to help to generate a

good system in Cash Conversion Cycle which are affected from profitability, firm's

size and firm's cash flow. In depth, the academicians may implement the output as to

conduct the future research related with different sectors listed in Bursa Malaysia.

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1.4 Scope of Study

This study will be conducted towards the consumer products sectors which

are listed in Bursa Malaysia with 595 samples in Malaysia. The purposes to study

these samples are to identify the nexus between the Cash Conversion Cycle and its

independent variables (Net Sales, Total Assets, ROA, ROE, and Cash & Short Term

Investment).

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CHAPTER TWO

LITERATURE REVIEW

2.0 Introduction

In this section, the researcher reviews the existing literature on the link

between the length of Cash Conversion Cycle and profitability, firm's size and

firm's cash flow from different views and in different environments.

2.1 Cash Conversion Cycle

In textbooks related to finance, Cash Conversion Cycle is mentioned in the

context of working capital management (Keown et al., 2003; and Bodie and Merton,

2000). The Cash Conversion Cycle is used as a comprehensive measure of working

capital as it shows the time lag between expenditure for the purchases of raw

materials and the collection of sales of finished goods (Padach~ 2006). Definitions of

Cash Conversion Cycles are not consistent. Oefinitions made by various authors are

given in Table 1.

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Table 1

Definition of Cash Conversion Cycle by various researchers

DESCRIPTION

Cash Cycle time

Cash Conversion Cycle

Cash Cycle

Cash Gap

.

DEFINITON

The number of days between the

date the flrm must start to pay cash

to its suppliers and the date it

begins to receive cash from its

customers.

The sum of days of sales

outstanding (average collection

period) and days of sales in

inventory less days of payables

outstanding.

The number of days that pass . before we collect the cash from

sale, measured from when we

actually pay for the inventory.

It measures the length of time

between actual cash expenditures

on productive resources and actual

cash receipts from the sale of

products 'or services.

SOURCE

Bodie and Merton

(2000)

Keown et al. (2003)

Jordan (2003)

Eljelly (2004)

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Keown et al. (2003) express Cash Conversion Cycle with the following

equation similar to many researchers as follows:

CCC Days of Sales Outstanding + Days of Sales in Inventory ­Days of Payables Outstanding

In the formula above, the three variables to which Cash Conversion Cycle is

dependent are defmed as follows:

Table 2

The Cash Conversion Cycle

Days of Sales Outstanding Accounts receivables

Salesl365

Days of Sales in Inventory Inventories

Cost of goods sold/365

Days of Pay abies Outstanding Accounts payables

Cost of goods soldl365

Source: Jordan (2003)

By (Hutchison et al., 2007) Cash Conversion Cycle is likely to be negative as

well as positive. A positive result indiCates the number of days a firm must

borrow or tie up capital while awaiting payment from a customer.

Meanwhile, a negative result indicates the number of days a firm has

received cash from sales before it must pay its suppliers.

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The ultimate goal is having low Cash Conversion Cycle which is in negative

due to the shorter the Cash Conversion Cycle, the more efficient the firm

handling its cash flow.

Based from the equation of Cash Conversion Cycle above, (Bodie and

Merton, 2000) mentioned that it is seen that a fInn can reduce its need for

working capital by:

• Reducing the amount of time that goods are held in inventory. This can be

done by improving the inventory control process or by having suppliers to

deliver raw materials exactly when they are needed in the production process.

• Collecting accounts receivable more quickly. Among the methods available

to speed up the collection process are improving the efficiency of the

collection process, offering discounts to customers who pay faster, and

charging interest on accounts that are overdue.

• Paying its mvn bills more slowly. The fInn must pay the obligations within

the longer days given as to maintain the cash flow.

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2.2 The Relationship between Cash Conversion Cycle and Firm's Profitability

As said by Deloof (2003) showed significant and negative relationships

between Cash Conversion Cycle and profitability of Belgian firms. In line with Shin

and Soenen (1998) also reported significant negative relationship between net trade

cycle and profitability for US flffilS.

On the other hand, ALShubiri, (2011) argues that funds committed to

working capital can be seen as hidden sources that can be used for improving firm's

profitability. As a comparison to the results of the study of Karaduman, et aI., (2010)

showed significant and negative relationship between the Cash Conversion Cycle

and profitability measured by return on assets of companies listed on Istanbul Stock

Exchange. The above statement grabs the same credit as the study by Deloof(2003).

In addition, the relationship between profitability and working capital

management for firms listed on the Athens Stock Exchange was examined by

Lazaridis and Tryfonidis (2006). The results showed significant relationship between

operational profitability and the Cash Conversion Cycle, the results also showed that

executives can increase profitability of their firms by correctly handling the

individual components of working capital to an optimal level. Most of the results

show the relationship between Cash Conversion Cycle and profitability is a negative p '

overview.

Nevertheless, the results of Besley and Brigham (2005) describe a Cash

Conversion Cycle as the average length of time from the payment for the purchase of

raw materials to until the collection of receivables associated with the sale of the

product. A shorter Cash Conversion Cycle could be associated with high

profitability because it improves the efficiency of using the working capital.

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Arcos and Benavides (2006) wanted to estimate the entrepreneurial

efficiency ofa set ofcompanies in the nonfinancial sector in Colombia for the period

from 2001 to 2004. The results obtained were consistent with similar studies

conducted abroad in that the Cash Conversion Cycle was inversely related to the

profitability ofthe companies when measured with respect to the level of sales.

The relationship of Cash Conversion Cycle with firm size and profitability

for firms listed at Istanbul Stock Exchange was studied by Uyar (2009) using

ANOVA and correlation analysis. The results showed retail/wholesale industry has

shorter Cash Conversion Cycle than manufacturing industries. Furthermore, study

found significant negative correlation between Cash Conversion Cycle and

profitability as well as between Cash Conversion Cycle and firm size.

Furthermore, managers can create profit by correctly handling the individual

components of working capital to an optimal level. Padachi (2006) has examined the

trends in working capital management and its impact on firm's performance for 58

Mauritian small manufacturing firms during 1998 to 2003. He explained that a well

designed and implemented working capital management is expected to contribute

positively to the creation of firm's value. The results indicated that high investment

in inventories and receivables is associated with low profitability and also showed an

increasing trend in the short term component ofworking capital fmancing.

In the study of Ganesan, (2007) analyze the working capital management

efficiency of flf1l1S from telecommunication equipment industry. The variables used

to represent the working capital are day's sales outstanding, days inventory

outstanding, days payable outstanding, days working capital, and current ratio while

profitability and liquidity represent by cash conversion efficiency, income to total

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