THE RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT AND FINANCIAL PERFOMANCE OF PRIVATE HOSPITALS IN KENYA BY: MUNGAI, JOHN MWANGI

Transcription

1 THE RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT AND FINANCIAL PERFOMANCE OF PRIVATE HOSPITALS IN KENYA BY: MUNGAI, JOHN MWANGI Research Project Presented in Partial Fulfillment of the Requirements for the Award of the Degree in Master of Business Administration (University of Nairobi) Nov, 2013

2 DECLARATION I declare that this research project is my original work and has not been presented for a degree in any other University. Signed. Mungai John Mwangi Date D61/62841/2010 This research project has been submitted for examinationwith my approval as the University supervisor. Signed Date. Supervisor: Mr. J. Barasa Department of Finance and Accounting School of Business, University of Nairobi

3 ACKNOWLEDGEMENT I wish to acknowledge, with gratitude, the contributions of my supervisor, Mr. Joseph Barasa, without whom my work would have been an impossible task. His overwhelming support, guidance and advice were extremely encouraging. I give my special thanks to my classmate BedanNdegwa and my good friend Anthony Amos Musundi. Their encouragement and moral support proved very crucial. I am grateful to my family members, especially my wife Irene and my elder brother, Paul Mbugua for encouraging me to pursue further studies My appreciation also goes to all the private hospitals that provided me with the requisite data. Finally, I give thanks to the Almighty God through whom all blessings flow. ii

4 DEDICATION I dedicate this project to my wife Irene Wacera Mwangi and my daughter FavourMwende Mwangi. They were inspirational and supportive in this venture. iii

5 ABSTRACT The study looked into the effect of working capital management on the profitability of private hospitals in Kenya. The data analysis was carried on 10 private hospitals for a period of 10 years between 2003 and The relationship of average collection period, inventory conversion period and average payment period with return on assets employed was analyzed in this study. The studyapplied correlation analysis and group wise weighted least squares regression analysis to identify the effects of these variables on profitability. The correlation analysis shows that the hospitals profitability is influenced by the variables relating to working capital. There is a positive relationship between profitability and Average collection period and inventory conversion period. Average payment period shows a negative relationship with profitability. iv

6 TABLE OF CONTENTS DECLARATION... I ACKNOWLEDGEMENT... II DEDICATION... III ABSTRACT... IV ABBREVIATIONS... VI CHAPTER ONE... 1 INTRODUCTION BACKGROUND OF THE STUDY STATEMENT OF THE PROBLEM OBJECTIVE OF THE STUDY VALUE OF THE STUDY... 8 CHAPTER TWO... 9 LITERATURE REVIEW INTRODUCTION THEORIES OF WORKING CAPITAL MANAGEMENT WORKING CAPITAL MANAGEMENT PRACTICES REVIEW OF EMPIRICAL STUDIES CONCLUSION CHAPTER THREE RESEARCH METHODOLOGY INTRODUCTION RESEARCH DESIGN POPULATION OF THE STUDY SAMPLE DESIGN DATA COLLECTION DATA ANALYSIS CHAPTER FOUR DATA ANALYSIS, FINDINGS AND DISCUSSIONS INTRODUCTION INVENTORY CONVERSION PERIOD AND PROFITABILITY AVERAGE COLLECTION PERIOD AND PROFITABILITY AVERAGE PAYMENT PERIOD AND PROFITABILITY OVERALL LIQUIDITY AND PROFITABILITY CHAPTER FIVE SUMMARY, CONCLUSIONS AND RECOMMENDATIONS INTRODUCTION SUMMARY AND CONCLUSIONS RECOMMENDATIONS LIMITATIONS OF THE STUDY SUGGESTIONS FOR FURTHER RESEARCH REFERENCES APPENDIX v

7 ABBREVIATIONS ANOVA CCC KSE LSD NGOs NHIF VAT WCM Analysis of Variance Cash Conversion Cycle Karachi Stock Exchange Least Significant Difference Non-Governmental Organizations National Hospital Insurance Fund Value Added Tax Working Capital management vi

8 CHAPTER ONE INTRODUCTION 1.1 Background of the Study Efficiency in working capital management is so vital for firms whose assets are mostly composed of current assets (Horne and Wachowitz, 1998) as it directly affects liquidity and profitability of any firm (Raheman and Nasr, 2007). According to Kargar and Bluementhal (1994) bankruptcy may also be likely for firms that put inaccurate working capital management procedures into practice, even though their profitability is constantly positive. While excessive levels of working capital can easily result in lower profitability, inconsiderable amount of it may incur shortages and difficulties in maintaining day-to-day operations Working Capital Management Working capital management involves the relationship between a firm's short-term assets and its short-term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable, and cash. Liquidity, as a function of current assets and current liabilities, is an important factor in determining working capital policies and indicates firm s capability of generating cash in case of need. Current, acid-test and cash ratios as traditional measures of liquidity are incompetent and static balance sheet based measures that cannot provide 1

9 detailed and accurate information about working capital management effectiveness (Finnerty, 1993; Jose et al., 1996). Drawing attention to limitations of traditional liquidity ratios, Hager (1976), Richards and Laughlin (1980), Emery (1984a), Kamath (1989), Gentry et al. (1990), Schilling (1996) and Boer (1999) have insisted on using ongoing liquidity measures in working capital management. Ongoing liquidity refers to the inflows and outflows of cash through the firm as the product acquisition, production, sales, payment and collection process takes place over time. As the firm s ongoing liquidity is a function of its cash (conversion) cycle (Pinches, 1992), it will be more appropriate and accurate to evaluate effectiveness of working capital management by cash conversion cycle, rather than traditional liquidity measures. Cash conversion cycle as a part of operating cycle is an ongoing liquidity measure developed by Gitman (1974). Closely related with operating cycle, cash conversion cycle is, in brief, the part of operating cycle financed by the firm itself (McLaney, 1997) and is simply calculated by adding inventory period to accounts receivables period and then subtracting accounts payables period from it. It focuses on the length of time between the acquisition of raw materials and other inputs and the inflow of cash from the sale of goods (Arnold, 1998). The shorter this cycle, the fewer resources the firm needs to tie up. Studies regarding working capital are mostly related with improving models to determine optimal liquidity and cash balance, rather than analyzing underlying reasons of relationships between liquidity, working capital management practices and profitability.pioneer studies of Baumol (1952) about an inventory management model and of Miller (1966) about a cash management model may be considered as the best- 2

10 known studies in working capital management. This model informs managers about problems related with working capital management practices. Later on, Johnson and Aggarwal (1998), similarly, have developed a cash management model focusing on cash flows and argued that cash collection and cash payment processes should have to be handled independently Financial Performance Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm's overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. These results are reflected in the firm's return on investment, return on assets, value added, etc.one of the most fundamental facts about businesses is that the operating performance of the firm shapes its financial structure.it is also true that the financial situation of the firm can also determine its operating performance.the financial statements are therefore important diagnostic tools for the informed manager Relationship between working capital management and financial perfomance In a study by Kamath (1989) about working capital management practices in retailing firms, it has been concluded that there is a reverse relationship between cash conversion cycle and profitability. The results of a more detailed study by Soenen (1993) have shown that, in case of overlooking industrial differences, there does not exist any statistically constant relationship between cash conversion cycle and 3

11 profitability. However, in case of considering industrial differences, the relationship between the mentioned variables has shown dissimilarities across industries as positive in some industries and negative in others. In another study of Shin and Soenen (1998), a sample consisting of American manufacturing firms for the period of has been analyzed and a statistically negative relationship between cash conversion cycle and profitability has been confirmed Private Hospitals in Kenya Increased financial pressures on hospitals have elevated the importance of working capital management, that is, the management of current assets and current liabilities, for hospitals' profitability. Efficient working capital management allows hospitals to reduce their holdings of current assets, such as inventory and accounts receivable, which earn no interest income and require financing with short-term debt. The resulting cash inflows can be reinvested in interest-bearing financial instruments or used to reduce short-term borrowing, thus improving the profitability of the organization. A study by Kenya National Bureau of Statistics conducted in 2012 revealed that for every 100,000 people in Kenya, there are 19 Doctors, 2 dentists, 8 pharmacists, 3 Bachelor of Science nurses and 83 a total of registered nurses. Most of these health care personnel are based in major cities, mainly Nairobi and Mombasa with virtually no staff in the remote areas.(kenya Facts and figures 2012.) Health services and programmes in Kenya are financed from three main sources: the government, the private sector and Non-Governmental Organizations (NGOs). 4

12 According to the Kenya Human Development Report (1999), government financing of health expenditure is about 60 percent of what is required to provide minimum health services, therefore implying that healthcare delivery in Kenya is under-funded. This is accentuated by inefficiency of the system, including lack of cost-effectiveness in service delivery. According to Obonyo et al (1997) the government finances 50 percent, private payments (insurance and out of pockets) finances 42 percent and donors, NGOs, missions and other institutions finance 6 percent of recurrent healthcare costs. 1.2 Statement of the Problem The importance of WCM is not new to the finance literature and the review of prior literature reveals that there exists a significant relationship between financial performance and working capital management by using different variable selection for analysis. Studies done in most companies have revealed varying degrees of negative relationship between working capital management and financial performance of companies. The study done by Raheman& Nasr, (2007) on a sample of 94 Pakistani firms listed on Karachi Stock Exchange for a period of 6 years from , demonstrate a strong negative relationship exists between variables of the working capital management represents by liquidity and debt with profitability of the firm. Afza and Nazir (2007) through cross-sectional regression models on working capital policies, profitability and risk of the firms, found a negative relationship between the profitability measures of firms and degree of aggressiveness on working capital investment and financing policies while Padachi (2006) found that high investment in inventories and receivables is associated with lower profitability similar to most 5

13 recent study by Christopher and Kamalavalli, (2009), which focus on 14 corporate hospitals in India for the period to Similar studies done locally in Kenya have revealed relatively similar results. Biwott, (2011) found a significant negative relationship between net operating profitability and the average collection period for a sample of Kenyan firms listed on Nairobi stock Exchange. Other studies done by Caffaso (2011), Kamula (2011), Kweri (2011), Mutungi (2010) and Bett (2009) have yielded similar results. However factors affecting working capital management are varied and quite a number of them including nature of the Industry, demand of Industry, nature of the Business and Production Cycle are industry specific. There are studies that have been done in particular industries and context that have yielded different results. Ganesan, (2007) found evidence that even though day s working capital is negatively related to the profitability, it was not significantly impacting the profitability of firms in telecommunication equipment industry. Additionally, Chowdhury and Amin (2007) had found positive correlations between WCM with financial performance of the Pharmaceutical industry in Bangladesh. Whereas, Narware (2004) in his empirical study on Indian National Fertilizer Limited, for to signify that working capital management and profitability of the Company disclosed both negative and positive association. He also found evidence that increase in the profitability of a company was less than the proportion to decrease in working capital. 6

14 Such industry variations cannot be wished away and will require studies to be conducted in virtually all different industries in their varying context. Although the issue on Working Capital has been widely studied, largely missing from literature is the focus on health sector and specifically on Hospitals in Kenya. Hospitals in Kenya are in significantly different industry setting compared to industries where studies have already been done locally. They are equally in significantly different context to other hospitals where studies have already been done elsewhere in the world. Kweri, (2011) has noted that different industries and lines of business will have different working capital requirements because of differing operating or business characteristics across industries recommending similar studies to be done in different industries and sectors. The researcher believes there might be differences on the relationship between working capital management and financial performance. Hospitals manage significant amount of working capital in inventory and accounts receivable and it would be interesting to study how this impacts on their performance. This research therefore aims to fill this research gap by answering one question: What is the relationship between working capital management and the financial performance of Private Hospitals in Kenya? 1.3 Objective of the study The objective of this study will be to examine the relationship between working capital management and financial perfomance of private hospitals in Kenya 7

15 1.4 Value of the Study The findings from this study will contribute to the body of knowledge by identifying how private Hospitals in Kenya manage their working capital and the impact it has on the profitability. This research will provide a general framework to other researchers, policy makers and professionals to guide future researches, appraise current business practices, and provide basic guidelines for policy makers in businessenvironment in Kenya. The results of this study would provide better insights to hospital administrators on how to create efficient working capital management policies that have ability to maximize firm s profitability. This study will be beneficial to private hospital clients since a better management of working capital my lead to lower operating costs by hospitals. Some of these hospitals may choose to share the accrued benefit with their clients. The benefits of this study will be beneficial also to the government policy makers. They will find it useful to benchmark with private hospitals and learn lessons on how to manage working capital. 8

16 CHAPTER TWO LITERATURE REVIEW 2.1 Introduction The nature of many businesses may cause seasonal variations in a firm s current assets. Working capital management approaches differ in terms of how the firm finances these seasonal variations in current assets. Three common ways of dealing with such seasonal variations are the maturity-matching, conservative, and aggressive approaches. 2.2 Theories of Working Capital Management Maturity-matching approach Stohs and Maurer (1996) or Morris (1976) argue that a firm can face risk of not having sufficient cash in case the maturity of the debt had shorter than the maturity of the assets or even vice versa in case the maturity of the debt was greater than asset maturity (the cash flow from assets necessary for the debt repayment terminates). The firm finances long-term assets (fixed assets and all permanent current assets) with long-term sources of funds (long-term debt and equity). By matching its seasonal variations in current assets with current liabilities of the same maturity, the firm essentially hedges against changes in short-term interest rates.the firm essentially hedges against unexpected changes in short-term interest rates. If short-term interest rates increase, the increases in the return earned on an equal amount of short-term current assets should offset the increased cost of short-term funds. 9

17 2.2.2 Conservative approach The firm finances long-term assets, all permanent current assets, and some temporary current assets with long-term sources of funds. This approach relies more heavily on long-term financing than do the other approaches. The firm uses more long-term financing and less short-term financing to finance current assets and is therefore less vulnerable to increases in short-term rates than under the other approaches. If shortterm interest rates rise, the firm has fewer short-term sources that it will need to refinance at the higher rates Aggressive approach The firm finances all temporary current assets and some of its permanent current assets with short-term sources of financing (Heyman et. Al., 2008). This approach relies more heavily on short-term financing than do the other approaches. Under the aggressive approach, increases in short-term interest rates will require the firm to refinance more current assets at the new higher rates. The firm could be in jeopardy of being shut off by suppliers. 2.3 Working Capital Management Practices Cash Management Practices The squeeze on cash and credit is threatening the survival of many businesses all over the world, as it is considered the source of company s working assets and the liabilities orcollectively referred to as working capital,noriza B. M., Nor E.A. (2010) Proper cash management practices stems from creation of a realisticcash flow budget that charts finances for both the short term (30-60 days) and longer term (1-2 years). Redouble efforts to collect outstanding payments owed to the company. Bill promptly 10

18 and accurately. The faster one mails an invoice, the faster one will be paid. If deliveries do not automatically trigger an invoice, establish a set billing schedule, preferably weekly. Businesses should also include a payment due date. Offer small discounts for prompt payment. Closely monitor and prioritize all cash disbursements. Contact creditors (vendors, lenders, and landlords) and attempt to negotiate mutually satisfactory arrangements that will enable the business to weather its cash shortage (provided it is a temporary one). In some cases, you may be able to arrange better payment terms from suppliers or banks. Better credit terms translate into borrowing money interest free. Assess other areas where operational expenses may be cut without permanently disabling the business Accounts receivable Management Practices Padachi (2006) found out that high investment ininventories and receivables is associated with lower profitability. The foundation behind account receivables is the policies and procedures for sales. The overall objective pursued is to reduce accounts receivable. One should consider whether to have a credit policy, who and how to evaluate a customer for credit. Additionally, one needs to establish sales terms. A system must be in place to track accounts receivables. This will include balance forwards, listing of all open invoices, and generation of monthly statements to customers. Aging of receivables will be used to collect overdue accounts. One must act quickly to collect overdue accounts. The significant factors here are terms of payment, invoicing, credit control and cash management among other factors. The reduction in terms of payment and effective collection procedures improves cash flows. The Reduction in losses on receivables through systematic credit control 11

19 increases profitability, while reduction in personnel costs through more efficient credit control and collection equally increases profitability Invetory management practices According to Lazaridis andtryfonidis (2006), Inventory, when managed in proper ways will facilitate a profit maximization and enhancement of companies growth. Review inventory periodically and revise stocking patterns and norms. Inventory is dependent upon the demand as well as the supply chain delivery time. Firms should not follow one stocking policy for all items. while some items may have a longer lead-time thus affecting the inventory holding, the demand pattern and the hit frequency in terms of past data may show up differently for each of the inventory items. Get into detailed inventory planning - one size does not fit all. understand the inventory types and the specific characteristics of the items you are carrying, then build the inventory stocking parameters taking into account the unique characteristics of the particular inventory. Getting into the detailed understanding will help one identify the inventory-stocking norm required to manage these characteristics to ensure optimum efficiency. The solution quite often may not be to carry stocks, rather it may involve setting up the customer service standard for such items and specifying a delivery time depending upon the frequency of demand. Quite a few items often have shelf life and hence require separate norms and focus to manage such items. Study demand pattern, movement patterns and cycles to build suitable inventory norms for different categories of inventory. Companies which are into retail segments and dealing with huge inventories in terms of number of parts as well as value will neccessarily need to ensure they practice review of inventory list and clean up operations on ongoing basis. It helps to periodically study the past data and 12

20 extrapolate the same to identify slow moving and obsolete items. The dead stocks should be flushed out and active catalogue items should be made available. Lower inventories and lower replenishment increases operating cash flow, lower write-offs and scrapping costs through reduction in excess and obsolete inventories increases profitability while lower space costs through the reduction in warehouse space needed improves profitability Accounts Payable Management Practices Crucial decisions need to be made not only in managing cash, account receivables and inventories, but also in management of account payables (Lamberson, 1995).The objective of credit mangement practices is to attain longer credit terms from suppliers while optimising on available terms of discounts. Paying bills is an integral part of any business, no matter what field one is in. A solid accounts payable policy can not only lead to improved cash flow but also to better relationships with vendors, suppliers and other creditors. The most important account payable practice is to make sure one is not paying more than the absolutely necessary like in the form of late fees, unnecessary interest charges, lost discounts for quick payment and other penalties. This means one needs to know exactly how much is due to each creditor and when at any given time. A good way to go about doing this is to keep all the due dates and amounts owed in a central location instead of constantly relying on a myriad of paper bills. Most small businesses can easily meet this challenge with a simple spreadsheet.at many levels, a good accounts payable policy is also good public relations policy. It is important to keep a line of communication open with all your creditors. If a bad cash flow problem arises which will cause you to be late on your bills, letting your creditors know in advance is almost always appreciated. Many may 13

21 be willing to make alternate arrangements with you, especially if they know you have a good payment history and a temporary hardship. 2.4 Review of Empirical Studies Working capital management (WCM) has become one of the most important issues in the organizations where many financial executives strive to identify the basic working capital drivers and the appropriate level of working capital (Lamberson, 1995). There is much evidence in the financial literature that present the importance of WCM. Working capital management efficiency plays a very significant and vital role in the performance of firms whose major part of assets is composed of current assets. Therefore, the level of Working Capital must be properly determined and allocated to various segments, effectively controlled and regularly reviewed in order to have adequate and efficient flow of working capital. The cash conversion cycle had been widely used as a major component represents working capital. One of the earlier studies done by Jose, Lancaster and Stevens(1996) for the twenty-year period from 1974 through 1993 of 2,718 firms offers strong evidence that aggressive working-capital policies indicated by shorter cash conversion cycle enhance profitability. Lazaridis and Tryfonidis (2006) also investigated relationship between working capital management and corporate profitability for the firms listed in Athens Stock Exchange for a sample of 131 listed companies. The researcher used the company financials from for the study. The results of the study of regression analysis showed that there was a statistically significant relationship between gross 14

22 operating profit, a measure of profitability and the cash conversion cycle. He suggested that by optimizing the cash conversion cycle the managers could create value for the shareholders. Results of empirical analysis show that there is statistical evidence for a strong relationship between the firm s profitability and its WCM efficiency. Zariyawati, Annuar, and Rahim, (2009), investigated the relationship between working capital management and profitability of the firm. Researchers have used cash conversion cycle as a measure of working capital management. This study has used a panel data of 1628 firm year for a period of 1996 to The coefficient results of pooled regression analysis provide a strong negative significant relationship between cash conversion cycle and profitability of the firms. It is revealed that by reducing cash conversion cycle firm sprofitability can be increased. Raheman and Nasr (2007) also investigated relationship between cash conversion cycle and its components by taking a sample of 94 firms listed on Karachi Stock Exchange for a period of six years from He investigated that cash conversion cycle is negatively related to net operating profit which is a measure of profitability. Similar relationship was observed for average collection period, inventory turnover in days, and average payment period. Eljelly (2004) empirically investigated the relationship between profitability and liquidity for a sample firms in Saudi Arabia. Researcher took cash gap and current ratio as a measure of liquidity. Using correlation and regression analysis a negative relationship was investigated between liquidity and profitability, where current ratio 15

23 was taken as measure of liquidity. At company level it was observed that cash gap (cash conversion cycle) is more important as measure of liquidity than the current ratio as measure of liquidity that affects profitability.at industry level it was observed that size have significant effect on profitability. Padachi (2006) investigated the working capital management practices for the manufacturing firms in Mauritius by taking a sample of 58 small firms. Researcher examined the trends in working capital management and its impact on performance. Regression results observed negative relationship between inventories and receivables with profitability. The study has also shown a positive relationship between various working capital components and profitability. An increasing trend was observed in the short-term component of working capital financing. Garcia and Martinez (2007) examined effect of working capital management on profitability for small and medium size Spanish firms first time. Using panel data authors revealed that there is a negative relationship between inventories and days account outstanding and profitability. The authors further concluded that by managing working capital such that the cash conversion cycle is reasonably minimum, the managers can create value for SMEs. Moss and Stine (1993) revealed that firm size was a factor in the length of the Cash Conversion Cycle (CCC) and the study indicated that larger firms have shorter CCC. Further the study revealed that when the CCC was compared to the current and quick ratios, a significant positive relationship was found. While Jose et al. (1996) examined the relationship between aggressive working capital management and profitability of 16

24 US firms using Cash Conversion Cycle (CCC) as a measure of working capital management where a shorter CCC represents the aggressiveness of working capital management. The results indicated a significant negative relationship between the cash conversion cycle and profitability indicating that more aggressive working capital management is associated with higher profitability. However the study undertaken based on the data from CFO magazine on the rankings of firms on WCM efficiency reveals that the measures of WCM efficiency vary across different industries. The study also gives significant evidence that issues of WCM are different for different industries and firms from different industry sectors adopt different approaches to working capital management. Firms follow an appropriate working capital management approach that is favorable to their industry. Firms in an industry that has less competition would focus on minimizing the receivable to increase the cash flow. For firms in industry where there are large numbers of suppliers of materials, the focus would be on maximizing the payable. Filbeck and Krueger (2005) highlighted the importance of efficient working capital management by analyzing the working capital management policies of 32 nonfinancial industries in the US. According to their findings, significant differences exist among industries in working capital practices overtime. Moreover, these working capital practices, themselves, change significantly within industries overtime. Afza and Nazir (2007) investigated the relationship between the aggressive and conservative working capital policies for 17 industrial groups and a large sample of 263 public limited companies listed on Karachi Stock Exchange (KSE) using cross- 17

25 sectional data for the period Using Analysis of Variance (ANOVA) and Least Significant Difference (LSD) test, the study found significant differences among their working capital investment and financing policies across different industries. Moreover, rank order correlation confirmed that these significant differences were remarkably stable over the six-year study period. Finally, ordinary least regression analysis found a negative relationship between the profitability measures of firms and the degree of aggressiveness of working capital investment and financing policies. Finally, Afza and Nazir (2009) made an attempt in order to investigate the traditional relationship between working capital management policies and a firm s profitability for a sample of 204 non-financial firms listed on Karachi Stock Exchange (KSE) for the period The study found significant different among their working capital requirements and financing policies across different industries. Moreover, regression result found a negative relationship between the profitability of firms and degree of aggressiveness of working capital investment and financing policies. They suggested that managers could crease value if they adopt a conservative approach towards working capital investment and working capital financing policies. Chiou and Cheng (2006) analyzed the determinants of working capital management and explored that how working capital management of a firm was influenced by the different variables like business indicators, industry effect, operating cash flows, growth opportunity for a firm, firm performance and size of firm. The study has depicted consistent results of leverage and operating cash flow for both net liquid balance and working capital requirements while variables like business indicator, 18

26 industry effect, growth opportunities, performance of firm, and size of firm were unable to produce consistent conclusions for net liquid balance and working capital requirements of firms. 2.5 Conclusion Several studies have already been conducted on the relationship between working capital management and financial performance of organizations. Most of the studies outside Kenya have concluded that there exists a negative relationship between working capital management and financial performance of companies. Similar studies done locally in Kenya have revealed relatively similar results as concluded by Biwott (2011) Caffaso (2011), Kamula (2011), Kweri (2011), Mutungi (2010) and Bett (2009). However, further studies have revealed that factors affecting working capital management are varied and quite a number of them including nature of the Industry, demand of Industry, nature of the Business and Production Cycle are industry specific. There are studies that have been done in particular industries and context that have yielded different results. Ganesan (2007) analyzing the working capital management efficiency of firms from telecommunication equipment industry found evidence that even though day s working capital is negatively related to the profitability, it was not significantly impacting the profitability of firms in telecommunication equipment industry. Chowdhury and Amin (2007) also found positive correlations in their work Whereas, Narware (2004) in his empirical study on Indian National Fertilizer Limited, for to signify that working capital management and profitability of the Company disclosed both negative and 19

27 positive association. He also found evidence that increase in the profitability of a company was less than the proportion to decrease in working capital. These industry variations reveal research gaps inviting more work to be done in industries that have not been subjected to research. As earlier noted, the issue on Working Capital has been widely studied. However, largely missing from literature is the focus on health sector and specifically on Hospitals in Kenya that are in significantly different industry setting compared to industries where studies have already been done locally. They are equally in significantly different context to other hospitals where studies have already been done elsewhere in the world. Indeed, Biwott (2011), Caffasso (2011) and Kweri (2011) have recommended similar studies to be done in different industries and sectors. This study therefore seeks to fill this research gap by seeking to find out the relationship between working capital management and financial performance of hospitals in Kenya. 20

28 CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction This chapter will discuss the research design that the proposed study took place. Population from which the study was conducted is defined together with the sample size and how it was determined. Finally, the chapter discusses the data collection techniques and how this data was analyzed and interpreted. 3.2 Research Design The research design for this study is a cross-sectional causal study in which financial data was gathered from the financial statements for the period 2003 to A causal relationship exists when one variable causes a change in another variable. These types of relationships are investigated by experimental research in order to determine if changes in one variable actually result in changes in another variable. 3.3 Population of the study Population can be defined as a collection or set of interest items in research and it represents a group that you wish to infer or draw conclusion regarding your findings from a sample selected inthat population. The population for the study consisted of all the 125 private hospitals listed in the NHIF accreditation list under category C. 21

29 3.4 sample design Kothari (2008) defines Sample size as the number of items to be selected from the universe to constitute a sample. It was not easy to collect data from the entire list due to various constraints mainly time and financial. Since all hospitals in Kenya operate largely under similar economic conditions, and due to financial and time constraints, the sample constituted 10 private hospitalsin Nairobi selected randomly from private hospitals within Nairobi City.This sample represents 21% of private hospitals in Nairobi and 8% of the entire population countrywide. 3.5 Data collection Secondary data was obtained from the published financial statements and management accounts of individualfor the period 2003 to Data Analysis The researcher conducted a regression analysis to establish the extent of relationship between working capital management and financial performance. The study applied the following multi-linear regression model; ROA=β0+β1ACP +β2icp +β3app +ε t Where ROA= Return on Assets β0= Constant ACP=Average collection period ICP= Inventory conversion period APP=Average payment period ε t = Error term 22

30 The correlation co-eficient and co-efficient of determination derived were used used to measure the strength of the relationship at 5% level of significance. 23

31 CHAPTER FOUR DATA ANALYSIS, FINDINGS AND DISCUSSIONS 4.1 Introduction This chapter covers data analysis and findings of the research. The data is summarized and presented in table form. Secondary data was obtained from the published financial statements and management accounts of individual private hospitals. The collected data has been analyzed and interpreted in line with the aim of the study that is to determine whether or not there is a relationship between working capital management and the profitability of private hospitals. Analysis was done using correlation and regression analysis. Table 1: Correlation matrix ROA ICP ACP APP CCC ROA 1 ICP ACP APP CCC Table 2: Regression matrix Variable Intercept ICP ACP APP ROA Table 3: Regression statistics Model R R Square Adjusted R square Std error of estimate

32 Predictors: Average collection period, Inventory conversion period, Average payment period Dependent Variable: Return on Assets 4.2 Inventory conversion period and profitability The study sought to establish what relationship exists between Inventory conversion period and profitability. The research findings indicated that there exists a positive relationship between Inventory conversion period and profitability. The positive relationship between Inventory conversion period and profitability suggests that long inventory conversion period leads the hospitals to a higher level of profitability and vice versa. 4.3 Average collection period and profitability The study sought to establish relationship between Average collection period and profitability. The research findings indicated that there is a positive relationship between average collection period and profitability. This relationship between average collection period and profitability means that as the average collection period increases, the hospitals level of profitability increases and vice versa. 4.4 Average payment period and profitability The research findings indicated that there is a negative relationship between Average payment period and profitability. Arunkumar and Ramanan (2013) found that creditors days show a significant negative relationship with return on assets. The negative relationship between Average payment period and profitability suggests that 25

33 long Average payment period leads the hospitals to a low level of profitability and vice versa. 4.5 Overall Liquidity and profitability The study found that there is positive relationship between profitability and hospitals overall liquidity. The return on assets is positively correlated to both inventory conversion period and average collection period while it is negatively correlated to average payment period. This suggests that a longer cash conversion cycle will lead to higher return on assets while lower cash conversion cycle will result in lower profits. 26

34 CHAPTER FIVE SUMMARY, CONCLUSIONSAND RECOMMENDATIONS 5.1 Introduction This chapter summarizes the findings and makes conclusions based on the specific objective of this study i.e. to determine whether or not there is a relationship between the working capital management of private hospitals and their profitability. It also includes the study recommendations for improvement, limitations of the study and further research. 5.2 Summary and conclusions It was noted that profits have a positive relationship with working capital management. This implies that profitability increases with increase in inventory and average accounts payable while decreasing with increasing average accounts payable. However, as per deloof (2003) argument it cannot be ruled out that relationship between WCM and profitability is to some extent a consequence of profitability affecting WCM, and not vice versa. Indeed, the most plausible explanation for the negative relation between accounts payable and profitability is that less profitable firms wait longer to pay their bills. A negative relation between inventory and profitability can be caused by declining sales, leading to lower profits and more inventories. Finance based models explaining trade credit (Schwartz, 1974) argue that firms able to obtain funds at a low cost will offer trade credit to firms facing higher financing costs. Emery (1984) sees trade credit as a more profitable short term investment than marketable securities. These models imply that higher profits should lead to more 27

35 accounts receivable, because firms with higher profits have more cash to lend to customers. This is confirmed by Deloof and jegers (1996), who find that Belgian firms with a shortage of cash reduce investment in accounts receivable. 5.3 Recommendations On the basis of findings of this project work, we conclude that profitability can be improved in a number of ways. It acknowledges the many factors at play which influence profitability depending on which industry the firm is in. These factors vary in degree of influence on profitability. However, management must continue to manage their working capital in a more efficient way as this will always affect profitability if not managed efficiently. Constant efforts should be made to reduce on the amount of inventories. They must also increase their debtors collection efforts while negotiating for higher credit periods with their creditors. Managers can create value for their shareholders by reducing the number of days for accounts receivables 5.4 Limitations of the Study Private hospitals remain a closed up sector with very little financial regulation and disclosure requirements. As such, the private hospital management did not want to disclose their information for fear of the unknown. This made it difficult in collecting secondary data. Management appeared suspicious when asked for financial information lest it is used against them later on. Others were just slow in providing data and by the close of data collection period; they had not provided the required information. 28

36 5.4 Suggestions for further Research The study was a survey of the private hospitals in Kenya and I recommend that further studies should be carried out in sectors and industries not yet researched to provide the uniqueness of each industry. Further on, a research should be done to determine why there is a positive relationship between working capital management and profitability of private hospitals. There is need to research further and find out what brings about this kind of relationship. 29

37 REFERENCES Afza, T.& Nazir, M. S. (2007). Is it Better to be Aggressive or Conservative in ManagingWorking Capital?, Journal of Quality and Technology Management,3, Arnold, G., (1998). Corporate Financial Management.1st Edn. London, Pitman Publishing. Baumol, W.J., (1952). The transaction demand for cash: An inventory theoretic approach. Quarterly Journal of economics., 66: Bett, T. (2009), An Evaluation Of The Working Capital Management Practices In Kenyan and National Referral Hospitals.Unpublished MBA management project,university of Nairobi Biwott, R. (2011), The Relationship Between Working Capital Management Practices andprofitability Of Companies Quoted At The Nairobi Stock Exchange,UnpublishedMBA management project, University of Nairobi Boer, G., (1999). Managing the cash gap.journal of Accountancy, 188: Caffasso, A.(2011), Relationship between Working Capital Management Financing Policy and profitability: A Survey of Manufacturing Firms in Kenya, Unpublished MBAManagement project, University of Nairobi 30

38 Chiou, J., Cheng, L.and Han-Wen, W., (2006).The Determinants of Working Capital Management, Journal of American Academy of Business, 10, Chowdhury, A.and Amin, M. M., (2007). Working capital management practiced in pharmaceutical companies listed in Dhaka stock exchange. BRAC University Journal, 4, Christopher, S., and Kamalavalli, L. (2009). Sensitivity of profitability to working capital management in Indian corporate hospitals. Retrieved from Deloof, M., (2003) Does working capital management affect the working capital of Belgian firms? Journal of business finance & Accounting 3, Deloof M., &Jegers, M. (1996). Trade credit, product quality, and intra group trade: some European evidence.financial Management, 25, Eljelly, M. A., (2004).Liquidity Profitability Tradeoff: An EmpiricalInvestigation in an Emerging Market, International Journal of Commerce andmanagement, 14, 2 Emery, G.W., (1984).A pure financial explanation for trade credit.journal of Financial and Quantitative Analysis 28(2)

39 Filbeck, G., Krueger, T. M. &Preece, D. (2007). Working CapitalSurvey: Do Selected Firms Work for Shareholders? Quarterly Journal ofbusiness& Economics, 46, (2) Filbeck, G. and Krueger, T. M., (2005). An Analysis of Working CapitalManagement Results Across Industries, Mid-American Journal of Business, 20, (2), Finnerty, J.E. (1993). Planning Cash Flow.2nd Edition.American Management Association, New York, ISBN: X, 124. Ganesan, V., (2007). An Analysis of Working Capital Management Efficiency In Telecommunication Equipment Industry, Rivier Academic Journal, 3, 2 Garcia, T., Pedro J. and MartinezS.,(2007). Effects of WorkingCapital Management on SME Profitability, International Journal of ManagerialFinance, 3, (2), Gentry, J.A., VaidyanathanR.andLee, H.(1990).A weighted cash conversion cycle. FinanceManagement., 19: Gitman, L.J., (1974). Estimating corporate liquidity requirements: A simplified approach.finance. Rev., 9: Government of Kenya (1999).Kenya Human Development Report

40 Hager, H.C., (1976).Cash management and the cash cycle.management. Accounting.,57: Heyman, D., Deloof, M., and Doghe, H. (2008). The Financial Structure of Private HeldBelgianFirms.Journal of Small Business Economics, 30, Horne, J. and Wachowitz, J., (1998). Fundamentals of Financial Management. 10 th edition, New Jersey, Prentice-Hall International, Inc ISBN: Johnson, J. and Aggarwal, J. (1988). Cash management comes to the ball. Accountancy,102: Jose M.L, Lancaste, C and Stevens, J.L. (1996). Corporate returns and cash Conversioncycles.Journal of Economics and Finance, Kamath, R., (1989). How useful are common liquidity measures? Journal of Cash Management 9, Kamula, W.(2011) Relationship between Working Capital Management and Profitability of Cement Companies in Kenya, Unpublished MBA management project, Universityof Nairobi. Kargar, J. and R.A. Bluementhal, (1994).Leverage impact on working capital in Smallbusiness.Turnaround Management Association Journal, 14:

41 Kenya National Burea of Statistics, (2012).Kenya Facts and Figures 2012 Kweri, S. (2011) the Relationship between Working Capital Management and Profitabilityof Manufacturing Firms Listed in the Nairobi stock exchange, Unpublished MBA management project,university of Nairobi. Lamberson, M. (1995). Changes in working capital of small firms in relation to changesineconomic activity. Mid-American Journal of Business 10(2) Lazaridis,I.andTryfonidis, D. (2006), Relationship Between Working Capital Management and Profitability of Listed Companies in the Athens StockExchange, Journal of Financial Management and Analysis, 19, (1), McLaney, E.J., (1997). Business Finance: Theory and Practice. 4th Edn.London, PitmanPublishing, ISBN: Miller, M.H. and Orr, D., (1966). A model for the demand of money by firms. Quarterly Journal of Economics., 80, Moss, J.D., and Stine, B. (1993). Cash conversion cycle and firm size: A study of Retailfirms.Managerial Finance, 19(8),