The working capital management practices of JSE-listed companies.

Abstract

Working capital management is a subject that was largely ignored in the theoretical and empirical literature until the 1980s, mainly because it was considered a non-value adding balance sheet item. It has gained pre-eminence, particularly among practitioners, in the wake of the recent global financial crises when access to short-term funds was difficult. The increased pressure on managers to achieve maximised market valuations and the quest for cheaper sources of funds, despite growing evidence of excessive investments in working capital, has made working capital management a key contemporary financial management issue. The main aim of this study was to analyse the working capital investment and financing practices of firms listed on the Johannesburg Stock Exchange (JSE) and investigate whether these practices play a role in alleviating financial constraints in an emerging market with a robust financial system. The study employed the Generalised Method of Moments (GMM) in order to overcome the problem of endogeneity, a major problem in working capital management estimations. It found that despite operating in an environment with a well-developed financial system, South African firms use trade credit as a key short-term financing instrument. These firms pursue target trade credit and short-term financial debt levels and they quickly adjust towards their target. Furthermore, these firms also have optimal working capital investment levels and they endeavour to adjust towards this optimal level. However, for these firms, the adjustment process was found to be relatively slow. The study found that the relationship between working capital investment and firm value is concave due to the benefits and costs associated with working capital investment. The study also found that working capital management plays an important role in alleviating the impact of financial constraints. In light of these findings, it is recommended that executives in South Africa embrace efficient working capital management as part of their overall corporate strategy as this can be a source of funds, competitive advantage and can help them cope with financial constraints; this strategy has enabled Chinese firms to register phenomenal growth. Managers should clearly understand the key drivers of their company’s working capital investment because deviating from the target level compromises the value maximisation goal. They should strive to maintain healthy relationships with suppliers as this ensures a continuous supply of goods and access to interest “free” finance. Poor relationships cause costly disruptions and loss of value through negative market perceptions.