1.1 Background
Actual analytical surveys show that the problem has not been solved entirely yet (D. Volkov, E. Nikulin 2012). Generally, working capital management can be observed at three levels. The details of working capital are observed on the first level. The most popular of them are cash management and inventory management. The second level investigates working capital on the corporate scale. The distinguishing feature of such a type of analysis is that working capital is regarded as an aggregate component. Traditionally, working capital is composed of inventory, accounts payables and receivables, cash and cash equivalents. Therefore their combination is the subject of interest on the second level. The third level considers working capital on the supply chain scale. The analysis in this sphere (Farris, Hutchison 2009; Hoffman, Kotzab 2010) focuses on the short-term financial policy of the partnership between the companies. Partners in the supply chain are regarded as an aggregate unit.

The results of the previous studies show that the key goals of the first level management have already been effectively explored. Since 1930 academic circles has been providing models explaining optimal parameters of the working capital components (Baumol model derived in 1952; Millerand Orr model derived in 1966).

At the same time the majority of academic papers focused on the second and third levels fall short of the reasonable explaining. In particular, there are no actual investigations in these areas in the emerging market of Russia. Recently the problem of managing working capital at the corporate level and the multi corporate level has been brought forefront. The global recession of 2007-2009 demonstrated that even stable and liquid corporations had to design short-term financial policy precisely. From the author’s point of view deep analysis of the second and third levels in the emerging markets is in demand. Application of smart working capital management will finally result in effective industry development. Efficient policy plays an important role in overall corporate strategy in order to create shareholder’s value.

1.2 Paper structure
The paper is structured as follows: Section 2 presents the actual literature review about working capital management and empirical experience in the emerging markets. At the next step the principal objectives of the study are introduced. Research process, data selection, model and its limitations are reported in Section 3. This section also considers the relevance and methodology of the research. Section 4 contains results anticipated from the econometric modeling approach. Finally, Section 5 concludes the investigation.

2. Theory

2.1 Literature Review
Generally, there are two actual types of studies about investigation of the working capital management at the corporate level (Volkov, Nikulin 2012).

The first type papers study the correlation between aggregate working capital policy and a corporation’s performance. The basic peculiarities of these studies are attempts to prove negative relation between cash conversion cycle and operational profitability.

In 2003 Deloof discovered the fact that large amount of cash is invested in working capital. The hypothesis of this study was that WCM could make significant impact on the profitability of firms. Utilizing the sample of 1009 large Belgian firms, author concluded negative relation between gross operating income and the number of days account receivable, payable, inventory.

Lazaridis Trifonidis (2006) proved statistical significance of the relation between profitability and cash conversion cycle for listed firms in Athens Stock Exchange. This paper revealed the opportunity of multiplying a firm’s value. Relevant handling of cash conversion cycle increases the value of the corporation.

Dong Su (2010) supposed that managers can create a positive value for the shareholders by keeping the relevant cash conversion cycle. They examined secondary data from the Vietnam stock market for a 4-year period and revealed the strong negative correlation between gross operating profit and cash conversion cycle. They designed four regression models in order to test the main hypothesis and used the OLS approach.

Kaddumi Ramadan (2012) assessed the effect of working capital management on the performance. They got data sample of Jordanian industrial corporations. It represented 70% of Jordanian industrial sector. Return on total assets and net operating profitability were used as a proxy of profitability. Traditional components of working capital were independent variables. They had created several models and conducted the experiment using the OLS and Fixed-Effect approaches. Finally, they reckoned negative dependence. The conclusion was that efficient management of conservative working capital policy can add value to the shareholders wealth.

Ding Knight (2012) analyzed linkage between investment in fixed capital and working capital in condition of financial constraints. The academics applied 116 000 panel of Chinese firms for the period 2000-2007. Investment in fixed capital is the determinant of growth. The paper presented the fact that active working capital management can help to mitigate the effect of financing constraints on their fixed capital investments.

The second type papers investigate the factors which could possibly affect working capital policy. The leverage and q-Tobin are some of these factors which could be observed.

Nakamura Palombini (2011) provided insights into determinants of working capital policy of the Brazilian companies. His paper enriched corporate finance knowledge with the set of efficient short-term financial decisions. The authors utilized data sample of Brazilian companies listed at the San Paolo Stock Exchange, during the period 2001-2008. The architecture of the model consisted of a dependent variable (cash conversion cycle as a proxy of working capital management), independent variables (debt level, managing monitoring mechanism, free cash flow) and control variables (size of the firm, growth). At the final step they made conclusions about industrial sector in Brazilian emerging market.

Nazir Afza (2009) represented a thorough examination of the factors which could possibly influence the working capital policy. Their data covers 14 industrial sectors of Pakistan. The period 2004-2007 was undertaken by the authors. Actually this study contributed to a better understanding of financial and non-financial factors determining working capital management in the emerging market of Pakistan.

2.2 Components of working capital
All corporations and other types of entities are required to maintain the balance between profitability and liquidity. Liquidity is the property which represents the ability of the firm to meet its current short-term obligations. Profitability represents the difference between revenues and costs of the venture. Generally liquidity and profitability are negatively dependent, because an increase in liquidity leads to reduction in profitability. So, in other words, WCM is a financial dilemma based on the trade-off concept of maximizing the shareholder value.

Without relevant WCM every business can not prosper and survive in the market economy. The aggregate success depends on the ability of the firm to generate a positive net cash flow. The corporation can be endowed with sufficient balance sheet profit but it does not reflect the real cash inflow. Many firms experience cash flow difficulties due to timing differences of cash receipts and cash disbursements. It is not surprising that profitable firms suffer from the lack of liquidity, which leads to bankruptcy. Positive working capital is required to ensure a firm’s successful performance. Investments in working capital are usually retained in the business for the period less than a year. That is why WCM is associated with short-term financial management. Some academics compare working capital of the corporation with the blood of the human body. Taking into account all these characteristics, the result is that WCM plays the vital role.

The main working capital components are current assets and current liabilities. Information about these components can be received from the financial reports and balance sheet, in particular. Current assets consist of inventory, cash, accounts receivable, cash equivalents, short-term investments and the portion of pre paid liabilities which will be paid within a year. Current liabilities consist of obligations which would be settled by current assets. In accounting the major part of current liabilities is called accounts payable. Short-term liabilities express the account payable of the firm which would be settled within a year or operation cycle of the corporation, regarding which period is longer. The difference between current assets and current liabilities is net working capital. Net working capital can be either positive or negative number. In case of negative value, firm is usually suffering from working capital deficiency.

A substantial amount of inventories provide liquid production process. It balances between the amount of supply and uncertain consumer demand. The key objective is to store the exact amount of inventories and raw materials which could be enough to avoid shortages of work-in-process. At the same time the amount of finished goods have to correspond to the demand. Excess inventory balance takes up financial resources but provides liquidity of the production. Nowadays there are many studies in the area of increasing efficiency of the inventory management. The most commonly used and simplest model is the EOQ (economic order quantity). The quintessence of this concept is «just in time» approach, which is widely spread among Japanese producers.

Accounts receivable appear when finished goods are sold on credit. The advantage is that this approach enlarges sales. The most serious disadvantages are payments collection, managing bad debts, sluggish float. Actual financial instruments of account receivable management are factoring, forfeiting and electronic commerce.

Cash management is the area of finance which is responsible for cash collection, handling and investing. The concept of cash management is partially similar to inventory management. The main idea is the balance between operating profitability and production liquidity process. Research conducted after the financial recession of 2008 demonstrated that corporations were risk dislike. So they are keeping extra reserves of cash, cash equivalents and other liquid assets, loosing alternative benefits. They considered these alternative costs to be smaller than possible cost of bankruptcy. Generally speaking, many models were constructed in order to maintain optimal cash reserves. Widely spread models are the reliable Miller-Orr model, simple Baumol model and progressive Premachandra model.

The problem of bankruptcy in response to the recent changes in the economy was examined by Makeeva Bakurova (2012) in detail, using the artificial neural networks approach. In particular the oil and gas industry was explored. With the help of the logit model they assessed the probability of bankruptcy in dependence of profitability, liquidity, turnover and leverage. The result showed that liquidity was the least important factor.

Analysis

3.1 Methodology and hypothesis
Working capital management is a crucial factor of successful performance of a firm. It directly influences the profitability and determines liquidity. However, these indicators are negatively correlated. This paper aims to address this gap and investigate the role of optimal balancing of working capital in the case of different industries. Previously attention of the major academics was paid to long-term financial management. Development of working capital and its management studies was not intensive. Short-term financial planning suffered from the lack of the relevant investigations. During the past two decades, a great deal of attention concerning short-term financing had been paid to the components of working capital. Some of them are inventory and cash management. While this topic continues to gain popularity, there are a lot of aspects of short-term financing in emerging markets, which are poorly understood. They are corporate level and supply chain level of WCM. The scale of the current research is limited by the corporate level. The interest of academics in WCM on the corporate level has run parallel to the attention devoted to this topic by practitioners. The specific objective of this study is to assess the effect of WCM on the profitability of the industrial firm. The next step is to determine factors which influence working capital policy of the firms performing in different industrial sectors.

Hypothesis #1: There is a linear negative correlation between cash conversion cycle and profitability of the industrial firms in the emerging market.

Hypothesis #2: There is a linear negative correlation between WCM measures and profitability of the industrial firms in the emerging market.

Hypothesis#3: Working capital effects on profitability depend on the industry specialization.

Hypothesis#4: The factors: firm’s size, fixed assets ratio, market power, accounting method, leverage, firm’s age, q-Tobin, ROA, firm’s growth and business cycle, influence the choice of working capital policy in the observed industries.

This paper provides three types of the variables: dependent variables, independent variables and control variables. Some variables used in this research are based on the previous investigations in this sphere. In order to test hypothesis #1 it is relevant to use the following variables.

Profitability measure is the dependent variable. Net operating profitability Net operating profitability = EBIAT/Total Assets. and return on assets ROA = Net Income/Total Assets. indicators are supposed to be proxy variables of profitability of the corporation.

Independent variables express WCM outstanding features. The cash conversion cycle (H1) is the generalized feature of the WCM. The other variables (H2) represent the corresponding element of management policy. The variables are the number of days accounts receivable, number of days accounts payable, and number of days inventories.

Control variables are held constant to test the relative impact of independent variables. The set of control variables is created by the following parameters: gross working capital, turnover, investment in working capital, working capital financing policy, size of the firm Size of firm = Natural logarithm of Sales., liquidity, and leverage ratio.

To test hypothesis #3 it is necessary to apply dummy variable approach. Dummy variables are utilized to sort the data into corresponding categories. Categories are determined in accordance with the amount of observed industrial sectors.

In order to test hypothesis #4 it is relevant to use the following variables. Dependent variables are working capital requirement and logarithm of cash conversion cycle. The cash conversion cycle measures the period of time in days between the payment for raw materials and the receivables for finished product sales. This component is relevant because it reflects the nature of the purchasing, production and sales processes of the firm. Working capital requirement is the other proxy of WCM. This measure is defined as current assets derived by total assets.

The independent variables are: firm’s size, fixed assets ratio, market power, accounting method, leverage, firm’s age, q-Tobin, ROA, firm’s growth, business cycle.

Model

The effect of WCM on profitability of Russian industrial firms is tested using panel data regression. The panel data is suitable in this case because it gives advantages of efficient estimation. The generalized concept of the model has the posterior form:

Subscripts i and t are the firm and the time determinant respectively. Profitability is the dependent variable. Proxy indicators are net operating profitability (NOP) and return on assets (ROA).Cash conversion cycle (Hypothesis #1) and WCM components (Hypothesis 2) are the independent variables. Proxy indicators are the number of days accounts receivable (AR), the number of days accounts payable (AP), and the number of days inventories (IVT). Control effects are introduced by control variables. They are gross working capital (GWC), turnover (TO), investment in working capital (INV_WC), working capital financing policy (FP_WC), size of the firm Size of firm = Natural logarithm of Sales. (SZ), liquidity (LQ), and leverage ratio (LVG). The concept of the model demonstrated in the equation 1 could be changed by substituting defined components. As a result it turns into eight regressions.

The rest four regressions have the same structure. The only difference is that ROA used as the dependent variable instead of NOP indicator. The models would be estimated using the Pooled Ordinary Least Squares Method (OLS).

In order to test hypothesis #3 about the correlation of WCM effect on profitability and industry sector is tested with dummy-variable regression. The dummy-variable approach is suitable in this case because it gives advantages of sorting data into groups. The profitability is the function of WCM, control effects and industry:

The examination of factors which could influence working capital policy in the observed industries (Hypothesis #4) is based on the panel data sample. The panel data consists of time series for each cross-section member in the data set. The research might be conducted on the base of OLS approach. The dependent variable is working capital policy. There are 2 proxy variables in the research. They are working capital requirement (WCR) and cash conversion cycle (CCC). The independent variables are firm’s size (SZ), fixed assets ratio (FAR), market power (MP), accounting method (AM), leverage (LVG), firm’s age (AGE), q-Tobin (QT), ROA (ROA), firm’s growth (GRTH), business cycle (BC). As a result it turns into 2 regressions:

The equation 7 and 8 represent the concept of the estimation hypothesis #4.
Results anticipated
All models have to be tested on multicollinearity and autocorrelation in order to confirm correct specification. In developing explicit hypotheses we augment prior research by incorporating our knowledge of a negative correlation between profitability and WCM measures in traditional economic literature. If hypothesis #1 is significant then it is possible to deduct the following fact. The length of the cash conversion cycle is negatively correlated with profitability. So, financial manager can increase the value of the company by reducing the cash conversion cycle. This approach demands the adequate short-term financial policy. This study takes into the account not only the internal factors, but also the external parameters. It is industry dummy variable.

To test the hypothesis #2 we would obtain the sample of industrial corporations in Russia. This analysis is based on both external and internal factors which affect working capital policy. Previous research demonstrated contradictions. The results of this research are anticipated to overcome contradictions and further explore the nature of the emerging markets.

Conclusion
Recently the problem of managing working capital has been brought to the forefront. Relevant WCM is one of the main keys to successful performance of the corporation. The financial crisis of 2008 forced academic society to reexamine the concepts of short-term financial management. The focus of attention shifted from long-term corporate finance to short-term financial policy. The companies which did not inject relevant financial management had become bankrupts in 2010. The results of the previous recession prove this fact. Most modern research show that the problem has not been solved entirely yet. The principal aim of this study is to examine the following: correlation between profitability and WCM, determinants of working capital policy in case of the emerging market of Russia.

Results are expected to be in accordance with the mainstream in the corporate finance theory. A negative dependence between profitability and WCM measures allow us to apply new methods of increasing company’s value. Hypothesis #4 reveals the structure of working capital policy. The suggested model helps to assess the effect of internal and external factors on working capital policy.

This paper can develop the knowledge about short-term financial management in the emerging markets. Outstanding emerging markets are represented by BRICS countries. The goal of this investigation is to contribute to previous research concerning this topic. Academics who examined Brazil and China are faced with contradictions. This paper can further explore the reasons for such contradictions in the emerging markets.

References

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