The relationship between the management of payables and the return to investors

Abstract

Effective working capital management assists a firm in achieving improved liquidity through the management of the components of receivables, inventory, and payables. Previous studies have established that changes in working capital have a strong positive correlation to profitability and that whilst changes to receivables and inventory have a positive correlation to profitability, changes in payables have an inverse relationship. The inverse correlation between payables and profitability is contrary to the theory that advocates extending payment terms as a means of managing working capital and improving liquidity. We apply a buy-and-hold portfolio methodology to an extensive database of Johannesburg Stock Exchange (JSE) listed South African companies over the period 1986 to 2014. We find that for those companies in industries that have a significant investment in payables, there is a significant positive association between changes in payable days and shareholder return, which supports the general theory of working capital management.

Keywords:

• Working Capital Management
• Accounts Payable

Acknowledgments

This research was supported by the National Research Foundation (Grant 85800).

Notes

1 The working capital cycle measures the average number of days’ worth of sales which is invested in net working capital. This is typically calculated as ((cash + marketable securities) / sales × 365) + (accounts receivable / sales × 365) − (accounts payable / cost of sales × 365).

2 In total, 210 different companies were included in the analysis, reflecting new listings and delistings.

3 We used annual financial statement data, so the change in payables is annual for each company. However, because companies report at different times, we review the quintiles quarterly. The table shows the average change in annual payables in Quintile 1 and Quintile 5 across 28 years of quarterly data.