Cash cycle: A cross‐country analysis

• DOI: http://doi.org/10.1111/fima.12273
• Date: 01 September 2020
• Published date: 01 September 2020
• Author: Shahriar Khaksari,Abu Jalal

DOI: 10.1111/fima.12273

ORIGINAL ARTICLE

Cash cycle: A cross-country analysis

Abu Jalal Shahriar Khaksari

SawyerBusiness School, Suffolk University,

Boston, Massachusetts

Correspondence

AbuJalal, Sawyer Business School, Suffolk Uni-

versity,73 TremontStreet, Boston, MA 02108.

Email:ajalal@suffolk.edu

Abstract

We study the cross-country differences in the cash cycles of compa-

nies and find a negative relation between a country’s development

and the cash cycles of its corporations. The ability of companies

to obtain raw materials on credit and to better manage inventory

plays significant roles in shortening the cash cycle. Variouscountry-

specific factors affect cash cycles. Firms with shorter cash cycles

invest more in R&D and participate in more acquisitions. They also

have a higher valuation and lower leverage. Overall, our findings

indicate a close relation between a company’s working capital

management, its valuation, and the country’s level of development.

KEYWORDS

cash, cash cycle, short-term capital, working capital, country

development

1INTRODUCTION

Along with capital budgeting and long-term financing activities, short-term financial management is one of the three

mostimportant responsibilities of corporate financial managers. With an eye toward maximizing shareholder value, the

primary goal of these short-term decisions is to ensure that the company can meet its operational obligations, retire

maturing debts quickly, and pay suppliers. The company must efficiently manage its liquid current assets and, most

importantly,its cash reserves to make the required payments. In this study, we examine the cross-country differences

in the management of short-term capital by public companies byusing cycle measures with an aim toward understand-

ing how they differ across countries, what some of the most important factors are, and how these policies affect the

decisions and valuations of the companies.

The finance literature has two distinct ways of studying short-term capital management: using some variant of the

cash ratio (i.e., cash divided by total assets) and calculating cycles that account for the turnovers in production, cash,

or credit. The use of the cash ratio is more prevalent (Opler,Pinkowitz, Stulz, & Williamson, 1999). Although the level

of cash that a company maintains can be a good proxy for its liquidity position, it fails to fully account for its man-

agement of short-term capital (Richards & Laughlin, 1980). Alternatively, companies can calculate the cash cycle by

c

2019 Financial Management Association International

Financial Management. 2020;49:635–671. wileyonlinelibrary.com/journal/fima 635

636 JALAL AND KHAKSARI

subtracting the accounts payable cyclefrom the sum of inventory and accounts receivable cycles.1Essentially, it is the

time between when the company pays its suppliers and when it gets paid by its customers. The company has a cash

deficit during this period and, as such, must finance its inventory.As it captures both the assets and liabilities sides of

the company’smanagement of working capital, the cash cycle and its components are better indicators of the decisions

of companies regarding how to manage their short-term capital (Richards & Laughlin, 1980).

A shorter cash cycle is more desirable as it lowers the costs associated with carrying inventory and credit sales. A

companycan minimize its cash cycle through efficient management of its inventory, accounts receivables, and accounts

payables. Wecollect data on approximately 42,250 nonfinancial firms from 79 countries over 25 years (between 1992

and 2017) and use a fixed effects method to limit country, industry, and year effects, along with controls for various

firm-level characteristics. We find that the cash cycle is shorter among companies in developedcountries. A propen-

sity score matched sample of comparable companies verifies this finding. We further determine that the inventory

cycle is shorter in developed countries. Alternatively, cycles for both accounts payableand accounts receivable are

longer in developed countries. However, the accounts payable cycle increases faster than the accounts receivable

cycle when a country is developing. This increase indicates that the ability to obtain raw materials on credit from

suppliers and to better manage their inventories plays significant roles in making the cash cycle shorter in developing

countries.

After controlling for year fixed effects, we observe a decreasing linear time trend in the inventory, the receiv-

able, and the payable cycles that lead to an overall decrease in the cash cycle in countries over time. We also find

that there are significant variations in the cash cycle that depends upon the industry the company belongs to. Com-

panies in both Consumer and Hi-tech industries have shorter cash cycles than companies in other industries. In con-

trast, Manufacture and Healthcare companies have longer cash cycles. If we rankthe cash cycles by the magnitude of

the coefficient estimates, then Healthcare has the longest cash cycle, followed by Manufacture,Consumer,andHi-tech

industries.

The panel data we use also allow us to examine the country characteristicsthat statistically and significantly affect

cash cycles. We propose that because a longer cash cycleis more expensive for a company if the interest rate is higher,

thereshould be a negative relation between the cash cycle and the interest rate of the country. Using the inflation, lend-

ing, and real interest rates, we find evidence consistent with our conjecture. The cash cycle is also shorter in countries

with higher total tax rates.

We find strong evidence that the cash cycle is negatively related to various indicators of the levelof development

in the financial market. Cihák, Demirgüç-Kunt, Feyen, and Levine(2013) divide those indicators into four broad cat-

egories: (a) access (the degree to which individuals can and do use financial institutions and markets), (b) depth (the

size of financial institutions and markets), (c) efficiency (the efficiency of financial institutions and markets in provid-

ing financial services), and (d) stability (the stability of financial institutions and markets). We find shorter cash cycles

in countries where private credit markets and stock markets are more developed.Similarly, better access to financial

institutions, greater efficiency in the banking institutions, lower bank concentration, and greater stability in the bank-

ing system are also negatively related to the cash cycle.

Becausethe cash cycle can showcase managerial efficiency (Farris & Hutchison, 2002; Preve & Sarria-Allende, 2010;

Richards & Laughlin, 1980), we propose that it will be related to the country-level indicators of governance and legal

protection for the shareholders. The results indicate that the cash cycle tends to be shorter for countries that provide

greater investor protection and encourage better corporate governance.We find a shorter cash cycle in common law

countries as compared to countries with civil law origins. This is reasonable as common law countries provide better

investor protection (Boyd& Jalal, 2012).

1Inventorycycle measures the time between the delivery of raw materials and the sale of finished goods. The accounts receivable period is the time it takes

for a firm to receive cash paymentsfrom the customers after making the sales. The accounts payable period is the time a company takes to pay its suppliers

afterreceiving the invoice accompanying the raw materials.

JALAL AND KHAKSARI 637

Weinvestigate the association between the cash cycle and the cultural characteristics of the people where the com-

panies are located. La Porta, Lopez-de-Silanes, Shleifer, and Vishny(1997) find that trust is absolutely necessary for

business relationships. We find results that support this argument and demonstrate that countries where the people

are more trusting, on average, have shorter cash cycles.Consistent with Hilary and Hui’s (2009) arguments that reli-

giosity is related to lower levels of risk exposure,we observe a positive relation between the cash cycle and religiosity.

Further,we determine that companies that are based in Catholic majority countries have longer cash cycles than those

that are based in Protestant majority countries. This finding could be explained by higher levels of uncertainty avoid-

ance (Baxamusa & Jalal, 2016) among people living in Catholic countries. This result is also consistent with the fact that

Protestant majority countries provide better corporate governance(Stulz & Williamson, 2003).

We also examine the relation between the cash cycle and the cash reserves of companies. The transaction theory

for holding cash argues that shorter cash cycles enable companies to hold less cash, ceteris paribus. This theory pro-

poses lower cash balances among companies with shorter cash cycles. However,a shorter cash cycle could also allow a

companyto be more opportunistic in its long-term investment decisions. That is, the company could use its lower trans-

actional cash needs to accumulate a higher cash balance to takeadvantage of future investment opportunities. We find

that companies with shorter cash cycles tend to invest more in research and development and acquisition activities

and have lower leverage.More importantly, companies with shorter cash cycles than their peers have a higher Tobin’s

Q. This is consistent with Johnson and Soenen (2003) and Gentry,Vaidyanathan, and Wai (1990) who determine that

efficient management of short-term working capital is related to higher valuation of a company. Overall,in addition

to a purely transactional motive, we find support for the opportunistic motive when it comes to cash holding among

companies with shorter cash cycles.

1.1 Contributions to the literature

This study contributes to the literaturein five ways. First, the cash cycle measure is widely used by companies to under-

stand and manage their short-term financing needs. The wide use of these interval measures in textbooks and univer-

sity classes testifies to this. Yet,there are few studies that examine the factors that affect the cash cycle in an interna-

tional setting. As far as we know,we are the first to attempt to show how the cash cycle varies across a large number of

countries and what the important issues are in a global context.

In addition, studying the decisions of companies regarding how to manage their short-term capital in a global set-

ting can have unique advantages. As Opler et al. (1999) point out, the decision to hold liquid assets is irrelevant in a

perfect capital market with no friction. Companies can simply access cash as they need to with no liquidity premium.

However,the capital markets are not frictionless. In fact, the frictions that create the need for better management of

short-term capital differ across countries and they tend to be more prevalent in developing countries. Our findings

provide evidence of this.

Moreover, systematic risk factors, such as the legal environment, culture, financial marketdevelopment, interest

rate, and inflation, can remain fairly stable over long periods of time within a country.This stability could prevent us

from developinga c omprehensiveunderstanding as to how these factors affect corporate decisions in a single country.

An international setting providesgreater diversity in these factors and, as a result, we are able to properly identify their

effects on the companies’ policies.

Additionally, by decomposing the cash cycle, our study demonstrates that the imbalance between payable and

receivable cycles largely creates the cross-country differences in the cash cycles. This is a channel through which a

country’s developmentcan affect the valuation of the company. A longer payable cycle essentially represents the avail-

ability of trade credit and, as such, is related to financial slack. This imbalance can help us relate the cash reserves of

companies to the economic and financial environment of a country.

Finally,we find that cultural factors have a strong influence on the cash cycles of companies. The corporate finance

literature has long found that the actions and decisions of financial managers are affected bytheir personal beliefs and