Modeling the Impact of Working Capital Management on the Profitability in Industrial Maintenance Business

Abstract

In this paper, we present an analytical model for flexible asset management, which is a new tool for company decision-making. The model reveals a significant negative correlation between the cycle times of operational working capital and the return on investment. Conventional research on working capital management has mostly focused on manufacturing industries. We show that working capital should be managed actively also in unconventional environments like service industries. The focus is on the industrial maintenance service providers, which still remain somewhat unexplored in academic literature. The importance of working capital management is actually emphasized in this industry, due to its light fixed assets and good profitability. Interestingly, there are some major differences between large enterprises and small and medium size enterprises in the industrial maintenance service sector. These can be explained through economies of scale and the fact that large maintenance service enterprises often focus on providing services mostly for their former host companies.

Appeasing company owners through effective working capital management

“…Deloof, 2003;García-Teruel and Martínez-Solano, 2007;Shin and Soenen, 1998;Talha, Christopher, and Kamalavalli, 2010;Viskari, Pirttilä, and Kärri, 2011;Wang, 2002). This finding has been supported by Marttonen, Viskari, and Kärri (2011) with analytical modelling. Some studies have suggested that companies can boost their sales with generous credit terms and secure the service level with larger inventories (Blinder and Maccini, 1991;Deloof and Jegers, 1996;Shah, 2009).…”

“…Modeling leads to high internal validity due to its transparency. In this paper, the flexible asset management (FAM) model developed by Marttonen, Viskari, and Kärri (2011) is expanded to include the financial perspective in addition to the managerial one. The model has been previously used to examine working capital management and ROI.…”

“…This sector of industrial services is optimal for the verification of the model: previous literature has indicated that the importance of active working capital management is emphasized in industrial maintenance companies (Marttonen, Viskari, and Kärri, 2011). This is caused by their exceptionally small amount of fixed assets, compared to for example traditional manufacturing industrial companies.…”

“…However, beyond this optimum, the interest rate of debt starts to increase, and the growth of required return on equity accelerates, both factors causing a decrease in company value (Brealey, Myers, and Allen, 2008). This traditional theory was challenged by Modigliani and Miller (1958), who stated that the capital structure of a company affects neither its market value nor its average cost of capital. There is an underlying assumption of perfect capital markets in this theory, but nonetheless, the view of Modigliani and Miller has received extensive support in academia.…”

“…The starting point for the modeling is the FAM-model, introduced by Marttonen, Viskari, and Kärri (2011). This model links the cycle time of operational working capital, the cash conversion cycle, to the ROI.…”