CHAPTER cash conversion cycle. Furthermore, the better working

CHAPTER 2 LITERATURE REVIEW

INTRODUCTION

            The purpose
of this chapter is to link to working capital management and firm’s
performance. The topic is the effect of working capital management on firm’s
performance toward economic growth. However, the previous study has examined in
different country, different manufacturing sector, and different year gap. The
theory that was using on firm’s capital management is Baumol cash management
model, operating cycle theory, keynesian theory and cash conversion cycle.

Furthermore, the better working capital management
gives the benefit of firm’s performance. Thus, the important of the working
capital management are the cash, collection, sales, and inventory. On other
hand, the cash cycle is the cash, payables, stock, and receivables.

Figure 2.0 shows the working capital
cycle

            As
usual, the literature review is divided into five parts, which introduction,
theoretical review, hypotheses, main variable, the determinant of firm
performance and theoretical framework.

THEORICAL
REVIEW

BAUMOL’S CASH MANAGEMENT MODEL

Pioneer study of Baumol’s cash management is about the
inventory model (Githinji, 2015). The Baumol model of
cash management helps in deciding a company’s optimum cash balance under
certainty (Baumol Model of Cash
Management).
This model used widely and very beneficial to the objective of cash and
inventory management. Kumar (2017) stated that Economic Order Quantity (EOQ) in
inventory management involves a trade-off between opportunity cost (i.e holding
cost, borrowing cost) and transaction cost (cost of converting market
security). In term of optimum, the cash balance is minimized total cost.

Figure 2.1 shows the optimum cash
balance

            In
this model, the financial manager has to decide on the refraction of liquid
funds of cash and marketable securities (Pandey, 2008) and (Githinji, 2015). Plus, the Baumol
model enables the firm to know their desired level of cash balance under
certainty (Baumol Model of Cash
Management).
Back to the trade-off, the opportunity cost can increase the level of cash
while the trading cost that occurs to transaction cost can decrease if the
level of cash increases (Cornet et al., 2009) and (Githinji, 2015).

             But the Baumol’s cash management model has a
limitation; the cash flow cannot be fluctuating, not consider the overdraft and
there are uncertainties in the pattern of future cash flows (Baumol Model of Cash
Management).

 KEYNESIAN THEORY OF MONEY

            Keynesian
theory is the theory that to encourage economic growth especially during
recession economy with government intervention. This theory is more suitable
for economic on the supply side. During the recession, the government has to
cut down the tax and increase government expenditure. Due to this, the economic
growth will be reactivated again. Hence, the government can avoid the inflation
conflict by increasing the tax and reduce expenditure of economic growth.

            Moreover,
Keynesian theory indicates cash flow in an investment. The Keynesian theory
came out with general theory of employment, interest, and money (Keynes, 1935)
that have reason why an individual would hold money, to handle daily
transaction in business operations; for safeguard (debt payments, liabilities
and other rebellion that can rise up during business); market trends pressure
in determined the increasing shareholder’s wealth at the least possible cost (Duale, 2016).

            The
Keynesian theory is a significant theory of financial managers involves
management of working capital ways to improve the organization in order to
business operation.

OPERATING
CYCLE THEORY

            The
operating cycle is the average time taken between the revenue of inventory and
cash from selling inventory. In order words, the operating cycle is related to
inventories turnover and account receivable turnover. The account receivable
turnover is average time taken receivables investment to convert into cash
while inventories turnover is average time taken from firms convert their cumulative
stock of raw material, work-in-process, and finished goods into product sales (Githinji, 2015). More importantly,
the operating cycle is significant to account receivable and inventories
turnover in order to generate high profitability and liquidity.

            Based
on the findings of Raheman (2010), higher inventories and receivables can
affect the lower profitability of the firm. The shorter time took the operation
cycle, the faster the return to investment of inventory of the firm. Tthe
operating cycle was last longer than in periods during recession economy (Nordmeyer, 2017). The writer further
said this theory was the method on business to reduce the cost of inventory
holding and made the high in liquidity.

           In
operating cycle measurement, the longer the operating cycle, the largest the
working capital business needs. Due to this, when the largest the working
capital, the higher the inventory holding cost and the larger the opportunity
cost. This because the interest payments and disability to invest money. Hence,
the lower operating cycle, the higher the net profit for the firm.

CASH
CONVERSION CYCLE

            The
cash conversion cycle (CCC) is a
part of working capital management. It’s measurement of time for cash flow from
sales and a cash outflow of payment. The CCC
is very helpful method to be used for the company evaluate the performance.
Plus, the CCC is very important to
create value of the shareholder (Shin & Soenen, 1998, and Raheman, 2015).

According to (Duale, 2016), the CCC is about purchase productivities sources and
when the fund is recovered though inflows of form of revenue and profits,
financial managers can form suitable WCM Policies. The researcher further said
a longer cash conversion cycle might be affecting the expense of cash
commitment to the optimal between liquidity and profitability. 

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