Comparing working capital practices in Canada, the United States, and Australia: A note
Nabil T Khoury
Our survey was motivated by a desire to better understand how working capital is managed by smaller firms in Canada. This includes the management of current asset and current liability accounts, as well as the working capital of the firm in the aggregate. We used a survey instrument that was used in three earlier comprehensive surveys of working capital practices. We ended up with 18 questions that are comparable across four surveys spanning two decades and three countries, which enabled us to see how working capital practices have varied over time and also across international borders. These comparisons also provide a useful perspective for considering future research directions in working capital management.
The first comprehensive survey of working capital practices was conducted in 1978 (Smith & Sell, 1980). The survey instrument used consisted of 35 questions, some of which asked the respondent to choose one answer among several possibilities, while others asked the respondent to rank alternatives in terms of their relative importance to the respondent’s firm. From a sample of 653 of the largest U.S. industrial firms, 210 were usable, for a 32.2% response rate. The study found large differences among responding firms in terms of the formality of working capital policies, as well as how individual working capital accounts were managed. They concluded that working capital management in practice is far more than just a series of independent technologies.
The survey was replicated a decade later in 1988 (Belt & Smith, 1992). The survey instrument was expanded to 38 questions and sent to a sample of 448 of the largest U.S. industrial firms. There were 105 usable responses, for a 23.4% response rate. Longitudinal comparisons over a 10-year period suggested a pattern in 1988 of more formal and sophisticated current assets and liabilities management practices.
Using the same instrument, the survey was replicated in Australia in 1989. The sample consisted of 144 of the largest Australian firms, and there were 39 usable responses, for a 27.1% response rate. This led to comparisons of working capital practices in Australia and the United States (Belt & Smith, 1991). They found similarities and differences in working capital practices in the two English-speaking countries. Australian firms seemed to lag behind U.S. firms in inventory, credit/collection, and marketable securities management. However, Australia’s national banking system helps firms in that country to manage cash flows more efficiently than in the United States.
To learn how smaller Canadian firms manage their working capital, we expanded the survey instrument to 45 questions. It was sent in 1994 (in both French and English versions) to a sample of 350 firms randomly chosen from 10 industries within the BOSS database obtained from the Ministry of Industry, Science, and Technology. The sample was limited to firms with sales between $500,000 and $5 million and those with 10 to 500 employees. We received 57 usable responses, for a 15.8% response rate.
Our findings are reported in Table 1, which contains the responses to 18 questions that are common to the four surveys (US in 1978, US in 1988, Australia in 1989, and Canada in 1994). First, we look at working capital policy, then we examine management practices for individual working capital accounts, and finally we examine overall management questions. Our major focus is on the practices of smaller Canadian firms, but we also look at practices in other countries in earlier time periods, to provide perspective. To simplify the presentation, we omit details about statistical significance for the comparisons that are made.
Working Capital Policy
Only 7% of Canadian firms have formal working capital policies. That result is much smaller than in any of the other three surveys. Responsibility for working capital policy tends to reside at a higher level in Canadian firms, namely, that of the board of directors or president, than it does for U.S. or Australian firms. Both these factors may be attributed to the fact that Canadian firms are smaller.
As for type of working capital policy, 28.5% of Canadian respondents have a cautious policy while 10.2% have an aggressive policy. This result is not very different from that seen in the earlier surveys. With respect to frequency of policy review, the greatest difference was in the response to monthly review. The 17% response of Canadian firms was greater than that of U.S. firms, both in 1978 and 1988, but less than the 21.6% response of Australian firms in 1989. About half of the respondents in all four surveys indicated that their policy is reviewed whenever necessary, rather than on a regular basis.
Cash and Equivalents
The next three questions deal with the management of cash and marketable securities, which are two of the current asset accounts. In terms of how firms decide to transfer funds between cash and marketable securities, 76% of Canadian firms use subjective judgments, while no firms reported the use of established guidelines. In contrast, just over 40% of Australian and U.S. firms use subjective judgments and 20-30% use established guidelines.
When asked to rank strategies for managing the marketable securities portfolio, the highest ranking response was to “buy and hold to maturity” in all four of the surveys. The response “play the yield curve” was a close second for the smaller Canadian firms, but ranked lower among U.S. and Australian firms.
For the interval of time reflected in cash budgeting, just about half the Canadian firms prepare their cash budgets monthly. The largest proportion of U.S. and Australian firms do their cash budgeting on a daily basis. Probably the smaller Canadian firms do not need to budget daily.
The next three questions in Table 1 deal with the management of accounts receivable as one of the important working capital accounts. If sequential credit analysis and credit scoring are more sophisticated methods than the traditional four C’s of credit, then Canadian firms are more sophisticated, as their average rankings were higher for those two responses. In contrast, there was very little difference between the responses to the four surveys as to how the turnover of accounts receivable is measured.
In terms of criteria for evaluating changes in credit terms, Canadian firms were more apt to look at the effect on firm sales or the effect on receivables level, whereas Australian and U.S. firms were more likely to focus on the impact on the effect on firm profits. We were surprised that “effect on return on investment” had the lowest ranking in all four surveys. Somehow, working capital is not seen as an ongoing investment by responding firms.
Inventory management is the subject of the next three questions in the four surveys that are being compared here. Techniques for replenishing inventory were far more likely to be ad hoc decisions for Canadian firms, while U.S. and Australian firms were more likely to use computerized control systems. Again, this difference may well reflect differences in firm size.
When asked to rank variables considered in purchasing inventory, respondents to all four surveys ranked “availability” highest. Rankings of the other variables were similar. Exactly the same result occurred when respondents were asked to rank variables considered in producing inventory. Apparently, availability is the key determinant for inventory replenishment for all firms in three countries and across two decades.
Accounts and Notes Payable
The next three questions deal with accounts and notes payable, which are part of the respondents’ current liabilities. When asked about their perception of the firm’s annual cost of trade credit, over 30% of U.S. firms (both surveys), around 10% of Australian firms, and over 40% of Canadian firms reported zero cost for their accounts payable. From all of the responses, it is clear that Canadian firms believe that the cost of their trade credit is lower than do their Australian and U.S. larger counterparts. In contrast, less than one-half of the Canadian respondents report that they “always take their cash discounts” from their trade suppliers, while 11% “never” take discounts. This is a seemingly inconsistent finding.
The responses of Canadian firms also differed considerably in terms of the collateral that is part of their bank borrowing. Over 90% of U.S. firms, 75% of Australian firms, and only 22.6% of Canadian firms reported that “collateral is never provided” for their working capital loans.
Managing Working Capital
The final two questions reported in Table 1 have to do with how working capital is built into longer-term capital budgeting decisions. Here, the response of Canadian firms is pretty much the same as those of Australian and U.S. firms. For all three countries, and over the two decades that separate the four surveys, nearly two thirds of the respondents always included working capital considerations in their capital budgeting.
What is the relevant discount rate used by firms in their handling of working capital accounts? The relevant interest rate is used by about one third of all responding firms. The average cost of capital is used by over 40% of Australian and U.S. firms, but only by 19% of Canadian firms. Over 40% of Canadian firms report that a hurdle rate is not needed in making decisions about their working capital accounts.
Future Research Directions
Overall, our survey of working capital practices in Canada extends the findings of three surveys conducted in the United States and Australia. There are similarities and differences in working capital practices in the countries as well as over time. Some of the notable differences are probably because the firms in the Canadian sample are smaller, and because of cultural difference across international boundaries.
Based on comparisons of the responses to the 18 questions that were common to the four surveys reported in Table 1, it is possible to reflect upon some areas of future research in working capital management. First, it would be desirable in future surveys to continue to ask similar questions in order to see how practices change over time. Second, it also would be desirable to do similar surveys in other countries, both English-speaking and others, so as to better understand differences and similarities across international borders. And third, it is likely that the rapid spread of computers and electronic communication have changed the ways that many firms manage at least certain components of their working capital, so more questions should be added to those used in the four surveys discussed in this paper.
Belt, B., & Smith, K.V. (1991). Comparisons of working capital management practices in Australia and the United States. Global Finance Journal, 2, 27-54.
Belt, B., & Smith, K.V. (1992). Recent changes in working capital management practices. Midwestern Journal of Business and Economics, 7, 1-18.
Smith, K.V., & Sell, S.B. (1980). Working capital management in practice. In K.V. Smith (Ed.), Readings on the management of working capital (pp. 51-84). St. Paul, MN: West Publishing.
Nabil T. Khoury
Keith V. Smith
Peter I. MacKay
Southern Methodist University
The authors appreciate the constructive suggestions of Brian Belt and Gerald D’Amboise.
Address all correspondence to Nabil T. Khoury, Universite Laval, Faculte des sciences de l’administration, Sainte-Foy, QC, Canada, GIK 7P4.
Copyright Administrative Sciences Association of Canada Mar 1999
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