A relationship between Firm Investmentand financial status of Nepalese enterprises -Kapil Deb Subedi

A Relationship between Firm Investment and Financial Status of Nepalese Organizations

Kapil Deb SubediHead- Department of Management

Saptagandaki Multiple Campus

Statement of the Problem

The present study attempts to disclose the results and explain the outcome of analysis in

the role of financial factors in explaining the investment behaviour of nepales

organizations. One of the objectives of the study is to assess the firm investment practices

in Nepalese enterprises and to find its relationship with financial status variables.

Many studies in industrialized countries {for example Fazzari et al. (1988), Kaplan and

Zingales (1997), and Cleary (1999)} support the existence of a strong relationship

between financial factors and investment decisions. They suggest that firms (even large

well established ones) operate in imperfect markets, which leaves researchers and policy

maker to deal with the critical issues of how and why these imperfections affect firm

investment decisions.

The vast literature in investment empirics evidences that the investment decisions of

firms with weaker financial positions are much more sensitive to the availability of

internal funds than those that are more creditworthy. The evidence also demonstrates that

a major reason for the weak investment- cash flow sensitivity displayed by healthy firms

is that they are able to invest even with the increased debt level if there exists the market

opportunity but the same is not true for unhealthy firms. This is because they appear to be

too preoccupied with reducing debt levels to undertake much long-term investment. The

present study covers the empirical test of this notion that whether the firm financial status

(i.e. healthy or unhealthy firms) have significant impacts in investment cashflow

sensitivity among the Nepalese enterprises or not.

Methodology and Analysis

Portfolios sorted by financial status variables

Firms' characteristics based on financial status variables e.g. current ratio, assets turnover

ratio, sales growth, interest coverage, debt ratio, and net profit margins have been used to

classify firms that a priori can be considered to differ in their access to external funds or

in other words in their liquidity constraints. Similar studies in industrialized countries

focus on firm characteristics such as size, age, and firms' relationship with banks, the

dividend payout and the leverage that can be used as criteria for sub sampling. Some of

these features are irrelevant for developing countries. All firms in Nepal are relatively

young, so the age does not matter and there is no tradition with respect to dividend

policy. As regards to firms' relationship with financial sector, there is simply lacking the

firm level data on linkage between the financial sector and the firms in our sample. Given

these limitations, the present study selected the financial status variables to split the firms

in their access to external funds.

The study sorts out all the sampled enterprises into three portfolios. The financial status

variables selected to split the sample into three portfolios are the current ratio, assets

turnover ratio, sales growth, interest coverage, debt ratio, and net profit margins. The

enterprises with the lowest, medium, and highest values of financial status variables are

contained in portfolios 1, 2, and 3 respectively. The properties of these portfolios are

sown in the following sections.

Each portfolio shows the summary statistics of financial status variables in part A and

statistics of quantitative measures of the investment, growth, and cash flow variables in

part B. The investment variable for this study comprises the three separate investment

indicator of the firms. They are the investment in fixed assets (i.e, growth in fixed

assets=IFAt/Kt-1), investment in Current assets (i.e. growth in current assets =ICA t/Ct-1)

and investment in total assets (growth in total assets=ITAt/ Tt-1).

In Table1, portfolios sorted by current ratios are presented. The priori considered for this

classification assumes that the portfolios with the highest current ratios have a good

access to external funds and in other words, never constrained by liquidity. The

enterprises with the lowest current ratio have the lowest investment in fixed assets,

current assets and total assets. The average growth in fixed assets increased from10.36

percent for lowest CR portfolio to 20.81 percent for highest current ratio portfolio.

Similarly, The average growth in total assets increased from6.99 percent for lowest CR

portfolio to 8.46 percent for highest current ratio portfolio. But as regards to growth in

current assets, the result is opposite. The enterprises with highest current ratio have

lowest growth (6.61 percent) in current assets and the enterprises with the medium

current ratio have the highest investment (26.46 percent) in current assets. The statistics

also revealed that the enterprises with the medium current ratios (Portfolio 2) have the

highest investment in current assets, total assets, and fixed assets than the other two

portfolios. All the results are also supported by the median values.

Table-1

Summary Statistics of portfolios sorted by Current Ratio (CR)

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (Current Ratio) of 26 enterprises over the sample period.

Portfolios

Basis of portfolio (CR)

1(Lowest)

<= .83

2(Medium)

.84 - 1.74

3(Highest)

1.75+

A. Financial statusNet Profit margin (Times) -.2421 .0317 .0659Interest Coverage (Times) 4.4562 12.656 16.5613Sales Growth (Times) .1337 .1435 .1372Debt Ratio (Times) .4193 .1481 .1680Assets Turnover (Times) .7547 1.5620 2.2660Current Ratio (Times) .5433 1.2746 2.9332Number of observations 54 52 54B.Investment, Cash flow, GrowthInvestment in Fixed Assets t /Kt-1 (Times) .1036 .2136 .2081

Investment in Current Assets t

/Ct-1

(Times).0905 .2644 .0661

Investment in Total Assets t /Tt-1 (Times).0699 .2506 .0846

Cash flowt/Kt-1 (Times) -.3367 .7001 1.6078ROA (Times) -.0200 .1040 .1213Number of observations 54 50 54

As regards to relationship between current ratio and cash flow, the mean and median

values of different portfolios support the priori assumption. The enterprises with the

lowest current ratio have the lowest cash flow to capital ratio

(-33.67 percent), medium enterprises have the medium cash flow to capital ratio(70.01

percent) and the enterprise with the highest current ratio have the highest cashflow to

capital ratio (160.78 percent). Return on Assets (ROA) is another variable considered for

corporate growth and taken as a proxy for market opportunity. The classification scheme

successfully captures the characteristics of portfolio to this variable also. The average

return on Assets for highest CR enterprise is 12.13 percent, where as it decreases to –2

percent for lowest CR enterprise.

The study also attempted to measure the relationship among the financial status variables

in different portfolios. The summary statistics for different portfolios in part B of Table 1

shows that the current ratio is positively related with the net income margin, assets

turnover, sales growth and interest coverage ratios, however it is negatively related with

the debt ratio. The net income margin increased from –24.21 percent for the enterprises

with the lowest CR portfolio to 6.59 percent for enterprises with highest CR portfolio.

Similarly the assets turnover ratio increased from 0.75 times for the enterprises with the

lowest CR portfolio to 2.26 times for enterprises with highest CR portfolio. Likewise,

The interest coverage ratio increased from 4.45 times for the enterprises with the lowest

CR portfolio to 16.56 times for enterprises with highest CR portfolio. As regards to sales

growth, the relationship with CR is not negative but also not increasing monotonically.

However, the debt ratio is negatively related with the current ratio. The debt ratio for

lowest CR enterprise is 41.93 percent and it declines to 16.80 percent for the portfolio of

highest CR enterprises.

From the above analysis, the following conclusions can be derived. First, the firms with

lower current ratios have first of all a lower investment to capital ratio than the firms with

larger current ratio. Secondly smaller CR firms have higher long-term debt. Third, small

CR firms have smaller cash flow to capital ratio than the larger CR firms.

In Table 2, portfolios sorted by sales growth are presented. The priori considered for this

classification assumes that the portfolios with the highest sales growth have a good

access to external funds and in other words, little constrained by liquidity. The enterprises

with the lowest sales growth have the lowest investment in fixed assets, current assets

and total assets.

The average investment in fixed assets increased from13 percent for lowest sales growth

portfolio to 21.77 percent for highest sales growth portfolio. Similarly, The average

growth in total assets increased from 5.73 percent for lowest sales growth portfolio to

23.17 percent for highest sales growth portfolio. As regards to growth in current assets,

the relationship is even strong. The enterprises with highest sales growth have highest

average investment (30.71 percent) in current assets and the enterprises with the lowest

sales growth have only the 3.51 percent investment in current assets. All the results are

also supported by the median values.

As regards to relationship between sales growth and cash flow, the mean and median


lowest sales growth have the lowest cash flow to capital ratio (36.25percent), medium

enterprises have the medium cash flow to capital ratio (55.27 percent) and the enterprise

with the highest sales growth have the highest cash flow to capital ratio (100 percent).

Table-2

Summary Statistics of portfolios sorted by sales growth

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (sales growth) of 26 enterprises over the sample period.

Portfolios

Basis of portfolio (Sales growth)

1(Lowest)

<= .00

2(Medium)

.01 - .19

3(Highest)

.20+

A. Financial status Variables

Net Profit margin (Times) -.0788 .0075 -.0742Interest Coverage (Times) 6.9424 17.3472 9.5583

Sales Growth (Times) -.2209 .0856 .5476

Debt Ratio (Times) .2618 .2491 .2282

Assets Turnover (Times) 1.4273 1.3216 1.8249

Current Ratio (Times) 1.5496 1.7201 1.4978

Number of observations 54 52 54

B.Investment, Cash flow, GrowthInvestment in Fixed Assets t

/Kt-1

(Times).1300 .1762 .2177


/Ct-1

(Times).0351 .0851 .3071

Investment in Total Assets t /Tt-

1

(Times).0573 .1069 .2317

Cash flowt/Kt-1 (Times) .3625 .5527 1.0079

ROA (Times) .0560 .0715 .0744


As regards to relationship between sales growth and cash flow, the mean and median


lowest sales growth have the lowest cash flow to capital ratio (36.25percent), medium

enterprises have the medium cash flow to capital ratio (55.27 percent) and the enterprise

with the highest sales growth have the highest cash flow to capital ratio (100 percent).

Return on Assets (ROA) is another variable considered for corporate growth and taken as

a proxy for market opportunity. The classification scheme successfully captures the

characteristics of portfolio to this variable also. The average return on Assets for highest

sales growth enterprise is 7.44 percent, where as it decreases to 5.60 percent for lowest

sales growth enterprise. The median value of ROA for highest sales growth enterprises is

8.76 percent and it declined to 6.19 percent to small sales growth enterprises. It suggests

that there is no negative relationship between sales growth and Return on Assets.

Part A of Table.2 reports the mean and median values of financial status variables across

the three different portfolios formed on the basis of lowest, medium, and highest sales

growth ratios. The firm-years in the lowest sales growth portfolio have the smaller net

profit margin, assets turnover, and interest coverage ratio as compared to the firm-years

in highest portfolio. On the other side, the sales growth ratio is negatively related with the

current ratio and the debt ratio when compared to lowest sales growth portfolio with the

highest one.

The median value of net income margin increased from 0.04 percent for the enterprises

with the lowest sales growth portfolio to 1.52 percent for enterprises with highest sales

growth portfolio. Similarly the average assets turnover ratio increased from 1.42 times for

the enterprises with the lowest sales growth portfolio to 1.82 times for enterprises with

highest sales growth portfolio. Likewise, The interest coverage ratio increased from 6.94

times for the enterprises with the lowest sales growth portfolio to 9.55 times for

enterprises with highest sales growth portfolio. However, the debt ratio is negatively

related with the sales growth. The mean debt ratio for lowest sales growth enterprise is

26.18 percent and it declines to 22.82 percent for the portfolio of highest sales growth

enterprises. But the median debt ratio for these portfolios is 3.96 percent and 6.54 percent

respectively. The large differences in mean and median values in the portfolios suggest

that the distributions are highly skewed.

Table 4.3 presents the summary statistics of portfolios formed on the basis of net profit

margin. The firm-years with negative net profit margin are included in portfolio 1. The

firm-years with the NP margin between zeros to 4.99 percent are categorized in portfolio

2 and the firm-years with the NP margin greater than 5 percent are formed in portfolio 3.

In part B of Table 4.3, the median investment in net fixed assets, current assets, total

assets, net cash flow and ROA increase monotonically across the three categories. For

example, the median level of net cash flow for portfolio 1 is -22.97 percent of beginning

of period net fixed assets while the median level of net cash flow for portfolio 3 is 57.05

percent. This suggests that the firms in portfolio 3 could have increased their investment

without tapping the external source of capital. At the same time, median level of

investment in fixed asset in portfolio 3 is 7.33 percent of its beginning of period net fixed

assets while it decreases to 2.07 percent for portfolio 1. The median level of

investment in current assets increased from 3.31 percent in portfolio 1 to 11 percent in

portfolio 3.

Table- 3

Summary Statistics of portfolios sorted by Net Profit Ratio

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (Net Profit Ratio) of 26 enterprises over the sample period.

Portfolios

Basis of portfolio (Net Profit margin)

1(Lowest)

<= -.01

2(Medium)

.00 - .04

3(Highest)

.05+

A. Financial status

Net Profit margin (Times) -.3282 .0127 .1668

Interest Coverage (Times) 1.082 3.4191 29.26

Sales Growth (Times) .0573 .2237 .1316

Debt Ratio (Times) .4759 .2234 .0401

Assets Turnover (Times) .8019 2.5488 1.211

Current Ratio (Times) .9343 1.9453 1.876


B.Investment, Cash flow, Growth

Investment in Fixed Assets t /Kt-1 (Times) .1354 .2372 .1501

Investment in Current Assets t /Ct-1 (Times) .1476 .1392 .1351

Investment in Total Assets t /Tt-1 (Times) .0858 .1622 .1489

Cash flowt/Kt-1 (Times) -.5284 1.3060 1.1303

ROA (Times) -.0757 .0956 .1810


This result suggests us that the firms with the higher NP margin have higher investment

ratio, higher cash flow to capital ratio and higher Return on assets.

Part A of Table 4.3 reports the mean and median values of financial status variables

across the three different portfolios formed on the basis of lowest, medium, and highest

NP margin. The firm-years in the negative NP margin portfolio have the smaller sales

growth, smaller assets turnover, and current ratio and smaller interest coverage ratio as

compared to other two portfolios. On the other hand, the debt ratio is negatively related

with the NP margin. The median value of net sales growth increased from 5.73 percent

for the enterprises with the negative NP margin portfolio to 13.16 percent for enterprises

with highest NP margin portfolio. Similarly the average assets turnover ratio increased

from 0.80 times for the enterprises with the negative NP margin portfolio to 1.21 times

for enterprises with highest NP margin portfolio. Likewise, The interest coverage ratio

increased from 1.082 times for the enterprises in the negative NP margin portfolio to

29.26 times for enterprises with highest NP margin portfolio. However, the debt ratio is

negatively related with the NP margin. The mean debt ratio for negative NP margin

enterprises is 47.59 percent and it declines to 4.01 percent for the portfolio of highest NP

margin enterprises. But the median debt ratio for these portfolios is 53.50 percent and

zero percent respectively.

Table 4.4 reports the portfolio sorted by Debt Ratio. The firm-years observations are

grouped in portfolio 3 if the debt ratio is higher than 30 percent. The firm-years

observations between 1 to 30 percent debt ratios are classified in portfolio 2 and the

observations with no debt at all are sorted in portfolio 1. For investment studies of

western economies, the intuition behind such a sample split is mostly that the companies

with a relatively large amount of debt are more likely (ex ante) to face liquidity

constraints.

Table-4:4

Summary Statistics of portfolios sorted by Debt Ratio

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (Debt Ratio) of 26 enterprises over the sample period.

Portfolios

Basis of portfolio (Debt Ratio)

1(Lowest)

<= .00

2(Medium)

.01 - .29

3(Highest)

.30+

A. Financial statusNet Profit margin (Times) .0681 -.0227 -.2138Interest Coverage (Times) 18.9520 12.6441 .5590Sales Growth (Times) .1861 .0648 .1314Debt Ratio (Times) .0000 .1340 .6331Assets Turnover (Times) 2.4280 1.0449 .7578Current Ratio (Times) 2.0310 1.2493 1.2816Number of observations 67 39 54

B.Investment, Cash flow, GrowthInvestment in Fixed Assets t

/Kt-1

(Times).1815 .1521 .1824


/Ct-1

(Times).1855 .0885 .1275

Investment in Total Assets t /Tt-

1

(Times).1750 .0912 .1088

Cash flowt/Kt-1 (Times) 1.5973 .1686 -.1587ROA (Times) .1619 .0660 -.0455Number of observations 66 39 53

From table 4.4 it could be discerned that there are a notable differences in among the

firms in the sample with respect to stock of long term debt. As can be seen from the table

the firms with the negative cash flow, and firms with negative ROA predominantly hold

long-term debt. For Nepalese firms it is the case that firms with the positive long-term

debt are on average relatively larger in size, do not make a profit and display a lower

sales growth. As can be seen from the table the ROA of unleveled firms is 16.19 percent

where as it declines to -4.55 percent for the heavily indebted firms (portfolio3)

The summary statistics of financial status variable in part A of Table 4.4 reports the debt

ratio has negative relation with CR, NP Margin, Assets turnover, Interest Coverage and

Sales growth. The median value of net sales growth increased from 13.14 percent for the

enterprises with the higher debt ratio to 18.64 percent for enterprises with no debt ratio.

Similarly the average assets turnover ratio increased from .75 times for the enterprises

with higher debt ratio to 2.42 times for enterprises with no debt ratio. Likewise, The

interest coverage ratio increased from 0.55 times for the enterprises with higher debt ratio

to 18.95 times for enterprises with no debt ratio. Similarly, the current ratio increased

from1.28 times for enterprises with the highest net cash flow ratio to 2.03 times for the

enterprise with no debt ratio. Very importantly the net profit margin for heavily indebted

firms are negative (-21.38 percent) but at the same time the firms with no debt at all have

positive net profit margin. All these results suggest that for the Nepalese firms higher the

debt ratio is the sign of financial weakness and they are liquidity constrained.

Table 4.5 reports portfolios sorted by Assets Turnover Ratio. Every year, the firms with

the lowest Assets Turnover Ratio (the bottom one-third) are categorized as Portfolio 1,

the next one third are categorized as portfolio 2, and the top one-third are categorized as

portfolio 3. Assets turnover ratio is the sign of operational health of the firm. The firms

with higher assets turnover ratio have higher cash flow, higher ROA and greater

investment in fixed, current and total assets as compared to the firms with smaller ATR.

Table-4: 5

Summary Statistics of portfolios sorted by Assets Turnover

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (Assets Turnover) of 26 enterprises over the sample period

Portfolios

Basis of portfolio (Assets turnover)

1(Lowest)

<= .65

2(Medium)

.66 – 1.30

3(Highest)

1.31+

A. Financial statusNet Profit margin (Times) -.1536 -.0189 .0243Interest Coverage (Times) 15.4776 10.4865 7.6699Sales Growth (Times) .1110 .0736 .2308Debt Ratio (Times) .3609 .2627 .1152Assets Turnover (Times) .4010 .9003 3.2920Current Ratio (Times) 1.1917 1.4027 2.1717Number of observations 54 52 54B.Investment, Cash flow, GrowthInvestment in Fixed Assets t /Kt-1 (Times) .1224 .1895 .2116Investment in Current Assets t

/Ct-1

(Times).1207 .0734 .2276

Investment in Total Assets t /Tt-1 (Times) .0888 .1116 .1969Cash flowt/Kt-1 (Times) -.1429 .2298 1.8246ROA (Times) .0075 .0440 .1487Number of observations 52 51 52

The cash flow ratio to fixed assets increased to 1.82 times for the portfolio 3 firms from

the -.14 times for the lowest assets turnover portfolio. Mean ROA for the portfolio 3 is

highest than other two portfolios. This suggests that the higher assets turnover ratio is the

sign of sound financial health for Nepalese enterprises.

Part A of Table 4.5 reports the mean values of financial status variables across the three

different portfolios formed on the basis of lowest, medium, and highest assets turnover

ratio. The firm-years in the portfolio 1 have the smaller sales growth, NP margin and

smaller current ratio as compared to other two portfolios. On the other hand, the debt

ratio is negatively related with the assets turnover ratio. The median value of net sales

growth increased from 11.10 percent for the enterprises with the smaller assets turnover

ratio to 23.08 percent for enterprises with larger assets turnover ratio. Similarly, the

current ratio declined from 2.17 times for enterprises with the highest assets turnover

ratio to 1.19 times for the enterprise with lowest assets turnover ratio. Likewise, The NP

margin increased from –15.36 percent for the enterprises with smaller assets turnover

ratio to 2.43 percent for enterprises with highest assets turnover ratio. However, the debt

ratio is negatively related with the assets turnover ratio. The mean debt ratio for smaller

assets turnover firms is 36.09 percent and it declines to 11.52 percent for the highest

assets turnover enterprises in portfolio 3. Similarly the Interest coverage ratio decreases

monotonically as the assets turnover ratio increases across the portfolio.

In Table 4.6 portfolios sorted by interest coverage ratio are presented. The firms with

higher interest coverage ratio also have higher investment ratio in fixed assets, current

assets, and total assets. The average growth in fixed assets increased from 13.37 percent

for the lowest interest coverage portfolio to 17 percent for the highest.

Table-4: 6

Summary Statistics of portfolios sorted by interest coverage

The reported results in section A are the means of firm financial status variables e.g. Net Profit Margin, Interest Coverage, Sales Growth, Debt Ratio, Assets Turnover and Current Ratio. The average yearly growth in fixed Assets, Current assets, Total assets, and average yearly cash flow and Return on Assets are reported in section B. Every portfolios are sorted by financial status variables (interest coverage) of 26 enterprises over the sample period

Portfolios

Basis of portfolio (Int.Cov)

1(Lowest)

<= .94

2(Medium)

.95 - 4.38

3(Highest)

4.39+

A. Financial statusNet Profit margin (Times) -.3205 .0206 .1510Interest Coverage (Times) .1303 2.0884 31.5738Sales Growth (Times) .0729 .1961 .1440Debt Ratio (Times) .4905 .2305 .0183Assets Turnover (Times) .8403 2.2248 1.5032Current Ratio (Times) .9263 1.9044 1.9259Number of observations 53 54 51B.Investment, Cash flow, GrowthInvestment in Fixed Assets t /Kt-1 (Times) .1337 .2193 .1700Investment in Current Assets t /Ct-1 (Times) .1527 .0857 .1883Investment in Total Assets t /Tt-1 (Times) .0905 .1191 .1865Cash flowt/Kt-1 (Times) -.5845 1.2824 1.2462ROA (Times) -.0737 .1021 .1771Number of observations 53 54 51

The enterprises with higher interest coverage also have higher average investment (18.83

percent) in current assets and the enterprises with the smaller interest coverage have only

the 15.27 percent investment in current assets. As regards to cash flow, the enterprises

with smaller interest coverage ratio have negative cash flow to capital ratio where as the

enterprises with higher interest coverage ratio have average cash flow of 1.24 times of

their fixed capital. It indicates that the enterprises with greater interest coverage ratio

reveal the sound financial health of Nepalese enterprises.

Among the financial status variables, a negative relation of interest coverage ratio with

debt ratio are noticed where as it has positive relation with all other financial status

variables. The median value of net sales growth increased from 7.29 percent for the

enterprises with the smaller interest coverage ratio to 14.40 percent for enterprises with

larger interest coverage. Similarly, the current ratio declined from 1.92 times for

enterprises with the highest interest coverage ratio to .92 times for the enterprise with

lowest interest coverage ratio. Likewise, The NP margin increased from –32.05 percent

for the enterprises with smaller interest coverage ratio to 15.10 percent for enterprises

with highest interest coverage ratio. Similarly the average assets turnover ratio increased

from .84 times for the enterprises with lower interest coverage ratio to 1.5 times for

enterprises with higher interest coverage ratio However, the debt ratio is negatively

related with the interest coverage ratio. The mean debt ratio for smaller interest coverage

firms is 49.05 percent and it declines to 1.83 percent for the highest interest coverage

enterprises in portfolio 3.

The overall results of the above analysis suggests that the financial status variables have a

relationship with firm investment, cash flow, and Return on Assets of Nepalese

enterprises. There is also noticed the existence of relationship among the financial status

variables themselves. The overall results indicate the two major trends in Nepalese

enterprises. First, the debt ratio is negatively related with other variables in all cases,

among others. For Nepalese firms it is the case that all firms with the positive long-term

debt are on average relatively larger in size, do not make a profit and display a lower

sales growth. All these results suggest that for the Nepalese firms higher the debt ratio is

the sign of financial weakness and they are liquidity constrained. Second, except the debt

ratio all other study variables are more or less positively related with each other and the

financial status variable have considerable impact on firm investment, cash flow and

growth.

4.3 Regression estimate of the financial status variables on firm investment

In this section, first, it has been examined the relationship between the firm financial

status and investment in capital expenditure by following the KZ-97 methodology and

estimating the separate regression equation for each independent variable. The regression

results are presented in table 4.7. The first six models include one of the six independent

variables at a time. Model 7 and 8 includes different combinations of independent

variables and model 9 includes all the six independent variables simultaneously. The

results of these alternative specifications support the summary statistics for portfolios

sorted by financial status variables.

The values reported in table 4.7 are all as per prior expectation and encouraging. The all

estimated coefficient of current ratio, assets turnover ratio and sales growth are positive

in different models. The intercept and slope coefficient for current ratio and assets

turnover ratio are significant on model 1 and model 5 respectively. It suggests that these

financial status variables have strong relationship with the investment in capital

expenditure of Nepalese enterprises.

Table: 4.7

Estimation of relationship between firm investment and financial status.

Values reported are OLS regression estimates over the whole sample period (1995-2004). See Table 1 for details on the construction of the data set and the variables. Capital expenditure (normalized by net fixed assets) is the dependent variable. The independent variables are the proxies for firm financial status i.e., the current ratio, debt ratio, sales growth, net profit margin, and assets turnover and interest coverage ratio. Model one to six presents the intercept and slope coefficient of regression equation of each independent variable at a time, model seven and eight include the different combination of independent

variables and model 9 presents the values of the multiple regression of all independent variables simultaneously.Model Intercept Regression coefficient of Adj.R2 F-

statisticCR Debt ratio Sales

GrowthNP Margin

Assets Turnover

Int.Cov.

1 .099{1.798}*

.046{1.684}*

0.011 2.83

2 .223{5.229}***

-.189{-1.76}*

0.013 3.10

3 .157{4.503}***

.128{1.497}

0.008 2.24

4 .175{5.201}***

.001{012}

0.006 0.99

5 .111{2.617}***

.041{2.306}**

0.026 5.38

6 .191{4.927}***

-.001{-.787}

.000 .619

7 .268{3.456}***

-.265{-1.98}**

.008{375}

-.003{-1.59}

.022 2.16

8 0.077{1.31}

0.048[1.70}*

.127{1.457}

-.014{-.215}

0.014 1.73

9 .189{2.186}**

.047{1.564}

-.265{-1.938}*

.104{1.191}

-.028{-.398}

0.01{-.027}

-.004{-1.61}

.029 1.80

Notes: t-statistics in the brackets. ***, ** and *:significance levels at the 1, 5, and 10

percent levels respectively

Net profit margin and interest coverage ratio are the proxies for profitability and are

considered as financial status variable to the present study. The estimated relationship

between firm investment and the interest coverage ratio is negative and insignificant in

all models as stated above. This result suggests that the interest coverage ratio has not

much explanatory power in capital expenditure of firms. The result of Net profit margin

is also similar to interest coverage ratio.

As regards to debt ratio, the debt coefficient is not only clearly significant but the size of

debt coefficient is relatively large in all equations and they are all negative in various

models. The size of coefficient is in line with the results found by others (see Fazzari et.

al, 1988, and Hubbard, 1998). This result indicates that the investment in capital

expenditure declines with the increase in debt ratio.

4.4 Regression estimate of the financial status variables on current assets growth

The regression results of various models of growth in current assets on financial status

variables are presented in table 4.8 First, it has been examined the relationship between

the firm financial status and investment in current assets estimating the separate

regression equation for each independent variable. The first six models include one of the

six independent variables at a time. Model 7 and 8 includes different combinations of

independent variables and model 9 includes all the six independent variables

simultaneously. The results of these alternative specifications support the summary

statistics for portfolios sorted by financial status variables.

The results reported in table 4.8 are mixed. The signs of coefficients for current ratio,

sales growth, assets turnover ratio and debt ratio are as per prior expectation.

Table: 4.8

Estimation of relationship between growth in current assets and firm financial

status.

Values reported are OLS regression estimates over the whole sample period (1995-2004). See Table 1 for details on the construction of the data set and the variables. Increase in current assets (normalized by beginning of period current assets) is the dependent variable. The independent variables are the proxies for firm financial status i.e., the current ratio, debt ratio, sales growth, net profit margin, and assets turnover and interest coverage ratio. Model one to six presents the intercept and slope coefficient of regression equation of each independent variable at a time, model seven and eight include the different combination of independent variables and model 9 presents the values of the multiple regression of all independent variables simultaneously.

Model

Intercept Regression coefficient of Adj.R2

F-statistic

CR Debt ratio

SalesGrowth

NP Ratio

Assets Turno.

Int.Cov.

1 -.007{-.128}

.096{3.309}***

.061 10.949

2 .147{3.339}**

-.022{-.21}

.006 .043

3 .101{2.967}**

.308{3.49}***

.069 12.23

4 .140{4.123}**

-.005

.000 .006

* {-.07}

5 .0581.309

.055{2.7}*

.042 7.7

6 .154{3.996}***

-.001{-.678}

.000 .460

7 .107{2.409}**

-.032{-.27}

.308{3.47}***

-.032{-.25}

0.057 4.058

8 -.012{-.197]

.077{2.419}**

.032{1.46}

-.002[-.814}

.068 4.69

9 -.136{-1.651}

.060{1.924}*

.144{1.12}

.347{3.93}***

-.017{-.25}

.062{2.5}**

.001{.285}

0.144 5.27



But the estimated coefficients of interest coverage and net profit margin are not as per our

prior assumptions. The models (model 4 and 6) for these two variables are also

insignificant as the F-statistics are very small. The adjusted R2 for these two models are

negative suggesting that these variables are unable to explain the changes in current

assets growth.

The estimated coefficients of current ratio, sales growth, and assets turnover ratio are all

positive for various models. The results, among others, show the positive relationship of

investment in current assets with current ratio, sales growth, and assets turnover ratio.

Basically, these all coefficients are not only positive but also statistically significant in all

the time whether they all exist alone or put together with other independent variables in

the regression models. (see Models 1,3,5,7,8, and 9). By this result it is noticed that the

explanatory power of current ratio, and sales growth are important to explain the

variation in investment in current assets.

As regards to debt ratio, the debt coefficient is negative for model 1 and model 7. But the

estimated debt coefficient is positive (see model 9) when all the independent variables

are considered simultaneously. However, in all the cases the debt coefficients are not

statistically significant.

It is noteworthy to suggest that the inclusion of current ratio, assets turnover ratio and

sales growth in regression models makes it more capable in explaining the total variation

in current assets investment: as indicated by the coefficient of multiple determination

(adjusted R2). F-statistics for Models 1,3, 5, 7, 8, and 9 are also statistically significant

indicating that these regression models have a proper goodness of fit.

4.5 Regression estimate of the financial status variables on total assets growth

The regression results of various models of growth in total assets on financial status

variables are presented in table 4.9 First, it has been examined the relationship between

the firm financial status and investment in total assets estimating the separate regression

equation for each independent variable. The growths in total assets are obtained as taking

the first difference of total assets divided by the beginning of period total assets. The

independent variables for the regression equation are Current ratio, assets turnover ratio,

debt ratio, sales growth, interest coverage ratio and net profit margin all considered as

proxies for firm financial status

The first six models include one of the six independent variables at a time. Model 7 and 8

includes different combinations of independent variables and model 9 includes all the six

independent variables simultaneously. The results of these alternative specifications

support the summary statistics for portfolios sorted by financial status variables.

The results reported in table 4.9 are mixed. The signs of coefficients for current ratio,

sales growth, assets turnover ratio and debt ratio are as per prior expectation. But the

estimated coefficients of interest coverage and net profit margin are not as per our prior

assumptions. The models (model 4 and 6) for these two variables are also insignificant as

the F-statistics are very small. The adjusted R2 for these two models are negative

suggesting that these variables are unable to explain the changes in total assets growth.

Table: 4.9

Estimation of relationship between total assets growth and firm financial status.

Values reported are OLS regression estimates over the whole sample period (1995-2004). See Table 1 for details on the construction of the data set and the variables. Increase in total assets (normalized by beginning of period total assets=∆TA/TAt0) is the dependent variable. The independent variables are the proxies for firm financial status i.e., the current ratio, debt ratio, sales growth, net profit margin, and assets turnover and interest coverage ratio. Model one to six presents the intercept and slope coefficient of regression equation of each independent variable at a time, model seven and eight include the different combination of independent variables and model 9 presents the values of the multiple regression of all independent variables simultaneously.

Model Intercept Regression coefficient of Adj.R2 F-statistic

CR Debt ratio

SalesGrowth

NP Margin

Assets Turnover

Int.Cov.

1 -.013(-.295)

.091{4.042}***

.089 16.33

2 .148{4.108}***

-.061{-.677}

.000 .459

3 .102{3.614}***

.224{3.16}**

.054 10.27

4 .131{4.690}***

-.007{-.130}

.000 .017

5 .068{1.886}*

.044{2.631}*

.036 6.92

6 .140{4.339}***

-.001{-.486}

.000 .236

7 .087{1.390}

-.031{-.296}

.041{2.224}**

-.001{-.344}

.025 2.32

8 -.057{-1.228}

.097{4.30}***

.223{3.28}**

-.040-.765

.146 9.92

9 -.087{-1.264}

.083{3.339}**

.028{.259}

.244{3.49}**

-.035{-.636}

.034{1.746}*

-.001{-.316}

.153 5.744



The estimated coefficients of current ratio, sales growth, and assets turnover ratio are all

positive for various models. The results, among others, show the positive relationship of

investment in total assets with current ratio, sales growth, and assets turnover ratio.

Basically, these all coefficients are not only positive but also statistically significant in all

the time whether they all exist alone or put together with other independent variables in

the regression models. (See Models 1,3,5,7,8, and 9). By this result it is noticed that the

explanatory power of current ratio, assets turnover ratio and sales growth are important to

explain the variation in investment in total assets.

As regards to debt ratio, the debt coefficient is negative for model 1 and model 7. But the

estimated debt coefficient is positive (see model 9) when all the independent variables

are considered simultaneously. However, in all the cases the debt coefficients are not

statistically significant.

It is noteworthy to suggest that the inclusion of current ratio, assets turnover ratio and

sales growth in regression models makes it more capable in explaining the total variation

in total assets investment: as indicated by the coefficient of multiple determination

(adjusted R2). F-statistics for Models 1,3, 5, 7, 8, and 9 are also statistically significant

indicating that these regression models have a proper goodness of fit.

4.6 Properties of portfolios formed on Growth in fixed assets.

The properties of portfolio on growth in fixed assets and its relationship with various

measures of Liquidity, Efficiency, Leverage, Profitability, Growth,and Market

opportunity are presented in table-4.5 The smallest, intermediate and largest groups are

formed by sorting all firm-years according to their percentage of growth in fixed assets.

Every year, the firms with the lowest percentage of growth in fixed assets (the bottom

one-third i.e., < 2%) are categorized as smallest; the next one third are categorized as

intermediate (3-12 %); and the top one-third (>13%) are categorized the largest.

Table- 4.10

Properties of portfolios formed on Growth in fixed assets

The followings are the reports of financial variable statistics for the sample of firms-year observations of Nepalese non-financial sectors of enterprises. A full-description of the variables is included in the Appendix. The smallest, intermediate and largest groups are formed by sorting all firm-years according to their percentage of growth in fixed assets. Every year, the firms with the lowest percentage of growth in fixed assets (the bottom one-third i.e., < 2%) are categorized as smallest; the next one third are categorized as intermediate (3-12 %); and the top one-third (>13%) are categorized the largest.

Financial variables Portfolios

N Mean Std. Deviation

Liquidity(Current ratio)

Smallest 54 1.4499 1.37958Intermediate 52 1.5092 1.14154Largest 54 1.8006 1.10598

Efficiency(Assets Turnover)


Leverage(Debt Ratio)

Smallest 54 .3162 .39326Intermediate 52 .2858 .27810Largest 54 .1385 .22012

Profitability(Net Profit Margin)

Smallest 54 -.1003 .37921Intermediate 52 -.0522 .29047Largest 54 .0048 .18835

Coverage(Interest Coverage)


Growth(Sales Growth)


Internal Liquidity(Cash flow)

Smallest 53 .3202 1.51196Intermediate 51 .4477 1.15720Largest 54 1.1486 2.07885

Market opportunity(ROA)


The characteristics of traditional financial ratios presented in the table-4.10, among others

reveal the followings;

The firms with the larger growth in fixed assets have higher liquidity. The average

current ratio increased from 1.44 times for the smallest portfolio to 1.80 for the

largest portfolio. Similarly, the cash flow to net fixed assets ratio also increased

from 0.32 times for smallest portfolio to 1.15 times for the largest portfolio. Thus

with the increase in liquidity position, the investment in fixed assets tends to

increase. Current ratio for smallest portfolio is more variable than for the largest

portfolio but the cash flow ratio is less variable for smallest portfolio.

The operational efficiency of the firm is measured by the assets turnover ratio.

The firms with the larger growth in fixed assets have higher assets turnover ratio.

The average assets turnover ratio increased from 1.31 times for the smallest

portfolio to 1.97 times for the largest portfolio. Thus a positive relationship is

noticed between the growth in fixed assets and assets turnover ratio. However, the

variability in assets turnover ratio is increased monotonically from the smallest to

largest portfolio.

The negative relationship is noticed between the leverage and growth in fixed

assets. The ratio of long term debt to total assets declined from 31.6 percent for

smallest portfolio to 13.85 percent to the largest portfolio. Similarly, the

variability in leverage ratio is decreased monotonically from the smallest to

largest portfolio.

A positive relationship is noticed between the investment in fixed assets and sales

growth. The firms with the larger growth in fixed assets have higher sales growth.

The sales growth increased from 13.02 percent for the smallest portfolio to 18.73

percent for the largest portfolio. This result suggests that with the increase in the

growth in sales, the investment in fixed assets tends to increase. However, the

variability in sales growth also increases from 38.57 percent to 44.28 percent from

smallest to largest portfolio.

A positive relationship is noticed between the Interest coverage ratio and growth

in fixed assets. Similarly the net profit margin, and the return on assets also have

the positive relationship with the growth in fixed assets. These results suggest that

with the increase in net profit margin, ROA, and interest coverage ratio,

investment in fixed assets tends to increase.

4.7 Properties of portfolios formed on Growth in Current Assets:

The properties of portfolio on growth in current assets and its relationship with various

measures of Liquidity, Efficiency, Leverage, Profitability, Growth, and Market

opportunities are presented in Table-4.6. The smallest, intermediate and largest groups

are formed by sorting all firm-years observations according to their percentage of growth

in fixed assets. Every year, the firms with the lowest percentage of growth in current

assets (the bottom one-third i.e., < -2%) are categorized as smallest; the next one third are

categorized as intermediate (-1 to20 %); and the top one-third (>21%) are categorized the

largest

Table- 4.11

Properties of portfolios formed on Growth in Current Assets

The followings are the reports of financial variable statistics for the sample of firms-year observations of Nepalese non-financial sectors of enterprises. A full-description of the variables is included in the Appendix. The smallest, intermediate and largest groups are formed by sorting all firm-years according to their percentage of growth in current assets. Every year, the firms with the lowest percentage of growth in current assets (the bottom one-third i.e., <- 2%) are categorized as smallest; the next one third are

categorized as intermediate (-1-20 %); and the top one-third (>21%) are categorized the largest

Financial

variables

Portfolios N Mean Std. Deviation

Liquidity

(Current ratio)

Smallest 50 1.4772 1.20458

Intermediate 52 1.5268 1.19327

Largest 51 1.5750 1.09463

Efficiency

(Assets

Turnover)

Smallest 50 1.7638 2.25984

Intermediate 52 1.0416 1.05032

Largest 51 1.8656 1.84915

Leverage

(Debt Ratio)

Smallest 50 .2409 .34516

Intermediate 52 .3132 .29230

Largest 51 .2085 .30895

Profitability

(Net Profit

Margin)

Smallest 50 -.0626 .28458

Intermediate 52 -.0910 .32012

Largest 51 -.0346 .25059

Coverage

(Interest

Coverage)

Smallest 50 7.1488 14.45916

Intermediate 52 9.9394 17.68230

Largest 51 13.0133 19.49479

Growth

(Sales Growth)

Smallest 50 .0028 .37592


Largest 51 .2740 .41536

Internal

Liquidity

(Cash flow)

Smallest 50 .5130 1.69828

Intermediate 52 .3865 1.23146

Largest 51 1.0192 1.99783

Market

opportunity

Smallest 50 .0448 .25630


(ROA)

Largest 51 .0625 .25347

The characteristic of traditional financial ratios presented in the Table 4.11, among others

reveals the followings;

The firms with the larger growth in current assets have higher liquidity. The

average current ratio increased from 1.47 times for the smallest portfolio to 1.57

for the largest portfolio. Similarly, the cash flow to net current assets ratio also

increased from 0.51 times for smallest portfolio to 1.02 times for the largest

portfolio. Thus with the increase in liquidity position, the investment in current

assets tends to increase. Current ratio for smallest portfolio is more variable than

for the largest portfolio but the cash flow ratio is less variable for smallest

portfolio.


The firms with higher assets turnover ratio have the larger growth in current

assets. The average assets turnover ratio increased from 1.76 times for the

smallest portfolio to 1.86 for the largest portfolio. Thus a positive relationship is

noticed between the growth in current assets and assets turnover ratio. However,

the mean assets turnover ratio and its variability is the smallest for the

intermediate portfolio.

The negative relationship is noticed between the leverage and growth in current




largest portfolio. However, the mean debt ratio is the smallest for the intermediate

portfolio.

A positive relationship is noticed between the investment in current assets and

sales growth. The firms with the larger growth in current assets have higher sales

growth. The sales growth increased from 0.2 percent for the smallest portfolio to

27.40 percent for the largest portfolio. This result suggests that with the increase

in the growth in sales, the investment in current assets tends to increase. However,

the variability in sales growth also increases from 37.59 percent to 41.53 percent

from smallest to largest portfolio.


in current assets. Similarly the net profit margin, and the return on assets also

have the positive relationship with the growth in current assets. These results

suggest that with the increase in net profit margin, ROA, and interest coverage

ratio, investment in current assets tends to increase.

4.8 Portfolios formed on Growth in Total Assets

The properties of portfolio on growth in total assets and its relationship with various measures of

liquidity, Efficiency, leverage, Profitability, Growth, Market opportunities are presented in Table-

4.7. The smallest, intermediate and largest groups are formed by sorting all firm-years

observations according to their percentage of growth in total assets. Every year, the firms with the

lowest percentage of growth in total assets (the bottom one-third i.e., < 2%) are categorized as

smallest; the next one third are categorized as intermediate (3 to14 %); and the top one-third (>15

%) are categorized the largest

Table 4.12

Properties of portfolios formed on Growth in Total Assets

The followings are the reports of financial variable statistics for the sample of firms-year observations of Nepalese non-financial sectors of enterprises. A full-description of the variables is included in the Appendix. The smallest, intermediate and largest groups are formed by sorting all firm-years according to their percentage of growth in fixed assets. Every year, the firms with the lowest percentage of growth in total assets (the bottom one-third i.e., <2%) are categorized as smallest; the next one third are categorized as intermediate (3-14 %); and the top one-third (>15%) are categorized the largest.

Financial variables Portfolios

N Mean Std. Deviation

Liquidity(Current ratio)


Efficiency(Assets Turnover)

Smallest 53 1.8077 2.20998Intermediate 53 .9766 1.06308Largest 52 1.8617 1.82500

Leverage Smallest 53 .2541 .34793

(Debt Ratio)

Intermediate 53 .2916 .29660Largest 52 .1915 .29377

Profitability(Net Profit Margin)

Smallest 53 -.0719 .32984Intermediate 53 -.0527 .31446Largest 52 -.0245 .25201

Coverage(Interest Coverage)


Growth(Sales Growth)


Internal Liquidity(Cash flow)

Smallest 53 .4655 1.65934Intermediate 52 .3462 1.23445Largest 51 1.0999 1.96019

Market opportunity(ROA)


The characteristic of traditional ratios presented in the table 4.12, among others reveals

the followings;

The firms with the larger growth in total assets have higher liquidity. The average

current ratio increased from 1.53 times for the smallest portfolio to 1.74 for the

largest portfolio. Similarly, the cash flow to net total assets ratio also increased

from 0.46 times for smallest portfolio to 1.09 times for the largest portfolio. Thus

with the increase in liquidity position, the investment in total assets tends to

increase. Current ratio for smallest portfolio is more total assets tends to increase.

Current ratio for smallest portfolio is more variable than for the largest portfolio

but the cash flow ratio is less variable for smallest portfolio.


The firms with the larger growth in total assets have higher assets turnover ratio.

The average assets turnover ratio increased from 1.80 times for the smallest

portfolio to 1.86 for the largest portfolio. Thus a positive relationship is noticed

between the growth in total assets and assets turnover ratio. However, the mean

assets turnover ratio and its variability is the smallest for the intermediate

portfolio.

The negative relationship is noticed between the leverage and growth in total




largest portfolio.

A positive relationship is noticed between the investment in total assets and sales

growth. The firms with the larger growth in total assets have higher sales growth.

The sales growth increased from 3 percent for the smallest portfolio to 24.42

percent for the largest portfolio. This result suggests that with the increase in the

growth in sales, the investment in total assets tends to increase. Similarly, the

variability in sales growth also increases from 39.97 percent to 42.47 percent from

smallest to largest portfolio.


in total assets. Similarly the net profit margin, and the return on assets also have

the positive relationship with the growth in total assets. These results suggest that

with the increase in net profit margin, ROA, and interest coverage ratio,

investment in total assets tends to increase.

4.9 Conclusion

In this chapter, it was attempted to test the empirics that whether the firm financial status

matters in the investment decisions of Nepalese enterprises. The overall results suggest

that there is the existence of strong relationship between the firm investment and

financial status variables. This section indicates the two major trends in Nepalese

enterprises. First, the debt ratio is negatively related with other variables in all cases. For

Nepalese firms it is the case that all firms with the positive long-term debt are on average

relatively larger in size, do not make a profit and display a lower sales growth. All these

results suggest that for the Nepalese firms, higher the debt ratio is the sign of financial

weakness and they are liquidity constrained.

Second, except the debt ratio all other study variables are more or less positively related

with each other and the financial status variables have considerable impact on firm

investment, cash flow and growth.

Documents

A relationship between Firm Investmentand financial status of Nepalese enterprises -Kapil Deb Subedi