capital management on profitability actually is. In addition, Reed and Storrud-Barnes (2009) claim that most management theories focus on manufacturing companies only, and do not address the applicability of the contributions to the service sector. In many respects this is the case also in the research of working capital management. In some studies service companies have been excluded from the sample (see e.g. Deloof, 2003; Dong & Su, 2010), while others have included them in the sample, but not separated them from manufacturing companies (see e.g. Baños-Caballero et al., 2010; Jose et al., 1996). This thesis contributes to the discussion by addressing service providing companies, and by examining how the differences between manufacturing and service companies can be exploited in flexible asset management.
Even though the relation between working capital and profitability has been studied before, the perspective of the company’s owners has not been embodied in the discussion. However, the literature on company valuation has linked the management of fixed assets and working capital to the cost of capital and the company owners’ perspective through the return on equity (henceforth marked with iE). For example Black et al. (1998) have presented a free cash flow model of company shareholder value, in which decreasing the amount of assets has a positive impact on future cash flows. Filbeck et al. (2007) on the other hand conclude that shareholders recognise and value efficient working capital management. Lambert and Pohlen (2001) stress the effect of both fixed assets and working capital on the economic value added (EVA). Their research topic has been carried on by Losbichler et al. (2008), whose main focus is on the role of working capital in creating shareholder value. This thesis contributes to the previous discussion by modelling the relations between asset management and the iE explicitly.
2.2 Strategic asset management in profitability modelling
In addition to the company valuation literature, the impact of asset management on profitability and the company owners’ contentment has also been recognized by the research area of profitability analysis. The DuPont model for financial ratio analysis was first introduced in the early 1900s by an engineer at the DuPont company (e.g. Burns et al., 2008). The original model simply described the relation between relative profitability and the invested capital. The concept of EVA came to the discussion on the efficient use of capital later, in the 1990s (see e.g. Veranen, 1996), and is often integrated with the original DuPont model. Like the DuPont model, the flexible asset management model (henceforth called the FAM model) introduced in this thesis combines aspects of asset
management, profitability and financing. Figure 5 illustrates the logics of the DuPont model and the FAM model to point out the main similarities and differences between the two. The mathematical derivation of the FAM model has been presented in publications 2 and 3 and is not repeated here.
There are three main differences between the presented DuPont model and the FAM model. The first one is related to the financial ratios to be analysed: while the DuPont model examines EVA through ROI and the weighted average cost of capital (WACC), the FAM model focuses on ROI as well as iE. This is because the purpose of the use of the FAM model in this thesis is in inter-organizational contexts and company networks. Thus comparisons of the ratios between companies are of utmost importance, which favours percentage ratios like iE over monetary ratios like EVA.
The second difference between the models is the way the invested capital is grouped. As regards the FAM model, the focus in on asset management, and thus fixed assets and operating working capital are highlighted, while the other components of net working capital are pooled into a single residual group. The third and final main difference between the models concerns the cycle times used in the FAM model: unlike in the DuPont model, the amount of working capital is proportioned to the amount of sales to examine the matter through cycle times instead of monetary sums. The cycle times, expressed in days, are easier to grasp than monetary sums, and they also enable inter-organizational comparison.
Figure 5. Comparison of the DuPont model (adapted from Petersen & Plenborg, 2012) and the FAM model constructed in this thesis
DuPont model
Amount of operating working capital Other components of net working capital
Cycle time of operating
Some models quite similar to the FAM model have been introduced in previous literature. Higgins (1977) has presented a model for sustainable growth, integrating growth with profitability and capital structure. In his model the sustainable growth rate of a company is composed of profitability, the dividend pay-out ratio, the debt-to-equity ratio, and the ratio of the company’s assets to net sales. The model does not separate fixed assets and working capital, but treats all assets together. The main purpose of this kind of models is to help managers preserve a viable capital structure during the growth or decrease of sales. Other growth and profitability models much alike that of Higgins (1977) have been discussed in the literature (see e.g. Aho, 1993; Donaldson, 1984;
Ruuhela, 1982; Talonen, 1973). It must be noted that the previous models have only considered the management of individual companies. In this thesis, however, the discussion is brought to the level of company networks.
The FAM model examines asset management on the strategic level. According to Komonen et al.
(2012), strategic company-level asset management has not been addressed often in the previous literature, but is currently gaining more and more attention, partly due to the increased dynamism of the operating conditions. As a result, new tools are needed for strategic asset management. It must be noted that, unlike tools like the FAM model may imply, in practice it is not easy for companies to adjust the amount of assets in their balance sheets according to the changes in demand. The management decisions made with strategic tools must be cascaded down in the organization to be implemented. As Parida (2012) emphasizes, it is crucial to translate the strategic level objectives in an appropriate language and to form for the tactical and operational levels of the company. Despite the probable challenges in cascading the strategic objectives downwards, strategic-level tools to support decision making in asset management are necessary.
According to PAS 55-1 (2008), asset management policies and strategies should be built on organizational strategic plans. However, the discussion in the literature has not reached strategies for comprehensive asset management, although more restricted perspectives, such as that of strategies in physical asset management, have been widely discussed. For example Swanson (2001) has classified maintenance strategies into reactive, proactive, and aggressive ones: reactive strategies advice intervention after a failure, proactive strategies try to maintain the asset before the failure occurs, and aggressive strategies, such as total productive maintenance aim at maximal overall effectiveness by adjusting also the function or the design of the physical production assets.
This kind of directive typologies and guidelines should be constructed for comprehensive asset
management as well to convey the organizational strategic plans to objectives for the strategies of managing different types of assets.