Working Capital

University of Groningen
Working capital management

Tewolde, S.
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Tewolde, S. (2002). Working capital management: the case of government-owned, transitional, and
privatised manufacturing firms in Eritrea s.n.
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Ter verkrijging van het doctoraat in de

Bedrijfskunde
aan de Rijksuniversiteit Groningen
op gezag van de
Rector Magnificus, dr D.F.J. Bosscher,
in het openbaar te verdedigen op
Dinsdag 24 september2002
om 10:30 uur
door
6HEKDWOHDE7HZROGH
geboren op 13 February 1957

te Akrur (Eritrea)
Promotor: Prof. dr. J. van der Meer-Kooistra
Co-promotor: Dr. J. H. von Eije
Beoordelingscommissie: Prof.dr. R. W. Scapens

Prof. dr. ir. C. Schweigman
Prof. dr. A. B. Dorsman
To
My wife and my children

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The research described in this thesis was written at the University of Groningen,
Faculty of Management and Organisation with empirical data collected from factories
in Eritrea. The co-operation and support of many people during the course of this
work has been very valuable to me. There is a saying in my vernacular Eritrean
(Tigrigna) Language. We say, ”to those who help you, if you can, you have to help
them, otherwise tell other people about their help”. Therefore, at least I owe those
who helped me many thanks and I would like to express my sincere appreciation.
First and foremost, I express my gratitude to my supervisors, Professor dr. Jeltje van
der Meer-Kooistra and Dr. Henk von Eije for their intensive guide throughout the
years of my study. Professor Van der Meer, I thank you for the professional guide and
critical comments, which became the corner stone of my work. I was very lucky to
have Dr. Henk von Eije as my immediate supervisor. Henk, you have deployed all
your time and professional effort in order to help me achieve my objective. You were
never tired reading many copies of the same chapter again and again. Your valuable
comments gave each of my work its final shape. My sincere gratitude also to the
reading committee of my thesis, Prof. dr. R.W. Scapens, Prof. dr. ir. C. Schweigman
and Prof. dr. A. Dorsman for taking their precious time to read and provide me with
valuable comments.
I am indebted to the general, financial and commercial managers of the central firms
as well as the general managers of their suppliers and customers for providing me
with all the data that I needed for my study. It is because of their hospitality and
unreserved co-operation that I have managed to complete this study. Special mention
is to the following general, financial and commercial managers of Keih Bahri Food
Products’ – Mr. Seyum Yohannes, Mrs. Fanna Tewolde and Mr. Zere Mehari. Barka
Canneries’ – Mr. Issak Gebresellasie, Ms. Almaz Abraha and Mr. Semere Debesai,
Keih Bahri Tannery’s – Mr. Mebrahtu Haile, Mr. Fessehaye Solomon and Mr. Haile
Mesfin, Asmara Textile Factory’s – Mr. Alem Araya, Mr. Abraham Tesfaghiorgis and
Mr. Tewolde Kiflu, Dahlack Shoe Factory’s – Mr. Yohannes Habte, Mrs. Assefash
Berhe and Mr. Tekeste Medhanie, Lalmba Sack Factory’s – Mr. Haile Tesfamichael,
Mr. Teklit Yohannes and Mr. Mohamed Abdu. For the same reason I would also like
to thank Sembel Household Factory’s – Mr. Tesfagebriel Gebresellasie and Mr.
Yohannes Neamn, Asmara Milk Factory’s – Mr. Mehreteab Okbamichael and Mr.
Alazar Habtom, Asmara Sweater Factory’s – Mr. Semere Okbamichael and Mrs.
Aster Beyene and Eritrea Steel Sheet Factory’s - Mr. Abraha Tucu, Mr. Berhane
Araya and Mr. Alem Ghebremariam.
I thank NUFFIC for financing my PhD project and the University of Asmara for
giving me the chance to continue my education. I also thank all the people at the
Office of the International Co-operation: Madeleine, Pieter, Regine, Marieke, Erik
and others – for all the uncountable help. I easily felt at home and adapted to the life
in Groningen because of the hospitality and support of Henk and his family, my
friends Albert and his wife Nanny, Johan and his friend Ina. I thank you for all the
invitations at your homes and making me feel at home and enjoy the Dutch
delicacies.
I am also grateful to Dr. Clemens Lutz in taking care of all issues regarding the
administration of my academic program. Colleagues at my Department (Department
of Financial Management) also helped me a lot in different ways, including the
surprising congratulatory gifts when my daughter Delina was born. Let me name our
tireless and ever polite secretaries, Anja, Jessica and Barbara and my other colleagues
– Albert, Wim, Pieter J., Pieter K., Teye, Ben, Marcel, Niels and Serge. My special
appreciation also goes to Jessica for taking her time to translate the summary to the
Dutch language, to my friend and officemate, Serge for reading the draft and Arthur
for the final edit and making the book ready for the publishers.
This work would have never been realised without the determination and
steadfastness of my wife Tsehai Haile. She suffered most in my absence to take care
and bring up our children, Habtit, Saron and Delina. My work is the result of your
perseverance. For this reason I have dedicated this work to you and our children.
Indeed, I thank you for everything. Last but not least, I thank for the moral and
financial help of my mother Ghidei Ghoniche, my uncle Aba Lucas Kelati, my
brothers and their families - Fiseha, Tesfamichael and Kiflom, my sisters - Mihret
and Netsihiti. I owe the same gratitude to my mother in-law Nighisty Berhe, brother
in-laws and their families - Hayelom and Laine, sister in-law Zewdi and her husband
Mebrahtu. All of you made a wonderful contribution.
Sebhatleab Tewolde Groningen, September 2002

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1.1. Relevance of working capital ............................................................................... 3

1.2. Research problem, purpose and questions ............................................................ 8
1.3. The Research methodology................................................................................. 12
1.4. Organisation of the book .................................................................................... 15
&+$37(5,17(51$/:25.,1*&$3,7$/0$1$*(0(17
2.1. Introduction ........................................................................................................ 19

2.2. Managing working capital investment................................................................ 21
2.2.1. General considerations..................................................................................... 21
2.2.2. Cash Management ........................................................................................... 24
2.2.3. Inventory Management .................................................................................... 28
2.2.4. Receivable management .................................................................................. 30
2.3. Managing working capital finances.................................................................... 31
2.3.1.Components of working capital financing........................................................ 31
2.3.2. Short-term loan financing................................................................................ 32
2.4. Managing the purchase and cash payment operations ........................................ 34
2.4.1. Purchase operations ......................................................................................... 34
2.4.2. Cash payment operations................................................................................. 34
2.5. Managing sales and cash collection operations .................................................. 35
2.5.1. Sales operation................................................................................................. 35
2.5.2. Cash collections............................................................................................... 39
2.6. Performance management of working capital levels and operations .................. 39
2.6.1. Performance evaluation of working capital investments.................................. 39
2.6.2. Performance evaluation of working capital financing ..................................... 40
2.6.3. Performance evaluation of working capital operations .................................... 41
2.7. Conclusion.......................................................................................................... 43
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3.1. Introduction ........................................................................................................ 45

3.2. The value network model.................................................................................... 46
3.3. The value chain model........................................................................................ 47
3.3.1. The value chain activities ................................................................................ 48
3.3.2. Working capital and value chains.................................................................... 49
3.4. Value chain management.................................................................................... 50
3.4.1. Internal value management .............................................................................. 50
3.4.2. External value chain management ................................................................... 51
3.5. A theory of transaction costs on working capital................................................ 55
3.5.1. Working capital operations from a transaction costs perspective .................... 56
3.5.2. The phases and costs of effecting transactions ................................................ 57
3.5.3. The management of transaction costs .............................................................. 59
3.5.4. Working capital operations from a managerial controls perspective ............... 60
3.5.5. Working capital levels from a managerial controls perspective....................... 62
3.6. Value measurement ........................................................................................... 65
3.7. Conclusion.......................................................................................................... 66
ii
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4.1. Introduction ........................................................................................................ 69

4.2. Ownership, market competition and operational efficiency ............................... 69
4.2.1. Where competition dominates ownership for efficient performance ............... 70
4.2.2. Where ownership dominates competition for efficient performance ............... 71
4.3. Government versus private firms........................................................................ 71
4.3.1. In favour of government ownership ................................................................. 71
4.3.2. In favour of private ownership......................................................................... 73
4.4. Privatised firms................................................................................................... 75
4.4.1. Regulatory institutions and market factors ...................................................... 75
4.4.2. Political objectives and privatisation ............................................................... 76
4.5. The case of firms in transition to privatisation ................................................... 77
4.5.1. The problems of transition firms ..................................................................... 78
4.5.2. Preparing transition firms for privatisation...................................................... 79
4.6. Firm ownership and inter-firm trust.................................................................... 80
4.7 Conclusion........................................................................................................... 82
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5.1. Introduction ........................................................................................................ 85

5.2. The conceptual framework and the central model .............................................. 85
5.2.1. Internal working capital management-
operations, levels and cash flows ............................................................ 85
5.2.2 External working capital management – supplier and customer linkages......... 87
5.2.3 Working capital performance evaluation.......................................................... 89
5.2.4. General issues affecting the management of working capital: ......................... 91
5.2.5. The inter-relationship among internal, external and general............................ 92
5.3. The Research methodology................................................................................. 93
5.3.1. Introduction ..................................................................................................... 94
5.3.2. Data collection................................................................................................. 96
5.3.3. Data analysis.................................................................................................. 104
5.3.4. Research credibility ....................................................................................... 107
5.4. Conclusions ...................................................................................................... 108
&+$37(5*29(510(17),506
6.1. Introduction ...................................................................................................... 113

6.2. Overall working capital management ............................................................... 113
6.2.1. Background information................................................................................ 113
6.2.2. Overall working capital management -
comparison of government firms ........................................................ 115
6.3. Internal working capital management............................................................... 116
6.3.1. Managing working capital investment........................................................... 116
6.3.1.1. Cash management .................................................................... 116
6.3.1.2. Inventory management ............................................................. 118
6.3.1.3. Receivables management ......................................................... 119
6.3.1.4. Managing working capital investment -
Comparison of government firms............................................ 120
6.3.2. Managing working capital finances............................................................... 121
6.3.2.1. Managing working capital finances -
iii
6.3.3. Managing working capital operations............................................................ 123

6.3.3.1. Managing purchase operations................................................. 123
6.3.3.2. Managing sales operations ....................................................... 124
6.3.3.3. Managing working capital operations -
6.3.4. Performance evaluation of working capital decisions.................................... 126
6.3.4.1. Performance evaluation of working capital investments .......... 127
6.3.4.2. Performance evaluation of working capital finances................ 128
6.3.4.3. Performance evaluation of working capital operations ............ 129
6.3.4.4. Performance management - Comparison of government firms 133
6.4. External working capital management: supplier and customer linkages........... 135
6.4.1. Firm-supplier co-operation ............................................................................ 135
6.4.1.1. Responses of the central firms – Keih Bahri Food Products .... 135
6.4.1.2. Firm-supplier co-operation: Comparison of government firms.. 136
6.4.1.3. Responses of supplier: Eritrean Grain Board ........................... 137
6.4.1.4. Firm-supplier co-op. Comparison of responses of government
suppliers .................................................................................. 138
6.4.2. Firm-customer linkages ................................................................................. 139
6.4.2.1. Responses of the central firms - Keih Bahri Food Products...... 139
6.4.2.2. Firm-customer co-operation -
Comparison of government firms ............................................. 141
6.4.2.3. Responses of customer - Asmara Pastry................................... 141
6.5. Conclusion........................................................................................................ 143
&+$37(575$16,7,21),506
7.1. Introduction ...................................................................................................... 147

7.2.2. Overall working capital management issues -
Comparison of transition firms ............................................................. 149
7.3.1. Managing working capital investments ......................................................... 150
7.3.1.1. Cash management .................................................................... 150
7.3.1.2. Inventory Management ............................................................ 151
7.3.1.4. Managing working capital investments -
Comparison of transition firms ............................................... 154
7.3.3.1. Managing working capital finances -
7.3.3.1. Purchase management.............................................................. 156
7.3.3.2 Sales management..................................................................... 157
7.3.4.1. Performance evaluation of working capital investment............ 160
7.3.4.2. Performance evaluation of working capital financing.............. 161
iv
7.3.4.4. Working capital performance - comparison of transition firms . 165

7.4. External working capital management - supplier and customer linkages ......... 167
7.4.1.1. Responses of the central firms - Keih Bahri Tannery ............... 167
7.4.1.2. Firm-supplier co-operation - Comparison of transition firms .... 168
7.4.1.3. Responses of supplier: Asmelash Hides and Skins .................. 169
7.4.1.4. Firm-supplier co-operation -
comparison of suppliers of transition firms............................. 170
7.4.2.1. Responses of the central firms - Keih Bahri Tannery............... 171
7.4.2.2. Firm-customer co-operation - Comparison of transition firms... 173
7.4.2.3. Responses of customer - Selamawit Shoe Factory ................... 173
7.4.2.4. Firm-customer co-operation -
comparison of customers of transition firms ........................... 174
7.5. Conclusions ...................................................................................................... 179
&+$37(535,9$7,6('),506
8.1. Introduction ...................................................................................................... 179

8.2.2. Overall working capital management issues -
comparison of privatised firms.............................................................. 181
8.3.1.1. Cash management .................................................................... 182
8.3.1.4. Managing working capital investment -
comparison of privatised firms................................................ 185
8.3.3.1. Purchase management.............................................................. 187
8.3.3.2. Sales management.................................................................... 188
comparison of privatised firms................................................ 189
8.3.4.1. Performance evaluation of working capital investment............ 191
8.3.4.2. Performance evaluation of working capital financing.............. 193
8.3.4.4. Performance management - comparison of privatised firms .... 197
8.4. External working capital management – supplier and customer linkages......... 200
8.4.1.1. Responses of the central firms – Asmara Milk Factory............ 200
8.4.1.2. Firm-supplier co-operation - comparison of privatised firms..... 201
8.4.1.3. Responses of supplier – DAS-UoA.......................................... 202
8.4.1.4. Firm-supplier co-operation -
comparison of suppliers of privatised firms ............................ 204
8.4.2.1. Responses of the central firms – Asmara Milk Factory............ 205
v
8.4.2.2. Firm-customer co-operation – comparison of privatised firms 205

8.4.2.3. Responses of customer – Berhane Frafre ................................. 206
8.4.2.4. Firm-customer co-operation - comparison of customers of
privatised firms ....................................................................... 207
8.5. Conclusions ...................................................................................................... 208
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9.1. Introduction ...................................................................................................... 213

9.3.1.1. Cash management .................................................................... 216
9.3.2. Managing short-term finances ....................................................................... 219
9.3.3.1. Managing purchase operations................................................. 220
9.3.3.2. Managing sales operations ....................................................... 222
9.3.4.1. Performance evaluation of working capital investments .......... 224
9.3.4.2. Performance evaluation of working capital finances................ 226
9.3.4.3. Performance of working capital operations.............................. 227
9.4. External working capital management – supplier and customer linkages......... 232
9.4.1.1. Responses of the central firms ................................................. 232
9.4.1.2. Firm-supplier co-operation- responses of suppliers.................. 233
9.4.2.1. Responses of the central firms ................................................. 235
9.4.2.2. Firm-customer co-operation - responses of customers ............. 236
9.5. The general Eritrean context............................................................................. 239
9.6. Conclusions ...................................................................................................... 241
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10.1 Introduction ..................................................................................................... 247

10.2. The conceptual framework - expectations and empirical findings................. 247
10.2.1. Overall working capital management -
expectations and empirical findings...................................................... 248
10.2.2. Internal working capital management -
10.2.3. External working capital management -
10.2.4. Performance evaluation - expectations and empirical findings.................... 254
10.2.5. The issues on Eritrean context -
10.2.6. Concluding remark - expectations and empirical findings .......................... 257
10.3. Conclusions .................................................................................................... 258
10.3.1. Implications for the conceptual framework ................................................. 258
vi
10.3.2. Internal working capital management.......................................................... 258

10.3.3. External working capital management......................................................... 260
10.3.4. General issues in the Eritrean context.......................................................... 262
10.4. Research implications..................................................................................... 264
10.4.1. The practical implications of the conceptual framework ............................. 264
10.4.2. Policy implications ...................................................................................... 265
10.4.3. Limitations of the study and future research directions ............................... 267
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Figure 2.1: Working capital cycle.............................................................................. 20

Figure 3.1: Shareholde value network ....................................................................... 47
Figure 3.2 The genric value activitiesl....................................................................... 48
Figure 3.3: The value creation approach.................................................................... 52
Figure 5.1: Working capital management: the central model .................................... 86
Figure 5.2: Framework for working capital managemnt............................................ 88
Figure 6.1 Asset structure and short-term debt leverage –
Keih Bahri Food Products..................................................................... 127
Figure 6.2: Working capital investment composition –
Keih Bahri Food Products..................................................................... 128
Figure 6.3: Liquidity ratios Keih Bahri Food Products............................................ 129
Figure 6.4: Short-term financing composition - Keih Bahri Food Products. ........... 129
Figure 6.5: Working capital activity - Keih Bahri Food Products............................ 130
Figure 6.6: Overall profitability - Keih Bahri Food Products ................................. 132
Figure 7.1: Asset structure and short-term debt leverage – Keih Bahri Tannery ..... 160
Figure 7.2: Working capital investment composition - Keih Bahri Tannery .......... 161
Figure 7.3 Liquidity ratios Keih Bahri Tannery ...................................................... 162
Figure 7.4: Short-term financing composition - Keih Bahri Tannery . .................... 162
Figure 7.5: Working capital activity - Keih Bahri Tannery .................................... 163
Figure 7.6: Overall profitability - Keih Bahri Tannery .......................................... 164
Figure 8.1: Asset structure and short-term debt leverage – Asmara Milk Factory ... 192
Figure 8.2: Working capital investment composition - Asmara Milk Factory......... 192
Figure 8.3: Liquidity ratios: Asmara Milk Factory .................................................. 193
Figure 8.4: Short-term financing composition - Asmara Milk Factory ................... 194
Figure 8.5: Working capital activity - Asmara Milk Factory .................................. 195
Figure 8.6: Overall profitability - Asmara Milk Factory ........................................ 195
Figure 9.1: Current assets to total assets – government, transition, privatised firms225
Figure 9.2: Current debt leverage - government, transition, privatised firms........... 225
Figure 9.3:Current ratio: government, transition, privatised firms .......................... 226
Figure 9.4: Inventory turnover - government, transition, privatised firms. .............. 227
Figure 9.5: Receivables turnover -........................................................................... 228
Figure 9.6: Overall working capital turnover –
government, transition, privatised firms................................................ 228
Figure 9.7: Net profit margin - government, transition, privatised firms ................. 229
viii
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Table 3.1: Link between value chain and working capital ........................................ 49
Table 3.2: Transaction activities and related costs .................................................... 58
Table 3.3: Managerial control patterns and working capital...................................... 64
Table 5.1: Linking the value chain and value networks............................................. 87
Table 5.2: The working coapital management –
expectations of the conceptual framework .............................................. 90
Table 5.3: General issues – expectations of the conceptual framework ..................... 92
Table 5.4: The data base - the firms, suppliers and customers.................................. 99
Table 5.5: The responses of firms, suppliers and customers .................................... 103
Table 5.6: Respondents and questions addressed .................................................... 105
Table 6.1: Cash flow analysis – Keih Bahri Food Products .................................... 133
Table 7.1: Cash flow analysis – Keih Bahri Tannery .............................................. 164
Table 8.1: Cash flow analysis – Asmara Milk Factory ............................................ 196
Table 9.1: Empirical findings on the internal working capital management............ 231
Table 9.2: Empirical findings on the external working capital management ........... 238
Table 9.3: Empirical findings on the general issues in the Eritrean context ............ 240
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Important theoretical developments in finance during the past decade have provided
the potential for improved decisions in business organisations. Unfortunately,
developments have not been uniform across all areas of financial decision making
within and between business organisations. Working capital appears to have been
relatively neglected in spite of the fact that a high proportion of the business failures is
due to poor decisions concerning the working capital of the firms (Smith 1980a). Of
interest in this book is therefore the area of intra and inter-firm working capital
management, which generally encompasses short-term investment and financing
decisions of firms.
In a perfect world, working capital assets and liabilities would not be necessary
because there would be no uncertainty, no transaction costs, no scheduling costs of
production or constraints of technology. The unit costs of producing goods will not
change with the amount produced. Firms would borrow and lend at the same interest
rate. Capital, labour and product markets would reflect all available information and
would be perfectly competitive.
In such an ideal business world there would be little need to hold any form of
inventory other than a limited amount of goods in process during production. But such
an ideal business assumes that demand is exactly known in advance, that suppliers
keep to their due dates, production can be smoothed and orders executed directly
without costs and delays. There would be no need of holding cash for working capital
other than for the initial costs, because it could be possible to make the payment from
every receipt of sales. There would also be no need for receivables and payables if
customers pay cash immediately and the firm would also make its payments promptly.
However, problems of working capital exist because these ideal assumptions are
never realistic and therefore working capital levels make a significant part of a firm’s
investment in assets and these assets have to be financed implying that investments
may have benefits as well as costs.
Working capital investments and related short-term finances originate from three
main business operations - purchasing, producing and selling. They can be considered
as consequences of business operations. However, as much as the operations affect
the balances of working capital investments and finances, the later also determine the
cost and flexibility with which the operations are performed. Efficient management of
working capital investments and related short-term debts can be used to make the
purchasing, producing and selling operations cheaper and more flexible. In the latter
sense they are used as instruments for the management of business operations, which
in the mean time create benefits and costs. Therefore, the relevance of working capital
investments and short-term debts originate from these benefits and costs. Beyond
doubt efficient management of both items can help the success of firms in generating
Chapter 1 4
value. Operations are results of inter-firm transactions. Therefore, managing working

capital investments, finances and operations internally within firms and the efficiency
with which firms co-operate among themselves determine their end result.
7KHKLVWRULFDOSHUVSHFWLYHRIZRUNLQJFDSLWDOPDQDJHPHQW
Historically, working capital management has passed through different stages, mainly
– the control, optimisation and value measurement. Working capital management
originally started as a systematic approach of controlling the incoming, outgoing and
remaining balances of cash, receivables and inventories. At this stage the main
objective is that working capital is not misappropriated for personal benefits of those
who are entrusted with its management. To this end both researchers and practitioners
developed various control measures over the receipts and collections of cash, receipts
and issuance of inventories as well as the increase of receivables through credit sales
and decrease of receivables through cash collection.
Under the optimality management phase, the main focus was not only on the physical
safety of working capital items but also on the minimisation of related costs and
maximisation of related income. At this stage particular models (see sections 2.2.2 to
2.2.4) were developed to ensure that firms do not get problems due to a lack of
liquidity or incur too much costs by holding excesses of working capital levels. Under
the control and optimality approaches the amount of accounting profit is taken as a
main measure of managerial efficiency.
Under the value measurement approach working capital management concentrated on

how to help managers in the creation and measurement of value without disregarding
the above two objectives. Particularly, the cash flows approach is used as a main tool
to measure the value created by firms.
The control, optimality and value measurement approaches more or less concentrate
on the internal management of working capital. In our study, we introduce a new
dimension to these approaches – the external management of working capital. We
argue that to have a maximum impact on value, firms should manage working capital
in co-operation with their backward linkages (suppliers) and forward linkages
(customers). By doing so firms can internally minimise the costs of the levels of
working capital investment and short-term financing and externally minimise the
costs of inter-firm transactional relations and thereby create more value.
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7KH EHQHILWV RI KROGLQJ ZRUNLQJ FDSLWDO Each of the working capital items (i.e.
cash, receivables and inventories) helps in the management of firms in its own
particular way. &DVK is used to keep the firm liquid so that it is able to pay its
obligations when they are due for payment and therefore it protects the firm from
bankruptcy (Moyer, Macguigan and Kretlow, 1995). Under investment in cash bears
the danger of being unable to pay back both short-term and long-term debts when they
are due. Every business needs also adequate levels of cash to maintain day-to-day
operations. For instance it needs enough to pay wages and salaries as they fall due and
enough to pay creditors to ensure its supplies. The different types of inventories are
Introduction 5
used to satisfy different purposes (Scherr, 1989, Stevenson 1993). 5DZ PDWHULDO
LQYHQWRULHV are used to make production scheduling easier, to take advantage of price
changes and quantity discounts, and to hedge against supply shortages. If raw material
inventories were not held, purchases would have to be made continuously at the rate
of production. This would not only mean high ordering costs and less quantity
discounts, but also production interruptions when raw materials cannot be procured in
time. Therefore, the firm has an interest in buying enough raw materials to provide an
effective cushion between purchases and production, (Ben-Horim, 1987). :RUNLQ
SURFHVV LQYHQWRULHV serve to make the production process smoother and more
efficient: they provide a buffer between the various production processes. ,QYHQWRULHV
RI ILQLVKHG JRRGV have to be held to provide immediate services to customers and to
stabilise production by separating production and sales activities. Most firms cannot
produce immediately when customers demand goods. Failure to supply products to
customers when demanded would mean the loss of sales to competitors. Therefore,
holding finished goods inventory helps to serve customers on a continuous basis and
to meet their fluctuating demands. Finally, UHFHLYDEOHV are used to attract customers
and increase sales.
Investments in working capital assets can be financed by VKRUWWHUP GHEWV which

include mainly trade credits and bank loans. Trade credit and short-term bank loans
have usually lower interest charges compared to long-term loan (Moyer and
Mcguigan, 1995) and can be useful to maintain a firm’s liquidity position. As Cote
and Latham (1999), argue the management of receivables, inventory and accounts
payable have tremendous impact on cash flows, which in turn affect the profitability
of firms.
7KH FRVWV RI KROGLQJ ZRUNLQJ FDSLWDO The benefits to firms arising from an
increased volume of working capital, however, do not come without their own costs.
Investment in working capital is expensive. The more funds accumulated in working
capital assets the more the costs of the investment. Over investment in cash,
receivables and inventories ties-up capital and results in the opportunity costs of lost
profits. Over investment in cash deposited in bank checking account results at paying
service charges while depositing in a saving account does not generate large revenue.
Over investment in receivables can result at debts, which may not be collected. Over
investment in inventories result at loss due to physical deterioration and obsolescence
of the inventory items. Financing working capital investment with short-term debts
(though it is cheaper compared to long-term debts) is also riskier for the firm, because
short-term creditors give less time to pay back the loans. Therefore, the trade-off
between the benefits and costs of holding the working capital investments and short-
term debts must be evaluated and managed.
7KH WUDGLQJRII EHWZHHQ ZRUNLQJ FDSLWDO EHQHILWV DQG FRVWV The management of
working capital has to do with the trading off between the benefits and cost of holding
working capital items. Working capital investments and short-term debts do not only
arise as a by-product of purchasing, producing and selling but also are manageable
variables. Management can manipulate purchasing, production and selling using
working capital investments and short-term debts. The ways in which managers try to
cope with the problems of working capital investments and short-term debts are very
relevant for the evaluation of firms’ performance.
Chapter 1 6
7KHYROXPHRIZRUNLQJFDSLWDOLQYHVWPHQW The importance of working capital also

originates from its size. It is a large portion of a firm’s investment in assets. It
amounts usually to 40% in manufacturing industries and 50% - 60% in retailing and
wholesales (Moyer, Mcguigan and Kretlow, 1995). Therefore, firms can save
relatively large amounts by economising on working capital investments and short-
term debts.
7KHPDQDJHPHQW WLPH ZRUNLQJ FDSLWDO RSHUDWLRQV WDNH Most business operations

affect or are affected by working capital operations (purchase of materials for
production, production of finished goods and sales of finished goods to customers).
Purchases of materials result in increasing the investment in materials inventory,
payment of cash, or increasing payables. Production results in increasing work-in
process inventory and finished goods inventory. Sales end-up in decreasing finished
goods inventory, and increasing cash or receivables. The management of these
activities is very time consuming and may even demand more time if the working
capital investments and short-term financing are actively managed. It is therefore
normal for managers to spend much of their time in activities directly or indirectly
related to working capital investments and short-term debts (Scherr, 1989).
([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQW
7KH EHQHILWV RI PDQDJLQJ LQWHUILUP ZRUNLQJ FDSLWDO RSHUDWLRQV Operations that
affect working capital balances are mainly transactions of purchases and sales. These
transactions have costs. In addition to the costs of carrying the working capital
balances that result as a consequence of the operations, there are costs that originate
from the inter-firm transactional relationship. The volume and spread of these costs
depend on the transaction characteristics that prevail between the transacting parties.
If both parties in the transaction try to maximise their own benefits without
considering the effect of their actions on the other transaction partner, they may end
up at increasing their aggregate costs. However, if the two transacting parties co-
ordinate their common operations according to Williamson (1985) avoidable costs
will not be incurred (discussed further in chapter 3). If firms can evaluate their
transaction and decide on the appropriate inter-firm managerial control pattern, it is
possible that their aggregate costs with co-operation can decrease to a level below the
sum total of the costs of both firms without co-operation. This reduction of costs
through the co-operation of transacting parties results at a concomitant benefit of
creating value to both firms.
The inter-firm co-operation in managing firms’ value chains (Porter 1985), both
with suppliers and customers become important as a result of specialisation and
globalisation. The design of appropriate inter-firm control patterns also becomes a
matter of necessity because of the benefit in managing inter-firm transaction costs
including those related to working capital. In search of efficiency in scale and scope
of operations, firms are increasingly specialising only in few of their operations and
leaving the rest to other firms. Inter-firm co-operation will not only decrease the inter-
firm transaction costs but also the intra-firm costs of holding working capital
balances. As we have mentioned earlier, holding working capital balances have
benefits as well as costs. Proper inter-firm co-operation decreases the need to hold
extra balances of cash, receivables and inventories. For example trade credit and bank
loan agreements decrease the need for cash. Agreement on purchases and sales
Introduction 7
shipment on the basis of just in time decreases the need for both materials and
finished goods inventory. Cost and market factors are forcing firms to go global, in
which case they are forced to depend on the co-operation of other firms, which are
accustomed to the new environment in terms of business culture, social culture and
regulatory requirements. This inter-firm co-operation creates a value chain (Porter
1985) which is inter-connected with value network (Rappaport 1986). However, firms
have to establish a workable inter-firm control patterns (Van Der Meer Kooistra and
Vosselman 2000).
:RUNLQJ FDSLWDO PDQDJHPHQW LQ GHYHORSLQJ HFRQRPLHV the importance of

managing working capital is magnified when it refers to firms in developing
economies. These firms have many problems (McComick, 1999), such as being small
in size (in terms of volume of investment and sales) and lack of resources. The list of
problems is long and includes low levels of product and process technology, small
product markets, lack of access to capital, lack of physical infrastructure and proper
institutional framework. Because of their small size, firms in developing economies
may quickly be exposed to problems of production capacity to satisfy the demand
they may have for their products and this makes inventory management more
relevant. Both human and financial resources of the firms in developing economies
are also very limited. The human aspect refers to both skilled labour and
knowledgeable, experienced and motivated management. Thus the problems of
managing working capital investments and short-term debt may be increased by such
lack of managerial knowledge. Financially, firms in developing countries lack the
opportunity of getting the benefit of financial markets. Even if financial markets exist
the small firms have less opportunity to go public and benefit from the financial
markets as sources of finance. Even banks will hesitate to provide them with long-
term loans. Small firms are less known and less equipped with appropriate
mechanisms that will help them to provide relevant information to potential
financiers. Therefore banks consider loans to small firms as risky and expensive
because it takes more time for a relatively less benefit. So, because of these reasons
short-term debt management is even more important in developing than developed
countries (Fishazion, Von Eije and Lutz, 2001). Proper working capital management
is particularly important for the firms in developing countries in order to solve these
problems. For example in Eritrea, the firms have their major investment in working
capital assets and they mostly use short-term debts as a main financing source. In the
absence of long-term investment and capital markets, managers are moreover
occupied with the short-term decisions affecting working capital. Therefore it is in
working capital related activities that they are trying to capitalise in order to create
value for the firms.
*RYHUQPHQW UHJXODWLRQV DQG FXOWXUDO IDFWRUV Government policy has always an

influence on every aspect of a firm’s activity. The government determines the rules of
business practices including the type of business operations, which have to be under
government ownership or privatised and what firms could enter into any form of
agreement in creating linkages. Government can set rules and guidelines on how the
firms have to be managed. It is therefore a matter of fact that their activities are affected,
directly or indirectly by government regulations. Culture also matters in the
management of working capital. Working capital management techniques developed
by world-renowned researchers, if replicated elsewhere, may end-up at failure.
Because as Williamson (1985) points out cultural practices, believes and norms also
Chapter 1 8
determine practical management approaches. The study of working capital

management has to be designed in such away that it takes full consideration of the
government regulations and cultural factors.
:RUNLQJ FDSLWDO PDQDJHPHQW DQG WUDQVLWLRQ WR SULYDWLVDWLRQ Working capital

management is also very important for firms in transition to privatisation or firms that
are recently privatised. These firms have no culture of private business management
and they have no experience of business to business co-operation, which mostly
affects working capital. There is also a far-reaching effect on the management when
firms are strictly regulated and owned by the government. If government owns
business firms, the benefits and costs of working capital management might be
considered to be of a lesser importance because taxpayer’s money can be used to pay
for their losses. When business firms are transformed to the private sector there will
be a change of management style because there will be transparency and
accountability of managers to owners. This is loose when the firms are government
owned. Therefore, the analysis and recommendations on working capital management
will enhance the knowledge of management of working capital investment and short-
term debts for managers of government, transition and privatised firms in developing
economies, which this research concentrates on.
5HVHDUFKSUREOHPSXUSRVHDQGTXHVWLRQV
7KH UHVHDUFK SUREOHP Research begins when a researcher’s curiosity is aroused
and motivated to formulate a problem demanding an answer. The idea of this research
originated from a field study in summer 1996. The researcher and other colleagues
made a survey asking managers in Eritrea on the practical applicability of some
conceptual accounting fields of study that the University of Asmara offer. The
response was that working capital management is one of the least used concepts for
practical managerial decision making. However, preliminary studies showed that
many of the firms had inappropriate working capital management. This resulted in a
number of problems, both internal and external that this research study uses as main
research background. Internally: (a) the firms hold inappropriate levels of working
capital – resulting in uncontrolled costs of holding the working capital items or in
deficient working capital levels. (b) The firms inappropriately manage their purchases
and sales activities and have a defective credit policy. Externally, the firms lack
proper policies and practices of co-operation with their suppliers and customers.
7KH UHVHDUFK SXUSRVH The purpose of this research has its origin from the
problems mentioned above. We therefore try to explain the reasons for the problems
mentioned and search solutions to them. Our main objective is therefore to investigate
and to have a critical analysis at the firms’ internal and external working capital
management practices and then to give relevant policy recommendations helpful to
enhance firm value to both the firms and the government. In order to realise this
objective we reviewed relevant literature in the developed world and formulated a
conceptual framework, which we used to determine the relevant issue of our study,
collect relevant data and analyse the findings. However, the existing literature in the
developed world does not fully address the issues in a developing environment. After
collecting the empirical data we found out that some of the issues that we considered
relevant in our conceptual framework have been over emphasised while others, which
Introduction 9
we considered to be less relevant where found to be of more importance in the

Eritrean situation. Hence after collecting our data we had to revise our theoretical
framework to make it more relevant to a situation in a developing country. We looked
at both the internal and external working capital management because looking only at
the internal part in isolation from the external environment, particularly the firms’
supplier and customer linkages, could not give a complete picture and will only be
partial solution to our research problem. To our knowledge this issue is new and has
not been researched so far.
We have opted to choose the former and existing manufacturing public enterprises,
that is government owned firms, firms in transition to privatisation and privatised
firms. The main reason is because we believe these are the only firms in Eritrea,
which have the relevant size and management system. The historical background of
the firms indicate that all manufacturing and service firms where nationalised by the
former Ethiopian Government. However, the current Eritrean government is in the
process of reversing that and privatising the firms. The government ownership has
resulted at a culture of government regulation and government influence on the
management of the firms. However, as a result of the privatisation program the
influence of the government regulation is having a differing applicability among the
firms depending on whether they are government owned, in transition to privatisation
or they are privatised and on which basis we therefore decided to categorise our study.
We have selected the manufacturing firms because there are very few public
enterprises in the service sector (only one commercial bank and one insurance
company), while the manufacturing firms are 41 in number.
In order to search adequate answers to the problems we sub-categorise our objectives

into three step procedure: )LUVW we study the concepts of internal and external
working capital and short-term debt management. Then we develop a conceptual
framework (model) that can be used to study government owned firms, firms in
transition to privatisation and privatised firms in the context of a developing economy,
specifically in Eritrea. 6HFRQG we use this conceptual model to describe the internal
and external working capital management practices of the firms and by doing this we
hope to learn how these firms manage their working capital. 7KLUG we compare the
conceptual and empirical findings and try to forward conceptual and practical
implications at both firm and government levels, moreover we also try to indicate
future research directions.
5HVHDUFK TXHVWLRQV This research focuses on looking at the internal and external
working capital management in the context of a developing economy, specifically

taking the case of Eritrea. Therefore, the main research question addressed is: ³+RZ
GRJRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPVLQWKHPDQXIDFWXULQJVHFWRURI(ULWUHD
PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO LQ VHDUFK RI HQKDQFLQJ ILUP
YDOXH?” This research question entails three main sub-questions: the first is
conceptual, the second is empirical and the third relates the conceptual and empirical
sub-questions. The conceptual sub-question is used to implement the first step in our
research procedure. That is, to study theoretical concepts of internal and external
working capital management and then to develop a conceptual model that can
empirically be used to study the government owned firms, firms in transition to
privatisation and privatised firms in a developing economy context. Because our
preliminary investigations indicated inadequate working capital management we had
Chapter 1 10
to use a benchmark. The theoretical benchmark we used is value creation. That is,
working capital management should assist in value creation and value creation
concepts are therefore introduced in the conceptual framework. The empirical sub-
question is used to implement the second step in our research procedure, that is, to use
the conceptual model to understand how these firms manage their internal and
external working capital. The third sub-question is used to implement the third step in
our research procedure. Within this part, we relate the conceptual framework to the
empirical findings and try to recommend practical approaches (by taking the
conceptual and empirical findings into consideration) that the firms and the
government can use to improve the management of internal and external working
capital. Specifically, the research questions that each chapter of this thesis deals with
are stated as follows.
7KH FRQFHSWXDO UHVHDUFK TXHVWLRQ :KDW DUH WKH FRQFHSWXDO DSSURDFKHV RI
LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW WKDW FDQ EH XVHG WR HQKDQFH ILUP
YDOXH" This question requires answers to the following four sub-questions:
1a. The first conceptual sub-question that this research addresses is: :KDW DUH WKH
FRQFHSWXDO DSSURDFKHV RI LQWHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW WKDW FDQ EH XVHG WR
HQKDQFH ILUP YDOXH" In order to answer this conceptual sub-question we will try to
present the financial management models found in the literature, which we believe are
of relevance to the working capital management in developing countries like Eritrea.
Chapter 2 presents the theoretical background that can be used to answer this
conceptual sub-question. Internal working capital management can conceptually be
divided into the management of levels of investment and financing as well as the
management of operations (i.e. purchasing materials for production and selling
finished goods to customers). With this in mind, approaches that can be used for
internal working capital management purposes are discussed in chapter 2. First we
present the general introduction and background of working capital management in
Section 2.1. Then we consider working capital management in terms of its investment
(section 2.2) and financing (section 2.3) as well as operations of purchasing (section
2.4) and selling (section 2.5).
1b. The second conceptual sub-question is :KDW DUH WKH FRQFHSWXDO DSSURDFKHV RI
H[WHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW WKDW FDQ EH XVHG WR HQKDQFH ILUP YDOXH"
Chapter 3 presents the concept of firm value and theoretical approaches of inter-firm
co-operation from the context of working capital management. This chapter deals
primarily with the theories that are useful for developing our research model. It
presents Rappaport’s (1986) value network model (section 3.2), Porter’s (1985) value
chain model (section 3.3) and value chain linkages (section 3.4) and lastly we present
Williamson’s (1985) transaction costs model (section 3.5).
1c. The third conceptual sub-question is stated as: ,V WKHUH D FRPSDUDWLYH DGYDQWDJH
RIRSHUDWLRQDOHIILFLHQF\IRUYDOXHFUHDWLRQGXHWRWKHW\SHRIRZQHUVKLSJRYHUQPHQW
) Chapter 4 covers this issue. Section 4.2 covers the debate on

WUDQVLWLRQRUSULYDWLVHG "
ownership, market competition and operational efficiency. Section 4.3 is devoted to

comparing the efficiency of government versus private ownership. Section 4.4 covers
the issue of privatised firms and section 4.5 presents the case of firms in transition to
privatisation. Section 4.6 relates firm ownership and value creation to inter-firm
Introduction 11
managerial control patterns (market, bureaucracy and trust) in the three transaction
phases (contact, contract and execution).
G The fourth conceptual sub-question that we addresses is: :KDWLVWKHDSSURSULDWH
FRQFHSWXDOIUDPHZRUNDQGUHVHDUFKPHWKRGRORJ\WKDWFDQEHXVHGWR ILQGDQVZHUVWR
RXUUHVHDUFKTXHVWLRQV" Chapter 5 combines the internal and external working capital

management approaches as well as issues of firm ownership into a conceptual
framework. We also present the research methodology that we have used in designing
the data collection and analysis. This chapter covers the issues, which are needed to
design the information retrieval and analysis of our study. The objective is to design
the conceptual framework and the research methodology. Section 5.2 deals with the
development of the conceptual framework. Section 5.3 presents the choice of case
study as a method of research. Section 5.4 describes the case research method chosen,
which is further sub-divided into the design of the overall case study (section 5.4.1),
data collection (section 5.4.2.), data analysis (section 5.4.3) and criteria used to ensure
the credibility of the research analysis (section 5.4.3).
7KH HPSLULFDO UHVHDUFK TXHVWLRQ +RZ GR JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG
ILUPV LQ WKH PDQXIDFWXULQJ VHFWRU RI (ULWUHD PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO
ZRUNLQJ FDSLWDO? By getting an answer to this empirical sub-question we try to find
out whether the working capital management models found in the literature are of
relevance to the financial management in developing countries, such as Eritrea.
Particularly we address issues that help us understand how the manufacturing firms in
Eritrea manage their internal and external working capital levels and operations. With
an objective of finding satisfactory answers, this empirical question is divided into
four sub-questions.
2a: The first empirical sub-question that this research addresses is: HRZ GR
JRYHUQPHQWRZQHGPDQXIDFWXULQJILUPV in (ULWUHDPDQDJHWKHLULQWHUQDODQGH[WHUQDO
ZRUNLQJFDSLWDO" In order to answer this sub-question, relevant data are collected and
analysed in chapter 6. Section 6.1 introduces the chapter and section 6.2 presents a
firm’s overall working capital management issues. Section 6.3 covers the internal
management of working capital levels and operations. Section 6.4 presents external
working capital management: including firm-supplier linkages and firm-customer
linkages.
2b: The second empirical sub-question that this research addresses is: +RZ GR
PDQXIDFWXULQJ ILUPV LQ WKH SURFHVV RI WUDQVLWLRQ WR SULYDWLVDWLRQ LQ (ULWUHD PDQDJH
Chapter 7 deals with this research

WKHLU LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO"
question. Section 7.1 introduces the chapter. Section 7.2 presents a firm’s overall
working capital management issues. Section 7.3 covers the internal management of
working capital levels and operations. Section 7.4 presents external working capital
management, including firm-supplier linkage and firm-customer linkage.
2c:The third empirical sub-question that this research addresses is: +RZGRSULYDWLVHG
PDQXIDFWXULQJ ILUPV in (ULWUHD PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO"
In order to answer this sub-question, relevant data are collected and analysed in
chapter 8. Section 8.1 introduces the chapter and section 8.2 presents the firm’s
overall working capital management issues. Section 8.3 covers the internal
management of working capital levels and operations. Section 8.4 is on the external
Chapter 1 12
working capital management, including firm-supplier linkages (8.4.1) and firm-

customer linkages (8.4.2).
2d. The fourth empirical sub-question that this research addresses is: CRPSDUDWLYHO\
KRZGRWKHJRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPVLQWKHPDQXIDFWXULQJVHFWRURI
” We specifically study
(ULWUHD PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWD "
the impact of ownership on the firms’ internal and external working capital policy and
their overall value creation potential? Chapter 9 provides the answers for this
empirical sub-question. It includes a cross-sectional analysis of the empirical study
incorporated in chapters 6, 7 and 8. Section 9-1 introduces the chapter. Section 9-2
covers a comparative description of the firms’ overall working capital management.
Section 9-3 deals with the firms’ internal management of working capital levels and
operations and section 9-4 covers the external management of working capital levels
and operations.
7KH FRQFOXVLRQV DQG VWXG\ LPSOLFDWLRQV :KDW DUH WKH FRQFOXVLRQV DQG IXWXUH
The third sub-question assesses the lessons that

UHVHDUFK LPSOLFDWLRQV RI WKH VWXG\"
can be learnt from the theoretical background and practical experience of firms in a
developing economy, particularly the firms in Eritrea. It winds-up the thesis by
presenting summaries, conclusions, evaluations and implications of the study. It gives
insights and recommendations at both the firm and the government level. Finally, the
chapter refers to the limitations of the study and proposes possible areas of future
research direction. It seeks answers to two sub-questions.
3a. The first concluding sub-question that this research addresses is: :KDW DUH WKH
FRQFOXVLRQV WKDW ZH FDQ PDNH IURP WKH VWXG\ RI ZRUNLQJ FDSLWDO PDQDJHPHQW
H[SHULHQFHV RI WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG PDQXIDFWXULQJ ILUPV LQ
(ULWUHD" Section 10.2 includes a summary of the theoretical background used with
reference to internal and external working capital management, issues of ownership
and competition for operational efficiency as well as the conceptual framework and
research methodology. Section 10.3 presents a summary of the empirical findings of
the firms’ internal and external management of working capital operations and levels.
3b. The second concluding sub-question is: “WKDW DUH WKH FRQFHSWXDO DQG SROLF\
LPSOLFDWLRQV DV ZHOO DV OLPLWDWLRQV DQG IXWXUH UHVHDUFK GLUHFWLRQ WKDW FDQ EH GUDZQ
IURPWKHVWXG\´" Section 10.5 addresses this sub-question. It deals with the theoretical
implications (section 10.5.1) and practical implications (section 10.5.2.) as well as
limitations and future research direction (section 10.5.3).
7KH5HVHDUFKPHWKRGRORJ\
Research is a process - a series of linked activities moving from a beginning to an end

(Bouma and Atkinson, 1995). Bouma and Atkinson propose an outline of three phases in
the research process. The first phase is the essential first step requiring a researcher to
clarify the issues to be researched and select a research method. In this phase the
researcher has to select, to narrow and to formulate the problem to be studied. Here the
researcher has also to select the research design, to devise measures for variables, and
selects the samples or the units of analysis. This is what this section on research
methodology aims to achieve.
Introduction 13
In selecting our research methodology, we refer to Yin (1994). He suggests that a case
study methodology is a preferred research approach where: the research question to be
addressed is a type of how-why, control of the researcher over the research is none or
very insignificant and the focus is on a contemporary phenomenon within a real life
context. Because of these differentiating characteristics the case research method
properly fits to the question and objective of this research. The question of this
research is: KRZGR WKHJRYHUQPHQW WUDQVLWLRQ DQGSULYDWLVHG PDQXIDFWXULQJILUPV LQ
(ULWUHDPDQDJHWKHLULQWHUQDODQGH[WHUQDOZRUNLQJFDSLWDORSHUDWLRQVDQG OHYHOV" It
would be difficult to cRQWURO the working capital management techniques that the
firms use. Management behaviour cannot also be manipulated in the same way as
experiments are manipulated. The IRFXV of the research is on finding contemporary
working capital management, relevant to the Eritrean firms.
Case research studies can be H[SORUDWRU\, GHVFULSWLYH K\SRWKHVLV WHVWLQJ or

H[SODQDWRU\ in nature (Sekaran, 1992). AnH[SORUDWRU\ case study explores new areas
of organisational research by making a complete investigation. It is used when the

researcher does not know much about the situation at hand or when s/he has no
information on how similar problems or research issues have been solved in the past.
Before a model is developed extensive preliminary work is done in order to get
familiarity with the phenomena and to understand what is happening. It is useful to
get a good grasp of the phenomena of interest and for advancing knowledge through
good theory building (Sekaran, 1992). A dHVFULSWLYH case study involves describing
certain characteristics of the phenomena that the researcher is interested in. It is
undertaken in order to ascertain and to describe the characteristics of the variables in
the situation. An H[SODQDWRU\ case study is concerned with explaining why the
variables under study behave in a certain way. +\SRWKHVLV WHVWLQJ is used to explain
the nature of certain relationships or to establish the differences among groups.
This research basically focuses both the GHVFULSWLYH and H[SODQDWRU\ case study. First,
we review literature in order to search for what conceptual internal and external
working capital management approaches are available. Second, we search and
GHVFULEH what internal and external working capital approaches the government,
transition and privatised firms use. Finally, we compare and H[SODLQ how our
conceptual expectations and empirical findings differ and forward possible
recommendations on how the government, transition and privatised firms can use
internal and external working capital management approaches in search of creating
value. Internally, we study the value creating characteristics of working capital.
Externally, we assess business to business co-operation. As a background the research
study uses management theories on working capital techniques (Scherr, 1989, Van
Horne, 1998), value chain (Porter 1985), value network (Rappaport, 1986) and buyer-
supplier linkages management (Shank and Govindarajan 1993) in a business to
business co-operation. It is based on the idea that, efficient working capital
management of a firm’s intra and inter-firm value chain linkages (Heck and Zuurbier,
1989) can reduce transaction costs (Williamson, 1986), generate more income and
create firm value.
Traditionally, it is believed that objectives of managing working capital can be achieved

by managing the internal affairs of a business firm. Managerial rewards were based on
how firm managers organise their internal affairs. In the contemporary period of
Chapter 1 14
globalisation, managers concentrating only on the efficiency of their internal operations

forget an important element: that of managing the external linkages (Shank and
Govindarajan 1993), which can make a difference in the race for business success.
Management in general and that of working capital in particular, has become a two-
edged sword - internal and external. Internally various working capital approaches are
used to maximise the benefits and reduce the costs of working capital. Externally, the
firm-supplier-customer linkages are managed such that the business to business co-
operation results in synergy effects on firm value. This is achieved by reducing inter-firm
transaction costs and creates firm value in a win-win condition (Rubin and Alvarez
1998).
'DWD FROOHFWLRQ As Yin (1993 p.32) noted one important aspect of a case study is
that it enables the use of multiple sources of evidence converging on the same issues.
Evidences for case studies may come from a number of sources (Yin, 1994b, p.78):
documentary information, direct observation, physical artifacts, interviews, and
archival records. Sekaran (1992) also adds the questionnaire as another alternative
mechanism of data collection.
'RFXPHQWDU\ LQIRUPDWLRQ – includes letters, memoranda and other internal

documents, studies of a similar case, articles and information appearing in the mass
media. 'LUHFW REVHUYDWLRQ – refers to collecting data where the researcher makes a
study on the case by direct physical observation of the subjects of the case. 3K\VLFDO
DUWLIDFWV as a data collection mechanism relates to collecting a technological device, a
tool or instrument, a work of art, or some other physical evidence. ,QWHUYLHZV are
personal contact questions put to key respondents. Interviews can be structured or
unstructured and can be conducted either face to face or by telephone (Sekaran, 1992).
In the case of unstructured interviews the researcher does not approach the respondent
with planned sequence of questions that he will be asking to the respondent. Its
objective is to formulate a conceptual framework for variables that need further in-
depth investigation. Structured interviews are conducted when the researcher has a
pre-determined list of questions and refers to this list while conducting the interview.
Structured interviews are used when the researcher knows what information is
needed. They can take the form of open-ended or focused interviews. Open-ended
interview questions refer to respondents’ opinion about events. In a focused interview
the researcher follows certain set of questions derived from the conceptual framework
of the case study. A qXHVWLRQQDLUH is a pre-formulated written set of questions to
which respondents record their answers, usually from defined alternatives (Sekan,
1992). A questionnaire is suitable when the researcher knows what is required and
how to measure the variables of interest and it can be administered personally or
mailed to the respondents. $UFKLYDO UHFRUGV include financial statements, customers’
and suppliers’ service records, organisational records etc. Archival records have the
advantage of providing stable data, getting data not collected for the case study, exact
information and broad coverage.
Because of their relevance to our research we have used DUFKLYDO UHFRUGV LQWHUYLHZV
and TXHVWLRQQDLUHV. Focused and open-ended interviews have been conducted with 45
respondents (managers of firms, their suppliers and customers). Interviews enabled us
to target directly at the case study topic and to perceive causal inferences.
Questionnaires have also been personally administered and collected from the 45
managers. As archival records, the audited (as much as it is possible) financial
Introduction 15
statements of the firms for seven years (1994 to 1998) were collected and are used in
this research. Taking audited financial data of five consecutive years has the
advantage of retrievability, unbiased selectivity (by both researcher and provider) and
accessibility.
2UJDQLVDWLRQRIWKHERRN
This book contains five parts sub-divided into ten chapters. Part I contains chapter 1
and introduces the research work. Part II contains chapters 2-4 where we deal with the
literature review on the internal and external working capital management and issues
of ownership and value creation. Part III contains chapter 5 where we decide on our
research approach and develop a conceptual framework. Part IV incorporates chapters
6 to 9 in which we analysed the empirical data in view of the literature reviewed and
conceptual framework developed. Part V includes chapter 10, which concludes the
research and forwards future research implications.
&KDSWHU described the relevance of the research, the research problem, the research
objective, the research questions and the research approach.
&KDSWHU deals with the literature review of internal working capital management. It
divides working capital management in to managing levels and operations. It
introduces the general view of working capital management and short-term debts and
deals with more detailed techniques of managing working capital levels and
operations.
&KDSWHU deals with the literature review of external working capital and the concept
of value management. Specifically, Rappaport’s (1986) theory of value network,
Porter’s (1985) value chain, Shank’s and Govindarajan’s (1993) value chain linkages
and Williamson’s (1985) theory of transaction cost economics are discussed. Finally,
the chapter ends with a discussion relating working capital management to the
theories of value management.
&KDSWHU deals with the issues of firm ownership, efficiency and value creation.
Conceptual theory is reviewed with regard to the contemporary argument over
government, privatised and private firm’s impact over operational efficiency. A
comparison is also made between the effect of ownership and market structure on
operational efficiency.
&KDSWHU deals with the issues of empirical data measurement and analysis. It
contains the research approach followed, the research framework developed and the
design of the information retrieval.
&KDSWHU starts the empirical data analysis. It deals with the working capital
management analysis of Keih Bahri Food Products and another government firm -
Barka Canneries.
&KDSWHU continues the empirical data analysis by emphasising on the internal and
external management of working capital levels and operations of Keih Bahri
Tanneries and other transition firms.
Chapter 1 16
concludes the empirical data analysis. It specifically deals with the case of
&KDSWHU
Asmara Milk Factory and other privatised firms.
&KDSWHU includes a cross-sectional and comparative data analysis of the empirical

study incorporated in chapters 6, 7 and 8. It compares working capital management in
the government firms (Keih Bahri Food Products and Barka Canneries), transition
firms (Keih Bahri Tannery and other transition firms) and privatised firms (Asmara
Milk Factory and other privatised firms).
&KDSWHU winds-up the thesis by presenting comparison between the expectations of
our conceptual research framework and our empirical findings, conclusions and
implications of the study. It covers the evaluation of our conceptual background and
empirical findings on the management of internal and external working capital as well
as general issues taking the Eritrean context. It also highlights the conceptual and
practical implications as well as limitations and future research direction of our study.
3$57,,
/,7(5$785(5(9,(:
&KDSWHU
,QWHUQDO:RUNLQJ&DSLWDO0DQDJHPHQW
“While long-term decisions, involving plant and equipment or market strategy, may well determine the
eventual success of the firm, short-term decisions on working capital determine whether the firm gets
to the long term” (Block and Hirt, 1992, P. 138).
Our main objective in this chapter is to search an answer for the first conceptual
research question, which states: “:KDW DUH WKH FRQFHSWXDO DSSURDFKHV RI LQWHUQDO
ZRUNLQJ FDSLWDO PDQDJHPHQW WKDW FDQ EH XVHG WR HQKDQFH ILUP YDOXH" First, we
present the general introduction and background of working capital management in

Section 2.1. Then we consider working capital management in terms of its investment
(section 2.2) and financing (section 2.3) as well as operations of purchasing (section
2.4) and sales (section 2.5). Lastly we conclude the chapter by summarising the main
issues (2.6).
,QWURGXFWLRQ
Business firms are established by investments in the form of assets that can be
classified on the basis of liquidity - as current or fixed. Firms finance the total
investment in assets with debt and/or owners’ equity, the supply of which is limited.
The principles of financial management form the basis of managing investments and
related financing with current debt, long-term debt, owners’ capital contributions or
retained earnings. The investment in current assets is a working capital and the related
financial management approach is working capital management. Working capital
management is defined here as a process of planning and controlling the levels of
investment and financing current assets as well as related operations of purchasing
and selling. Specifically, working capital management requires managers to decide on
what levels of current assets the firm will hold at any point in time and on how these
current assets are to be financed.
This research divides the management of internal working capital into levels and
operations. Levels refer to investments in working capital assets (cash, inventories,
accounts receivable) and short-term financing instruments (payables: trade credit, bank
loan and accruals). Operations include activities related to the purchase of materials and
the sales of finished goods. It is worth noting here that, internal working capital
management refers only to the levels and operations which are directly connected with
the with the firm’s external linkages (that is suppliers and customers). This implies that
we do not refer to internal operations such as production operations and other internally
performed administrative activities.
We argue here that working capital investment is mostly a result of purchase and sales
operations. As figure 2-1 reveals, there is a working capital cycle that starts with
financing (for the purchase of materials), continues to operations (purchases,
production and sales) and ends-up at investment (in cash, inventories and receivables).
According to Moyer, Mcguigan and Kretlow, (1998), a firm’s operating cycle consists
of three primary activities - purchasing resources from suppliers, producing the
Chapter 2 20
product internally, and selling the product to customers. This operating cycle
determines a firm’s working capital investment and its financing needs. The purchase
and sales operations create cash inflows and outflows, which are both unsynchronised
and uncertain (Scherr 1989). They are unsynchronised because cash disbursements
(like payments for resource purchases) usually take place before cash receipts (for
example collections of receivables). They are uncertain because future sales and costs,
which generate cash receipts and disbursements respectively, cannot be forecasted
with complete accuracy. Therefore, besides managing the flow of materials and
goods, working capital also plays an important role in the management of these
unsynchronised and uncertain cash flows from purchase of materials and sales of
goods.
Figure 2-1 Working capital cycle
Financing Operations Investment
Internal
External Purchases Materials
Production Finished goods
Sales Receivables
Cash collection
Cash
Cash payment
Figure 2.1 explains the functions of working capital management using the working
capital financing, operations and investment cycle. The flow starts with cash obtained
from internal sources such as collections from operations and retained earning as well
as externally from suppliers of capital (creditors or owners) which is used to finance
the purchase of materials. The purchase and cash payment operations result in the
investment of materials inventory, which is used in the production process. The
production operation ends-up in the investment of finished goods inventory, which is
sold either for cash (resulting in investments in cash) or credit, (which results in
accounts receivable which is eventually turned into cash). The cash generated is then
used to settle the short-term debts - trade payables, bank loans and unpaid government
tax. Finally, because the ultimate objective of a firm is the creation of cash value to
the owners (Rappaport 1986), all or part of this cash is paid to the suppliers of capital
in the form of dividends or retained in the firm. This makes the end of a cycle and the
start of another. We now consider the levels of investment and financing and then the
operations of purchasing and selling.
Internal Working Capital Management 21
0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQW
*HQHUDOFRQVLGHUDWLRQV
According to Moyer, Mcguigan and Kretlow (1998), the major policy issue
encountered in the management of working capital is related to levels of investment
and its financing. Therefore, we consider first the main components of working
capital investment and liquidity management, then we continue describing the main
issues of managing working capital investment (section 2.2) and financing (section
2.3). The components of working capital investments are categorised in terms of
liquidity and stability of balances.
/LTXLGLW\ Liquidity is a term used to describe the ease with which the assets can be
converted into cash within a year during the normal course of business operations.
Current assets include cash, marketable securities, accounts receivable, and
inventories. Short-term debts or current liabilities are credit falling due within a year,
and include accounts payable, accruals, tax payable, dividend payable, short-term
loans, and long-term loans maturing within a year. &DVK consists of coins, currency,
bank deposits, and negotiable instruments such as money orders, certified checks,
cashiers’ checks, personal checks, and bank drafts. Cash is the most liquid of all assets
and it is the medium of exchange that permits management to carry on the various
functions of the business organisation. In fact the survival of the firm can depend on
the availability of cash (liquidity) to meet financial obligations on time. Near-cash
liquid assets are PDUNHWDEOH VHFXULWLHV. Marketable securities consist of short-term
investments that a firm makes with its idle cash, which can be sold quickly and
converted into cash when needed. Unlike cash, marketable securities provide a firm
with interest income. $FFRXQWVUHFHLYDEOHincludetrade credit and/or consumer credit.
A trade credit originates when a firm sells goods or services to another firm with an
agreement that cash will be paid in some future period. Firms may also sell goods to
final consumers. These consumer credits, make up the remainder of accounts
receivable. ,QYHQWRULHV consist of raw materials, work-in-process and finished goods.
5DZ PDWHULDOV are inventories waiting to get into the production process, wRUNLQ
SURFHVV inventories are materials in various stages of production and ILQLVKHG JRRGV
LQYHQWRU\ are goods whose production process is completed and ready for sale.
Inventories in retail and wholesale firms include the merchandise kept for sale.
6WDELOLW\RIEDODQFHV On the basis of the stability of balances compared to changes

in the volume of sales and production, current assets can also be divided into
permanent and fluctuating. The balance of permanent current assets remains constant
regardless of the change in sales volume or production capacity, while fluctuating
current assets vary with a change in sales volume and production capacity. Permanent
current assets include the safety stocks of cash and inventories. They are often used to
meet the long-term minimum needs of investment in current assets. Their balance is
constant over a longer period of time and is therefore comparable with the firms fixed
assets because investments in permanent current assets remain within the firm. The
main difference between permanent current assets and fixed assets is that permanent
current assets constantly change in physical terms, while fixed assets do not (Van
Horne and Wachowicz, 1998).
Chapter 2 22
0DQDJLQJ OLTXLGLW\ According to Moyer, Mcguigan and Kretlow (1998), firms

have two goals - liquidity and profitability. Many types of costs are related to the
excesses and shortages of working capital levels of investment and financing. Managing
these costs can increase the profitability of a firm’s operations. Firms have to determine
the individual and joint impact of the levels of short-term investment and financing on
the dual objectives of working capital management. These goals imply that decisions
that tend to maximise profitability tend not to maximise the chances of adequate
liquidity. Conversely, focusing almost entirely on liquidity will tend to reduce the
potential profitability of the firm. Liquidity is the ability to pay all expenditures and
short-term debt obligations. Firms can remain liquid by either selling assets or
borrowing. When liquidity is maintained by selling assets, the convertibility of assets
into cash (or liquidity) matters. Assets in general have varying degrees of liquidity.
For assets other than cash liquidity has two dimensions, (Van Horne, 1986): the WLPH
required to convert the assets into cash, and the degree of FHUWDLQW\ to convert the
assets into cash without loss. When liquidity is maintained through borrowing, there
will be a trade-off between the interest costs paid to creditors and the income earned
from the investment in the assets financed from the borrowing. Therefore, both too
much and too little liquidity have costs (Yeager and Seitz, 1989). Now we consider
the costs of keeping too much (costs of liquidity) and too little (costs of bankruptcy)
liquid assets.
/LTXLGLW\DQGEDQNUXSWF\FRVWV According to Yeager and Seitz, (1989), the cost of
excess liquidity is the interest on credits and loans used to finance investment in liquid
assets and opportunity cost or profit lost due to investing in less profitable current
assets, compared to fixed assets. The cost of too little liquidity is the cost of additional
borrowing needed as well as the loss experienced when assets have to be sold too
quickly and the damage done by a failure to meet payment demands which may end
up in bankruptcy (so the bankruptcy costs). If a firm does not keep proper amounts of
working capital, it will be forced to go bankrupt on technical grounds leading to
liquidation, in which case the primary claimants of a firm are its creditors while
investors of the firm’s capital have a residual claim on the assets. According to Van
Horne (1986), the eventual liquidation and realisation of assets into cash has two
types of bankruptcy costs - out of pocket costs and interest costs. The GLUHFWRURXWRI
SRFNHW FRVWV are associated with the bureaucratic procedures of liquidating the non-
cash assets and distributing it to the claimants. These costs include the time that the
management spends dealing with the creditors of the bankrupt firm, legal expenses,
court costs and advisory fees. ,QWHUHVW FRVWV of bankruptcy are costs of compensating
creditors ex-ante. Van Horne (1986), argues that since creditors are primary claimants
of firm's assets at bankruptcy, they charge the firm a default premium on the interest
rate, which reflects the probability of the firm's bankruptcy. Grinblatt and Sheridan
(1998) also add a third type - the indirect costs of bankruptcy, which is created due to
a firm becoming financially distressed and close to bankruptcy but which may
actually never go bankrupt. These indirect costs include the losses due to the fact that
the firm may be unable to get or give credit when demand for its products decreases.
Therefore, liquidity decreases bankruptcy costs. However, investment in liquid assets
has a cost of financing. Therefore, there is a trade-off between the benefits associated
with liquidity and the cost of maintaining liquidity. Management can optimise this
trade-off using investment and financing policy decisions (see Scherr 1989).
:RUNLQJ FDSLWDO PDQDJHPHQW DQG SURILWDELOLW\ OLTXLGLW\ ULVN WUDGHRIIfrom the

point of view of working capital management, firms have dual objectives, that is,
maximise profitability and minimise liquidity risk. In this case risk as defined by
Walker (1980) means, (a) risk of not maintaining adequate liquidity, (b) the risk of
having too much or too little inventory to maintain production and sales and (c) the
risk of not granting adequate credit to support the proper level of sales. Profitability
has to do with the overall objective of owner wealth maximisation. Liquidity on the
hand has to do with ensuring that the firm is able to satisfy all its financial obligations
and has adequate funding to carry on its long-term activities of the firm. Thus the
liquidity goal is closely aligned with working capital management while the
profitability goal reflects both short-term and long-term decision making. The
difficulty with the dual objectives of profitability and liquidity is that, one tends to be
a trade-off of the other. In other words, decisions that tend to maximise profitability
tend not to maximise the chances of adequate liquidity and vice versa. Moreover, the
way in which working capital is managed can have a significant impact on both the
profitability and liquidity goals of the firm.
Moyer, Mcguigan and Kretlow (1998) argue that, there is an optimal level of working
capital investment, which changes with the variability of output and sales that a firm
must maintain. For a given level of output or sales there is certain working capital
level that results in the highest profit. Other factors that affect the optimality of
working capital include the variability of cash flows, the degree of financial leverage
and the degree of operating leverage. The issue of profitability and liquidity risk
trade-off is based on the argument that short-term investment and financing have
opposing effect on liquidity and profitability. Investment in current assets though
useful to achieve the objectives of liquidity, but it does not generate as much profit as
investing in fixed assets. Financing with current liabilities though it is cheaper and
therefore more profitable it is risky because it gives less time to pay.
In order to minimise liquidity risk and maximise profitability, management can have
differing risk attitudes (Van Horne and Wachowicz, 1998), by comparing the levels of
current assets against volume of sales or production. These are called “conservative”,
“moderate” and “aggressive”. &RQVHUYDWLYH working capital management policy
implies that at the given volume of sales or output the firm has a high level of current
assets. The conservative policy prepares the firm for all conceivable liquidity needs
and gives the lowest liquidity risk position. However, at this level profitability will be
low. $JJUHVVLYH working capital management policy implies that at the given volume
of sales or output the firm has the lowest current asset level. Aggressive working
capital policy exposes the firm to any conceivable liquidity risk and therefore gives
the highest liquidity risk position. It is the riskiest and supposedly the most profitable
working capital management policy. 0RGHUDWH working capital management policy is,
of course in between these two extremes. If other things remain the same, decreasing
the levels of current assets held will increase potential profit. However, profit
increases only if the firm’s investment in current assets can be reduced if the firm is
still being able to properly support output and sales while it also is able to settle its
short-term debt becoming due for payment. Hence, management should search for an
optimal proportion between the level of current assets and the volume of output and/or
sales that results in the best optimal point in the profitability and liquidity risk trade-
off. To solve the problem of profitability and liquidity risk trade off, Smith (1980a)
suggests that parallel monthly forecasts of profitability and required borrowing be
Chapter 2 24
made. This Smith argues will have the benefit of making trade-offs between
profitability and liquidity risk objectives of the firm, estimating the impact of certain
working capital policies on profitability and liquidity risk trade-offs and reflecting the
uncertainty of the future.
&DVK0DQDJHPHQW
7KHLPSRUWDQFHRIFDVKPDQDJHPHQW Cash management is concerned with how a
firm manages its cash levels and operations (cash collections and payments), cash
investments and disinvestments, and cash borrowing and lending. According to Scherr
(1989), cash management deals with determining the optimal level of cash, the
appropriate types and amounts of short-term investments in cash as well as the
efficient methods and controls of cash collections and disbursements. Because many
transactions of a company involve the receipt or disbursement of cash, it’s efficient
management has a great significance for the management’s success in the process of
achieving organisational objectives. Efficient cash management can be instrumental in
preventing losses from fraud or theft, to maintain a sufficient amount of cash, to make
necessary payments and to have a reasonable balance for emergencies. It also prevents
unnecessarily large amounts of cash from being held idle in bank accounts that
produce little or no revenues. Cash and short-term interest bearing investments are the
firm’s least productive assets. Unlike the firm’s other liquid assets (inventories and
accounts receivable), cash is not required for producing goods or services. When
firms hold cash in currency and in non-interest bearing accounts they obtain no direct
return. So, why hold cash and marketable securities at all? Couldn’t the firm’s
resources be better used elsewhere? Despite the seemingly low returns, there are
several good reasons why firms hold cash and marketable securities and we consider
each of these motives with some detail.
Cash normally would not be needed if it were not

7KH UHDVRQV IRU KROGLQJ FDVK
for the market imperfections and resulting transaction costs of urgently needing cash
at short notice if the need arises and there is no enough cash (von Eije and
Westerman, 2001). The reasons for holding cash are divided into four main
categories, transactions, precautionary, speculative, and compensating (Van Horne
and Wachowicz, 1998, Ross, Westerfield, Jaffe, 1996).
7UDQVDFWLRQV The transactions motive refers to the cash held in the form of non-
interest bearing currency and checking deposits for paying bills, making changes for
customers, paying for salary and other day-to-day operating activities. The
transactions demand comes from the normal cash collection and disbursement
activities which are not always perfectly synchronised, (Ross, Westerfield, Jaffe,
1996). Therefore, transaction demand is related to the volume of transactions. The
more payment the company expects to make, the greater will be its transaction
demand for cash. If the firm maintains too small cash balance it may run out of cash.
In that case, it must sell marketable securities or borrow in the short-term, which both
involve considerable costs. Also, liquid assets help a firm handle seasonal fluctuations
in cash flows, for example a firm may keep a large amount of liquid assets during
surplus months and withdraw it during deficit months. The amounts needed and the
timing of payments for transaction demand may be known in advance. For example,
the payment for long-term loan principal and interest as well as periodic wages and
salaries can more or less be forecasted in advance.
3UHFDXWLRQDU\ At times, a firm’s future cash needs for transaction purposes are
quite uncertain. The major causes of uncertainty about cash available for paying bills
are uncertainties about the amount and timing of sales and the collections from
accounts receivable. If the expected collections do not materialise, the firm will not
have enough cash to pay its bills. Therefore, the firm holds additional cash for
precautionary purposes in excess of its transaction needs. The size of precautionary
balances is positively related to the extent of uncertainties about the timing and the
amount of cash inflows and outflows. Other things remaining constant, the greater the
uncertainties of cash inflows and outflows the greater would be the precautionary
balances. Precautionary balances are usually held in highly liquid marketable
securities, which provide interest income. The more of this precautionary balance held
in near cash assets, the less cash kept and the greater the interest earned. However,
there is a trade-off between the interest revenue and the transaction costs involved in
purchasing and selling such near cash assets [Ross, Westerfield and Jaffe, 1996].
Therefore whether, it is economical to invest part or all of the precautionary reserve in
near cash assets depends on the trade-off between these transaction costs and the
related income earned.
6SHFXODWLYH Speculative cash balances are held to take advantage of yet unknown
temporary investment opportunities. If firms intend to grow by acquiring other firms

or to take advantage of a sudden decline in prices of raw materials they may hold cash
in reserve waiting for the opportunistic condition. As with precautionary demand,
cash for speculative purposes could be invested in income-earning securities.
&RPSHQVDWLQJ Banks may require a minimum compensating balance to be kept in

the firm’s bank account in order to give lending services. Therefore, another motive to
keep cash is for the purpose of bank compensating balances, where cash balances are
kept at commercial banks to compensate for banking services rendered to the firm.
All the four reasons of holding cash result in the costs related to liquidity. Therefore,
cash decisions require managers to consider explicitly the “profitability and liquidity
risk trade-off” of alternative decisions. So, in order to get the benefits of cash
management, the periodic balance and flows of cash has to be properly managed and
planned well in advance.
3ODQQLQJFDVKUHTXLUHPHQWVWKHFDVKEXGJHW A cash forecast or cash budget is a

statement of the firms expected cash inflows and outflows over a projected time
period, usually a quarter, a month, a week or a day. It is primarily used to estimate a
firm’s borrowing and lending needs, and as an input to prepare for the uncertainties
and mismatches between cash inflows and outflows (Scherr, 1989). It can also be used
for various other ways like planning the impact of reductions of short and long-term
debts. A cash budget is also useful in determining the minimum balances to be
maintained and to negotiate short-term financing arrangements with banks.
If a firm does not plan its cash requirements, the resulting cash deficit or surplus can
be unforeseen. If there is an unexpected cash deficit, cash shortages would occur and
the firm would have to slow down its cash outflows, for example by delaying
payments to its suppliers or to use its cash reserves or to get emergency financing.
Chapter 2 26
Delaying payments to suppliers may result in suppliers retaliating by holding the

supply of critical materials and thereby cause extensive production interruptions. This
may force the firm to act on an emergency basis, such as selling at rushed prices,
selling fixed assets or borrowing from its bank. Under these conditions, the bank
might be reluctant to grant such a loan on favourable terms and reflect this by
increasing interest charges. So the firm’s relation with its suppliers and bank will be
put in jeopardy. If an unexpected cash surplus occurs, the firm will have no way of
knowing for how long the surplus will exist and it will not be able to make investment
plans for a longer period. Thus a cash forecast is a critical tool for effective financing
of temporary deficits and for investing surpluses. The types of cash forecasts are
categorised on the basis of the length of the period that cash is forecasted and the
approach to cash flow forecasts, (Maness and Zietlow, 2002, Scherr, 1989).
7KHOHQJWKRIWKHFDVKIRUHFDVWSHULRG This refers to the units of time into which
the cash forecast is divided. Cash forecasts can be made in terms of yearly, quarterly,
monthly, weekly and even daily flows. The most popular - in particular for small
firms - is the monthly cash forecast (Scherr, 1989). Because of the transaction costs
involved in the short-term investment and dis-investment of near-cash assets, the
length of the shortest forecast period depends critically on the volume of the firm’s
cash inflows and outflows. If the timing of cash flows is frequent and the volume
large, the firm can use a shorter cash forecast period. For smaller firms with a lesser
amount to invest in the short-term, cash forecast on a monthly basis can suffice.
Another issue related to time is the breakdown within the periods. One method is the
distribution approach, which starts with yearly data and breaks them down into
quarterly, monthly, weekly and even daily data. The other approach is the scheduling
method, which starts with a shorter period, for example with weekly data then,
aggregates it to monthly, quarterly and yearly.
7KH DSSURDFK XVHG WR IRUHFDVW FDVK IORZVForecasting cash flows can have two
approaches - the receipts and disbursements approach and the adjusted net income
approach. The receipts and disbursements approach estimates the amounts of cash
expected to be received and paid by the firm over the forecast period and traces the
detailed movement of cash. This method is preferred to exercise close control over
cash in the short term (daily to monthly). The adjusted net income approach (also
called sources and uses) starts with projected net income on an accrual basis and
adjusts it to a cash basis. The adjusted net income approach forecasts a change in
assets and liability accounts and it is therefore useful to forecast cash flows over a
longer period of time. However it does not trace the individual inflows and outflows
for any given period.
&DVKRSWLPDOLW\PRGHOV In order to decide whether it is worthwhile to make short-
term investments of cash in marketable securities, the interest income earned is

compared with related transaction costs including the out-of-pocket costs such as:
commissions, postage, telephone charges, the opportunity cost of diverted
management time and effort. In this case specific cash management models are used
to determine the most economic amount and the appropriate time that cash will be
held, invested and dis-invested. Cash management models show that transaction costs
play a central role in determining the cash balance to be held. If transaction costs were
zero, the firm would require no working cash balance at all; it simply would sell its
short-term income earning assets or borrow to pay every bill. There are four types of
cash management models which are named after their authors – the Baumol model,
the Beranek model, the Miller-Orr model, and the Stone model (see Scherr 1989,
p124-144). These models deal with optimal approaches for investments and dis-
investments in short-term near-cash assets. They are useful in providing with
optimum strategies for a given time pattern of cash flows based on the trade-off
between investment income and related transaction costs.
+HGJLQJ IRU XQFHUWDLQWLHV RI FDVK OHYHOV During each cash forecast period, the
firm most likely will end up with a cash deficit or a surplus, the exact timing and
amount of which is uncertain. The cash level uncertainty is due to the variation
between forecasted and actual factors affecting cash levels, such as the volume and
rate of cash payment and collection, sales, production cost etc. If the firm gets cash
inflows that are smaller than expected and reaches the maximum bank borrowing
limits, it will face a number of problems discussed earlier in this chapter. Without
some kind of hedge against the uncertainties of future cash flows, the firm may incur
costs that could be avoided by the use of a hedging strategy. There can be a number of
hedging arrangements (Scherr, 1989) that include depositing temporary extra cash
surpluses in saving accounts or checking accounts, investing in near-cash assets and
the arrangement of extra borrowing capacity with the bank. However, these hedging
arrangements have their own costs, and there is a trade-off between the cost of the
hedge and the expected cost that it avoids. Therefore, it would not be cost effective to
hedge against all possible future costs if the probability of occurrence is very small.
&DVKFRQWUROCash is more susceptible to misappropriation and theft because it can
easily be concealed and because it is not readily identifiable. Therefore, it is essential,

that firms establish procedures of cash safeguarding controls through every phase of
its cash receipt and payment operations. The effective control of cash transactions
begins at the moment that cash is received by the business. A basic rule of effective
internal control over FDVK FROOHFWLRQ is that receipts are deposited in the bank, intact
and on a timely basis. Other basic principles of controlling cash receipts also include
separation of duties for sequential cash operations, handling and recording.In order to
exercise the necessary control over FDVKSD\PHQWV, all disbursements should be made
by check, with the exception of certain small payments that can be made from a petty
cash fund. The functions of handling cash receipts and cash disbursements should also
be separated or divided among employees to the greatest extent practical. The
following are procedures that may be used to establish effective control over cash
disbursements. All checks should be sequentially pre-numbered, controlled and
accounted for on a regular basis. Checks that are avoided or spoiled should be retained
and marked “void” or mutilated to prevent any possible unauthorised use. A voucher
that has been approved properly should support each disbursement. Invoices and
vouchers should be indelibly marked as “paid” or otherwise cancelled in order to
prevent their use for duplicate payments. The bank statement and returned checks
should be routed to the employee charged with the preparation of the bank
reconciliation and this employee should be someone other than the person responsible
for making the cash disbursements.
Chapter 2 28
,QYHQWRU\0DQDJHPHQW
Inventory management is the art of managing the amount of stock held in various
forms of inventories within a firm in order to efficiently and economically meet the
demands for products. It includes the principles and techniques for deciding what,
when and how much to purchase and sell as well as how and where to store.
Inventory management supports the achievement of organisational objectives by
attaining the desired levels of customer service at a minimum cost of inventory
carrying and ordering.
7KH REMHFWLYHV RI LQYHQWRU\ PDQDJHPHQW Due to the large size of inventories
maintained, firms commit a considerable amount of funds to inventories. Therefore, in

order to avoid unnecessary investments it is absolutely imperative to manage
inventories efficiently. Neglecting the management of inventories will jeopardise a
firm’s short and long-term profitability. Inventories are the least liquid of all current
assets, it should therefore provide the highest yield to justify investment (Block and
Hirt, 1992). Both excessive and inadequate inventories are not desirable. Therefore,
the main objective of inventory management should be to determine and maintain
optimum level of inventory level that lies between these two undesirable situations
related to meeting two conflicting needs. First, to maintain a large size of inventory
for efficient and smooth production and sales operations. Second, to maintain a
minimum investment in inventories in order to lower ordering and carrying costs and
to maximise profitability. In line with these objectives Kaen, (1995) argues that each
inventory type serves different purposes.
5DZ PDWHULDO inventories are used to make production scheduling easier, to take
advantage of price changes and quantity discounts, and to hedge against supply
shortages. If raw material inventories were not held, purchases would have to be made
continuously at the rate of production. This would not only mean high ordering costs
and less quantity discounts, but also production interruptions when raw materials
cannot be procured in time. Therefore, the firm has an interest in buying enough raw
materials to provide an effective cushion between purchases and production, (Ben-
Horim, 1987). The level of raw materials inventories would depend not only upon the
level of co-ordination between the firm’s purchases and production but also between
the firm and its supplier. If there is a closer link between the firm and its supplier, a
small raw materials inventory could be maintained and production needs could still be
met.
:RUNLQSURFHVV inventories are needed because there is no perfect synchronisation

among production processes - they do not all produce at the same rate at all times.
Each production station needs its own inventory of work-in-process. Thus work-in-
process inventories like the raw materials inventories serve to make the production
process smoother and more efficient - they provide buffers between the various
production processes. Under normal conditions, the longer the production process and
the more production stations, the higher the work-in-process inventories.
)LQLVKHG JRRGV LQYHQWRU\has to be held to provide immediate service to customers

and to stabilise production. Production and sales are not instantaneous. Most firms
cannot produce immediately when customers demand goods. Failure to supply
products to customers when demanded would mean a loss of sales to competitors. The
basic objective in holding finished goods inventory is therefore to separate production

and sales operations. Finished goods inventory is maintained to serve customers on a
continuous basis and to meet the fluctuating demands. The level of finished goods
inventories would depend upon the level of co-ordination between the firm’s sales and
production as well as the efficiency of firm-customer linkages. If there is a close link
between the firm and its customers, it is possible to know early when goods will be
needed, therefore, a small finished goods inventory could be maintained and
customers' needs could still be met.
Overall, in line with that of cash there are three motives for holding inventories – the
transactions motive, the precautionary motive and the speculative motive. The
transaction motive emphasises on the need to maintain inventory in order to facilitate
smooth production and sales operations. Inventory held for precautionary motive
guards against the risk of unpredictable changes in inventory price, demand and
supply factors. The speculative motive refers to carrying inventory in order to take
advantage of unpredictable changes in inventory price. To be effective, management
has to apply a system to keep track of inventory on hand and on order, knowledge of
lead times and its variability, a reliable forecast of inventory demand and reasonable
estimates of inventory holding, ordering and shortage costs (Stevenson, 1982).
3ODQQLQJ LQYHQWRU\ UHTXLUHPHQWV According to Scherr, (1989), inventory planning
helps to match inventory requirements to sales and production needs. It also helps to
know inventory acquisition and usage during lead-time, quantity on hand and on order as
well as the levels of safety stock. There are different methods of planning inventory
needs including managerial opinion (or judgmental) and time series data (Stevenson,
1982). Stevenson, contends that forecasts based on opinion relies on the analysis of
subjective inputs obtained from various sources, such as, opinions of sales staff,
managers and executives as well as consumer surveys. Forecasts on time series data are
based on observations taken at regular intervals over a period of time (daily, weekly,
monthly etc) and are made on the assumption that future inventory demand can be
estimated from past. The accuracy of inventory planning depends on whether the
forecast is made in conditions of relative certainty or uncertainty (see Scherr, 1989).
,QYHQWRU\ RSWLPDOLW\ PRGHOV Inventory optimality models can be used to determine
the optimal, reorder and safety levels of inventory. Inventory optimality models include
economic order quantity model, just-in-time inventory management and materials
requirement planning (MRP). All models deal with four basic questions - (a) how much
inventory to order, at any given time, (b) at what point of inventory level to order, (c)
whether to hedge changes in inventory costs, and (d) to what inventory items to give
special attention and selectively control. Answering these questions helps to manage the
levels and costs of inventories efficiently.
,QYHQWRU\ FRVWLQJ DQG YDOXDWLRQ As inventories move from storeroom to
production and from production (or stores) to customers, the unit and total costs may
be computed to know the cost of production and the cost of goods sold respectively.
The most common methods of costing inventories assume cost flows such as, first in
first out, average cost, and last in first out. Different from its costing approach,
inventory can be valued at cost, or cost or market value whichever is lower. The later
approach is based on the accounting principle of conservatism, which in order not to
Chapter 2 30
overstate the value of the firm requires the choice of an approach that provides the
lower value of an asset.
,QYHQWRU\ FRQWURO No matter how perfect an inventory plan is, it can rarely be
equal to the actual outcome. Therefore, there should always be a monitoring

mechanism to check whether what has been expected also approximates reality. The
starting point in developing a control system is an analysis of the objectives of the
intended system and determining the critical activities in the operation where control
can be most effective. According to Tersine (1998), effective inventory controls
should (a) provide a supply of required materials for efficient and uninterrupted
operation and assure adequate inventory for prompt delivery to customers. (b) Provide
ample stock in periods of short supply and anticipate price changes. (c) Store
inventories with a minimum cost and maximum protection from loss. (d) Keep
inactive, surplus and obsolete items to a minimum by systematically reporting on
product changes, which affect inventories. (e) Maintain the amount of capital invested
in inventories at a level consistent with operating requirements and management plan.
In order to achieve these objectives management can use alternative inventory control
approaches including the quantity limit systems (periodic, perpetual optional
replenishment, two bin and mini-max), money limit systems and time limit systems
(Tersine, 1998).
5HFHLYDEOHPDQDJHPHQW
&RQWURO RYHU FUHGLW VDOHV DQG DFFRXQWV UHFHLYDEOHCredit sales create accounts
receivable because firms give more time before their customers are required to pay.
Allowing credit increases sales but it has also costs of managing accounts receivable
and the possibility of bad debts. Therefore, management needs to install control
mechanisms over credit sale policies and credit customers. The controlling process is
intended to detect deviations from policy and to provide signals of deviations from
expectations. Some of the deviations may be due to uncontrollable random external
factors but others may be controllable. So, the main objective of credit and accounts
receivable control is to give signals when (non-random) deviations in sales, collection
expenses, receivables turnover and bad debts occur (Scherr, 1989).
Firms need to compare the outcomes of credit sales policy and the trend in the balance
of accounts receivable with what was estimated. In establishing policies regarding
terms of sale and credit granting standards, management makes expectations on
accounts receivable turnover and resulting bad debts. In order to control the collection
of account receivable, the deviation from expected payment patterns has also to be
observed. If expectations are not realised or there are deviations, it may signal
problems like changing customer characteristics, inaccurate policy forecasts or
improper policy implementations. According to Scherr (1989), common signals
include receivables ageing, days sales outstanding and average collection period.
When a signal is detected, it is up to the managers to investigate and to assess the
reason for the deviation. Managers must then take the necessary corrective action,
which will vary with the cause of the deviation and which may include applying
collection efforts and changing sales policies.
&ROOHFWLRQSROLF\ Once the firm decides to sell its goods on credit it should establish
control policies to check if any debtor is falling behind schedule, in which case the
firm will have to make collection efforts. Collection policy refers to obtaining
payments of past-due accounts. Receivable collection management begins by
developing an information system for monitoring outstanding receivables in order to
check if customers are taking more time. In case any credit customer is found to be
overdue for more than the receivables monitoring criteria established, different types
of collection efforts can be applied (Scherr 1989). A firm can use the following
procedures for customers that are overdue and may refuse to grant credit in the
meantime: First: send a letter informing the customer of the past due status of the
account. Second: make a telephone call to the customer. Third: employ a collection
agency. Fourth: take legal action against the customer.
0DQDJLQJZRUNLQJFDSLWDOILQDQFHV
Any working capital investment needs to be paid at the time of acquisition (cash
purchase) or at a later time (credit purchase). This ability to make cash payments or
the assumption of credit is a source of financing. Due to many factors (the firm being
a high liquidity risk, culture, linkages), the availability of credit as a source of
financing may or may not be an alternative to the management. We consider now the
financing dimensions and start with the main components.
&RPSRQHQWVRIZRUNLQJFDSLWDOILQDQFLQJ
Working capital investments can be financed with internally generated or externally

acquired financing alternatives. Some firms solve their financing problems by
borrowing or securing their current assets (external financing) and others by selling
their current assets (internal financing). When firms borrow on the strength of their
current assets, the major sources of short-term finances include trade credits, accruals,
short-term bank loans, collateral papers, commercial papers, and factoring accounts
receivable (Van Horne, 1980).
7UDGH FUHGLW ILQDQFLQJ Firms would rather sell for cash than on credit, but
competitive pressure forces most companies to offer trade credits. Unlike credit from
financial institutions, trade credit does not rely on formal collateral but on trust and
reputation (Fafchamps, 1997). Trade credits create the accounts payable. Accounts
payable is a form of short-term financing common to all businesses with a credit
purchase policy. It originates when buyers are not required to pay for goods upon
delivery but are allowed a short deferred period before payment is due, which may or
may not include discount for earlier payment. During this period the seller of the
goods extends credit to the buyer. There are three types of credit: open account,
promissory note payable and trade acceptance (Van Horne, 1980). The most common
type is the RSHQDFFRXQW arrangement, where the seller ships goods to the buyer along
with an invoice that specifies the goods shipped, the price, the total amount due and
the terms of sale. 3URPLVVRU\ QRWH SD\DEOH is a statement where debtor writes a note
or letter of IOU. It is required if the creditor has not yet developed full confidence on
the creditworthiness of the debtor or the value of the transaction is too large for an
open account and therefore the risk of loss is very large. 7UDGH DFFHSWDQFH is a
Chapter 2 32
supporting letter written by a bank addressed to a creditor guaranteeing a debtor’s

credibility with regard to a specific transaction. It is usually used in international
transactions.
$FFUXDO DFFRXQWV Accruals are short-term non-trade credit obligations. Accruals

represent an interest free source of financing. The most common accrual accounts are
wages and taxes. Firms pay employees on a weekly, bi-weekly, or monthly basis. The
longer the payment interval, the greater the amount of the accrual funds. Although
firms do not have much control over the frequency and magnitude: interest to be paid
and taxes can also be an important source of accrual financing.
6KRUWWHUPEDQNORDQV When the bank loan is approved, the agreement is executed

by signing a promissory note specifying the amount borrowed, the interest rate,
repayment schedule and any other terms or conditions. Very often the loan takes the
form of line of credit or overdraft. This is an arrangement between the bank and its
customers with respect to the maximum amount of unsecured credit the bank will
permit the borrower firm. There are also other forms of short-term financing like
collateral papers, commercial papers and factored accounts receivables.
&ROODWHUDOSDSHU Borrowings can be secured or unsecured. If the firm's borrowings
are secured, the firm can pledge a non-cash current asset as collateral securing for
borrowed fund. Borrowings can therefore be secured with marketable securities,
accounts receivable or inventories as collateral. This gives the lender such as banks
advantage over the unsecured lenders if the firm is forced to liquidate.
&RPPHUFLDO SDSHU Commercial paper is usually short-term unsecured debt

security sold by larger firms (Scherr, 1989). It can effectively be used to finance
short-term investments. For firms with less liquidity, banks can guarantee the issue of
commercial paper by allowing lines of credit or bank guaranteed letters of credit,
which obliges the bank to pay if the issuing firm cannot pay.
)DFWRULQJ DFFRXQWV UHFHLYDEOH is a form of borrowing funds from a factor. The
factor takes over the firm's credit granting function and the firm sells the face value of
the accounts receivable to the factor. It takes moreover not the full amount because
the factor calculates a service charge and interest.
6KRUWWHUPORDQILQDQFLQJ
&XUUHQW DVVHWV ILQDQFLQJ SURILWDELOLW\ULVN WUDGHRII The short and long-term
financing sources have differing effects on the trade-off between profitability and
liquidity risk (Block and Hirt, 1992). For the purpose of working capital financing, the
profitability of short and long-term debt is considered from the point of interest cost.
The higher the interest cost the lesser the profitability and vice-versa. From a lenders
point of view a long-term loan has in general higher interest charge compared to a
short-term loan due to the risk involved in lending for a longer period of time. Short-
term loans are more risky from borrowers point of view, because of the problem to get
cash in the short-term, and the higher variability of interest rates compared to that of
the long-term loans (Moyer, Mcguigan and Kretlow, 1998). To the borrower, long-
term loans are more expensive but less risky, while short-term loans are more risky
but less expensive. Therefore, management must get an optimum point between the
two. Empirically, Fisman (2001) showed short-term credit, particularly supplier credit
is positively correlated with capacity utilisation because firms lacking credit face
inventory shortages leading to lower capacity utilisation. Petersen and Rajan (1997)
argue that even in the United States, with extremely well developed financial markets,
trade credit is the largest single source of short-term financing. Fisman, particularly
claims in developing countries where formal lenders are limited, trade credit plays an
even more significant role in funding firm’s activities.
6KRUWDQGORQJWHUPGHEWPL[ The financing logic is that, temporary current assets
are financed with short-term loans and the permanent current assets with long term
debt or equity capital. However, the actual investment and financing mix match-up
depends on management’s approach towards risk and profitability (Van Horne and
Wachowicz 1998, Moyer, Mcguigan and Kretlow 1998, Brealy and Myers, 1996).
Based on the interest cost and liquidity risk, management can use maturity matching,
conservative, or aggressive approaches to financing working capital investments.
0DWXULW\ PDWFKLQJ The maturity matching approach to working capital considers the
maturity structure of the firm’s assets and liabilities. The maturity structure of the
firm’s liability is made to correspond exactly to the life of its assets by matching
current assets life and balances it with that of current liabilities, so that each asset is
offset with a financing instrument of the same maturity. Temporary current assets will
be financed with current liabilities while the permanent portion of current assets and
fixed assets are financed with long-term debt and equity capital. This financing
approach suggests that apart from the current portion of long-term debt, a firm would
need no short-term borrowings when sales are low. As the firm goes to seasonal asset
needs, it borrows on the short-term and later it pays off the borrowing with the cash
released by the decrease of current assets when sales are again low, (Van Horne and
Wachowicz, 1998).
$JJUHVVLYH DSSURDFK Risk taking in search of higher profits requires an aggressive
approach using the less costly but more risky short-term debt. This means financing a
portion of the permanent current assets and all temporary current assets with short-
term debt. This approach puts the firm at a considerable risk of technical insolvency.
The frequency of refinancing the short-term debt increases the risk that the firm will
be unable to obtain new financing as it is needed (Moyer, Mcguigan, Kretlow, 1998).
However, there is a better chance for the firm to earn a higher rate of return, because
interest on short term debt is less costly.
7KH&RQVHUYDWLYHDSSURDFK The third option of financing working capital investment
requires a conservative approach to risk and profitability. Under this approach all the
fixed assets and permanent current assets as well as a certain portion of the temporary
(or fluctuating) current assets are financed with long term debt and equity capital.
This puts the firm at a minimum risk of not being able to reschedule its short-term
debt. However, the firm will have little opportunity to earn a premium rate of return
due to the excessive use of long term debt.
Chapter 2 34
0DQDJLQJWKHSXUFKDVHDQGFDVKSD\PHQWRSHUDWLRQV
Working capital management on operations concerns purchases, sales and related

activities, namely cash payments and cash receipts. The argument here is that by
managing the sales and purchase operations efficiently we can effectively increase the
benefits and reduce the costs of working capital levels and maximise a firm’s value
creating potential. The purchasing and sales policies, like credit purchasing and payment
as well as credit selling and collection policies also have other direct effect in a firm’s
external value chain. For example, a policy of speeding-up collections and slowing down
payments may have negative effects in the value chain and on the confidence and trust
building with transaction partners.
3XUFKDVHRSHUDWLRQV
Purchases affect the inventory of materials. How much and at what cost materials have
to be purchased will depend on various factors like cost of purchasing the materials, the
cost of transportation, the discounts and the costs of holding. So, firms have to use
materials purchase budget to plan the cost, source and timing of their purchase. The
materials purchase budget depends on the management’s inventory policy. The
amount of materials to be purchased is based on the available inventory of materials at
the beginning of each period, the production requirements and the inventory at the end
of each period. Management also has to apply proper procedures of purchasing
materials. It must specify who should initiate the purchase requisition and who should
evaluate the purchase order and shipments. Here we give less emphasis to the
discussion of purchase management because it is the other side of sales management
that we discuss with more detail in section 2.5.
&DVKSD\PHQWRSHUDWLRQV
The firm has to slow-down cash disbursements and pay debts as late as it is consistent
with maintaining its credit standing with suppliers so that it can make the most
efficient use of the money it already has.
6ORZLQJ GRZQ FDVK SD\PHQWV Some of the methods used to slow-down cash
disbursements include: control of disbursements, using payable through drafts, zero

base account, and managing payroll and dividend disbursements and playing the float,
(Scherr 1989).
&RQWURO refers to controlling the build-up of excess cash in the

RI GLVEXUVHPHQWV
firm’s bank accounts. There must be control of disbursements that will slow down
cash outflows and minimise the time that cash deposits are idle. If daily information is
available on collections and disbursements, excess funds may be transferred to
disbursement bank accounts either to pay bills or to be invested in marketable
securities. One procedure for strict control for disbursements is to centralise payables
into a single account so that payments are made at a time they are needed. If cash
discounts are allowed on accounts payable, the firm should make payment at the end
of cash discount period, otherwise the firm should not pay until the end of the due
date in order to have a maximum use of the cash. 3D\DEOH WKURXJKGUDIW requires the
bank to present it to the issuer for acceptance, therefore unlike ordinary checks,
payable through draft is not payable on demand. Then the issuing firm transfers the
funds used to cover the payment of the draft, thereby taking time. Slowing down cash
payment through SD\UROO DQG GLYLGHQG GLVEXUVHPHQW refers to maintaining separate
cash accounts for disbursements of payroll and dividends in order to minimise the
balance kept in these accounts. The firm has to forecast when the checks issued to
these accounts will be presented for payment so that to have funds enough to cover
only that period’s needs, and not to keep the entire amount of payroll or dividend for a
longer period.
Under the =HUR %DVH $FFRXQW system agreement will be reached with the bank such
that one main or master disbursing account services all other subsidiary disbursing
accounts (payroll, payables etc.). When payroll is cleared at the end of each day, the
bank automatically transfers just enough funds from the master account to each
disbursement account to just cover the checks presented. So, a zero ending balance is
kept in all accounts except for the master account. This reduces the cash balance in
the master account by eliminating idle balance from all subsidiary accounts.
2YHUGUDIW is a check written for an amount in excess of funds on deposit. The check
overdraft, will be honoured by the bank according to a prearranged set of rules and
credit limits (Kaen, 1995). The bank extends a loan to the writer of the check for the
amount necessary to cover the payment. So, the firm does not hold cash balances; it
simply borrows whatever cash it needs for transaction purposes from the bank and
pays the market interest rate, as transaction costs on borrowings. 3OD\LQJ WKH IORDW
refers to managing the net float, (also called “play the float”), that is the difference
between the firm’s bank balance and its book balance, which is a result of delays
between the time checks are written and their eventual clearing by the bank. It is
possible to use this net float, if a firm can have a negative cash balance on its books
and a positive bank balance, because checks just written by the firm may still be
outstanding. If the size of the float can be estimated, the bank balances can be reduced
and the funds invested to earn a positive return.
0DQDJLQJVDOHVDQGFDVKFROOHFWLRQRSHUDWLRQV
6DOHVRSHUDWLRQ
There is a close relationship between sales and working capital policies such as credit
terms and standards, finished goods inventory levels and cash collection policies.
Relaxing credit terms and standards and holding an appropriate level of finished goods
inventory can enhance the possibility of more sales for the firm. A sale is made on cash
or credit. When a firm sells on cash, it requires its customers to pay at the time they buy
their purchases, in which case the firm will have no problem of cash collection.
However, cash is limited so buyers would like to take time before they pay. Therefore,
the buyers who are willing to pay cash are only those who get no alternative choice.
Credit sales give more time to buyers to pay and that makes buying from a firm that
extends credit interesting and sales might increase. However, it has its own costs of
management and risk of making bad debts. We concentrate on the credit sales more than
on buying on cash because comparatively it needs more managerial skill. Moreover,
Chapter 2 36
with credit sales, management has to set alternative sales terms, standards and it has to
evaluate customers’ relations.
7KH FDVH RI FUHGLW VDOHV Like the product’s price, quality and service, credit
granting policy determines the products attractiveness and affects its sales volume and
profit. If credit granting is properly made it can enhance the firm’s performance, sales
and profitability (Moyer, Mcguigan and Kretlow, 1998). Trade credit policies have a
number of important functions (Scherr, 1989): (a) for small firms: to minimise the
effects of market imperfections. (b) For sellers: to guarantee the quality of their
products and to overcome information problems with a buyer. (c) For buyers: to
increase and control the purchase of goods. Credit sales policy and management of
accounts receivable deals with decisions related to terms of sale, credit-granting
standards, credit analysis and control of accounts receivable. A term of sale is
concerned with the credit period, the cash discount and type of credit instrument.
Credit standards refer to the criteria used to screen credit applicants. Credit analysis is
the use of a number of devices and procedures to determine the probability of a
customer payment to proposed credit sales. Credit collection and control refer to the
establishment of policy and control procedures for collecting the cash when the credit
is due. According to Kaen, (1996), before a firm grants credit to its customers, it has
to establish a credit policy, the establishment of which involves three stages. First:
establishing the terms of credit sale policies. Second: formulating credit standards,
which will be used to analyse and evaluate individual applicant’s credit worthiness.
Third: establish accounts receivable collection and control policies (see also section
2.2.4).
A firm's credit terms specify the conditions under

7HUPV RI FUHGLW VDOH SROLFLHV
which the customer is required to pay for the credit extended. It includes terms related
to the mode of payment and to ownership transfer (outright transfer, consignment or
conditional sale).
0RGH RI SD\PHQW FDVK DQG FUHGLW WHUPVCash terms refer to terms of sale where
firms demand payment before or on delivery of the product sold. It is normally used
when the buyer represents a high credit risk or if the product is a special order with
significant asset specific expenditures. Credit terms refer to the sale of goods on the
basis of an open account, promissory note or special conditions like seasonal dating.
An open account is used when the buyer buys on a continuing basis from the same
seller and it may also include discounts for early payment. The only formal credit
instrument is the invoice - a document sent along with the shipment of the goods and
which the customer signs as evidence for receiving the goods. If the order is large and
the firm anticipates a problem in collections it may require the customer to sign a
promissory note or IOU, in order to eliminate controversies later about the existence
of a credit agreement. Within credit terms the credit period, the cash discount terms
and credit instruments such as drafts and letters of credit are of prime importance
(Ross, Westerfield and Jaffe, 1996).
For any firm, selling

$QDO\VLQJ WKH FUHGLW WHUPV DQGDVVHVVLQJ WKHULVN RIFUHGLW VDOH
its products in a competitive situation, there is a set of optimum terms of sales,

(Scherr, 1989). Decisions on terms of sale involve the setting of three parameters: the
rate of discount, the discount period, and the net date. Management has to analyse the
effects of changes in these parameters. If the proposed changes in these parameters
increase the value of the firm, then the change should be implemented. When changes
in the terms of sale policy occur, the decision rule is made by comparing the
difference between incremental profit margin of the sales and incremental carrying
cost of receivables (Scherr, 1989).
2ZQHUVKLS WUDQVIHU FRQVLJQPHQW RU FRQGLWLRQDO VDOHV With open account and
seasonal dating (where sales is made during low sales season and collection made
during or after the high sales season), ownership is transferred to the buyer at the time
of sales. With consignment sales, the buyer collects and holds the cash from the sale
of the goods and pays to the seller according to the pre-arranged terms, so the buyer
acts as an agent to the seller. Consignment sales refer to the term of sales where
ownership remains with the seller until the goods are sold to the ultimate buyer. With
conditional sale or instalment loan contracts, the seller also retains ownership and the
buyer signs a promissory note to make payments on an agreed-upon time. When all
payments are made ownership passes to the buyer and if the buyer defaults, the seller
can repossess the goods.
&UHGLW VWDQGDUGV DQG DQDO\VLV Credit standards are the criteria a firm uses to
screen credit applicants in order to determine which of its customers should be offered
credit and how much. The process of setting credit standards helps a firm to exercise
control over the quality of the accounts accepted. When granting credit, a firm
evaluates the creditworthiness of customers and distinguishes between customers that
may pay and the customers that may not pay.
)RUPXODWLQJ FUHGLW VWDQGDUGV Among the policy issues that must be addressed while
formulating credit granting standards are: (Scherr, 1989): (a) How to estimate the
credit related parameters of a credit applicant. (b) The amount of information that the
firm should collect on each credit applicant to solve the credit investigation problem.
(c) The method of analysis the firm should use in order to determine which applicants
should be granted credit. Credit standards mainly focus at the establishment of
policies to measure two factors (Scherr, 1989, Kaen, 1995): The time it takes a
customer to repay the credit obligation and the default risk or the probability that a
customer will fail to repay the credit. Based on the result of time and default risk
analysis a decision will be made to accept or reject a buyers credit application. The
time a customer takes to repay the credit obligation is measured by the average
accounts receivable collection period which indicates the average number of days a
firm must wait after making a credit sale before receiving the customers cash
payment. The longer the average collection period the higher the firm’s investment in
receivables and by extension, its cost of extending credit to a customer. The default
risk or the probability that a customer will fail to repay the credit is measured by the
bad debt to the average accounts receivable ratio. The higher a firm’s bad debt loss
ratio, the greater are the costs of extending credit.
Once a firm has established its credit standards and collection policies, it can use them
to evaluate a credit applicant in four steps. First: gathering relevant information on the
credit applicant. Second: analysing the applicants credit worthiness using the
information collected and standards established. Third: making the decision to grant
or not to grant credit after determining the probability that the applicant will or will
not pay. Fourth: follow-up and control its receivables. According to Kaen (1995)
sources of credit information may include the seller’s and other firms’ prior payment
Chapter 2 38
experience with the customer, the applicant’s financial statements, customer visits and
personal contact with the applicant’s banks and other creditors. After acquiring
information, the firm can use it to analyse the credit applicant and to make an
informed judgement. All these sources of credit information differ in reliability and
cost of acquisition. In general it is advised that credit-granting approaches be
developed systematically and applied with care.
&UHGLW DQDO\VLV Ross, Westerfield and Jaffe, (1996) discuss the so called traditional
approach, that is capital, character, collateral, capacity, and conditions. &DSLWDO
indicates the buyer's financial reserves and liquidity position. This approach requires
computing liquidity and leverage ratios in order to know whether the applicant is
stronger or weaker compared to other firms in its industry that the seller believes are
creditworthy. &KDUDFWHU refers to the customer’s willingness to pay. In order to make
payments to trade creditors, an applicant must have both the funds (as measured by
the capital dimension) and the willingness to pay the debt (as measured by a character
dimension). The applicant’s character is assessed by answering questions on its
history of payments, that is, if the applicant has defaulted before and if he or she
makes efforts in good-faith to pay debts as they come due. &ROODWHUDO refers to the
existence of a pledged asset in case of default. If the credit applicant gets financial
difficulty, it may be forced to liquidate. If the firm liquidates, the recoveries will go
first to the secured debt-holders. So, the existence of earlier commitment of secured
financing to others means lower credit worthiness to new creditors. Information on
secured borrowings may be obtained from the applicant’s financial statements, the
bank, credit reports on the applicant and directly from conversations with applicant.
&DSDFLW\ refers to the buyer's managerial and production capacity, which may indicate
the ability to meet credit obligations out of operating cash flows. Managerial capacity
refers to management’s ability to run the firm’s business. The firm’s history of
success (or failure) and the number of years that it has been in business measure
managerial capacity. The value and technology of the applicant's production and
service facilities measure the firm's plant capacity. &RQGLWLRQV refer to the economic
situation in the applicant’s industry and the general economy. There will be a danger
of non-payment if there is strong domestic and foreign competition or if the economy
is undergoing a contraction. Instead of either granting or refusing to grant credit to an
applicant, a firm can also grant a limited amount of credit, which is a form of line of
credit or credit limit.
Van Horne and Wachowicz (1998) divide the cost of

7KH FRVWV RI FUHGLW SROLF\
credit management into the costs of credit standards and the cost of terms of sale. The
costs of credit standards arise due to enlarged credit administration, increased volume
of bad debt losses and the opportunity costs of committing funds in receivables. The
costs of establishing and changing the firm’s terms of sale include the cost of printing
new invoices, preparing and printing manuals and price specifications, as well as the
cost of notifying the firm’s customers and sales personnel about the new terms. If a
firm grants credit, it will incur the costs of the credit policy and in the absence of
credit there is the possibility of opportunity cost of lost sales due to refusing to offer
credit. As the levels of credit increase the credit costs increase while the opportunity
costs of the loss of sales decrease. Therefore, management must compare the costs of
credit granting against the opportunity cost of lost sales and set an optimal credit
policy.
&DVKFROOHFWLRQV
Almost every transaction of a business enterprise will eventually result in either the
receipt or disbursement of cash. A firm can create value to shareholders by managing
cash collections. Managing cash collections requires speeding-up and controlling cash
collections (see also section 2.2.2).
6SHHGLQJXSFDVKFROOHFWLRQV A firm has to speed-up the collection of sales so that

it earns income and uses the money sooner, for investment or paying bills and save
future expenses. The methods that can be used to speed up the cash collection process
includeearlier billing, a lock-box system and concentration banking(DUOLHUELOOLQJ is
used to expedite the preparation and mailing of sales invoices internally and shorten
the processing floats. It also accelerates the mailing of payments from the customer to
the firm and shorten the mail float. A lRFNER[ V\VWHP is used to reduce the time
during which payments received by the firm remain uncollected and to reduce the
deposit or processing float. &RQFHQWUDWLRQ EDQNLQJ refers to firms, which use one
central bank account instead of many small accounts in many banks. Firms that use a
lock-box networking system, and those receiving funds over the counter may
normally have bank deposit balances at a number of banks. It is advantageous for the
firm’s cash concentration if all of these funds are held in one central location or
concentration bank.
3HUIRUPDQFHPDQDJHPHQWRIZRUNLQJFDSLWDOOHYHOVDQGRSHUDWLRQV
Working capital management requires managers to decide what quantities of cash,

near cash assets, account receivable, and inventories the firm will hold at any point in
time and must decide how these current assets are financed. Managers have also to
plan and evaluate whether actual performances are as per their expectations.
There are techniques of measuring and evaluating a firm's performance in managing

working capital operations and levels. Some of these performance measurements
relate to financial and others non-financial criteria. According to Rappaport (1986) the
non-financial performance indicators include customer satisfaction and product
quality, while the financial accounting related performance indicators, according to
Scherr, (1989) are based on ratio analysis. For the purpose of this study we emphasise
on the later because they are to be derived from the financial statements of firms and
it is possible to make inter-firm comparisons. We divide the financial accounting
related performance indicators into those that help us to study working capital
investment composition (asset structure), financing (liquidity and leverage) and
operations (efficiency of activities and overall profitability). The interpretation of the
financial statement ratios can be made by comparing ratios of the same firm of
different years or ratios of the same year of different firms.
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOLQYHVWPHQWV
We can evaluate the performance of working capital investments by analysing asset

structure and working capital investment composition.
Chapter 2 40
$VVHW VWUXFWXUH UDWLRVare used to investigate the composition of asset investment in

terms of quality and quantity. There are three asset structure ratios which are very
often used - working capital to total assets, inventory to working capital and
receivables to working capital. :RUNLQJ FDSLWDO WR WRWDO DVVHWV LV expressed in
percentages and shows the amount of working capital in total assets. It is used to
investigate whether such a composition is sound given the nature of the activities the
firm is in, for example a wholesale firm should have a higher current asset
composition compared to a manufacturer. The iQYHQWRU\ WR ZRUNLQJ FDSLWDO UDWLR LV
expressed in a percentage and measures the composition of inventory in the current
assets. A higher ratio may indicate slow moving or obsolete inventory. 5HFHLYDEOH WR
ZRUNLQJ FDSLWDO UDWLR indicates the composition of receivables in the total current
assets. A higher ratio may indicate problem in credit policy or lack of collection
efforts.
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOILQDQFLQJ
We can evaluate the performance of working capital financing by studying a firm’s

liquidity position and short-term financing composition.
Liquidity position measures the relative degree of certainty and ease with which an
asset is converted into cash at no discount from full value. A weak liquidity position
shows the inability of a firm to meet its current obligation and excessive liquidity ties
up funds in current assets, which earn relatively less value. Liquidity ratio analysis is
one of the most important devices used to study liquidity position and short-term debt
financing. /LTXLGLW\ UDWLRV measure a firm's ability to pay its current debt by
converting its most liquid or current assets into cash. It is also used to evaluate
management's attitude towards liquidity risk.
Liquidity ratios include mainly current ratios and quick or acid test ratios.TheFXUUHQW
UDWLR measures the firm's ability to pay its current liabilities by converting all current
assets into cash, including, marketable securities, receivables and inventories. It is
expressed in terms of the number of times the current assets can cover the current
liabilities. A preferred current ratio is between 1 and 2 with a global norm of 2. If it is
less than 1 the firm may face a high risk of technical bankruptcy and if it is more than
2, the firm will be foregoing the opportunity of investing in more productive long-
term fixed assets. The problem with the current ratio is that it mixes current assets and
current liabilities of different maturity period.7KHTXLFNUDWLR is an improvement over
the current ratio because it excludes the least liquid assets (the inventories) from the
current assets. Inventory is excluded because it has to be converted to sales (usually
very uncertain as to the occurrence and amount) to receivables and then to cash - a
very long process. The preferred quick ratio is between 1 and 1.50 with a global norm
of 1. We can also evaluate the performance of working capital financing by analysing
leverage or short-term financing structure (short-term debt to total assets ratio) and
working capital financing composition. Working capital financing composition can be
evaluated by studying the composition of each short-term financing element (trade
creditors, short-term bank loans, bank overdrafts and others such as accruals of taxes,
salaries, interest etc.) in the total current debt
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDORSHUDWLRQV
We can evaluate the performance of working capital operations by studying the

efficiency of a firm’s working capital activities (with activity ratios) and overall
profitability (with profitability ratios).
$FWLYLW\UDWLRV show the efficiency of working capital activities. They give insight into
how fast the receivables and inventories are converted (turned over) to cash. They are
also used to analyse the operational efficiency of a firm from the point of view of
sales volume, inventory, credit terms, types of assets and volume of assets used.
Frequently used ratios include, inventory turnover, receivables turnover, average
receivables conversion period, working capital (or current assets) turnover and overall
assets turnover.,QYHQWRU\ WXUQRYHU is expressed in terms of times, this ratio indicates
the rapidity with which inventory is turned over to cash through sales, a higher turn
over indicates a better efficiency, a quick moving inventory and less capital tied-up.
Low inventory turnover shows slow moving inventory possibly due to inefficient
working capital management and/or poor buying and selling practices. 5HFHLYDEOHV
WXUQRYHU is expressed in times, it measures the number of times credit sales or
receivables is turned over to cash. High turnover indicates quick collection or a strict
credit policy and low turnover indicates slow collection or a liberal credit policy.
$YHUDJHUHFHLYDEOHVFROOHFWLRQSHULRG is expressed in number of days. It is the inverse

of receivables turnover multiplied by 365 days. It measures "every how many days"
receivables are collected. The smaller the collection period the quicker the collection.
7KHLQYHQWRU\FRQYHUVLRQSHULRG is the length of time required to produce and sell the
inventory. A smaller inventory conversion period means efficient and a faster sales
operation. 2SHUDWLQJ SHULRG is a sum total of inventory and receivables conversion
periods. It is expressed in terms of days and measures the total length of time it takes
to produce the inventory as well as to turn it into credit sales and then collect cash
from the receivables. A shorter operating period shows an efficient working capital
management and less capital tied up. An increase in the operating cycle without a
corresponding increase in the payables deferral period, lengthens the cash conversion
period and creates further working capital financing needs for the firm. 3D\DEOHV
GHIHUUDO SHULRG is expressed in terms of number of days and measures the length of
time the firm is able to differ payment on its various payables on purchase of
materials, wages and taxes. The longer the period payables remain unpaid the better.
&DVKFRQYHUVLRQSHULRGis expressed in the number of days and represents the net time
interval between the collection of cash receipts from product sales and the cash
payments. The cash conversion period is the length of time that elapses from the
period when the firm pays for materials it uses in its production cycle until it receives
cash from the sale of its products. The length of time is important because the amount
of working capital needed to finance the firm is related to the speed with which
“input” is converted to “output” and payment is received from the sale of this
“output” (Kaen, 1995). A shorter cash conversion period shows efficient management
of the firms purchase and sales operations. 2YHUDOO ZRUNLQJ FDSLWDO WXUQRYHU is
Hxpressed in times and it measures the capacity of working capital to generate the
sales volume. A high turnover shows efficient utilisation of working capital

investment, effective marketing management efforts, and favourable business
conditions.
Chapter 2 42
3URILWDELOLW\RIRYHUDOORSHUDWLRQV3URILWDELOLW\UDWLRV relate a firm’s profit to sales,
costs, assets, capital invested and financing costs incurred. They interalia include:
gross profit margin, operating profit margin, return on total assets and return on
equity. *URVV SURILW PDUJLQ measures the margin at the factory level and can be
refined to operating profit margin by deducting operating expenses from the gross
profit and dividing by sales to measure the overall profitability of the firm. 5HWXUQRQ
WRWDO DVVHWV LV Hxpressed in a percentage, it measures the profitability of all assets
financed by both debt and equity. The return to equity can also be computed similarly
by replacing total assets with equity.
3UREOHPVZLWKUDWLRDQDO\VLV Financial performance analysis using ratios has some

shortcomings. Particular problems occur on the standardisation and objectivity of the
resultant information. It is difficult to make intra-firm comparisons at different
periods because the information may not be comparable because ratios being
exceptionally good or bad as a result of exceptionally good or bad economic
condition, the firm's inter-period changes in accounting policies and seasonality of
operations. Inter-firm ratios may not be comparable due to differing accounting
policies and other firm specific characteristics like the types and number of products,
production technology and production capacity, size in terms of number of employees
and sales volume. The differences that arise as a result of differing accounting policies
can be solved using cash flow based evaluation. Though there may thus be problems
to use the ratios in comparisons, it may be better to use some information on the ratios
than no information at all.
&DVK IORZEDVHG YDOXDWLRQ DQG SHUIRUPDQFH DQDO\VLV Cash flow from operations
reported on the statement of cash flows, indicates the excess amount of cash that a
firm derives from operations after funding working capital needs and making required
payment on current liabilities. The ratio used for this purpose is the FDVK IORZ IURP
RSHUDWLRQV WR DYHUDJH FXUUHQW OLDELOLWLHV, which has a global norm of 0.40 (Stickney
1996). According to Stickney (1996), cash flow based valuation gives a better picture
of a firm's operating efficiency. This is mainly because of two reasons. First, cash is
the ultimate source of value, that is, when firms invest in resource they delay current
consumption and it is the medium of exchange that will permit them to consume
various goods and services in the future. He argues that a resource has value because
of its ability to provide future cash flows. Second, cash serves as a common
measuring unit of future benefits and to compare future benefits of alternative
operating and investment opportunities. Therefore, cash flow accounting becomes a
viable alternative to traditional historical cost statements (Rees, 1990). This is so
because cash flow statement is based on matching periodic cash flows and outflows,
free of credit transaction and arbitrary accounting allocations. The change in firm
values is dependent on the change in actual and expected cash flows. Future firm
value can best be predicted by changes in current cash flows than current earnings. By
using cash flow from operations it is also possible to overcome the deficiencies in
using current assets as an indication of a firm’s liquidity or ability to generate cash in
the short-term.
&RQFOXVLRQ
Firms are created to generate revenues for their owners in the long-term. However, the
long-term value is a sum-total of short-term values. Working capital management
takes care of the short-term value creation. Working capital management requires
managing the short-term levels of investment and financing as well as operations of
purchasing and sales. Managing working capital levels refer to the investment in cash,
inventories and receivables as well as short-term financing sources such as trade
credits and bank loans.
Managing cash levels can assist in creating firm value because it is important for
transactions, precautionary and speculative purposes as well as for controlling the
costs and the physical safety of cash collections and receipts. In order to manage cash,
a firm needs to plan and properly implement the above needs as well as the control
mechanisms. It is only then that cash management can contribute to the creation of
firm value. Materials and finished goods inventory management play similar roles.
Managing materials inventory is useful to separate production and purchases so that
there will be no need to purchase each time a good is produced and because it can
help to hedge against supply shortages and for taking advantage of price changes and
quantity discounts. Work-in-process inventory helps to make the production process
smoother and more efficient by providing buffers between the various production
processes. Finished goods inventory is used for two reasons. First, to provide
immediate services to customers. Second, to stabilise the production process by
separating production and sales. Both materials and finished goods inventory are
important for purpose of transaction (for regular purchases and sales), precautionary
(for unforeseen inventory shortages) and speculative (for reasons of price changes).
But a firm needs to control the carrying and ordering costs of inventory as well as its
physical safety. In order to manage inventory efficiently firms need to plan their needs
and control mechanisms. Receivables management is, directly related to the credit
sales policy. If a firm has credit sales policy it creates accounts receivables, in which
case it needs efficient plans and controls using a number of alternative techniques and
collection efforts.
Working capital management also includes managing short-term financing sources

mainly accounts payable and bank loans. Accounts payable results due to a firm’s
credit policy and bank loans mainly include overdrafts and short-term loans. Accounts
payable may include the provision of discounts, in which case the firm should
compare the benefit of the discount due to making early payments and the costs
related to financing the payments. With regard to the bank loans, the bank service
charge and interest costs of overdrafts and short-term loans have to be compared with
the benefits generated by their financing.
However, liquidity and profitability management comes to the picture when a firm is
faced with the dilemma of using short-term financing sources and investing in
working capital levels. Liquidity and profitability management requires fine-tuning
because they have offsetting risk-profit effects. The combination of liquidity and
profitability depends upon management’s risk attitude, based on which it can use
maturity matching, aggressive or conservative approach.
Chapter 2 44
In addition to managing working capital levels a firm will also be concerned with
managing working capital operations of purchases and sales. Purchase operations can
be made on the basis of cash or credit. Cash purchases result in cash payments and its
management is related to cash management. However, credit purchase needs a
separate managerial issue, that of establishing credit terms and standards as well as
credit payment policy which is considered earlier in this section. Sales can also be
made on cash or credit. While credit sales requires a firm to establish credit terms and
standards, cash sales results in cash collection and its management is related to cash
management. Credit sales results in accounts receivable, which may include a
provision for discounts to motivate customers to pay early. This needs considering the
costs (or income lost) due to the discount that could be taken by customers, the costs
of financing the investment in the receivables and the costs of collection efforts and/or
eventual bad debts.
Overall, management should evaluate the efficiency of its internal management of

working capital levels and operations. In order to do this, it can use financial and non-
financial criteria. The non-financial criteria could be based on product quality and
customer satisfaction. The financial criteria could include financial ratio and cash
flow analysis and be used to evaluate the efficiency of managing working capital
operations (activity and profitability) and levels (investment composition and
liquidity).
We therefore conclude that firms create value when the objective of working capital
management is tailored to taking the necessary risk in the process of aspiring for value
creation. Managing working capital levels and operations can emphasise on custody
or value creation. Custody management is safeguarding a firm’s assets and operations
from theft and misappropriation as well as applying the operations as prescribed by
control measures. Managing for value creation refers to management’s ability to use
the firm’s working capital levels and operations such that they are applied in an
efficient cost minimising and revenue maximising manner. Value management
presumes management of working capital levels to decrease the holding costs of cash,
receivables and inventories, investing any short or long-term surplus cash as long as
the firm does not use it. It also requires applying appropriate measures to minimise
inter-firm transaction costs of working capital operations of purchasing and selling - a
topic discussed in the next chapter (chapter 3).
&KDSWHU
([WHUQDO:RUNLQJ&DSLWDO0DQDJHPHQW
Our main objective in this chapter is to search an answer for the second conceptual
research question, which states: “:KDW DUH WKH FRQFHSWXDO DSSURDFKHV RI H[WHUQDO
ZRUNLQJ FDSLWDO PDQDJHPHQW WKDW FDQ EH XVHG WR HQKDQFH ILUP YDOXH´" This chapter
deals primarily with the theories that are useful for developing our research model,
but first we present the general introduction and background in Section 3.1. Then we
continue with Rappaport’s (1986) value network model (section 3.2), Porter’s (1985)
value chain model (section 3.3), Shank’s and Govindarajan’s (1993) value chain
linkages (section 3.4), Williamson’s (1985) transaction costs model (section 3.5) and
lastly we present the essence of value measurement as it applies to our case studies
(section 3.6) and then we conclude the chapter (section 3.7).
,QWURGXFWLRQ
Rappaport’s (1986) model is used to explain the logic behind dividing internal
working capital management into levels of investment and financing as well as
operations of purchasing and sales. Using Porter’s (1985) value chain model we
divide the external working capital management into firm-supplier and firm-customer
linkages. It is used as a background concept to argue that the management of generic
value activities (particularly primary activities) are the basis for firm value creation.
We focus on the inbound activities for firm-supplier linkages and outbound activities
for the firm-customer linkages (see figure 3-2). We also use it to identify the inbound
and outbound activities, which are of relevance for the management of working
capital levels and operation (see Table 3-1). Williamson’s (1985) transaction costs
model is used to relate Porter’s value chain model and Rappaport’s model of
shareholder value network. These theories help us to look deeper into the linkages
between the firm and its suppliers and customers. We argue that it is possible to
achieve Rappaport’s corporate value objective (shareholder value creation) by
reducing transaction costs internally as well as externally. However, we first start with
a general introduction on the objectives of the firms.
7KH REMHFWLYH RI D ILUP The objectives that firms pursue depend upon the
stakeholder’s interest. Stakeholders are groups of individuals or organisations that
play a role in the survival and success of the organisation and who are affected by its
activities (Ancona et al. 1996). They include employees, unions, suppliers, customers,
shareholders, creditors, government, local communities and even the general public.
Normally, a firm has to satisfy many and at times conflicting objectives of these
various stakeholders. Though there are a number of objectives that firms pursue, their
main objective is often considered to be, the creation of economic value or profit
maximisation to the owners (Rappaport, 1986). This is because when investors bring a
firm into existence they do so on the condition that managers will follow their wishes
- to make profit and to increase their value in the business firm (Galliger and Poe,
1995). However, there are many reasons why owners may also have objectives other
than that of profit maximisation. First, some of the owners may be customers or
employees of the firm and may expect the firm not to maximise profit but favour them
Chapter 3 46
with better prices and terms, adapt policies to protect the workers’ jobs, pay higher
wages and give on-the-job-benefits. Second, the decision-making stakeholders
(owners and managers) may wish to maximise their portion of the flows rather than
the total returns to all the stakeholders.
However, there is no universal agreement on the primary objective of firms.

Copeland, Koller and Murrin, (1994) argue that shareholder value maximisation is for
instance commonly taken as firms’ primary objectives in the USA while balanced
stakeholders value is taken as a primary objective in Japan and Europe. To make our
research analysis more manageable and for the sake of clarity of focus of objective, we
argue that firms engage in activities that create shareholder value. Therefore, it will be
beyond the scope of this research to evaluate the management of internal and external
working capital levels and operations from the point of view of all the stakeholders.
Moreover, it may be worthwhile to minimise the confusion over the meaning of value
added and value network by airing out their definition adapted from McGrath (1999).
McGrath defines value added as the difference between the total cost of raw materials
and total revenue (average price times quantity sold). While value chain is an
analytical technique that concerns intra and inter-organisational dynamics of value
addition. Value chain analysis is a careful, piecemeal and low level examination of
how resources that enter a firm are processed into being valued goods and services. It
is used to identity key areas among organisational sub-units and independent
organisations. Next we discuss the arguments of the aforementioned authors on how
firms can manage their affairs in order to create value.
7KHYDOXHQHWZRUNPRGHO
Rappaport’s (1986) theory on shareholder value network is adapted because it

explains the linkage between the corporate objective of value creation and its value
drivers. He argues that to be effective, management must be guided by a set of
principles that can be applied to decision making in various situations. To this effect,
he also developed a number of financial management approaches and basic principles
applicable for the management of working capital. Two of the most important of these
principles are the objective of shareholder value creation and the cash flow approach
to decision making. The objective of the shareholder is value creation according to
Rappaport because owners of firms hire managers to act in order to maximise their
wealth by generating profit. Therefore, the criterion of shareholder value creation
becomes a basic approach to formulate and evaluate firm objectives. As Figure 3-1
illustrates, the main purpose of this shareholder value model is to demonstrate how
management decisions on value drivers and valuation components be used to create
shareholder value.
9DOXHGULYHUV are the variables that create value and are taken as the building blocks
by which firms create a product valuable to buyers. Rappaport’s shareholder value
network depicts the essential link between the corporate objective and the basic value
drivers (or valuation parameters) – sales growth rate, operating profit margin, income
tax rate, working capital investment, fixed capital investment, cost of capital, and
value growth duration. 9DOXDWLRQ FRPSRQHQWV cash flow from operations and the
discount rate are the factors used to measure the achievement of the FRUSRUDWHREMHFWLYH
or firm value created. Firm value is measured in terms of discounted cash flow from
External Working Capital Management and the Theories of Value Creation 47
operations (net of cash outflows). Cash flows from operations reflect the result of the
firm’s activities and the discount rate estimates the cost of financing.
In order for shareholder value to be created, management has to concentrate on three

main decision categories (Figure 3.1) - operating decisions, investment decisions and
financing decisions. The changes in a firm’s value depend on the decisions made by
management on each value driver. 2SHUDWLQJ GHFLVLRQV refer to the decisions with
respect to the purchase of materials, the production process and the sales of finished
goods. Operations also include other supporting activities like promotion, advertisement,
distribution, product mix, and pricing. Which alternative operating decision to apply
depends on their effect on the amount and the length of the period that sales grow as well
as their effect on the profit margin net of tax. ,QYHVWPHQW GHFLVLRQV refer to managerial
decisions on capital tied-up in working capital (cash, receivables, and inventories) and
fixed capital (buildings, machinery, equipment etc.). Which investment type to choose
depends on the investment’s effect on the cash flows from operations. )LQDQFLQJ
GHFLVLRQV refer to what financing sources to use - debt (short or long-term) or owners’
equity. Which type of financing source to use according to Rappaport depends on the
costs of the components.
Figure 3-1: Shareholder Value Network Model
)LUP Shareholder value

REMHFWLYH
9DOXDWLRQ Cash flow from Discount rate

FRPSRQHQWV operations
-via-
9DOXH Sales growth Operating Level of Cost of

'ULYHUV rate and duration profit margin & working and fixed debt and equity
-via- income tax rate capital investment capital financing
0DQDJHPHQW Operating Investment Financing

'HFLVLRQV decisions decisions decisions
Source: Based on Rappaport (1986, p.77)
7KHYDOXHFKDLQPRGHO
If firms are to remain competitive, they have to manage costs effectively and this
requires a broad approach, internal and external to the firm, that Porter (1985) calls the
value chain. The value chain consists of the interconnected value creating activities of a
firm, starting with activities related to the purchase of basic raw material sources from
suppliers to delivering the product to ultimate consumers. According to Porter the
Chapter 3 48
objective of a value chain strategy is to increase competitive advantage through cost

minimisation, product differentiation, lower transaction costs, improved co-ordination
between firms in the value chain, improved performance and/or reduced uncertainty.
Porter’s value chain theory considers a firm as composed of discrete but related
internal and external activities, including aspects like product design, purchase of
materials from suppliers, production and sales to customers. Porter’s value chain
model provides a method of breaking down these value creating chains of activities into
strategically relevant activities in order to understand the behaviour of costs and the
sources of differentiation (see also section 3.3.2.).
7KHYDOXHFKDLQDFWLYLWLHV
A firm's success depends on how efficiently it manages its internal and external
activities, which Porter (1985) divides into primary and support activities (Figure 3-2).
Figure 3-2: The generic value chain activities

Firm infrastructure
SUPPORT Human resource management
ACTIVITIES Technology development
Procurement
,QERXQG Operations 2XWERXQG Marketing and After sale
ORJLVWLFV (of production) ORJLVWLFV sales service
35,0$5<$&7,9,7,(6
Source: Porter, 1985, p.37
3ULPDU\ DFWLYLWLHV According to Porter (1985), primary activities are the activities
involved in the product's physical creation, sale, transfer and after sale service. Porter
divides a firm’s primary activities into inbound logistics, operations, outbound logistics,
marketing/sales and after sale services. ,QERXQG ORJLVWLFV are activities associated with
receiving the raw materials purchased as well as storing and distributing them to
production. Examples of working capital related inbound logistics are material handling,
freight-in, storing, inventory control, vehicle scheduling, administration and payments to
suppliers. 3URGXFWLRQ RSHUDWLRQV refer to transforming material and other inputs to the
final product and include machining, packaging, assembly, equipment maintenance
product testing and facility operations. 2XWERXQG ORJLVWLFV are activities related to
collecting the finished product from the production process, storing and physically
distributing the products to customers. Specifically the activities include finished goods
warehousing and handling, delivery vehicle operation, order processing, freight-out and
inventory control. 0DUNHWLQJDQGVDOHV are activities related to convincing buyers and to
provide them with information so that they purchase the product. Marketing and sales
activities include advertising, promotion, sales force, sales channel selection and pricing.
$IWHU VDOH VHUYLFHV are activities related to providing after sales service to customers in
order to maintain values to the product. The after sales service to customers include
activities such as installation, repair, customer training, parts supply and product
adjustment.
6XSSRUW DFWLYLWLHV According to Porter, support activities are activities that help the
primary activities and each other. They include firm infrastructure, human resources
development, technology/research development and procurement. )LUP LQIUDVWUXFWXUH
include activities such as planning, finance, accounting, legal advice, and quality
management. +XPDQ UHVRXUFHV GHYHORSPHQW activities are related to employee
recruitment, hiring, training, development and compensation of all types of personnel.
7HFKQRORJ\ GHYHORSPHQW activities are the efforts made to improve the product or the
production process such as the creation of know-how, procedures, computer programs

and work automations, communications, basic research on product design and servicing
procedures. 3URFXUHPHQW activities refer to the purchasing of inputs used in the firm’s
value chain but not the purchased inputs themselves. The final objective of Porters value
chain model is establishing efficient and value creating linkages among the chains of a
firm’s primary and support activities. This value can be created by minimising costs and
becoming a cost leader or by differentiating a firm’s products from the products of
competitors and generate profit that competitors cannot.
For the purpose of our research, we concentrate more on the primary activities in order
to have a focussed study on the issues related the primary activities. It is also our opinion
that the working capital levels and operations are more directly affected by the primary
than by the support activities.
:RUNLQJFDSLWDODQGYDOXHFKDLQV
Rappaport (1986) has established a model were operating expenses are categorised by
primary value activities rather than the conventional accounting system. He argues
that the conventional accounting system combines costs that belong to different value
activities or separate costs that belong to the same value activity. He uses the model
to adjust the conventional accounting operating profit to operating profit based on the
value chain, which is the cash flow from operations. Cash flow is computed by adding
back the non-cash expenses to profit after tax and deducting increases in net working
capital and capital expenditures, which according to Rappaport is the more objective
measure of value created compared to the conventional operating profit (See Table
3.1).
Table 3.1 Link between value chain and working capital

3ULPDU\DFWLYLWLHV
Inbound Production Outbound Marketing and After sale Service

development Operations logistics sales
:RUNLQJFDSLWDORSHUDWLRQV
Purchases Production Sales Sales Sales

&RVWRISURGXFWLRQDQGRSHUDWLQJH[SHQVHVRIUHODWHGZRUNLQJFDSLWDODFWLYLWLHV
Materials - Processing Materials - Sales force Installation

handling Assembly handling Advertising Training
Freight-in Testing Warehousing Promotion Maintenance
Administrative Packaging Freight-in Administrative Returns
Administrative
:RUNLQJFDSLWDOOHYHOV
Raw materials Work-in- Fished goods Accounts Parts inventory

inventory Process inventory receivable Service
Inventory receivables
Source: based on Rappaport (1986), p. 86
Moreover, Rappaport enriches Porter’s strategy for competitive advantage by

incorporating two basic steps involving competitive analysis that have to be
Chapter 3 50
performed before identifying competitive advantage - assessing industry

attractiveness and evaluating business competitive position within an industry.
Industry attractiveness depends on the bargaining power of suppliers and customers,
threat of new entrants and substitutes and rivalry among existing firms. Competitive
position within industry is evaluated by studying the industry segmentation, including
its characteristics and the firm’s position within it. Thus assessing industry
attractiveness and evaluating business competitive position within an industry enables
managers to identify the firms’ competitive advantage in terms of cost leadership and
differentiation. According to Rappaport (1986), the shareholder value approach that
applies value drivers (operating, investment and financing value drivers) management
is used to evaluate if the chosen strategies are creating sustainable competitive
advantage.
9DOXHFKDLQPDQDJHPHQW
Porter’s value chain activities are inter-dependent and connected by linkages. Linkages
are the relationships between the way activities are performed. They exist when the
performance of one activity affects the efficiency and effectiveness of others. According
to Trombly (2000) value chain management is managing integrated information about
product flow from suppliers to end users to reduce defects and inventories, speed time to
market and improve customer satisfaction. Shank and Govindarajan (1993), argue that
whether or not a firm can develop and sustain strategic advantage in terms of
differentiation or cost advantage or differentiation-with-cost depends fundamentally on
how it manages its value chain linkages. Value chain linkages refer to a firm’s
management of its value chain relative to the value of its competitors. The value chain
linkage concept is based on two directional profit improvement areas, which Shank and
Govindarajan (1993), describe as LQWHUQDO (intra-process and inter-process) and H[WHUQDO
(backward with suppliers and forward with customers). According to Porter (1985),
exploiting both internal and external linkages require co-ordination of activities that cut
across the conventional organisational lines of authority.
,QWHUQDOYDOXHPDQDJHPHQW
The LQWHUQDO YDOXH FKDLQ refers to activities within the firm that Shank and
Govindarajan (1993) divide into intra-process and inter-process. The intra-process
linkages are the connections within a process of activities of a firm's unit and inter-
process linkages are the connections across processes of activities producing different
products or services. Intra-process linkages within the value chain of a business unit
are concerned with increasing the efficiency of primary and support activities within
the firm. They deal with handling a firm’s linked processes of purchasing,
manufacturing and marketing, such that every process helps the other processes
directly connected to it. It recognises that the individual value activities within a firm
are mutually dependent to each other and that they have to be managed concurrently.
Inter-process value chain linkages within the firm across business units refer to
managing the internally independent activities of the firm, which do not have a
common process. This approach recognises that developing a competitive advantage
through linkages across a business unit’s value chains within the firm can create
value.
'HYHORSLQJ WKH LQWHUQDO YDOXH FKDLQ Shank and Govindarajan (1993) propose three
steps to follow in applying a value chain methodology. First, identify the industry’s
value chain and assign costs, revenues, and assets to value activities. Second, diagnose
the value drivers regulating each activity. Third, develop sustainable competitive
advantage, either through controlling cost drivers better than competitors or by
reconfiguring the value chain and/or creating product differentiation.
([WHUQDOYDOXHFKDLQPDQDJHPHQW
Linkages exist not only within a firm’s value chain but also between a firms value chain
and the value chain of buyers and suppliers, which can jointly optimise the performance
of their activities to create value with synergetic effects. This means that buyer-supplier
relationships are not a zero sum game where one gains only at the expense of the other.
It is a relationship in which both can gain. According to Heck and Zuurbier (1989), the
external value chain is a form of quasi-integration between vertically related firms. It
refers to the activities done with the firm's external environment (between the firm and
other firms). It includes backward linkages with suppliers and suppliers of suppliers and
forward linkages with customers and customers of customers. The suppliers value chain
creates and delivers the purchased inputs used in a firm’s internal value chain, while the
customers value chain takes a firm's products and determines the value created by the
firm. Shank and Govindarajan (1993) argue that, by carefully managing the
relationship between the firm and its external linkages, transaction costs can be reduced
and operational efficiency achieved, thereby creating firm value. External value chain
analysis is used to understand the relationships and associated costs between the firm and
its external linkages in order to maximise the value delivered to customers. It aims at
developing a co-operative advantage through linkages between a firm's value creating
activities (Porter, 1985) and those of its suppliers and customers (Shank and
Govindarajan, 1993).
The internal management of working capital levels and operations can have a positive
effect on performance if a firms try to synchronise their internal management with
that of their buyers and suppliers. This external management can eliminate
unnecessary costs of working capital operations of inter-firm transactions as well as
costs of carrying short-term investments and financing. Inter-firm co-operation can be
used to establish value network (Rappaport 1986) and strengthen the value chain
(Porter 1985). Inter-firm co-operation with suppliers in purchasing and materials
inventory management and with customers in selling and finished goods inventory
management can minimise the need to keep unnecessary levels of cash and
inventories and eliminate unnecessary purchasing and selling activities. This may
result at a reduction of the costs of inter-firm transactional relations and a lowering of
the carrying costs of working capital levels. Customers and suppliers can benefit
substantially from a knowledge and co-operation with each other, which can be
gained by working together over time (Helper, 1987). Customer can benefit from
reduced transaction costs, improved quality, speed of communication and process
performance (Fuss and Waverman, 1992). Suppliers can realise stable sales and
reduced levels of working capital investment and their costs.
Chapter 3 52
Shank and Govindarajan, (1993) compare the traditional treatment of value addition
management and Porter’s value chain management. They argue that, in contrast to the
value chain linkage approach, the traditional treatment of value management takes the
value added perspective and focuses on the internal activities of the firm. The traditional
value added approach (see Figure 3-3) starts by managing value from payments to
suppliers (purchase), and ends up at charges to customers (sales). It's objective is to
maximise the difference between revenues and expenses of the firm in the short term.
This value added approach according to Shank and Govindarajan (1993), starts too late,
because it begins value management with purchases, missing all the opportunities for
exploiting linkages with the firm’s suppliers. It also stops too soon, because it ends-up at
sales and misses all the opportunities for exploiting linkages with the firm’s customers.
Figure 3-3: The value creation approach
Supplier’s Suppliers THE FIRM Customers Customer’s

suppliers customers
The traditional approach to value addition
Raw materials R & D Manufacturing Marketing Distribution Service
(starts at PURCHASES - too late) (stops at SALES - too early)
Source: Based on Shank and Govindarajan, 1993 p. 57
'HYHORSLQJ H[WHUQDO YDOXH FKDLQ FRRSHUDWLRQ Within the context of business to
business co-operation on working capital management, we emphasise here on how firms

can use inter-firm co-operation using the concepts of the value chain methodology.
Competition has brought about major changes in linkage management, forcing firms into
close interaction with both suppliers and customers. The linkages management approach
argues that firms establish and develop their supplier and customer linkages firmly so
that they position themselves better in a competitive environment. Firms have to manage
their connections with suppliers in such a way that the linkage created helps them to
streamline their activities by following tactics of cost leadership or differentiation
strategies so that both the firms and their suppliers benefit. The argument here is that if
the firm and its suppliers co-ordinate their activities they can create value with a
synergetic effect on both sides. The approach to the linkages with the firm’s customers
should also be in line with its approach to the linkages management with suppliers.
Buyers should perceive the competitive strategy of the firm in terms of lower price with
equitable quality (cost leadership) or the benefit of differentiation worth of paying a
premium price. The achievement of high level performance in terms of cost, quality and
time to market becomes ever more dependent on the quality and effectiveness of the
firms co-operation with suppliers and customers.
Inter-firm relationships have changed greatly over recent decades because new
organisational configurations have emerged like strategic alliances, partnerships and
networks of firms. According to Petroni (2000), relationships between buyers and
suppliers are usually positioned between two extreme poles “DGYHUVDULDO DQG
FROODERUDWLYH”. However, due to increased inter-firm dependencies on economic,
technological and commercial factors, the relationships are moving towards more
collaborative forms. Petroni, attributes the changes towards closer collaborative co-
operation due to factors that bring the buyer and supplier closer to each other. These
factors include the influence or urgency of the customer and the dependence of the
supplier, a firm’s technological and organisational competencies as well as
performance in a product’s price, quality, delivery, reliability and flexibility.
According to Rubin and Alvarez (1998), co-operations that provide for opportunities
for business LINC (learning, information exchange, networking, and collaboration)
can determine the difference between success and failure. They present the benefits
that smaller and bigger firms get as result of co-operation with each other. The
benefits that smaller firms get by co-operating with larger firms include, getting
technical advice, enhancing management development, leveraging core strengths,
accessing sources of financing and entering into sub-contracts and joint ventures. The
benefits that large firms get by co-operating with smaller firms are: reaching new
markets, partnering with agile firms, cultivating a world class supplier base, thriving
in industries that call for inter-firm collaboration and creating stronger business
environment.
&KRRVLQJ SRWHQWLDO SDUWQHUV LQ H[WHUQDO YDOXH FKDLQ OLQNDJHV Rubin and Alvarez
(1998) argue that business to business co-operation beginning with existing suppliers
and sales channels and extending to new suppliers and sales channels can increase
competitiveness. However, before beginning business to business co-operations, firms
have to make an analysis of their supply side and market opportunities. On the supply
side firms have to look for strategic value that a firm can provide - such as freight-in
advantages, small production runs, faster results of research and development, and
greater ability to integrate employees and production lines. On the market analysis
side firms have to look for firms that have value added role to services - like the
ability to service small markets with lower overheads, make introductions to new
customers, provide more detailed customer knowledge about niche customer
segments, and reach newly expanding customer segments.
([WHUQDO YDOXH FKDLQ PDQDJHPHQW VWUDWHJLHV According to Rubin and Alvarez
(1998) the strategies that firms can use in implementing business-to-business co-
operation include: one-on-one technical assistance and consulting, classroom and
group training, peer groups and boards of advisors, and sales channel development.
2QHRQRQH WHFKQLFDO DVVLVWDQFH DQG FRQVXOWLQJ can be used to achieve business to

business co-operation to fit into the recipient’s unique phase of business growth,
sector and location if specific steps are taken between consulting meetings in order to
ensure that the relationship is productive. &ODVVURRPDQG JURXS WUDLQLQJ can be cost-
effective to teach groups of business owners. Businesses can open their in-house
classroom training to outside firms in the form of firms offering quality management
classes for their suppliers and customers. 3HHUJURXSVDQGERDUGVRIDGYLVRUV can help
business firms to develop skills to solve business problems by drawing on networks of
people outside the business. The most effective settings are participatory connections
between firms at various levels (from executive to senior staff to shop floor
managers), within the same industry, or in complementary industries. 6DOHV FKDQQHO
GHYHORSPHQW can be used to increase the sales of both firms participating in the
business to business co-operation. Sales channels refer to any intermediary firm

between the manufacturer and the ultimate consumer including dealers, distributors
and franchises. According to Rubin and Alvarez, the strategies used for supplier
Chapter 3 54
development such as adapt-a-supplier, joint venturing and executive grooming can

also be used for developing new sales channels.
7KH EDVHV RI LQWHUILUP FRRSHUDWLRQ A business inter-firm network includes
actors, activities and resources (Hakansson and Johanson 1992). The actors include
individuals and organisations controlling certain resources and activities. They make
decisions, which is subject to bounded rationality. The activities are inter-connected
and make chains with each other forming networks of activities and one activity is
dependent on another activity to be performed. Then there are resources, which
according to Kock (1992) can be categorised into personnel resources, software
resources, hardware resources, organisational resources and capital resources.
Personnel resources make the organisation run by making decisions and establishing
and maintaining relationships with others both inside and outside the organisation.
Software resources include know how of all functions. The term software resource is
used as a common term for knowledge of both hardware and software. It includes
technology, knowledge of manufacturing process, machinery, marketing as well as
knowledge of buyers and suppliers. Hardware resources include tangible assets such
as machinery, buildings, equipment etc. Organisational resources include
organisational structure, goals and culture. Organisational structure identifies the
firms potential towards interacting with partners, how customer oriented the firm is,
how fast decisions can be made, empowerment etc. In inter-firm business networks
the partners adapt their organisational structure to each other as mutuality and trust
make it necessary. Management goals are very important in managing and directing
business activities. They provide individual members of the firms with something to
aim at and motivate them. However, goals do not strictly have profit maximisation as
a central focus, otherwise transaction partners will probably act opportunistically,
which might lead to conflicts with each other. An organisation’s culture (Wheelen and
Hunger, 1992) consists of beliefs, expectations and values learned and shared by
individuals. Usually, culture is transferred from senior to junior managers in the firm.
Very seldom is the culture recorded, rather it is defined according to informal rules or
norms. Moreover, culture reflects the goals, strategies and policies of a firm. It is the
identity of a firm and can to some extent be explained by its past history. Capital
resources mostly from stockholders, financiers and banks are of great importance and
usually have to be obtained through long-term relationships because few firms have
the ability to internally raise substantial amounts of it.
Rubin and Alvarez

.H\ IDFWRUV LQ VXFFHVVIXO LQWHUILUP FRRSHUDWLRQ VWUDWHJLHV
(1998) find that the following factors contribute to the success of inter-firm co-
operation. The inter-firm relationship must be mutually beneficial (a win-win) for
both firms. The greatest benefits come over a long-term and often in unanticipated
ways. The best inter-firm co-operation blends several approaches and sequences them
to provide the participants with multiple opportunities to learn. From the beginning,
both firms should have a clear definition of their goals and expectations, with honest
and frequent communication. The firm must be committed to the relationship at both
the top management and staff levels, with appropriate incentives. A firm’s needs
assessment, at the outset of the relationship, improves the match of the skills and
resources between the firms. Effective business advisory strategies adapted to the
firm’s size, industry and phase of growth. Firms should be selective in assuring that
their inter-firm co-operation partner is ready, willing, and able to make the
relationship work. Intermediary organisations can be helpful in matching and
supporting inter-firm co-operation. Successful inter-firm co-operation ultimately

relies on successful personal relationships.
After describing relevant value creation models and issues of inter-firm linkages we
do not yet know how working capital levels and operations are affected in the inter-
firm relationships. In order to become more specific and study the benefits of the
linkages we will here discus the concept of transaction costs.
$WKHRU\RIWUDQVDFWLRQFRVWVRQZRUNLQJFDSLWDO
This section deals with the theoretical concept of transaction costs as well as its
implications for managing working capital operations and levels. We argue that firms
can create value by properly managing transaction costs of their backward linkages
with suppliers and forward linkages with customers.
According to Coase, (1937) and Williamson, (1985), firms exist because, there are
transaction costs of using the price mechanism in the market. Therefore, firms exist in
order to reduce these transaction costs by developing distinctive competencies. A
transaction is the fundamental unit of economic activity where one party agrees to
take an action in return for equitable reciprocal value. According to Williamson
(1985) a transaction occurs if a good or a service is transferred across a
technologically separable interface and can therefore occur within the firm (hierarchy)
or outside the firm (market). Generally, product costs are divided into costs of
production and costs of the transaction (Milgrom and Roberts 1992). Production costs
are the costs of labour, material and capital, while transaction costs are the governance
costs of the transaction, such as costs incurred while negotiating prices, drawing up
contracts, monitoring quality and building up trust, (Sako, 1992). In order to remain
competitive, firms have to minimise both production costs and transaction costs.
Though we give some focus on the production costs, this research will primarily
concentrate on the transaction costs because we are concentrating on the inter-firm
transactional relations. Inter-firm transaction relations are managed such that the
transaction costs created in the process are minimised and value is created. According
to Douma and Schreuder (1991) division of labour and specialisation create
transactions. Divisions of labour create opportunities for specialisation, which in
return necessitate co-ordination of economic activities (Milgrom and Roberts 1992).
Specialisation makes producers, sellers, buyers and consumers to be different from
each other. This will necessitate some effort and resources not only for producing the
goods and for shipping them to consumers, but also for effecting the exchange of
transactions. Effecting the exchange of transactions include, identifying potential
buyers, describing the goods to them, setting the terms of trade, transferring the
property rights and finalising the transaction through an exchange of values.
The basic idea behind the theory of transaction costs is that, the characteristics of a
transaction exchange determine the type of efficient governance structure in inter-firm
and intra-firm linkages (Heck and Zuurbier, 1989). According to Williamson, (1985),
the extent of transaction cost is affected by the prevailing environmental and
behavioural dimensions. With regard to their environmental dimensions transactions
differ in some basic characteristics such as asset specificity, frequency and volume,
complexity and uncertainty, possibility of performance measurement, connectedness
Chapter 3 56
to other transactions and number of potential transaction partners. In addition to the

environmental dimensions of transactions, transaction costs theory is also based on
the notion that human beings are bounded rational and sometimes display
opportunistic behaviour (Williamson 1985). While people aim to be rational, their
capacity to do so is limited due to behavioural uncertainty, which concerns the
intentions and competencies of transaction partners that may affect the execution of
agreements and outcomes of their co-operation. The possibility for this follows the
unpredictability of conditions and asymmetric information of transaction partners.
Nobody is equally opportunistic, but the possibility of opportunism exists and prior to
a relation one does not know to what extent it may arise. In the process of exchange
one can distinguish between three stages of a transaction: contact, contract and control
or execution (Williamson 1985, Van Der Meer-Kooistra and Vosselman 2000). In
section 3.5.2 we focus on the external dimension of firms’ transactional relation and
in particular on the costs of contact, contract and control.
:RUNLQJFDSLWDORSHUDWLRQVIURPDWUDQVDFWLRQFRVWVSHUVSHFWLYH
In order to manage transaction costs, firms have to design the management of value
chain approaches in order to efficiently reduce the costs of asset specific transactions.
According to Williamson (1985), there are a number conditions that may create the
situation of asset specific transactions. For our purpose of working capital
management the relevant situation is the asset specificity created due to dedicating
assets to a transaction, which refers to the nature of investment that the parties must
make with that asset in mind. According to Williamson, an asset is a transaction
specific, if it cannot be applied to an alternative use without a significant reduction in
the value of the asset. In case of asset specificity, partners to the transaction become
dependent or locked-into each other. The producer looses value if the transaction is
discontinued after committing to an investment required to produce only a specific
product on the demand of a specific customer. The goods produced for a particular
customer may not have any other use for the firm’s other customers. Therefore, the
products’ value will be highly diminished if the customer decides to discontinue the
relation. By the same logic, where a firm produces for the general market, first they
may have inter-firm transactional relations with many alternative partners. However,
frequently transacting for an extended period of time with one of the customers
creates an asset specific relation due to the characteristics of small numbers
transacting (Williamson 1985). Breaking up with this relation and starting a new one
results in transaction costs of switching and this prohibits them from breaking-up their
relations. In order to minimise this potential loss firms may have to incur transaction
costs of ex-ante screening and ex-post safeguarding measures.
3XUFKDVH GHFLVLRQV DQG WUDQVDFWLRQ FRVWV HFRQRPLFV Purchases can create asset
specific relations with the firm’s suppliers. After repeated purchase from the same
supplier it creates habituation and so the control over the purchase can be loosened.
Purchases from the same supplier affect a firm’s inventory management (timing of
orders, safety level held, order levels etc.) due to the confidence of the firm in the
efficiency of its supplier. After a certain number of transactions, the supplier will
build confidence and will not apply the stringent controls over credit validity due to
trust having been built. If these attachments are going to be discontinued there will be
certain switching costs incurred by the firm and suppliers. The routine ordering,
purchasing and receiving process may create trust and it may decrease the transaction
costs in the firm’s purchasing, receiving and storing departments. If the purchase is to
be made from a new supplier, the purchase procedure of collecting information,
processing the comparison among the potential suppliers, negotiating the terms of sale
as well as inspecting the goods upon arrival will take time, money and effort. These
activities increase the transaction costs of switching the purchase from another
supplier. So, firms will normally not shift from one supplier to another, because it will
mean increasing transaction costs. Similar explanations could also apply to the firm’s
relation with its bank as a financial supplier.
6DOHV GHFLVLRQV DQG WUDQVDFWLRQ FRVWV HFRQRPLFV Routine and repetitive sales of
goods connect the firm and its customers so much that not only asset specific
transaction conditions but also the habitual management through co-operation results
in trust. Once the firm establishes such a close connection, the routines of sales,
particularly credit sales, such as ex-ante transaction costs of negotiating, drafting and
safeguarding the credit sales agreements will be by-passed and will decrease related
transaction costs. Once the firm becomes confident of its customers’ credit
worthiness, it will respond to a customer with favourable credit terms. It will provide
its customers higher discounts (in terms of both quantity and cash) and longer credit
periods. It will use the informal open account as instrument for the evidence of credit
granting and outright ownership transfer rather than consignment or conditional sales.
The information needed to evaluate the future credit application by the buyer will be
less and it comes from cheaper sources. The firm can use its own experience with the
buyer and analyse the buyers financial statements, rather than using expensive
information sources like customer visits or buying information from credit
information supplying firms. The cumulative effect of all these positive experiences
will be that repeated transaction relations of a firm and its customers create conditions
of asset specificity and trust as well as potential costs of breaking the relationship.
7KHSKDVHVDQGFRVWVRIHIIHFWLQJWUDQVDFWLRQV
In line with the phases in which they occur (Table 3-2) transaction costs under a
market system are divided into three parts (Williamson 1985, Nooteboom 1992,
Milgrom and Roberts 1992, Knorringa and Knox 1992): costs of contact (or ex-ante
costs), costs of contract and costs of control (or ex-post costs). Though other
distinctions can be made [Sako 1992] this research adapts the categorisation of
transaction costs by Williamson.
Chapter 3 58
7DEOH7UDQVDFWLRQDFWLYLWLHVDQGUHODWHGFRVWV
Transaction Activities of transaction Category of transaction costs

phase
Contact Finding the market and searching for a partner, Ex-ante costs of contact
identifying a potential partner, describing the offer to (searching costs)
a potential partner, advertising in the media,
attending trade fairs and exhibitions.
Contract Negotiating prices, setting the terms of trade, writing Costs of contract
and evaluating a proposal, credit investigation and (costs of negotiating drafting
discussion, setting-up governance structures. and signing contract)
Execution Bonding secure commitment, monitoring quality, Ex-post costs of control
(Control) building-up trust and customer confidence, collection (cost of safeguarding
efforts, taking legal measures. agreement)
Source: Based on Williamson, 1985, Sako, 1992, Knorringa and Knox 1992
In the cRQWDFW SKDVH transaction partners search for an opportunity to meet because
before the arrangement of a contract one must find a partner. They encounter each
other and create mutual relations of a transaction partnership. This phase helps
transaction partners to determine why they meet, how they meet, and what their
mutual status is (Knorringa and Knox, 1992). In order to get together and transact,
potential buyers and sellers need to know each other’s existence and location and in
the mean time they create H[DQWH FRVWV RI FRQWDFW. These are the costs that occur
before the transactions take place and they include search costs for the buyer and
marketing costs for the supplier (Nooteboom, 1999). Search costs of a buyer are
associated with becoming aware of a need and the possibilities of fulfilling it,
searching for fitting solutions and alternatives and evaluating them. Marketing costs
for a seller form the other side of the search costs. They include the research of latent
needs of a potential customer, investigating market needs, possibilities to satisfy them,
development of specifications, tests and search for entry to customers. Milgrom and
Roberts (1992) also call these costs of contact as costs of co-ordination and they claim
that the costs arise because of the need to determine prices and the other details of a
transaction, which they further specify in the contract phase.
7KHFRQWUDFW SKDVHrefers to the settlement of the transaction. An agreement is made

on the exchanged values. This includes agreeing on what is given for what price, in
what quantities and by what criteria. The exchange proportions can be expressed in
terms of agreement either by an arms length market price or by an intra-company
transfer price. The phase of contract involves costs of preparing implicit or explicit
agreements in order to reduce the risks of opportunism in conditions of uncertainty
that may arise during execution. Sako (1992) says these are costs of drafting and
negotiating agreements once trading partners are identified. So, they include costs
paid to lawyers and the time spent by purchasing or marketing personnel in
negotiating the terms of price, quality, delivery and payment.
7KH H[HFXWLRQ SKDVH refers to agreements made to curb opportunistic behaviour of

transaction partners and the future potential of the transaction. Transaction costs of
control (ex-post costs) occur once the transaction agreements start to be implemented.
They include costs of monitoring transactions, performance measurement, judging
conformance to the agreement, identifying and solving any disagreement,
renegotiations and adjustment of the agreement, enforcement and application of
sanctions, litigation and possible loss of specific investments and hostages if the
relation breaks (Nooteboom, 1999). Williamson (1985) also refers to these costs as
the adaptation costs incurred when a transaction costs get out of alignment and
haggling costs will be incurred when bilateral efforts are made to correct ex-post
mishaps. In every phase of effecting a transaction the firm-supplier-customer linkages
increase some transaction costs and decrease others. Identifying those costs that
increase with closer firm-supplier-customer linkages and using mechanisms to reduce
these costs can help in creating firm value. We call this the management of transaction
costs and discuss about it in the next section (section 3.5.3).
7KHPDQDJHPHQWRIWUDQVDFWLRQFRVWV
Transactions are often organised in order to economise on bounded rationality while

simultaneously safeguarding against the hazards of opportunism (Williamson 1985).
According to Williamson two remedies (ex-ante screening and ex-post safeguarding
measures) can be taken to protect against opportunism, otherwise those who are less
principled (more opportunistic) will be able to exploit those who are more principled.
Ex-ante screening measures include stringent control in selecting transaction partners
and designing all-inclusive contracts. Williamson argues that ex-ante screening is a
weaker form of managing opportunism compared to ex-post safeguarding measures
and it is less effective because of the existence of bounded rationality. Because of
uncertainty there are more unforeseeable conditions during contract execution of a
transaction relation. There is more room for opportunistic behaviour when the ability
to acquire and investigate information is limited. Therefore, in order to reduce
transaction costs, governance structures are used with an effect on bounded rationality
and opportunistic behaviour of transaction partners. According to Williamson [1985]
governance structures of transactions are grouped according to the level of asset
specificity associated with them, namely market governance, hierarchy governance
and a hybrid of the two.
Within the hybrid governance, transactions can have differing degrees of control. Van
der Meer-Kooistra and Vosselman (2000) have developed a model of alternative
governance patterns. They argue that inter-firm transactional relations can have
different control patterns: (market, bureaucratic and trust based). Within the control
patterns different control mechanisms can be at work depending on the contingency
factors that prevail in a given transaction relation. A control pattern depends on the
existence of three possibilities or contingency factors namely, transaction
characteristics, transaction environment and transacting parties. The FKDUDFWHULVWLFVRI
WKH WUDQVDFWLRQ refer to the degree and type of asset specificity, frequency and
repetition, length of the transaction period and measurability of activities and outputs.
&KDUDFWHULVWLFV RI WKH WUDQVDFWLRQ HQYLURQPHQW include uncertainty about future
contingencies, degree of market risks, institutional environment (rules, systems and

organisations). The FKDUDFWHULVWLFV RI WKH WUDQVDFWLQJ SDUWLHV are described by the
information asymmetry, reputation, risk attitude and bargaining power.
0DQDJHPHQW FRQWURO SDWWHUQV DQG WKH WUDQVDFWLRQ SKDVHV According to Van der
Meer-Kooistra and Vosselman (2000), the alternative management control patterns

that could be applied in inter-firm transactional relation differ not only with
alternative contingency factors.
Chapter 3 60
With a transactional relation based on a PDUNHWFRQWUROSDWWHUQ, a meeting of potential

partners on the basis of competitive bidding characterises the contact phase. In the
FRQWUDFW SKDVH there will be no detailed contracting and payment will be based on
standardised activities or output. Control is imposed during the execution phase

through a periodic ex-post competitive bidding. When an inter-firm transactional
relation occurs on a EXUHDXFUDF\EDVHGFRQWUROSDWWHUQ, the contact phase is identified
by the contact on the basis of pre-selection of potential partners using detailed bidding
procedures and selection criteria. In the contract phase there will be detailed and
comprehensive contracting. Payment will be made on the basis of the evaluation of
real activities or output. Control is imposed during the execution phase through close
supervision, performance measurement and evaluation, detailed ex-post information
processing, direct intervention as well as periodic ex-post-competitive bidding. When
inter-firm transactional relation occurs on a WUXVW EDVHG FRQWURO SDWWHUQ, the FRQWDFW
SKDVH is identified by the contact of potential partners on the basis of trust stemming
from friendship, former contractual relationships or reputation. In the contract phase

there will be intentional contracting, framework contracts, contractual trust, loose
links between payment activities and output. Execution is imposed through personal
consultation and co-ordination, development of competence and goodwill trust, while
control will be process oriented and culture based. Van der Meer-Kooistra and
Vosselman (2000) also propose especially to look further into the importance of
organisation’s culture and historical situational factors. We consider this to be a
relevant addition that we can apply with regard to the management of working capital
levels and operations in inter-firm relationship in government, transition and
privatised firms, given their historical background and organisational set-up.
However, before going deeper into the historical backgrounds and the three ideal
types of control systems we will address aspects of transaction costs related to
purchases and sales and see what they might imply for working capital management.
:RUNLQJFDSLWDORSHUDWLRQVIURPDPDQDJHULDOFRQWUROVSHUVSHFWLYH
After having discussed the creation of asset specificity and trust from frequent
transactions with the same partner within a linkage, we will here relate the managerial
control patterns of Van der Meer-Kooistra and Vosselman (2000) to the working
capital operations of purchasing materials and selling finished goods. The inter-firm
working capital operations have transaction costs, which can be minimised if
prevailing contingency factors are managed within the appropriate managerial control
pattern. The idea is that transaction governance structures (management control
patterns) and the characteristics of the transactions contingency factors have the “best
fit”, in which case transaction costs are the lowest. If managers are able to determine
and apply the best fit transaction costs are low otherwise they are high.
Van der Meer-Kooistra and Vosselman assume that management is able to know the
contingency factors that can possibly occur in an inter-firm transactional relationship.
Based on this knowledge management can find the “best fit” among the contingency
factors and appropriate type of transaction control pattern or governance can be
designed. Though this may be a valid academic argument as a research model, it is
quite difficult practically for the management to find and evaluate all factors that
determine the best control pattern and contingency factor match-up. This may be
worse particularly in situations of underdeveloped countries that this thesis takes as a

context.
0DUNHW EDVHG FRQWURO SDWWHUQV DQG ZRUNLQJ FDSLWDO RSHUDWLRQV Under the market
based control pattern, the FRQWDFW SKDVH of inter-firm-transactional relation of working

capital operations presume no previous contact between the buyer and the supplier. So,
both buyers and suppliers do not have readily available potential partners. In this
situation the buyers and suppliers are forced to search for partners in the open market.
The buyer starts by preparing documents for competitive bidding, announces it publicly
or conducts marketing research to collect data on sellers. Buyer then compares
alternative suppliers based on some yardstick and then start negotiating with the
prospective supplier. The seller may also advertise his/her products publicly or search
potential buyers through various channels.
At the FRQWUDFW SKDVH of the market control pattern, the WUDQVDFWLRQ FKDUDFWHULVWLFV are
identified by first time contacts between buyer and supplier who are competitively
chosen from many alternative suppliers. This results in a weak asset specific investment
and a short-lived inter-firm relation, which may not be repeated again. A partner has no
means of ex-ante measuring the efficiency of the other in performing the contract. The
WUDQVDFWLRQ HQYLURQPHQW is characterised by the buyer’s dependence on the price of the
product as a reflection of its quality. The established institutional and social factors have
little role in making an impact on the transacting parties. &RQWURO during execution is
imposed by a reference to how efficiently the previous transaction was implemented.
The purchases and sales are effected on cash basis. Since there are many buyers and
suppliers in the market, partners will not expect their relations to continue and will not
opt for incentive measures like transacting on a credit bases.
%XUHDXFUDF\EDVHGPDQDJHPHQWFRQWUROSDWWHUQDQGZRUNLQJFDSLWDORSHUDWLRQV At
the FRQWDFW SKDVH the potential suppliers are pre-selected and invited to take part in a
bidding competition whose procedure and criteria of selection are known to both. The
usual purchase procedures like preparing purchase requisition, preparing bid documents
and processing bid competitions will be applied. TheFRQWUDFWSKDVH is characterised by
detailed and comprehensive contracting and payments based on real activities or output.
Both the buyer and supplier will resort to checking the authenticity of sources of
information and quality of products and services. At this phase the parties will conduct
rigorous verification of the information before the contract is agreed upon and install
strict safeguarding measures of control that will protect the parties during contract
execution. Control in the H[HFXWLRQ SKDVH is identified by the parties strict supervision,
performance measurement and evaluation, detailed ex-post information processing and
direct intervention.
The close but cautious interaction may result at transacting on a credit basis albeit on
stricter terms because it needs writing notes and bank guarantees rather than using the
open credit or cash transaction. Suppliers give incentives like cash and quantity
discounts. Buyers follow-up the purchase with regard to the quality and quantity as well
as the timing and means of shipments.
7UXVWEDVHGFRQWUROSDWWHUQDQGZRUNLQJFDSLWDORSHUDWLRQV The FRQWDFW SKDVH of a

trust based management control pattern starts from a trust as a result of relational
development of buyers. Transaction will be effected on a credit basis with very relaxed
Chapter 3 62
standards and terms that resembles a hierarchy approach of transaction governance. So,
the buyer needs to send a very informal purchase order to a seasoned and reliable
customer. The usual purchase procedures like preparing purchase requisition, preparing
bid documents and processing bid competitions will not be applied. The FRQWUDFWSKDVH
is characterised by intentional contracting, framework contracts and loose links between
payment activities and output. Both the buyer and supplier will not resort to checking the
authenticity of sources of information or quality of products and services. At this phase,
the contract can be implied without any documents or documents exchanged after the
transaction. The interacting party’s personal consultation and co-operation generate
control in the H[HFXWLRQSKDVH. The buyer spends less time and effort in the follow-up of
purchases with regard to the quality and quantity as well as the timing and means of
shipments which can be conducted on the basis of f.o.b. destination. It is also possible
for the two parties to use the just in time approach of inventory control and use other
contingency factors for emergency needs. This decreases the efforts, the time and the
resources that both buyers and suppliers need for the transaction and therefore it reduces
the transaction costs.
:RUNLQJFDSLWDOOHYHOVIURPDPDQDJHULDOFRQWUROVSHUVSHFWLYH
Based on the insights of the Van der Meer-Kooistra and Vosselman model, we
continue the argument that if appropriate managerial control patterns are applied the
costs arising from inter-firm working capital relations can be reduced.
0DUNHWEDVHGFRQWUROSDWWHUQVDQGZRUNLQJFDSLWDOOHYHOV In a market based control
pattern the asset specificity is low and the duration of the transactional relation is short,
while the need for performance measurements is high. The parties will not commit
themselves to investment in asset specific transactions and they will interact frequently
over a short period of time. Managing working capital levels in a PDUNHW EDVHG
transaction environment takes place within potentially many alternative partners and
the buyer relying on the price as a reflection of the products characteristics. Since the
other party knows all the contingency factors s/he will not be motivated to remain
loyal to one or a few partners. This makes the inter-firm relationship loose favouring
the transaction to be managed by a market based control pattern. The influence of the
institutional and embedded social norms and rules will have little effect on the manner
of the transacting parties because they may shift immediately when these factors are
not to the liking of one partner. In a market based management control pattern the
characteristics of WUDQVDFWLQJSDUWLHV are not important because there are many parties
with the same characteristics and because switching costs are low.
With respect to the working capital aspect, we would suggest that in the market based
pattern of buyer-supplier interaction, the parties need to maintain high levels of liquidity
because the inter-firm relation is loose while the transactions will take place on a cash
basis. The level of accounts receivables is expected to be low and so is short-term credit
financing, since the firms will not have the level of trust in each other to settle
transactions on a credit basis or to allow short-term finances. The investment in cash and
inventory for transaction, precaution and speculation purposes will be quite high.
Moreover, because investment in working capital levels remains large, the related costs
increase.
%XUHDXFUDF\EDVHGFRQWUROSDWWHUQVDQGZRUNLQJFDSLWDOOHYHOV A bureaucracy based

control pattern is more prevalent in situations where individual contact, detailed contract
and strict control is relevant.
In a bureaucracy based control pattern the transaction characteristics of asset specificity,

repetition of inter-firm transaction and the duration of interaction increase while
performance of activities and outputs can be measured by agreed upon standards and
rules in the contract. Under the bureaucracy based control pattern, the WUDQVDFWLRQ
HQYLURQPHQW reveals a decreasing number of partners and the market price gives little
information about the characteristics of the product. This fact forces the buyers and
suppliers to be closely bonded by commonly agreed ex-post control mechanisms. This
interaction necessitates the use of well designed institutional factors and a strong socio-
cultural dependence. The WUDQVDFWLQJ SDUWLHV understand that they have asymmetric
information and they keep closer to each other by establishing detailed contracts and
imposing strict control. They will keep a good reputation in order to continue their
relationship. If one of the parties fails to do its share, institutional and social control
measures are applied. This includes mechanisms of contract enforcement by the court of
law, revenge in the form of disallowing any further transaction when the opportunist
party wants it most or by socio-cultural consequences like making public the bad
experience which might result into a bad reputation for the failing party.
Overall, the management of working capital levels of investment and financing under
bureaucracy based control pattern reveals a close but cautious relationship. This close
but cautious interaction keeps the investment in working capital levels for transaction,
precautionary and speculative purposes at medium levels. While the levels of receivables
and payables may increase, the effect of reduced inventory levels decreases the related
costs compared to a market based management control pattern. The possibility of
financing working capital investments with the “interest free” trade credit also increases.
This is because there is a higher possibility that suppliers will grant credit but require
some legal assurances from the buyer in the form of promissory notes or the buyer’s
bank in the form of letters of credit.
7UXVW EDVHG FRQWURO SDWWHUQV DQG ZRUNLQJ FDSLWDO OHYHOV With a trust based control
pattern the transacting parties are convinced that they can trust each other and there is no
need for a bureaucratic control as revealed by the detailed contract and stringent control
mechanisms.
Under a trust based management control pattern the transacting parties enter into asset
specific agreements repeatedly for a long-term period and see no need to measure the
performance of activities and output of each other. However, the fact that they trust
each other regarding their professional competence, contractual seriousness and
reputation decreases the opportunistic behaviour and the need for the imposition of
strict control mechanism. The WUDQVDFWLRQ HQYLURQPHQW under a trust based control
pattern shows few transacting partners bonded tightly together and influenced by
socially embedded factors with an institutional network. The trust based control
pattern implies that the WUDQVDFWLQJ SDUWLHV prior experience of close co-operation
proved their reputation and both sides know that there is no asymmetry of information
and bargaining power. They are willing to share any forthcoming possible risk.
Chapter 3 64
Under this management control pattern the working capital level of investment needed
for transaction, precaution and speculative purposes are not important. A credit
transaction is made on an open account basis with no guarantee from the buyer or its
bank. So, the accounts receivable balance remains quite high while the cash and
inventory balances are low and transfer of inventory could be made on terms of
consignment. The investment in working capital levels is the minimum and so are the
related costs. It is possible also that trade credit financing is high increasing accounts
receivable and bank loans such as short-term debts and overdrafts.
We conclude the discussion on the working capital operations and levels versus
managerial control patterns with a description of Table (3-3).
7DEOH0DQDJHULDOFRQWUROSDWWHUQVDQGZRUNLQJFDSLWDO
:RUNLQJFDSLWDO 0DUNHWEDVHG %XUHDXFUDWLFEDVHG 7UXVWEDVHG
/HYHOV
Cash H M-H L
Receivables L M-L H
Inventories H M-H L
Payables L M-L H
Bank loans L M-L H
2SHUDWLRQV
Repetitions/reputation L M-L H
Trust L M-L H
Key: H (high), L (low), M (medium), M-H (medium to high), M-L (medium to low)
As Table 3-3 reveals, in a market based transaction control pattern the levels of cash
and inventories are normally expected to be high. This is because there is high risk of
liquidity for the purposes of day to day transaction and payment of maturing debt. In
addition the precautionary and speculative needs cannot be financed with the help of
inter-firm linkages. The levels of accounts receivable, accounts payable and short-
term loans are expected to be low because there will be no trust and firms will not
transact on credit basis. On the operation side inter-firm repetition and reputation is
low because firms will shift frequently from one partner to another and therefore trust
will not develop. For these reasons inter-firm transaction costs remain at a high levels.
In a bureaucracy based transaction control pattern the levels of cash and inventories
are expected to be medium to high because there is risk of liquidity for transaction
purposes as well as that precautionary and speculative needs may not be financed with
the help of inter-firm linkages. The levels of accounts receivable and short-term debts
are again medium to low because trust among transacting partners is not fully matured
and firms may or may not transact on credit basis. In the transaction operation among
partners, repetition and reputation is medium to low because firms may sometimes
shift from one partner to the other and therefore trust may not develop. For these
reasons inter-firm transaction costs remain medium to high.
In a trust based transaction control pattern the levels of cash and inventories are low
because there is low risk of liquidity for transaction purposes and precautionary and
speculative needs can be financed with help of inter-firm linkages. The level of
accounts receivable, accounts payable and bank sort-term loans and overdrafts are
high because of inter-firm trust, firms transact on credit basis and banks offer short-
term loans if firms require it. On the operation side inter-firm repetition and reputation
is high, firms will not shift from one partner to another and trust develops. For these
reasons inter-firm transaction costs are expected to be low.
9DOXHPHDVXUHPHQW
$OWHUQDWLYH DSSURDFKHV WR YDOXH PHDVXUHPHQW The main objective of business firms
as it has been disclosed in section 3.1 is the creation of value. However, the term
value has been used by both researchers and practitioners in different ways, three of
the commonly used terms according to (Stewart, 1990) are – accounting earnings,
economic value added and net cash flows. The accounting earning takes the accrual
accounting into consideration where income earned is considered as value created and
expenses incurred as offsetting the value created. The difference between the income
earned and expenses incurred is the net profit (after tax), which is used as a final
measure of value created. The economic value added approach measures value by
taking the difference between the net accounting earnings (or operating profits) and
the cost of all the capital employed to produce those earnings (Stewart, 1990 p. 2).
This approach considers the time and risk taken in the process of creating value.
Under the net cash flows approach, income is considered to be realised only if cash is
collected from the goods sold or services rendered and expenses are recognised only if
cash is paid for the goods bought or services received. The net cash flow is considered
the final measure of value created or destroyed. Therefore, firms can be evaluated not
only by the net accounting profit that they earn but also by the net cash flows (net
accounting profit adjusted for the changes in working capital investments and finances
as well as non-cash expenses).
Without going into details about the pros and cons of these approaches we can safely
conclude that the economic value added gives a relatively accurate measure of value
but is relatively difficult to measure particularly in developing conditions. The
accounting earning and the net cash flows are easily measured (given the standard and
widely used accounting practices). For this reason we only consider accounting
earnings and cash flows as measurable variables in the analysis of our study.
We therefore have used mainly the accounting earnings because information

regarding the accounting earnings is widely and easily available from the all the firms
so it was easy to compare the value of the firms. Moreover, we could not get cash
flow statements for all the firms for the seven years that we have covered in our study.
Therefore, it was not possible to make a comparative study of the firms, so we have
tried to study the cash position of the three main firms for at least three consecutive
years and evaluated the effect of each working capital item on the net cash flows of
the firms and thereby we study the role of working capital in the creation of value in
terms of net cash flows.
7KH PHDQLQJ RI YDOXH IRU WKH SXUSRVH RI RXU FDVH VWXG\ The notion of value in the
developed (western) countries is based on the shareholder value maximisation

(Rappaport, 1986), which can make sense only if there are efficient financial
institutions and capital markets. This notion of the shareholder value cannot be easily
adapted to the study of value creation in the developing countries where there are no
efficient financial institutions and capital markets. For example in Eritrea there is no
stock market and therefore there are no companies whose shares are publicly traded
Chapter 3 66
and all the relatively larger firms (in terms of size of capital and sales volume) were
government owned. The government slated these firms for privatisation only in 1996
through direct sales and not through public share offerings. Because of these facts, we
applied the meaning of value in terms of its accounting sense and we believe the
meaning of value and value creation given by Porter is appropriate in this case. Porter
(1998 p. 38) describes value as the amount buyers are willing to pay for what a firm
provides them, which is measured by the total revenue, as reflected in the price a
firm’s product commands and the units it can sell. He further provides that a firm is
profitable if the value it commands exceeds the costs involved in creating the product.
We have opted for this option of the meaning of value so that to be applied in the
study of internal and external working capital management, in a developing context,
particularly in the government, transition and privatised manufacturing firms in
Eritrea. Value according to this definition can be observed by the amount of sales,
costs of sales, operating expenses and the resultant net profit or loss (or margin
according to Porter) reflected in a firm’s financial statements, particularly the income
statement. As it is indicated in Appendices 6.1, 7.1 and 8.1, we have obtained the
managers’ opinion on the role of working capital management on the value creation
on the basis of this definition.
&RQFOXVLRQ
This chapter has covered the theoretical background for the research study on the
external working capital management. According to Rayan, Scapens and Theobald
(1992), in case studies the use of background theory is important. Theory is used as a
background to decide on what research approaches to follow and what data to collect
in order to analyse the research and to arrive at a conclusion about the study. Having
this objective in mind, we use three interconnected theories as a background:
Rappaport’s (1986) value network, Porter’s (1985) value chain and Williamson’s
(1985) transaction costs.
We applied Rappaport’s (1986) value network model to explain the relation between
the corporate objective of value creation and its drivers. His model is useful to
demonstrate the creation of firm value by managing value drivers and value
components. Rappaports value network model helps us to focus on how value can be
created with particular reference to working capital levels and operations. Based on
Rappaport’s argument we divide the conceptual framework of our study into working
capital operations of purchases and sales as well as levels of investment and
financing. The ensuing proposition is that if firms manage their internal and external
activities related to the working capital operation and levels they can create value to
the owner, which can be measured and realised on the basis of Rappaport’s assertions.
We used Porter’s (1985) value chain model to help us find answers to issues of value
drivers. Porter divides value drivers into specific primary and support activities which
are inter connected by internal linkages to each other and external linkages to buyers
and suppliers. We used this value chain linkage model as an input to describe inter-
firm transactional relations useful to create value. The main drivers of this value
creation are activities inside the firm (the primary and support activities) and outside
the firm (supplier and customer linkages). The external value drivers with regard to
firm-supplier and firm-customer value chain helped us to understand that the efficient
management of a firm’s internal value drivers alone cannot enable a firm to exploit its
value creation potential to the maximum possible. There is value chain that starts with
suppliers, connected to the firms and continues to customers. Exploiting this value
chain pre-supposes that firms co-operate with each other such that all players
connected to the chain apply well co-ordinated and cohesive management in their
internal and external value chain linkages. Therefore, value creation can be enhanced
if a firm manages its internal activities efficiently and co-ordinates it with its external
supplier-customer value chains. However, for value to be created tangible managerial
decisions and actions have to be taken.
We used Williamson’s (1986) theory on transaction cost to argue that efficiently

reducing these costs (along with income increasing approaches) contribute to the
creation of value. We use Williamson’s transaction costs management approaches to
study the transaction costs characteristics of working capital levels and operations and
Van der Meer-Kooistra and Vosselman’s (2000) model on managerial control
patterns. Van der Meer-Kooistra and Vosselman [2000] argue that inter-firm
transactional relations can have different managerial control patterns - market,
bureaucratic and trust based. Within these managerial control patterns different
control mechanisms can be applied depending on the contingency factors (transaction
characteristics, transaction environment and transacting parties) that prevail in a given
transaction relation and in every transaction phase (contact, contract and execution).
Their model helped use to relate the management of working capital operations and
levels to the approaches of transaction cost management.
Before starting to formulate our conceptual framework in chapter 5, that we use to

design our information retrieval from a field study on the government, transition and
privatised manufacturing firms in Eritrea, we need to answer the following theoretical
question. “Does ownership matter for creating value by managing a firm’s internal
and external working capital levels and operations”? This is a topic that we cover in
the next chapter (chapter 4).
&KDSWHU
)LUP2ZQHUVKLSDQG9DOXH&UHDWLRQ
,QWURGXFWLRQ
Our main objective in this chapter is to search an answer for the third conceptual
research question, which states: “IV WKHUH D FRPSDUDWLYH DGYDQWDJH RI RSHUDWLRQDO
HIILFLHQF\ IRU YDOXH FUHDWLRQ GXH WR WKH W\SH RI RZQHUVKLS JRYHUQPHQW RU SULYDWH´"
With this objective in mind section 4.2 covers the debate on ownership, market
competition and operational efficiency. Section 4.3 is devoted to comparing the
efficiency of government versus private ownership. Section 4.4 covers the issue of
privatised firms and section 4.5 presents the case of firms in transition to privatisation.
Section 4.6 relates firm ownership and value creation to inter-firm managerial control
patterns (market, bureaucracy and trust) in the three transaction phases (contact,
contract and execution). Section 4.7 concludes the chapter.
This research’s main objective is to study the internal and external working capital
management in the context of a developing economy with particular reference to the
government, transition and privatised firms in the manufacturing sector of Eritrea. It is
therefore necessary to cover with some detail the current debate on firm ownership
and value creation. We explore here the current debate on ownership (government,
transition, privatised and originally private firms) and operational efficiency for value
creation. However, our empirical study concentrates on the government, transition and
privatised firms. We exempt the study about the originally private firms in order to
concentrate on the comparative effect of ownership change on management policy
from government (and transition) to privatised.
2ZQHUVKLSPDUNHWFRPSHWLWLRQDQGRSHUDWLRQDOHIILFLHQF\
A firm’s transfer from the government to the private sector implies a change in the
allocation of property rights and the relationship between those responsible for the
decisions and the beneficiaries of a firm’s profit inflows. This in return leads to a
different structure of incentives for management. The relationship between
management and the owners (who are ultimate recipient of residual profit) can be
considered from a particular set of agency problems. The general agency problem is
characterised as a situation in which a principal seeks to establish incentives for an
agent (who takes decisions which affect the principal) to act in ways that contribute to
the maximum possible to the principals own objective. The difficulties to establish
such an agent-principal relationship arises from two factors (a) the objectives of the
principal and the agent differs, (b) the information available to the principal and agent
the differs. Within this framework the management of firms can be regarded as agents
acting for shareholders (in private firms) or for the government department to which
they are responsible (in government firms). Ultimately government managers are
responsible for the public in general. As owners and managers have different
objectives, their incentives also differ. Contractual agreements are made between the
managers and owners so that the managers give priority to the objectives of the
Chapter 4 70
owners and act according to their contractual agreement. Moreover, incentives of both
depend on many factors including the incentives given to the managers so that they
act to achieve the objectives of the owners and the level of economic efficiency that
results in a firm’s profit inflows. Economic efficiency according to Vickers and
Yarrow (1988) is considered in terms of allocative efficiency in the market - which
depends on the output levels of the firms and internal efficiency – which depends
upon the total cost of producing certain levels of output. Three main factors influence
economic performance Shirley and Walsh (2000): (a) ownership - publicly or
privately owned, (b) competition - competitive structure of the industry that the firm
is in and (c) regulation – legal constraint that the firm faces.
This section brings about the debate on ownership, market competition and
operational efficiency. Based on these arguments the chapters in the empirical
analysis are divided into internal and external working capital management of
government, transition and privatised firms. However, an important question that
needs to be cleared before discussing about the government and private ownership is
whether it is ownership (government versus private) or competition (monopoly versus
competition) that influences operational efficiency.
:KHUHFRPSHWLWLRQGRPLQDWHVRZQHUVKLSIRUHIILFLHQWSHUIRUPDQFH
Shirley and Walsh (2000) argue that market competition enhances performance in the
form of operational efficiency while government ownership is more efficient in
achieving the objective of equitable allocation of government resources. They find
that when there is competition, price will tend towards marginal cost and resources
will be allocated to their highest value, otherwise prices are raised and production is
lowered relative to competitive equilibrium. The argument over competition’s impact
on operational efficiency is based on agency theory’s incentive and information
effects. Incentive effects in competition create threats to managers of inefficient firms,
which have to be efficient otherwise threats of loss, bankruptcy and take-overs will
force the firms to disappear from the market competition and this puts managers’ jobs
at risk. Information effects in a competitive environment enable the owners of firms to
know the costs of the firms’ operations and the managers efforts to reduce the costs.
With these information owners are able to design a better system to control the
managers and evaluate their efforts.
In competitive markets private firms perform better than government firms because in
the latter case there is no way to force a productively inefficient firm out of business.
So in government firms, managers will have no incentive to raise efficiency.
Therefore, introducing credible threats of bankruptcy and take-overs would produce
the best efficiency results. However, the degree to which market competition
influences operating efficiency depends on the relative vulnerability of government
and private firms to political interference and success in creating effective
governance. Many researchers have found that increasing competition (deregulation)
rather than changing ownership (denationalisation) is an importance mechanism in
stimulating performance. For example, Yarrow (1986) argues, it is the competitive
and regulatory environment that determines the incentive to managers and concludes
that reforms emphasising on ownership over market competition are misguided. A
study in China by Li (1997) shows that market liberalisation (competition) has the
Firm ownership and value creation 71
greater impact on productive efficiency compared to ownership. He finds that the

Chinese economy demonstrated large efficiency gains through extensive market
competition and freedom of entry of independent firms without rapid privatisation of
larger government firms.
:KHUHRZQHUVKLSGRPLQDWHVFRPSHWLWLRQIRUHIILFLHQWSHUIRUPDQFH
There are theorists who argue that ownership has greater impact on operating
efficiency compared to market competition. The basis of their argument is that
government owned firms are more inefficient in both competitive and non-
competitive markets. In addressing the effect of ownership versus competition,
Shleifer and Vishny (1994) find that government owned enterprises are less efficient
compared to private firms even in fully competitive markets. This is because political
objectives in government owned firms are given more priority over competition and
inherent difficulties in the government firms negate the effect of competition. Given
political interference and poor governance in the public sector, government owned
firms would perform poorly even in highly competitive markets and they may even
cripple competitive markets in which they prevail.
*RYHUQPHQWYHUVXVSULYDWHILUPV
The debate on government versus private ownership is intensified after the rise of
Margaret Thatcher’s privatisation of public enterprises in the United Kingdom
(Bishop, Kay and Mayer, 1994) and the emergence of Michael Gorvachev’s
“Perestroyka and Glasnost” (Schroeder, 1991), which initiated the fall of communism
in the former Soviet Union. Government ownership was very popular in the
developing economies during the cold war. After the fall of communism the debate
seemed to favour privatisation. However, it cooled down with the disappointing
results of insider privatisation in Russia, voucher privatisation in the Czech Republic
and infrastructure privatisation in many developing countries. Moreover, still there are
quite a number of theorists who argue in favour of private ownership and others who
support the government ownership under certain situations.
,QIDYRXURIJRYHUQPHQWRZQHUVKLS
According to Frydman et al (1997), developing countries justify the choice of

government ownership in order to accumulate productive assets as well as control
externalities, natural monopoly and price facilitate industrialisation through central
planning, acceleration of technology transfer, increased employment, reduced
inequality, and national security. Frydman et al (1997) find that when firms exist in an
economy which is under crisis, that is, when there are shrinking markets and
collapsing trade links, government ownership helps operational efficiency of firms by
offering government contracts, protecting from import competition and participating
in government subsidised programs. They also argue that governments can restructure
better than highly distributed private ownership for two reasons. First, outsider private
owners are too disbursed to impose meaningful control over the management. Second,
insider private owners do not have the motive and the efficiency to effectively
Chapter 4 72
restructure the firm. These shortcomings of private firms particularly are highlighted
where the countries have underdeveloped legal and regulatory framework, unsound
business environment and weak contract enforcement. Cook, Kirkpatrick and Nixson
(1998) take the case of developing countries and conclude that public ownership is the
best response to market failure. They argue that privatisation in developing economies
may produce private monopolies, so promotion of competition in government
ownership is the best remedy to market failure. The argument of Yarrow (1986),
favouring improvement on competitive and regulatory environment rather than
emphasising on reforms of ownership is another argument against privatisation.
5HJXODWLRQLQQDWXUDOPRQRSRO\ILUPV Shirley and Walsh (2000) have also argued
that in case of a natural monopoly (such as water, electricity etc.), where indivisibility
of networks or ever increasing returns to scale dictate the most efficient market,
effective competition is neither possible nor desirable. The results of operational
efficiency in government firms and regulated private monopoly depend on the legal
point of view, that is, whether the contracts are complete or incomplete. If contracts
are complete and define all aspects of performance and every possible eventuality,
both private regulation and government ownership yield the same result of productive
efficiency. Where there is a situation of incomplete contract and some aspects of
performance and eventualities cannot be defined in advance, the result depends on the
regulatory environment. If government firms have more autonomy both government
ownership and controlled private ownership may end-up at the same efficiency levels.
Otherwise Shirley and Walsh (2000) claim that the efficiency of government firms
grows with the efficiency of political markets and the levels of autonomy of the
government firms.
Therefore, the success of privatising natural monopolies depends on the regulatory

capacity of the government (Vickers and Yarrow, 1991). Thus countries with more
developed regulatory bodies are better able to privatise and regulate than countries
with weak regulation. So, in more regulated and developed countries, privatisation
coupled with regulation is preferred to continued public ownership. Moreover,
developing countries may be less able to manage potentially competitive government
firms and hence benefit more from privatisation despite poor regulation because
privately regulated firms perform better or the same as government firms. Shirley and
Walsh also find that, if public monopoly is to be replaced by private monopoly,
government monopolies out-perform private monopolies. However, generally
performances of firms depend on management culture and clarity of objectives. When
objectives are vague and contradictory and the management culture does not value
efficiency, performance objectives will not be achieved.
As far as the design of a regulatory framework and its effective implementation is

concerned the behaviour of governments play a very crucial role. The behaviour of
governments depends whether political markets work efficiently or inefficiently. If
political markets work efficiently, rational governments (social welfare maximising
governments) have incentives to maximise social welfare. With a social welfare
maximising government, the bureaucrats and politicians act as loyal agents of the
citizens due to competition among them for the voters and align their interests with
those of the voters or else leave the job. This assumption argues in favour of
government ownership of firms. It is based on social welfare maximising government
and efficient (transparent and accountable to voters) political markets. However, if the
political markets are inefficient and self-interested government employees are able to
maximise their utility, the common good can be suppressed and government
ownership may be worse.
Finally, the failed privatisation in some transition countries (the former Soviet Union
and the Check Republic), and the relative success of gradual government reform in
China, has strengthened the argument for privatisation alternatives. The Chinese
experience has brought two insights here. First, the entry of new private firms is
crucial because they reduce the scope of government firms and enhance competition.
Second, non-privatisation reforms like market liberalisation, increased autonomy of
government firms and retention of profits can motivate efficiency of government
firms. If managers of government firms are made to compete with the private firms
without any government interference or unfair support, the government firms can be
more efficient and value creating. The risk that the government firms may go
bankrupt and get out of business will expose the managers of government firms to
face the risk similar to the managers of the private firms.
,QIDYRXURISULYDWHRZQHUVKLS
The idea that government owned firms are inherently less efficient than private firms
is based on the government firms’ failure to achieve operational efficiency as much as
the private firms. This is mainly because the control of government firms is difficult
for three reasons: first, failures in the political market, second, government monitoring
with self-serving political interests and third, the existence of highly distorted market
for public managers. However, there are controversies around the idea that public
ownership is the best solution to market failure, even with a welfare maximising
government for two main reasons. First, market failures can be addressed in private
firms by more efficient means and second, even benevolent government can have
incentives to distort efficiency of distribution of social welfare. Thus even when
government maximises social welfare, public ownership may not be the best solution
to market failure. In this situation Shirley and Walsh (2000) argue that the choice
between public and private ownership depends on the ease with which contracts are
monitored and enforced and the degree of potential competition among firms.
Based on theories of self-interested governments, Shirley and Walsh (2000) argue that
there are no efficient political markets as such, particularly in non-democratic
systems, which face little competition aside from the occasional threat of a coup by
another would be dictator. Therefore, a self-interested government in an inefficient
political market has more scope for intervention in government firms than in private
firms. Vickers and Yarrow (1988) trace the cause for governments self interested
character to three reasons. First, information asymmetry between voters and
politicians, second, elections being poor mechanisms for producing information on
voter’s preferences, and third, benefits of welfare enhancing policy being widely
dispersed but losses are concentrated in terms of time. However, in terms of those
affected, the losses are also dispersed into the general public and will not be easily felt
as with the case of private firms. In a world of limited information politicians may use
government firms to produce potential benefits for themselves at the cost of
inefficient and distortionary government firms. Thus government firms may be
Chapter 4 74
inferior to private firms not only on operational efficiency but also on allocative
efficiency.
The principal-agent relationship can also be applied to this argument. Principal-agent

relationship favours private firms because the principal (voters) in government firms
can impose less control over agents (politicians and bureaucrats) compared to the
principals over agents in private firms. This argument is based on the fact that
government managers and politicians interact in ways that benefit themselves at the
expense of general welfare. These inefficiencies result from political meddling in the
firms, which take the form of excess employment, prevention of layoffs, above market
wages, investment in projects that benefit the politicians rather than consumers, and
allocative distortions resulting from skewed pricing systems. This “politicisation” of
government firms makes restructuring more difficult. Shleifer and Vishny (1994)
argue that “politicisation” depends on five factors. First, the degree of political market
imperfection (the more the political markets are distorted the further the politicians
deviate from the social welfare). Second, the ease with which budgets and regulations
can be manipulated. Third, the nature of the institutional relationship (autonomy)
between the government and the government firm. Fourth, the existence of corruption
and bribes, fifth, the low opportunity cost of inefficiency of government firms to the
politicians.
Problems of separation of ownership and control: Both “owners” of government and

owners of private firms rarely manage the day-to-day operation of the firms.
Therefore, they face the problems of separation of ownership and control. Managers
have every incentive to use their control to serve their own interest at the expense of
profitability and owner welfare. In this case, Shirley and Walsh (2000), argue that
there are important differences between government and private firms, which affect
their performance. These differences emanate from the differences in controlling,
legal constraints as well as threats of take-overs and bankruptcy.
When private ownership and control are separate, owners write a FRQWUDFW with
managers so that managers make their income and continued employment dependent
upon performance. Control by owners will be weak when information asymmetry
gives managers undue advantage in writing the contract and when the ownership is
distributed among many small owners. &RQWUDFW HQIRUFHPHQW is based on the
assumption that owners can turn to the court system if they believe that the managers
have violated the contract by failing to maximise the owner’s welfare. However, the
outcome of this approach depends on the strength of the government’s OHJDO V\VWHP.
Where neither monitoring nor legal regulation of the owner-manager relationship
brings about efficient manager behaviour the risks of WDNHRYHU bring a possible tool
of corporate governance in private firms. In a take-over the owners of the acquiring
and target firms benefit as a result of efficiency rather than from increased market
power (Jensen and Ruback 1983). However, unlike the private firms, government
firms are immune from take-overs.
If the corporate control mechanisms of take-overs, contract enforcement and

monitoring by owners fail to promote efficient management, a private firm in a
competitive market cannot continue making losses forever because after sometime it
will go bankrupt. %DQNUXSWF\ implies a change in management, liquidation of assets
and restructuring of debt. Because of difficulty of collecting debts in bankruptcy both
owners and creditors prefer that bankruptcy functions as an ex-ante threat to

management, rather than ex-post remedy (Shleifer and Vishny, 1995). An ex-ante
threat of bankruptcy (which is effective only where there are efficient court systems
and well-designed laws) to management is effective in boosting managers
performance and thus owner value. However, whenever the political cost of
bankrupting a government firm exceeds the political cost of subsidising it, politicians
will extend subsidies (Sheshinski and Lopez-calva 1999) and this everlasting subsidy
can be reduced by privatising the government firm. Therefore, loss making
government firms will be subsidised by the government directly or indirectly in the
form of unpaid taxes and overdraft from government directed banks. Hence, managers
of government firms have little incentive to improve efficiency or avoid unprofitable
investment. In this sense it can be concluded that competition cannot substitute for
private ownership because politicians in inefficient markets may distort operations of
government firms for their own interests and the task of motivating the managers is
more difficult in the public sector than in the private sector.
3ULYDWLVHGILUPV
This section refers to the comparative efficiency between government firms and
privatised firms, that is firms which have moved from government to private
ownership. The distinction between government and privatised firms is particularly
relevant in developing countries where mostly governments are self-interested (not
social welfare maximising). This case is argued with two reasons. First, regulatory
institutions and market structures can play a major role in privatisation outcomes.
Second, political objectives and motivations of policy makers can be causes to design
sub-optimal privatisation plans. Both of them are not favourable in most developing
countries.
An immediate consequence of privatisation will be some shift in the objective of

principals and incentives to be offered to the agents. Privatisation tends to improve
internal efficiency but at the expense of allocative efficiency unless checked by some
competitive or regulatory constraints. According to Bennel (1997), privatisation is
justified on the grounds that state owned enterprises are invariably inefficient and
without decisive intervention in the form of privatisation they will continue to drain
on the extremely limited public resources. Privatisation mostly includes the full or
partial transfer of either ownership rights or management control of government firms
to the private sector. The sales of government firms to private investors can take the
form of private sales on competitive bidding, pre-emptive sales, sales/auction of assets
or public flotation. Megginson, Nash and Randenborgh (1994), found out that after
being privatised firms increase real sales, become more profitable, increase their capital
investment spending, increase their operating efficiency and increase their work force.
5HJXODWRU\LQVWLWXWLRQVDQGPDUNHWIDFWRUV
Shirley and Walsh (2000) argue that privatisation and regulation of natural
monopolies can present a viable alternative option to government ownership. In
developing countries it is highly likely that monopolies exist because of market
failure, lack of information, high entry costs, underdevelopment of capital markets,
Chapter 4 76
bankruptcy procedures and court systems. Thus privatisation in developing countries

may simply replace public monopoly by private monopoly, as a result of which
allocative and operational efficiency suffers relative to the competitive market
outcome. However, since competition prevails over ownership (section 4.2.1.), a
private (and by extension a privatised) firm, even in an imperfect market may perform
better than a government firm. Overall, in developing economies, institutional
problems can weaken corporate governance by preventing take-overs and softening
budget constraints (government subsidies, granting government subsidised projects
and other privileges), which can result in sub-optimal performance. However, since
the main issue is whether government ownership produces better results compared to
privatised firms, the argument is that institutional weaknesses do not prevent
privatised firms from increasing their performance compared to government firms.
This is because underdeveloped markets, poor information and weak and poorly
enforced bankruptcy and take-over laws do not necessarily mean that privatised
monopoly will under-perform government firms. It is also possible that privatised (or
newly formed) banks allocate credit more efficiently in developing economies and are
better able to break themselves free from old lending habits and that they achieve a
more efficient allocation of credit than government institutions.
3ROLWLFDOREMHFWLYHVDQGSULYDWLVDWLRQ
Privatisation indicates a change of government goals and policy. This change may be
due to an external economic factor due to increased opportunity cost of inefficiency of
government firms or a change in the make-up of the government. Where in the latter
case the new government places a priority on efficiency rather than maximising its
own interest. The objectives of privatisation according to Shirley and Walsh (2000)
can be enterprise efficiency, private sector development and budgetary relief.
Therefore, which objective the government pursues is of utmost importance.
Governments may also seek to maximise government revenues from the sales of
government firms. In the process, governments may distort the efficiency potential of
the firm by limiting competition, distributing ownership shares as widely as possible
and dilute ownership among many small owners with negative consequences on
monitoring.
Shirley and Walsh (2000) find also that private ownership can be as inefficient as
government ownership, unless there is vigorous competition. They are critical of
privatisation without competition because they say the gains of privatisation are lost if
a public monopoly is simply replaced with a private monopoly, which is more likely
in the self interested governments of developing countries. The argument here is not
whether the performance of privatised firms is optimal but whether it is better than
under government ownership. Their empirical studies reveal that even in imperfect
markets of developing countries privatised firms can show better performance
compared to government firms. Privatisation can be implemented through insider or
management sell-out (selling the government firm to its managers and/or workers)
and outsider privatisation (transferring ownership to small shareholders outside the
firm or the wider public). Management sell-out may eliminate the ownership-control
gap but capital infusion is limited, in addition to this, managers and employees are
less likely to engage in effective restructuring and they may maximise their own
objectives. Wider public sell-out may also bring the principal-agent problems.
As a result of their empirical study, Sheshinski and Lopez-Calva (1999) arrived at a

number of conclusions in favour of privatised firms. They find that privatised firms in
competitive environments perform better than government firms in terms of
productivity, competition and profitability. Their research applying different
profitability indicators and different market structures showed that privatised firms
improve their profitability after the sales. However, they also find that partial
privatisation has a smaller effect than full privatisation. Changes in ownership from
government to private result in increased productivity, competition and profitability
but first the firms in regulated markets have to go through restructuring after sale and
they may show lower increases in productivity as compared to those firms that exist
under competitive market conditions. Elimination of restrictions on foreign direct
investment, trade barriers and government controls on prices and quantities may also
helps privatised firms to be more competitive and to increase productivity and
profitability. In non-competitive markets profitability increases more than
productivity. If loss making government firms are privatised they may turn profitable
and increase the financial health not only to themselves but also to the government.
This is because government may end-up at less net transfers to the privatised firms
and get positive transfers by collecting taxes from the privatised firms in the long-
term. According to Sheshinski and Lopez-Calva (1999), financial sectors also benefit
from privatised firms because the firms after privatisation have lower deficits and
lower unpaid debts to the financial sector. Finally, though privatisation may have a
negative effect in the short-term due to measures of restructuring during the transition
period, it results at a positive effect on employment in the medium and long term.
7KHFDVHRIILUPVLQWUDQVLWLRQWRSULYDWLVDWLRQ
Now we take the case of firms in transition to privatisation. Firms face a period of
transition to privatisation from the time the government officially declares its
intention to sell the firms to the time they are fully privatised. Transition firms
encounter a number of problems during the period of transition.
According to Bennel (1997), the success of privatisation depends on the extent of

opposition to privatisation and the saleability of the government firms. Opposition to
privatisation can take the form of political factors such as lack of commitment at the
highest political levels, public managers and workers in fear of unemployment,
nationalistic feeling against foreign buyers, payment of high terminal payments by
investors to the workers. The saleability of the firms is subject to factors affecting the
economy as whole or specific firms. The overall factors include the government’s
creditability: investor assessment of government’s creditability regarding its economic
policies and privatisation program, transparency and corruption in the management of
the privatisation process, success of attempted privatisations etc.
Factors affecting the government firms include difference in determining the price
between the government and prospective investors. Governments use political or
financial criteria such as asset-based valuation to maximise the net proceeds from the
sale while prospective investor’s evaluation is based on business. According to
Bennel (1997) the transition period is identified by political and economic crisis,
hastily implemented privatisation programs, weak and unmotivated management,
obsolete technology and inadequate working capital as well as government
Chapter 4 78
maintaining overall control (though some autonomy can be given to the firms’
management). The privatisation process is another factor that affects the saleability of
the transition firms because once the privatisation is announced it is difficult for the
firms to do business. This is mainly because the diminishing trust of suppliers and
customers. Suppliers will not allow credit to the firms and customers will be hesitant
to do business on a long term.
7KHSUREOHPVRIWUDQVLWLRQILUPV
The problems of transition emanate from the firms’ historical origin as government
owned firms of which the effects spill over to the period of transition. In order to
solve the problems of government ownership, the firms have to undergo restructuring
before they are fully privatised, which also brings with it problems that have to be
tackled. These problems refer to issues such as organisational structure, employment
policy, sources of finance, operational set-up and uncertainty of employment both to
managers and employees.
2UJDQLVDWLRQDO VWUXFWXUH DQG PDQDJHULDO HPSRZHUPHQW As originally

government firms the organisational structure of the transition firms is dictated by
government regulations, which is mostly set-up to enhance the political and social
objectives of the government more than the firms’ operational efficiency and
profitability. These objectives increase allocative efficiency, accountability to central
authorities and custodial-control of assets and operations. To this end the
organisational structure is designed and implemented. In the process of restructuring
the firm’s management policy may have to be changed so that it reflects policies of
operational efficiency and profitability. During the process of privatisation much of
the managerial decision may be shifted from the management of the firms to higher
government officials (or privatisation agencies). This may negatively affect the
managerial empowerment and confidence of the managers. As a result the operations
of the transition firms may be crippled and lack both short and long term vision
(Hailemariam, 2001).
(PSOR\PHQW Particularly with self-interested governments in developing countries,

political objectives dictate the organisational structure and the employment criteria of
government managers and other employees. The managers are handpicked from
government on the basis of their political affiliation rather than on their professional
qualification and practical experience, which are relevant to the objective of the firms’
value creation. Employees are hired not only on their productive potential but also on
political and social grounds. This results in less quality and excessive number of
managers and employees. As a solution to this problem the government may after a
privatisation deal transfer the firms to their new private owners free of any labour
commitment. All workers may be paid their severance allowances and officially laid-
off from their jobs at the time of transfer from government to private investors, so that
it is up to the new bosses to rehire them or not.
7KH SUREOHP RI XQFHUWDLQW\The environment of transition is characterised by a

high degree of uncertainty and deep institutional change (Frydman et al 1997). Both
management and the workers as a whole are faced with an uncertain future as far as
maintaining their job is concerned. This decreases their confidence and affects
efficiency. As a result competitive managers and workers who can get employment
opportunity elsewhere leave the transition firms and worsen the manpower problems.
Therefore, unless the period of transition is cut short the firms will continue to loose
value (Hailemariam 2001) and become more unattractive to prospective buyers.
)LQDQFLDO SUREOHPV As government firms, transition firms may be accustomed to
financing their financial deficits not only through government subsidies but also with
loans in the form of short-term debts and overdrafts from government banks as well as
credits from related government firms. These financial obligations are mostly used as
permanent sources of working capital financing regardless of their cost-benefit
justification. Usually the costs of these short-term financing do not warrant their
benefits. During restructuring, the transition firms may have problems of working and
fixed capital investment and financing. This is because the firms may be required to
pay dividends to the government while at the same time they may be forbidden by the
government from making new capital investments and financial commitments with a
long-term effect. This implies that the firms’ value creating potential is severely
affected in the long-term. Though the attractiveness of the government firms to
private buyers basically depend on the long-term cost-benefit analysis; transition
firms with higher debts will have problems of getting private buyers because buyers
do not like to acquire highly indebted firms. As a solution to this, governments may as
a privatisation deal assume the accumulated debt in order to attract buyers.
2SHUDWLRQDO SUREOHPV The purchases and sales operations of government firms

(and by extenuation transition firms) are oriented towards (less quality) mass
production in order to help achieve the objectives of allocative and control efficiency
rather than the operational and profitability efficiency. Mostly purchases are made
from government and transition suppliers and sales are made to government and
transition buyers in a non-competitive manner. In order to solve these problems
during transition firms have to change their internal and external management of the
operations.
The conclusion in the ownership and value creation argument is that external
objectives and underdeveloped markets and regulatory institutions can introduce
distortions in the privatisation process that cause transition firms to perform less than
privatised firms and privatised firms to perform less efficiently compared to purely
private firms. Overall, in terms of their operational efficiency and value creation we
can list private firms, privatised firms, government firms and lastly transition firms.
Hence in order to minimise the value that may be lost by the transition firms during
the period of their transition, the transition process has to be well prepared and
systematically managed.
3UHSDULQJWUDQVLWLRQILUPVIRUSULYDWLVDWLRQ
The problems of transition make the transition process very difficult particularly if the
government itself manages it. If it is to be successful carried out some remedies have
to be taken place before the firms are declared for privatisation. Some alternative
ways to prepare the firm’s transition to privatisation may include the following
measures. (a) Make internal restructuring before announcing the privatisation. (b)
Give the management of the privatisation process to private firms. (c) Give full
Chapter 4 80
responsibility not only limited autonomy to the firm’s management. (d) Increase
ownership involvement of citizens (local investors, the public, and management and
employee buy-outs) in order to reduce political opposition. (e) Where governments
are reluctant to privatise, use the non-asset privatisation approach such as
performance contracts and leases. (f) Make serious restructuring of the firms
including taking over debt, modernisation of the technology and sub-contracting the
management of the transition process to private consultants. (g) Decrease the
bureaucracy and time it takes to privatise.
)LUPRZQHUVKLSDQGLQWHUILUPWUXVW
This section relates the debate on firm ownership (government, transition and
privatised) and value creation to inter-firm managerial control patterns (market,
bureaucracy and trust) in the three transaction phases (contact, contract and
execution). We consider that the transaction characteristics covered in chapter 3
(section 3.5.3 to 3.5.5) closely relate to private firms. So, we emphasise here on
government, transition and privatised firms. How government, transition and
privatised firms interact in an inter-firm transactional relation depends on their control
pattern, which in turn depends on how closely the firms are related and upon the
confidence or trust they have in each other. It also depends on the character of the
inter-firm transactions, the parties and their environment (Van Der Meer-Kooistra and
Vosselman, 2000).
In a buyer-supplier relation the important issue is what factor determines how close an
inter-firm transaction relation can be. According to the transaction cost theory and the
insights of trust this is determined by the potential occurrence of the human
characteristics of opportunistic behaviour of a supplier and bounded rationality of a
buyer and possibly vice-versa. The existence of these human characteristics combined
with the transaction characteristics of asset specificity, transaction duration, repetition
and measurability of activities and outputs determine the risk of loss to the parties’ ex-
ante and ex-post transaction agreement. We claim here that these characteristics also
differ on the basis of ownership.
Inter-firm transaction relation is influenced by the ownership status because firms

with a similar ownership status will also have similar objectives and control patterns.
Generally, government firms will reflect a common objective of enhancing political,
social and allocative efficiency. Privatised firms will have operational efficiency with
a firm’s value creation as the ultimate objective. Transition firms reflect
characteristics of both government and privatised firms. They reflect the objectives of
the government firms because they still remain under government ownership and
control (though temporarily on transition basis). They also reflect the characteristics
of privatised firms because they have to transform their policies and practices to that
of privatised firms if they are to be attractive to private investors. Therefore, in order
to approach the salient features of these three groups of firms we divide this topic in
to three sections. First, we cover the inter-firm transactional relationships with
government firms, second we deal with the inter-firm transactional relations with the
transition firms and lastly we consider the inter-firm transactional relations with the
privatised firms.
*RYHUQPHQWILUPV The objective of the government owned firms is not necessarily

to increase the monetary value of the stakeholders. The government as an owner will
have a policy of job creation, continuity of employment, safeguarding consumer
interest, maximising the government’s returns rather than retaining profits in the firm.
These factors will deter the firm’s management from searching only for approaches
that would result in higher profits and risks to the firm. Therefore government firms
have a low risk, low return environment. Management will not necessarily go for the
best approach of working capital management, value chain linkages management and
transaction cost management for increasing the value to owners, because other
priorities surpass the objectives of these approaches to shareholder value creation.
The control oriented government policy, organisational structure and managerial

control as well as public ownership of the firms detract government managers from
reflecting potential opportunistic behaviour. The managers personally have very little
to gain from being opportunistic. However, they have much to loose if as a result of
internal control or external audit it is found that they have acted against the stated
government rules. Managers of government firms can be expected to reflect the
highest possible honesty and to be trusted by managers of all the three groups of
firms. Therefore, firms which get into inter-firm transactional relations with
government managers can manage their inter-firm transactional relation on the basis
of the trust right from the beginning regardless of the prevailing contingency factors
in all the three phases of transaction. In fact the government ownership is the decisive
contingency.
7UDQVLWLRQ ILUPV Transition firms, while still in the hands of the government, are
destined for privatisation. As a first step to privatisation the government may give
these firms a certain degree of autonomy, so that they can run their operations as if
they are privately owned. The government’s primary objective of creating and
securing jobs as well as profit optimisation is sidelined in favour of market oriented
value creation. The transition creates some kind of dilemma and uncertainty for the
management of the firms. Special government bodies (privatisation agencies), which
are formed for the purpose of selling the firms may administer them. The management
of the firms is responsible and accountable to this governmental agency.
So long as they are not privatised, the transition firms remain under government
ownership, organisational structures and control. Therefore, we could normally expect
the control mechanisms of the transition firms to resemble that of the government
firms. However, the objective of the transition firms (to remain profitable and attract
private investors) and other transition problems such as uncertainty can introduce
opportunistic behaviour to the transition managers. This can be a good reason for
partners who get into inter-firm transaction relation with transition firms to exercise
caution in their inter-firm relation. In addition, partners of transition firms will not
enter into long-term transaction relation, because no one knows for sure when these
firms are going to be privatised, who is going to buy them and what type of
characteristics the new management will reflect. No matter the prevailing contingency
factors, transition firms are unlikely to get into long-term trust with inter-firm
transaction partners during the transition period.
3ULYDWLVHG ILUPV Privatised firms are those firms, which have been sold to private
investors and which are owned purely by non-governmental, private individuals or

Chapter 4 82
shareholders. The objective of shareholder value creation and maximisation can best
be applied here. In privatised firms, management policy can indicate some
characteristic difference compared to that of government and transition firms.
The standard inter-firm managerial control patterns applicable to private firms are
more appropriate to the privatised firms. However, privatised firms in Eritrea have a
relatively short history and managerial experience. However, the duration and
repetition of inter-firm transactional relations of the privatised firms can increase the
trust in each other and in the long-term partners transacting with privatised firms can
develop better managerial control patterns and trust.
&RQFOXVLRQ
The discussion in this chapter has centred on the effect of ownership status on value
creation. We concentrated on the argument that, it is the competition not the
ownership that determines the potential ability to create firm value. However, the
possibility that government and transition firms can retain their ownership status and
at the same time be competitive is hindered by political interference from the
government. This political interference renders the firms unable to generate value
enough to make them comparable with that of privatised and private firms. The
private ownership status is divided into those firms, which are originally privately
owned and those firms, which were originally government owned and then privatised.
We find theoretical reasons that privatised firms perform better than government and
transition firms but not better than the private firms.
We also introduced the issue of ownership and inter-firm managerial control pattern.
We argued that the managerial control patterns that the firms could possibly apply in
order to decrease inter-firm transaction costs are also affected by ownership status.
We claimed that managers of government firms reveal the least opportunistic
behaviour and that there is a higher possibility that these managers can be trusted
because of the legal control factors that they are subjected to. Therefore, inter-firm
transactional relation with government firms can be made on the basis of trust though
the government may interfere in the relationship. On the other hand managers of
privatised firms can reveal the standard behaviour of private firms and the managerial
control applied depend on the contingency factors prevailing in the inter-firm
transactional relation. The transition managers can reveal characteristics somewhere
in between the government and privatised firms. However, they cannot be fully
trusted on the long-term because their relationship is temporary and will be removed
when the firms are privatised.
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This chapter covers the issues, which are needed to design the information retrieval of
our study. The objective is to design the conceptual framework and the research
methodology. Section 5.2 deals with the development of the conceptual framework.
Section 5.3 presents the choice of case study as a method of research. Section 5.4
describes the case research method chosen. It is further sub-divided into the design of
the overall case study (section 5.4.1), the field research and data collection (section
5.4.2.), data analysis (section 5.4.3) and criteria used to ensure the credibility of the
research analysis (section 5.4.3). Section 5.5 concludes the chapter by presenting the
highlights.
Particularly, this chapter answers part 1d of the research question stated as: :KDW LV
WKHDSSURSULDWHFRQFHSWXDOIUDPHZRUNDQGUHVHDUFKPHWKRGRORJ\WKDWFDQEHXVHGWR
We combine the internal and external

ILQG DQVZHUV WR RXU UHVHDUFK TXHVWLRQV"
working capital management approaches into a conceptual framework. We also

present the research methodology that we have used in designing the data collection
and analysis.
7KHFRQFHSWXDOIUDPHZRUNDQGWKHFHQWUDOPRGHO
As Miles and Huberman (1994) point out, a conceptual framework explains, either
graphically or in narrative form, the main issues to be studied. A conceptual
framework covers the main features (aspects, dimensions, factors, variables) of a
study and their presumed relationships (Robson, 1993). Robson also argues that
developing a conceptual framework enables to be explicit about what the researcher
thinks s/he is doing. It helps to be selective and to decide, which relationships are to
be of importance and therefore, what data are going to be collected and analysed. In
line with this, our conceptual model takes into account the issues of internal and
external working capital management in the Eritrean context. Figure 5-1 provides the
overall relationship between working capital levels and operations and figure 5-2
presents more detailed factors that will be discussed under internal (section 5.2.1) and
external (section 5.2.2) working capital management.
,QWHUQDOZRUNLQJFDSLWDOPDQDJHPHQWRSHUDWLRQVOHYHOVDQGFDVKIORZV
Internal working capital involves the co-ordinated management of a firm’s working

capital operations and levels within the firm. Our general conceptual framework (figure
5.1) is based on the insights of Rappaport’s (1986) value network as a central model.
According to Rappaport (1986), the main purpose of a shareholder value network model
is to demonstrate the creation of value by managing operations and levels. Particularly,
for shareholder value to be created, management decisions have to concentrate on three
main decision categories - operating decisions, investment decisions and financing
decisions (See Figure 5.1).
Chapter 5 86
2SHUDWLQJ GHFLVLRQV with respect to working capital management include the decision
regarding the purchase of materials, production process and sales of finished goods.
Operations also include other supporting activities like promotion, advertisement,
distribution, product mix, and pricing. Which operation to apply depends on its effect on
sales and on the profit margin. ,QYHVWPHQW GHFLVLRQV in the field of working capital
management relate to managerial decisions on capital tied-up in working capital (cash,
receivables, inventories). Which investment type to choose depends on its effect on the
cash flows from operations. Working capital ILQDQFLQJGHFLVLRQV refer to the managerial
decisions regarding to what sources of financing to use, which may include debt (short or
long-term), capital equity or retained earnings. The working capital financing decision
incorporates, trade credit or accounts payable, bank credits and others. Which type of
financing source to use depends on its cost. The conceptual framework of this research
study uses these internal working capital management assertions as building blocks for
the analysis on working capital operations (purchasing materials and selling finished
goods) and levels (investment and financing).
If a firm is to create value, management has to design sales and purchases policies and
carefully implement its plans so that the cash generated from sales is enough to finance
the investment needed or at least to fill the gap between the short-term investment
needed and financing available. The purchase policies affect not only the levels of cash
but also the levels of inventory in materials and the need to finance this inventory with
trade credits and bank loans. The sales policies also affect the level of cash and the levels
of inventory in finished goods and receivables. Therefore, the proper management of
these intra-firm working capital operations and levels should enhance a firm’s cash flow
and its overall potential of value creation.
)LJXUH:RUNLQJFDSLWDOPDQDJHPHQW±WKHFHQWUDOPRGHO
(ULWUHDQ&RQWH[W
3HUIRUPDQFHHYDOXDWLRQ
Purchases Sales Working capital Working capital

operation operation investment financing
Operating Investment Financing

decisions decisions decisions
2SHUDWLRQV /HYHOV
Management decisions
6XSSOLHUV &XVWRPHUV
Conceptual Framework and Methodology 87
([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQW±VXSSOLHUDQGFXVWRPHUOLQNDJHV
In order to achieve a firm’s objective of value creation, a firm’s internal policies on

working capital operations and levels might be co-ordinated with that of supplier’s and
customer’s. This inter-firm co-operation can create a tripartite value network with the
firm and its suppliers and customers making a chain (See Figure 5.2). This co-operation
can help the firms, their suppliers and customers in decreasing inter-firm transaction
costs (See chapter 3, section 3.5.2) as well as the carrying costs of their working capital
levels – cash, inventories, receivables and payables.
The firm’s purchase operations and suppliers’ sales operations have to be co-ordinated
so that their inter-firm transaction costs and the carrying costs of suppliers’ inventory of
finished goods and the firm’s inventory of materials are minimised. This will result in
the optimum amount of cash needed in the inter-firm transactions. It will also result in
the minimum level of receivables and finished goods for the suppliers. An efficient inter-
firm management with a supplier can also help in optimising a firm’s levels of payables
and supplier’s receivables. The firm’s sales operations and customers purchase
operations can also be co-ordinated so that their inter-firm transaction costs and the
carrying costs of customer’s inventory of materials and the firm’s inventory of finished
goods and receivables are minimised. The cumulative effect is that all three parties - the
firm, its suppliers and customers can enhance their respective cash flows and create more
value than they could without co-ordinating the management of their operations and
levels.
The inter-marriages between Porter’s value chain and Rappaport’s value network is
used as main point of reference in our research. Figure 5.2 shows a theoretical
addition to Rappaport’s Model by realigning the management decisions into
operations, levels and performance as in Figure 5.1. The external linkages with
suppliers and customers can then be related to the distinction, which Porter makes
between inbound and outbound activities, a summary of which is presented in the
following section (Table 5-1).
7DEOH/LQNLQJWKHYDOXHFKDLQDQGYDOXHQHWZRUN
$,QWHUQDOZRUNLQJFDSLWDOPDQDJHPHQW %([WHUQDO:&0
3ULPDU\DFWLYLWLHV 2SHUDWLRQV /HYHOV ([WHUQDOOLQNDJHV
,QERXQG 3XUFKDVHV ,QYHVWPHQWVDQG 6XSSOLHUFRRSHUDWLRQRQ
DFWLYLWLHV ILQDQFLQJ
Receiving Investment in materials Receiving

Storing inventory and Storing
Distributing to financing with Distributing to production
Production Trade credits Inventory control
Inventory control RU$FFRXQWV
SD\DEOH
%DQNORDQV
2XWERXQG 6DOHV ,QYHVWPHQW &XVWRPHUFRRSHUDWLRQRQ
DFWLYLWLHV
Finished goods Investment in finished Finished goods

warehousing goods inventory and warehousing
Finished goods handling financing with Finished goods handling
Delivery vehicle Trade credits (or Delivery vehicle operation
Operation Accounts receivable) Order processing
Order processing
Chapter 5 88
,QERXQG Porter’s inbound activities applied to working capital

DFWLYLWLHV
management give an insight into management policies on purchase operations and

levels of investment in materials inventory as well as levels of financing in trade
credits (accounts payable). The relevant questions to be considered in the inbound
purchase activities are how the firms deal internally and externally with regard to
receiving, storing, distributing to production and inventory control. The efficiency in
managing inbound activities also determine the cost of the investment in materials
inventory and cost of financing with trade credits and bank loans.
2XWERXQGDFWLYLWLHV Outbound activities give an insight into management policies

on sales operations, levels of investment in finished goods inventory and levels of
financing working capital. The efficiency in managing outbound and related activities
determines the income and cost of sales operation as well as the cost of investment in
finished goods inventory and related financing cost. The relevant questions considered
in the outbound sales activities are how the firms deal internally and externally with
regard to finished goods warehousing, finished goods handling, delivery vehicle
operation and order processing.
)LJXUH:RUNLQJFDSLWDOPDQDJHPHQWWKHQHWZRUN
:RUNLQJFDSLWDOPDQDJHPHQW
LQWKH(ULWUHDQFRQWH[W
Firm
Supplier External linkages ownership External linkages Customer
Inbound and other Outbound and other
primary activities primary activities
2SHUDWLRQV
Sales Purchases Sales Purchases
/HYHOV
Finished goods Materials Finished goods Materials
Cash
Receivables Payables Receivables Payables
Financial statements
3HUIRUPDQFHHYDOXDWLRQ
External External
supplier Internal customer
evaluation evaluation evaluation
:RUNLQJFDSLWDOSHUIRUPDQFHHYDOXDWLRQ
Performance evaluations are made to check if the firm’s internal and external
management of working capital operations and levels are creating value to the owners.
There can be inward looking and outward looking performance measurement and
evaluation systems.
,QWHUQDO SHUIRUPDQFH HYDOXDWLRQ Internally, firms have to evaluate the

performance of their internal decisions on working capital operations and levels. The
inward looking performance measurement and evaluation systems are based on
comparing the best expected internal practices (forecasts and budgets) with their
outcomes. The LQZDUG ORRNLQJ performance measurement and evaluation can be
performed using the accounting based performance measurement and evaluation
methods like the analysis of ratio and cash flows, quality (measured by defects) and
labour (number, training and development). For the purpose of our study, we have
used two approaches of internal performance evaluation. Fist, we asked the firms’
managers if they apply any of the above internal performance measurements to
evaluate their decisions. Second, we measured the firms’ internal performance by
computing financial performance indicators from the data we obtained from their
financial statements. Specifically, we checked for working capital investment
composition, liquidity position as well as efficiency of working capital activity and
profitability.
([WHUQDOSHUIRUPDQFHHYDOXDWLRQ Externally, it is important for the firms to assess

their customers’ and creditors’ views and thereby appraise and plan their own
operations of sales and purchases as well as the levels of investment and finance
strategies. This type of performance measurement and evaluation can also be based on
other external sources of information such as customer and supplier satisfaction
(based on commitment, customer retention rates, perceived quality of goods and
services, response times). We have studied the external performance of the firms by
asking both firms under study and some of their relevant linkages. We asked the
firms’ managers how they evaluate their external performance. We have also asked
the suppliers and customers to evaluate the firms in terms of their marketing
approach, product quality and cost, efficiency of delivery, bilateral communication,
explanation to inquiries as well as knowledgeability of their suppliers’ and customers’
needs. Table 5.2 indicates the internal and external working capital management
expectations of our conceptual framework in a summary form.
Chapter 5 90
7DEOH7KHZRUNLQJFDSLWDOPDQDJHPHQW±H[SHFWDWLRQVRIWKHFRQFHSWXDOIUDPHZRUN
Internal External
2YHUDOO:&0 Efficient internal working capital Co-operation among firms, their
management if there are no constraints suppliers and customers can help to
can be used to create value by increasing increase sales and decrease costs and
sales and decreasing costs. thereby create value.
/HYHOV
Investment Enhance value by investing when there With closer firm-customer co-
are surpluses and dis-investing when operation sales can be enhanced and
there are shortages. Take care of the the carrying costs of inventories and
carrying costs of surpluses and shortage receivables can be minimised.
costs of deficits of cash, receivables and Synchronise the policies of cash,
inventory levels. Synchronise policies of receivables and inventories with the
cash levels with that of trade receivables policies of suppliers and customers so
and inventory of products so that the that all minimise their working capital
balances are optimised. levels of investment.
Co-operation with trade creditors and

Financing Working capital financing policies banks can expedite the availability of
enhance value by taking care of financing sources and minimise the
financing sources, costs and liquidity cost of financing as well as the timing
positions. Synchronise policies of cash and ease of the medium of payment.
levels with that of trade payables and Synchronise credit policies with that of
inventory of materials so that the suppliers so that to maximise financing
balances are optimised. sources and minimise related costs.
2SHUDWLRQV
Purchasing Apply purchasing policies (purchase and With closer firm-supplier co-operation
cash payment terms and standards) to the transaction costs of ordering,
enhance value. Synchronize cash purchasing and transporting materials
payments with purchases and trade can decrease. Synchronise purchases
credits so that cash needed is minimised with suppliers sales so that both are
and purchase and trade credits are maximised while at the same time the
maximised. firm’s balances of cash and inventory
of materials and the supplier’s cash
collection and inventory of products
are optimised.
Selling Design, apply and control sales policies Close firm-customer co-operation
(sales and cash collection terms and decreases the transaction costs of
standards) to enhance value creation. ordering, selling and transporting
Synchronize cash collections with sales products. Synchronise sales with
and receivables so that their balances are customers purchases so that both are
optimised. maximised while at the same time the
firm’s cash and inventory of products
and the customer’s cash needed and
inventory of materials are maximised.
3HUIRUPDQFH Compare the best expected internal Compare the best practices of other
HYDOXDWLRQ practices (forecasts and budgets) with firms (competitors in the same
related outcomes using the accounting industry or other industries). Evaluate
based performance measurement and customer and supplier satisfaction
evaluation methods. Operational (based on commitment, retention
efficiency is evaluated using activity rates, perceived quality of goods and
ratios, levels of investment and financing services, response and delivery
efficiency using asset structure and times).
liquidity/leverage ratios and profitability
using gross profit and net profit margins
and return on assets.
*HQHUDOLVVXHVDIIHFWLQJWKHPDQDJHPHQWRIZRUNLQJFDSLWDO
LQWKH(ULWUHDQFRQWH[W
The factors considered above may not explain everything. It is possible that other
factors in the firm’s overall environment determine the way the internal and external
working capital operations and levels are managed to create value. To take care of
these eventualities this conceptual framework looks at the influences of other factors
including, ownership, government regulations, management potential and cultural
factors, (Table 5-3).
2ZQHUVKLS The form of ownership also affects the potential of firms to create
value (See chapter 4 section 4.6). Market competition has a determining role in a
firm’s potential for managerial efficiency and value creation. However, the possibility
that government and transition firms can retain their ownership status and at the same
time be competitive is hindered by political interference from the government. Inter-
firm transaction relations are also influenced by the ownership status because firms
with a similar ownership status will also have similar objectives and control patterns.
Generally, government firms will reflect a common objective of enhancing political,
social and allocative efficiency. Privatised firms will have operational efficiency with
a firm’s value creation as the ultimate objective. Transition firms may reflect
characteristics of both government and privatised firms but may also be different in
some other aspects (Hailemariam 2001).
*RYHUQPHQW UHJXODWLRQV Directly or indirectly government regulations influence
every aspect of a firm's activity. The government regulations also influence the rule of
business practice including the type of business operations and inter-firm linkages.
Government can set rules and guidelines on how the firms have to be managed. It can
determine the type of firms that enter into agreements, the type of competition and it
may even set rules and guidelines on how the firms have to be managed. The more
regulations and laws prohibiting the development of value chains, the less likely that
the firm will use the value chain linkages approach to manage transaction costs of
working capital operations and levels. Enquiry is made to find out to what extent
government regulations affect the firms' working capital policy on operations and
levels of investment and financing.
0DQDJHULDO EDFNJURXQG Management potential can determine the selection from
alternative management approaches. The higher the management potential the more
likely the firm is to use value management as a guiding principle. This implies that,
internal management of working capital and its backward and forward linked
activities with those of its suppliers and customers will be determined by the firm's
managerial capability. Management’s practical experience and background plays a
very determining role in the development, acquisition and adaptation to proper
managerial policies.
&XOWXUDO IDFWRUVCulture also affect a firm’s overall management. Hence, working

capital management has to be designed such that it takes full consideration of the
cultural factors. Transactions are made between people who contact, contract and
control each other’s behaviour not only on the basis of business agreements but also
on their cultural practices, believe, and norms. Working capital management
techniques developed by world-renowned researchers, practically and repeatedly tried
Chapter 5 92
and proved to produce positive results in the western world, if replicated somewhere
else, might end-up at failure. Why? Because cultural practices, believes and norms
also determine practical management approaches (Williamson 1986). Even
introducing developed infrastructure and information technology cannot be expected
to bear fruit in developing countries’ cultures, like that in Eritrea that place high value
on face-to-face communication as norms. Enquiry is made to find out how culture,
habits and norms influence the process of managing working capital operations and
levels.
7DEOH*HQHUDOLVVXHV±H[SHFWDWLRQVRIWKHFRQFHSWXDOIUDPHZRUN
General issues Effect on firm management

Ownership Competition in government and transition firms can be hindered by political
interference from the government. Firms with similar ownership status can have
similar objectives and control patterns. Government firms may enhance political,
and social objectives, privatised firms may opt for operational efficiency with a
firm’s value creation as the ultimate objective. Transition firms may reflect
characteristics of both government and privatised firms.
Government Government regulations can influence the type of business operations and inter-
regulation firm linkages, the type of competition and set rules and guidelines on how the
firms have to be managed.
Managerial Managerial empowerment, practical experience and academic background can
empowerment determine the selection from alternative management approaches and play a
and background determining role in the development, acquisition and adaptation to proper
Cultural factors Cultural factorsalso affect a firm’s overall management because transactions are
made between people who contact, contract and control each other’s behaviour on
the basis of their cultural practices, believe, and norms.
7KHLQWHUUHODWLRQVKLSDPRQJLQWHUQDOH[WHUQDODQGJHQHUDO
LVVXHVRIPDQDJLQJZRUNLQJFDSLWDO
There is direct relationship among internal, external and general issues of working
capital management. We believe the most important starting point is the internal
working capital management. Before a firm tries to establish external linkages it has
to put its own house in proper conditions. A firm has to design and implement proper
management of working capital levels of investment and financing as well as
operations of purchasing and selling. It is only when a firm is able to manage its
internal value activities (both primary and supporting) that it can start to establish
efficient external linkages and inter-firm co-operation with its suppliers and
customers. The same argument applies to the firm’s suppliers and customers. Unless
they have successful internal management of their respective value activities, it is
possible that they get problems of co-operation externally.
A firm’s overall environmental issues also affect how efficiently it can manage its
working capital levels and operations both internally and externally. The existence of
conducive environment, such as skilled labour (both at the management level and
work force), developed information and technology infrastructure, supportive
government policy and cultural factors can have a very determining role in a firms’
ability to design and implement efficient internal and external management of
working capital.
7KH5HVHDUFKPHWKRGRORJ\
This section presents the case research as our main research method and is further
sub-divided into the design of the overall case study (section 5.3.1), data collection
(section 5.3.2), data analysis (section 5.3.3) and criteria used to ensure the credibility
of the findings (section 5.3.4).
5HVHDUFK PHWKRGRORJ\ deals with the study, design as well as the activities and
approaches used in the empirical data collection and analysis. A number of authors of
research methodology (Yin, 1994, Ghauri, Gronhaug and Kristianslund 1995, Rayan,
Scapens and Theobald 1992) have provided alternative research methods. The
literatures on research methods with differing emphasis deal with the question of
which research methods are appropriate, suitable or scientific. Ghauri, Gronhaug and
Kristianslund (1995), argue that which method or methods to follow depends on the
research problem and its purpose. Yin (1994) describes four alternative research
approaches: case research, experiment, survey as well as history and analysis of
archival information. According to Yin, the decision to use one of these approaches
depends on the type of the research question, the control a researcher has over actual
behavioural events and the focus on contemporary as opposed to historical
phenomena. Yin provides that a FDVHVWXG\ is preferred where, the research question to
be addressed is of the type of how-why, when control of the researcher over the
research is none or very insignificant and the focus is on a contemporary phenomenon
within a real life context. He also points that, H[SHULPHQW - is used when the form of
research question is how and why, when the researcher is required to control the
behavioural events and the research focuses on contemporary events. 6XUYH\ - is used
when the form of the research question is who, what and where, how-many and how-
much the researcher is not required to control the behavioural events and the research
focuses on contemporary events. $UFKLYDO DQDO\VLV - is used when the form of the
research question is who, what and where, how-many and how-much as well as that
the researcher is not required to control the behavioural events and s/he may not
concentrate on contemporary events. +LVWRU\ DQGDQDO\VLVRIDUFKLYDOLQIRUPDWLRQ - is
used when the form of research question is how and why, when the researcher is not
required to control the behavioural events of the research subjects, and when the
research does not focus on contemporary events.
Research can also be qualitative or quantitative based. According to Ghauri,

Gronhaug and Kristianslund (1995) in qualitative research, findings are not arrived at
by statistical methods or other procedures of quantification but with a mixture of
rational, explorative and intuitive where the skills and experiences of the researcher
play an important role in the analysis of the data. In view of our research problem and
because of the differentiating characteristics of the research methods we believe that a
qualitative approach with emphasis on the case research method is the best approach
that can help us to find a proper answer to our main research question. Our main
research question is stated as: ³+RZ GR JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG
PDQXIDFWXULQJILUPVLQ(ULWUHDPDQDJHWKHLULQWHUQDODQGH[WHUQDOZRUNLQJFDSLWDO"´
This research question focuses on finding answers to ZKDW working capital

management approaches the firms use and KRZ they apply those approaches. In this
case cRQWURO is difficult with working capital management techniques used by business
firms. Management behaviour cannot be manipulated in the same way experiments
Chapter 5 94
are manipulated. The IRFXV of the research study is on finding contemporary working
capital management techniques, within a real life context. We described each firms
working capital management, then compared it with the firms in its category. Finally,
we compared the working capital management of all three categories of firms, that is,
government, transition and privatised. Most of our analysis is based on the opinion of
the general, financial and commercial managers of the firms as well as general
managers of their suppliers and customers.
7KHFDVHVWXG\GHVLJQ
Yin (1994) suggests that case studies can be used either to verify or falsify results,
which were predicted on the basis of previous theory. Moreover, according to Rayan,
Scapens and Theobald (1992), the value of the theory in case study research is
measured by the extent to which the theory explains the practice. Therefore, theory is
important in explaining observations. We have reviewed the literature on the internal
and external working capital management. Internally, we studied ways of maximising
the value creating characteristics of working capital. Externally, we assessed
approaches of business to business co-operation. As background theories we have
studied management theories on working capital approaches (Scherr, 1989, Van
Horne 1998), value chain (Porter 1985), value network (Rappaport, 1986) and buyer-
supplier linkages management (Shank and Govindarajan 1993). We have used
Williamson’s transaction costs economics theory to understand the characteristics of
transaction costs in both internal and external linkages of firms. Specifically, we have
used Williamson’s transaction costs management approaches to study the transaction
costs characteristics of working capital levels and operations. Van der Meer-Kooistra
and Vosselman’s (2000) model on the management of inter-firm transactional relation
helped us to understand how transaction costs can specifically be managed. Based on
these theoretical backgrounds we have formulated the conceptual framework of our
case study on the assertion that, efficient working capital management of a firm’s
intra and inter-firm value chain linkages can reduce transaction costs, generate more
income and create firm value.
As Yin (1994) notes, cases are not samples and should not be selected as such. In the
case study methodology, the focus is not on a limited number of predetermined
independent variables, but on factors, which are helpful in explaining the observed
phenomena. According to Rayan, Scapens and Theobald (1992), case study methods
are different from experiments, surveys and the other research methods. Case studies
are viewed as tools by which theories are used to explain methods. The theories,
which provide convincing explanations, will be retained and used in other cases,
whereas the theories, which do not explain, will be modified or rejected. The
objective of individual cases is to explain the particular circumstances of a case. Such
an approach to case study research requires that we look for theoretical
generalisations and not statistical generalisations. In a theoretical generalisation the
focus is not on specific observations but on description, explanation and exploration
of general practices.
According to Rayan, Scapens and Theobald (1992), case studies can be descriptive,
explanatory or exploratory. 'HVFULSWLYH case studies describe the systems, techniques
and procedures currently in use by firms. ([SODQDWRU\ case studies aim at explaining
the reasons for observed practices and the focus is on a specific case. Here theory is
used in order to explain the specific rather than to produce generalisations.
([SORUDWRU\ case studies search the reasons for a particular practice and enable
researchers to generate hypothesises about the reasons for those observed practices.
Though we have an input of the H[SORUDWRU\ case study, we have basically focused on
the GHVFULSWLYH and H[SODQDWRU\ case study approach. We try to GHVFULEH and H[SODLQ
the internal and external working capital approaches used by the government,
transition and privatised firms.
4XDOLWDWLYH GDWD DQDO\VLV Our research approach requires us to use the qualitative
data analysis. According to Miles and Huberman (1994), qualitative data refer to
essences of people, objects and situations. It is expressed in terms of words based on
observations, interviews and documents. In Miles and Huberman’s (1994) terms,
qualitative data analysis consists of three concurrent flows of activities – data
reduction, data display and conclusion drawing/verification. Data reduction refers to
the process of selecting, focusing, simplifying, abstracting and transforming the data
that appear in written-up field notes or transcriptions. Data display is organising,
compressing and assembling information to permit conclusion drawing. Conclusion
drawing is deciding what the information displayed means and verification is testing
for internal and external validity. These activities basically make-up the phases of our
case research.
7KHSKDVHVRIFDVHUHVHDUFK
Bouma and Atkinson (1995) propose an outline of three phases in the research process.
The first phase requires a researcher to clarify the issues to be researched. In this phase
the researcher has to select, narrow and formulate the problem to be studied and to
formulate the research question, select the research method, design and devise measures
for variables, set-up tables for analysis and select samples or the units of analysis. The
second phase concerns the collection of data about the research question, summarising
and organising the data. The third and final phase relates to the analysis and
interpretation of data. This stage is concerned with relating the data to the research
question, drawing conclusions, assessing the limitations of the study and making
suggestions for further research.
3KDVH7KHLQLWLDORUSUHSDUDWLRQSKDVH
Phase 1 deals with the formulation of the conceptual model, and links current
theoretical ideas and concepts with practical insights. Working capital management
techniques and associated theories (transaction cost economics, shareholder value
creation and value chain linkages) are reviewed and used to incorporate the theory
with the practice. The result is the theoretical framework used for the research analysis
and presented in section 5.2. Sample business firms are also selected (See Table 5-2).
The research design in the first phase is based on the four important parts of a case study
(Yin, 1994): the study questions, units of analysis, the logic linking the data to the
prepositions and the criteria for interpreting the findings.
6WXG\ TXHVWLRQVThis research focuses on looking at the internal and external

working capital management in the context of a developing country, specifically
taking the case of Eritrea. The main research question addressed is: ³+RZ WKH
Chapter 5 96
JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG PDQXIDFWXULQJ ILUPV LQ (ULWUHD PDQDJH WKHLU
LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO´ Details of the selected specific research
questions have already been discussed in chapter one.
3KDVH7KHH[HFXWLRQRUHYLGHQFHFROOHFWLRQSKDVH
The literature review has helped us to develop a conceptual framework and it has given
us an initial indication of the types of evidence, which should be looked for in the case
study. Based on the conceptual framework we designed data collection mechanisms
(interviews, questionnaires and archival records). Specifically, our research methodology
has taken a practical case of ten firms in the manufacturing sector and assessed their
internal and external management of working capital operations and levels using both
secondary and primary data collected. Primary data are collected from the firms’ as well
as their suppliers’ and customers’ top management using questionnaires and interviews.
We have followed three phases in collecting data. First, we developed questions for the
interview and questionnaire. Then a pilot study was made of one firm and its main
supplier and main customer. This helped us to make some adjustments on the procedure
of the data collection and on the questions. Second, data were collected from the
remaining nine firms. Third, data were collected from the suppliers and customers of the
nine firms. The secondary data collected (mainly from the firms’ archives) include
financial statements and written manuals and other policy guidelines related to working
capital management. Both primary and secondary data collected were summarised and
made ready for analysis. Our objective was to understand the firms’ policies and
practices of working capital management, which resulted in data processed for use in the
next (analytical) phase.
3KDVH7KHDQDO\WLFDOSKDVHRIDVVHVVLQJHYLGHQFH
The objective of this phase is to make analysis of the internal and external working
capital operations and levels by imputing relevant techniques of working capital
management and supporting theories identified as a result of the literature review and
empirical findings. This phase is a study of the data collected. The data collected is
analysed against the background of the conceptual framework. The task is first, to
describe the internal and external management of working capital operations and
levels that the firms apply. The second task is to explain the reasons why the firms
have opted for those managerial approaches or why they have not. Finally, our case
research includes the conclusions, evaluations and recommendation for further
research and lastly executive summary.
'DWDFROOHFWLRQ
As Yin (1993) noted, an important aspect of a case study is that it enables the use of
multiple sources of evidence converging on the same set of issues. According to Yin
(1994b), evidence for case studies may come from various sources including,
documentary information, direct observation, physical arti-facts, interviews, and
archival records. Sekaran (1992) also adds the questionnaire as another alternative
mechanism of data collection.
According to Sekaran, LQWHUYLHZV - are personal contact questions put to key

respondents. Interviews can be structured or unstructured, open-ended or focused and
can be conducted either face to face or by telephone. A qXHVWLRQQDLUH - is a pre-
formulated written set of questions to which respondents record their answers, usually
from defined alternatives. A questionnaire is suitable when the researcher knows
exactly what is required, and how to measure the variables of interest. Questionnaires
can be administered personally or mailed to the respondents. $UFKLYDO UHFRUGV -
include financial statements, customers’ and suppliers’ service records, organisational
records such as charts and budgets, maps and charts, lists of names, survey data
previously collected about the case, as well as personal records such as diaries,
calendars and telephone listings. 'RFXPHQWDU\ LQIRUPDWLRQ – include letters,
memoranda and other communiqués, agendas, announcements, minutes,
administrative documents like progress reports and other internal documents, formal
studies or evaluations of similar cases, articles and other information appearing in the
mass media. 'LUHFWREVHUYDWLRQ – refers to collecting data where the researcher makes
a study on the case by direct physical observation of the subjects of the case.
3DUWLFLSDQWREVHUYDWLRQ - pertains to a situation where the researcher takes active part
in the activity being studied. 3K\VLFDO DUWLIDFWV - relate to collecting a technological

device, a tool or instrument, a work of art, or some other physical evidence.
In implementing our plan with regard to the sources of evidence, we used

questionnaires and we made in-depth structured interviews with the general, financial
and commercial managers of ten firms as well as the general manager of one supplier
and the general manager of one customer. We conducted focused and open-ended
interviews. Though they can have the disadvantage of both interviewee and
interviewer bias and inaccuracies due to poor recalling, interviews have enabled us to
target directly at the case study topic and insightfully perceive causal inferences.
Personally administered questionnaires are also distributed to and collected from
managers of the firms, suppliers and customers.
A checklist of questions for each variable in the conceptual framework is prepared. Care
is taken so that all the relevant questions are asked, allowing for flexibility in order to
permit the natural flow of ideas and events. All questions in the structured interviews and
questionnaires are prepared and discussed with colleagues in advance. A pilot test is
conducted in order to refine the questionnaires and interviews before approaching
respondents and distributing the questionnaires to them. The personal interviews,
questionnaire distribution, follow-up and collection is done by the researcher.
We also used audited financial statements of seven years (1994 to 2000) from the
archival records of the firms’ to collect secondary data for our research. Taking
financial data of seven consecutive years solves the disadvantage of low retrievability,
biased selectivity by both researcher and provider. However, audited financial
statements of some firms were not available. In which case we used draft financial
statements and in some cases we based the analysis on a period of less than seven
years.
&ULWHULDIRUILUPVHOHFWLRQ: The first criterion that we have used for selection of the firms
is comparability in the form of RZQHUVKLS (See chapter 4 section 4.6). We have selected
the firms on the basis of ownership status. The origin of Eritrean firms mainly goes
back to the Italian colonial era, which numbered about 56 in 1930 and more than 300
Chapter 5 98
in 1945. During the Ethiopian occupation they amounted to about 165 in 1970 and 44
in 1975 (Haile, 1991). In 1975 the then socialist government of Ethiopia nationalised
all industries and administered them until independence in 1991 and the Eritrean
government inherited them as such. The Eritrean government under its market
economic policy declared in 1996 that most factories in the manufacturing industry
were to be privatised except few of them, two of which are in the food industry – Keih
Bahri Food Products and Barka Canneries. By the time we conducted our research
more than half of the firms were privatised. Our study investigates the internal and
external working capital management of the factories as a result of being government
owned, being in transition to privatisation or having changed ownership from
government to private. The second criterion for selection is the DYDLODELOLW\ RI ORFDO
VXSSOLHUV DQG FXVWRPHUV. The choice of suppliers and customers was made by the
general managers of the firms on the basis of frequency of inter-firm transactions. Our
conceptual framework includes the study of external linkages between a firm, its
suppliers and customers. In order to economise on time and volume of our book, we did
not take all the ten firms as main cases. So, as our main cases we have selected firms,
which have suppliers and customers available for our study. However, there are still
some firms where one firm is a supplier or customer of more than one of them or whose
suppliers or customers were abroad and so were not included in the study. In order to see
if the firms in the same ownership category have similarities or reveal material
differences in their management of internal and external working capital levels and
operations, we compared the main cases selected with other firms in the same category.
At the end we made inter-category comparison.
7KHFDVHVVHOHFWHGWKHILUPVDQGWKHLUVXSSOLHUDQGFXVWRPHUOLQNDJHV
7KHILUPV The firms that this study concentrates on are ten main firms along with one
supplier and one customer for each firm (Table 5-2). The firms include two
government firms - Keih Bahri Food Products and Barka Canneries, five WUDQVLWLRQ
ILUPV Asmara Textile factory, Keih Bahri Tannery, Lalmba Sack Factory, Dahlak Shoe
Factory and Sembel Household Utensils Factory as well as three SULYDWLVHG ILUPV
Asmara Sweater Factory, Eritrean Steel Sheet Factory and Asmara Milk Factory.
7KHVXSSOLHUV The suppliers of the government firms whose responses we have studied
include Eritrean Grain Board - supplier of Keih Bahri Food Products and Gejeret
Carton Factory - supplier of Barka Canneries. The suppliers of the transition firms are
Asmelash Hides and Skins Wholesale - supplier of Keih Bahri Tannery, Alighider
Agricultural Project - supplier of Asmara Textile Factory and Keih Bahri Tannery -
supplier of Dahlak Shoe Factory. Suppliers of the privatised firms include Department
of Animal Science (DAS- UoA) - supplier of Asmara Milk Factory and Beatay
Leather Factory - supplier of Asmara Sweater Factory.
7KH FXVWRPHUV The customers of the government firms whose responses we have
studied include Asmara Pastry - customer of Keih Bahri Food Products and Ministry
of Defence - customer of Barka Canneries. The suppliers of the transition firms are
Selamawit Shoe Factory - customer of Keih Bahri Tannery, Ministry of Defence -
customer of Asmara Textile Factory, Mulugheta House Hold - customer of Dahlak
Shoe Factory, Testec Impex - customer of Lalmba Sack Factory and Tesfai House
Hold Utensils - customer of Sembel House Hold Utensils. Customers of the privatised
firms include Berhane Frafre - customer of Asmara Milk Factory and Segen
Construction - customer of Eritrean Steel Sheet Factory. Table 5-4 shows the firms as
well as their suppliers and customers. The incomplete data indicated refers to the
suppliers and customers, which we did not include in our study because they are abroad.
7DEOH7KHGDWDEDVHWKHILUPVVXSSOLHUVDQGFXVWRPHUV
)LUPDQGRZQHUVKLSJURXS 6XSSOLHU &XVWRPHU
,*RYHUQPHQWILUPV
1. Keih Bahri Food Products Eritrean Grain Board (G) Asmara Pastry (P)
2. Barka Canneries Gejeret Carton Factory (P) Ministry of Defence (G)
,,7UDQVLWLRQILUPV
3. Keih Bahri Tannery Asmelash Hides and Skins (P) Selamawit Shoe Factory(P)
4. Asmara Textile Factory Alighider Agricultural Project (P) Ministry of Defence (G)
5. Dahlak Shoe Factory Keih Bahri Tannery (T) Mulugheta House Hold (P)
6. Lalmba Sack Factory NA Testec Impex (P)
7. Sembel House Hold Utensils Tesfai House Hold Utensils (P)
,,,3ULYDWLVHGILUPV
8. Asmara Milk Factory Dept. of Animal Science (G) Berhane Frafre (P)
9. Asmara Sweater Factory Beatay Leather Factory (P) NA
10. Eritrean Steel Sheet Factory NA Segen Construction (P)
/HJHQG The letters in parenthesis indicate ownership status - G (Government), T (Transition)
and P (private), (NA) implies “not locally available”.
7KHPDLQFDVHV We selected a typical firm from each group as a main case for the
detail study. First, (Chapter 6) as a representative of government firms we present an

analysis of Keih Bahri Food Products internal working capital management, its
supplier linkage with Eritrean Grain Board and its customer linkage with Asmara
Pastry. Then, we compare internal and external management of working capital levels
and operations of Keih Bahri Food Products and another government firm - Barka
Canneries. Second, (Chapter 7) we present the firms in transition to privatisation, by
primarily considering Keih Bahri Tannery’s internal working capital management, its
supplier linkage with Asmelash Hides and Skins Wholesale and its customer linkage
with Selamawit Shoe Factory. A comparison is then made between the management
of the internal and external working capital levels and operations of Keih Bahri
Tannery and the other four firms in transition, namely - Asmara Textile Factory,
Lalmba Sack Factory, Sembel House Hold Factory and Dahlak Shoe Factory. Third,
we studied how three privatised firms manage their working capital levels and
operations (Chapter 8). Particularly, we present an analysis of Asmara Milk Factory’s
internal working capital management, its supplier linkage with DAS (Department of
Animal Sciences of the University of Asmara) and its customer linkage with Berhane
Frafre. A comparison is then made between the management of internal and external
working capital levels and operations of Asmara Milk Factory and the other two
privatised firms namely – Asmara Sweater Factory and Eritrea Steel Sheets Factory.
Lastly, we made a comparative study of the government, transition and privatised
firms in Chapter 9.
%DFNJURXQGLQIRUPDWLRQRIWKHILUPV
The background information of the three firms (one from each category) is presented
at the beginning of the chapter that deals with the study of the firms. In order to avoid
repetition and redundancy, we concentrate in this section on the background
information of the firms that are not selected as main topic of out study in the
chapters. These include Barka Canneries from the government firms, Asmara Textile
Chapter 5 100
Factory, Lalmba Sack Factory, Sembel House Hold Factory and Dahlak Shoe Factory
from the transition firms as well as Asmara Sweater Factory and Eritrea Steel Sheets
Factory from the privatised firms. The information is based on the data obtained by
interviewing the firms’ general mangers.
%DUND &DQQHULHV Originally Barka Canneries was established by uniting three
factories – SARCE, ENCODE and SOPRAAL. Therefore, the history of this firm is
the united history of these three firms. All these firms were established in the nineteen
sixties by Italian owners. Until 1975 they were working independently as separate
firms. However, in 1975 the then colonial government of Ethiopia nationalised these
factories and they were united under the present name - Barka Canneries. At the time
of nationalisation the capital of ENCODE and SARCE was not recorded and there
was no cash in these two firms. Therefore, the accounting records started only with
the capital of SOPRAAL, which at the time of nationalisation was 500,000 Ethiopian
Birr. So, ENCODE and SARCE were made to run their operations with the money
available in SOPRAAL. Their operations are independent from each other because the
types of operations they do are different. Their original agreement at time of
unification was a type of lease agreement. ENCODE was dealing mainly with
slaughtering animals, SARCE with processing and canning while SOPRAAL had all
operations for slaughtering, processing and canning meat.
When they were united the money paid to ECODE was based on the amount of meat
supplied to the processing plants in SARCE and SOPRAAL. The money paid to
SARICE was based on the amount of processed product and number of canned food.
So SOPRAAL was given the authority to organise the operations in the three firms
and management was organised under the leadership of SOPRAAL. In 1991 (Eritrean
independence), the government of Eritrea took the responsibility of running these
firms. The old organisational structure of these firms was not changed up to 1996. In
1996 the value of the assets of these firms was re-evaluated and capital was assigned
to these firms as one entity. The original capital of 500,000 Ethiopian Birr assigned to
only SOPRAAL and increased to about 9,000,000 Birr, because new assets were
added in the mean time in SOPRAAL. Overall these firms among themselves own
around 59,000,000 Nakfa as of the year 2000. The operations of the firms were not
materially changed and their product is mainly supplied to the army because their
production capacity can not exceed this demand.
$VPDUD 7H[WLOH )DFWRU\ In 1957, an Italian investor, named Baratollo established

Asmara Textile Factory under the name “Cottoneficio Baratolo and Company”, with a
capital of 110,000Ethiopian Birr. At a later stage Signor Baratollo formed alliance
with other investors and continued doing business up until 1975, when the then
Ethiopian government nationalised all major private firms including Cottoneficio
Baratolo and Company and named it as “Asmara Textile Factory”. The Eritrean
government inherited the factory as such at independence. The factory started
operation with 6,912 spindles, however this is expanded and diversified to-date to
include two ginning plants, two spinning mills, one weaving department, one knitting
department, one blanket department and one sanitary towel department. The factory is
involved in the production of T-shirts, Pyjamas, Yarn and Fabrics (including
Abujedid, Shash, Khaki Twil, Poplin, Bed sheets, Blankets, Sweaters). Other than the
manufacturing of the above products it also gives ginning service to all textile
factories, cotton plantations and edible oil factory because it is the only ginning firm
in the country.
/DOPED6DFN)DFWRU\ The factory was established in 1960 by an Italian under the
name “Manufatura Sachi”. It started with a capital of 1,250,000 Ethiopian Birr and
production capacity of 4000 kg of sacks per day with 246 employees. Then the factory
was nationalised by the Ethiopian government and run as such up to the time of
Eritrean independence. The main operation of the factory is to produce different types
of sacks, which can be used for cereals, cotton, sugar, twine etc. The factory has not
made considerable difference from its initial operations except that of ownership.
6HPEHO +RXVH +ROG )DFWRU\ Hong Kong Chinese with initial capital of 858, 000
Ethiopian Birr established Sembel House Hold Utensils Factory in 1968. The number
of workers at the time of its establishment was 257. It started with initial operations to
produce Enamel wire, Aluminium wire and Tin plate. The main change according to
the financial manager from the start of its establishment is in the volume of
production, which has doubled from that of the original. The factory has also
introduced new machinery in order to adapt to new technology.
'DKODN 6KRH )DFWRU\ In 1964, an Italian named Rafaele Bini established Dahlak
Shoe Factory under the name “Bini Shoe Factory”. The factory was nationalised in
1974 by the then Ethiopian government. After independence of Eritrea the original
owner of the factory tried to re-purchase the factory but it was too expensive for him
to buy and therefore bought another shoe factory which was called Eritrea shoe
factory and renamed it “Bini Shoe Factory“. The factory started by producing plastic
shoes and added leather shoes in 1969/70, canvas shoes, bags, tents and stretchers in
1972. The capital at the time of establishment is not known however, its capital as of
2000 is about 5,500,000 Nakfa. After independence some machines producing plastic
shoe and other plastic items like PVC granules, jerkins [water containers], plastic
utensils, which were used by the freedom fighters in the field were also incorporated
in to the machines in the factory. The factory is now declared for sale to private
owners.
$VPDUD6ZHDWHU)DFWRU\ The factory was established in 1954 by an Italian named

Gargano with an initial capital of 1.6 million Ethiopian Birr to produce different types
of sweaters. The Ethiopian government nationalised the factory in 1975 and the
Eritrean government took over the factory after independence. In 1996 the Eritrean
government passed a proclamation to privatise most of the state owned factories one
of which is this factory.
Before independence the factory’s main operation was the production of sweater and
was marketed to Ethiopia. However, after independence the traditional market was
lost and the factory was forced diversify in 1994 to the leather production in
partnership with a South Korean firm. Nevertheless, the partnership was dissolved in
1996 by the request of the Korean partners. Based on the privatisation policy Asmara
Sweater Factory was sold to private owners in the form private limited company to
two Ertrean businessmen [husband and wife]. The owners reside in Italy and are
engaged in the same textile industry there. After independence, the firm continued the
production of sweater and leather jackets and increased its capital from an original 1.6
to 3.5 million Nakfa.
Chapter 5 102
(ULWUHD 6WHHO 6KHHWV )DFWRU\ The factory was established in 1965 under the name
of Ethiopia Steel Sheet Share Company with five people including two British, one
Italian and one Eritrean with an initial capital of 50,000 Ethiopian Birr. The Ethiopian
government nationalised the factory in 1972 and closed it in 1973 because another
similar government factory was established in Akaki [Ethiopia]. The Ethiopian
government dismantled the machines and other equipment of the factory and took it
over to Ethiopia and the factory building was changed to military barracks and
ammunition stores. In 1993, after Eritrean independence, the government re-
established [rehabilitated] the factory with a capital of 5,000,000 Birr. The factory
was privatised in 1998. The main operation that the firm is involved in include,
importing black sheet in coils and then coating with zinc, galvanising and changing it
into corrugated sheets for roofing and other construction purposes. It also meshes wire
and produce aluminium pans.
7KH UHVSRQVHV We planned to approach 50 respondents with questionnaires and
interviews – 30 managers, (general, financial and commercial manager) from each of the
ten central firms of our case, 10 general managers of suppliers and 10 general managers
of customers. Actually, we have contacted 45 managers (See Table 5.3) including 30
managers of the ten central firms, 7 managers of their suppliers and 8 managers of
their customers. We expected a response rate of at least 25 (50%). However, the actual
case analysis has a response rate of 90% of all respondents. This includes 100% internal
response rate and 75% external response rate. The missing data in the external part refers
to linkages with the Ministry of Defence and others who reside abroad. We approached
the Ministry of Defence, which is the customer of Barka Canneries, Keih Bahri Food
Products and many other firms including Asmara Textile Factory. The head of the
Procurement Division of the Ministry of Defence said that the Ministry applies the same
managerial approach in all its supplier linkages. Since we have collected data on the
inter-firm co-operation between the Ministry of Defence and Asmara Textile Factory we
have excluded that of Barka Canneries and the Ministry of Defence. We did not contact
suppliers of Lalmba Sack, Sembel Household Utensils and Eritrean Steel Sheet Factories
as well as the customer of Asmara Sweater Factory because according to their general
managers their linkages are with partners who are abroad. The general managers in
Asmara Milk Factory and Asmara Sweater Factory also act as commercial managers so
the interviews and questionnaires related to the commercial managers in these factories
are conducted with the general managers. Table 5.5 summarises the result of the
responses. We have also checked for missing data. There are missing data on the
questionnaire responses. As Appendix 5-1 indicates, the missing data are relatively
small. Therefore, we considered their effect on the overall conclusions of the research
as minor.
7DEOH7KHUHVSRQVHVRIILUPVVXSSOLHUVDQGFXVWRPHUV
&DWHJRU\)LUP ,QWHUQDOUHVSRQVHV ([WHUQDOUHVSRQVHV
*0 )0 &0 *0RI *0RI
VXSSOLHU FXVWRPHU
,*RYHUQPHQWILUPV
1. Keih Bahri Food Products IQ IQ IQ IQ IQ

2. Barka Canneries IQ IQ IQ IQ -
,,7UDQVLWLRQILUPV
3. Keih Bahri Tannery IQ IQ IQ IQ IQ

4. Asmara Textile Factory IQ IQ IQ IQ IQ
5. Dahlak Shoe Factory IQ IQ IQ IQ IQ
6. Lalmba Sack Factory IQ IQ IQ - IQ
7. Sembel House Hold Factory IQ IQ IQ - IQ
,,,3ULYDWLVHGILUPV IQ IQ IQ IQ IQ
8. Asmara Milk Factory IQ IQ IQGM IQ IQ
9. Asmara Sweater Factory IQ IQ IQGM IQ -
10. Eritrean Steel Sheet Factory IQ IQ IQ - IQ
/HJHQG IQ - represents that the manager has answered both interviews and questionnaires. (-) Represent
that the manager did not answer the interviews and questionnaires. GM - represents general manager, FM -
financial manager and CM - commercial manager. IQGM - indicates that, the general manager answered
interviews and questionnaires referring to the commercial manager because the general manager also acted
as a commercial manager too.
During
)DPLOLDULW\ RI WKH PDQDJHUV ZLWK WKH (QJOLVK ODQJXDJH DQG UHOHYDQW WHUPV
our data collection (using the process described in next section 5.3.3), we had
enquired on the academic qualification of general, financial and commercial
managers. We found out that 90% of the financial and commercial managers hold a
BA degree (4 years of training) or Diploma (2 years of training) in business studies
from the University of Asmara (in Eritrea) and the University of Addis Ababa (in
Ethiopia). The medium of academic instruction in these two universities is the English
language and they follow the American system of education and textbooks. A number
of these financial and commercial managers were also former students the researcher
in the University of Asmara, so, we were applying the same terms that we used in the
process of teaching and learning then. As it can be observed in the appendices (6.1,
7.1, 8.1), our information on the role of working capital management on the firms
value creation is obtained from these financial managers. Therefore, we believe that
they clearly understood the meaning of value and value creation the way we have
used in the questionnaires and interviews and in our conceptual framework. However,
only few of the general managers hold a BA degree in business studies with some
background experience of firm management. While the rest are political appointees
who were ex-freedom fighters (EFF) before they were appointed to the job and they
had neither relevant academic background nor practical experience. However, we
found out that all the general managers can communicate in the English language to
the level of our satisfaction. It is worthwhile here to note that we went back to the
firms one year after the data was collected in order to observe the developments after
our data collection and also to observe the ability of the respondents to understand the
English language. We discussed with most of the general managers and we are
satisfied with the ability of the general managers to communicate in the English
language and understand the meanings of the terms we used in our data collection.
It worth to note thatEritrea was colonised by Italy for more than 50 years until 1942,
(the end of the Second World War). At the end of the Second World War the UN
assigned the UK to administer Eritrea until 1952. Then it was federated with Ethiopia
Chapter 5 104
up to 1962, when Ethiopia annexed Eritrea and made it one of its provinces. Eritrea
had to wage a war against occupation for 30 years, up to May 1991, when it got its
freedom by force of arms. It declared its formal independence in May 1993 after a
referendum. Thus, the EFF (Ex-Freedom Fighters) are those who fought in the war of
independence.
'DWDDQDO\VLV
Our data analysis mainly concerns the comparison of the theoretical background (as
summarised by our conceptual framework) and the empirical findings that will be
collected from the firms’ managers using questionnaires and interviews. However,
before we embark into the discussion of the specific methods of primary and
secondary data collection approaches and methods of data analysis we will describe
our units of analysis and study period as well as criteria for interpreting the findings.
8QLW RI DQDO\VLV DQG VWXG\ SHULRG The central unit of analysis of our case study is
“the government, transition or privatised manufacturing firm in Eritrea” whose internal

and external management of working capital is studied and the sub-units are the 10
firms, which are the topic of the study. The study period applicable to the data collection
with regard to the interviews and questionnaires refer to 11 months (November 1999 to
September 2000). The financial statements refer (as much as the data is available) to the
7 years (1994 to 2000).
&ULWHULDIRULQWHUSUHWLQJWKHILQGLQJV We collected data on the manager’s opinions

on their internal and external working capital management. Managers were asked
what approaches they use in managing their working capital levels of investment and
finances as well as operations of purchasing materials and selling finished goods and
how they apply the working capital management approaches. The main criteria for
interpreting the findings are the existence and relevance of management systems on the
internal and external working capital operations and levels moreover the influence of
managerial empowerment on working capital management is also studied. ([LVWHQFH
looks at whether there are policies, procedures and techniques implicitly or explicitly
applied by the firms with regard to the management of working capital operations and
levels. 5HOHYDQF\ refers to whether the policies, procedures and techniques (if any) are
relevant to create firm value. 0DQDJHULDO HPSRZHUPHQW refers to whether firms’
management has the required authority to manage the internal and external working
capital operations and levels. It also refers to whether the implementation of the policies,
procedures and techniques are assigned to the responsibility of an appropriate manager
who is given the required authority that s/he needs to make relevant decisions at that
level.
3ULPDU\GDWDDQDO\VLVXVLQJTXHVWLRQQDLUHVDQGLQWHUYLHZV
In order to find the views of the firms’ managers as well as their suppliers and
customers, we used structured interview questions and questionnaires. The interview
questions and questionnaires referring to the general, financial and commercial
managers of the central firms were prepared and conducted in the English language
while those that refer to the firms’ suppliers and customers were translated into the
local language - “Tigrigna”. As it is indicated in Table 5.6 below, we referred the
questions on overall working capital management to the firms’ general managers,
questions on levels of investment and financing to financial managers and the

questions on operations to commercial managers.
It would be worthwhile to note here that, we did not consider the study of work in
progress inventory for two reasons. First, we want to concentrate on the working capital
inventory levels that have a direct linkage with the firms’ suppliers (raw materials
inventory) and customers (finished goods inventory). Second, empirically we have found
out that many firms consider work in process inventory left at the end of the year as
either raw materials inventory or finished goods inventory, in which case we have
included in our study of raw materials inventory or finished goods inventory. We did not
also approach the production manager of the firms because we wanted to concentrate on
the managers who have direct linkages with the firms’ suppliers and customers.
Moreover, we also expected that approaching the other three managers, that is, general
manager, financial manager and commercial manager could also help to obtain the
information that we could get from the production managers.
7DEOH5HVSRQGHQWVDQGTXHVWLRQVDGGUHVVHG
Question on working capital management issues

Respondents General Internal External
*HQHUDOPDQDJHU General issues Competitive strategy - Firm-supplier co-
On general issues operation on primary
activities
- Firm-customer co-
operation on primary
activities
)LQDQFLDOPDQDJHU - General issues Investment policy on Inter-firm co-operation
On the management of - Performance the levels of cash, on managing the levels
working capital levels evaluation inventory and of cash, inventories and
receivables receivables
- Financing policy and
management of costs of
financing
&RPPHUFLDOPDQDJHU - Policies on purchases -Firm-supplier
On the management of and suppliers contact, co-operation on
working capital contract and control purchase related
operations - Policies on sales and activities
customers contact, - Firm-customer
contract and control co-operation sales
related activities
4XHVWLRQQDLUH GDWD DQDO\VLV Each question in the questionnaire is provided with a
number of alternative answers and ends-up with “others” so that the managers can
include their own reasoning. We measured the responses on the basis of five point
Likert’s scale, ranging from 5 to 1 (Murphy and Likert 1967). The scales indicate how
positive or negative the managers’ responses are to the alternative choices in each
question. A scale of 5 indicates very positive, 4 positive, 3 neutral (between 4 positive
and 2 negative), 2 negative, 1 very negative and (-) represents that the manager did
not give an opinion. The researcher personally administered the distribution and
collection of the questionnaire. In administering the distribution and collection of the
questionnaires, a first appointment is made by telephone with the managers. On the
appointment date, first, an official letter that identifies the researcher was handed
over. Second, the objective of the study and how the questionnaires have to be filled
in was explained to the managers. Lastly, the questionnaires were submitted and left
with the managers with an appointment for the collection of filled questionnaires. This
Chapter 5 106
took around 30 minutes. Before collecting the questionnaire, at least one reminder call
was made a day before the date of the appointment and a final reminder about one
hour before the time of appointment (or one day if the manager resided outside the
city of Asmara). When collecting the questionnaire about 15 minutes was taken to
explain questions that the manager might have and an appointment was made for
conducting the interview. After collection of the questionnaire data, information was
transferred to a data summary sheet by the researcher and notes of inconsistencies or
unfilled questionnaires were taken. Before the final interview session started
managers were asked questions of clarification regarding their responses to the
questionnaire. These questions of clarification took generally from 15 to 30 minutes.
,QWHUYLHZ GDWD DQDO\VLV: The interview questions were designed to substantiate the
questionnaire. The interview questions required the managers to give their opinion on
what working capital management approaches they use, how they apply the
approaches, what problems they face and how they solve the problems. Again at least
one reminder call is made before the due date of the interview appointment and a final
reminder about one hour before the time of appointment (or one day if the manager
was outside the city of Asmara). All the interviews were tape-recorded, except for two
managers who were not willing to have their interview recorded, in which case notes
were taken during the interviews. The tape-recorded interviews were transcribed on
the same day that the interviews were made so that some observations taken while
interviewing were not forgotten. Interview questions took generally from 60 to 90
minutes.
6HFRQGDU\GDWDDQDO\VLVXVLQJILQDQFLDOVWDWHPHQWV
The secondary data refer to the information collected from the firms’ audited financial
statements of 7 years from 1994 to 2000 (as far as they were consistently available).
The financial statements include balance sheets, income statements and cash flow
statements. The data on financial statements’ were used to answer questions regarding
the firms’ performance.
We divided the evaluation of the financial performance into four sections. First, we
studied the investment composition using asset structure ratios including working
capital to total assets and working capital related ratios such as cash, receivables and
inventory to working capital.
Second, the liquidity ratios (current ratios and quick ratios) are used to evaluate the
firms’ liquidity and capacity of short-term financing. We also analysed working
capital liquidity and financing in order to study how the firms’ investments are
financed and evaluate the firms’ liquidity position.
Third, we used activity and profitability ratios to study the firms’ overall efficiency in
turning over the assets and generating profit. Activity ratios show the operational
efficiency of working capital activities, in terms of how fast receivables and
inventories are converted or turned over to cash. The activity ratios include, inventory
turnover, receivables turnover and overall working capital turnover. We also used
profitability ratios, specially gross profit margin, net profit margin and return on
assets.
5HVHDUFKFUHGLELOLW\
According to Yin (1994), credibility of the research findings can be verified by

subjecting the data to two tests of measurement, namely, reliability and validity
(content, construct, internal and external).
5HOLDELOLW\ Reliability refers to the objectivity of the data and its source. Reliability
is implemented by checking for errors and bias. The reliability of a measure indicates
the stability and consistency with which the instrument is measuring the concept
(Sekaran 1992). Stability indicates the ability of the measure to remain the same over
time despite uncontrollable conditions. Internal consistency of the measurement is
indicative of the homogeneity of the items in the measurement. The items measured
should “hang together as a set” and be capable of independently measuring the same
concept such that the respondents attach the same overall meaning to each item. The
reliability of a case study refers to the extent to which repeatedly applying the same
data collection procedures lead to the same result (Yin 1994).
For a case study to be reliable there must be a database that can be transparently
used so that other investigators can review the evidence. This database may include
documents collected from the researched firm, questionnaire data recorded in data
summary sheets, narrative records of interview conducted. We used multiple sources
of evidence as a means to check the reliability. In this research, first, the questionnaire
is collected and imputed to data summary sheets for use in the research analysis and
further reference. Second, after evaluating the managers answers to the questions in
the questionnaires (noting for unanswered questions or inconsistent answers),
interview questions are designed and conducted with the same managers and then a
narrative report of the interviews conducted is transcribed and filed for use in the
research analysis. Third, archival records of audited (as much as possible) financial
statements are collected and summarised for analysis of the firms’ financial
performance.
In a case study based on a grounded theory the reliability of subjective responses is

checked using a number of measures, so we have checked the reliability of the
responses of the managers in different ways. We found that the managers of the
government and transition firms are more reliable because they have very little
personal benefit that they gain as a result of falsifying their responses and they are
generally required to co-operate with researchers from the University of Asmara,
which is another government organisation and that the researcher is a member. We
did not also find reason to doubt the responses of the privatised firms because they
still are not accustomed to the culture of secrecy in order to keep their firms future
strategies confidential to protect from their competitors. Moreover, we have also used
the following methods to check the reliability of the managers’ responses. We have
asked similar questions to managers at different levels, that is, the general, financial
and commercial managers. We have designed the interview questions to support the
reliability and objectivity of the answers to the questionnaires. Managers of ten firms
have been asked the same questions and so we checked the answers of mangers of one
firm with the answers of other firms. The same questions have also been asked to the
mangers of the firms and the mangers of their suppliers and customers. We have
checked in advance that the general managers have good command of the English
language to enable them to understand and answer general questions. We have also
Chapter 5 108
checked that the financial and commercial mangers have good command of both the
language and technical terms that we have used. Using the externally audited financial
statements (as much it is possible) is used to check the reliability of the data we
obtained form the financial statements.
9DOLGLW\ Validity tests help to check what is being measured is what the researcher
wants to measure and not something else. Validity measures are grouped into content
validity, construct validity, internal validity and external validity or generalisation
(Yin 1994, Ryan, Scapens, Theobald, 1992, Sekan 1992).
&RQWHQW YDOLGLW\ ensures that the measure includes an adequate and repetitive set of
items that are relevant to the concept. In this research study, content validity is taken
care of by checking whether the responses to questions in the interviews and
questionnaires converge into the same direction. Questionnaire responses, which the
researcher found to be unclear, unfilled or contradicting with each other, were also
discussed with the respondents as a first step during interviewing.
&RQVWUXFWYDOLGLW\ measures how well the results obtained from the use of the measure
fit the theories around which the tests are designed. It refers to establishing correct
operational measures (Yin 1994) and tests whether the data collection mechanisms
actually measure the factors intended to be measured in the case research. In support
of construct validity we have compared the relations between the empirical findings
of the research with the supporting theories in chapter 10. To further support the
construct validity we have used multiple sources of evidence (questionnaire, interview
and archival records). We have also intensively interacted with the respondents during
the distribution and collection of the questionnaire as well as during interviews.
([WHUQDO YDOLGLW\ RU JHQHUDOLVDWLRQis used to know if case research findings can be
generalizable beyond the immediate case study. Generalisation can be statistical or
analytical. Statistical generalisation deals with generalisation of a sample from a
population. Analytical generalisation can be attained if a previously developed theory
is used as a pattern with which to compare the empirical results of the case study. But
it can also be possible to generalise a particular set of results to some broader theory
or to develop insights to build a new theory. We opted for analytical generalisations in
our external validity. We used the theories of value management, particularly, value
network, value chain and transaction costs and compared them with the result of our
empirical study, the result of which is included in our research conclusions and future
research direction.
&RQFOXVLRQV
In this chapter we presented the conceptual framework and the research methodology.
We illustratively (using Figures 5-1 and 5-2 and Tables 5-1 and 5-2) explained the
main variables and their interrelationship. We categorised the research model into the
main model where we adopted Rappaport’s value network model into our research
framework. This helped us to segregate our conceptual framework into internal and
external working capital management and to look for relevant factors. We then
described the alternative research methods that we use for data retrieval and research
analysis. Particularly, we argued that it is the case research that can serve our purpose.
Based on the case research we discussed the phases of our research.
In the initial or SUHSDUDWLRQSKDVH we covered the design and implementation of the

field research and data collection. Here we reviewed the various alternatives of data
retrieval techniques and disclosed that we have opted for interviews, questionnaires
and archival records. In the execution phase we presented the implementation of our
research plan as well as the sub-phases of the implementation. In the analytical phase
we aired out the sequences of analysis that we apply and from which conclusions and
recommendations will be drawn. Under GHVLJQRIGDWDDQDO\VLV, we disclosed our unit
of analysis and the criteria for interpreting our findings. We argued here how we have
used the primary data collected through interviews and questionnaires as well as the
secondary data from the firms’ financial statements.
Finally, we covered how we try to ensure the FUHGLELOLW\ of our data and research
analysis, particularly the reliability of our data and the validity of our analysis.
Generally, we claim here that applying multiple sources of data, namely, interviews
and questionnaires, ensures the reliability of the data source as well as externally
audited financial statements. The construct validity is ensured through the researcher’s
intensive interaction with the firms. Content validity is taken care of by discussing the
questions with colleagues and then testing with the help of pilot study before fully
distributing the questionnaires to the respondents and conducting the interviews. We
also checked that the responses in the interviews and questionnaires converge into the
same conclusion.
3$57,9
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&KDSWHU
*RYHUQPHQW)LUPV
,QWURGXFWLRQ
In the previous chapter we developed a conceptual framework for the research study,
based on which we conducted fieldwork to collect relevant data. In this chapter, we start
describing and explaining the data collected. After introducing the chapter in this section
(section 6.1), we present Keih Bahri Food Products’ overall working capital
management issues in section 6.2. Section 6.3 covers the internal management of
working capital levels and operations. Section 6.4 presents external working capital
management - including firm-supplier linkages and firm-customer linkages. Finally,
section 6.5 winds-up the chapter with conclusions.
Specifically, this chapter answers part 2(a) of the research question: “HRZ GR
JRYHUQPHQWRZQHGPDQXIDFWXULQJ ILUPV in (ULWUHDQ PDQDJH WKHLULQWHUQDODQG H[WHUQDO
ZRUNLQJ FDSLWDO´" To this end, we studied the internal and external management of
working capital operations and levels of the two relevant government firms - Keih Bahri
Food Products and Barka Canneries. Particularly, we present an analysis of Keih Bahri
Food Products’ internal working capital management, its supplier linkage with Eritrean
Grain Board and its customer linkage with Asmara Pastry. We selected Keih Bahri Food
Products because it is one of the very few factories that the government has decided not
to privatise. The government has decided to retain some factories because of their
strategic importance for the availability of food supplies to the public in general and
particularly to the army at affordable costs and in large volume. Keih Bahri Food
Products represents a typical government firm whose supplier and customer linkages we
have included in our study. We finally compare internal and external management of
working capital levels and operations of Keih Bahri Food Products and Barka Canneries.
2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQW
This section presents Keih Bahri Food Products’ overall working capital management
issues. It includes management responses to questions related to the firm’s historical
background, organizational structure, objectives of working capital management and
constraints to achieve the objectives as well as the role of working capital management
in creating value. We start with a background information on Keih Bahri Food Products
(section 6.2.1) and then present a comparative analysis of the government firms (section
6.2.2). For detailed information on overall working capital management issues, see
Appendix 6.1.
%DFNJURXQGLQIRUPDWLRQ
+LVWRULFDO EDFNJURXQG Keih Bahri Food Products is government owned and

administered under the Ministry of Defence. It is made up of three small business
firms - Maribetti, Kekia and St. Giorgio. The factories were nationalised in 1982 by
the then Ethiopian colonial government. They were used to produce foodstuffs for the
army. However, the Ethiopian Government found these three factories too small to
Chapter 6 114
satisfy the demands of its huge army. Therefore, in 1987 it established another factory
- Asmara Food Products with initial capital of 15,500,000 Ethiopian Birr, which is
currently merged with the other three factories under the name – “Keih Bahri Food
Products”.
2UJDQLVDWLRQDOVWUXFWXUH The organisational structure of Keih Bahri Food products
is based on a governmental regulation applicable to all government firms. The

governmental guidelines provide for four main sections under the general manager:
first, a production and repairs section including production and maintenance sub-
sections. Second, a finance and administration section with accounts and personnel
sub-sections. Third, a marketing and purchasing section. Fourth, the quality controls
section. The finance and administration section is responsible to take care of the
financial management of the firm. It prepares annual and quarterly budgets and
presents monthly and quarterly financial and budgetary reports to the general manager
of the firm and higher authorities in the Ministries of Finance and Defence. It
specifically manages the working capital levels of the firm. The marketing section
deals with the management of working capital operations - purchase of materials and
the sales of products. It is responsible to purchase the raw materials mainly (wheat)
from the Grain Board. It is also responsible to store and control inventories including
the raw material wheat, finished goods (flour) and spare parts and its statistics sub-
section prepares reports on the forecasted and actual operations such as purchases,
periodic production and sales and then reports to the general manager. The quality
controls section, controls the standard of work done by all the departments and
periodically reports to the general manager.
)LUP SROLFLHV DQG FRQVWUDLQWV The objectives of working capital management

according to the firm’s financial manager are mainly to increase sales and decrease
costs but not to generate profit or remain liquid which is guaranteed by bank overdraft
facilities and government subsidies (see also Appendix 6.1-A). Moreover, the
financial manager said that: ³7KHREMHFWLYHVLQ PDQDJLQJ WKH ILUP¶V ZRUNLQJ FDSLWDO LV
SDVVLYHEHFDXVHLWLVDJRYHUQPHQW ILUPDQG DV VXFK ILQDQFLQJ VRXUFHV FDQEH REWDLQHG
IURPWKHJRYHUQPHQWLQWKHIRUPRIVXEVLG\DQGEDQNRYHUGUDIW7KHFRVWRIWKHVHVKRUW
WHUP VRXUFHV RI ILQDQFHFDQ DOVR EH ILQDQFHG ZLWK JRYHUQPHQW VRXUFHV VXFK DV VXEVLG\
Therefore, the factory management is only concerned with the

DQG EDQN RYHUGUDIW´
short-term period. Moreover, the cost of its materials is subsidised and the firm does
not have any problem with regard to short-term investments or financing.
According to the general manager, formulating long-term investment and financing

policies is not the responsibility of the factory management. Higher government
authorities, particularly in the Ministry of Defence, make long-term investment and
financing decisions. So, the firm’s management does not have the required autonomy
to make relevant investment and financing decisions. He said: ³7KHILUP¶VLQYHVWPHQW
DQG ILQDQFLQJ DUH VWULFWO\ FRQWUROOHG E\ WKH 0LQLVWU\ RI 'HIHQFH +DG WKHUH EHHQ QR
UHVWULFWLRQVLPSRVHGRQWKHIDFWRU\PDQDJHPHQWE\KLJKHUDXWKRULWLHVZHZRXOGKDYH
According to the financial manager, the factors

DFKLHYHG IDUUHDFKLQJ REMHFWLYHV´
that influence working capital levels include mostly sales growth, price levels of
inputs and operating efficiency. However, the financial manager believes that the
credit policy and availability of credit as well as seasonality of sales do not matter
much as far as the levels of working capital are concerned.
Government Firms 115
According to the general manager’s opinion, the factors that hinder the firm from
achieving its objectives include lack of production capacity, lack of skilled labour and
a lack of fixed capital investment. Other factors such as working capital investment,
working capital financing, product demand and markets are no problems for the firm.
According tothe opinion of the financial manager, government regulations dictate the
management of working capital levels and operations. She says that: ³7KH GHFLVLRQ
UHJDUGLQJ ERWK VKRUW DQG ORQJWHUP LQYHVWPHQW LV QRW ZLWKLQ WKH DXWKRULW\ RI WKH ILUP¶V
PDQDJHPHQW 7KH ILUP¶V PDQDJHPHQW KDV OLPLWHG DXWKRULW\ WR PDQDJH ZRUNLQJ FDSLWDO
RSHUDWLRQVDQG YLUWXDOO\ QRSRZHU RQ ORQJWHUP LQYHVWPHQW DQG ILQDQFLQJ *RYHUQPHQW
UHJXODWLRQV GLFWDWH WKH VRXUFH DQG FRVW RI PDWHULDOV WKH SURFHGXUH RI EX\LQJ WKH
PDWHULDOVWRZKRPDQGKRZWKHSURGXFWVKDYHWREHVROGDQGDWZKDWSULFH´
The firm cannot invest its extra cash in revenue generating business or deposit it at a
bank saving account. It has to purchase its main material from the Eritrean Grain
Board and sell its products to the Ministry of Defence and other authorised (by the
Ministry of Trade and Industry) bakeries and pastries. According to the firm’s
commercial manager, culturally, Eritreans prefer white flour or “fino” for white bread.
However, the factory produces black flour. Had the products of the factory been
subjected to the normal market competition, the demand for its products would have
been much lower than that of competitors who import and supply white flour to
consumers. It is the very cheap government subsidised price, which has increased the
demand of the factory’s products.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW LQ YDOXH FUHDWLRQ According to the
opinion of the firm’s general manager, decisions regarding working capital levels and
operations take almost all the management time. He said that: ³0DQDJLQJ ZRUNLQJ
FDSLWDOKDVDYHU\VLJQLILFDQWUROHWRSOD\LQSURPRWLQJWKHILUP¶VVKRUWDQGORQJWHUP
REMHFWLYHV´ The financial manager believes that, managing working capital items affect
the firms’ value. Accordingly, she believes that, sales can increase as a result of
managing cash, receivables, inventory, purchase of materials and trade credit (See also
Appendix 6.1D). The firm’s costs can also decrease by managing overall working
capital, cash and purchase of materials. On the other hand the financial manager believes
that managing liquidity, trade receivables, inventory, trade payables and bank loans do
not help to decrease costs.
2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQWFRPSDULVRQRIJRYHUQPHQWILUPV
Here we want to know if the two government firms reveal similarity or difference on
the overall working capital management. For detailed information on the issues on
overall working capital management, see Appendix 6.1(C-D).
)LUP SROLFLHV DQG FRQVWUDLQWV The financial managers of the government firms
responded that their working capital management policy is tailored towards increasing
sales and decreasing costs but not to generating profit or to remain liquid. The general
managers of the two government firms believe that the factor that is constraining firm
objectives is mainly fixed capital investment. Keih Bahri Food products also has
problems with its production capacity and with skilled labour and Barka Canneries
has constraints of working capital financing. Both general managers are of the opinion
that working capital investment, product demand and markets are no constraints to
achieve firm objectives. Reportedly (by the financial managers), the factors that
Chapter 6 116
determine working capital levels include mostly sales growth, price levels of inputs
and operating efficiency. Seasonality of sales also affects the working capital levels in
Barka Canneries. However, the financial managers believe that their credit policy and
availability of credit do not matter much as far as the levels of working capital are
concerned.
7KHUROHRI ZRUNLQJ FDSLWDO LQ YDOXH FUHDWLRQ The financial managers of both firms
are of the opinion that, overall working capital management has an important role in
value creation. Their response shows that working capital management, particularly
managing cash, receivables and inventory as well as purchase of materials is important
for the purpose of increasing sales. They also believe that cash management and
purchase of materials management can reduce operating costs but not the management
of receivables, payables, bank loans and liquidity. However, they differ on the
importance of managing trade payables, inventory and sales of finished goods for the
purpose of increasing sales and decreasing costs. Only the financial manager of Keih
Bahri Food Products believes that managing trade payables helps in increasing sales, and
only the financial manager of Barka Canneries believes that managing inventory can
decrease costs.
This section (6.3) deals with the internal working capital management, which is
divided into levels and operations. Working capital levels refer to investments
(section 6.3.1) and financing (section 6.3.2) and working capital operations include
purchases (sections 6.3.3) and sales operations (section 6.3.4).
&DVKPDQDJHPHQW
The purpose of this section is to study if government firms, specifically Keih Bahri
Food Products and Barka Canneries create value by managing cash balances,
collections and payments. Therefore, we asked the financial managers regarding their
motive for holding certain balances of cash levels, why and how they forecast and
control cash, cash flows as well as cash payments and collections. For detailed
information on cash management, see Appendix 6.2.1.1.
7KHPRWLYHVRIKROGLQJFDVK We have reviewed in section 2.2 that cash can be held
for transactions, precautionary, speculative and bank compensating motives. The

empirical findings show that the main purpose for holding cash in Keih Bahri Food
Products is only for transaction purposes - to make regular predetermined payments. The
firm does not keep any cash to pay for unforeseen transactions (precautionary purpose),
nor does it deposit bank-compensating balances as a guarantee for bank loans or hold
extra cash for unforeseen investment opportunities (speculative purpose). According to
the financial manager, cash for precautionary purposes is not needed because the cash
inflows and outflows are quite certain, it is not held for speculative purposes because the
opportunity is not there to make any monetary investment and the government
regulations do not allow it. The Commercial Bank of Eritrea, is also a government firm
and does not require the firm to keep any minimum bank balance as a guarantee for
loans.
&DVK EXGJHWLQJ DQG FRQWURO The Factory management prepares cash budgets
because according to the financial manager, it is a government requirement and it is

also used to plan short-term cash needs as well as to control cash payments and
receipts. However, the firm does not use the cash budgets to control its liquidity
position. The primary bases used to forecast the cash budget are past experience,
forecasted sales levels and management opinion but not market research. The
financial manager believes that the cash budget is quite certain. As for the control of
cash levels, the financial manager said that: ³:H HYDOXDWH RXU FDVK SHUIRUPDQFH E\
FRPSDULQJWKHFDVKEXGJHWZLWKWKHDFWXDOUHVXOWVDQGUHSRUWLWPRQWKO\WRWKHIDFWRU\
PDQDJHPHQWDQGRQFHHYHU\WKUHHPRQWKVWRWKH0LQLVWU\RI'HIHQFH´
In addition to the budgetary comparison, Keih Bahri Food Products prepares yearly a
cash flows statement applying the receipts and disbursements method (rather than the
adjusted net income). The use of receipts and disbursements method is a government
requirement and is one of the annual financial statements. By analysing the trend in
the change of annual cash balances, the firm uses its cash flows statement to improve
future cash forecasts as well as to control cash payments, receipts and balances.
Empirically, as the above finding indicates, Keih Bahri Food Products uses its cash
budget and cash flow statements mainly for control purposes.
0DQDJLQJFDVKSD\PHQWVDQGFROOHFWLRQV The factory pays its expenditures using
checks except for small payments and salary expenditures. It has a policy of slowing-
down cash payments by making credit purchases. Its cash payment policy is to
purchase on credit without discount, and not to pay at the time of purchase or in advance
of the purchase. The firm controls its cash payments using – voucher and petty cash
systems, checks sequentially numbered, controlled and accounted regularly and bank
reconciliation prepared by an employee other than the one involved in cash
collections and payments. It also controls its cash collections by depositing collections
daily and separating sequential duties for cash operations and recording. The firm
speeds-up cash collections by making cash sales and earlier billings. It rarely makes
its customers deposit their payments at its bank account.
By the end of 2000, Keih Bahri Food Products had idle cash of more than 16.5 million
Nakfa in its balance sheet. This cash is kept in the checking account and the firm pays
a bank service charge, which would have been saved and interest earned had the cash
been deposited at least at a bank saving account. With regard to the cost of cash
levels, the firm’s financial manager said: ³2XU FDVKOHYHOV DUHDOZD\VSRVLWLYH VRWKH
FRVWRIFDVKOHYHOVLVWKHEDQNVHUYLFHFKDUJHRQWKHFKHFNLQJDFFRXQWDQGLQYHVWPHQW
”. The firm has to simply keep

SURILW ORVW ZKLFK ZH DUH QRW HPSRZHUHG WR PDQDJH
whatever surplus cash it has at its bank checking account until the government decides
what to do with it.
&RQFOXGLQJUHPDUNV Keih Bahri Food Products’ cash management is very passive.

Its management has no power to decide on the cash surpluses, other than technically
controlling cash payments and collections. Given its monopoly over the market, it is
very difficult to consider the firm’s cash surplus as representing its operational
efficiency.
Chapter 6 118
,QYHQWRU\PDQDJHPHQW
The objective of this section is to know if Keih Bahri Food Products creates value by
managing materials and finished goods inventory balances. With this objective in
mind, we asked its managers if and how they determine inventory costs and values, if
and how they formulate and implement inventory planning and control (physical and
cost) and whether the costs are relevant and worth of special managerial attention. For
detailed information on inventory management see Appendix 6.2.1.2.1 (materials
inventory) and 6.2.1.2.2 (finished goods inventory).
0DWHULDOVLQYHQWRU\PDQDJHPHQW According to the commercial manager,the firm’s
primary policy of materials management is to keep production running, safeguard

against inventory shortages and to reduce holding and ordering costs. The financial
manager said that: ³:HEX\PDWHULDOVJUDLQIURPWKH(ULWUHDQ*UDLQ%RDUGDQ\WLPH
ZHIHHOWKHUDZPDWHULDOVWRFNLVORZ´
The major KROGLQJFRVWV of materials inventory, according to the commercial manager,

include costs of insurance, handling, and record keeping. The costs of storage (power,
security, handling and space), physical deterioration (depreciation, shrinkage,
pilferage), opportunity costs of capital tied-up in the inventory and property taxes are
small. However, according to the financial manager, because the materials are easily
perishable, holding cost of materials inventory is considered relevant and is reduced
by arranging with the supplier to ship the materials just in time for production.
Whenever Keih Bahri Food Products feels that its materials stock is low, it orders
from the Eritrean Grain Board for immediate shipment. Since both the Eritrean Grain
Board and Keih Bahri Food Products are government firms, they have no problem of
trusting each other. Therefore, the commercial manager claims to use the “just-in-
time” approach to minimise inventory level and control the holding and ordering
costs. As a result of this, investment in inventory of materials is very low. Moreover,
according to the commercial manager, the firm also keeps materials safety stock
enough for two to three months’ production. The firm selectively manages the SK\VLFDO
PRYHPHQW of materials inventory on the basis of cost, usage rate and criticality in case of
shortage. Scarcity in the market is rarely used as a selective control mechanism. Keih
Bahri Food Products uses the average cost approach to determine the value and cost of
materials issued to production and remaining in inventory.
0DQDJLQJ ILQLVKHG JRRGV LQYHQWRU\ According to the Keih bahri Food Products
financial manager, the firm’s main purpose in managing finished goods inventory is
only to reduce holding costs. Because the demand by far exceeds the supply of the
firm’s products, goods once finished are immediately sold. According to the financial
manager: “)LQLVKHG JRRGV VWRFN LV DOPRVW QRQH[LVWHQW EHFDXVH FXVWRPHUV RUGHU LQ
DGYDQFH DQG WDNH WKHLU DGYDQFH RUGHUV LPPHGLDWHO\ 7KHUHIRUH WKH LQYHVWPHQW LQ
This helps
LQYHQWRU\RIILQLVKHGJRRGVUHODWLYHWRWKHDQQXDOSURGXFWLRQ LVYHU\ORZ´
the firm to decrease inventory-holding costs. However, it does not help to satisfy
customer demands. The yearly average level of finished goods inventory is less
relevant and its holding costs are very small. Private customers order their purchase
well in advance of production and take it immediately after production (which is a
typical just-in-time approach) and pay immediately on receipt of their orders.
However, the Ministry of Defence, which is the main customer, takes time before
paying for its purchases because of the long bureaucratic procedure involved in
securing the government approval for payments.
According to the financial manager, the cost of holding inventory of finished goods is
mainly cost of insurance. The cost of storage (deterioration, obsolescence, shrinkage,
depreciation and pilferage), handling, power and security, opportunity cost of capital
invested or interest on capital tied-up, property tax and clerical record keeping are
small. So, these costs are not significant for the management to give special attention
and the firm manages the cost of inventory by holding only the minimum level
required. The firm selectively controls its finished goods inventory based on usage or
sales rate and criticality in case of shortage and not based on costs. The average cost
technique (not the market value) is used to determine the cost of goods sold and in
inventory.
&RQFOXGLQJ UHPDUN± LQYHQWRU\ PDQDJHPHQW Keih Bahri Food Products uses the
just in time approach to manage both raw materials and finished goods inventories. It
orders and receives materials from the Eritrean Grain Board immediately before
production is completed and it gets it in time for production. Except for the two to
three month supply of materials and finished goods awaiting shipment to customers, it
does not carry any inventory. This inventory management approach has kept its
inventory levels and costs to the minimum possible. Its inter-government firms’ co-
operation with the Eritrean Grain Board and the Ministry of Defence as well as its
monopolistic market position has enabled it not to bother about its supply of materials
and demand for its products.
5HFHLYDEOHVPDQDJHPHQW
In this section we try to study if Keih Bahri Food Products creates value by managing
its receivables. Therefore, we asked the firm’s financial manager if and how
management formulates its policies of accounts receivable management, controls its
credit collection, costs of accounts receivable balances and bad debts.
&UHGLWSROLF\DQGUHFHLYDEOHVPDQDJHPHQW The commercial managers’ response is
that, the firm totally relies on its customer’s commitment and has no credit policy or
costs of credit control. The financial manager has explained the issue of receivables
management by saying that: ³:H KDYH WZR W\SHV RI FXVWRPHUV ± JRYHUQPHQW
PLQLVWULHV PDLQO\ WKH 0LQLVWULHV RI 'HIHQFH DQG RI (GXFDWLRQ IRU ZKRP ZH VHOO RQ
The firm’s
FUHGLW DQG SULYDWH EDNHULHV DQG SDVWULHV ZKR DUH FDVK FXVWRPHUV´
commercial manager elaborated it as follows, “7KHFUHGLWFXVWRPHUVSD\ZLWKLQWZRWR

WKUHH PRQWKV VR WKHUH LV QR QHHG WR ERWKHU DERXW KRZ WR FROOHFW WKHVH UHFHLYDEOHV
ZKLOH WKH EDNHULHV DQG SDVWULHV SD\ FDVK DW RU LQ DGYDQFH RI SXUFKDVH +HQFH WKH
LQYHVWPHQW LQ UHFHLYDEOHV LV VR PLQLPDO WKDW WKH ILUP¶V PDQDJHPHQW WDNHV OLWWOH
DWWHQWLRQ´ . The response of the financial manager to the questionnaire also indicated
that the firmdoes not incur costs like customer screening, debt collection or bad debt
losses and that it does not have any credit term, credit standards or collection policy.
The lack of an accounts receivable management policy is reflected in the accounts

receivable (debtors) level of the firm’s balance sheet. Observations on the balance
sheets of Keih Bahri Food Products for the period 1994 to 2000 reveal that the
Chapter 6 120
composition of debtors to total working capital ranges from 6% (in 1995) to 69% (in
2000) with an average of 51% and shows a sharp increase in the last two years. This
fact when compared to the opinion of the financial and commercial managers is
contradictory. The firm’s management does not seem to be worried about the
increasingly excessive investment in receivables for two reasons. First, the firm has
excessive liquidity and it is never worried about the need of cash. Second, the main
debtors are the Ministry of Defence, for the credit sale, which is also its supervising
government body and the Ministry of Finance for unpaid government subsidy. This
implies that the firm has no power to impose any pressure on its debtors to pay back
the debts owed. Therefore, it is no wonder the firm’s management is not at all worried
about collecting its receivables.
0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQW&RPSDULVRQRIJRYHUQPHQWILUPV
This section examines if the two government firms reveal similarity or have material
differences in managing their working capital levels of investment, particularly cash,
inventories and receivables. For more information on the management of working
capital investment, refer to Appendices 6.2.1.1 (cash), 6.2.1.2 (inventory) and 6.2.1.3
(accounts receivable).
&DVK PDQDJHPHQW The purpose of cash planning for both firms is only the
transaction purpose of making regular pre-determined payments because it is a

requirement of the government. The firms do not budget cash requirements for
speculative, precautionary or bank compensating balance purposes. This is mainly
because they have neither the opportunity nor the authorisation to make cash investments
with a profit motive. The government firms forecast their cash budget mostly on the
basis of past experience and management opinion, which they use to plan short-term
cash needs and to control cash payments and receipts but not to control liquidity. Both
mangers said cash budgets are quite certain and they make no hedges because the bank
provides overdraft if they need it. Both firms purchase on credit without discounts. Keih
Bahri Food Products considers the credit purchase as a technique of slowing down
payments. Both firms control cash payments using vouchers, checks, bank
reconciliation, and petty cash. Keih Bahri Food Products and Barka Canneries collect
cash at sales from private buyers and on the basis of credit from their common owner –
customer the Ministry of Defence. Both firms consider cash sale as a means of speeding-
up cash collection. The firms control cash collections by separating the duties for
sequential cash operations and depositing cash at the bank on a daily basis. In addition to
this, Barka Canneries also allows its customers to pay directly at its bank.
0DWHULDOVLQYHQWRU\ PDQDJHPHQW The materials inventory policy of Keih Bahri Food

Products and Barka Canneries is tailored strongly towards minimising inventory holding
costs and ordering costs, safeguarding against inventory shortages and keeping
production running. They have very small carrying cost of materials because both apply
just in time inventory management approaches. They use only the average cost (not first-
in-first out or last-in-last out) technique to determine the cost of materials used in
production and in inventory. They also use only the cost (rather than market value or
cost or market whichever is lower approach) as a base to determine the value of the
materials inventory. The firms selectively control the physical safety of their materials
inventory on the basis of cost and criticality in case of shortage. In addition to, this Keih
Bahri Food Products applies usage rate as a criterion for selective materials inventory
management.
)LQLVKHG JRRGV LQYHQWRU\ PDQDJHPHQW The financial manager of Keih Bahri Food
Products reported that the purpose of managing finished goods inventory is to decrease
inventory holding costs, while that of Barka Canneries is to satisfy customer demands, to
keep inventory for safety stock and meet high seasonal demands. Both firms reported
that the main cost of holding cost with regard to finished goods inventory is insurance
expense. However, Barka Canneries considers opportunity costs of capital, handling and
clerical costs as relevant costs. The firms use the average inventory costing approach to
determine the cost and the value of their finished goods inventory. Keih Bahri Food
Products selectively controls its finished goods inventory on the basis of usage rate and
criticality in case of shortage while Barka Canneries uses the average cost technique as a
control mechanism.
5HFHLYDEOHV PDQDJHPHQW Both government firms sell to private firms only on cash
basis while they sell on credit to the government firms particularly the Ministry of
Defence which administers both of them. According to the interview conducted with the
commercial managers, the firms do not sell on credit to private firms because
government policy does not allow. Therefore, they do not have a policy of credit terms,
screening credit applicants or collecting overdue receivables. They have no risk of bad
debts because their debtor (the Ministry of Defence) is very reliable, and therefore they
do not have doubtful accounts nor do they use any other technique of managing accounts
receivable.
&RQFOXGLQJ UHPDUNV Both Keih Bahri Food Products and Barka Canneries manage
their materials inventory on a just in time basis. According to the interview we
conducted with the firm’s commercial manager, Keih Bahri Food Products has an
agreement with Eritrean Grain Board (another government firm) to get the shipment of
the materials as soon as it orders a purchase. Barka Canneries enters into an annual
contract with suppliers to get materials periodically as needed. As a guarantee suppliers
deposit in the firm’s bank account money enough for one month supply, which the firm
can use if the supplier fails. Both government firms’ main business is with the Ministry
of Defense, which also happens to be the supervising government body. Therefore, the
executive managerial decision lies with the Ministry. As a result both government firms
show very little interest in considering dynamic approaches of working capital
management. With both firms cash and inventories are kept only for transaction
purposes, and both have no credit policy for private customers.
In order to study the alternative sources and costs of working capital financing for Keih
Bahri Food Products, we asked the financial manager about the firm’s sources of
finance. We also asked if the firm gets cash deficits, how it finances its deficits and
whether the cost of financing is a relevant amount. For detailed information on
managing working capital finances refer to Appendix 6.2.2.
6RXUFHV FRVWV DQG LQIOXHQFHV RI ZRUNLQJ FDSLWDO ILQDQFLQJ As a result of its
surplus cash the firm does not use short-term bank loans or any other short-term
Chapter 6 122
financing and it does not hedge against uncertainties of cash balance. With regard to
working capital financing sources, Keih Bahri Food Products’ financial manager said
that: ³:H KDYH VXUSOXV FDVK IURP RSHUDWLRQV ZKLFK ZH XVH WR SD\ IRU VKRUWWHUP
ILQDQFLQJ QHHGV VXFK DV SD\LQJ IRU WKH SXUFKDVH RI UDZ PDWHULDOV DQG RWKHU
RSHUDWLQJ H[SHQVHV +RZHYHU ZH FDQQRW LQYHVW WKH VXUSOXV FDVK LQ LQWHUHVW RU RWKHU
In
LQFRPH HDUQLQJ EXVLQHVV RSHUDWLRQV EHFDXVH JRYHUQPHQW UHJXODWLRQV IRUELG XV´
case cash level is too low, Keih Bahri Food Products has an agreement with the
commercial bank of Eritrea to use overdraft facilities.
However, in addition to its own cash revenues, we find that Keih Bahri Food Products
finances its working capital needs with government subsidy. According to the financial
manager, 50% of the firm’s cost of material is subsidised by the government, which the
Ministry of Finance reimburses periodically. Trade credit is next to government subsidy
in financing working capital investments. The firm also uses retained earnings (general
reserve) and equity (state) capital, to finance its short-term financing needs. Bank
overdraft, short or long-term bank loan, secured borrowing and accruals are not
considered as the sources of finance. According to the financial manager, the main
factors that influence the financing of working capital items are sales growth, price levels
of inputs, operating efficiency and government subsidy. The seasonality of sales, the
firm’s credit policy and availability of credit do not contribute to the financing of
working capital items.
&RQFOXGLQJUHPDUN Keih Bahri Food Products finances its working capital levels and
operations with the surplus cash that it generates from its government subsidised
operations and monopolised food market. Trade creditors which make hundred percent
of the total liabilities are other sources of short-term finances. Since the balances of
current assets and current liabilities are equitable, Keih Bahri Food Products uses the
maturity matching approach to financing working capital investments. This usually
implies using the riskier but less expensive short-term debts. However, since the total
short-term debt is owed to other government firms (Eritrean Grain Board and Ministry of
Finance), there is no conceivable risk of liquidity or costs of financing. Therefore no
wonder the management of working capital financing of Keih Bahri is very passive.
0DQDJLQJZRUNLQJFDSLWDOILQDQFHV&RPSDULVRQRIJRYHUQPHQWILUPV
6RXUFHV FRVWV DQG LQIOXHQFHV RI ZRUNLQJ FDSLWDO ILQDQFLQJ The main source of
short-term financing for both government firms is the cash flow from operations,
retained earnings, trade creditors and government subsidy. None of the firms use bank
overdraft, long-term debt, bank loans, secured borrowing or accruals. Both reported that
they have no problem of financing their short-term working capital needs mainly
because the government subsidy and bank overdraft are readily available regardless of
their profitability.
Both firms experience cash surplus for most of their operation periods. However, they
are not allowed to invest the cash in any profit or interest earning business ventures.
They never use bank overdraft so the cost of financing working capital investment is
insignificant. According to the financial manager of Keih Bahri Food Products the main
factors that influence the levels of financing of working capital levels are sales growth,
price levels of inputs, operating efficiency and government subsidy but not seasonality of
sales, credit policy or availability of credit. However, the financial manager of Barka
Canneries does not believe any of the above mentioned factors to influence the levels of
working capital financing.
0DQDJLQJZRUNLQJFDSLWDORSHUDWLRQV
0DQDJLQJSXUFKDVHRSHUDWLRQV
In this section we study if Keih Bahri Food Products creates value by managing
working capital purchases of materials required for production. We asked questions
on the firm’s purchase policy, purchasing techniques, purchasing activities and costs
as well as approaches of contacting, contracting and control of suppliers. For detailed
information on managing working capital operations with regard to purchases, refer to
Appendix 6.2.3.1.
3XUFKDVH SROLFLHV During our interview with the commercial manager he said that:
³:H SXUFKDVH RXU PDWHULDOV RQ FUHGLW IURP (ULWUHDQ *UDLQ %RDUG 8S WR ZH
XVHG WR SXUFKDVH UDZ PDWHULDOV GLUHFWO\ IURP VXSSOLHUV +RZHYHU VLQFH WKHQ WKH
UHVSRQVLELOLW\ RI SXUFKDVLQJ PDWHULDOV LV WUDQVIHUUHG WR WKH *UDLQ %RDUG ZKLFK
VXSSOLHVWKHUDZPDWHULDOVE\SXUFKDVLQJPRVWO\IURPWKHIRUHLJQPDUNHWV6RZHRUGHU
IRU WKH VXSSO\ RI WKH PDWHULDOV DOPRVW FRQWLQXRXVO\ DQG GR QRW QHHG WR VWRUH RU
PDQDJHLQYHVWPHQWLQLQYHQWRU\RIPDWHULDOV´ .
The firm forecasts the purchase of its materials requirements in order to estimate its
production demands, to know the quantity on hand and on order and to determine the
safety stock requirement, but not to determine the inventory usage during lead time. The
base that the firm uses to estimate materials requirement is mainly its past experience
and the opinion of the management. In the interview the firms commercial manager said
that production capacity is the major factor considered when estimating the annual
purchase requirements. The factory’s purchase operations are subsidised by the
government to the extent of 50% of the total cost of materials. According to the firm’s
commercial manager, the firm purchases its materials on cash bases as per the relevant
government regulations and there is no problem of co-ordinating materials purchase
and inventory management with the supplier. The firm buys its materials only on cash
basis because of the government requirement it does not have credit purchases policy.
&RQWDFWLQJ FRQWUDFWLQJDQGFRQWURO RI VXSSOLHUV The only supplier of the factory
is the Eritrean Grain Board, which is a government firm itself so there is no factor
other than the government regulations that affect the contacting, contracting and
control with this supplier. According to the opinion of the commercial manager of the
firm, it does not employ purchasing agents and does not need purchasing employees
to buy materials. There is no need to negotiate the term of purchase agreements
because it is well known to both Keih Bahri Food Products and its supplier Eritrea
Grain Board. The factory prepares the forecasts of its annual and monthly needs and
presents it to the Grain Board, which supplies periodically upon the factory’s request.
The firm does not need to select its suppliers or to choose preferred credit terms.
Moreover, the commercial manager believes that the firm’s linkages with Eritrea Grain
Board help to use the cheapest channel of communication on the basis of trust as well as
apply routine control agreements with terms known to both partners in advance. As a
Chapter 6 124
result of this the commercial manager believes also that the costs of contact, contract and
control of suppliers are small and not relevant for the management to take special
attention.
0DQDJLQJVDOHVRSHUDWLRQV
In this section we study if Keih Bahri Food Products creates value by managing
working capital operations of sales. Therefore, we asked its commercial manager
questions on sales policy, selling and distribution techniques, and approaches the firm
uses to contact, contract and control its customers. For detailed information on
managing working capital operations of selling see Appendix 6.2.3.2.
6DOHV SROLF\ Keih Bahri Food Products’ sales policy is dictated by government
regulations. It sells on credit to the Ministry of Defence and Ministry of Education and
on cash basis to small private bakeries and pastries. The reason for this, according to the
firm’s commercial manager is: ³WKH PDWHULDOV ZH EX\ IURP WKH JUDLQ ERDUG LV
VXEVLGLVHGWRWKHH[WHQWRIRIFRVW6RWKHUHDUHJRYHUQPHQWUHJXODWLRQVWKDWUHTXLUH
XV WR VHOO DW SURILW UDWH RQO\ WR DXWKRULVHG PLQLVWULHV IRU GLUHFW FRQVXPSWLRQ DQG
SULYDWH EDNHULHV DQG SDVWULHV IRU EXVLQHVV´ In the interview conducted with the firm’s
financial manager, she said that: ³6WULFWO\ VSHDNLQJ WKH WLPH WDNHQ EHWZHHQ VHOOLQJ DQG
FDVKFROOHFWLRQRIWKHJRYHUQPHQWILUPVLVRQO\PHDQWWRDOORZWLPHIRUWKHEXUHDXFUDWLF
SURFHGXUHV QHHGHG WR PDNH WKH SD\PHQWV ,W GRHV QRW VHUYH DQ\ SXUSRVH RI EXVLQHVV
FUHGLWJUDQWLQJDWDOO´ The objective of the firm’s sales policy is to fulfil the sales quota
and not to expand market share, to take care of regular customer demands, to meet
seasonal sales requirements or to decrease inventory holding costs. It forecasts sales
requirements using the production capacity over the net working days during the year,
opinion of the management and its past experience as bases. It does not use statistically
forecasted sales volumes, or opinion of the sales staff. So its main objective in
forecasting sales is to fully use the production capacity and forecast safety stock needs.
It is not to estimate the demands for future months during the year, to determine the
inventory usage or to establish the quantity on hand and on order during lead time.
&RQWDFWLQJ FRQWUDFWLQJ DQG FRQWURO RI FXVWRPHUV The same as with suppliers the
contacting with the firm’s customers is done as per the regulations of the government.
The government requires the firm to supply mainly to the Ministry of Defence and small
bakeries and pastries. So its contacts are made with these customers. The factory does
not need to sign contracts with these customers. The firm’s private customers buy only
on cash so there is no need to control or sign contracts with these customers. Therefore,
the firm does not make much effort to contact, contract or control its customers because
the relevant government regulations are known to all of them and the sale-purchase
operation becomes a routine procedure. The financial manager believes that the costs
of these activities are not relevant for the management. According to the opinion of
the commercial manager, Keih Bahri Food Products does not need to control its credit
customers because they are government firms like itself so they fully trust each other.
0DQDJLQJZRUNLQJFDSLWDORSHUDWLRQV&RPSDULVRQRIJRYHUQPHQWILUPV
3XUFKDVHRSHUDWLRQ The two government firms (Keih Bahri Food Products and Barka
Canneries) have different policies and practices of purchasing materials. However, both
have to comply with the relevant government regulations. Barka Canneries purchase
materials from private suppliers on a bid basis to take advantage of quantity discounts
and cash discounts, to minimise inventory holding costs and meet seasonal customer
demands but not to decrease inventory ordering costs. While Keih Bahri Food Products
purchases materials from the Grain Board as per the relevant government regulations,
which has nothing to do with taking advantage of cash discounts or quantity discounts.
They both forecast purchases of materials based on past experience and management
opinion. However, Barka Canneries also uses forecasted sales volume and opinion of the
purchasing staff to establish its purchasing policy. Keih Bahri Food Products is restricted
to buy only from the Eritrean Grain Board so it does not have the option to choose from
alternative suppliers while Barka Canneries buys from local market through competitive
bidding. Therefore, the cost of purchasing operation is relevant for the management of
Barka Canneries but not for Keih Bahri Food Products.
According to the commercial manager of Barka Canneries, the firm makes efforts to
contact and screen potential suppliers as well as describe the materials that it wants to
buy. Therefore, the cost of the contacting, screening and describing to potential suppliers
is considered relevant. Hence the firms manage these costs by choosing the cheapest
channel of communication (advertising in the public news papers), as well as employing
purchasing agents. Compared to that of Keih Bahri Food Products, Barka Canneries’
contacting, contracting and control of purchase activities are better managed. This is
because Barka Canneries is more empowered to the activities, while that of Keih Bahri
Food Products purchase is done by the Eritrean Grain Board so the firm has very little to
do with the purchase policy of its materials.
6DOHVRSHUDWLRQ According to the commercial managers, the objective of sales and

production policy of Keih Bahri Food Products is only to fulfil the quota given by the
government. However, that of Barka Canneries is to take care of customer demands,
meet seasonal sales requirements and expand market. The firms forecast sales to
establish the quantity on hand and on order during lead time as well as the safety
stock requirement. Both firms forecast sales based on past experience and
management opinion. In addition Keih Bahri Food Products uses production capacity
and Barka Canneries uses statistical forecasts also. Both firms sell their products to
the local market and mainly to the Ministry of Defence, which also supervises both of
them, so the sales operation practically looks like intra-firm management. The contact,
contract and control with customers’ in both government firms is tailored towards
choosing the cheapest channel of communication, with routine control agreements and
terms known in advance. Both firms consider the related costs to be small and not
relevant to the management.
&RQFOXGLQJ UHPDUN Generally, the management of Barka Canneries is more
empowered to manage its purchase operations. The firm manages these costs by
establishing long-term relationships and trust, which it implements by committing its
suppliers on the quality, quantity, price and time of delivery for one year. For control
purposes the government regulations require the firms to make new advertisements
for supplies of materials and therefore new contractual agreements each year with the
Chapter 6 126
winning suppliers. On the other hand, Keih Bahri Food Products has very little
managerial power and therefore uses no management approach on its purchase and
related costs. With regard to the management of sales operation, both firms sell
mainly to the Ministry of Defence and have very little power to manage the sales and
related costs. This has resulted in close firm-customer relations in both firms, which
may decrease transaction costs of contact, contract and control.
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOGHFLVLRQV
In this section we aim at studying if and how the government firms evaluate the
performance of their working capital levels of investment and financing as well as
operations of purchasing and selling. With this aim, first we asked the managers if and
how they apply performance evaluation criteria. Then we used the firms’ financial
statements to study their working capital levels and operations. We divided the
evaluation of Keih Bahri Food Products’ financial performance into three sections. First,
we studied the investment composition of working capital in the total assets using asset
structure ratios. Second, we evaluated the firm’s working capital financing using
liquidity ratios and short-term financing composition using trade creditors, short-term
bank loans, bank overdrafts and other accruals. Third, we used activity and profitability
ratios to study the firm’s operational efficiency in turning over the assets and overall
profitability. For detailed information on financial evaluation of working capital
decisions, refer to Appendix 6.2.3.4 (Keih Bahri Food Products) and 6.2.3.5
(comparative government firms).
3HUIRUPDQFH PHDVXUHPHQW DQG HYDOXDWLRQ FULWHULD According to the financial

manager, Keih Bahri Food Products evaluates the performance of its working capital
investment decision using comparative analysis of past versus present, actual versus
expected and inter-firm benchmarks (see also Appendix 6.2.3.3A-D). It measures its
performance using accounting information and customer satisfaction.In the interview
conducted with the general manager, he stated that: ³7KH ILUP¶V RYHUDOO SHUIRUPDQFH
RQ SURGXFWLRQ FDSDFLW\ VDOHV DQG HPSOR\PHQW KDV JUHDWO\ LQFUHDVHG DIWHU
LQGHSHQGHQFHEHFDXVHRIWZRUHDVRQV)LUVWLQFUHDVHGSURGXFWLRQFDSDFLW\DVDUHVXOW
RI UHSDLULQJ D IDFWRU\ 6W *LRUJLR IDFWRU\ ZKLFK ZDV QRW IXQFWLRQLQJ EHIRUH
LQGHSHQGHQFH6HFRQGDGGLWLRQVRIVRPHPDQXIDFWXULQJSODQWVLQFRUSRUDWHGLQWRWKLV
IDFWRU\´
The customer satisfaction based performance measurement criteria that the firm uses
include FRVW PLQLPLVDWLRQ by charging lower prices, increasing the SURGXFW TXDOLW\ by
decreasing defect rates and increasing customers’ perceived value of its goods as well as
FRPPXQLFDWLRQ - by having faster response time and faster delivery time. According to
the firm’s financial manager, the accounting based performance measurement criteria
that the firm frequently uses include, liquidity ratios (current ratio and quick ratio). It
measures its activity performance by checking the inventory turnover, receivables
turnover and overall working capital turnover as well as profitability ratios such as
gross profit margin, net profit margin, return on working capital investment and return
on total assets. The firm also evaluates its asset structure by evaluating its working
capital assets to total assets ratios.
:RUNLQJ FDSLWDO LQYHVWPHQW FRPSRVLWLRQ We analysed financial statement data

using asset structure ratios to find Keih Bahri Food Products’ composition of
investment in assets. As we have reviewed in Chapter 2 section 2.6.3, the main asset
structure ratio relevant for our study is working capital (or current assets) to total
assets and related ratios such as cash, receivables and inventory to working capital.
We used the terms “inventories and stock” as well as “accounts receivable and
debtors” inter-changeably. We have used the terms inventories and receivables in our
literature review while empirically we found that the firms in Eritrea use the terms
“stock for inventories and debtors for accounts receivable”.
:RUNLQJFDSLWDOWRWRWDODVVHWVUDWLR is expressed in percentages, it shows the relevance
of working capital in total assets. As it is indicated in Appendix 6.2.3.4, asset structure

ratios of Keih Bahri Food Products for the seven years studied reveal that an average of
93% of the firm’s total investment is in current assets. It can be observed from figure 6-1
that the trend of the firm’s current assets to total assets showed stable but a large
proportion through out the years. Moreover, We can understand from this that Keih
Bahri Food Products invests extensively in current assets. This is because of the stagnant
investment in fixed assets and a reflection of the lack of managerial empowerment over
the management of investment and financing. Therefore, the low production capacity
experienced by Keih Bahri Food Products is also causing this high current asset
investment.
)LJXUH$VVHWVWUXFWXUHDQG67GHEWOHYHUDJH±.HLK%DKUL)RRG3URGXFWV
100%
90%
80%
70%
60% Current assets to total assets
50%
Short-term debt to total
40%
assets
30%
20%
10%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
As it is revealed by Figure 6-1, the short-term debt compared to the total assets
accounted to a considerable percentage. This implies that the total assets are largely
financed by current liabilities instead of equity capital or long-term debt.
We also analysed the composition of each working capital element in the total current
assets using inventory to working capital, receivables to working capital and cash to
working capital ratios (see also Appendix 6.2.3.4A-1). The seven-year average of
inventory to working capital was 22%, receivables to working capital was 47% and cash
to working capital was 31%. The analysis also indicates that most of Keih Bahri Food
Chapter 6 128
Products current assets is tied up in receivables, while the investment in inventory and
cash is much less compared to the receivables and declining. This suggests a defective
receivables collection policy. It can also be observed from figure 6-2 that the firm’s
working capital investment composition is generally lowest in inventory and highest in
receivables while the investment in cash is also declining. This implies that working
capital management has contributed negatively to the net cash flows of the firm.
)LJXUH:RUNLQJFDSLWDOLQYHVWPHQWFRPSRVLWLRQ±.HLK%DKUL)RRG3URGXFWV
80%
70%
60%
50% Stocks
40% Debtors
30% Cash
20%
10%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOILQDQFHV
We analyzed Keih Bahri Food Products’ working capital financingin order to study how
the firm’s investments are financed and how it manages its liquidity position. Detailed
information regarding liquidity ratios is indicated in Appendix 6.2.3.4.
/LTXLGLW\SRVLWLRQ We analysed the liquidity position of Keih Bahri Food Products

using current and quick ratios. The current ratio of Keih Bahri Food Products
averaged 1.3 times the current liability of the factory. Though it is within the
acceptable range of 1 to 2, it falls below the global norm of 2. Therefore, it gives a
good reason to check for the quick ratio. The quick ratio averaging 1 with a generally
acceptable range of 1 to 1.50 and a global norm of 1 clearly indicates that the firm has
optimal liquidity position. Figure 6-3 supports this assertion.
)LJXUH/LTXLGLW\UDWLRV±.HLK%DKUL)RRG3URGXFWV
1,6
1,4
1,2
1,0
Current ratio
0,8
Quick ratio
0,6
0,4
0,2
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
6KRUWWHUPILQDQFLQJFRPSRVLWLRQ: We also studied the impact of working capital
decisions on short-term financing by computing the percentage composition of each

short-term financing element in the total short-term financing.
)LJXUH6KRUWWHUPILQDQFLQJFRPSRVLWLRQ±.HLK%DKUL)RRG3URGXFWV
120%
100%
80%
Trade creditors
60%
Others
40%
20%
0%
1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
As it is indicated in appendix 6.2.3.4C. Keih Bahri Food products short-term

financing is composed mainly of trade creditors which accounted to 92% of the total.
The rest includes other short-term financing sources, particularly provision for
taxation and dividends payable, which account to 8% on average. The factory does
not use short-term bank loans and bank overdraft to finance its working capital
investments. (See also figure 6.4).
We studied the efficiency and profitability of Keih Bahri Food Products’ using activity
and profitability ratios (Appendix 6.2.3.4).
Chapter 6 130
2SHUDWLRQDO HIILFLHQF\ Activity ratios show the operational efficiency of working

capital activities, in terms of how fast receivables and inventories are converted or
turned over to cash. They are also used to analyse the operational efficiency of a firm
from the point of sales volume, cost of goods sold and volume of assets used. The
ratios include, inventory turnover and days inventory held, receivables turnover and
collection period as well as overall working capital turnover. We did not include the
data on the days inventory held and receivables collection period because it can be
derived from the data presented in Appendix 6.2.3.A-3 (activity ratios).
The average LQYHQWRU\ WXUQRYHU of Keih Bahri Food Products for the seven years
(1994-2000), show that annual cost of goods sold was 3.4 times average inventory.
Inventory turnover is converted to “days inventory is held” in order to have a clearer
picture of how fast inventories were turned to sales. The days inventory held was an
average of 107 days. 5HFHLYDEOHV WXUQRYHU is expressed in annual sales “times”
average receivables. It measures the number of times credit sales or receivables is
turned over to cash. High turnover indicates quick collection or strict credit policy and
low turnover indicates slow collection or liberal credit policy. The firm’s seven year
average receivables turnover indicates that annual sales was 5.2 times average
receivables. This means receivables were turned over every 70 days. 2YHUDOOZRUNLQJ
FDSLWDO WXUQRYHU, measures the capacity or speed (in number of days) of working
capital to generate sales volume. A high turnover shows efficient utilisation of

working capital investment, effective marketing management efforts and/or
favourable business conditions. 2YHUDOO ZRUNLQJ FDSLWDO WXUQRYHU for the firm in the
seven years (1994-2000), indicate that on the average sales was 1.4 times average
current assets or it took the firm on the average 261 days to turnover the working
capital assets. It can be observed from figure 6-5 that in particular the trend of the
firm’s inventory and receivables turnover declined sharply up to 1997 and then
inventory turnover revealed a sharp increase in 2000 while receivables turnover
stabilised.
)LJXUH:RUNLQJFDSLWDODFWLYLW\±.HLK%DKUL)RRG3URGXFWV
12,0
10,0
Inventory turnover
8,0
Account Receivable
6,0
turnover
4,0 Working capital turnover
2,0
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUNV The point of reference for analysing activity ratios is a firm’s
credit policy for receivables and policy on turnovers for inventories. Activity showing
an average inventory turnover of 3.4 with average inventory held of 107 days denotes
a slow turnover and a long period inventories remaining unsold. However, closer
examination reveals that the low inventory turnover is mainly attributed to the pre
1998 (when the firm lost its market in Ethiopia) but it increased again after 1999.
However, after 1998 (the start of Eritrea-Ethiopia war) its activities showed a sharp
increase and its inventory turnover in 2000 was 6.7 with only 54 days inventory held.
This is in support of our findings during the interviews that the firm does not keep
inventory because the customers take their orders as soon as the production is
completed. An average receivables turnover of 5.2 (70 days collection period) shows
a similar situation to that of inventories. In 1996 the firm had a more strict credit
policy (with turnover of 6 and a collection period of 61 days) compared to that of
2000 (with turnover of 2.1 and collection period of 170 days). Moreover, the overall
working capital turnover of 261 days on average is hardly an indication of efficient
management. This finding also supports the fact that the firms’ debtors are mainly the
ministries of Defence for credit sales and the Ministry of Finance for subsidies. They
take their time to pay but there is no risk of default so the firm does not make a
desperate effort to recover amounts overdue from these ministries. Similarly, the time
the firm takes to pay its debt to the Eritrean Grain Board (another government firm) is
very long for the same reason.
Overall we have learned that the firms with which Keih Bahri Food Products interact
are mainly government owned, so their inter-firm transactions are highly based on
trust in each other for the following four reasons. First, the fact that they are all
government owned implies that they rely on government subsidies if the worst
happens. Second, the transactions are considered as inter-governmental firms’
transactions. So, their managers know (and are confident) that no government
manager has a motive to take opportunistic advantage over another because no one
will get a personal benefit out of it. Third, the Ministry of Defence is their common
supervising body with more or less clearly defined regulations known to all managers.
Fourth, as government firms there is no risk of default because even if the firm is
unable to afford to pay the government can settle its debt.
2YHUDOOSURILWDELOLW\ 3URILWDELOLW\UDWLRV were computed to study whether Keih Bahri
Food Products’ operations are profitable. As Appendix 6.2.3.4 shows the firm’s seven-
year average gross profit margin and net profit margin are 6% and 3% respectively,
while the return on assets was 3%. It can be observed from figure 6-6 that the trend of
the firm’s profitability has continuously decreased during the seven years of our
study. It has finally crossed the break-even point and resulted at loss in the year 2000.
Chapter 6 132
)LJXUH2YHUDOOSURILWDELOLW\±.HLK%DKUL)RRG3URGXFWV
12%
10%
8%
6% Gross profit margin

Net profit margin
4%
Return on asset
2%
0%
1994 1995 1996 1997 1998 1999 2000
-2%
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUNV It is observed from Appendix 6.2.3.4 and figure 6-6 that the
firm has low and decreasing rates of profit and return on assets. This is a reflection of the
government regulation on the firm’s policy. The government regulation allows it to
make a minimal profit from its operations. As the firm’s financial manager in an
interview said, ³7KHILUP¶VSURILWPDUJLQLVUHVWULFWHGDWDERXWWZRSHUFHQWRIWKHFRVWRI
WKHSURGXFWV´. Moreover, we believe this positive profitability has very little to do with
the efficiency of the firm’s management, because as it is mentioned earlier in this chapter
the firm has almost a monopsonist position in the supply of its materials and a
monopolist position in the market for its products. It has nothing to do with the firm’s
ability to purchase raw materials at favourable terms, efficient utilisation of plant and
machinery, lowering cost of production or reduction of prices to obtain large sales
volume. The concluding remark that can be inferred by comparing the liquidity and
profitability is that the firm’s management has very little control over its operations,
investments and financing. Working capital levels of financing and investment as well as
operations of selling and purchasing based and dictated by government regulations and
supervised by higher government bodies, particularly, the Ministry of Defense. The
management of the firm has no role in the determination of the purchasing approaches,
sources and costs of materials as well as the selection of customers and pricing of
finished goods.
&DVKIORZDQDO\VLV It can be observed from table 6-1 that the net cash inflows of Keih
Bahri Food Products were positive except for 1996. It can moreover be observed that
both the changes in working capital assets (stocks and debtors) had an average
negative impact on the net cash flow while the changes in creditors had positive
effect. However, the overall net cash flow ended up at a positive average and implies
that the major sources of cash for the firm were items other than stocks, debtors and
creditors and these items did not make much contribution to the positive net cash
flows of the firm.
Table 6.1: Cash flow Analysis - Keih Bahri Food Products (figures in ‘000)
1995 1996 1997 1998 Average
$$QQXDOQHWFDVKIORZ 11,003 -12,391 15,442 5,883 4984
%1HWFDVKIORZWRWRWDODVVHWV 20% -17% 24% 7% 8%
&$QQXDOFKDQJH
Increase (-), decrease: stocks* -27,504 1,622 29,004 -1,115 -2008

Increase (-), decrease: debtors* 4,561 -30,398 -7,868 1,911 -7948
Increase, decrease (-): creditors** 13,781 5,997 305 14,475 8639
'$QQXDOHIIHFWRQ1&)
Increase (-), decrease: stocks -250% -13% 188% -190% -66%

Increase (-), decrease: debtors 41% 245% -51% 32% 67%
Increase, decrease (-): creditors 125% -48% 2% 246% 81%
Others: Increase, decrease (-) 84% 184% -139% -88% -82%
*(Year1-year2), **(Year2-year1)
3HUIRUPDQFHPDQDJHPHQW&RPSDULVRQRIJRYHUQPHQWILUPV
Appendix 6.2.3.3 includes the information on the performance evaluation and evaluation
criteria and Appendix 6.2.3.5 reveals relevant financial performance evaluation ratios of
the two government firms.
3HUIRUPDQFH PHDVXUHPHQW DQG HYDOXDWLRQ FULWHULD According to their financial

managers, both Keih Bahri Food Products and Barka Canneries evaluate their
performance of working capital investment decisions using comparative analysis of
past versus present, actual versus expected and inter-industry benchmarks. However,
while Keih Bahri Food Products uses various accounting based measures (mentioned
earlier), Barka Canneries uses only liquidity and activity measures of accounting as
well as customer satisfaction criteria particularly faster response and delivery time to
evaluate its performance. Our computation of the firms accounting based performance
reveals the following results.
,QYHVWPHQW We compared the asset structure ratios to study the overall investment
composition. Keih Bahri Food Products and Barka Canneries have a seven-year average
current asset to total asset composition of 93% and 92% respectively. For manufacturing
firms this working capital ratio is an indication of excessive current asset and/or deficient
fixed asset investments. Almost the total investment of the government firms is in
current assets. This finding has been substantiated by the managers’ opinion that the
firms have serious problem of production capacity because investment in capital assets is
completely disregarded. The study of working capital investment composition in the two
government firms suggests that in particular debtors are higher in Keih Bahri Food
products than in Barka Canneries, while receivables and cash are lower in Keih Bahri
Chapter 6 134
Food products. On the average however, the three types of working capital assets are
almost evenly distributed among inventories, receivables and cash.
)LQDQFLQJ We analysed the overall financing management of the two government
firms by computing liquidity ratios. The liquidity positions of Keih Bahri Food Products
and Barka Canneries indicate a current ratio of 1.3 and 4.4 and A quick ratio of 1.0 and
2.6 respectively. This reveals that Keih Bahri Food Products may possibly face problems
of liquidity because a current ratio of 1.3 and quick ratio of 1.0 is barely enough to cover
the short-term debts, while Barka Canneries is overly liquid. Appendix 6.2.3.5 also
shows that there is a mismatch between the short-term investments and financing.
Keih Bahri Food Products uses trade creditors to the extent of 92% while Barka
Canneries trade creditors account only for 37%. Barka Canneries mostly uses other
short-term sources such as accrued tax payable to the extent of 73%. However, both
firms do not use bank loans.
2SHUDWLRQV We study the efficiency of overall management of working capital
operations by analysing activity and profitability ratios. The seven-year average for
activity ratios indicate that Keih Bahri Food Products and Barka Canneries respectively
have an inventory turnover of 3.4 (or 107 days held) and 1.3 (or 281 days held).
Receivables turnover for the two firms was 5.2 (or 70 days collection period) and 5.3 (or
69 days collection period). The ratio for the overall working capital turnover shows 1.4
and 0.9 respectively for Keih Bahri Food Products and Barka Canneries. Profitability
ratios indicate gross profit margins of 6% and 22%, net profit margin of 3% and 13%
and a return on asset of 3% and 14% respectively for the two firms. Keih Bahri Food
Products scored thus higher on inventory, receivables and working capital turnovers.
This implies a longer period of inventory held and a larger receivables collection
period for Barka Canneries. With regard to profitability Keih Bahri Food Products
trails far behind Barka Canneries on all the indicators. The main reason for this is that
Barka Canneries management is relatively more empowered to manage its purchase
operations while Keih Bahri Tanneries is restricted in both purchases and sales
operations.
&DVK IORZ $QDO\VLV The comparison of the net cash flows of the two government
firms revealed that whileKeih Bahri Food Products ended up at a positive net cash flow
that of Barka Canneries was negative. However, the trend of both inventories and
receivables for Keih Bahri Food Products was much larger than that of Barka Canneries
and indicated a proportional impact on net cash flows.
&RQFOXGLQJUHPDUN Evaluation of the two government firms’ average composition of

current assets in total assets indicates their major investment is in current assets. This
is because the government is not allowing investment in fixed assets and this has
resulted in the firms’ problem of production capacity. Moreover, on average the
investment in the working capital and current asset to total asset investment ratio is
similar. The liquidity ratios indicate differing positions, that is, Keih Bahri Food
Products being only marginally liquid while Barka Canneries being overly liquid.
Keih Bahri Food Products uses mostly (92%) trade creditors while Barka Canneries
uses other short-term financing sources particularly tax and dividend accruals. In both
cases working capital activities show low turnovers. Though both show profits during
the first six years, Keih Bahri Food Product’s profitability has revealed a continuos
decline and finally resulted at loss in the final year of our study while Barka Canneries
remains still profitable.
([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQWVXSSOLHUDQGFXVWRPHUOLQNDJHV
As we have reviewed in chapter 3, value is created not only by managing a firm’s

internal affairs but also through co-operation in the value chain (the co-operation
among a firm, its suppliers and customers). This means that value chain linkages exist
not only within a firm but also between a firm, its buyers and suppliers. If the firms,
their suppliers and customers jointly optimise the performance of their activities they
can create value with synergetic effects. This means that buyer-supplier relationships
are not a zero sum game where one gains only at the expense of the other. Based on
these assertions this section explores if the government firms have proper inter-firm
co-operation with their suppliers and customers on primary activities including
purchase and sales operations and inventory management. We also asked what
benefits they get as a result of their co-operation or why they do not co-operate. For
detailed information on external working capital management and inter-firm co-
operation, see Appendix 6.3.1 – for the responses of firms on firm-supplier co-
operation (6.3.1.1) and firm-customer co-operation (6.3.1.2), Appendix 6.3.2 – for
responses of suppliers and Appendix 6.3.3 – for responses of customers.
)LUPVXSSOLHUFRRSHUDWLRQ
5HVSRQVHVRIWKHFHQWUDOILUPV±.HLK%DKUL)RRG3URGXFWV
Our objective in this section is to study how the government firms manage their supplier
linkages. Therefore, we asked their managers if and how they co-operate with suppliers
on the primary operations. We review the response of Keih Bahri Food Products,
which is one of the government firms and compare the responses of both government
firms and later then we also analyse the responses of their suppliers (section 6.4.1.3
and 6.4.1.4) and customers (section 6.4.2.3).
The general manager of Keih

)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV
Bahri Food products is of the opinion that the firm co-operates on inbound activities
(receiving and storing) but not on production, marketing or after sale service with its
only supplier – Eritrea Grain Board. Moreover, the factory cannot buy from other
private suppliers even if it would get better terms.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW The

government regulations dictate how the factory has to co-ordinate its purchasing,
inventory management and other activities related to the backward linkage with its
supplier (Eritrean Grain Board). The commercial manager’s opinion is nevertheless
that the two firms (Keih Bahri Food Products and Eritrean Grain Board) co-operate on
having advance agreements on the quality and quantity of materials to be purchased
and on the terms of transportation during purchase, which he believes is usually on the
basis of just in time. With regard to this issue, the firm’s commercial manager says
that: ´2XUVROHVXSSOLHURIPDWHULDOVLVWKH(ULWUHDQ*UDLQ%RDUGDJRYHUQPHQWILUP
LWVHOI VR LW LV RQO\ WKH JRYHUQPHQW UHJXODWLRQV WKDW DIIHFW RXU FRRSHUDWLRQ RQ
Chapter 6 136
SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW :H SUHSDUH WKH PRQWKO\ EUHDNGRZQ RI DQQXDO
FRQVXPSWLRQ RI PDWHULDOV DQG SUHVHQW LW WR WKH *UDLQ %RDUG ZKLFK VXSSOLHV XV WKH
TXDQWLW\ZHUHTXHVW´
According to the commercial manager’s opinion, Keih Bahri Food Products’ co-
operation on primary and purchase activities with Eritrean Grain Board helps to
minimise the time taken to purchase materials, the cost of ordering, carrying and
purchasing materials as well as creating firm-supplier trust.
&RQFOXGLQJ UHPDUN Keih Bahri Food Products co-operation with its supplier
Eritrea Grain Board in purchase ordering, transportation and storage of materials is
dictated by the fact that both firms are government owned. According to the
interviews conducted and questionnaire data collected from the firm’s general,
financial and commercial managers the backward linkage is passive and their co-
operation is similar to the management of two departments of the same firm. The only
time that the two firms negotiate on the terms of purchase is during the preparation of
the yearly forecasts. Once they agree on the type, quality, quantity (volume) and
budgeted costs of Keih Bahri Food Products’ annual demand, the communication
becomes routine - writing purchase orders, receiving and inspecting the shipment.
Though they are two firms with different entity, the fact that they both are government
firms has increased trust between each other and decreased the possibility of
opportunistic behaviour and the need for ex-ante safeguarding and ex-post control
measures. As a result of this close inter-government co-operation, the financial
manager of Keih Bahri Food Products believes that the firm is getting benefits such as
decreasing the time needed to purchase materials, decreasing the cost of ordering and
carrying materials. He also believe that the close inter-government co-operation
creates inter-firm trust.
)LUPVXSSOLHUFRRSHUDWLRQ&RPSDULVRQRIJRYHUQPHQWILUPV
)LUPVXSSOLHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV Both Keih Bahri Food Products

and Barka Canneries responded that they co-operate their inbound activities,
particularly shipment and storing. Barka Canneries is also positive with regard to
inter-firm co-operation on production operations on product testing and facility
operations as well as after sales service on repair, parts supply and products
adjustments. However Keih Bahri Food Products does not co-operate on all the
activities related to production operations and after sales service.
)LUPVXSSOLHUFRRSHUDWLRQRQSXUFKDVHDQGLQYHQWRU\PDQDJHPHQW As has been
mentioned earlier, the government regulations require Keih Bahri Food Products to
co-ordinate its purchasing and inventory management with its supplier Eritrean Grain
Board which is a government firm itself. However, Barka Canneries buys its materials
from the open market through open bidding. Moreover, the commercial managers of
both firms believes that they co-operate with their suppliers on the quality and
quantity of materials to be purchased, the terms of transportation during purchase and
in supplying the materials on the basis of just in time. According to the commercial
managers of both firms, their firm-supplier co-operation on primary and purchase
activities helps them to decrease the time needed to purchase materials and to
minimise costs of purchasing materials as well as helps in the creation of inter-firm

trust.
&RQFOXGLQJ UHPDUNV The firm-supplier co-operation of the two government firms
differs depending on whether they deal with fellow “related” government firms, (case
for Keih Bahri Food Products) or private firms, which applies to Barka Canneries.
Keih Bahri Food Products deals with another government firm (Eritrean Grain Board)
so its firm-supplier linkages are dictated by government regulations and subsidised
costs. Both manage the transaction costs of their firm-supplier linkages on the basis of
abiding by the regulations of the government and inter-firm trust. In which case
related costs are minimal. Their suppliers store and bear the costs of transporting the
purchase and ship just-in-time for production, which further reduces the costs of
materials inventory. Both the central firms have close agreements and co-operation
with suppliers on the quality and quantity of materials to be purchased, the terms of
transportation during purchase and in supplying the materials on the basis of just in
time. As a result of their co-operation their managers believe that they get benefits
such as minimising the time needed to purchase materials, decreasing the cost of
ordering and transportation of purchasing materials. Barka Canneries deals with
private suppliers and it therefore requires them to deposit cash at its bank account
enough to pay for one month’s supply of materials – a form of risk sharing.
5HVSRQVHVRIVXSSOLHU(ULWUHDQ*UDLQ%RDUG
We approached the suppliers of the government firms to find their responses and
study the value creation potential of the backward linkages. In this section we study
the firm-supplier co-operation of Keih Bahri Food Products from the point of view of
its main supplier - Eritrean Grain Board. We explored firm-supplier co-operation on
primary activities and on sales and inventory management as well as related benefits
or the reasons for non-co-operation. Finally, we evaluate the supplier responses on
firm efficiency. The data related to the empirical findings are presented in Appendix
6.3.2.
)LUPVXSSOLHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV According to the general manager of

Eritrean Grain Board the two firms co-operate on outbound activities particularly,
delivery vehicle operation and order processing but not on finished goods warehousing
or inventory control. Overall, the manager believes that the firms do not co-operate on
primary activities such as production operations, marketing and sales as well as after sale
services.
)LUPVXSSOLHUFRRSHUDWLRQRQVDOHVDQGLQYHQWRU\PDQDJHPHQW Both Eritrean Grain

Board and Keih Bahri Food Products are government owned and their co-operation is
governed by related government regulations. According to the general manager of
Eritrean Grain Board the two firms co-operate in having credit transactions without
discount and providing goods when just needed for production. However, the two
firms do not have inter-firm co-operation on exchanging skilled staff, credit
transactions with discounts. In the interview we conducted with the general manager
of Eritrean Grain Board he said that: ³7KH 0LQLVWU\ RI )LQDQFH DQG WKH 0LQLVWU\ RI
'HIHQFH VHUYHV DV D EULGJH EHWZHHQ (ULWUHDQ *UDLQ %RDUG DQG .HLK %DKUL )RRG
3URGXFWV 7KH 0LQLVWU\ RI )LQDQFH SD\V XV IRU DOO VXEVLGLVHGSXUFKDVHV PDGH E\ .HLK
Chapter 6 138
%DKUL )RRG 3URGXFWV ,I .HLK %DKUL )RRG 3URGXFWV ZDQWV D VXSSO\ RI JUDLQ LW JHWV
DQQXDOEXGJHWDU\DSSURYDORIWKH0LQLVWU\RI'HIHQFHDQGWKHQLQIRUPV XV %DVHG RQ
ZKLFK ZH SXUFKDVH FHUWDLQ TXDQWLWLHV DQQXDOO\ E\ DQQRXQFLQJ QDWLRQDO DQG
LQWHUQDWLRQDOELGVIRUSRWHQWLDOVXSSOLHUV
According to the general manager of Eritrean Grain Board, both firms are supposed to
co-ordinate their activities as per the government regulations and there is no problem
of co-operation. The benefits that Eritrean Grain Board is getting as a result of its co-
operation with Keih Bahri Food Products include, a decrease in the time needed to sell
goods and in the costs of selling, as well as the cost of ordering, transportation and
carrying inventory.
6XSSOLHU HYDOXDWLRQ RI ILUP HIILFLHQF\ The general manager of Eritrean Grain
Board believes that the relation between the two firms is very good. He is also of the
opinion that Keih Bahri Food Products is efficient in processing its purchase orders,
explanations to inquiries and in its payment habits, in its marketing approach, bilateral
communication and courtesy.
&RQFOXGLQJ UHPDUNV Keih Bahri Food Products and its supplier - Eritrean Grain
Board responded similarly to the questions on firm-supplier co-operation. Because
both are government firms they closely co-operate on their primary activities,
particularly inbound and outbound activities as well as sale-purchase and also in
inventory management. It is however, still possible that they co-operate only because
they are obliged by government regulations. In this case abiding by government
regulations is a main reason for inter-firm co-operation and trust.
)LUPVXSSOLHUFRRSHUDWLRQ±
&RPSDULVRQRIUHVSRQVHVRIJRYHUQPHQWVXSSOLHUV
)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV As it is indicated in Appendix
6.3.2, the suppliers of the two government firms replied that they co-operate with the
government firms on outbound activities, particularly order processing and delivery
vehicle operation. However, their response indicates that they do not believe that they
co-operate with these customers on other primary activities, such as production
operations, after sale service and the inventory control aspect of the outbound activities.
The response of the suppliers differed on the inter-firm co-operation on the primary
activities of outbound and marketing/sales. Both the suppliers of Keih Bari Food
Products and Barka Canneries responded that there is close co-operation on outbound
activities, particularly delivery vehicle operation and order processing. In addition the
supplier of Barka Canneries responded positive to the inter-firm co-operation on the
outbound activities of finished goods warehousing as well as marketing/sales, on
advertising sales force and sales channel selection
)LUPVXSSOLHUFRRSHUDWLRQRQVDOHVRSHUDWLRQV Both suppliers of the government
firms have the opinion that they co-operate with the government firms on having an
advance agreement in providing goods when just needed for production. However, the
two firms do not have inter-firm co-operation with their suppliers on exchanging
skilled staff and credit transactions with discounts, while that Keih Bahri Food
Products, nevertheless co-operates with its supplier on credit transactions without
discounts. Suppliers believe that their co-operation in the sales operations and
inventory management helps to decrease cost of selling, particularly cost of ordering
and transportation. The supplier of Keih Bahri Food Products believe also that the co-
operation results at decreasing the time it needs to sell goods and the cost of carrying
finished goods inventory, while the supplier of Barka Canneries believes it results at
creating trust between the two firms.
The supplier of Keih Bahri Food Products believes that the two firms are fully co-
operating with each other. However, the supplier of Barka Canneries responded there
is some lack of co-operation and the main reason for that he believes is because the
government firm has not developed the business culture of co-ordinating its primary
activities as well as sales and inventory management policies with customers.
The general managers of suppliers of the

6XSSOLHU HYDOXDWLRQ RI ILUP HIILFLHQF\
government firms are satisfied with their inter-firm co-operation. Both suppliers
evaluated their relation as good because they believe the government firms are efficient
in processing purchase orders, explanation to enquiries, payment habits, marketing
approach, bilateral communications and courtesy.
&RQFOXGLQJ UHPDUNV Keih Bahri Food Products and its government supplier
Eritrea Grain Board closely co-operate their outbound/inbound activities of delivery

vehicle operation as well as purchase and sales operations. This co-operation has an
impact on decreasing the level of Keih Bahri’s inventory of materials. Both firms are
required to co-operate because they are government owned and subject to the same
government regulations. Barka Canneries and its privatised supplier- Gejeret Carton
Factory have continued their co-operation that existed before Gejeret Carton Factory
was privatised and both are satisfied with their co-operation. There is also a lack of an
alternative supplier for Barka Canneries. In the absence of a viable competitor Gejeret
Carton Factory is the only one of its kind in the country. The overall effect of the
close inter-firm co-operation according to the opinion of the managers suppliers of the
government firms is that both sides have benefited in decreasing the carrying costs of
their inventories and inter-firm transaction costs of operations.
)LUPFXVWRPHUOLQNDJHV
How efficient are the government firms in managing their customer linkages? To get an
answer to this question we asked the general and commercial managers of the
government firms about if and how they co-operate with their customers on primary
activities sales operations and inventory management. We also studied the benefits that
the government firms believe they get as a result of their co-operation or why they do not
co-operate and whether they assess their customers’ opinion.
5HVSRQVHVRIWKHFHQWUDOILUPV.HLK%DKUL)RRG3URGXFWV
Here we deal with the firm-customer co-operation from the point of view of Keih Bahri
Food Products. For detailed information on the response of the managers of Keih
Bahri Food Products and another government firm, refer to Appendix 6.3.1.2.
Chapter 6 140
The customers of Keih Bahri

)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV
Food Products’ are divided into two categories – the ministries (particularly the
Ministry of Defence) and private bakeries and pastries. The firm’s inter-firm co-
operation differs among these customers. When asked to describe the firm’s
relationship with its customers, the commercial manager said that: ³2XU IDFWRU\ LV
DGPLQLVWHUHG XQGHU WKH 0LQLVWU\ RI 'HIHQFH ZKLFK LV DOVR LWV PDLQ FXVWRPHU VR RXU
UHODWLRQVKLS LVJRYHUQHGE\ VWDWH UHJXODWLRQV 7KH VPDOO EDNHULHV DQG SDVWULHV JHW WKHLU
TXRWDGHWHUPLQHGE\WKH0LQLVWU\RI7UDGHDQG,QGXVWU\EDVHGRQZKLFKZHVHOOWRHDFK
FXVWRPHU 7KHUHIRUH ZH KDYH DOPRVW QR UROH LQ GHWHUPLQLQJ RXU SROLF\ RQ FXVWRPHU
UHODWLRQV´The general manager is of the opinion that the firm co-operates with the
Ministry of Defence on outbound activities such as finished goods warehousing,
materials handling, delivery vehicle operation and order processing but not on
production, marketing or after sale service. The bakeries and pastries take their
periodic quota and the factory provides them with their approved quota if there is
stock available.
)LUPFXVWRPHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW According to the

firm’s commercial manager Keih Bahri Food Products co-ordinates its sales and
inventory management with customers by specifically agreeing on the transportation
terms, quality and quantity of goods to be produced and sold on the basis of just in
time. According to the financial manager of Keih Bahri Food Products the benefit that
the firm gets include minimising the cost of transportation, decreasing the cost of
carrying inventories as well as increasing sales. As for the non-co-operation with the
private customers, the firm’s commercial manager responded that the main reasons
are the firm does not have the policy because it does not see the benefit of co-
operation.
$VVHVVLQJ FXVWRPHU VDWLVIDFWLRQ According to the commercial manager, Keih

Bahri Food Products gets the feedback from its customers on their opinion on the
quality of its products and services by allowing them to return any product with
inferior quality and by having strict quality control at the production floor. However,
it does not allow its private customers to pay after they made sure that the products
are as per their expectation.
&RQFOXGLQJ UHPDUNV Keih Bahri Food Products’ relationship with its customers is
determined by government regulations, which dictate how the factory has to co-
ordinate its management of sales, inventory and other activities related to the forward
linkage with its customers. Hence the firm’s management has little room to manoeuvre
around. Therefore, the factory’s management does not use any particular approach to
keep in touch with its privately owned customers or expedite its forward linkages with
them. As a result, its private customers are mostly not satisfied with the way it sells its
products because they have to wait for a very long period in order to get their quota.
Its production capacity is much lower than the demand for its products, so it has strict
government instructions to satisfy the demand of the Ministry of Defence before that
of its private customers. Moreover, it has very close co-operation with the Ministry of
Defence, which also happens to be its supervising body. This co-operation has greatly
enhanced its sales and decreased costs of sales and inventory holding.
)LUPFXVWRPHUFRRSHUDWLRQ &RPSDULVRQRIJRYHUQPHQWILUPV
)LUPFXVWRPHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV The area of co-operation between

the two firms and their customers with regard to the primary activities is that Barka
Canneries co-operates with its customer on production operations particularly equipment
maintenance and product testing. Moreover, both Keih Bahri Food Products and Barka
Canneries co-operate only on the outbound activities, particularly finished goods
warehousing, delivery vehicle operation and order processing.
)LUPFXVWRPHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQWBoth

government firms produce mostly by the order of their main customer – the Ministry of
Defence. However, Keih Bahri Food Products also produces to the general market for
the small bakeries and pastries. According to the firms’ commercial managers they co-
operate with customers on their sales and inventory management by specifically
agreeing on the transportation terms, quality and quantity of goods to be produced and
sold on the basis of just in time. According to their financial managers of Keih Bahri
Food Products and Barka Canneries the benefit that the firms get include, minimising
the cost of transportation, decreasing the cost of carrying inventories as well as
increasing sales. As for the non-co-operation with the private customers, the firms’
commercial managers say that the main reason is that the customers do not co-operate
while Keih Bahri Food Products’ general manager also believe that the firm does not
have the policy because it does not see the benefit of co-operation.
$VVHVVLQJ FXVWRPHU VDWLVIDFWLRQ Keih Bahri Food Products and Barka Canneries
reported that they make strict quality control at the production floor and if customers
are not satisfied they are allowed to return any product with inferior quality. Barka
Canneries makes periodic assessment of customer opinions and the manager believes
that its customer relation is very good.
&RQFOXGLQJUHPDUNV The main customer of both firms is the Ministry of Defence,

under whom they are also administered. Therefore, relevant government rules (and
trust) dictate their co-operation on the primary activities. Keih Bahri Food Products
also deals with private businesses, particularly Bakeries and Pastries. The firm sells its
products to these customers on government-subsidised prices. It makes cash sales on a
quota basis because the demand for its products by far exceeds its production
capacity. The findings on firm-customer co-operation reveal very close inter-
government firm co-operation because the main customer of both firms is also the
supervising government body. Therefore, as a result of the inter-government co-
operation the firms have managed to minimise the cost of transportation, to decrease
the cost of carrying inventories as well as to increase sales.
5HVSRQVHVRIFXVWRPHU$VPDUD3DVWU\
We approached the customer of Keih Bahri Food Products to find its responses on
firm-customer relations and to study the value creation potential of the forward
linkages. We search for the specific co-operation on the primary activities as well as
sales operation and inventory management. We also study the benefits that the
customer gets as a result of the co-operation or the reasons for the non-co-operation.
Chapter 6 142
Finally we evaluate the customer rating of firm efficiency. For further information on
the responses of the general manager of Asmara Pastry refer to Appendix 6.3.3.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to general manager
of Asmara Pastry, the two firms do not co-operate on any primary activity related to
production operations, outbound activities, marketing and sales or after sale service.
)LUPFXVWRPHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW According to

the Asmara Pastry’s general manager, the firm does not co-operate with its main
supplier Keih Bahri Food Products in any activity related to the sales and inventory
management. He replied that there is no co-operation specifically on the
transportation terms, quality and quantity of goods to be produced or getting goods
when just needed. According to general manager the only benefit is buying the
products at a reduced price, though he believes the quality is also low. As for the non-
co-operation with its customers, the firms managers believes that the main reason is
that Keih Bahri Food Products does not co-operate and not because Asmara Pastry
does not have the policy and does not see the benefit of co-operation.
According to the general manager of Asmara Pastry, the firm buys flour from Keih
Bahri Food Products based on the quota given to it by the Ministry of Trade and
Industry. This quota is divided into the amount of flour that the firm can buy every
week, so the purchase policy of Asmara Pastry or the sales policy of Keih Bahri Food
Products has nothing to do with their managerial policies. The manager said that: ³7KH
VDOHVSROLF\RI.HLK%DKUL)RRG3URGXFWVZKLFKLVDJRYHUQPHQWRZQHGILUPLVEDVHG
RQWKHJRYHUQPHQWSROLF\RIVXEVLGLVLQJFRVWVRIIRRGSURGXFWVSDUWLFXODUO\EUHDG6R
.HLK %DKUL )RRG 3URGXFWV GRHV QRW DFW DV D EXVLQHVV SDUWQHU EXW DV D IDWKHU
GLVWULEXWLQJIRRGWRKLVFKLOGUHQ .HLK%DKUL)RRG3URGXFWVNQRZVYHU\ZHOO ZKHQ ZH
FRPHDQGKRZPXFKZHEX\´ The manager of Asmara Pastry is not satisfied with the

selling, shipment and transporting system of its supplier. He says that: ³$V D
JRYHUQPHQWILUPVHOOLQJRQDVXEVLGLVHGSULFHWKHVHOOHUVHHVQREXVLQHVVUHDVRQZK\
LWKDVWRWDNHFDUHRIWKHLQWHUHVWVRILWVFXVWRPHUVEHFDXVHZKHWKHUWKHFXVWRPHUVOLNH
LWRUQRWWKH\ZLOOFRQWLQXHFRPLQJWREX\ ”.
The manager of Asmara Pastry believes

&XVWRPHU HYDOXDWLRQ RI ILUP HIILFLHQF\
that Keih Bahri Food Products is very efficient in its cash collection habits, costs of
products, bilateral communication, impartiality with other buyers, knowledge of its
customers and explanation to inquiries. However, the manager believes that Keih
Bahri Food Products is less efficient in sales processing and marketing approaches.
The manager of Asmara Pastry said that, ³:H EX\ IURP SULYDWH EXVLQHVVHV DQG .HLK
%DKUL )RRG 3URGXFWV FRPSDUDEO\ ZH FRRUGLQDWH RXU DFWLYLWLHV ZLWK WKH SULYDWH
EXVLQHVVHV LQ D PXFK EHWWHU ZD\ 6R WKHUH LV D ORW WR LPSURYH LQ RXU UHODWLRQVKLS ZLWK
.HLK%DKUL)RRG3URGXFWV3ULYDWHEXVLQHVVHVNHHSLQWRXFKZLWKHDFKRWKHUZKLOH.HLK
%DKUL)RRG3URGXFWVLVLQGLIIHUHQW ”.
&RQFOXGLQJUHPDUN According to the general manager of Asmara Pastry, the firm’s co-
operation with Keih Bahri Food Products is not satisfactory on both primary activities as
well as sales operation and inventory management. He therefore believes that his firm
gets very little benefit as a result of the co-operation. The main reason for the lack of
closer inter-firm co-operation he believes is that the supplier is government owned and
does not care much about its customers.
&RQFOXVLRQ
This chapter has presented an analysis of Keih Bahri Food Products’ internal and
external working capital management. The intra-firm analysis is divided into
managing working capital levels of investment and financing and working capital
operations of purchasing materials and selling finished goods. The inter-firm
management of working capital levels and operations refer to backward linkages with
suppliers and forward linkages with customers. We explored Keih Bahri Food
Products linkage with its supplier - the Eritrean Grain Board and its customer linkage
with Asmara Pastry. A comparison of working capital management is also made
between Keih Bahri Food Products and another government firm – Barka Canneries.
Here we give overview of our findings. First, we review the intra-firm management
with regard to the overall objective of value creation and the constraints to achieve the
objective. Then, we comment on our findings with reference to working capital levels
of investments and financing as well as operations of purchases and sales. Finally, we
comment on the evaluation of the firms overall results of management decisions as
reflected by the financial indicators of performance.
7KH UROH RI PDQDJLQJ ZRUNLQJ FDSLWDO The managers of both firms believe that
managing working capital operations and levels has a very significant role in creating
value to their firms. However, we find that the government firms in general lack a clear
objective and vision of managing both working capital levels and operations. Actually
they are restricted to the control function, which is evidenced by the stringent control
mechanisms imposed over cash, receivables and inventory levels. The reason for the lack
of a clear working capital management policy is the imposition of government
regulations, which are implemented under the supervision of higher government
authorities (the Ministry of Defence). The response of the managers of both firms was
that they are not fully empowered to manage the affairs of their firms. The authority to
take policy measures and decisions, which can have both short and long-term effect lies
with higher authorities. This makes the managers less empowered because the firm’s
management is practically overtaken. This also explains the fact that the managers of the
government firms reported that they have no problem of working capital levels of
investment and financing as well as operations of purchasing and sales.
:RUNLQJ FDSLWDO LQYHVWPHQW DQG ILQDQFLQJ We find that the firms have no clear
policy of managing working capital investment and both firms have excessive levels of
cash and receivables. However, inventories are kept to a lower level due to the close
relationship of inter-government firms in Keih Bahri Food Products as well as efficient
purchase and materials inventory management in Barka Canneries. The inventory of
finished goods is also minimised due to the excessive demands of the Ministry of
Defence and the firms’ monopolised food market. The government firms finance their
working capital levels and operations with the net cash inflow from operations,
government subsidy and trade credits (due mostly to related -government firms). The
firms cannot expressly state their working capital financing policies. However, because
of the profitable operations (thanks to the subsidised costs and monopolised market),
which have resulted in positive net cash flows, the firms have no problem of financing
their working capital levels and operations.
The main conclusion that we make on the management of working capital levels of
investment and financing is that the firms have no clearly set objectives. This is
Chapter 6 144
affecting the efficiency of managing internal working capital levels of investment in

cash, receivables and inventories as well as short-term financing sources.
:RUNLQJ FDSLWDO RSHUDWLRQV The management of the firms working capital
operations was restricted only to the application of clerical procedures of purchases

and sales (Appendix 6.2.3.1 and 6.2.3.2). Analysis of purchase and sales operations
showed that the management of Keih Bahri Food Products is not empowered to
manage its SXUFKDVH RSHUDWLRQV So it has nothing to do with it except preparing the
annual budget and having it approved by the Ministry of Defence and sending
periodic purchase orders to the Eritrean Grain Board. However, Barka Canneries
applies purchase approaches, though it of course abides by the relevant government
regulations. It also makes annual contractual agreement with its suppliers, who make
deposits that will enable the firm to buy one month supplies in case the supplier fails
to deliver according to the agreement. The firm uses this approach as a mechanism to
control any future opportunistic behaviour of the supplier. Most of the VDOHV of both
firms are made to the Ministry of Defence, which is also their supervising body. The
Ministry of Defence simply forwards purchase orders and the firms supply whatever
is requested. Keih Bahri Food Products also sells to small pastries and bakeries
according to the rationed quota approved by the Ministry of Industry and Trade. So,
both firms have very little to do with how to sell their finished goods. We therefore,
claim that both government firms are not fully empowered to manage their working
capital operations as a result of which their efficiency and value creating potential in
that area is restricted. Therefore, the managers are concentrating at the custodial rather
than at the value maximisation aspect of working capital management.
(YDOXDWLRQ RI LQWHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW Analysis of performance has

indicated that the firms use no accounting, customer satisfaction or quality based
performance measurement and evaluation criteria. Responses of the managers as well as
observations of their financial statements reveal that the firms have excessive cash and
marginal profits. Liquidity analysis showed that Keih Bahri Food Products is
marginally liquid. On the other hand, Barka Canneries is excessively liquid. The
activities of both firms show very low asset turnovers and increasingly higher
receivables collection periods. All profitability ratios (gross profit, net profit and
return on assets) indicate decreasing levels.
,QWHUILUP FRRSHUDWLRQ Firm supplier linkages indicate that the co-operation on
working capital levels and operations between Barka Canneries and its supplier –
Gejeret Carton Factory, (which is a non-government firm) is low. The main reason for
this according to the managers is the interference of government regulations. Both
firms reported that they make little co-operation in all the primary activities.
However, Keih Bahri Food Products and its government supplier (the Eritrean Grain
Board) fully co-operate in their activities in as much as the government regulations
permit. Firm-customer linkages revealed that the main customer of both government
firms is the Ministry of Defence, which is also their supervising body. Keih Bahri
Food Products also deals with private Bakeries and Pastries. Because the Ministry of
Defence is the supervising and controlling government body for both firms, intra-firm
hierarchy governance dominates the relationship between the Ministry of Defence and
both Keih Bahri Food Products and Barka Canneries. The inter-firm relationship
between Keih Bahri Food Products and the private bakeries and pastries is also
dictated by government regulations. However, when the relationship between
government and private firms is considered, there is less inter-firm co-operation and
the government firms play a dominant and controlling position. Moreover, the closer
inter-firm co-operation among the government firms has a positive effect in inter-firm
trust related costs of activities. However, the relevant government regulations rather
than business linkages dictate the inter-firm relationship.
(YDOXDWLRQ RILQWHUILUP ZRUNLQJ FDSLWDO PDQDJHPHQW The government suppliers
and customers evaluated each other’s linkages as efficient while the non-government
firms considered that the government firms are less efficient in co-ordinating their
primary activities. The government firms’ supplier and customer co-operation is
unsatisfactory from the privately owned suppliers and customer’s points of view. Both
private linkages reported that there is no firm-supplier or firm-customer co-operation
between them and their government partners except in few areas for control purposes.
Overall, the findings reveal that the government firms are doing very little to create
value by managing working capital levels of investment and financing as well as
operations of purchasing and sales.
&KDSWHU
7UDQVLWLRQ)LUPV
,QWURGXFWLRQ
In the previous chapter we started the empirical study by describing and analysing the
internal and external working capital operations and levels of the government owned
firms. In this chapter, we continue with regard to firms in transition to privatisation.
This section (7.1) introduces the chapter. Section 7.2 presents a firm’s overall working
capital management issues. Section 7.3 covers the internal management of working
capital levels and operations. Section 7.4 presents external working capital
management, including firm-supplier linkages and firm-customer linkages. Section
7.5 winds-up the chapter with conclusions.
The objective of this chapter is to help us answer question 2(b) of this research study:
³+RZ GR PDQXIDFWXULQJ ILUPV LQ WKH SURFHVV RI WUDQVLWLRQ WR SULYDWLVDWLRQ LQ (ULWUHD
Specifically, the objective of

PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO ZRUNLQJ FDSLWDO´"
the study presented in this chapter is to investigate how a typical firm in transition to
privatisation manages its (a) internal and (b) external working capital operations and
levels and then to compare this with other transition firms.
With this objective in mind, we approached the managers of Keih Bahri Tannery and
studied its internal working capital management, its supplier linkages with Asmelash
Hides and Skins Wholesale and its customer linkages with Selamawit Shoe Factory.
We have selected Keih Bahri Tannery because it represents a typical firm in transition
to privatisation and it was also possible to get responses of its main supplier and
customer. A comparison is also made between the working capital management of
Keih Bahri Tannery and other four firms in transition, namely - Asmara Textile
Factory, Lalmba Sack Factory, Sembel Household Utensils Factory and Dahlak Shoe
Factory.
This section presents the transition firms’ background information on issues related to
the overall working capital management, including historical background,
organizational structure, objectives of working capital management and constraints to
achieve the objectives as well as the role of working capital management in creating
value. We start with a background information on Keih Bahri Tannery (section 7.2.1)
and then present a comparative analysis of the firms in transition to privatisation
(section 7.2.2). For detailed information on the overall working capital management
issues, refer to Appendix 7.1.
+LVWRULFDOEDFNJURXQGRI .HLK %DKUL7DQQHU\ According to its general manager,

Keih Bahri Tannery was established in 1946 by an Italian investor under the name of
“Conceria Baldini”. It started by producing semi-processed hides and fully finished
Chapter 7 148
leather for both the local and foreign markets. Its original capital is estimated to be
around 1.6 million Ethiopian Birr. In 1975 the Ethiopian government nationalised the
factory and did not make any capital investment thereafter. According to its general
manager, at present the factory produces 30% for export and 70% for the local
market. Upon independence the foreign market in Ethiopia was totally lost. However,
since 1993/94 the local and other foreign markets increased so much that at the
moment demand is above its production capacity. According to the interview
conducted with the firm’s general manager, Keih Bahri Tannery’s overall
performance in terms of volume of sales, production capacity, number of employees
and market has increased after independence. Under the Ethiopian government, the
factory was producing to fill its quota as determined by the then Ministry of Industry
while at present it produces on order basis and the incoming orders are enough to
make the factory operate at its full capacity. However, the manager says there are
some bottlenecks with regard to the investment in machines and maintenance, as a
result of which a large liming drum is not functioning. The factory cannot repair this
because the cost amounts to a capital expenditure that the factory is not allowed to
make in this period of transition to privatisation.
2UJDQLVDWLRQDOVWUXFWXUH Keih Bahri Tannery’s organisational structure is composed

of the general manager, who is responsible to the privatisation agency, NASPPE
(National Agency for Supervising and Privatising Public Enterprises) and other
managers responsible to the general manager, including heads of quality control,
finance and administration, marketing and operation. The NASPPE controls the
overall managerial policies pending its privatisation. According to the general
manager’s opinion, he is only partially empowered to make decisions regarding
working capital levels of investments and financing, as well as operations of
production, purchasing and sales. Along with the commercial manager he is also
responsible to investigate and assess the market and apply appropriate marketing
strategy. The financial manager controls the firm’s financial operations and reports to
the general manager periodically. The general manager reports to the NASPPE
periodically.
)LUP SROLF\ DQG FRQVWUDLQWV Keih Bahri Tannery’s financial manager believes that
the objectives of the firm include mainly decreasing costs, remaining liquid and
generating profit. According to the firm’s general manager, Keih Bahri Tannery has no
long-term objectives because it is in the process of privatisation. He said that: ³7KHQHZ
RZQHUV KDYH WR ERWKHU DERXW WKHLU ORQJWHUP REMHFWLYHV´. During the interview the
financial manager also stated that, ³:H GR QRW KDYH D ZHOO SODQQHG DSSURDFK RI
PDQDJLQJ ZRUNLQJ FDSLWDO OHYHOV DQG RSHUDWLRQV GXH WR ODFN RI PDQDJHULDO SROLF\ DQG
EHLQJ LQ WUDQVLWLRQ WR SULYDWLVDWLRQ *LYHQ WKLV VKRUWFRPLQJ ZH WU\ WR IXOO\ RSHUDWH WKH
IDFWRU\ LQFUHDVH VDOHV YROXPH GHFUHDVH FRVWV E\ PLQLPLVLQJ FDSLWDO WLHGXS LQ
UHFHLYDEOHVDQGLQYHQWRULHVJHQHUDWHSURILWDQGUHPDLQOLTXLG ”. According to the general

manager, what hinders the firm from achieving its objectives is the lack of investment in
fixed assets, production capacity, skilled labour and the process of transition to
privatisation. As Appendix 7.1 indicates working capital investment, short-term
financing, fixed capital financing, product demand and markets are not constraints. The
general manager said that: ³:H FDQ¶W SURGXFH DV PXFK DV ZH ZDQW WR VHOO EHFDXVH WKH
PDFKLQHV DUH ROG VORZ DQG RIWHQ RXW RI IXQFWLRQ :H FDQQRW LQYHVW LQ PDMRU UHSDLUV
EHFDXVH ZH DUH LQVWUXFWHG E\ WKH JRYHUQPHQW WKDW ORQJWHUP FRPPLWPHQWV DUH QRW
DOORZHGVLQFHWKHILUPLVH[SHFWHGWREHSULYDWLVHG ”.
Transition Firms 149
All three managers (general, financial and commercial) of the firm believe that the
strict government regulations on the privatisation process are the virtual points of
reference for the management of the firm at the moment. The regulations that refer to
working capital management include restricting the firm from buying or selling on
credit for more than three months. The managers say this rule is to ensure that when
the firm is privatised there will be no uncollected receivables or unpaid debt transfer
from the government to the new owners. The firm is also advised not to collect large
inventories of both materials and finished goods. As it is the case with the government
firms, Keih Bahri Tannery is permitted to transact on account both purchases and
sales only with fellow government and transition firms and cash balances cannot be
invested in profitable ventures or deposited into interest bearing bank accounts. With
regard to cultural factors the general manager said that: ³7KH XOWLPDWH VXSSOLHUV RI
UDZ PDWHULDO VNLQV DQG KLGHV DUH WKH UXUDO IDUPHUV &XOWXUDOO\ WKH IDUPHUV
GLIIHUHQWLDWHWKHLUDQLPDOVE\HQJUDYLQJDVLJQRQWKHLUVNLQZLWKKRWLURQZKLFKDOVR
VKRZVWKHZHDOWKRIWKHIDUPHUV7KLVDIIHFWVWKHTXDOLW\RIWKHVNLQGXULQJSURGXFWLRQ
7KH0LQLVWU\RI$JULFXOWXUHLVWU\LQJWRFRQYLQFHWKHIDUPHUVQRWWRGRWKLVEXWLWLVD
FXOWXUHDQGQRWVRHDV\MRE ”.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW RQ YDOXH FUHDWLRQ Before getting into
more specific issues on working capital management we asked the general manager a
question on the role of working capital management on value creation. He said that:
³7KHRQO\MREWKDWZHDUHGRLQJDWWKHPRPHQWLVPDQDJLQJZRUNLQJFDSLWDOOHYHOVRI
LQYHVWPHQWV DQG ILQDQFLQJ DV ZHOO DV UHODWHG RSHUDWLRQV RI SXUFKDVLQJ DQG VHOOLQJ´
The firm’s financial manager also believes that overall working capital management has
a pivotal role to play on value creation, particularly in increasing sales by managing
cash, receivables, inventory, sales of finished goods, purchase of materials and trade
payables can help to achieve objectives of value creation. The financial manager also
believes cash management can help in decreasing costs.
2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQWLVVXHV&RPSDULVRQRIWUDQVLWLRQILUPV
Here we want to know if the transition firms reveal similarity or have a material
difference on the overall working capital management, particularly with respect to the
policy of working capital management, constraints in achieving firm objectives and
the factors determining firm objectives.
)LUP SROLFLHV DQG FRQVWUDLQWV The financial managers of the transition firms
responded that their working capital management policy is tailored towards,
decreasing costs thereby generating profit and to remain liquid. However, only two
out of the five transition firms responded that their working capital management aims
at increasing sales.
Regarding the constraints in achieving firm objectives, the transition managers

response to interview questions indicate that the factors which are constraining firm
objectives are government regulations referring to the transition process have a direct
effect on the working capital investment. Except for Sembel House Hold and Dahlack
Shoe Factory, fixed capital investments, production capacity and availability of labour
are considered to be constraints for of the firms. The transition firms responded
Chapter 7 150
differently to the question regarding the factors that determine their working capital
levels. All except Asmara Textiles Factory agreed that seasonality of sales is the most
important factor, which affects the working capital levels. In addition to this while
credit policy and availability of credit is relevant for Lalmba Sack Factory, Dahlack
Shoe Factory and Keih Bahri Tannery reported that sales growth is also important
factor. Asmara Textiles Factory reported that availability of credit, price levels of
inputs and operating efficiency affect the levels of working capital most.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW LQ WKH YDOXH FUHDWLRQ All managers of
the transition firms are of the opinion that overall working capital management has an
important role for value creation. Keih Bahri Tannery and other transition firms
responses show that working capital management is important for the purpose of
increasing sales by managing trade receivables, inventory, sales of finished goods,
purchase of materials and trade payables. Unlike the financial manager of Keih Bahri
Tannery who was not sure whether managing working capital items could reduce costs,
the other managers believed that managing inventory, sales of finished goods and
purchase of materials could decrease costs.
This section covers Keih Bahri Tannery’s internal working capital management, which
is divided into levels and operations. Working capital levels refer to investments in cash,
inventories and receivables (section 7.2.1) and financing (7.2.2). Working capital
operations include purchases (section 7.2.3) and sales (section 7.2.4). For detailed
information on internal working capital management of transition firms, refer to
Appendix 7.2.
0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQWV
Here, we discus the managers’ responses to questions on how the firm manages its
working capital investments on cash, receivables and inventories. The objective is to
study if Keih Bahri Tannery applies efficient value creating methods of managing
working capital investments. First, we describe and analyse that of Keih Bahri Tannery
and then we compare the outcomes with the other firms in transition to privatisation.
&DVKPDQDJHPHQW
In this section we study if Keih Bahri Tannery creates value by managing cash
balances, collections and payments. Therefore, we asked questions regarding the
motive of holding certain balances of cash levels, purposes for cash forecasts and
forecasting approaches, purposes and approaches in preparing cash flow statements as
well as approaches of controlling cash payments and collections. For detailed
information on cash management, refer to Appendix 7.2.1.1.
According the financial manager, Keih

7KH PRWLYHV RI KROGLQJ FDVK EDODQFHV
Bahri Tannery’s only purpose of holding cash is to make regular predetermined

payments (transaction purpose). It has no other specific purpose such as to make
unforeseen investment opportunity (speculative purpose), to pay for unforeseen

transactions (precautionary purpose) or as a guarantee for bank loans. According to the
firms financial manager, Keih Bahri Tannery pays and collects cash through the bank
and mostly has a moderate cash surplus.
&DVK EXGJHWLQJ DQG FRQWURO According to the financial manger, the management
of Keih Bahri Tannery does not prepare cash budgets. He said: ³:H GR QRW KDYH WKH
WUDGLWLRQ RI SUHSDULQJ FDVK EXGJHWV +RZHYHU ZH SUHSDUH RWKHU LWHPV RI D PDVWHU
EXGJHW LQFOXGLQJ PDWHULDOV SXUFKDVHV DQG XVDJH VDOHV DQG SURGXFWLRQ
UHTXLUHPHQWV´ The firm prepares cash flow statements using the receipts and
disbursements method because it is a requirement by the government, which it uses to
control cash payments and receipts but not to control liquidity or to long-term needs.
The firm hedges a possible cash shortage by having an agreement with the bank for
overdraft facility. According to the firm’s financial manager cash for working capital
purposes is guaranteed by the overdraft agreements. He stated that: ³:HGRQRWKDYHD
SROLF\ RI PLQLPXP FDVK EDODQFH EHFDXVH WKH EDQN RYHUGUDIW VHUYHV DV D VDIHW\
PHDVXUHZKHQFDVKLVQHHGHGLQH[FHVVRIRXULQWHUQDOUHVRXUFHV´
0DQDJLQJ FDVK SD\PHQWV DQG FROOHFWLRQV Keih Bahri Tannery controls its cash
payments using the voucher system, that is, by approving for expenses before
payment is made. It also uses other three control mechanisms - using checks
sequentially numbered, which are controlled and accounted regularly, preparing the
bank reconciliation by someone other than the one involved in cash collections and
payments and using a petty cash system. As a policy of speeding-up cash collections,
the firm sells only on cash. The factory controls cash collections by depositing
receipts at the bank on a daily basis and by separating duties for sequential cash
operation, handling and recording. The financial manager believes that the firm has no
problem in managing cash collections and payments. Therefore, it does not make
agreements with the bank like borrowing at short notice, extending outstanding loans
or extending outstanding trade credits.
&RQFOXGLQJUHPDUN The firm has surplus cash flow from its operations but because
of a lack of investment opportunities and managerial empowerment, it does not value
creating approaches of cash investment and financing. The motive of holding cash is
only to take care of regular cash collections and payments. So we observed that the
firm has efficient control measures against unauthorised cash payments and
collections. The firm does not prepare cash budgets and therefore performance
evaluation of cash operations is not done. Therefore, as the financial manager stated,
the management of Keih Bahri Tannery’s cash management has very little do with
achieving firm objectives.
,QYHQWRU\0DQDJHPHQW
The objective of this section is to know if Keih Bahri Tannery creates value by
managing its materials and finished goods inventory balances. Therefore, we asked
questions regarding if and how it determines inventory costs and values, formulates
and implements its inventory planning and control. For detailed information on
inventory management, refer to Appendix 7.2.1.2.1 for materials inventory and see to
Appendix 7.2.1.2.2 for finished goods inventory.
Chapter 7 152
0DWHULDOV LQYHQWRU\ PDQDJHPHQW As per the financial manager’s opinion, Keih
Bahri Tannery’s primary policy in the management of materials is to safeguard against

inventory shortages, to minimise the holding costs and the purchase ordering costs. The
factory has no major problem of co-ordinating its materials inventory management
with its suppliers. According to the firm’s commercial manager, Keih Bahri Tannery
has well co-ordinated firm-supplier linkages. This linkage has enabled it to almost
eliminate both inventories of materials and finished stock. During the interview the
commercial manager stated that: ³:HKDYHVXSSOLHUVDOORYHU(ULWUHD7KHVHVXSSOLHUV
EX\ UDZ DQLPDO VNLQV IURP IDUPHUV :H SURYLGH WKHVH VXSSOLHUV ZLWK SUHVHUYDWLYH
FKHPLFDOVOLNHVDOWDQGZLWKPHDQVRIWUDQVSRUWDWLRQE\SHULRGLFDOO\ VHQGLQJYHKLFOHV
WR SLFNXS WKH UDZ PDWHULDOV IURP WKHLU SODFH :KHQ WKH PDWHULDOV DUULYH DW WKH
IDFWRU\ WKH SURGXFWLRQ SURFHVV VWDUWV LPPHGLDWHO\ VR WKHUH LV QR UDZ PDWHULDOV
LQYHQWRU\LQWKHIDFWRU\´
According to the firm’s financial manager, the inventory reflected in the balance
sheet refers to an import from the Sudan, which the firm is not using. He said: “,Q
WKHUHZDVVKRUWDJHRIUDZPDWHULDOVLQ(ULWUHDDQGZHLPSRUWHGLQIHULRUTXDOLW\
UDZPDWHULDOVIURP6XGDQDQGVRPHRIWKLVUDZPDWHULDOVLVVWLOOLQWKHLQYHQWRU\:H
DUH QRW XVLQJ LW EHFDXVH ZH DUH JHWWLQJ EHWWHU TXDOLW\ UDZ PDWHULDOV IURP WKH ORFDO
PDUNHWDWSUHVHQW´ The firm’s major cost of holding inventory of materials is the cost
of physical deterioration. The opportunity cost of capital invested or interest on capital
tied-up, cost of power, costs of handling, security and record keeping are very small.
Overall, the commercial manager believes that this cost of holding inventory of
materials is very small amount. Applying the economic order quantity in order to keep
only the minimum level required reduces the level and costs of the important items.
Keih Bahri Tannery selectively controls the physical movement of materials inventory
on the basis of cost and not criticality in case of shortage, usage rate or scarcity in the
market. It uses average cost (not first-in-first-out or last-in-first-out) approach to
determine the cost of materials issued to production and remaining in inventory.
Therefore, inventory of materials is valued in the balance sheet on the basis of cost (not
on cost or market whichever is lower or market-replacement cost).
)LQLVKHGJRRGVLQYHQWRU\PDQDJHPHQW According to the firm’s financial manager,
Keih Bahri Tannery produces mostly on the production order of customers so it does not
hold much inventory. It does not use selective inventory control bases like costs, usage
or sales rate and criticality in case of shortage. The average cost technique is mostly used
to determine the cost of goods sold and in inventory. The firm values the finished goods
inventory in the balance sheet at cost. Cost or market whichever is lower and market
value are not used for inventories valuation purposes.
According to the financial manager of Keih Bahri Tannery, the firm has no reason for
holding finished goods inventory and does not forecast its finished goods production and
inventory requirements. The yearly average level of finished goods inventory is less
relevant and the costs of holding inventory of finished goods particularly power,
insurance, opportunity cost of capital invested or interest on capital tied-up as well as
the cost of deterioration, obsolescence, shrinkage, depreciation and pilferage are
small. While the costs of property tax, handling, security, and clerical record keeping
are not incurred at all. Therefore, as per the opinion of the financial manager, costs of
holding inventory of finished goods is less significant for the management to give
special attention. Keih Bahri Tannery uses both materials and finished goods
inventory as a guarantee to get overdraft facility from the bank. In order for the bank to
allow overdraft, the bank requests financial statements including a cash flow statement
of the current year, budgeted financial statements for the next year and insurance
coverage’s of the firm’s current and fixed assets. The insurance coverage is based on the
estimated market value of the working capital assets mainly inventory and receivables.
However, the financial manager said that:³1$633(KDVWRDSSURYHILUVWLQRUGHUIRUXV
WRKDYHWKHULJKWWRXVHWKHRYHUGUDIWIDFLOLWLHV´.
&RQFOXGLQJ UHPDUNV The financial manager believes that because of its close
linkages with its suppliers and customers, the inventory levels of Keih Bahri Tannery
are kept to a minimum. He also believes that raw materials inventory is minimised
because suppliers store them at their own premises until they accumulate certain
minimum level. In which case the cost of inventory holding is shifted from the factory
to the suppliers. The factory collects its materials from the places of its suppliers and
production starts upon arrival of the shipment. The inventory level of its finished
goods is also reduced because these goods are shipped to the customer upon
completion of the production process. Therefore, the firm applies a type of the “just-
in-time” approach to manage its inventory. According to the financial manager, the
firm has established long-term supplier and customer relations, which it manages by
trust. However, compared to the total assets, we can observe that there is large amount
of current assets in the firm’s balance sheet (see section 7.3.4.1). The major part of
this current asset is inventory. This is indication that the firm’s management has not
proper understanding of the level and impact of its inventory costs.
In this section we want to know if Keih Bahri Tannery creates value by managing
receivables. Therefore, we asked the firm’s financial manager questions regarding if
and how it formulates its policies of accounts receivable management, controls its
credit collection, the costs of accounts receivable balances and bad debts. For more
detailed information see also Appendix 7.2.1.3.
&UHGLWSROLF\DQGUHFHLYDEOHVPDQDJHPHQWAccording to the financial manager, Keih
Bahri Tannery gives little attention to receivables management because it sells only on
cash basis (except for government and transition firms) and it has an insignificant level
of receivables. According to the financial manger, there are three main reasons for not
selling on credit (see also Appendix 7.2.1.3-A), first, the firm does not want to extend
credit, second, there is no tradition of selling on credit and the third, because there is
high uncertainty of customers credit worthiness. However, the commercial manager
believes it is not because the customers do not ask for credit or because there is lack
of information on credit applicants. Since it does not have credit policy and therefore
it does not sell on credit, the firm does not incur costs such as costs of customer
screening, receivable collection or bad debt losses. However, a reference to the firm’s
financial statements reveals a very significant amount of receivables from debtors and
related enterprises. This amount according to the financial managers is due from the
Dahlack Shoe Factory (the main customer and transition firm itself) and Asmara Shoe
Factory. During the interview the financial manager stated that: ³:H GR QRW VHOO RQ
Chapter 7 154
DFFRXQWVRWKHTXHVWLRQRIUHFHLYDEOHPDQDJHPHQW LV QRW UHOHYDQW KHUH +RZHYHU WKHUH
LVRQHRXWVWDQGLQJUHFHLYDEOHZKLFKZDVGXHIURP$VPDUD6KRH)DFWRU\QRZSULYDWLVHG
XQGHU D QDPH RI %LQL 6KRH )DFWRU\ 6LQFH SULYDWLVHG ILUPV DUH VROG WR WKHLU SULYDWH
As a result
RZQHUVIUHHRIGHEWLWLVWKH1$633(ZKLFKLVUHVSRQVLEOHWRSD\WKHGHEW´
the firm is incurring carrying cost of this uncollected debt. However, the financial
manager’s opinion is that, the cost of holding the levels of receivables is still not
significant therefore the firm does not use any receivables management approaches.
0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQW&RPSDULVRQRIWUDQVLWLRQILUPV
Do the transition firms reveal similarity or do they have material differences in

managing their working capital levels of investment, particularly cash, inventories and
receivables? This section will try to answer this question.
&DVK PDQDJHPHQW All transition firms apply the receipts and disbursements
approach to plan for their cash requirements. The purpose of cash planning for all
firms is only for transaction purposes. None of them reported that they budget cash
requirements for speculative, precautionary or bank compensating balance purposes.
This is mainly because they are not allowed to make investments with a long-term
motive. The transition firms other than Keih Bahri Tannery and Sembel House Hold
Factory forecast their cash budget mostly on the basis of past experience. Asmara Textile
Factory and Dahlack Shoe Factory also use expected sales as base to forecast their
annual cash requirements. Since they all belong to the government, the government
owned Commercial Bank of Eritrea provides overdraft if they need it. They control cash
payments using the voucher system, checks, bank reconciliation and with a petty cash
system. The transition firms collect cash at sales, which they use as a mechanism to
speedup cash collection. Only Asmara Textiles Factory makes credit sales. They all
control cash collections by depositing at the bank on a daily basis as well as by
separating sequential operations where cash is involved.
0DWHULDOV LQYHQWRU\ PDQDJHPHQW The materials inventory policy of Keih Bahri
Tanney and the other transition firms strongly aim at minimising inventory holding costs
and ordering costs, safeguarding against inventory shortages and keeping production
running. The major cost of inventory holding that the transition firms reported include
opportunity cost of capital tied-up in materials inventory, cost of deterioration (including
obsolescence, shrinkage, depreciation and pilferage). Other costs like power, insurance,
property tax, handling, security and clerical record keeping are small in all the firms
except the costs of materials handling and security which is significant for Dahlack Shoe
Factory. So, all firms reported that these costs on the average are less significant for the
management attention and they all try hold the minimum level required. Only Keih
Bahri Tannery uses economic order quantity and just in time inventory management
approaches for selected materials. Most firms have a differing opinion on the use of
selective control of materials inventory. Lalmba Sack Factory, Sembel House Hold
Factory and Dahlack Shoe Factory control on the basis of criticality in case of shortage,
while Lalmba Sack Factory and Dahlack Shoe Factory also use usage rate. Moreover,
Sembel House Hold Factory and Dahlack Shoe Factory apply scarcity in case of
shortage in the market. All use only the average cost technique to determine the cost and
value of materials used in production and in inventory.
)LQLVKHG JRRGV LQYHQWRU\ PDQDJHPHQW The transition firms (except Lalmba Sack
Factory and Keih Bahri Tannery) hold finished goods inventory to satisfy customer
demands and to take advantage of economies of scale. While Lalmba Sack Factory and
Sembel House Hold Factory keep inventory for safety stock, Asmara Textile Factory and
Lalmba Sack Factory use stocks to meet high seasonal demands but none of them uses
stocks to decrease holding costs. Inventory holding costs for all the firms is very small or
not incurred at all and therefore not relevant for the management and all (except Keih
Bahri Tannery which does not use any) try to hold only the minimum level required. The
firms except Keih Bahri Tannery and Lalmba Sack Factory selectively control the
physical safety of the finished goods on the basis of usage rate rather than cost or
criticality in case of shortage. All the firms in transition to privatisation use the average
cost technique to determine the costs and value of finished goods sold and in inventory.
5HFHLYDEOHV PDQDJHPHQW None of the transition firms use any technique of

managing accounts receivable because they sell to private customers only on cash basis.
So they rarely have a policy of credit terms, screening credit applicants, measures to
collect overdue receivables. Therefore, they have no risk of bad debts or doubtful
accounts. The reason why they do not sell on credit according to their commercial
mangers is because they do not have the policy due to government regulations. They also
believe that there is high uncertainty that private debtors may not pay back and that there
is no tradition of buying and selling on credit. However, they have the opinion that it is
not because customers do not ask for credit or that there is lack of information on credit
applicants.
&RQFOXGLQJUHPDUNV The management of the firms in transition to privatisation give
emphasis to controlling the physical safety of working capital investments. They have no
short or long-term vision on how to maximise the value of their investments. They are
not empowered to manage their working capital levels and operations. The firms are not
allowed to accumulate inventory, which they will not sell within three months. They are
also not allowed to buy or sell on credit whose cash transaction extends for more than
three months. In general, the firms are not allowed to design and implement short and
long-term investment policies. As one manager put it, they have become a hostage of the
privatisation process.
In this section we study if Keih Bahri Tannery creates value by managing working
capital finances. Therefore, we asked questions regarding the sources of financing,
costs of financing and their relevance to management. For detailed information on
managing working capital finances, refer to Appendix 7.2.2.
In order to finance its

6RXUFHV FRVWV DQG LQIOXHQFHV RI ZRUNLQJ FDSLWDO ILQDQFLQJ
short-term financing needs Keih Bahri Tannery uses the surplus cash that it generates
from its operations. According to the firms’ financial manager, trade credits, secured
borrowing, accruals, bank overdrafts and short or long-term debt are not considered as
the firm’s sources of finance. However, the frims balance sheets show a sizable trade
credit balance indicating it also purchases on credit. Moreover, the financial manager
of Keih Bahri Tannery has explained the financing of working capital investment as
follows: ³%DVLFDOO\ZHILQDQFHRXUZRUNLQJFDSLWDOLQYHVWPHQWZLWKLQWHUQDOO\JHQHUDWHG
Chapter 7 156
FDVK +RZHYHU LI ZH JHW FDVKSUREOHPV ZH FDQXVH EDQN RYHUGUDIW IDFLOLWLHV WR ILQDQFH
ZRUNLQJ FDSLWDO QHHGV ,Q WKDW FDVH WKH RYHUGUDIW LQWHUHVW DPRXQWLQJ WR SHU \HDU
EHFRPHVWKHFRVWRIILQDQFLQJ´
Since the firm uses its own financing resources for its working capital needs, the only
measure it takes when its financing needs exceed its resources is to increase its cash sales
or use overdraft if the worst comes. In order to allow overdraft, the bank requests audited
financial statements of the current year including a balance sheet, income statement and
cash flow statement, budgeted financial statements for the next year and insurance
coverage of the firm’s current and fixed assets. Since inventory and receivables are part
of the current assets they are used as a guarantee in applying for overdraft facilities.
Before the bank approves the overdraft facilities the firm has to get permission from
NASPPE to request for overdraft facilities from the bank. According to the financial
manager, it is not the firm managers but NASPPE which is empowered with the
decisions regarding the firm’s short-term financing. However, the firm’s financial
manager believes that there is no problem of short-term financing that the firm
encounters so far.
0DQDJLQJZRUNLQJFDSLWDOILQDQFHV&RPSDULVRQRIWUDQVLWLRQILUPV
6RXUFHV FRVWV DQG LQIOXHQFHV RI ZRUNLQJ FDSLWDO ILQDQFLQJThe main source of
short-term financing for all the transition firms (except Keih Bahri Tannery) is the bank
overdraft. Moreover, Asmara Textile Factory, Lalmba Sack Factory and Sembel House
Hold Factory also use short-term debt from the commercial Bank of Eritrea as a source
of working capital financing. Lalmba Sack Factory also uses retained earnings a source
of short-term financing. Unlike the other transition firms Keih Bahri Tannery does not
use bank loans to finance its working capital needs mainly because it has enough cash
inflow from its operations. None of the firms claimed to use long-term debt, retained
earnings, equity capital, bank loans, trade creditors, secured borrowing or accruals to
finance working capital investments. All reported that they have no problem financing
their short-term working capital needs mainly because there is the bank overdraft facility
readily available for them regardless of their profitability.
All transition firms except Keih Bahri Tannery experience cash deficits, which they
finance with bank overdraft. Again with the exception of Keih Bahri Tannery and
Dahlak Shoe Factory (the only two firms showing good profit for most of the seven
years), all reported that the costs of financing are mainly bank interest expense and bank
service charges.
3XUFKDVHPDQDJHPHQW
In this section we study if Keih Bahri Tannery creates value by managing working
capital operations of purchases. We asked questions on the firm’s purchase policy,
purchasing techniques, purchasing activities and costs, approaches of contacting,
contracting and control of suppliers. For detailed information on managing working
capital operations with regard to purchases, refer to Appendix 7.2.3.1.
3XUFKDVHVSROLFLHV According to the commercial manager of Keih Bahri Tannery the

objective of purchasing materials is to take advantage of cash discounts and quantity
discounts. The firm rarely purchases to decrease ordering costs and never to meet
seasonal high production requirements. It forecasts its materials requirements in order to
determine the quantity on hand and on order and the inventory usage during lead time
but rarely to determine the safety stock requirement. The base that the firm uses to
estimate materials requirement is mainly its past experience and the opinion of the
management but rarely the forecasted sales volume. The firm purchases chemicals from
foreign markets and animal skin from the local market. With regard to the local
purchase the commercial manager said that: ³$Q\ WUDGHU ZLWK DQ DSSURSULDWH WUDGLQJ
OLFHQVHUHJLVWHUVLWVDGGUHVVDQGJHWVSUHVHUYDWLYHFKHPLFDOVNLORVRIVDOWSHUDXQLWRI
PDWHULDO IUHH RI FKDUJH DQG DGYLVHV RQ KRZ WR EX\ DQG KDQGOH WKH PDWHULDOV :KHQ
VXSSOLHUVLQIRUPXVWKDWWKH\KDYHFROOHFWHGWKHQHFHVVDU\YROXPHRIPDWHULDOZHXVHRXU
RZQWUDQVSRUWDWLRQWRJHWWKHUDZPDWHULDOVWRWKHIDFWRU\VLWH´
According to the commercial manager, the firm purchases on a cash basis. It does not
purchase on credit mainly because there is no tradition of buying and selling on credit
and so its suppliers do not provide it with credit facilities, but not because the firm does
not want to buy on credit. According to the commercial manager the purchasing
procedure is also dictated by government regulations, which aims at controlling the
purchase operation.
&RQWDFWLQJ FRQWUDFWLQJ DQG FRQWUROOLQJ VXSSOLHUV Keih Bahri Tannery makes

efforts to find suppliers by getting in contact and describing the materials to potential
suppliers. According to the commercial manager, the firm’s supplier contact policy is
tailored towards choosing the cheapest channel of communication and managing by
trust. When entering into contract with a potential supplier the firm’s policy emphases
on routine contract agreements with terms known to both partners in advance of the
contract agreement. Its supplier control is also based on routine control agreement
with terms known to both partners in advance. Keih Bahri Tannery controls its
purchase agreements by relying on the commitment of its suppliers and by trusting
them and it rarely requires a pledge or guarantee. But still, according to the
commercial manager, the overall costs of contacting, contracting and controlling
suppliers are relevant to the management.
6DOHVPDQDJHPHQW
In this section we to study if Keih Bahri Tannery creates value by managing working
capital operations of sales. With this objective in mind we asked questions on sales
policy, selling and distribution techniques, sales activities and costs, approaches of
contacting, contracting and control of customers. For detailed information on
6DOHVSROLF\ The sales technique applied is that buyers come to the factory site with
a production order, on the basis of which the factory produces. When the production
process is completed the factory informs the customers to collect the goods.
According to the financial manager, Keih Bahri Tannery sells to the private buyers only
on cash basis because there is high uncertainty that debtors may not pay back and there
Chapter 7 158
is also no tradition of buying and selling on credit. However, he believes that it is not
because customers do not ask for credit or there is lack of information on credit
applicants. Since Keih Bahri Tannery sells only on a cash basis it does not have any
policy of credit granting and control of credit standards. The financial manager believes
this policy may be affecting the volume of sales and its customer relation. The firm sells
its products mainly to the local markets and rarely to foreign markets. The objective of
Keih Bahri Tannery’s sales policy is to take care of regular customer demands and
expand its market share but rarely to decrease inventory holding costs or to meet
seasonal sales requirement. The main base that it uses to forecasts its sales requirements
are mainly the production capacity and customer demands, the objective of which is to
establish the quantity on hand and on order, to determine the safety stock requirement
and inventory usage.
&RQWDFWLQJ FRQWUDFWLQJ DQG FRQWUROOLQJ Keih Bahri Tannery’s

FXVWRPHUV
approach of finding markets for its products is by getting directly in contact with
potential customers and attending trade fairs and exhibitions. The commercial
manager believes that the overall cost incurred in the process of contacting customers
is relevant to the management. It also negotiates the sales agreement with potential
customers, including the terms of sale and evaluates the proposed purchase terms of
its customer. Keih Bahri Tannery also relies on the commitment and trust of its
customers. He believes that the overall costs of contacting customers, getting into
contract and controlling sales agreements is relevant to the management. Therefore, it
uses approaches such as making terms of agreement known in advance, developing
long-lasting relationships and routine contract agreements but rarely employs lawyers
or sales agents.
0DQDJLQJZRUNLQJFDSLWDORSHUDWLRQV&RPSDULVRQRIWUDQVLWLRQILUPV
Here, we present a comparative analysis of the transition firms’ management of working

capital operations of purchasing materials and selling finished goods.
7KH SXUFKDVH RSHUDWLRQ According to the commercial managers, the firms in
transition to privatisation have no clear policy on the purchase of their materials. It is

only Keih Bahri Tannery that manages its purchase of materials mainly to take
advantage of quantity and cash discounts, while Dahlack Shoe Factory also reported that
it has a policy of decreasing holding costs and meeting seasonal production
requirements. All reported that they forecast purchase requirements based on the
expected sales volume. While Lamba Sack Factory and Dahlak Shoe Factory use the
opinion of their purchasing staff, Dahlak Shoe Factory and Keih Bahri Tannery use their
past experiences to estimate purchase requirements. They all purchase on cash basis
from the cheapest source. The reason why they do not buy on credit at least from the
local market with all the firms is because suppliers do not provide credit. Lamba Sack
Factory, Dahlack Shoe Factory and Keih Bahri Tannery also reported that there is no
tradition of buying and selling on credit.
All the firms make efforts to contact and screen suppliers as well as to describe the
materials to a potential supplier. In order to contact, enter into contract and control
suppliers the firms choose the cheapest channel of communication, with routine
agreements where terms are known in advance to the partners (see Appendix 7.2.3.1-F).
However, only Keih Bahri Tannery reported that the costs of these efforts to be relevant.
7KHVDOHVRSHUDWLRQ The sales policy of the firms in transition to privatisation is to
take care of customer demands and meet seasonal sales requirements but not to
decrease cost of inventory holding or expand market share except for Keih Bahri
Tannery. All transition firms forecast sales according to their past experience and
statistical forecasting approaches with the objective of estimating future demands.
Except for Asmara Textile Factory and Lalmba Sack Factory, other transition firms sell
on cash basis so for these firms there is no question of customers defaulting. All firms
except Keih Bahri Tannery said that there is no probability of customers backing down
from their agreement and the difficulty of getting another partner is small for the
transition firms. While all transition firms reported that they use the cheapest channel of
communication, Asmara Textile Factiory, Dahlack Shoe Factory and Keih Bahri
Tannery also make their terms known in advance, develop long lasting relationships and
customer trust to manage the costs of contact, contract and control of sales transactions.
However, it is only Keih Bahri Tannery, which considers that the costs of contact,
contract and control of sales transactions to be relevant.
Here, we study if and how the transition firms make performance evaluation of their
working capital decisions regarding levels of investment and financing as well as
operations of purchasing and selling. First, we asked the managers if and how they
evaluate their working capital decisions. Then, we used the firms’ financial statements to
analyse the performance of working capital levels and operations. For detailed
information refer to Appendix 7.2.3.3 on performance evaluation of working capital
decisions, Appendix 7.2.3.4 for financial analysis of Keih Bahri Tannery and
Appendix 7.2.3.5 for a comparative financial analysis of the transition firms.
:RUNLQJ FDSLWDO SHUIRUPDQFH HYDOXDWLRQ FULWHULD According to the financial

manager, Keih Bahri Tannery has a policy of comparing its working capital
investment performance with other firms using specific criteria of inter-firm
benchmarks. As Appendix 7.2.3.3 reveals the firm also evaluates its internal
performance of working capital investment decisions by comparing the performance
of the past with the present and the actual with the expected. However, it does not use
any customer satisfaction or accounting based approaches to evaluate its performance.
We nevertheless computed accounting ratios to study the firm’s financial
performance. We divided the evaluation of Keih Bahri Tannery’s financial
performance into three sections. First, we studied its investment composition using
asset structure ratios, second, the liquidity ratios and short-term financing composition
are used to evaluate the firms’ working capital financing and lastly, we used activity
and profitability ratios to study the firms overall efficiency in turning over the assets
and generating profit.
Chapter 7 160
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOLQYHVWPHQW
:RUNLQJ FDSLWDO LQYHVWPHQW FRPSRVLWLRQ In order to find Keih Bahri Tannery’s

investment composition, we evaluated its financial statement data using asset structure
ratios. The main asset structure ratio relevant to our study is working capital to total
assets and its breakdowns, particularly cash, receivables and inventory to working
capital ratios. We used the terms “inventories and stock” as well as “accounts
receivable and debtors” inter-changeably. We have used the terms inventories and
receivables in our literature review while empirically we found that the firms in
Eritrea use the terms “stock” for inventories and “debtors” for accounts receivable.
is expressed in percentages and may indicate the

:RUNLQJ FDSLWDO WR WRWDO DVVHWV UDWLR
extent that the firm uses working capital assets. It can also be used to study if such a
composition is sound given the nature of the activities the firm is in. Asset structure
ratios of Keih Bahri Tannery for the seven years studied indicate that, on the average
91% of total investment is in current assets. Taking the global norm of 50% into
consideration, this working capital to total assets investment ratio is very high. This is a
reflection of the absence of investments in fixed assets. This working capital to total
assets investment ratio has increased from a percentage 59% in 1996 to as high as 98%
in 1999 and 2000 (See figure 7-1). Normally, this is at the expense of expanding
production capacity by investing in more productive fixed assets in the long-term.
Therefore, the low production capacity and profit margins experienced by Keih Bahri
Tannery may also be due to this high current asset investment.
)LJXUH$VVHWVWUXFWXUHDQGFXUUHQWGHEWOHYHUDJH±.HLK%DKUL7DQQHU\
120%
100%
80%
Current asset to total assets
60%
Short-term debt to total asset
ratio
40%
20%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
As it is revealed by Figure 7-1, the short-term debt compared to the total assets
accounted to relatively smaller percentage. This implies that the leverage of short-
term financing is relatively small in the total assets. We also computed inventory to
working capital, receivables to working capital and cash to working capital, which on
average accounted to 56%, 25% and 19% respectively. A reference to Figure 7-2
reveals that the firm’s major working capital investment is on inventory, which has
moderately increased during the seven years. Generally, the composition of inventory
in the total working capital assets is large (see Appendix 7.2.63.4 and Figure 7-2),
which normally implies a warning on the policy of working capital management
particularly with respect to inventory management.
)LJXUH:RUNLQJFDSLWDOLQYHVWPHQWFRPSRVLWLRQ±.HLK%DKUL7DQQHU\
80%
70%
60%
50% Stocks
40% Debtors
30% Cash
20%
10%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUN The analysis of Keih Bahri Tannery’s asset structure ratios has
revealed that the firm has excessively invested on working capital whose turnover is
very slow (see figure 7-5 on working capital activity). This implies that it misses both
targets of minimising investments in current assets and increasing the activity of
working capital investments. This indicates that the firm is not doing well as far as
working capital investment is concerned. The financial analysis also shows an
excessively large proportion of investment in inventories, which contradicts with the
manager’s opinion that inventory management is no problem to the firm. Investment
in receivables, which is mostly owed by related enterprises (other government or
transition firms), is not as large. Moreover, the fact that debtors are related
government firms gives less risk of bad debts.
Here, we use ratios on liquidity and short-term financing composition to study Keih
Bahri Tannery’s liquidity management and the use of short-term financing sources. We
analysed Keih Bahri Tannery’s short-term financing in order to study how the firm’s
investments are financed and its liquidity position. Detailed information regarding
liquidity ratios and short-term financing compositions are indicated in Appendix 7.2.3.4.
/LTXLGLW\ SRVLWLRQ The ability to pay debts as they fall due and the degree of
certainty and ease with which an asset is converted into cash is measured using
liquidity ratios. The liquidity position is analysed using the current ratio and the quick
ratio, which for the seven years averaged 2.2 and 1.0 respectively. As figure 7-3
shows, during the seven years, the firm has maintained a more or less constant above
the global norm current ratio and quick ratio and we can therefore conclude that it has
satisfactory liquidity position.
Chapter 7 162
)LJXUH/LTXLGLW\SRVLWLRQ±.HLK%DKUL7DQQHU\
3,0
2,5
2,0
Current ratio
1,5
Quick ratio
1,0
0,5
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
6KRUWWHUP ILQDQFLQJ FRPSRVLWLRQ: As it is indicated in Appendix 7.2.3.4 and
Figure 7-4, short-term financing of Keih Bahri Tannery is composed mainly of trade
creditors which accounted on the average 64% of the total short-term financing also
include the debt to related enterprises. However, we have observed from the firms
balance sheet that the credits to “related enterprises” (that is to other government and
transition firms) has been paid back in total in 1997 after the firm was slated for
privatisation. The remaining short-term financing includes other sources, particularly
provision for taxation amounting to 36% on the average. The factory does not use
short-term bank loans or bank overdraft to finance its working capital investments
(see also figure 7.4).
)LJXUH6KRUWWHUPILQDQFLQJFRPSRVLWLRQ±.HLK%DKUL7DQQHU\
80%
70%
60%
50%
Trade creditors
40%
Others
30%
20%
10%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
We used activity and profitability ratios to study how efficient and profitable Keih Bahri
Tannery’s investments and operations are managed.
We wanted to know how

2SHUDWLRQDO HIILFLHQF\ RI ZRUNLQJ FDSLWDO DFWLYLWLHV
efficient the management of Keih Bahri Tannery turns over each type of working
capital element. We measured the operational efficiency of working capital activities
using activity ratios including inventory turnover, receivables turnover and overall
working capital turnover. The turnovers are also converted to average days they are
held before they are sold (inventory) and collected (receivables). ,QYHQWRU\ WXUQRYHU
indicates the rapidity with which inventory is turned over to cash through sales.
Inventory turnover of Keih Bahri Tannery for the seven years indicates that annual
cost of goods sold is on the average 0.8 times average inventory. This implies
inventories were held an average of 456 days. 5HFHLYDEOHV WXUQRYHU measures the
number of times credit sales or receivables is turned over to cash. The firm’s average
receivables indicate that annual sales was 1.3 times average receivables or 281 days
accounts receivable held uncollected. 2YHUDOOZRUNLQJFDSLWDOWXUQRYHU, measures the
capacity of working capital to generate sales volume and was 1.0 times average
current assets. As Figure 7-4 clearly shows the firm’s working capital turnovers are
decreasing during the seven years of study.
)LJXUH:RUNLQJFDSLWDODFWLYLW\±.HLK%DKUL7DQQHU\
4,0
3,5
3,0
Inventory turnover
2,5
Account Receivable
2,0
turnover
1,0
0,5
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUNV Our activity analysis shows a very slow inventory and
receivables turnover and long periods of inventory and receivables held. The above
analysis of working capital turnovers indicates that all types of current assets turned
over very slowly. These low turnovers also reveal the firm’s inefficient inventory
management, non-existent receivable collection policy, low sales as a result of non-
encouraging sales policy (we have observed that one of its major customers - Asmara
Sweater Factory - has shifted to another competitor recently) and low levels of
production capacity. These aspects indicate that the firm is not doing very well as far
as the decision related to the management of working capital activities is concerned.
2YHUDOO SURILWDELOLW\ We have analysed profitability ratios, in order to assess the

profitability of Keih Bahri Tannery’s seven year operations. These ratios relate the
firm’s gross and net profits to sales as well as net profits to total assets and
respectively include, gross profit margin, operating profit margin and return on total
assets. As Appendix 7.2.3.4 shows, the firm’s average gross profit margin amounted to
34%, net profit margin was 15% and the return on assets 14%. It can also be observed
from Figure 7-6 that the firm has a quite good profit position. As it is revealed earlier in
Chapter 7 164
this chapter the firm has more or less monopolistic market position. In addition
private firms have not yet entered the market except for the comparatively very small
import firms owned by individuals or families. This profitability rate is also a result of
the firm’s ability to purchase raw materials at favourable terms, efficient utilisation of
plant and machinery and lowering cost of production. The firm’s relatively more
efficient management of its backward linkages may have also contributed to this high
profitability. Moreover, a reference to Figure 7-6 indicates that the profitability ratios
have been more or less constant since 1996.
)LJXUH2YHUDOOSURILWDELOLW\±.HLK%DKUL7DQQHU\
50%
40%
30%
Gross profit margin
20% Net profit margin
Return on asset
10%
0%
1994 1995 1996 1997 1998 1999 2000
-10%
6RXUFH$SSHQGL[
&DVK IORZ $QDO\VLV It can be observed from table 7-1 that the net cash inflows of
Keih Bahri Tannery except for 1996 and 1999 ended at positive balance. It can
moreover also be observed that both the changes in working capital assets (stocks and
debtors) had an average negative impact on the net cash flow while the changes in
creditors had positive effect. The fact that the overall net cash flow ended up at a
positive average implies also that the major sources of cash for the firm were items
other than stocks, debtors and creditors, implying that these items did not make much
contribution to the net cash inflows of the firm.
Table 7-1: Cash flow Analysis – Keih Bahri Tannery (figures in ‘000)
1995 1996 1997 1998 1999 2000 Average
$$QQXDOQHWFDVKIORZ 1903 -954 1042 1252 -904 630 494
%1HWFDVKIORZWRWRWDODVVHWV 2% -8% 9% 8% -8% 5% 1%
'$QQXDOFKDQJH
Increase (-), decrease: stocks* -1911 -2605 1407 -1241 1252 -175 -545
Increase (-), decrease: debtors* -185 -788 -1317 -450 1582 28 -189
Increase, decrease (-): creditors** 138 -222 1093 1282 -1218 568 273
($QQXDOHIIHFWRQ1&)
Increase (-), decrease: stocks -100% 273% 135% -99% -139% -28% -144%
Increase (-), decrease: debtors -10% 83% -126% -36% -175% 4% -58%
Increase, decrease (-): creditors 7% 23% 105% 102% 135% 90% 88%
Others 103% -279% -114% 33% 179% -66% 114%
Source: computed from the firm’s financial statements
:RUNLQJFDSLWDOSHUIRUPDQFHFRPSDULVRQRIWUDQVLWLRQILUPV
In order to study the impact of management’s decisions on the transition firms’

investments, financing and operations, relevant ratios have been computed from the
firms’ financial statements. For more information refer to Appendix 7.2.3.3 for
comparative performance measurement and evaluation criteria applied by the
transition firms and Appendix 7.2.3.5 for comparative accounting based performance
evaluation.

managers, the transition firms (except Asmara Textile Factory) evaluate their
performance of working capital investment decision by using a comparative analysis
of past versus present and actual versus expected. However, none of them uses inter-
industry benchmarks. Moreover, except Lalmba Sack Factory, which reported that it
uses almost all the accounting and customer satisfaction measures of performance, the
other firms reported that they use none of them. The computation of the firms’
accounting based performance evaluation reveals the following results.
,QYHVWPHQW Here we compare asset structure ratios of the five transition firms. The
seven-year average composition of current assets to total assets revealed 97% for
Asmara Textile Factory, 64% for Lalmba Sack Factory, 92% for Sembel House Hold
Factory, 86% for Dahlak Shoe Factory and 91% for Keih Bahri Tannery.
The seven year average working capital investment composition on inventories,

receivables and cash respectively shows 88%, 10% and 1% for Asmara Textiles Factory,
80%, 18% and 2% for Lalmba Sack Factory, 95%, 5% and 0% for Sembel House Hold
Factory, 84%, 11% and 5% for Dahlak Shoe Factory. As it has been indicated earlier the
inventory, receivables and cash investment composition for Keih Bahri Tannery was
56%, 25% and 19% respectively.
It could be observed from the above information on current assets to total assets and
working capital investment composition that Asmara Textile Factory has the highest
(97%) current asset composition, 88% of which is invested in inventories. The second to
Asmara Textile Factory current asset composition is Sembel House Hold Factory with
92% of total assets invested in current assets out of which 95% is on inventories.
)LQDQFLQJ We analysed the overall financing management of the transition firms

using liquidity ratios, particularly current and quick ratios. The current and quick ratio
positions respectively for the transition firms show an average of 0.7 and 0.1 for Asmara
Textiles Factory, 1.8 and 0.4 for Lalmba Sack Factory 1.4 and 0.1 for Sembel House
Hold Factory, 1.5 and 0.3 for Dahlak Shoe Factory. As it was mentioned earlier in this
chapter the current and quick ratios for Keih Bahri Tannery were respectively 2.2 and 1.
Asmara Textile Factory has recorded the lowest liquidity position while Keih Bahri
Tannery is the most liquid transition firm.
The average working capital financing composition of trade creditors, short-term

bank loans, bank overdrafts and others accruals respectively shows 52%, 5%, 38%, 4%
for Asmara Textiles Factory, 76%, 5%, 18%, 4%, for Lalmba Sack Factory. Moreover,
trade creditors, short-term bank loans, bank overdrafts and others accruals respectively
were 47%, 0%, 25%, 29%, for Sembel House Hold Factory and 58%, 0%, 19%, 23%,
Chapter 7 166
for Dahlak Shoe Factory. As it has been indicated earlier that of Keih Bahri Tannery was
64%, 0%, 0%, 36%, respectively. Trade creditors (which includes credits to related
firms) is observed to be the main source of finance while the short-term bank loans is the
least used in all the transition firms.
2SHUDWLRQV Profitability and activity ratios are used to study a firms’ efficiency of its
overall operations. The seven year average activity ratios – inventory, receivables and
working capital turnovers respectively revealed 0.7, 1.2 and 1.2 for Asmara Textiles
Factory, 0.4, 0.7 and 0.7 for Lalmba Sack Factory, 0.1, 10.4 and 0.6 for Sembel House
Hold Factory, 0.5, 2.0 and 0.9 for Dahlak Shoe Factory. As it has been indicated earlier
the inventory, receivables and working capital turnovers for Keih Bahri Tannery were
0.8, 1.3 and 1.0 respectively. The receivables turnovers for Sembel House Hold
Fascotrry and Dahlack Shoe Factory indicates excessively high and abnormal ratio.
Otherwise, Asmara Textile Factory and Keh Bahri tannery scored the highest while the
other three transition firms have relatively low working capital turnovers.
Profitability (gross profit, net profit and return on assets) ratios for the seven years
averaged respectively -8%, -11% and -13% for Asmara Textiles Factory, 11%, -20% and
-5% for Lalmba Sack Factory, 20%, -22% and -2% for Sembel House Hold Factory,
13%, 4% and 4% for Dahlak Shoe Factory. The inventory, receivables and working
capital turnovers for Keih Bahri Tannery were 34%, 15% and 14% respectively. Keih
Bahri Tannery with 15% and 14% and Dahlack Shoe Factory with only 4% each for net
profits and return on assets are the only transition firms which have made profits during
the seven years that we have studied. The other three transition firms reported negative
returns through out the seven years of our study.
&DVKIORZ$QDO\VLV Comparison of net cash flows of the five transition firms revealed
that all except Asmara Textile Factory and Keih Bahri Tannery had experienced
negative net cash flows on the average during the years because both the working
capital assets have showed an increasing trend. The largest impact on net cash flows
for Asmara Textile Factory and Keih Bahri Tannery was by the stocks while debtors
made the largest impact for the other three firms.
&RQFOXGLQJUHPDUNV Comparing the transition firms’ average composition of current

assets in the total assets with the global norm of 50% gives a clear indication that their
major investment is in current assets. As we have understood from the interviews with
the firms’ managers this is because the government has followed a policy of not
investing in the transition firms because they are in the process of privatisation.
Therefore, investment in capital assets is completely disregarded. This has resulted in the
firms’ serious problem of production capacity and sales. More than 80% of the
investment in working capital for all the firms, (except for Keih Bahri Tannery) is on
inventories. Asmara Textiles Factory has the highest current asset to total asset ratio
(97%).
The liquidity ratios indicate that all transition firms except Lalmba Sack Factory and
Keih Bahri Tannery face liquidity problems because both current and quick ratios are
well below the acceptable global norm of 2 for current ratio and 1 for quick ratio. It is
also observed that Asmara Textiles Factory, which has the highest current to total asset
ratio, has also the lowest current and quick ratios. This implies that the excessive current
asset investment is financed with current liabilities and that the firm may possibly face
liquidity problems. The analyses of the working capital activities indicate that all the
firms have extremely low inventory, receivables and overall working capital turnovers.
The implication of this is that the firms are holding their inventories and receivables for a
very long period, which is a sign of inefficiency in working capital management. As for
the profitability ratios, three out of the seven firms reveal that they experienced losses
and ended up at a negative return on assets during the seven years.
([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQWVXSSOLHUDQGFXVWRPHUOLQNDJHV
This section explores if the transition firms have proper inter-firm co-operation with
their suppliers and customers. We evaluate if the transition firms have proper inter-
firm co-operation with their suppliers and customers on the primary activities as well
as on sale/purchase operations and inventory management. We also asked what
benefits they get as a result of their co-operation or why they do not co-operate.
Therefore, we review the response of one of the transition firms – Keih Bahri Tannery
and compare the responses of the transition firms. We also examine the responses of
their suppliers and customers. For detailed information on external working capital
management particularly, for the responses of firms on firm-supplier co-operation and
firm-customer co-operation, see Appendix 7.3.1. See also Appendix 7.3.2 for
response of suppliers and Appendix 7.3.3 for responses of customers.
The objective of this section is to study how transition firms manage supplier linkages.
We asked the firms’ management if and how they co-operate with suppliers on primary
activities, as well as purchase operations and inventory management. We also inquired
about the benefits of firm-supplier co-operation or reasons for the lack of firm-supplier
co-operation.
5HVSRQVHVRIWKHFHQWUDOILUPV.HLK%DKUL7DQQHU\
)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to its general
manager, the specific activities thatKeih Bahri Tannery strongly co-ordinates with its
suppliers include in most inbound activities, production operations and outbound
activities. On the primary activities of marketing and sales it co-operates only on the
purchase channel selection. It also co-operates on the after sales services like
installation, parts supply and products adjustment. However, the general manager
also believes the firm does not co-operate with its suppliers on primary activities such
as advertising, promotion and sales force as well as on the primary activity of after
sales service, particularly on repair and customer training.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW Keih Bahri
Tannery co-ordinates its materials purchase and inventory management with suppliers
by specifically agreeing on the timing, quality and quantity of materials to be
purchased as well as the terms of transportation. However, the firm’s co-operation
policy is only with selective suppliers because the commercial manager believes it is
not beneficial to co-operate with all suppliers. In addition to this some suppliers also
Chapter 7 168
lack the willingness to co-operate. Moreover, the financial manager agrees that this
co-operation reduces the cost of inventory ordering and carrying, the time and cost of
purchasing materials and that it helps in creating firm-supplier trust.
&RQFOXGLQJ UHPDUNV The commercial manager of Keih Bari Tannery believes that
his firm co-operates with its suppliers on most primary activities as well as activities of
purchase operations. This co-operation creates inter-firm trust and reduces the cost of
inventory carrying and ordering as well as the cost of purchasing and time it takes to
purchase the materials. Keih Bahri Tannery is one of the very few firms that have close
firm-supplier co-operation. It has a very strong supplier network through out the country.
It gives its suppliers incentives such as preservative chemicals and transportation
facilities for their goods from their location to its factory site. As a result of this it is able
to generate more income and decrease costs. This assertion is supported by the findings
in its financial statements, which indicate that compared to the other transition firms it
has the highest gross and net profit percentage and the highest liquidity positions.
)LUPVXSSOLHUFRRSHUDWLRQ&RPSDULVRQRIWUDQVLWLRQILUPV
)LUPVXSSOLHU FRRSHUDWLRQRQ SULPDU\ DFWLYLWLHV Asmara Textiles, Dahlack Shoe
Factory and Keih Bahri Tannery responded that they co-ordinate inbound activities
with their suppliers. Asmara Textiles Factory and Keih Bahri Tannery also co-operate
on production operations. Except for Keih Bahri Tannery and Asmara Textile Factory
the other three firms have no co-operation linkages with their suppliers on production
operations, marketing/sales or after sales service.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW The
commercial managers of the transition firms (except for Eritrea Steel Sheets Factory)
responded that they co-operate with their suppliers specifically on the timing, on the
quality and quantity of materials to be purchased as well as the terms of
transportation. They believe this co-operation reduces the time needed to purchase
their materials as well as the cost of purchasing materials and carrying inventory of
materials. This co-operation, they believe, helps them in creating firm-supplier trust.
&RQFOXGLQJ UHPDUNV Three out of the five transition firms co-operate with their
suppliers on primary activities related to the inbound activities and two of them in
production operations but all do not co-operate on marketing and sales. Only Dahlack
Shoe Factory and Keih Bahri Tannery reported of firm-supplier co-operation on after
sales service particularly parts supply and product adjustment. All except Sembel House
Hold Factory co-operate with their suppliers on purchase related activities and inventory
management (see Appendix 7.3.1.1-B). Moreover, the transition firms believe that their
co-operation with their suppliers helps them to reduce the time needed to purchase their
materials as well as the cost of purchasing materials and carrying inventory of
materials and that it creates firm-supplier trust. However we observed that, since the
transition firms are still government owned they reveal typical characteristics of the
government firms. Particularly, we observed (except for Keih Bahri Tannery) that they
care very little about establishing strong long-term firm-supplier relationship with the
private suppliers. The fact that they are in transition to privatisation has also put their
managers into a very uncertain future position, crippling their managerial confidence and
job security. As a result of which very few of them have officially pursued objectives
and/or mission statements on how to achieve their objectives.
5HVSRQVHVRIVXSSOLHU$VPHODVK+LGHVDQG6NLQV
We also had to find the responses of the suppliers of the transition firms, in order to
answer part 2(b) of the research question: “How do the transition firms in Eritrea manage
their supplier linkages”. We evaluated the firm-supplier co-operation on primary
activities and on sales and inventory management as well as related benefits or the
reasons for non-co-operation. Finally we study the supplier evaluation of the central
firm efficiency. So, we approached Asmelash Hides and Skins, one of the main
suppliers of Keih Bahri Tannery whose general manger responses follow. For more
detailed information on the responses of the suppliers of the transition firms on firm-
supplier co-operation, see Appendix 7.3.2.
)LUPVXSSOLHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV According to the general manager

of Asmelash Hides and Skins the two firms co-operate only on some outbound
activities, particularly delivery vehicle operation and order processing but not on finished
goods warehousing or inventory control. Overall, the manager believes that his firm
does not co-operate with Keih Bahri Tannery on most primary activities. Specifically,
the two firms do not co-operate on, production operations (machining, packaging,
assembly, equipment maintenance, product testing or facility operations), marketing and
sales (advertising, promotion, sales force, sales channel selection) and after sale service
(installation, repair, customer training, parts supply or product adjustment). According to
its general manager, Asmelash Hides and Skins is not co-operating with Keih Bahri
Tannery on the primary activities because the Keih Bahri Tannery has not developed a
culture of co-ordinating with its suppliers.
)LUPVXSSOLHUFRRSHUDWLRQRQ VDOHV DQG LQYHQWRU\PDQDJHPHQW The manager of

Asmelash Hides and Skins believes that his firm co-ordinates its sales ordering
procedure with Keih Bahri Tannery’s purchase procedure. It is co-ordinated in such a
way that Keih Bahri Tannery does not need to order now and then. Asmelash Hides
and Skins buys and collects the raw materials, which it stores until enough materials
are collected, then informs Keih Bahri Tannery to pick up the materials. Keih Bahri
Tannery uses its own means of transportation and also supplies Asmelash Hides and
Skins with salt free of charge to preserve the materials. The two firms make their sale-
purchase transactions on a cash basis, so Keih Bahri Tannery pays cash once the
quality and quantity is checked and approved by its management. However, the
manager of Asmelash Hides and Skins has reservations with regard to exchanging
skilled staff and credit facilities. He believes that Keih Bahri Tannery does not co-
operate in providing credit facilities and he said that, ³.HLK %DKUL 7DQQHU\ LV YHU\
VORZ LQ UHVSRQGLQJ WR WKH UHTXHVW RI VHQGLQJ WUDQVSRUWDWLRQ WR SLFNXS WKH PDWHULDOV
”. Despite of these shortcomings the manger of

DQG LW VRPHWLPHV HYHQ UHIXVHV WR EX\
Asmelash Hides and Skins believes that the inter-firm co-operation with Keih Bahri
Tannery enables his firm to decrease the time needed to sell the goods, the cost of
selling as well as the cost of ordering and transportation (see Appendix 7.3.2C).
6XSSOLHUHYDOXDWLRQRIILUPHIILFLHQF\ The manager of Asmelash Hides and Skins
believes that his firm’s relation with Keih Bahri Tannery is not good enough. The
Chapter 7 170
manager’s opinion is that, even though Keih Bahri Tannery is efficient in its payment
habits, it is less efficient in processing its purchase orders, marketing approach,
bilateral communication, explanation to inquiries, in taking advantage of the services
that Asmelash Hides and Skins offers and in its courtesy.
&RQFOXGLQJ UHPDUNV: We particularly inquired on Keih Bahri Tannery’s firm-
supplier co-operation from the point of view of its main supplier – Asmelash Hides and
Skins. As a result of the interviews that we conducted with the manager of Asmelash
Hides and Skins we find that the strongest link is on the purchase/sales operation. Keih
Bahri Tannery helps its suppliers in transporting the materials to its factory thereby
decreasing the costs of transportation of its supplier and it also provides them with
preservatives so that their storage costs, particularly loss due to spoilage is reduced. The
weakest link is on the primary activities such as production, marketing and after sale
operations as well as providing credit facilities. This according to the supplier of Keih
Bahri Tannery is limiting its operational capacity and liquidity.
)LUPVXSSOLHUFRRSHUDWLRQFRPSDULVRQRIVXSSOLHUVRIWUDQVLWLRQILUPV
In order to get a comparative knowledge of inter-firm co-operation on the supplier side;

we approached the suppliers of three firms in transition to privatisation. These suppliers
include, Alighider Agricultural Project - supplier of Asmara Textile Factory, Keih
Bahri Tannery - supplier of Dahlak Shoe Factory as well as Asmelash Hides and
Skins - supplier of Keih Bahri Tannery. The questions asked to the suppliers refer to
their co-operation on the primary activities, with particular emphasis on purchase
operation, inventory management and evaluation of the firms’ efficiency. For detailed
information of suppliers’ response on firm-supplier co-operation, refer to Appendix
7.3.2.
)LUPVXSSOLHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV Overall the suppliers believe that

they are not co-operating on the primary activities with the firms in transition.
Particularly, they all agree that they do not co-operate on production operations
(machining, packaging, assembly, equipment maintenance, product testing or facility
operations), marketing and sales (advertising, promotion, sales force, sales channel
selection) as well as after sale service (installation, repair, customer training, parts
supply and product adjustment). The supplier who responded positively on the inter-
firm co-operation on outbound activities such as delivery vehicle operation is the
supplier of Keih Bahri Tannery. Suppliers of Dahlak Shoe Factory and Keih Bahri
Tannery also reported that they co-operate on order processing. Most of the suppliers
of transition firms (except for the supplier of Keih Bahri Tannery) responded that they
do not co-operate on finished goods warehousing and inventory control.
)LUPVXSSOLHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW : The suppliers do

not believe that they efficiently co-operate their sales and inventory management with
the transition firms. The only co-operation reported is between Asmara Textile
Factory and its supplier on credit transactions without discount and between Dahlack
Shoe Factory and its supplier on providing goods when just needed. They all do not
have co-operation agreements on exchanging skilled staff or credit transactions with
discounts.
The main reason for the lack of co-operation they believe is because the transition
firms have not developed the business culture of co-ordinating their primary activities
as well as sales and inventory management policies. Moreover, all the suppliers
believe that the lack of co-operation is not because they do not have the specific
policy or that they do not see the benefit of closely working with specific customers.
Though they reported of the above shortcomings, the suppliers of Asmara Textile
Factory and Keih Bahri Tannery believe that the limited inter-firm co-operation helps
them to decrease the time needed to sell the goods, the cost of selling as well as the
cost of ordering and transportation. The supplier of Asmara Textile Factory also
reported that its co-operation helps it to decrease the carrying costs of finished goods
inventory as well as in creating inter-firm trust.
6XSSOLHUVHYDOXDWLRQRIILUPHIILFLHQF\The suppliers’ opinion is that the transition
firms are efficient only in their payment habits. It is only the supplier of Asmara
Textile Factory who is satisfied with inter-firm co-operation and rated the firms as
efficient in processing purchase orders, bilateral communication and explanation to
inquiries, marketing approach and courtesy but not in using the services that the
supplier provides. The suppliers of Keih Bahri Tannery and Dahlack Shoe Factory
agree that, the transition firms are not efficient in processing purchase orders, bilateral
communication and explanation to inquiries as well as marketing approach and
courtesy.
&RQFOXGLQJ UHPDUNV Overall, the suppliers’ responses reveal that the transition
firms do not co-operate with their suppliers. With the exception of the few primary
activities that Keih Bahri Tannery co-ordinates with its supplier, the transition firms’
supplier linkages are very weak on all primary activities, purchase operations and
inventory management. The suppliers’ responses also indicate that the overall
efficiency of transition firms is poor. The interviews conducted with the managers of
the suppliers indicate that they all would like to have a closer link with the central
firms if it were not for the lack of co-operation from side of the transition firms.
In order to study how efficient transition firms manage their customer linkages we
studied their general and commercial managers’ response about what and how they co-
operate on primary activities, particularly, sales operations and inventory management.
5HVSRQVHVRIWKHFHQWUDOILUPV.HLK%DKUL7DQQHU\
This section deals with the firm-customer co-operation from the point of view of Keih
Bahri Tannery and its customer Selamawit Shoe Factory. For detailed information on
the response of the managers of Keih Bahri Tannery and the other transition firms,
refer to Appendix 7.3.1.2.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to the general
manager of Keih Bahri Tannery, the firm co-ordinates its primary activities with its
customers. These customer co-ordinated primary activities include, inbound activities
(receiving, storing, distributing to production, and inventory control), production
Chapter 7 172
operations (machining, assembling, equipment maintenance and product testing),

outbound activities (finished goods warehousing and handling as well as order
processing). However, according to the firm’s commercial manager, the firm does not
co-operate with its customers on all primary activities related to marketing and sales
and after sales service. Where there is no firm-customer co-ordination, the manager’s
opinion is that it is because some customers have not developed the business culture
and at times Keih Bahri Tannery does not see the benefit of closely working with
specific customers. But the commercial manager believes that it is not because due to
Keih Bahri Tannery’s lack of policy on inter-firm co-operation.
firm’s commercial manager Keih Bahri Tannery co-ordinates its sales and inventory
management with customers. It specifically agrees on the terms of transportation, the
quality and quantity of goods to be produced and presented to the customers on the
basis of just in time. According to the financial manager the benefit that Keih Bahri
Tannery gets as a result of its inter-firm co-operation include, minimising the cost of
transportation, decrease the cost of carrying inventories and increasing sales. As for
the reason of non-co-operation with customers, the main reasons according to the
firm’s commercial manager are that the firm’s customers do not co-operate and the
firm does not see the benefit of co-operation as well.
$VVHVVLQJ FXVWRPHU VDWLVIDFWLRQ According to the commercial manager, Keih
Bahri Tannery gets customers feed back on the quality of its products and services by
making periodic assessments of customer opinion. It also allows customers to return
any product with inferior quality in addition to making strict quality control at the
production floor. However, it does not give its customer the option of paying only if
the products are as per their expectation. As per the general manager's opinion, the
factory’s customers sometimes show their dissatisfaction with regard to the speed of
production and quality of products. The manager agrees on the firm’s weakness here and
he traces the problem to the old machines and the lack of skilled labour. He says´7KH
ROGPDFKLQHVZKLFKGRQRWJHWSURSHUPDLQWHQDQFHDQGUHSDLUDUHFDXVLQJXQDFFHSWDEOH
GHOD\V DQG UHGXFH SURGXFW TXDOLW\ 7KH ODFN RI TXDOLW\ ODERXU LV DQRWKHU SUREOHP
EHFDXVHDOPRVWDOOWKHEHVWRIWKHZHOOWUDLQHGDQGSURGXFWLYHZRUNHUVKDYHJRQHWRWKH
ZDU IURQW´ He also adds, ³6LQFH .HLK %DKUL 7DQQHU\ LV LQ WUDQVLWLRQ WR SULYDWLVDWLRQ
WKH JRYHUQPHQW GRHV QRW DSSURYH DQ\ FDSLWDO LQYHVWPHQW RU PDMRU UHSDLUV GXULQJ WKLV
WUDQVLWLRQSHULRG ”.
&RQFOXGLQJ UHPDUNV According to interviews conducted and the questionnaire data
collected from the commercial and general mangers of Keih Bahri Tannery, it can be
concluded that its firm-customer linkages is strong on co-ordinating primary activities,
particularly, outbound activities and production operation. However, the firm has very
weak firm-customer co-operation on marketing and sales (particularly it lacks a sales
credit policy) and after sales service. Therefore, its firm-customer co-operation policy is
concerned with cost reduction while it does very little to increase sales. Nevertheless, the
firm’s managers believe that Keih Bahri Tannery benefits as result of its co-operation
with its customers.
)LUPFXVWRPHUFRRSHUDWLRQ&RPSDULVRQRIWUDQVLWLRQILUPV
With the exception of the activities that Keih

&RRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV
Bahri Tannery co-ordinates with its customers, the other firms response indicates very
low firm-customer co-operation on any primary activities. Dahlack Shoe Factory co-
operates only on outbound activities particularly finished goods warehousing, delivery
vehicle operation and order processing while Lalmba Sack Factory also co-operates
on outbound activities of finished goods warehousing and handling.
)LUPFXVWRPHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW The commercial

managers of the transition firms reported in the questionnaire that they all co-operate
with their customers by having an advance agreement on the product quality and
quantity. Asmara Textile Factory, Dahlak Shoe Factory and and Keih Bahri Tannery
also co-operate on the means and terms of transportation. However, only Keih Bahri
Tannery has an agreement with its customers to get the goods just when they are
needed for production. This co-operation, according to the managers decreases the
inventory carrying costs, cost of transportation and it helps to increase sales. The main
reasons for the non-co-operation with customers according to the firms’ commercial
managers is because their customers do not co-operate.
&XVWRPHU DVVHVVPHQW The transition firms assess customers opinion by allowing

customers to return any product with inferior quality and making strict quality control at
the production floor. Keih Bahri Tannery and Sembel House Hold Factory also make
periodic assessment of customers’ opinion. However, none of the transition firms give
their customers the option of paying only if the products are as per their expectation.
&RQFOXGLQJ UHPDUN All the firms except Keih Bahri Tannery have very weak firm-
customer co-operation. Their very limited co-operation is on outbound activities - order

processing, which according to the opinion of their managers, helps to decrease the
carrying costs of the inventory. Moreover, we observed that the firms’ managers believe
the (limited) co-operation helps them to decrease the inventory carrying costs, the costs
of transportation as well as to increase sales.
5HVSRQVHVRIFXVWRPHU6HODPDZLW6KRH)DFWRU\
We now turn to the study of the transition firms firm-customer co-operation from the
point of view of their customers’ and try to answer part 2(b) of the research question
³+RZ GR WKH WUDQVLWLRQ ILUPV LQ (ULWUHD PDQDJH WKHLU FXVWRPHU OLQNDJHV´. So, we
approached Selamawit Shoe Factory, one of the main customers of Keih Bahri Tannery.
We inquired for the specific co-operation on the primary activities and sales operation
as well as inventory management. We also asked the customers of the transition firms
about the benefits that they gets as a result of the co-operation or the reasons for the
non-co-operation. Finally we analyse the customer rating of firm efficiency. For
detailed information on the response of the customers on inter-firm co-operation, refer to
Appendix 7.3.3.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHVAccording to its general

manager, Selamawit Shoe Factory co-operates with Keih Bahri Tannery only on
inbound activities, particularly order processing. Overall, the general manager
Chapter 7 174
believes that the two firms do not co-operate on other inbound activities, production
operations, outbound activities, marketing/sales and after sale services.
)LUPFXVWRPHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW The general
manager of Selamawit Shoe Factory reported that the two firms do not have explicit
agreement sales and inventory management. Particularly, they do not co-operate in
exchanging skilled staff, using credit transactions with or without discount or in
providing with goods when just needed. The manager of Selamawit Shoe Factory
believes that this lack of co-operation does not help to decrease the inventory carrying
costs, the cost of transportation as well as it does not help to increase sales. The
reason for this lack of co-operation he believes is because Keih Bahri Tannery has not
developed the business culture and not because Selamawit Shoe Factory does not
have the specific policy or that it does not see the benefit. Overall, the manager’s
opinion is that this business relation is not creating long-term trust and co-operation.
&XVWRPHU HYDOXDWLRQ RI ILUP HIILFLHQF\ The manager of Selamawit Shoe Factory
evaluated Keih Bahri Tannery as efficient in its cash collection habits, bilateral
communication, impartiality with other buyers, explanation to inquiries, knowledge of
its customers, product quality and delivery. However, the manager believes that Keih
Bahri Tannery is less efficient in processing purchase orders and in its marketing
approach. The general manager of Selamawit Shoe Factory believes that Keih Bahri
Tannery’s inter-firm co-operation is not efficient for three reasons. ³)LUVW LW LV D
PRQRSRO\ LQ WKH 7DQQHU\ LQGXVWU\ QR PDUNHW ZLOO EH ORVW IRU LW LI LW GRHV QRW FR
RSHUDWH ZLWK LWV FXVWRPHUV 6HFRQG LW LV D JRYHUQPHQW ILUP WKHUHIRUH LWV PDQJHUV
KDYHMREVHFXULW\UHJDUGOHVVRIWKHILUP¶VSURILWDELOLW\7KLUGLWVPDFKLQHVDUHWRRROG
WRVDWLVI\FXVWRPHUGHPDQGVLQTXDQWLW\DQGTXDOLW\WHUPV ”.
&RQFOXGLQJ UHPDUNV According to the results of the interview conducted and

information collected using a questionnaire, the customer of Keih Bahri Tannery is
not positive about the firm’s firm-customer co-operation. Keih Bahri Tannery does
not co-operate on primary activities, sales operations and inventory management with
its customer. This according to the manager of Selamawit Shoe Factory does not help
to decrease the carrying costs of inventory or the ordering and purchasing costs, so it
does not contribute to the creation of value.
)LUPFXVWRPHUFRRSHUDWLRQFRPSDULVRQRIFXVWRPHUVRIWUDQVLWLRQILUPV
In order to compare the views of customers of the transition firms, interviews were
made and structured questionnaires distributed and collected from the customers of
the five transition firms. For detailed information of the response of the customers of
transition firms on firm-customer co-operation, refer to Appendix 7.3.3.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV Most of the customers of the
transition firms agree that the transition firms do not co-operate with them. The only
aspects of primary activity that most of them co-operate are on the inbound activity of
order processing. The customers responded that the transition firms do not co-operate
on other inbound activities, production operations, outbound activities,
marketing/sales and after sale services.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SXUFKDVHV DQG LQYHQWRU\ PDQDJHPHQW The

customers of the transition firms also reported that do not have co-operation
agreements on exchanging skilled staff, credit transactions with or without discount or
in providing with goods when just needed. The customers believe that the cause for
the lack of co-operation is that the transition firms have not developed the culture of
co-ordinating their purchase activities and inventory management. However, it is not
because the customers do not have the policy of not co-operating or that they do not
see the benefit of closely working with specific supplier. Since the transition firms
and their customers are not co-operating, customers believe that there is no benefit of
co-operation.
&XVWRPHU HYDOXDWLRQ RI ILUP HIILFLHQF\ Most of the customers evaluated that the
central firms are efficient in their cash collection, product costs and quality (except for
Keih Bahri Tannery), delivery (except for Asmara Textile Factory and Keih Bahri
Tannery) as well as impartiality with other buyers. Most of the customers responded
that, the transition firms are not efficient on marketing approaches, explanation to
inquiries, purchase order processing, bilateral communication and knowledge of their
customers.
&RQFOXGLQJUHPDUN According to the general managers of the five transition firms, there
is very little inter-firm co-operation on all primary activities as well as purchase
operations and inventory management. The managers of the customers believe that the
main reason for the lack of closer inter-firm co-operation is that the transition firms do
not have the policy of inter-firm co-operation.
&RQFOXVLRQV
In this chapter, we explored Keih Bahri Tannery’s and other transition firms’ internal
and external management of working capital levels and operations. Here we try to
have an overview of our findings.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW All managers of the transition firms
believe that the management of working capital levels of investment and financing as
well as operations of purchases and sales has a pivotal role in creating firm value.
However, the firms’ value creation potential in this area is hampered by the lack of
managerial empowerment and uncertainty due to the privatisation process. Other
managerial constraints include a lack managerial empowerment for making decisions
working capital investment and financing as well as lack of production capacity and
skilled labour. The transition firms lack a clear objective in managing both working
capital levels and operations. The managers believe also that they are doing very little
in managing their working capital because they are not empowered. They are
restricted to the control function, which is evidenced by the strict control mechanisms
imposed over the levels of cash, receivables and inventory as well as operations of
cash collections, cash payments, purchases and sales. The reason for the lack of a clear
working capital management policy is the imposition of government regulations, which
are implemented under the supervision of NASPPE (National Agency for Supervising
and Privatising Public Enterprises). Policy measures and decisions, which can have both
a short and long-term effect are taken by the higher authorities in the privatisation
agency which practically overtakes the firms’ overall management.
Chapter 7 176
:RUNLQJFDSLWDOLQYHVWPHQWDQGILQDQFLQJ We find that the transition firms have no
clear policy of managing the levels of working capital investment and financing. As a
result all firms except Keih Bahri Tannery are in a serious problem of liquidity. They all
have negative net cash flows that they finance with a bank overdraft, the annual interest
cost of which is a sizable proportion of their total costs. Over the first five years of study,
overdraft interest cost as percentage of total expenses was: 48% for Asmara Textile
Factory, 32% for Lalmba Sack Factory, 31% for Sembel House Hold Factory, 36% for
Dahlack Shoe Factory and 3% for Keih Bahri Tannery. This is an indication that the
firms have financed their working capital needs with bank overdraft. Given that Asmara
Textile Factory, and Lalmba Sack Factory made losses and the other firms made
marginal profits, it would have been a good signal for them to change the management
of their working capital levels and operations, which they did not. Their level of
receivables is increasing mainly because of the slow paying related (government)
enterprises. While inventory balance is increasing due to mainly low sales. The
cumulative effect of this lack of policy is the increase of both bank overdraft and
creditors. Management has no opportunity or motive for reducing the investments in
working capital levels or minimising the cost of short-term financing. This has greatly
affected the efficiency of the firms in managing internal working capital levels of
investment in cash, receivables and inventories.
:RUNLQJ FDSLWDO RSHUDWLRQV Analysis of purchase and sales operations shows that
the transition firms have no policy on how to purchase their materials and sell their
products. The management of the firms working capital operations is restricted only to
the application of clerical procedures of purchases and sales. The study showed that
there is no mechanism of enhancing the contact, contract and control aspects of
purchase and sales transactions. Their purchase and sales policies are dictated by
government regulations to a large extent. So long as they remain in transition, their
management of working capital operations will probably remain crippled and they
will have no vision of the long-term. This makes the managers quite powerless. They
reported that they are totally restricted to think in terms of short-term control of
working capital levels and operations and/or the custody aspect of working capital
management. So the benefits that they can get in the long run by efficiently managing
working capital operations are forgone.
(YDOXDWLRQ RI LQWHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW Analysis of performance
evaluation has also indicated that the firms use no accounting, customer satisfaction or
quality based performance measurement and evaluation criteria. Liquidity analysis
showed that the firms are in immediate risk because all liquidity ratios except for Keih
Bahri Tannery are below the generally accepted global norm. Investment in current
assets, whose turnover ratios are very low, make more than 80% (except for Lalmba
Sack Factory) of the total investment in assets. Except that of Keih Bahri Tannery all
profitability ratios (gross profit, net profit and return on assets) indicate low or
negative levels.
,QWHUILUP FRRSHUDWLRQ All transition firms (except Keih Bahri Tannery) reported
that they make little co-operation on all the primary activities with both their suppliers
and customers. However, Keih Bahri Tannery and its supplier Asmelash Hides and
Skins and customer Dahlack Shoe Factory reported that they co-operate in their in and
out bound activities, particularly delivery vehicle operation and order processing. This
may have contributed to the fact that Keih Bahri Tannery is observed to be the most
successful transition firm. Though the remaining transition firms co-operate closely
with related firms (government and transition), they have less inter-firm co-operation
with the private firms. As a result both private suppliers and private customers have
expressed their dissatisfaction on the transition firms’ co-operation regarding primary
activities. The weak inter-firm co-operation between the transition and private firms
has negatively affected the transition firms’ value creation potential as revealed by the
working capital activity and profitability measurements. The main reasons for the lack
of co-operation according to the managers of both transition firms and their suppliers
is the interference of government regulations, lack of management policy and the
uncertainty during the transition process. All the customers of the transition firms
believe that the reason for the lack of inter-firm co-operation is because the transition
firms do not co-operate.
&KDSWHU
3ULYDWLVHG)LUPV
,QWURGXFWLRQ
In chapters 6 and 7 we assessed the management of working capital levels and

operations of the government and the transition firms. In this chapter we continue
with regard to the privatised firms. We study how three privatised firms - Asmara Milk
Factory, Asmara Sweater Factory and Eritrean Steel Sheet Factory manage their internal
and external working capital levels and operations. We particularly concentrate on
Asmara Milk Factory’s internal working capital management, its suppliers co-operation
with University of Asmara, - Department of Animal Sciences or (DAS) and its customer
co-operation with Berhane Frafre. We have selected Asmara Milk Factory because it
represents a typical privatised firm whose supplier and customer responses we have
included in our study. A comparison is also made between that of Asmara Milk Factory
and the other privatised firms.
Our objective in this chapter is to answer question (2c) of the research study: ³+RZ
GR SULYDWLVHG PDQXIDFWXULQJ ILUPV in (ULWUHD PDQDJH WKHLU LQWHUQDO DQG H[WHUQDO
ZRUNLQJ FDSLWDO´" 6ection 8.1 introduces the chapter and section 8.2 presents the
firm’s overall working capital management issues. Section 8.3 covers the internal
management of working capital levels and operations. Section 8.4 deals with the
external working capital management, including firm-supplier linkages (8.4.1) and
firm-customer linkages (8.4.2). Section 8.5 concludes the chapter.
This section presents Asmara Milk Factory’s overall working capital management
issues, including its historical background, organisational structure, objectives of
working capital management and constraints to achieve the objectives as well as the role
of working capital management in creating value. We start with a background
information on Asmara Milk Factory (section 8.2.1) and then present a comparative
analysis of the privatised (section 8.2.2). For detailed information on overall working
capital management issues, refer to Appendix 8.1.
+LVWRULFDO EDFNJURXQG RI WKH ILUP Asmara Milk Factory initially started as co-
operative business whose members were dealing in the production of milk and milk
products. The co-operative members were selling their milk production to the factory.
The factory continued its operation in its original form until 1974 when it was
nationalised by the Ethiopian Government. At independence, the Eritrean government
continued administering the factory as a government firm until July 1999. As result of
the government’s privatisation policy, Asmara Milk Factory was privatised in August
1999. Among others, Asmara Sweater Factory and Eritrean Steel Sheet Factory were
also privatised in May 1998 and in April 1998 respectively. Asmara Milk Factory is
sold to its suppliers [about 500 to 600 in number], who own and manage it as a co-
operative. The firm’s general management does not have information on the original
Chapter 8 180
capital of the firm. It has not changed its original operations, which is still to process
and sell milk and milk products. According to the general manager, the factory is
making capital investments and will start producing additional milk products like
Yoghurt and Cheese within few months. It has also a plan to computerise its
information processing and record keeping activities in the near future.
2UJDQLVDWLRQDO VWUXFWXUH Its organisational structure includes the owners, the
general manager (who also serves as a commercial manager) and a financial manager.
According to the general manager’s opinion, he is fully empowered to make decisions
regarding working capital levels of investments and financing, as well as operations of
production, purchasing and sales. As a marketing manager he is also responsible to
investigate and assess the market and apply an appropriate marketing strategy. The
financial manager controls the firm’s financial operations and reports to the general
manager periodically. The general manager reports to the owners’ annual general
meeting.
)LUP SROLFLHV DQG FRQVWUDLQWV According to the opinion of the firm’s financial
manager, the main objectives of working capital management include the increase of
sales, the decrease of costs and to generate profit but not to remain liquid. The firm
manages its working capital in such away that it buys its materials on credit and sells
its goods to larger customers on a monthly credit basis and uses cash collected from
operations to finance its working capital investments and daily activities. It pays its
suppliers and collects from customers in the first 10 days following the months of
purchases and sales. It does not keep raw materials and finished goods inventory in
the store because production starts immediately when the materials are received and
the sales is directly after production. Milk is received at the beginning of a day
processed and sold in that same day. The firm has a policy of generating income
enough to cover current operations and earn a decent profit margin with the current
lines of production. During the interview conducted with the firm’s general manager,
he said that: ³2XU VKRUW±WHUP REMHFWLYH LV WR PDLQWDLQ WKH FXUUHQW SURGXFWLRQ DQG
VDOHVFDSDFLW\:KLOHLQWKHORQJWHUPZHKDYHDSODQLQFRRSHUDWLRQZLWKDQ,WDOLDQ
ILUP WR GLYHUVLI\ RXU SURGXFWV DQG LQYHVW LQ WKH SURGXFWLRQ RI FKHHVH \RJKXUW LFH
FUHDP PL[HG MXLFH RI PLON DQG RUDQJH DQG RWKHU PLON SURGXFWV´ The financial
manager believes that the factors that determine working capital levels include mostly
sales growth and operating efficiency. However, price levels of inputs, credit policy
and availability of credit do not influence the levels of working capital.
On the constraints in achieving short and long-term objectives the manager said that:
³:H KDYH QR FRQVWUDLQW WR DFKLHYH VKRUWWHUP REMHFWLYHV DW DOO +RZHYHU KRZ
HIILFLHQWO\ ZH DFKLHYH RXU ORQJWHUP REMHFWLYHV ZLOO GHSHQG RQ WKH DYDLODELOLW\ RI
FDSLWDO DQG WKH DJUHHPHQW RI ILUPRZQHUV RQ WKH SDUWQHUVKLS ZLWK WKH ,WDOLDQ ILUP´
According to the general manager, the factors that hinder the firm from achieving its
objectives are fixed capital investment and financing. However, production capacity
and markets are not problems. According to the opinion of the general manager, there
are no government regulations that affect management’s decisions. However, there
are cultural issues, which seriously affect the sales of the firm’s products. The two
religions strictly followed in Eritrea are Christianity and Islam, which require their
followers to have at least one-month fasting per year. During the months of April and
May, most Christians fast and do no take milk, milk products and meat. During the
month of December, Moslems do not take any food during the daytime when the
Privatised Firms 181
businesses are open. They start taking food in the evenings but by then businesses are
closed. So, the firm’s sales considerably decrease during this fasting periods. As a
solution, during these fasting months the firm produces milk products such as butter
that can be stored for a later use.
7KHUROHRIZRUNLQJFDSLWDOPDQDJHPHQWRQYDOXHFUHDWLRQ On the role of working
capital management in promoting the firm’s objectives on value creation, the general
manager said that: ³0DQDJLQJ ZRUNLQJ FDSLWDO LQYHVWPHQWV DQG VKRUWWHUP ILQDQFLQJ
KDV D PDMRU UROH WR SOD\ LQ SURPRWLQJ RXU VKRUW DQG ORQJWHUP REMHFWLYHV 2XU
SODQQHG FDSDFLW\ H[SDQVLRQ DQG SURGXFW GLYHUVLILFDWLRQ ZLOO GHSHQG RQ KRZ
VXFFHVVIXOO\ ZH SHUIRUPHG WKH FXUUHQW ZRUNLQJ FDSLWDO LQYHVWPHQWV DQG ILQDQFLQJ
EHFDXVH IXWXUH VXFFHVV FDQ RQO\ EH DQ H[WHQVLRQ RI FXUUHQW VXFFHVV´The firm’s
financial manager also believes that overall working capital management has a pivotal
role to play in value creation, particularly in increasing sales and decreasing costs of
purchases, production and inventory. He believes that managing cash, receivables,
inventory, purchase of materials and trade payables can achieve these objectives.
2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQWLVVXHVFRPSDULVRQRISULYDWLVHGILUPV
Here we try to study if the three privatised firms reveal similarity or have a material
difference on the overall working capital management, particularly the policy of
working capital management, the constraints in achieving firm objectives and the
factors determining firm objectives. For detailed information on the overall working
capital management issues, see Appendix 8.1.
)LUP SROLFLHV DQG FRQVWUDLQWV The financial managers of the privatised firms
responded that their working capital management policy is tailored towards increasing
sales, decreasing costs and thereby generating profit but only Eritrean Steel Sheet
Factory responded that it also aims at remaining liquid. On the constraints in achieving
firm objectives, the managers of Asmara Milk Factory and Asmara Sweater Factory
believe that the factors, which are constraining firm objectives, include working capital
investment and financing as well as fixed capital investment and financing. Asmara
Sweater Factory also has a lack of production capacity, labour availability, product
demand and markets. The manager of Eritrean Steel Sheet Factory did not give an
opinion on the firm’s constraints to achieve objectives.
7KHUROHRIZRUNLQJFDSLWDOPDQDJHPHQWLQ YDOXHFUHDWLRQ Financial managers of
Asmara Milk Factory and Eritrean Steel Sheet Factory believe that working capital
management has an important role in value creation. The managers’ response denote
that working capital management is important for the purpose of increasing sales by
managing cash, trade receivables, inventory, trade payable, sales of finished goods and
purchase of materials. They also believe that working capital management can be used to
decrease costs by managing purchase of materials, inventory, cash and receivables, but
not payables, bank loans or liquidity.
Chapter 8 182
This section covers Asmara Milk Factory’s internal working capital management,
which is divided into levels of investment (8.3.1.) and financing (8.3.2.) as well as
operations of purchasing (8.3.3.) and selling (8.3.4).
In this section we discus the managers responses to questions on how the privatised
firms manage working capital investments of cash, receivables and inventories. The
objective is to find out if Asmara Milk Factory and the other two-privatised firms apply
value-creating methods of managing working capital levels of investment. First, we
consider Asmara Milk Factory then compare it with the other privatised firms.
&DVKPDQDJHPHQW
In this section we examine if Asmara Milk Factory and the other privatised firms create
value by managing cash balances, collections and payments. Therefore, we asked the
managers on their motive for holding certain balances of cash levels, purposes and
approaches of forecasting cash, on preparing cash flow statements as well as
controlling cash payments and collections. For detailed information on Asmara Milk
Factory’s cash management, refer to Appendix 8.2.1.1.
7KH PRWLYHV IRU KROGLQJ FDVK According to the firm’s financial manager, the main
purpose for holding cash in the firm is for transaction purposes - to make regular
predetermined payments. The firm rarely keeps any cash for making unforeseen
investment opportunity (speculative purpose) and it does not keep cash to pay for
unforeseen transactions (precautionary purpose) or as a guarantee for bank loans.
&DVK EXGJHWLQJ DQG FRQWURO The factory’s management prepares cash budgets
mainly to plan for short and long-term cash needs, to control liquidity, cash payments
and receipts. The primary bases used to forecast the cash budget are past experience,
opinion of the management and forecasted sales levels. Asmara Milk Factory prepares
cash flow statements using the receipts and disbursements method, which it uses to
improve its future cash forecasts as well as to control cash payments and receipts.
0DQDJLQJ FDVK SD\PHQWV DQG FROOHFWLRQV The firm has a petty cash fund with a
maximum balance of Nakfa 4000. It uses this petty cash fund to pay for expenses less
than Nakfa 500, payments above this amount are made using checks approved by the
general and financial managers. Collections from lager customers (from the point of
sales volume) are made mostly using customer checks. However, cash from the
smaller shops is collected by the firm’s door to door sales persons and is deposited in
the bank on a daily basis. The firm purchases only on credit without discount, which it
considers as a policy of slowing-down cash payments and the cash sales to smaller
customers is considered as a means of speeding-up the cash collection. The factory
controls its cash payments using a petty cash system, voucher system, using checks
sequentially numbered, which are controlled and accounted regularly and preparing
bank reconciliation by employees other than those involved in cash collections and
payments. It controls cash collections by separating duties for sequential cash
operations, handling and recording.
&RQFOXGLQJ UHPDUNV Asmara Milk Factory makes little use of its bank overdraft
facilities because it generates enough surplus cash from its operations. Partially it uses
its cash surplus to pay for the debt borrowed when the firm was privatised and what
remains is deposited at its bank’s checking account to pay for day to day working
capital operations. It has a minimum cash balance for transaction purposes including
the petty cash fund, which it uses for small payments. We observe that the firm
management is fully empowered to manage the cash affairs of the firm but makes no
use of its managerial empowerment because of the lack of investment opportunities.
However, according to the general manager, there is a plan to invest its surplus cash in
machinery that it will use to diversify products.
,QYHQWRU\PDQDJHPHQW
The objective of this section is to study if Asmara Milk Factory creates value by
managing its materials and finished goods inventory balances. Therefore, we asked
the managers if and how they determine inventory costs and values, formulate and
implement inventory forecasting and control (physical and cost) approaches. For
detailed information on inventory management, refer to Appendix 8.2.1.2.1 -materials
inventory management and 8.2.1.2.2 - finished goods inventory management. For
detailed information on Asmara Milk Factory’s inventory management, refer to
Appendix 8.2.1.2.1 (materials inventory) and Appendix 8.2.2.2 (for finished goods
inventory).
0DWHULDOV LQYHQWRU\ PDQDJHPHQW According to Asmara Milk Factory’s financial

manager, the firm’s materials inventory is mostly raw milk or plastic cases, which are
used to pack the processed milk. The plastic cases are imported once in six months,
which the financial manager says that it takes little space and is not perishable.
Asmara Milk Factory’s main objective in managing these inventories of materials is
to reduce holding and ordering costs as well as to safeguard against shortages and to
keep the production running. The firm’s major cost of holding inventory of materials
is the costs of handling, and record keeping. The cost of physical deterioration,
obsolescence, shrinkage, depreciation and pilferage costs, the opportunity cost of
capital invested or interest on capital tied-up, security and power are very small.
The firm minimises materials holding and ordering costs using the “just-in-time”
approach of inventory management and tries to keep only the minimum required. It is
also minimised by agreeing with the suppliers so that they bring their daily milk
production only from 6 am to 10 am, after which the firm stops accepting for that day.
Management uses this system mainly due to the problem of storage capacity. The
firm cannot continue production throughout the day because supply is very small, so it
accumulates incoming supply by limiting the time it purchases materials. The
suppliers bring to the factory any amount of milk that they can produce. Ordering
costs are minimised by making a contract agreement only once. The factory uses the
average cost approach to determine the cost of materials issued to production and
remaining in inventory and these inventories are valued in the balance sheet as such.
Chapter 8 184
)LQLVKHGJRRGVLQYHQWRU\According to the financial manager, the firm produces only
one type of product - pasteurised milk. The production process takes only half a day, so
there is no work-in-process in the factory.
The cost of holding inventory of finished goods include, mainly the cost of physical
deterioration, Other costs such as power, insurance, property tax, handling, security,
and clerical record keeping are considered to be small. Finished goods inventory is
valued on the basis of average cost. According to the firms general and financial
managers the factory minimises finished goods holding and ordering costs using the
“just-in-time” approach of inventory management. Holding costs of finished goods
inventory is minimised by agreeing with customers for the firm to use its own
transportation to take the goods to the place of its customers on a daily basis. Ordering
costs are minimised by making a contract agreement only once, where its customers
indicate the supply of milk that they want on a daily basis. Asmara Milk Factory uses
the average cost approach to determine the cost and value of cost of goods sold and
remaining in inventory.
&RQFOXGLQJ UHPDUN Asmara Milk Factory manages its materials and finished
goods inventory such that the ordering and carrying costs are minimised. The
bottleneck for the firm is the lack of supply of milk. As a result of this its production
capacity is utilised only to the extent of 50%. In order to solve this problem the firm’s
management is planning to diversity its production in the short-term to other types of
products which have a higher profit margin. Therefore, we could conclude that
Asmara Milk Factory’s materials and finished goods inventory management has
contributed positively to the profit, the net cash flows and the liquidity position.
In this section we try to study if Asmara Milk Factory creates value by managing
receivables. Therefore, we asked the firm’s financial manager if and how management
formulates its policies of accounts receivable management, how it controls its credit
collection and the costs of accounts receivables and bad debts. For detailed
information on Asmara Milk Factory’s receivables management, refer to Appendix
8.2.1.3.
&UHGLW SROLF\ DQG UHFHLYDEOHV PDQDJHPHQW Asmara Milk Factory sells to larger
customers on the basis of a monthly credit without discounts and these customers
generally pay within the first 10 days of the month after sales. However, the financial
manager believes that the firm does not have problem of managing receivables. The
main source of information for screening credit applicants is the size of the customer’s
proposed purchase and the firm’s prior experience with the customer. Customers who
order large daily purchases are preferred for credit sales. The applicant’s financial
statements, visits to the customer, personal contact with the applicant’s banks and other
creditors, credit reports on the customer’s payment history with other firms are not used
at all as a source of information for screening credit applicants. The firm uses an open
account with no discount for those who buy on credit. However, it does not use credits
with discount, promissory note or seasonal dating. The 5 C's (capital, character,
collateral, capacity, conditions) are used to evaluate any future credit application. In
order to collect overdue receivables the firm makes telephone calls and extends credit
periods. However, it never employs a collection agent or take legal action. It rarely sends
a reminder (or delinquency letter) nor makes personal visit in order to collect overdue
receivables. If the level of receivables is too high the firm does not have a control
mechanism.
0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQWFRPSDULVRQRISULYDWLVHGILUPV
Here we want to know if the privatised firms reveal similarities or differences in

managing their working capital levels of investment, particularly cash, inventories and
receivables. For more supporting information on the privatised firms’ comparative
management of working capital investment, refer to Appendix 8.2.1.1 (cash
management), Appendix 8.2.1.2 (inventory management) and Appendix 8.2.1.3
(receivables management).
&DVKPDQDJHPHQW The purpose of cash planning for all the privatised firms is the
transaction purpose of making regular pre-determined payments. The financial manager

of Eritrean Steel Sheet Factory also reported that the firm’s cash management has the
objective of speculation and precaution. The other two privatised firms reported that they
do not manage cash for the purposes of speculative or precautionary reasons mainly
because they have no opportunity to make cash investments with a profit motive. It is
only Asmara Milk Factory that forecasts cash in order to control cash payments,
collections and levels as well as to plan short-term and long-term cash needs using past
experience, management opinion and forecasted sales as bases. The other two privatised
firms do not forecast cash requirements and do not make hedges against cash shortages
because the bank provides overdraft if they need it. However, all firms prepare cash flow
statements by using the receipts and disbursements approach and they use it to control
cash payments and collections. Only Asmara Milk Factory experiences cash surpluses
that it deposits at its bank checking account. Asmara Sweater Factory and Eritrean Steel
Sheet Factory are experiencing cash deficits which they finance using short-term bank
borrowings and overdraft. They control cash payments by using a voucher system,
checks, bank reconciliation, and a petty cash system. Asmara Sweater Factory and
Eritrean Steel Sheet Factory collect cash at or in advance of sales while Asmara Milk
Factory collects cash at sales and in the ten days after the month of sale. The firms
consider the cash sale as means of speeding-up cash collection, which they control by
separating duties for sequential cash operations and depositing cash at the bank on a
daily basis.
0DWHULDOV LQYHQWRU\ PDQDJHPHQW Materials inventory policy of all three privatised

firms is tailored strongly towards minimising inventory holding and ordering costs as
well as safeguarding against inventory shortages and to keep production running. They
apply inventory management approaches like holding the minimum level required, just
in time and economic order quantity (except Asmara Milk Factory). They all selectively
control the physical safety of their materials inventory on the basis of average cost and
usage rate. Asmara Sweater Factory and Eritrean Steel Sheet Factory also control on the
basis of scarcity in the market. While Eritrean Steel Sheet Factory also uses criticality in
case of shortage. They use only the average cost technique to determine the value and
cost of materials used in production and left in the inventory. For Asmara Sweater
Factory and Eritrean Steel Sheet Factory the opportunity costs of capital invested in the
Chapter 8 186
materials inventory and the costs of insurance are considered relevant costs of materials
inventory. Moreover, Asmara Sweater Factory and Asmara Milk Factory reported that
the cost of handling materials is large enough to deserve managerial attention. However,
the overall cost of material inventory management is not relevant with all the firms.
)LQLVKHGJRRGVLQYHQWRU\ PDQDJHPHQW The financial managers of all three privatised
firms reported that they hold finished goods inventory to satisfy regular customer
demands, to meet high seasonal demands and to keep safety stock (except Asmara
Sweater Factory). None of them manages finished goods inventory to decrease inventory
holding costs, while Eritrean Steel Sheet Factory holds it to take advantage of economies
of scale. For Asmara Sweater Factory and Eritrean Steel Sheet Factory the opportunity
costs of capital invested in the materials inventory and the costs of insurance are
considered relevant costs of finished goods inventory. The privatised firms, except
Asmara Milk Factory use only the technique of holding the minimum level required in
managing the costs of holding finished goods inventory. All three privatised firms
selectively control the physical safety of the finished goods on the basis of costs while
Asmara Milk Factory and Eritrean Steel Sheet Factory use the usage rate too. On the
issue of inventory costing and valuation they all use the average cost technique to
determine the costs and value of finished goods sold and in inventory.
5HFHLYDEOHV PDQDJHPHQW The privatised firms have different sales policies

depending on whether the customer is large or small and a government firm or a private
firm. The cash sales refer to smaller private firms while the credit sales refer to larger
private and all government firms. With regard to their private credit customers they
apply credit standards based on a repeat sale approach while Eritrean Steel Sheet Factory
and Asmara Milk Factory also use the five C’s (capital, character, collateral capacity and
conditions). In order to collect overdue receivables they all make telephone calls and
extend credit periods, but it is only Asmara Sweater Factory, which makes personal
visits and none of them employs collection agents or takes legal action. However, the
risk of bad debt is very low and none of them makes allowances for it.
6RXUFHVFRVWVDQGLQIOXHQFHVRIZRUNLQJFDSLWDOILQDQFLQJAsmara Milk Factory uses
the cash earned from operations and deposited in its bank’s current account as a source
of working capital financing. The response of the general manager indicated that, the
firm’s cash balance is not excessive, but enough to pay for the working capital needs and
a periodic reduction of government and bank loans which the firm borrowed when it was
privatised. The firm’s owners borrowed cash from the bank and the government when
the firm was bought from the government. The general manager said that: ³7KH WRWDO
EX\LQJ SULFH LV 1DNID 2XW RI WKLV WRWDO FRVW LV RZHG WR WKH
JRYHUQPHQWWREHSDLGLQVHYHQ\HDUVZKLOHWKHLVERUURZHGIURPWKHEDQNDW
LQWHUHVWRISHU\HDUWREHSDLGLQWHQ\HDUV´ .
Asmara Milk Factory does not consider short-term loans from banks, long-term debt,
retained earnings, bank overdraft, trade creditors, secured borrowings or accruals as
sources of financing its working capital investments. The response of the financial
manager to interview questions indicated that, Asmara Milk Factory uses cash collected
from operations to finance its working capital investments operations. According to the
financial manager, sales growth, price levels of inputs, operating efficiency, seasonality
of sales, the firm’s credit policy and availability of credit do not influence the levels
short-term financing (See Appendix 8.2.2).
0DQDJLQJZRUNLQJFDSLWDOILQDQFHVFRPSDULVRQRISULYDWLVHGILUPV
6RXUFHVFRVWVDQGLQIOXHQFHVRIZRUNLQJFDSLWDOILQDQFLQJAll three privatised firms
(Asmara Milk Factory, Asmara Sweater Factory and Eritrean Steel Sheet Factory) use
cash collected from operations to finance their short-term financing needs. However,
Asmara Sweater Factory and Eritrean Steel Sheet Factory also use short-term debt and
bank overdraft. Only Asmara Milk Factory reported that its operations result at cash
surplus so it does not have any external cost of financing its working capital investments.
However, the other two firms - Asmara Sweater Factory and Eritrean Steel Sheet
Factory use bank overdraft loan with annual interest costs of around 9.5% to finance
their short-term investments in working capital assets.
According to the financial managers of Asmara Sweater Factory and Eritrean Steel
Sheet Factory, the main factors that influence the levels of financing of working capital
levels are price levels of inputs and operating efficiency. The financial manager of
Asmara Sweater Factory also considers sales growth as a factor influencing the levels of
short-term financing. On the other hand, the financial managers of the three-privatised
firms believe that seasonality of sales, credit policy and availability of credit do not
determine the levels short-term financing for working capital investments (see Appendix
8.2.2).
3XUFKDVHPDQDJHPHQW
In this section we study if Asmara Milk Factory creates value by managing working
capital operations of purchases. We asked the general manager who is also the
commercial manager on the firm’s purchase policy, purchasing techniques,
purchasing activities and costs as well as on approaches of contacting, contracting and
control of suppliers. For detailed information on managing working capital operations
with regard to purchases, refer to Appendix 8.2.3.1.
3XUFKDVH SROLFLHV The firm’s suppliers are also its owners, so they have vested
interests in the firm. When the factory was slated for privatisation its suppliers
organised themselves and bought the factory. So, almost all suppliers are co-operative
owners of the factory. However, according the general manager, any person who can
supply milk above 10 litres per day can come to the place of the factory and register as
supplier. The factory buys whatever its supplier-owners sell. The manager said that:
“$W WKH PRPHQW WKH IDFWRU\ LV RZQHG E\ LWV VXSSOLHUV VR LW LV GLIILFXOW IRU XV WR UHIXVH
PLON SUHVHQWHG WR WKH IDFWRU\ E\ D VXSSOLHURZQHU ,W LV WKHLU ILUP DQG ZH FDQQRW
UHIXVH WKHP HYHQ LI WKH GHPDQG IRU PLON LV VR ORZ WKDW LW PD\ UHVXOW DW ORVV VXFK DV
GXULQJ IDVWLQJ PRQWKV´ As a solution for this problem the factory produces more
butter and less pasteurised milk when the demand is low, though the profit margin of
butter is much lower compared to that of milk.
Chapter 8 188
Asmara Milk Factory purchases its materials on a credit basis with a policy geared
towards smoothing out production during normal periods of supply, to take care of
seasonal fluctuations in demand and production requirements and to take advantage of
quantity discounts. According to the commercial manager, the firm’s purchase policy is
also to decrease inventory holding and ordering costs. The firm forecasts its materials
purchase requirements in order to establish the quantity on hand and on order during lead
time, to determine the safety stock requirement and to meet its production demands. The
base that the firm uses to estimate materials purchase requirement is mainly its past
experience. Asmara Milk Factory has a long-standing agreement with two factories
(Asmara Brewery and Keih Bahri Food Products) whose by-products serve as animal
feed. It has an agreement with these factories that they sell their animal feed only to
those who supply milk to Asmara Milk Factory. So, when suppliers are registered with
Asmara Milk Factory they will have the right to buy animal feed from the factories. This
procedure serves as a control mechanism for suppliers not to shift to other
competitors. The agreement between the factory and the animal feed supplying
factories was established when all three firms in the linkage (Asmara Milk Factory,
Asmara Brewery and Keih Bahri Food Products) were government owned.
&RQWDFWLQJ FRQWUDFWLQJ DQG FRQWUROOLQJ VXSSOLHUV Asmara Milk Factory makes

efforts to find suppliers by getting in contact and describing the materials to potential
suppliers. According to the commercial manager, the costs of the efforts made to find
suppliers are significant and therefore relevant for the management. When entering into
contract with a potential supplier the firm evaluates the proposal and negotiates the
agreement and the manager believes that the costs are relevant to attract managerial
attention. Overall, according to the commercial manager, the costs of contacting,
contracting and controlling suppliers are relevant to the management. Therefore,
management uses approaches like choosing the cheapest channel of communication,
making its terms of agreement known to its suppliers in advance, developing long-
lasting relationships, managing by trust and routine contract agreements but it does
not employ lawyers or purchase agents.
6DOHVPDQDJHPHQW
In this section we study if Asmara Milk Factory creates value by managing working
capital operations of sales. With this objective in mind we asked questions on sales
policy, selling and distribution techniques, sales activities and costs, approaches of
contacting, contracting and control of customers. For detailed information on
6DOHV SROLF\ According to the firm’s general manager, Asmara Milk Factory sells
its products only to local markets and its sales policy is a door to door approach.
According tot the general/commercial manager, Asmara Milk Factory’s approach to
find markets for its products is by getting directly in contact with potential customers.
The firm sends market investigators to ask shops, restaurants and bars if they are willing
to buy milk from the factory, which it will bring to their place of business, free of charge.
So if they are willing they become regular customers. The firm does not make any other
effort like, attending trade fairs and exhibitions, advertising products in the public
media, distributing free samples for promotion or describing the goods to potential
buyers. The firm sells on cash basis to small customers and on credit basis (using the
5 Cs) to the larger customers and government firms. According to the

general/commercial manager, the reason why it makes preferential customer treatment
is because of the trust factor. He says: ³7KH ODUJHU SULYDWH ILUPV DQG DOO JRYHUQPHQW
ILUPV DUH KLJKO\ WUXVWHG DQG ZLOO QRW IDLO WR SD\ EDFN WKHLU GHEW ZKLOH WKH VPDOO
SULYDWH ILUPV EX\ VPDOOHU DPRXQWV ZKRVH FROOHFWLRQ FRVW DQG HIIRUW GRHV QRW ZDUUDQW
”. Its sales objective is to take care of

FUHGLW VHOOLQJ DQG PD\ QRW SD\ EDFN RQ WLPH
regular customer demands. In our interview with the general-commercial manager we

have come to understand that the firm’s other sales objective is to decrease inventory
holding costs. It forecasts its sales requirements in order to determine safety stock
requirements but not to manage inventory usage or to determine the quantity on hand
and on order during lead-time. The firm uses statistically forecasted sales as a base to
plan the sales volume but not the opinion of the sales staff.
&RQWDFWLQJFRQWUDFWLQJDQGFRQWUROOLQJFXVWRPHUV$VPDUD0LON)DFWRU\FRQWDFWVLWV
FXVWRPHUV by directly approaching potential customers. It also negotiates the sales
agreement with potential customers, including the terms of sale and evaluates the
proposed purchase terms of its customer. However, the firm does not sign the
agreements. Asmara Milk Factory also relies on the commitment and trust of its
customers. However, according to the general/commercial manager’s experience the
probability that customers will back down from their agreement is none and if
partners back down the loss is small and it is not difficult to find another customer.
Moreover, he believes that the overall costs of contacting, contracting and controlling
customers is not relevant to the management. Therefore, it uses approaches such as
making terms of agreement known in advance, developing long-lasting relationships
and routine contract agreements but it does not employ lawyers or sales agents.
0DQDJLQJZRUNLQJFDSLWDORSHUDWLRQVFRPSDULVRQRISULYDWLVHGILUPV
0DQDJHPHQW RI SXUFKDVH RSHUDWLRQ The managers of Asmara Sweater Factory and
Asmara Milk Factory reported that they purchase materials mainly to get cash discounts,
while Eritrea Steel Sheets Factory aims at getting quantity discounts and minimising the
costs of inventory holding. They all forecast the purchase of materials based on past
experience; however, Asmara Sweater and Eritrea Steel Sheets Factories also use
forecasted sales volume and management opinion. Asmara Sweater Factory and Asmara
Milk Factory purchase both on cash and credit terms while Eritrean Steel Sheet Factories
purchase only on cash basis because its commercial manager says that the firm’s
suppliers do not provide credit.
Asmara Milk Factory controls its suppliers by agreeing with animal feed producing
factories such that they sell only to those certified by Asmara Milk Factory. The costs of
the efforts made to contact, contract and control suppliers are relevant only to Asmara
Milk Factory. Moreover, the commercial managers of all firms replied that they use
approaches such as choosing the cheapest channel of communication and making
terms of agreement known in advance to contact suppliers as well as having routine
contract agreement with terms known in advance during contracting. They install
routine control procedures with terms known in advance to both partners as control
measures. However, none of them employs lawyers or purchase agents to manage the
costs of contact, contract and control of suppliers (see also Appendix 8.2.3.1).
Chapter 8 190
0DQDJHPHQWRIVDOHVRSHUDWLRQ All privatised firms sell their products to the local

market while Asmara Sweater Factory also exports. The commercial managers of all
privatised firms said that the objective of their sales policy is to satisfy customer
demands. The objective of sales policy for Asmara Sweater factory and Eritrean Steel
Sheet Factory is also to decrease the costs of inventory ordering and holding as well as
to expand their market share. Asmara Sweater Factory has also the objective of meeting
seasonal sales requirements. All three privatised firms forecast sales based on past
experience and also use statistical forecasts while Asmara Sweater and Eritrean Steel
Sheet Factories also use management opinion. Only Eritrea Steel Sheets Factory uses
the opinion of its sales staff to forecast its sales. Asmara Sweater and Eritrea Steel
Sheet Factories forecast sales in order to estimate future demand as well as to establish
inventory usage and the quantity on hand and on order during lead-times. Asmara
Milk Factory and Eritrea Steel Sheet Factory forecast sales to determine safety stock
requirements.
The privatised firms produce for the general market while Asmara Sweater Factory and
Eritrean Steel Sheet Factory also produce by the order of specific customers. Asmara
Sweater and Eritrea Steel Sheet Factories ensure that their customers do not back down
from their agreement by having a written contract. The firms reported from their
experience that there is no probability of customers backing down from their agreement
and the difficulty of getting another customer is small. Eritrea Steel Sheet Factory and
Asmara Milk Factory choose the cheapest channel of communication to contact
customers and they enter into routine contract agreements with terms known in advance
of transaction to get into contract and control customers. All firms do not employ sales
agents or lawyers to facilitate the contacting, contracting and controlling customers.
&RQFOXGLQJ UHPDUN As a result of the data collected through interviews and

questionnaires we can conclude that the privatised firms use relatively better approaches
to manage the levels of their working capital investment compared to the government
and the transition firms. All the firms apply a credit policy both with their suppliers and
customers. However, their credit sales policy depends on the trust they have in the
customer. The trust depends on whether their partner is government or privately owned.
Government firms are trusted and are offered credit. While their policy towards private
firms depends on the experience and the size (using the 5C’s as a measuring criteria) of
the firm. The more positive the experience and the larger the size of the firms the more
the possibility that the credit applicant will get credit. The privatised firms are also
observed to control the holding costs of working capital investment levels more
efficiently. They make explicit agreements with their suppliers and customers to
minimise repetitive contacts and contracts, which increases trust in each other and
eliminates strict controls. These measures, we believe create value to the firms because
they decrease the costs of inter-firm transactions and increase revenues. This is
substantiated by the fact that all the privatised firms except Asmara Sweater Factory
have net profits, net cash inflows and good performance indicators (See Appendix
8.2.3.4).
Up to this section, we dealt with the internal working capital management approaches
applied by the privatised firms. Here, we explore if they evaluate the performance of
their working capital related management decisions, and if they do what type of
performance measurement criteria they apply. We particularly asked the managers what
type of performance measurement criteria they use to measure their performance and
how they evaluate the result of their decisions. For supporting data to this section refer to
Appendix 8.2.3.3.
We also evaluated the result of their decisions as it is reflected in the firms’ seven year
(1994 - 2000) financial statements. We applied various types of financial performance
indicators using the approach of ratio analyses. For detailed information on financial
analyses of working capital decisions, refer to Appendix 8.2.3.4 (Asmara Milk Factory)
and 8.2.3.5 (comparative financial analyses of the privatised firms).
3HUIRUPDQFH PHDVXUHPHQW DQG HYDOXDWLRQ FULWHULD According to the firm’s financial
manager, Asmara Milk Factory evaluates the performance of its working capital
decisions by comparing the performance of its past with the present and the actual with
the expected. However, it does not compare its performance with other firms using inter-
firm benchmarks. Moreover, as it is indicated in Appendix 8.2.3.3, the financial manager
did not indicate any specific accounting based criteria he uses to measure the firm’s
performance. However, the firm uses customer satisfaction criteria particularly on
quality of products by decreasing defect rates as well as communication-based criteria
following the policy of fast delivery time.
Moreover, by taking data from the firm’s financial statements, we computed accounting
based performance measurement and evaluation criteria to study the firm’s financial
position. We divided the evaluation of Asmara Milk Factory’s financial performance
into three sections. First, we studied the investment composition using asset structure
ratios. Second, the liquidity and short-term financing composition ratios are used to
evaluate efficiency of the firm’s working capital financing and liquidity position. Third,
we used activity and profitability ratios to study the firms overall efficiency in turning
over the working capital assets and generating profit. Appendix 8.2.3.4 contains the
financial analysis of working capital decisions referring to Asmara Milk Factory’s
investment, financing and operational performance.
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOLQYHVWPHQW
:RUNLQJ FDSLWDO LQYHVWPHQW FRPSRVLWLRQ We analysed the financial statement data to

find the composition of Asmara Milk Factory’s investments. We used asset structure
ratios particularly working capital to total assets and its breakdowns - inventory,
receivables and cash to working capital. Financial statements for 1994 and 1995 are not
included, because until the end of 1995, its financial statements were consolidated with
other three firms. We used the terms “inventories” and “stock” as well as “accounts
receivable” and “debtors” inter-changeably. We have used the terms inventories and
receivables in our literature review while empirically we found that the firms in
Eritrea use the terms “stock” for “inventories” and “debtors” for “accounts
receivable”.
As Appendix 8.2.3.4 reveals, asset structure

:RUNLQJ FDSLWDO WR WRWDO DVVHWV UDWLR
ratios of Asmara Milk Factory for the seven years studied reveal that current assets to
total assets is an average of 52%. As it is indicated by Figure 8-1 the firm’s asset
Chapter 8 192
structure decreased sharply when it went private and then increased sharply in the
year after privatisation. As it is revealed by Figure 8-1, the short-term debt compared
to the total assets accounted to a relatively smaller percentage both before and after
privatisation implying that short-term debt was not used to finance the total assets to a
large extent.
)LJXUH$VVHWVWUXFWXUHDQGVKRUWWHUPGHEWOHYHUDJH±$VPDUD0LON)DFWRU\
90%
80%
70%
60%
Current asset to total assets
50%
40% Short-term debt to total asset
ratio
30%
20%
10%
0%
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
In order to study the composition of each working capital element in the total working
capital investment, we computed inventory to working capital, receivables to working
capital and cash to working capital. The computations revealed a seven-year average
of inventory to working capital of 40%, receivables to working capital of 11% and
cash to working capital of 49%. For the trend over the seven years, see Figure 8-2.
)LJXUH:RUNLQJFDSLWDOLQYHVWPHQWFRPSRVLWLRQ±$VPDUD0LON)DFWRU\
90%
80%
70%
60%
Stocks
50%
Debtors
40%
Cash
30%
20%
10%
0%
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUN Generally the investment in working capital is not large when
compared with the global norm. From the detailed computations (Appendix 8.2.3.4) it
can be observed that Asmara Milk Factory’s major working capital investment is in
inventories and idle cash. The investment in receivables is minimal, indicating the firm’s
lack of credit policy. Its inventory investment has shown a sharp increase in 1998, which
then remained constant. Overall the inventory levels has remained at an acceptable range
because the firm does not keep inventory for a long time due the perishability of the
inventory, low production capacity and high demand for its products. The trend in the
investment in cash balances is observed to be the opposite of inventory. It revealed a
very sharp decrease in 1998 when the inventory balance increased, indicating that the
increase in the level of inventory caused the cash levels to diminish. The working capital
to total assets ratio has gradually decreased over the last two years.
We analysed Asmara Milk Factory’s financial statements using liquidity and short-term
financing composition ratios in order to evaluate its liquidity position and to study how
the firm’s investments are financed.
/LTXLGLW\SRVLWLRQ The liquidity position of Asmara Milk Factory is analysed using
current and quick ratios, which respectively show a seven-year average of 1.5 and 1.1
times the current liabilities. This also supports the firm’s deteriorating asset structure
after its privatisation (see Figure 8-3).
)LJXUH/LTXLGLW\SRVLWLRQ±$VPDUD0LON)DFWRU\
2,5
2,0
1,5
Current ratio
Quick ratio
1,0
0,5
0,0
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
6KRUWWHUPILQDQFLQJFRPSRVLWLRQ As it is indicated in appendix 8.2.3.4 short-term
financing of Asmara Milk Factory is composed mainly of non-trade creditors (such as

provision for taxation and dividend payable) and trade creditors which on the average
accounted for 44% and 37% of the total respectively. The remaining 19% is short-
term bank loans. The factory does not use bank overdraft to finance its working
capital investments (see also figure 8.4.).
Chapter 8 194
)LJXUH:RUNLQJFDSLWDOILQDQFLQJFRPSRVLWLRQ±$VPDUD0LON)DFWRU\
80%
70%
60%
50% Trade creditors
40% Short-term bank loans
30% Others
20%
10%
0%
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
After privatisation trade creditors which increased to an average of 44% surpassed the
other financing sources, followed by short-term bank loans amounting to 42% while
other financing sources are on the average of 14%.
We used activity and profitability ratios to study the efficiency and profitability of
Asmara Milk Factory’s working capital operations. More data on the performance
evaluation of working capital operations is indicated in Appendix 8.2.3.4.
2SHUDWLRQDOHIILFLHQF\RIZRUNLQJFDSLWDODFWLYLWLHV The firm’s financial statement
data are analysed using activity ratios to study the efficiency of the firm’s operations
of purchasing, cash payments, selling and cash collections. Activity ratios show the
efficiency of managing working capital items or how fast receivables, payables and
inventories are converted or turned over. The ratios include, inventory turnover,
accounts receivable turnover and overall working capital turnover. In order to
simplify the analysis we also computed the days that inventories and receivables are
held.
,QYHQWRU\ WXUQRYHU of Asmara Milk Factory indicates average annual cost of goods
sold is 4.8 times average inventory, which means that inventory was held 76 days
during the year on average. 5HFHLYDEOHV WXUQRYHU VKRZV that, annual sales is 38.4
times average receivables, that is receivables were turned over every 10 days. 2YHUDOO
ZRUNLQJFDSLWDOWXUQRYHU shows that sales is 3.1 times the average current assets. As it
can be observed from Figure 8-5 the firm’s inventory turnover has been constantly
low throughout the seven years while its receivables turnover shows a higher turnover
except for the two years (1998 and 1999) until its privatisation, which then picked up
indicating a change of credit collection policy.
)LJXUH:RUNLQJFDSLWDODFWLYLW\±$VPDUD0LON)DFWRU\
60,0
50,0
Inventory turnover
40,0
Account Receivable
30,0
turnover
10,0
0,0
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
&RQFOXGLQJUHPDUN The receivables turnover ratio shows a relatively short period
taken to collect receivables possibly due to efficient receivables collection

management. However, the inventory turnover ratio indicates a relatively slow
moving inventory.This implies that the days inventory is held is relatively long while
the average receivables collection period is short. Again, overall working capital
turnover is rather low and does not give a promising indication as to the efficient
utilisation of working capital investment.
2YHUDOOSURILWDELOLW\ We computed profitability ratios (gross profit margin, net profit

margin and return on assets) to study the efficiency of the firm’s operations in generating
profit during the seven years. Profitability ratios relate the firm’s profit to sales, costs
and assets invested. The firm’s gross profit and net profit margins are an average of
17% and 9% of the annual sales respectively. The return on assets shows that the net
profit after tax is on the average 20% of total assets. However, a reference to figure 8-6
indicates that the gross profit and net profit margins of Asmara Milk Factory are
continuously deteriorating since 1998.
)LJXUH2YHUDOOSURILWDELOLW\±$VPDUD0LON)DFWRU\
25%
20%
15% Gross profit margin

Net profit margin
10% Return on asset
5%
0%
1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
Chapter 8 196
&DVK IORZ$QDO\VLV Table 8-1 revels that the net cash flows of Asmara Milk Factory
was positive during the first two years but finally decreased. It can also be observed
that inventories decreased and creditors increased so both items contributed positively
to the net cash inflows while receivables had negative impact. However, the
percentage effect of the individual items indicate that inventories contributed 27% of
the increase in net cash flows while receivables and creditors made a negative
contribution of 30% and 14% respectively. The fact that the overall net cash flow
ended up at a positive average implies other items were the major sources of cash for
the firm.
Table 8-1: Cash flow analysis – Asmara Milk Factory (figures in ‘000)
1997 1998 1999 Average
$$QQXDOQHWFDVKIORZ 2319 1474 -1128 889
%1HWFDVKIORZWRWRWDODVVHWV 22% 13% -8% 9%
'$QQXDOFKDQJH
Increase (-), decrease: stocks* 671 410 -287 265

Increase (-), decrease: debtors* -21 -666 499 -63
Increase, decrease (-): creditors** 67 83 556 235
($QQXDOHIIHFWRQ1&)
Increase (-), decrease: stocks 29% 28% 25% 27%

Increase (-), decrease: debtors -1% -45% -44% -30%
Increase, decrease (-): creditors 3% 6% -49% -14%
Others: Increase, decrease (-) -69% 11% 68% 17%
Source: computed from the firm’s financial statements
&RQFOXGLQJUHPDUNV The profitability measures show that the firm has a sound profit
position. The firm has monopolised the supply of materials through its connection with
the firms producing animal feed. This has enabled the firm to purchase raw materials at
favourable terms and lowers its cost of production. Moreover the firm’s sizeable profit
margin could also be attributed to its monopoly in a market with increasing demand,
which the firm may get difficulty to sustain if more competitive private firms would
come in the future. However, the decreasing trend of its gross and net profit margins as
well as return on assets indicates a demanding problem which need further study and
analysis.
3UHDQGSRVWSULYDWLVDWLRQILQDQFLDOSHUIRUPDQFH Comparing financial analysis of

the pre and post privatisation reveals that the firm’s current asset to total assets ratio
has decreased by about 43% mainly because of additional investment in fixed assets.
While the working capital investments in inventories have increased by 62%, the
working capital investment composition in cash has decreased by 38%. Moreover, the
working capital investment composition in receivables has only marginally decreased
by about 17%. Its liquidity position in terms of both current and quick ratios has also
deteriorated. Moreover, after privatisation the firm shifted from financing its working
capital investment using accrual accounts such as taxes and dividends payable (which
showed a decrease of 73%) to short-term bank loans and trade creditors, which
respectively increased by 223% and 26%. The firm’s inventories, receivables and
overall working capital turnovers all indicate an increase after privatisation. However,
the firm’s profitability measures particularly gross profit and net profit margins have
decreased by 17% and 70% respectively after privatisation. Figure 8-6 reveals that
privatisation did not help the firm to improve its profitability. For more information on
pre and post privatisation financial performance refer to Appendix 8.2.3.4.
*HQHUDO HYDOXDWLRQ RI SRVW SULYDWLVDWLRQ GHYHORSPHQW According to the general

manager, both the personnel composition and policy of the management has not been
changed from what it used to be before privatisation. However, Asmara Milk Factory
has invested in production machines and transportation vehicles with the help of a soft
loan obtained from DANIDA (a Danish co-operation firm). As a result of this
investment it has added new product lines, particularly for the production of Cheese
and Yoghurt. These two products according to the firm’s general manager will help to
smooth the seasonal fluctuations in the demand of the firm’s products. According to
the general manager, the firm increased its production capacity after privatisation. It
has increased both the volume and types of products. The factory is processing 18,000
litres per day compared to 4000 litres before privatisation - an increase of 300%.
However, the number of employees after privatisation [which stands at about 50
employees in the year 2000] has decreased.
3HUIRUPDQFHPDQDJHPHQWFRPSDULVRQRISULYDWLVHGILUPV
In this section we make a comparative analysis of the impact of management’s decisions

on the privatised firms’ investments, financing and operations. For more information
refer to Appendix 8.2.3.3 for comparative performance measurement and evaluation
criteria and Appendix 8.2.3.5 for comparative accounting based performance
evaluation.

managers, all three privatised firms evaluate performance of their working capital
investment decision using comparative analysis of past versus present and actual
versus expected (except for Eritrea Steel Sheets Factory) but none of them use inter-
industry benchmarks. They apply communication based particularly having the policy
of fast delivery time to satisfy their customers. Asmara Sweater Factory and Eritrea
Steel Sheets Factory also take care of their customers by minimising costs and
charging lower prices and having fast response to their demands. Eritrea Steel Sheets
Factory and Asmara Milk Factory also increase the quality of their products by
decreasing defect rates. Asmara Sweater Factory and Eritrea Steel Sheets Factory
apply some accounting based performance measurement and evaluation criteria. Both
firms evaluate their liquidity using current and quick ratios, their working capital
activity using inventory and receivables turnover ratios, their profitability using gross
profit, return on working capital and return on total assets. While Asmara Sweater
Factory also evaluates its working capital activity using overall working capital
turnover, its working capital investment composition using inventory, receivables and
working capital to total assets, Eritrea Steel Sheets Factory also evaluates its working
capital investment composition using cash to working capital ratio. The computation
of the firms’ accounting based performance indicates the following results.
,QYHVWPHQW We evaluated the efficiency of managing overall investment by analysing

asset structure ratios. The average current assets to total assets for Asmara Sweater
Factory, Asmara Milk Factory and Eritrean Steel Sheet Factory are 66%, 52% and 85%
respectively. The average working capital investment composition of inventory,
receivables and cash to total working capital respectively shows 83%, 17% and 2% for
Chapter 8 198
Asmara Sweater Factory, 40%, 11% and 49% for Asmara Milk Factory and 39%, 33%
and 24% for Eritrean Steel Sheet Factory. Eritrea Steel Sheets Factory with 85%
recorded the highest current assets to total assets ratio while Asmara Milk Factory had
only 52% of its assets invested in the current.
)LQDQFLQJ We used liquidity ratios (current and quick ratios) and composition of
short-term financing to study the liquidity position and short-term financing management
of the privatised firms. The current and quick ratio positions respectively are an average
of 0.7 and 0.2 for Asmara Sweater Factory, 1.5 and 1.1 for Asmara Milk Factory and 2.2
and 1.3 for Eritrean Steel Sheet Factory. Sembel Steel Sheets Factory is the only liquid
privatised firms. Though Asmara Milk Factory slightly above the global norm quick
ratio its current ratio fell below the globally acceptable norm of 2. Asmara Sweater
Factory reported below the norm in both the current and quick ratios and it can therefore
be conclude that it has a real problem of liquidity.
The composition of trade creditors, short-term bank loans, bank overdraft and others
accruals are respectively 13%, 2%, 77%, 8% for Asmara Sweater Factory. Short-term
financing composition for Asmara Milk Factory as indicated earlier was composed of
37% trade creditors, 19% short-term bank loans, 0% bank overdraft and 44% accruals.
Moreover, that of Eritrean Steel Sheet Factory was 33%, 14%, 22% and 32%
respectively for trade creditors, short-term bank loans, bank overdraft and other accruals.
The privatised firm use different sources of short-term financing. While Asmara Milk
Factory used both trade creditors and other sources such as dividend payable and
provision for taxation, Asmara Sweater Factory used mostly Bank overdrafts. Eritrea
Steel Sheets Factory used trade creditors (including credits to related enterprises up the
period of its privatisation) and other sources such as short-term loans and bank overdraft
after it was privatised, dividend payable and provision for taxation before it was
privatised.
2SHUDWLRQV We also studied the privatised firms’ efficiency in managing overall

operations by analysing activity and profitability ratios. The activity ratios, for the three
firms - Asmara Sweater Factory, Asmara Milk Factory and Eritrean Steel Sheet Factory
show an average inventory turnover of 0.7 (or 358 days), 4.8 (or 76 days) and 1.4 (or 260
days), respectively. Accounts receivable turnover reveals 8.6 (or 42 days), 38.4 (or 10
days), and 2.4 (or 152 days) respectively. Working capital turnover was 0.7, 3.1 and 0.9
respectively. Except for the abnormally high receivable turnover recorded by Asmara
Milk Factory, the inventories, receivables and overall working capital turnovers for all
the privatised firms is low. Moreover, relatively, Asmara Milk Factory registered the
highest turnover in all the working capital activity ratios.
Profitability ratios for Asmara Sweater Factory, Asmara Milk Factory and Eritrean Steel
Sheet Factory show an average gross profit margin of 22%, 17% and 19% respectively
while net profit (loss) margin was (35%), 9% and 6% respectively while the return on
assets was (19%), 13%, and 10% respectively. Asmara Sweater Factory is the only
privatised firm which has recorded loss both pre and post privatisation. The other two
privatised firms were profitable throughout the years that we have studied (except that
Eritrea Steel Sheets factory made loss during the first year after its privatisation).
&DVKIORZ$QDO\VLVComparison of the net cash flows of the privatised firms revealed
that all the privatised firms have increasing trend o net cash flows with Asmara
Sweater Factory having the largest average increase and Eritrea Steel Sheet Factory
the lowest average increase. However, inventory and creditors increased on the
average for the firms during the years except for Asmara Milk Factory, which had a
no change f creditors balance. Inventory made the largest impact on net cash flows for
Asmara Sweater Factory and Eritrea Steel Sheet Factory while debtors made the
largest impact for Asmara Milk Factory cash flows.
&RQFOXGLQJ UHPDUNV Asset compositions of the privatised firms show that a large
proportion (an overall average of 68%) of the total investment is in current assets. This
(according to their managers) is because the firms have serious problems of production
capacity due to lack of a finances to pay for the investment in capital assets. The liquidity
ratios indicate that the firms have differing degrees of liquidity. Asmara Sweater Factory
has a problem of liquidity and Asmara Milk Factory is marginally liquid while Eritrean
Steel Sheet Factory has slightly more than the normally acceptable liquidity. Operational
performance indicators for Asmara Sweater Factory, Asmara Milk Factory and Eritrean
Steel Sheet factory indicate very low inventory turnovers, resulting in a long periods that
the assets are held and the overall working capital turnover for all the firms is low. These
low turnovers have resulted at a problem of generating profit for Asmara Sweater
Factory. However, Asmara Milk Factory and Eritrean Steel Sheet Factory generated
profit. Comparatively Asmara Milk Factory has the highest inventory and receivables
turnovers, shortest period receivables and inventory are held and this has intern resulted
at the highest net profit margin and return on assets, which is a sign of relative success.
3RVWSULYDWLVDWLRQILQDQFLDOSHUIRUPDQFH Comparing financial performance of the
pre and post privatisation periods reveals that the privatised firms’ current asset to
total assets ratio has decreased except for Eritrea Steel Sheets Factory because of
additional fixed assets investment. However, their liquidity position in terms of both
current and quick ratios has remained almost unchanged on average. We also checked
the short-term debt to total assets ratio to study the extent of short-term debt used in
financing the firms assets. This ratio indicates that the privatised firms have decreased
their short-term debt ratio after they were privatised. The composition of inventories
and cash in the total working capital have also decreased by 23% and 58%
respectively while the average investment in debtors has increased by more than 4.5
times. The firms’ inventories, receivables and overall working capital turnovers also
indicate a marginal increase after privatisation. While the average gross profit ratio
has increased by 57%, their average net profit margins and return on assets have
decreased by 6 and 1.3 times respectively mainly because of the extremely poor
performance of Asmara Sweater Factory after privatisation. Moreover, it can also be
observed that Asmara Milk Factory and Eritrea Steel Sheets Factories net profit
margins and returns on assets have relatively decreased after privatisation though both
remained positive.
3RVW SULYDWLVDWLRQ ZRUNLQJ FDSLWDO PDQDJHPHQW One year after our data collection,
we contacted the general managers of the privatised firms to find out whether they
have made changes on management, investments and operations after they are
privatised. We tried to find information on the developments that the firms have made
with regard to management in terms of both composition of the personnel and general
managerial policy. We also investigated if the privatised firms have made any
investment expansion or retraction of product lines or products. Our findings indicate
that generally, the privatised firms made changes in terms of both management
Chapter 8 200
personnel and policy. We found out that all have introduced some policy changes with
regard to operations and linkages. Two privatised firms have made some capital
investments, closed some production lines and have started to concentrate mainly on
those products that the management considered profitable.
This section explores if the privatised firms have proper inter-firm co-operation on the
primary activities on both the supplier side and the customer side. With this objective
in mind we asked the firms’ general, financial and commercial managers if and how
they co-operate with their supplier and customer linkages on the primary activities as
well as on purchase and inventory management. We then asked what benefits they get
as a result of their co-operation or why they do not co-operate. First, we review the
response of one of the privatised firms – Asmara Milk Factory and compare the
responses of the privatised firms. Then we examine the responses of the suppliers and
customers. For detailed information on external working capital management and
inter-firm co-operation, see Appendix 8.3.1 – for the responses of firms on firm-
supplier co-operation (8.3.1.1) and firm-customer co-operation (8.3.1.2), Appendix
8.3.2 – for response of suppliers and Appendix 8.3.3 – for responses of customers.
5HVSRQVHVRIWKHFHQWUDOILUPV±$VPDUD0LON)DFWRU\
The objective of studying firm-supplier co-operation in this section is to know if

Asmara Milk Factory creates value by co-operating with its suppliers so that it
decreases costs of inter-firm transaction relation by managing supplier linkages. We
asked the firm’s managers if and how they co-operate on primary activities including
purchase and materials inventory management and what benefits they get as a result
of their co-operation or why they do not co-operate.
)LUPVXSSOLHUFRRSHUDWLRQRQSULPDU\DFWLYLWLHV According to the general manager,

who also acts as commercial manager, the primary activities that Asmara Milk Factory
strongly co-ordinates with its supplier include, inbound activities, production operation
and marketing and sales. However, it has weak suppliers’ co-operation with its suppliers
on activities related to after sale services.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW Asmara
Milk Factory co-ordinates its materials purchase and inventory management with
suppliers by specifically agreeing on the quality and quantity of materials to be
purchased, the terms of transportation as well as supplying the materials purchased
just in time for production.
However, the firm’s co-operation policy is only with selective suppliers because the
commercial manager believes it is not beneficial to co-operate with all suppliers. In
addition to this some suppliers also lack the willingness to co-operate. Moreover, the
financial manager does not believe that this co-operation reduces the cost of inventory
ordering and carrying, the time and cost of purchasing materials and it does not help
in creating firm-supplier trust.
Moreover, according to the general manager, this results in a mutual benefit and two-
way co-operation between Asmara Milk Factory and its suppliers. On one side, the
suppliers are also owners, so as owners they help in supplying the firm with materials,
on the other hand, the firm provides its suppliers with the exclusive right to get animal
feed from the animal feed producing factories. Therefore, the firm’s sustainability of
supply is ensured as a result of its agreement with the firm’s suppliers of suppliers -
Asmara Brewery and Keih Bahri Food Product. As per the agreement, the factories sell
animal feed only to the suppliers of the factory whose list Asmara Milk Factory sends
periodically. In the interview conducted with the Asmara Milk Factory’s general
manager he said that: ³2XUVXSSOLHUVSUHIHUWREX\WKHDQLPDOIHHGIURPWKHWZRIDFWRULHV
IRU WZR UHDVRQV )LUVW WKH DQLPDO IHHG LV LQ VKRUW VXSSO\ VR WKH RQO\ ZD\ WKDW WKH\ FDQ
HQVXUH WKH DYDLODELOLW\ RI WKHLU VXSSO\ LV WR FRQWLQXH WKHLU UHODWLRQ ZLWK WKH WZR DQLPDO
IHHG SURGXFLQJ IDFWRULHV 6HFRQG $VPDUD %UHZHU\ DQG .HLK %DKUL )RRG 3URGXFWV DUH
JRYHUQPHQWILUPVVRWKHLUSULFHLVFKHDSHU ”.
3RVWSULYDWLVDWLRQ VXSSOLHUDQG FXVWRPHUFRRSHUDWLRQ According to the general

manager Asmara Milk Factory has added new supply lines outside Asmara. It is now
collecting milk using its collection offices from towns 40 to 50 kilometres outside
Asmara such as Mendefera and Dekemhare. Moreover, the factory is still maintaining
the linkages that it had established with both its suppliers and suppliers of suppliers.
Asmara Milk Factory has also opened new markets in Masawa about 115 kilometres
outside Asmara. The general manager is hopeful that the new products (Cheese and
Yoghurt) will enable the firm to satisfy its customers and to enable it to have closer
customer relationships.
&RQFOXGLQJ UHPDUNV Asmara Milk Factory is co-operating with its suppliers
because the firm’s suppliers are its co-operative owners too, so they have vested
interest in supplying milk to the firm. In addition to this, we also found the linkages
between Asmara Milk Factory and the animal feed producing factories serving as
major control mechanism for suppliers to continue dealing with the firm and settle
their debts on time. Both reasons have helped the firm and its suppliers to remain
closely linked and minimise the cost of the firm’s contact, contract and control and be
more profitable.
)LUPVXSSOLHUFRRSHUDWLRQFRPSDULVRQRISULYDWLVHGILUPV
)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV Asmara Milk and Asmara

Sweater Factories replied positively to firm-supplier co-operation on primary
activities (see Appendix 8.3). They reported that they co-operate with their suppliers
on inbound activities and production operations. As it is mentioned earlier in this
section Asmara Milk Factory also co-operates with its suppliers on marketing and sales
activities except on advertisement. However, Eritrean Steel Sheet Factory does not co-
operate with its suppliers in any of the primary activities because, as the firm’s
general manager responses to the interview questions revealed, its suppliers are
abroad and the firms-supplier linkages are dictated by the import-export regulations of
the government.
Chapter 8 202
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVH DQG LQYHQWRU\ PDQDJHPHQW Asmara
Milk Factory and Asmara Sweater Factory co-ordinate their materials purchase and
inventory management with suppliers by specifically agreeing on the quality and
quantity of materials to be purchased as well as supplying the materials purchased just
in time for production. Moreover, the commercial manager of both Asmara Sweater
Factory and Asmara Milk also believe that the firms co-operate with their suppliers on
the terms of transportation. However, as a result of its co-operation only Asmara
Sweater Factory replied that it gets benefits such as a decrease in the time needed to
purchase the materials and costs of ordering and purchase as well as in creating inter-
firm trust.
Where the firms are not co-operating with their suppliers they replied that it is
because the firms themselves do not have the specific policy and their suppliers have
not developed the business culture of co-operation. The commercial managers of
Asmara Sweater Factory and Eritrean Steel Sheet Factory reported that they have
selective policy because they do not see the benefit of co-operating with all their
suppliers.
&RQFOXGLQJ UHPDUN We conclude from the findings of the privatised firms’
management of working capital operations and levels that it takes time for privatised
firms to fully develop the efficiency and supplier linkages exemplified by private
firms. Asmara Milk Factory is still influenced by its historical legacy as government
firm, particularly with regard to its supplier linkages because the government has
allowed the firm to continue dominating the supply market since suppliers are
indirectly obliged to sell to the firm, else no animal feed. However, we find Asmara
Sweater Factory breaking its past experience as a government firm. It has shifted its
source of supply from Keih Bahri Tannery (a government firm in transition to
privatisation) to Tesfagiorghis Beatay Leather Factory (a private firm) because
according to the general manager of Asmara Sweater the private firm has more
flexible and efficient production and better customer relations.
5HVSRQVHVRIVXSSOLHU±'$68R$
In order to answer section 2(c) of the second research question: ³+RZ GR SULYDWLVHG
ILUPVLQ(ULWUHDPDQDJHWKHLUILUPVXSSOLHUOLQNDJHV´ , we had to find the response of
their suppliers. We evaluated the firm-supplier co-operation on primary activities and
on sales and inventory management as well as related benefits or the reasons for non-
co-operation. We also study the supplier evaluation of firm efficiency. So, we
approached the farm manager of a farm owned by the University of Asmara –
Department of Animal Science (DAS), one of the main suppliers of Asmara Milk
Factory whose responses follow.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV The farm manager believes that
the two firms do not co-operate on the primary activities like production operations,
outbound activities, marketing/sales and after sales service. However, they have an
agreement that the DAS sells its daily milk production to Asmara Milk Factory and
that it maintains an agreed quality and fat content. In return Asmara Milk Factory
provides DAS with animal feed through its connection with Keih Bahri Food
Products. Moreover, the farm manager is not satisfied with the purchasing system of
Asmara Milk Factory. He says that: ³7KH IDFWRU\¶V EX\LQJ SULFH LV ORZ LW LV FORVHG
GXULQJ KROLGD\VLW GHFUHDVHV LWV SXUFKDVHV GXULQJ UHOLJLRXV IDVWLQJ SHULRGV DQG GRHV
QRW JLYH WUDQVSRUWDWLRQ VHUYLFHV XQOLNH LWV PDLQ FRPSHWLWRU $VPDUD 0HDW DQG 0LON
)DFWRU\ ”. His opinion is that Asmara Milk Factory forces its suppliers to stick to it by
having an agreement with animal feed producing factories such as Keih Bahri Food
Products, which the manager believes is very unfair business dealing. He believes that
it is unfair because the suppliers cannot shift to alternative suppliers on the basis of
other criteria than getting the supply of animal feed, such as higher prices or customer
efficiency in inter-firm transaction relations.
)LUPVXSSOLHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW : The supplier of

Asmara Milk Factory does not believe that it efficiently co-operates its sales and
inventory management with its customer. The only co-operation reported is on credit
transactions without discount and in providing goods when just needed but not on
exchanging skilled staff. The farm manager is therefore not satisfied with the
purchase, shipment and transportation system of Asmara Milk Factory. As a result of
its dissatisfaction, he said that: “:HDUHLQWKHSURFHVVRIFKDQJLQJRXUFXVWRPHUIURP
$VPDUD0LON)DFWRU\WRLWVPDLQFRPSHWLWRU$VPDUD0HDWDQG0LON)DFWRU\ZKLFKLV
D UHFHQWO\ SULYDWLVHG ILUP´. The manager believes that this lack of co-ordination is
mainly because Asmara Milk Factory has not developed the business culture of co-
ordinating its inventory and purchase activities. However, he is of the opinion that, it
is not because the farm does not have the specific policy on customer co-operation or
that it does not see the benefit of closely co-operating with a specific customer.
Moreover, the limited co-operation helps in decreasing the time need to sell and the
costs of selling goods, but it does not help to minimise the costs of transportation.
The manager's opinion is that Asmara Milk

6XSSOLHU DVVHVVPHQW RI ILUP HIILFLHQF\
Factory is efficient in its payment habits and in taking advantage of the services that
DAS offers. However, it is less efficient in its marketing approach and purchase order
processing. The farm and Asmara Milk Factory exchange special services most
frequently on product quality and less frequently on employee training. Generally, the
farm manager believes that the co-operation between the two firms is not good mainly
because Asmara Milk Factory is inefficient in providing transportation, storage and
customer treatment. The manager said that if it is to be competitive, the factory has to
provide these services and establish milk collection centres located in the vicinity of its
suppliers.
&RQFOXGLQJ UHPDUNV Unlike what the general manager of Asmara Milk Factory
claims, (that it fully co-operates with its suppliers on purchasing and materials inventory
management), the opinion of its supplier tells us a different story. The firm’s purchasing
and inventory management is geared totally in favour of the factory. According to its
supplier the firm’s linkages with the suppliers’ of suppliers help the firm to practice
unfair business dealings because regardless of its efficiency, suppliers are forced to
continue their linkages.
Chapter 8 204
)LUPVXSSOLHUFRRSHUDWLRQFRPSDULVRQRIVXSSOLHUVRISULYDWLVHGILUPV
In order to get a comparative response of firm-supplier linkages, we approached the

suppliers of the two privatised firms. These suppliers include, Tesfagiorgis Beatay
Leather Factory - supplier of Asmara Sweater Factory and University of Asmara –
Department of Animal Science (UOA-DAS) - supplier of Asmara Milk Factory. The
responses of the two suppliers follow and for more information refer to Appendix
8.3.1.2.
)LUPVXSSOLHU FRRUGLQDWLRQ RQ SULPDU\ DFWLYLWLHV Only the supplier of Asmara

Sweater Factory replied that the two firms co-operate on outbound activities particularly,
order processing and delivery vehicle operations as well as on marketing and
sale/purchase, specifically advertisement. Otherwise, both suppliers replied that they do
not co-operate on other primary activities such as outbound activities, production
operations or after sale service.
)LUPVXSSOLHU FRRSHUDWLRQ RQ VDOHV DQG LQYHQWRU\ PDQDJHPHQW : The suppliers of

privatised firms do not believe that they co-operate their sales and inventory
management with their customers. The only co-operation reported is on credit
transactions without discount and providing with goods when just needed by the
customer but not on exchanging skilled staff. The suppliers believe that this lack of
co-ordination is mainly because the privatised firms do not co-operate. However, their
opinion that, it is not because they do not have the specific policy on customer co-
operation or that they do not see the benefit. Moreover, the limited co-operation helps
them to decrease the time needed to sell and the cost of selling goods and carrying
inventory as well as it assists in creating inter-firm trust.
Both suppliers of Asmara Milk Factory

6XSSOLHUDVVHVVPHQW RI ILUPHIILFLHQF\
and Asmara Sweater Factory agree that the firms are efficient on their payment habits.
However, it is only the supplier of Asmara Sweater Factory who believes that the firm
is efficient in processing purchase orders, bilateral communication, explanation to
inquiries, courtesy and marketing approach.
&RQFOXGLQJ UHPDUNV As a result of the interviews conducted and questionnaire

responses received from the suppliers of the two privatised firms, we conclude that
the firms have differing policy on firm-supplier co-operation. Asmara Milk Factory
keeps its firm-supplier linkages using adversarial tactics, a typical character of a
government or monopoly firm. While Asmara Sweater factory co-operates with its
supplier on an equal footing using collaborative tactics. Therefore, the supplier of
Asmara Sweater Factory is much more satisfied and willing to co-operate in the future
compared to the supplier of Asmara Milk Factory. We find a clear indication that the
firm-supplier linkage of Asmara Milk Factory is temporary because if Asmara Milk
Factory’s co-operation with the suppliers of suppliers is lifted, its suppliers will shift
to other competitors unless the firms shifts to more co-operative approaches.
In order to study how efficient privatised firms manage their customer linkages we asked
their general and commercial managers about what and how they co-operate on primary
activities, sales operations and inventory management. We also inquired on the benefits
the privatised firms get as result of their co-operation or why they do not co-operate and
whether the firms assess their customers’ opinion.
5HVSRQVHVRIWKHFHQWUDOILUPV±$VPDUD0LON)DFWRU\
This section deals with the firm-customer co-operation from the point of view of Asmara
Milk Factory. For more information refer to Appendix 8.3.1.2.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to the general

manager, the primary activities that Asmara Milk Factory strongly co-ordinates with its
customers include, production operations (packaging, assembly, equipment maintenance,
product testing and facility operations), outbound activities (delivery vehicle operations,
materials handling and order processing as well as finished goods warehousing). Its
customer co-operation also includes on marketing and sales particularly with respect to
the promotion and sales channel selection but not with respect to advertising. The factory
has weak inter-firm co-operation with its customers in all activities related to after sale
service.
commercial manager of Asmara Milk Factory, the firm co-ordinates its sales and
inventory management with customers by specifically agreeing on the transportation
terms, quality and quantity of goods to be produced and sold on the basis of just in
time. According to the financial manager the benefit that the firm gets is increasing
sales but the co-operation does not help in minimising the cost of transportation or the
cost of carrying inventories.
&XVWRPHU DVVHVVPHQW The firm gets the feedback of customers opinion on the
quality of its products and services by allowing them to return any product with
inferior quality and making strict quality control at the production floor. But it does
not make periodic assessments on customer opinion.
&RQFOXGLQJ UHPDUNV As much as it dominates the supply market Asmara Milk
Factory more or less dominates the demand market. There are few and smaller milk
processing factories in the country, which can effectively compete with the factory in
supplying milk and milk products. However, we find that the small milk processing
factories and the black market of direct sales of milk to consumers by the milk
producers has exerted enough pressure on the factory. This has motivated the factory
to co-operate with its customers on primary activities, particularly transporting to their
place of business and allowing credit to its larger customers.
)LUPFXVWRPHUFRRSHUDWLRQ±FRPSDULVRQRISULYDWLVHGILUPV
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV The managers of Asmara Milk
and Asmara Sweater Factories responded that they strongly co-operate with customers
on production operations (particularly - packaging, assembly, equipment maintenance,
product testing and facility operations) as well as on outbound activities (such as
materials handling, order processing and finished goods warehousing). Asmara Milk
Factory also co-operates with its customers on outbound activities with respect to the
Chapter 8 206
delivery vehicle operations while Asmara Sweater Factory co-operates on the after sales
services particularly with respect to installation and after sales services. Eritrean Steel
Sheet Factory does not have specific co-operation with its customers in any of the
primary activities. The privatised factories have weak co-operation with customers in all
activities related to marketing and after sale service.
commercial managers of Asmara Milk Factory and Asmara Sweater Factory, they co-
operate with their customers on sales and inventory management. They specifically
have mutual agreements on the transportation terms, quality and quantity of goods to
be produced and sold on the basis of just in time. According to their financial
managers the benefit that the firms get is increasing sales but the co-operation does
not help to minimising the cost of transportation or the cost of carrying inventories.
The commercial manager of Eritrea Steel Sheets Factory however, believes that the
firm does not get any benefit because it has no specific co-operation with its
customers. The commercial manager of Eritrean Steel Sheets Factory replied that the
weak firm-customer co-operation is because the firm does not have the policy and
because it does not see any benefit in co-operating with a specific customer. In addition
to this customers have not developed the business culture of co-ordinating their
management with suppliers.
&XVWRPHU DVVHVVPHQW All three privatised firms get the feedback of their
customers’ opinion on the quality of products and services by allowing their

customers to return any product with inferior quality and making strict quality control
at the production floor. Asmara Sweater Factory and Eritrean Steel Sheet Factory
reported that they also make periodic assessments of their customer opinion.
However, none of the privatised firms allow its customers to pay only if the products
are as per their expectation.
&RQFOXGLQJ UHPDUNV Comparatively, Asmara Milk and Asmara Sweater Factories

have small but numerous competitors, so both have demonstrated remarkable signs of
competition to satisfy the demand of their customers by developing firm-customer
linkages. The managers of both firms believe that they co-operate with their
customers on the primary operations particularly, outbound activities and in some
areas of production operation like packaging. However, Eritrean Steel Sheet Factory
is the only one in the country producing steel sheets. This has enabled it to completely
dominate the market as a result of which it does not bother to create any firm-
customer co-operation.
5HVSRQVHVRIFXVWRPHU±%HUKDQH)UDIUH
In order to find out and analyse the views of the customers of the privatised firms,
interviews were made and structured questionnaires distributed to their customers. In
this section we study the firm-customer co-operation of Asmara Milk Factory from
the point of view of one of its main customers – Berhane Frafre. We search for
specific co-operation on the customer’s primary activities, purchase operations and
inventory management. We will also review the customers’ opinion on the benefit that
they get as a result of their co-operation with the privatised firms or the reasons why
they do not co-operate. Finally, we study the customer evaluation of firm efficiency.
For detailed supporting information, see Appendix 8.3.3.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to the owner-
manager of Berhane Frafre, Asmara Milk Factory co-operates only on inbound

activities particularly order processing, materials handling and delivery vehicle operation
or transportation. The two firms do not co-operate in all the other primary activities, such
as production operations, marketing/sales and after sale service.
)LUPFXVWRPHUFRRSHUDWLRQRQSXUFKDVHDQGLQYHQWRU\PDQDJHPHQW According
to the owner-manager of Berhane Frafre, the only purchase related co-operation is on
credit transaction without discount. The two firms do not co-operate on other
activities such as exchanging skilled staff, credit transaction with discounts or
providing goods when just needed. Hence the owner-manager of Berhane Frafre
believes that there are no benefits such as the decrease in the time and cost of
purchasing or decrease in the holding costs of inventory. She also believes that this
lack of inter-firm co-operation does not enhance the creation on inter-firm trust.
According to the manager of Berhane Frafre the weak inter-firm co-operation is
because Asmara Milk Factory has not developed the business culture of co-ordinating
its management policy with its customers. However, it is not because Berhane Frafre
does not have the specific policy or that it does not see the benefit of closely working
with a specific supplier. The owner-manager of Berhane Frafre says that: ³$VPDUD
0LON )DFWRU\ ZDV JRYHUQPHQW RZQHG XQWLO UHFHQWO\ DQG LW LV WKH RQO\ PDMRU PLON
SURFHVVLQJ ILUP 6R PRVW RI WKH ILUPV GHDOLQJ ZLWK PLON SURGXFWV DUH IRUFHG WR EH LWV
FXVWRPHUV´
&XVWRPHU DVVHVVPHQW RI ILUPHIILFLHQF\ The manager of Berhane Frafre rates
Asmara Milk Factory as very efficient in its cash collection habits, in sales processing,
impartiality with other buyers, explanation to inquiries and delivery. She has also
rated the factory as efficient in product quality and bilateral communication.
However, the manager believes and that the factory is less efficient in minimising the
costs of its products, in using customer services and in its marketing approach.
&RQFOXGLQJ UHPDUNV From the point of view of the owner-manager of Berhane

Frafre, the inter-firm co-operation of Asmara Milk Factory on most of the primary
activities, purchase operations and inventory management is weak. The owner-
manager blames Asmara Milk Factory for not having the proper policy of inter-firm
co-operation and traces the cause to the fact that Asmara Milk Factory is dominating
the market and not doing much in trying to satisfy its customers.
)LUPFXVWRPHUFRRSHUDWLRQFRPSDULVRQRIFXVWRPHUVRISULYDWLVHGILUPV
)LUPFXVWRPHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV According to the opinion of
their customers the privatised firms co-operate on the inbound activities particularly
on order processing. It is only Asmara Milk Factory, which according to the opinion
of its customer, that co-operates on production operation, particularly materials
handling and delivery vehicle operation. There is no co-operation on primary
activities such inbound activities (other than those mentioned above), production
operations, marketing and sales or after sales services.
Chapter 8 208
)LUPFXVWRPHU FRRSHUDWLRQRQ SXUFKDVHDQG LQYHQWRU\PDQDJHPHQW According
to the opinion of the customers, the only activity related to purchases that both
privatised firms co-operate with their customers is in granting credit without discount.
Moreover, the customer of Eritrea Steel Sheet Factory also reported that the two firms
co-operate in providing goods when just needed. The customers also believe the cause
for the weak inter-firm co-operation is that the privatised firms have no policy of co-
operating their management policies with that of their customers.
&XVWRPHU HYDOXDWLRQ RI ILUP HIILFLHQF\The two customers believe that the firms
are efficient in their cash collection, delivery, product quality, impartiality with other
buyers and bilateral communication. The customer of Asmara Milk Factory also
believes that the firm is efficient in sales processing and explanations to enquiries,
while the customer of Eritrean Steel Sheet Factory believes that its supplier is efficient
in its familiarity with customers’ needs. However, both agree that the firms are less
efficient in their marketing approaches and in using customer services.
&RQFOXGLQJ UHPDUN Overall, the customers reported that the firm-customer co-
ordination of the privatised firms is limited only to the inbound activities, which includes
order processing, materials handling and transportation for Asmara Milk Factory and
only order processing for Eritrean Steel Sheet Factory. Moreover, the customers revealed
that they are not satisfied with the way the privatised firms are handling their firm-
customer relations. We find the main reason for this is that Asmara Milk Factory and
Eritrea Steel Factory have been transferred from a government monopoly to a private
monopoly, which has motivated the firms not to have sufficient interest in their firm-
customer linkages.
&RQFOXVLRQV
In this chapter we presented the empirical data analysis of Asmara Milk Factory’s
internal working capital management, its supplier linkage with DAS and its customer
linkage with Berhane Frafre. A comparative data analysis of working capital
management is also made among the three privatised firms – Asmara Milk Factory,
Asmara Sweater factory and Eritrean Steel Sheet Factory.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW The managers of Asmara Milk Factory
and Eritrean Steel Sheet Factory believe that managing working capital levels and
operations can have a major role in the creation of firm value. As a result they
reported that it takes a lions share of their time for which they are fully empowered.
The privatised firms have more or less identified their policy on how to manage their
working capital levels and operations, which they all claim is tailored towards
generating profit by increasing sales and decreasing costs. However, we still observe
problems in the speed by which the privatised firms adapt to the culture of private
business management.
:RUNLQJ FDSLWDO LQYHVWPHQW DQG ILQDQFLQJ The objective of cash management of

all the privatised firms is to take care of routine transactions, because after what has
been spent to buy the firms from the government during privatisation, there is very
little money left. The firms have been bought from the government in the last couple
of years of our study mostly by borrowing heavily from the government banks.
Therefore, except for Eritrean Steel Sheets Factory they are getting problems of liquidity
for working capital purposes and their investment capacity has been affected. As a
result, they reported that they lack production capacity and therefore they have very
little finished goods inventory in order to bother about its costs. Only Asmara Milk
Factory provides credit to its larger customers. The other two firms have very little
investment in receivables and do not bother about managing it. In the absence of
financing capacity for both working capital and fixed capital investment, managers
are concentrating on controlling the costs and physical safety of their existing
investments and financing sources.
:RUNLQJFDSLWDORSHUDWLRQV The management of the firms working capital operations

was restricted to the application of clerical procedures of purchasing and selling.
Analysis of purchase and sales operations however showed that there is no mechanism
of enhancing the contact, contract and control aspects of purchase and sales operations.
(YDOXDWLRQ RI LQWHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW Our study of performance

evaluation has indicated that most privatised firms evaluate their performance by
comparing their past with the present and actual with the expected. However, they
neither compare their performance with their competitors nor do they use inter-firm
benchmarks to compare their performance with other firms in their industry. They apply
communication based particularly having the policy of fast delivery time to satisfy their
customers. Asmara Sweater Factory and Eritrea Steel Sheets Factory also take care of
their customers charging lower prices and having fast response to their demands. Eritrea
Steel Sheets Factory and Asmara Milk Factory have a policy to improve the quality of
their products. Asmara Sweater Factory and Eritrea Steel Sheets Factory evaluate their
liquidity, working capital activity and investment composition as well as their
profitability. On the other hand ASARA Milk Factory uses neither customer satisfaction
nor accounting based performance criteria to assess its performance.
Financial analysis showed that the firms have differing liquidity position. Asmara
Sweater Factory has liquidity problems, Asmara Milk Factory is marginally liquid while
Eritrea Steel Sheets Factory has no problem of liquidity. Investment in current assets,
(whose overall working capital turnover ratios are low for all the firms), is modest for
Asmara Sweater Factory and Asmara Milk Factory, but excessive for Eritrea Steel
Sheets Factory. All profitability ratios (gross profit, net profit and return on assets) for
Asmara Milk Factory and Eritrea Steel Sheets Factory is positive while that of Asmara
Sweater Factory shows negative levels except for gross profit margin.
,QWHUILUP FRRSHUDWLRQ The privatised firms’ external working capital management
on supplier linkages showed that Asmara Milk Factory controls its supply market and
keeps its suppliers by controlling their supply line. Eritrean Steel Sheet Factory imports
its materials totally from abroad so it has very little contact with its suppliers. Asmara
Sweater Factory has a very competitive supply market and is establishing closer firm-
supplier linkages. The privatised firms’ customer linkages show that Asmara Milk
Factory and Eritrean Steel Sheet Factory still dominated their local market while Asmara
Sweater Factory is exporting its products through its connection with another factory in
Italy, which belongs to the same owners.
Chapter 8 210
We also obtained the responses of suppliers and customers to study how they
perceive the privatised firms’ external management of working capital operations and
levels. One of the suppliers responded that it is forced to sell to the privatised firm in
fear of loosing the sources of his firm’s supply, which is controlled by the privatised
firm because of the agreement between the privatised firm and the firm that produces
his supply. According to the supplier this is a very improper business dealing and this
power base is encouraging the privatised firm to ignore the interests of its suppliers.
The supplier of the second privatised firm reported that she is happy with regard to the
inter-firm co-operation on transportation of the products but that she had reservations
on other issues such as co-operation on credit facilities and inventory storage. We also
approached two customers and both responded that their inter-firm co-operation with
the privatised firms on their primary operations is weak. The customers believe that
the cause for not co-operating is because the privatised firms have not developed the
business culture of co-ordinating their management policies with their customers.
Moreover, the empirical findings show that the privatised firms have not completely
freed themselves from the business practice they were used to when they were
government firms. The internal management of their working capital levels and
operations as well as external management of supplier and customer linkages closely
resemble that of transition and government firms. There are two main reason for this
conclusion. First, there are no relevant private firms that can compete with the
privatised firms so that the privatised firms can learn from. In addition to this, the
government policy on market liberalisation and the war with Ethiopia has not
encouraged for new entrants in the market. Hence the privatised firms are more or less
as dominant as when they were government firms. Second, it is observed that the
firms have changed ownership, where the owners took over the top management who
administer mostly in abstention and still maintained most of the top management. For
example, final management decisions in Asmara Milk Factory is done at the annual
general meetings of the co-operative owners, the general manager of Asmara Sweater
factory resides in Italy and the general manager of Eritrea Steel Sheets Factory we
were told is abroad and the manager represents him mostly. We believe this has
caused less exposure to new management policies and reluctance to changes.
The privatised firms’ supplier and customer co-operation is very unsatisfactory from
their supplier and customer points of view. Both linkages reported that there are few
activities that the firms co-ordinate in their supplier-customer linkages. Overall
findings reveal that the privatised firms are improving their working capital
management. Therefore, we believe that for a successful transformation from
government to private ownership, a well established private sector is needed to serve
as point of reference to the privatised firms and to put pressure on them so that they
try to enhance competition and improve inter-firm linkages. Changing ownership
alone will not help firms to increase their value creation potential. Employing
management with academic and practical experience, the use of proper technology
and enhancing market competition determine the firms’ efficiency and value creation.
3RVWSULYDWLVDWLRQ GHYHORSPHQWV One year after we collected the original data, we

went back to the privatised firms to study if they have made any policy changes with
regard to personnel management, production capacity expansion and product
diversification. We found encouraging developments because generally, a change in
terms of both management personnel and policy is observed in all the privatised firms.
We observed that the management team in two of the three firms is lead by the
owners as general managers and the former general managers hold the position of
managers under the owners. The former general manager in the third firm still holds
the position of general manager. However, all have introduced some policy changes
with regard to internal operations and external linkages. We also investigated if the
privatised firms had made any investment expansion or retraction. We particularly
investigated if the firms have invested in new machines, overhauled old machines and
trained employees. We found out that two of the three privatised firms have made
some capital investments. They have also closed some production lines and have
concentrated only on those products that the management considered profitable. With
regard to linkages, the privatised firms have made changes in both their supplier-
customer linkages and in their policies towards the linkages.
&KDSWHU
&RPSDUDWLYH6WXG\RI*RYHUQPHQW7UDQVLWLRQDQG3ULYDWLVHG)LUPV
,QWURGXFWLRQ
To recapitulate on the work so far accomplished in this research study; in chapter 1,

we introduced the research problems as well as objective and methodology of the
study. In chapters 2 to 4, we presented the literature review on the internal and
external working capital management and related theories of value management as
well as relevant debates on ownership and value creation. In chapter 5, we developed
the conceptual framework for the empirical study, based on which we collected data
on the internal and external management of working capital levels and operations
from three groups of firms - government owned firms, firms in transition to
privatisation and privatised firms. In the last three chapters (chapters 6-8) we
described and analysed our data by taking one representative firm from each group of
firms. At the end of each main section in the chapters we made a comparative study of
the firms in each category.
In this chapter, we compare the approaches of internal and external working capital
management applied by the three groups of firms. This section (section 9-1)
introduces the chapter. Section 9-2 covers a comparative description of the firms’
overall working capital management. Section 9-3 deals with the firms’ internal and
section 9-4 the external management of working capital levels and operations.
Section 9-5 concludes the chapter. The discussion in the chapter is based on the
Appendices for chapters 6, chapter 7, chapter 8 as well as Appendix for this chapter
(chapter 9), which represents averages of the data included in the Appendices for the
three chapters.
The objective of this chapter is to answer the fourth empirical sub-question that this
research addresses: “CRPSDUDWLYHO\ KRZ GR WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG
ILUPVLQWKHPDQXIDFWXULQJVHFWRURI(ULWUHDPDQDJHWKHLULQWHUQDODQGH[WHUQDOZRUNLQJ
” We specifically study the impact of ownership on the firms’ internal and

FDSLWDO "
external working capital policy and its effect on the overall value creation potential.
With this objective in mind, we made a comparative study of the government,
transition and privatised firms’ internal and external working capital management.
Table 5-2 (in Chapter 5), shows a list of names of the central firms of our case study as
well as their suppliers and customers.
In this section we make a comparative study of the three categories of firms’ with
regard to overall working capital management policy. Particularly, we consider the
background information of the firms with regard to their organisational structure, their
overall management policies and constraints with particular reference to government
regulations. Finally, we examine the managers’ opinion on the role of working capital
management on value creation. For more information on the overall working capital
management, see Appendix 9.1.
Chapter 9 214
7KH RUJDQLVDWLRQDO VWUXFWXUH The government and transition firms have the same
organisational structure. According to government directives, which were established
before the government proclaimed its privatisation policy, their organisational
structure was categorised into three divisions under the general manager, namely,
production, personnel and financial administration. In 1995/1996 the government
streamlined their employee size with an objective of cutting costs. So, the government
restructured the firms’ organisational structure into the following four main sections.
First, production and repairs section with production and maintenance sub-sections.
Second, finance and administration section with accounts and personnel sub-sections.
Third, a marketing and purchasing section. Fourth, a quality controls section. The
finance and administration section is responsible to manage the financial affairs,
which includes working capital levels. The marketing section deals with the
management of working capital operations including the purchase of materials and the
sales of products. It is particularly responsible to purchase, store and control
inventories including raw materials, finished goods and spare parts.
With regard to the privatised firms the owners’ first action after privatisation was to
restructure the managerial set-up. Although specific organisational set-up may differ
from one privatised firm to another, a noticeable change that all the firms made is that
the owner taking the place of the general manager. Under the owner, a manager takes
care of the overall operations and particularly the marketing and commercial section.
We found this change similarly applied in two out of the three privatised firms. The
main reason for this structural change is that the owners want to make closer control
over operations, but at the same time they also want to cut costs at least with regard to
the marketing and commercial section that the managers of the firms take the
responsibility for.
)LUPSROLFLHVDQGFRQVWUDLQWVOur main objective here is to study if the firms have
clearly stated mission statements on the overall policy of working capital

management. Particularly, we asked the managers whether their working capital
management policy was targeted at increasing sales, decreasing costs, generating
profit or remaining liquid. The government firms replied that their main objective was
to decrease costs and increase sales but not to increase profits. Interviews with the
managers revealed that the costs and profit margin of the government firms is dictated
by government regulations. For example according to the financial manager of Keih
Bahri Food Products, profit is kept at about 2% of sales price and cost of materials is
subsidised by 50%. We also found out that the government firms do not bother about
liquidity because they have readily available government funds in the form of
government subsidy and bank overdraft. On the other hand, the transition firms
responded that their main working capital policy is tailored towards increasing sales,
decreasing costs, remaining liquid as well as generating profit. These firms are to be
sold free of debt and until then they are forbidden from entering into long-term
investment and financing commitments. This focus on liquidity has made a negative
impact on the transition firms’ profitability objective because the firms reported that
their major emphasis is on decreasing costs without focusing at its impact on product
quality and customer satisfaction. Privatised firms’ working capital management
policy is tailored towards maximising profit by decreasing costs and increasing sales.
They show less interest on liquidity aspects of working capital management.
Comparative study of government, transition and privatised firms 215
On the issue of constraints in achieving firm policy, the managers of the

government firms replied that it is only the lack of fixed capital investments, that is a
problem in achieving firm objectives. Moreover, the transition firms consider fixed
capital investments and financing as well as production capacity and skilled labour to
be their main constraints. However, the privatised firms are hindered from achieving
their objectives because of problems in working capital investment and financing,
fixed capital investment, product demand and skilled labour. The government and
transition managers blame the government for the lack of proper investment policy
particularly not allowing them to invest on capacity building. The privatised firms’
problem of working capital investment and financing is created by the fact that they
have been privatised only recently and the owners have exhausted their financial
resources in buying the firms. So they have little funds left that can be used to finance
investments in working capital. The empirical findings reveal that both government
and transition firms are highly affected by the government regulations as well as
interference by higher government bodies because the Ministry of Defence supervises
the government firms while the NASPPE (National Agency for Supervising and
Privatising Public Enterprises) controls the transition firms. Therefore, it is only the
managers in the privatised firms who are fully empowered to decide on working
capital levels and operations without interference from outside.
On the factors affecting working capital levels, the government and the privatised
firms replied that the sales growth and the overall operational efficiency mainly affect
the levels and operations of working capital. In addition to this, the price levels of
inputs in the government firms, seasonality of sales in the transition firms and the
availability of credit in the privatised firms are also considered as important factors
affecting working capital. Credit policy and availability of credit are not considered as
main factors in both government and transition firms. This supports the finding that
the government and transition firms have no problem of financing their short-term
investments because of the government subsidy and bank overdraft facilities.
7KH UROH RI ZRUNLQJ FDSLWDO PDQDJHPHQW RQ YDOXH FUHDWLRQ It can be observed
from Appendix 9-1 that most managers consider overall working capital management,
particularly managing working capital levels of investment and operations to be
relevant both for increasing sales and decreasing costs (see Appendix 9.1D). When it
comes to details, the managers of the firms believe managing working capital
investments particularly cash, receivables and inventory as well as operations of sales
and purchases help to increase sales and decrease costs. We also observed that
managers of all the firms consider managing short-term financing particularly, trade
payables, bank loans and overall liquidity is not as important for increasing sales and
decreasing costs as managing working capital investment and operations.
This section (9.3) covers the internal working capital management, which is divided
into levels and operations. Working capital levels refer to investments (sections 9.3.1)
and financing (section 9.3.2) and working capital operations include purchase
(sections 9.3.3) and sales operations (section 9.3.4). Table 9-1 also summarised our
findings.
Chapter 9 216
&DVKPDQDJHPHQW
In this section we compare how the government, transition and privatised firms
manage their cash balances, cash collections and cash payments. We concentrate on
the firms’ motives for holding cash levels, purposes for cash forecasts and forecasting
approaches, cash flow approaches and purposes as well as approaches of controlling
cash payments and collections. Appendix 9.2.1.1 shows the summary of the responses
of the firms’ managers on cash management.
7KH PRWLYHV RI KROGLQJ FDVK As Appendix 9.2.1.1 indicates, all the government,
transition and privatised firms reported that the main objective of cash management is
for transaction purposes. No firm manages cash for speculative, precautionary or bank
compensating purposes. This is for three main reasons. First, there is no alternative
investment opportunity, so there is no need to keep money for speculative purposes.
Second, if the firms need cash, the bank overdraft facility is there to use, hence there
is no need to keep extra cash for precautionary purposes. Third, the banks do not
require any compensating balance for extending overdraft facilities so they do not
need to deposit extra cash for that purpose. Therefore, all the firms do not have a
problem of borrowing from the bank. From the financial statements and responses of
the managers, we can infer that, the government firms have surplus cash lying idle in
their bank checking accounts. However, it is only because of the easily available
financing source (bank overdraft) that most transition firms (except Keih Bahri
Tannery) and the privatised Asmara Sweater Factory are managing to survive.
&DVK EXGJHWLQJ DQG FRQWURO According to their financial managers, both

government firms prepare cash budgets as a government requirement, which they also
use to plan their cash needs, to control the safety of cash levels as well as operations
of cash collection and payment. It is only Asmara Milk Factory from the privatised
firms as well as Asmara Textile Factory, Dahlak Shoe Factory and Keih Bahri
Tannery of the transition firms that reported to use cash budgets to control liquidity.
None of the government firms use cash budgets for liquidity purposes. Therefore
control of liquidity is more important in the transition and privatised firms than in the
government firms. In addition to this, both government firms, two transition firms
(Asmara Textile Factory, Dahlak Shoe Factory) and Asmara Milk Factory from the
privatised firms use cash budgets to plan cash needs in the short-term. Both
government and privatised managers agree that the main forecasting base that they
use to estimate their cash collections, cash payments and balances is their past
experience and management opinion. For the transition firms it is only their past
experience that they use for cash budgeting purposes. In addition, Keih Bahri Food
Products from the government firms, Asmara Textile Factory and Dahlak Shoe
Factory from the transition firms as well as Asmara Milk Factory from the privatised
firms use forecasted sales as a source of information for cash budgeting. Only the
commercial manager of Asmara Sweater Factory reported that he uses marketing
research as a source to prepare cash budgets. All firms except Asmara Sweater
Factory and Eritrea Steel Sheets Factory from the privatised firms use the receipts and
disbursements approach in preparing cash flow statements, which they also use to
improve future cash forecasts and to control cash. The accounting and government
regulations also require all firms in Eritrea to prepare cash flow statements along with
the other standard financial statements – income statement and balance sheet.
0DQDJLQJFDVKFROOHFWLRQVDQGSD\PHQWV Most of the firms strictly control their cash
payments using the voucher system, sequentially numbered checks, bank

reconciliation and the petty cash system. They also control cash collections by
depositing daily in the bank and separating responsibility for sequential cash
operations, handling and record keeping. We can conclude that cash management in
all government, transition and privatised firms is highly control oriented. There is
very little reason to believe that cash management is serving a good purpose in
creating value to the firms because these control measures do not help in increasing
income or decreasing costs related to investments in cash.
,QYHQWRU\PDQDJHPHQW
The objective of this section is to make a comparative study of the three categories of
firms in order to know if they create value by managing their materials and finished
goods inventory balances. For this purpose, we asked the managers how they
determine inventory costs and values, how they formulate and implement their
inventory planning and control (physical and cost) and in doing so if the costs are
relevant and worth of special managerial attention. For more detailed information on
the inventory management refer to Appendix 9.2.1.2.1 for materials inventory
management and Appendix 9.2.1.2.2 for finished goods inventory management.
0DWHULDOVLQYHQWRU\PDQDJHPHQW The managers of most firms reported that the main

purposes for managing materials inventory is to reduce costs of holding and ordering
(except Dahlack Shoe Factory of the transition firms), to safeguard against shortages
and to keep production running (except Lalmba Sack Factory of the transition firms).
The government and some transition firms are involved in manufacturing products
related to the current war efforts and are therefore concerned with the continuous
availability of critical materials. The government firms consider the costs of insurance
and handling as major costs in holding inventory of materials. Out of the five
transition firms, three consider the opportunity cost of capital and cost of
deterioration, another two the cost of power and handling as major KROGLQJ FRVWV of
materials inventory. From the privatised firms Asmara Sweater Factory considers all
costs, that is, costs of power, security, handling, insurance and record keeping as
major costs. While Eritrea Steel Sheet Factory considers only the opportunity costs of
capital and insurance as major costs. Asmara Milk Factory considers only the cost of
handling and clerical cost of record keeping as the main costs. However, only the
financial managers of the government firms consider the costs of materials inventory
as significant for the management to give it special attention.
The approach that all firms apply in order to achieve the objectives of materials
inventory management is by strictly controlling and minimising the inventory level.
All the privatised and government firms as well as Dahlack Shoe Factory from the
transition firms buy just in time for production. Barka Canneries, from the
government firms, Keih Bahri Tannery from the transition firms as well as Asmara
Sweater Factory and Eritrea Steel Sheet Factory apply economic order quantity to
control selective items of materials. The firms selectively control the SK\VLFDO
Chapter 9 218
PRYHPHQW of materials inventory on the basis of cost. In addition the transition firms use
scarcity and criticality of the materials while the privatised firms also apply usage rate.
As for the costing and valuation, all firms use only the average costing approach to
determine the cost of materials issued to production and left in inventory.
)LQLVKHG JRRGV LQYHQWRU\ PDQDJHPHQW The government firms have differing
purposes in holding the finished goods inventory. The main purpose in holding
finished goods inventory for Keih Bahri Food products is to reduce holding costs and
for Barka Canneries is to satisfy customer demands, to keep safety stock and meet
seasonal high demands. From the transition firms Asmara Textile Factory, Sembel
House Hold Factory and Dahlak Shoe Factory have the purpose of satisfying
customer demands and take advantage of economies of scale, Lalmba Sack Factory
and Sembel House hold Factory also keep safety stocks. Moreover, the purpose of
holding inventory for Asmara Textile Factory and Lalmba Sack Factory is also to
meet seasonal high demands. The privatised firms reported that the main purpose for
managing the finished goods inventory is to satisfy customer demands, to meet
seasonal high demands and to keep safety stock.
Insurance is considered the main inventory holding costs in the government firms.
While two of the three privatised firms consider the opportunity cost of capital
invested in the inventory and the cost of insurance as a main cost, the transition firms
reported no major cost of inventory holding. Generally, only the government firms
consider the holding inventory of finished goods as significant for the management to
give special attention. The firms have differing management policy in controlling
inventory costs, particularly the specific approach of inventory control they apply. In
order to manage their costs of inventory all the government firms, three of the
transition firms and the privatised firms (except Asmara Milk Factory) try to hold
only the minimum. The selective control approaches used by the government firms
include usage rate and criticality in case of shortage for Keih Bahri Food Products and
average cost for Barka Canneries. Asmara Textile Factory, Sembel House Hold
Factory and Dahlak Shoe Factory from the transition firms apply usage rate. All the
privatised firms use the average cost and usage rate (except for Asmara Sweater
Factory). Asmara Milk Factory also applies criticality in case of shortage to
selectively control its inventory items. The firms use the average costing approach to
determine the cost of goods sold and the value of finished goods remaining in
inventory.
The purpose of this section is to study if and how the firms’ manage their receivables.
Hence, we asked the managers if they have a credit sales policy (if not, why). If the firms
have a credit policy we asked what their sources of information are for screening credit
applicants, determining credit terms and standards as well as what measures they take to
collect overdue receivables. We also asked them about the risk of uncollectables and
how they monitor their credit customers and reduce the level of receivables. For more
detailed information on the receivables management refer to Appendix 9.2.1.3.
&UHGLWSROLF\DQGUHFHLYDEOHVPDQDJHPHQW Both government and transition firms sell

to private firms only on cash basis while they sell on credit to fellow government and
transition firms. According to the interviews conducted with the commercial managers
of the government firms do not sell on credit to private firms because government policy
does not allow it. From a purely business point of view credit management is non-
existent with these firms. The only debtor account in the balance sheet of both
government and transition firms is due from related enterprises and ministries. This
represents intra-government transfers and has nothing to do with the purpose of
extending credit to enhance sales. Therefore, government and transition firms do not
use any technique of managing accounts receivable, such as establishing policy of credit
terms, mechanisms of screening credit applicants or measures in collecting overdue
receivables. They have no risk of bad debts because their debtors are related enterprises
and other ministries and are not considered to create doubtful accounts.
The privatised firms have different sales policies depending on whether the customer is a
government or private (large or small) firm. The cash sales refer to smaller private firms
while the credit sales (without discount) refer to larger private and all government and
transition firms. All the privatised firms use their past experience as a main source of
information for screening new credit applicants. While all privatised firms use a repeat
sales approach, Eritrea Steel Sheets Factory and Asmara Milk Factory Factory also apply
credit standards based on the five C’s. In order to collect overdue receivables they all
make telephone calls and extend credit periods, but they do not make personal visits nor
do they employ collection agents or take legal action. Moreover, according to the
financial managers, the risk of bad debt is very low (except for Asmara Sweater Factory)
and none of them makes allowances for it. Overall, the conclusion is that, while firms in
the developed world have began to use financial electronic data interchange rather than
the more traditional methods to manage accounts receivable (Megginson, Nash and
Randenborgh (1994), the firms in Eritrea are not yet able to install and properly
implement the traditional approaches. The main reason we believe is because of the
factors typical to underdevelopment that prevail in Eritrea, including weak managerial
background, lack of financial institutions and markets as well as the firms’ historical
background in a command economy and strict regal requirements that the firms have
to abide by.
0DQDJLQJVKRUWWHUPILQDQFHV
In order to study the sources and costs of short-term financing, we asked the financial
managers on their sources of finance, the cost of financing and the factors influencing
the need for short-term financing. For detailed information on inter-firm comparison of
managing short-term finances, see Appendix 9.2.2.
6RXUFHV FRVWV DQG LQIOXHQFHV RI VKRUWWHUP ILQDQFLQJIn addition to cash collected
from operations, all firms have the opportunity to use bank overdraft to the extent of
the insured value of their assets, therefore they all consider it as a main source of
short-term financing. Both government firms also reported that, retained earnings and
trade creditors are the main sources of their short-term financing. The main source of
financing for all the transition firms and privatised firms (except Asmara Milk Factory)
is the overdraft they get from the Commercial Bank of Eritrea. In addition to this Asmara
Textile Factory, Lalmba Sack Factory and Sembel House Hold Factory from the
transition firms as well as Asmara Sweater Factory and Eritrea Steel Sheets Factory from
the privatised firms consider short-term bank loans to be a main source of short-term
Chapter 9 220
financing. We have also interviewed the managers of the government, transition and
privatised firms about the extent of their co-operation with the financial suppliers
particularly the Commercial Bank of Eritrea regarding short-term borrowing, overdraft
and long-term loans. All firms responded that they are satisfied with the relationship
with the commercial bank. However, most managers of the transition and privatised
firms replied that they do prefer to take over draft rather than short-term or long-term
bank loans. The main reason they give for not opting for the short and long-term
borrowing is because the term borrowings unlike the overdraft loans oblige them to
clear their outstanding loans within a limited time period.
The bank interest cost and service charges are singled out to be the main cost of
financing working capital investments for the transition firms. According to the
commercial managers of the government and privatised firms the cost of financing is not
relevant for management to give it special attention. Nevertheless, the cost of short-term
financing in the transition firms is found to be a major portion of the firms’ annual
expenses and we observed that the firms do very little to reduce it.
Only Keih Bahri Food Products from the government firms consider sales growth, price
levels of inputs, operational efficiency and government subsidy as main factors that
influence the short-term financing items. From the transition firms, while Sembel House
Hold Factory and Asmara Textile Factory consider respectively the availability of credit
and price levels of inputs as main factors that influence the financing of working capital
only Lalmba Sack Factory considered seasonality of sales, sales growth and credit policy
as main factors. From the privatised firms Asmara Milk Factory considers sales growth,
price levels of inputs and operational efficiency and Eritrea Steel Sheets Factory
considers price levels of inputs and operational efficiency as main factors that influence
the financing of working capital.
Our aim in this section is to compare how the government, transition and privatised
firms manage their working capital operations, particularly purchases and sales.
Therefore, we asked the firms’ commercial managers about policies and terms, as
well as about the relevance and management of costs related to purchase and sales
management. For detailed information, refer to Appendix 9.2.3.1 (purchase
management) and to Appendix 9.2.3.2 (sales management).
0DQDJLQJSXUFKDVHRSHUDWLRQV
3XUFKDVH SROLFLHV We observed that few firms could state what their purchasing
policy is about. Moreover, from the government firms only Barka Canneries reported
that the main purpose of its purchase policy is to take advantage of quantity and cash
discounts as well as to decrease inventory holding costs. Keih Bahri Food Products
considers only the decrease of inventory holding costs as its objective. From the five
transition firms only Dahlack Shoe Factory considered the decrease of inventory
holding costs and meeting seasonal production requirements as a main purpose, while
Keih Bahri Tannery considered taking advantage of quantity and cash discounts as the
main purpose of their purchase policy.
The government and transition firms do not have the policy of credit purchase that
they apply for privatised (or private) firms because they are not allowed. There is also
some time delay in the payment of purchases made to related government and
transition firms, which according to their commercial managers is mainly due to the
bureaucratic procedure of the government. The privatised firms buy most of their
locally available materials on cash. Moreover, all of them also import some of their
materials from foreign countries, in which case they pay with foreign currency that
they get from the national bank, which according to their financial managers is quite
difficult to obtain. Hence mostly their owners use their own foreign currency
resources or exchange the local currency to foreign currency in the black market to
get funds for to pay foreign purchase.
)RUHFDVWLQJ DQG FRQWURO RI SXUFKDVLQJThe purpose of purchase forecasting in all

government firms is to meet production demands, to help in determining the quantity
on hand and on order during lead times and to take care of safety stocks. All transition
firms considered determining inventory usage during lead time as their main purpose
in forecasting purchases. From the transition firms Asmara Textile Factory, Sembel
House Hold Factory and Dahlack Shoe Factory, considered meeting production
demands as their main purpose in forecasting purchases. In addition to this Lalmba
Sack Factory’s and Sembel House Hold Factory’s main purpose of forecasting
purchases is to determine quantity on hand and on order during lead times and to take
care of the safety stocks.
With all the government firms, purchase forecasting is based on past experience and
management opinion. The transition firms consider the forecasted sales volume as a
main base. Moreover, for Dahlack Shoe Factory and Keih Bahri Tannery it is the past
experience, for Lalmba Sack Factory and Keih Bahri Tannery, the management
opinion and for Lalmba Sack Factory and Dahlack Shoe Factory the purchasing staff
opinion which are the main sources of information for forecasting purchases. The
purchasing staff almost have no role to play in estimating how much to purchase
except with the transition firms.
As for the contact, contract and control of suppliers, all government, transition and
privatised firms, choose the cheapest channel of communication to get in contact with
suppliers. In addition to this from the government firms Keih Bahri Food Products
manages its contact by trust and Barka Canneries employs purchasing agents. The
transition firms (except Sembel House Hold Factory) and privatised firms (except Eritrea
Steel Sheets Factory) also manage their supplier contact by trust. In getting into contract
with suppliers all government, transition and privatised firms make routine purchase
agreements with their terms of purchase known to the suppliers in advance of
purchase. All government, transition and privatised firms have routine control
agreements with their suppliers with the control terms known in advance to both
transaction partners as well. We observed that the contact, contract and control of
inter-firm transactions in the government and transition firms are done as per the
government requirements while the privatised firms are mostly continuing what they
used to do as government firms and are not innovating any new approaches
subsequent to their privatisation.
Chapter 9 222
0DQDJLQJVDOHVRSHUDWLRQV
In this section we compare the government, transition and privatised firms’

approaches in managing sales operation. Therefore, we asked the firms’ commercial
managers about policies and terms, as well as about the relevance and management of
costs related to sales management. For detailed information, refer to Appendix
9.2.3.2.
6DOHV SROLF\ The responses of the government firm’s commercial managers to
interview questions indicated that their main objective of sales policy is to satisfy the
demands of the Ministry of Defence and to fill the production quota provided by
higher authorities. Barka Canneries also has a sales policy to meet seasonal sales
requirements and to expand its market. The purpose of the sales policy in the
transition firms (except for Asmara Textile Factory) is to satisfy customer demands.
For Asmara Textile Factory and Keih Bahri Tannery the sales policy is to meet
seasonal sales requirements while that of Sembel House Hold Factory and Keih
Bbahri Tannery is also to expand their markets. The privatised firms’ main sales
policy includes satisfying customer demands. All privatised firms (except Asmara
Milk Factory) also include to decrease inventory ordering and carrying costs as well
as to meet seasonal sales requirements and expand market. The reported sales term for
all the government, transition and privatised firms is the cash basis. The government
and transitions firms sell also on credit to fellow government and transition firms but
do not apply any credit sales standards. However, the privatised firms apply both cash
and credit sales policy using the 5C’s and repeat sales as main credit standards.
6DOHV IRUHFDVWLQJ DQG FRQWURO Except for Keih Bahri Food Products from the
government firms and Asmara Milk Factory from the privatised firms, the purpose of
sales forecasts in all the government, transition and privatised firms is to estimate future
sales demand. The forecast of safety stock is also a main purpose for both government
firms and privatised firms (except Asmara Sweater factory). For most of the firms sales
forecasts are based on past experience and management opinion. The exception is Keih
Bahri Tannery, which uses production capacity. The transition and privatised firms also
consider the forecasted sales demand as a main source of information for forecasting
sales.
All government, transition and privatised firms (except Asmara Sweater Factory)
choose the cheapest channel of communication to get in contact with customers. In
addition to this, Keih Bahri Food Products from the government firms, Asmara
Textile Factory, Dahlak Shoe Factory and Keih Bahri Tannery from the transition
firms as well as Asmara Milk Factory from the privatised firms manage their
customer contact by developing long-lasting relationships. In getting into contract with
customers all government, transition and privatised firms make routine contract
agreements with their terms of sales known to both parties in the sales transaction. All
government, transition and privatised firms also make routine control agreements with
control terms known in advance to both transaction partners.
Generally, all firms except one transition firm (Keih Bahri Tannery), reported that
the costs of contact, contract and control of sales transaction are very small and
therefore not relevant for the management. All firms reported also that the possibility
of customers to back down from their sales agreement is very small and it is not
difficult to find another customer. According to the firms’ commercial managers
opinion because their customers had never backed down from their agreements they
never been to the court to regain something that they have lost as a result of an
opportunistic or non-credit worthy customer.
In this section we study if the government, transition and privatised firms evaluate the
performance of their working capital decisions with regard to the levels of investment
and financing as well as operations of purchasing and selling. For this purpose, we asked
the managers what specific financial and non-financial criteria they apply to measure and
evaluate their performance, and what factors determine their overall performance. We
have also used the firms’ financial statements to study the comparative performance of
their working capital levels and operations. For more information of performance
measurement and evaluation refer to Appendix 9.2.3.3, for performance evaluation of
working capital decisions and 9.2.3.4 for a comparative financial performance.
'HWHUPLQDQWV RI SHUIRUPDQFH It is only the availability of labour that determines
the performance of the government firms. The transition firms (except Sembel House
Hold Factory and Dahlack Shoe Factory) reported that their performance is
determined by the availability of short-term and fixed capital investment and
financing as well as labour (both skilled and unskilled). According to the managers of
the privatised firms’ working capital investment and short-term financing, fixed
capital investment and long-term financing as well as availability of labour determine
how good or bad they perform. The exceptions here are Asmara Sweater Factory,
which reported that short-term financing is not relevant and Asmara Milk Factory, for
which short-term financing and the availability of labour are not considered
determining factors of performance.
3HUIRUPDQFH PHDVXUHPHQW DQG HYDOXDWLRQ FULWHULD We asked the firms’

managers, what mechanisms they use to evaluate the internal and external
performance of their working capital decisions. In order to evaluate their performance,
all government, transition and privatised firms reported that they compare their past
performance with their present achievements. Moreover, both governemnt firms, the
transition firms (except Asmara Textile Factory and Sembel House Hiold Factory)
and the privatised firms (except Eritrea Steel Sheets Factory) compare the actual with
the expected performance. However, only the government firms and Keih Bahri
Tannery from the transition firms reported that they compare their performance with
the performance of other firms using benchmarks.
&XVWRPHU VDWLVIDFWLRQ EDVHG SHUIRUPDQFH HYDOXDWLRQ: All the government,

transition and privatised firms reported that the take care of their customers
satisfaction by trying to be efficient on their communication by applying the policy of
faster response and delivery time. The government firms, Lalmba Sack Factory and
Sembel House Hold Factory from the transition firms and the privatised firms except
Asmara Milk Factory use cost minimisation by charging lower prices. Very few firms
use other customer satisfaction based performance evaluation. Those who try to
decrease defect rates and increase customer’s perceived value of goods include Keih
Chapter 9 224
Bahri Food Products from the government firms, Lalmba Sack Factory and Sembel
House Hold Factory from the transition firms as well as Eritrea Steel Sheets Factory
and Asmara Milk Factory from the privatised firms.
$FFRXQWLQJ EDVHG SHUIRUPDQFH HYDOXDWLRQ FULWHULD Both government firms use

liquidity and activity ratios as well as inventory, receivables and overall working
capital turnovers to evaluate their financial performance. However, it is only Keih
Bahri Food Products, which reported that it also uses leverage and profitability ratios.
Lalmba Sack Factory from the transition firms as well as Asmara Sweater Factory and
Eritrea Steel Sheets Factory from the privatised firms reported that they use all
liquidity, activity, asset structure and profitability ratios to evaluate their managerial
decisions with regard to financial performance.
In the next section we present a comparative evaluation of the firms’ financial

performance (see Appendix 9.2.3.4). We evaluate the investment composition using
asset structure ratios. Liquidity and short-term financing composition ratios are also used
to evaluate the firms’ short-term financing and liquidity position and lastly, we used
activity and profitability ratios to study the firms’ overall efficiency in turning over
working capital assets.
,QYHVWPHQW FRPSRVLWLRQ We study the firms’ investment composition by computing

working capital to total assets. In order to have specific insight into the firms’ working
capital investment composition, we evaluated the breakdowns of working capital into
cash, receivables and inventory. We used the terms “inventories” and “stock” as well
as “accounts receivable” and “debtors” inter-changeably. We have used the terms
inventories and receivables in our literature review, while empirically we found that
the firms in Eritrea use the terms “stock” for inventories and “debtors” for accounts
receivable.
As it is indicated in Appendix 9.2.3.4, the seven year average FXUUHQW DVVHWV WR WRWDO
DVVHWVUDWLRV for the government, transition and privatised firms are 92%, 69% and 68%
respectively. The implication of these ratios is that the composition of working capital in
total assets is excessive (when compared to the global ratio of 50%) given the
manufacturing nature of the activities that the firms are in. Particularly, the government
firms with an average of 92% of total investment tied up in working capital assets show
excessive investment in current assets. The comparative trend over the seven years of
current assets to total assets composition that is indicated by Figure 9-1 also supports the
above argument.
)LJXUH&XUUHQWDVVHWVWRWRWDODVVHWV±JRYHUQPHQWWUDQVLWLRQSULYDWLVHGILUPV
100%
90%
80%
70%
60% Government
50% Transition
40% Privatised
30%
20%
10%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
We also computed cash, receivables and inventory to working capital, which on average
accounted to 31%, 47% and 22% respectively for the government firms, 5%, 14% and
81% respectively for the transition firms and 25%, 20% and 54% respectively for the
privatised firms. The government firms have invested most of their working capital
assets in receivables, while the transition and privatised firms have heavily invested in
inventory. Particularly, the composition of inventory in the total working capital assets is
very large for the transition firms, which normally implies a warning on the policy of
working capital management.
)LJXUH&XUUHQWGHEWOHYHUDJH±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
120%
100%
80%
Government
60% Transition
Privatised
40%
20%
0%
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
As it is revealed by Figure 9-2, the short-term debt compared to the total assets in the
government firms was relatively small but increased in the last three years and at the
end of the study period accounted for the largest proportion of total assets. This
implies that the assets are increasingly financed by the short-term debts. The
privatised firms on the other hand had at the end of the period the smallest percentage
of assets financed by short-term debt.
Chapter 9 226
3HUIRUPDQFHHYDOXDWLRQRIZRUNLQJFDSLWDOILQDQFHV
/LTXLGLW\ SRVLWLRQ In order to study how the firms’ investments are financed and their
liquidity position, we analysed the firms’ financial statements by computing liquidity
ratios (see Appendix 9.2.3.4). The liquidity position of the firms is analysed using
current and quick ratios.
&XUUHQW UDWLRV The average current ratios for the government, transition and
privatised firms were 2.8, 1.5 and 1.4 respectively. When compared with the global
norm on current ratio of 2 the government firms are excessively liquid while the
transition and privatised firms may indicate liquidity problems. Moreover, the trend
in Figure 9-3 shows that the current ratio of the transition and the privatised firms at
the end of our study period fell below the generally accepted norm (see Appendix
9.2.3.4).
)LJXUH&XUUHQWUDWLR±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
4,0
3,5
3,0
2,5 Government
2,0 Transition
1,5 Privatised
1,0
0,5
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
4XLFN5DWLR We can observe from Appendix 9.2.3.4, that the government, transition
and privatised firms respectively have quick ratio of 1.8, 0.4 and 0.9.When compared
with the global norm of 1, these ratios still indicate that the transition and privatised
firms have problems of liquidity, implying also that relatively a large portion of their
current assets is composed of inventory.
6KRUWWHUP ILQDQFLQJ FRPSRVLWLRQ: As it is indicated in appendix 9.2.3.4 the
government firms use only trade creditors and others (such as tax payables), which
accounted to about 59% and 41% respectively. The transition firms use trade creditors
(59%), bank overdrafts (20%), other (19%) and short-term bank loans (2%). However,
the privatised firms use mainly Bank overdrafts (49%) and trade creditors and other
accruals each amounting 28%, while short-term bank loans (11%) remain relatively
smaller.
3HUIRUPDQFHRIZRUNLQJFDSLWDORSHUDWLRQV
We used activity and profitability ratios respectively to study how efficient and
profitable the government, transition and privatised firms were during the years of our
study.
2SHUDWLRQDO HIILFLHQF\ RI ZRUNLQJ FDSLWDO DFWLYLWLHV Operational efficiency of
working capital activities is measured by using activity ratios, which include,

inventory turnover, receivables turnover and overall working capital turnover. The
turnovers can also be converted to average days the current assets are held. The
computations regarding activity ratios is included in Appendix 9.2.3.4.
,QYHQWRU\ WXUQRYHU and days that the inventory was not collected indicate that annual
cost of goods sold for the government, transition and privatised firms respectively is
3.4 (or 107 days), 0.6 (or 608 days) and 2.3 (or 159 days). This inventory turnover
ratio and days outstanding for all the firms and particularly the transition firms,
indicate very slow moving inventory possibly due to inefficient working capital
management, that is, poor buying and selling practice and unsound inventory
management. A closer observation at Figure 9-4 reveals that the inventory turnover of
the government firms is improving while that of the transition and privatised firms fell
sharply though the privatised firms are picking up after privatisation.
)LJXUH,QYHQWRU\WXUQRYHU±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
4,5
4,0
3,5
3,0
Government
2,5
Transition
2,0
Privatised
1,5
1,0
0,5
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
5HFHLYDEOHVWXUQRYHUand average collection days reveal 5.2 (or 70 days), 3.1 (or 117
days) and 16.4 (or 22 days) respectively for the government, transition and privatised
firms. As indicated by Figure 9-5, the receivables turnover except for the privatised
firms indicate very slow turnover implying longer time taken in collecting
receivables.
Chapter 9 228
)LJXUH5HFHLYDEOHVWXUQRYHU±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
25,0
20,0
15,0 Government
Transition
10,0 Privatised
5,0
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
2YHUDOO ZRUNLQJ FDSLWDO WXUQRYHU respectively for the government, transition and
privatised firms indicate that sales is 1.4, 0.9 and 1.6 times the average annual balance
of current assets (see Figure 9-6). Again the overall working capital turnover is very
low implying the days that the working capital assets take to turnover is very long.
)LJXUH2YHUDOOZRUNLQJFDSLWDOWXUQRYHU±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
2,5
2,0
1,5 Government
Transition
1,0 Privatised
0,5
0,0
1994 1995 1996 1997 1998 1999 2000
6RXUFH$SSHQGL[
2YHUDOO SURILWDELOLW\ measures of performance evaluation include gross profit

margin, net profit margin and return on total assets. As Appendix 9.2.3.4 shows, the
firms’ JURVV SURILW PDUJLQ respectively for the government, transition and privatised
firms was 14%, 14% and 19% and QHWSURILWPDUJLQ was 8%, -7% and -7% respectively
while the UHWXUQRQDVVHWV was 7%, 0% and 3% respectively for the three groups of firms.
(See also Figure 9-7).
All firms show positive gross margins, but only the government firms have positive
net profit margins and return on assets. As Figure 9-7 reveals the gross profit of the
privatised firms has changed to a net loss after the deduction of operating costs. This
drastic change is only caused by Asmara Sweater Factory, whose operations
continuously ended up at net losses in most of the years of study. Otherwise the other
two privatised firms, Asmara Milk and Eritrean Steel Sheet Factories have ended up at a
successful operating results – gross profit, net profit and return on assets through out the
years. However, most of the transition firms reveal the lowest gross profit, which ended
up at net losses throughout the years of study. Keih Bahri Tannery is the exception in
this case.
)LJXUH1HWSURILWPDUJLQ±JRYHUQPHQWWUDQVLWLRQDQGSULYDWLVHGILUPV
40%
30%
20%
10%
0% Government
-10% 1995 1996 1997 1998 1999 2000 Transition
-20% Privatised
-30%
-40%
-50%
-60%
6RXUFH$SSHQGL[
&RQFOXGLQJ UHPDUNV Firms create value when the objective of working capital
management is tailored towards value creation, rather than only the custody of
property and operations. Empirically, the managers reported that they apply
controlling mechanisms in order to manage their working capital levels and
operations. In the government and transition firms the problem is mainly due to
managerial empowerment. In the privatised firms we trace this lack of managing for
value creation due to problems of liquidity, as well as lack of capital market
investment opportunities and alternative financing sources.
*RYHUQPHQW DQG WUDQVLWLRQ ILUPV lack managerial empowerment. Managers of

government and transition firms are not fully empowered to manage their internal
working capital levels and operations as well as their external supplier linkages. In the
transition firms, the privatisation agency - National Agency for Supervising and
Privatising Public Enterprises (NASPPE) has the final say in both internal and external
affairs of the firms and the Ministry of Defence plays the same role in the government
firms. The management of these firms is given very little authority and power to
manage the affairs of the firms.
For the privatised firms, the main constraint is not the problem of managerial
empowerment. The privatised firms’ problems can be traced to lack of managerial
experience in the private sector, management culture tailored towards managing
government firms, lack of clarity of managerial objectives, lack of capital market
investment and financing opportunities as well as lack of both skilled and unskilled
labour. We will concentrate on the privatised firms’ problems of liquidity, investment
opportunities and financing sources.
Chapter 9 230
(a) The lack of liquidity: The response of the managers of privatised firms and
observation of the firms’ financial statements indicate that the privatised firms barely
finance their working capital expenditures and have nothing left for both short-term and
long-term investment. Though the firms have an option to deposit in a bank saving
account, which can earn some interest they rarely use this option. They all use the
current or checking account, which the bank requires them to maintain for the overdraft
account to function. Moreover, the firms who have surplus cash are the government and
some of the transition firms who are not allowed even to deposit surplus cash at a bank
interest earning saving or time deposit accounts.
(b) The absence of investment opportunities: As we have conceptually reviewed in

chapter two, excess cash can be invested in both primary and secondary capital
markets. Long-term surplus cash can be invested in bonds and shares with long-term
expected returns while short-term cash surplus is invested in near-cash liquid assets
such as PDUNHWDEOHVHFXULWLHV. The government had introduced the issuance of bonds
during the war with Ethiopia (1998-2000), but it was mainly targeted at the Eritreans
in the Diaspora and there is no capital market in Eritrea available for the local level.
Some managers of privatised firms attributed their inability to manage their short-term
cash surplus to this absence of capital markets. Any surplus cash is kept in bank
deposits or invested in receivables and inventories whose turnover is very low.
(c) The absence of alternative financing sources: The external financing source
available to management is the bank overdraft and term loans. The firms prefer the
bank overdraft facility because it is easily available. However, for some firms the cost
of the bank overdraft is very expensive but still they have no way out but to take it.
The firms do not prefer the short-term loans because as one manager put it, “,W KDVD
OLPLWHG SD\ EDFN SHULRG DQG VR EHDUV OLTXLGLW\ ULVN DQG FUHDWHV VWUHVV RQ WKH
PDQDJHPHQWZKHQLWKDVWREHIXOO\SDLGEDFN ”.
The following table (Table 9-1) summarises our overall findings with regard to the
internal management of working capital.
7DEOH7KHHPSLULFDOILQGLQJVRQWKHLQWHUQDOZRUNLQJFDSLWDOPDQDJHPHQW
Government Transition Privatised

2YHUDOO Management policy is to decrease Objective is to remain liquid Management policy is to
:&0 costs. Objectives constrained by and generate profit. Objectives increase sales, decrease costs
lack of fixed capital investment, constrained by the transition and generate profit.
production capacity, skilled process, lack of fixed capital Objectives are constrained by
labour and managerial investment, labour and lack of investment and
empowerment. managerial empowerment financing opportunities.
,QWHUQDO
/HYHOV
Investment Do not manage the carrying costs Do not manage the carrying Do not manage the carrying
of surpluses and shortage costs of costs of surpluses and costs of surpluses and
deficits of cash, receivables and shortage costs of deficits of shortage costs of deficits of
inventory levels. Do not try to cash, receivables and cash, receivables and
harmonise policies of cash levels inventory levels. Do not try to inventory levels.
with that of trade receivables and harmonise policies of cash Management is restricted to
inventory. Management is levels with that of trade the control of costs and
restricted to the control function. receivables and inventory. physical safety. Do not try to
Management is restricted to harmonise policies of cash
the control function. levels with that of trade
receivables and inventory.
Financing Working capital investment Do not harmonise policies of Do not try to harmonise
financed through subsidies. Lack cash levels with that of trade policies of cash levels with
careful management of financing payables and inventory of that of trade payables and
sources, costs and liquidity materials. Objectives inventory of materials.
positions. Do not harmonise constrained by lack of Objectives constrained by
policies of cash levels with that of financing opportunities. lack of financing
trade payables and inventory of opportunities.
materials.
2SHUDWLRQV Managerial policy on purchase Do not have clear managerial Have policy on purchase
Purchases terms and standards is dictated by policy on purchase terms and terms and standards. Try to
government regulations. standards. Management does harmonise cash payments
Management is restricted to the not try to harmonise cash with purchases and trade
control function. Management payments with purchases and credits so that cash needed is
does not try to harmonise cash trade credits. Management is minimised and purchase and
payments with purchases and more restricted to the control. trade credits are maximised.
trade credits.
Lack clear policy on sales and Have policy on sales terms
Sales Policy on sales and cash cash collection terms and and standards. Credit
collection terms and standards is standards. Do not try to standard to evaluate credit
dictated by government harmonise cash collections applicants depend on the
regulations. Do not try to with sales and receivables. five C’s. Government firms
harmonise cash collections with Have to comply with the are trusted more and are
sales and receivables. Have to relevant government offered credit. Try to
comply with the relevant regulations. harmonise cash collections
government regulations. Have to with sales and receivables.
sell their products mainly to the
Ministry of Defence, which
supervises them.
Chapter 9 232
This section presents a comparative study of the external working capital management
of the three categories of firms - government, transition and privatised. It explores if
the firms have proper inter-firm co-operation on both the supplier and the customer
side. Particularly, we study if the firms have proper inter-firm co-operation with their
suppliers and customers on the primary activities, purchase and sales operations and
inventory management and what benefits they get as a result of their co-operation or
why they do not co-operate. Detailed supporting data on the firms’ responses on firm-
supplier co-operation are included in Appendix 9.3.1.1 and Appendix 9.3.1.2 is on the
firms’ responses on firm-customer co-operation. Table 9-2 summarised our findings.
5HVSRQVHVRIWKHFHQWUDOILUPV
)LUPVXSSOLHU FRRSHUDWLRQ RQ SULPDU\ DFWLYLWLHV We asked the managers if they
co-operate with their suppliers on the primary activities. As indicated in Appendix

9.3.1.1, the only primary activity that most of the firms claimed to co-operate with
suppliers is on the inbound activity particularly shipment. The firms that do not co-
operate with any local supplier (because their backward linkages are mainly with
suppliers abroad) in any primary activity are Lalmba Sack Factory and Sembel House
Hold Factory from the transition firms and Eritrea Steel Sheets Factory from the
privatised firms. Both government firms also co-operate with suppliers on other
inbound activities such as material storage. Moreover, Barka Canneries co-operates
with suppliers on inbound activities - inventory control and distribution to production,
production operation - product testing and facility operations, after sales service –
repairs, parts supply and facility operations.
From the transition firms Asmara Textile Factory and Keih Bahri Tannery co-
operate with suppliers on the inbound activities of distribution to production and
inventory control, production operations of assembling, product testing and facility
operations. Dahlack Shoe Factory co-operates with suppliers only on the inbound
activities of shipment, storing, distribution to production and inventory control. The
privatised firms except Eritrea Steel Factory co-operate with suppliers on all inbound
activities and production operations. In addition to this while Asmara Sweater Factory
co-operates on marketing and sales – sales channel selection, after sales service
repairs and product adjustment, Asmara Milk Factory co-operates on marketing and
sales, including equipment maintenance, sales force and sales channel selection. The
government and transition firms also co-operate on storing and distribution to
production respectively. However, the privatised firms reported that they co-operate
on all the inbound activities and production operations but not on the marketing/sales
and after sales services.
)LUPVXSSOLHUFRRSHUDWLRQRQSXUFKDVHVDQGLQYHQWRU\PDQDJHPHQW On the issue of

firm-supplier co-operation on purchases and inventory management, most
government, transition and privatised firms co-operate with regard to quality and
quantity of materials, terms of transportation as well as getting the materials just in
time for production. The firms, which reported non-co-operation are Sembel House
Hold Factory from the transition firms and Eritrea Steel Sheets Factory from the
privatised firms. Both government firms, as well as the transition firms (except
Sembel House Hold Factory) and only Asmara Sweater Factory from the privatised
firms reported that they get benefits such as a decrease in the time needed to purchase
materials as well as in the costs of ordering and carrying materials. Keih Bahri Food
Products from the government firms, the transition firms except Asmara Textile
Factory and Sembel House Hold Factory as well as Asmara Sweater Factory from the
privatised firms also reported that this firm-suppler co-operation creates inter-firm
trust. The first reason that the managers of Lalmba Sack Factory and Keih Bahri
Tannery from the transition firms and the privatised firms give for a lack of co-
operation is that their suppliers do not co-operate. The second reason is that the firms
themselves also have a selective policy of co-operation because they do not see
benefits of co-operation with some suppliers. Both government firms reported that
they co-operate fully with fellow government and transition firms. However, the
interviews with the managers indicate that they do not co-operate with their private
suppliers in specific primary activities because they are not allowed to establish close
inter-firm linkages except with “related” government firms. For control purposes
government regulations oblige the firms to purchase their materials from other
government firms or from private firms on the basis of continuos competitive bidding.
)LUPVXSSOLHUFRRSHUDWLRQUHVSRQVHVRIVXSSOLHUV
We approached the suppliers of the firms to find their responses and study the value
creation potential of the backward linkages. In this section, we comparatively study
the firm-supplier co-operation of the government, transition and privatised firms from
the point of view of their main suppliers. We explored their co-operation on primary
activities, sale-purchase operations and related benefits or the reasons for the lack of
co-operation. Finally, we cover the suppliers’ evaluation of firm efficiency.
)LUPVXSSOLHU FRRSHUDWLRQ RQ WKH SULPDU\ DFWLYLWLHV The suppliers of all the
government, transition and privatised firms responded generally that they do not have
strong firm-supplier co-operation on most primary activities. No supplier responded
any co-operation with the firms on any activity related to production operation and after
sales service. However, the suppliers of both government firms responded that they co-
operate on outbound activities, particularly delivery vehicle operation and order
processing. From the transition firms, the suppliers of Dahlack Shoe Factory and Keih
Bahri Tannery co-operate respectively on order processing and delivery vehicle
operation. From the privatised firms only the supplier of Asmara Sweater Factory
reported of the existence of inter-firm co-operation on the outbound activities,
particularly delivery vehicle operation and order processing. With respect to the firm-
supplier co-operation on the primary activities the strongest firm-supplier linkage is
observed to be between the privatised firms and their suppliers. The weakest firm-
customer linkage is between the transition firms and their suppliers.
)LUPVXSSOLHU FRRSHUDWLRQ RQ SXUFKDVHV DQG LQYHQWRU\ PDQDJHPHQW The suppliers
of both government firms responded that they co-operate with the firms in providing
goods when just needed. In addition to this the supplier of Keih Bahri Food products
also reported positively to the co-operation on credit transactions without discount.
From the transition firms the supplier of Asmara Textile Factory and Dahlak Shoe
Factory claimed to co-operate respectively in providing credit without discount and
Chapter 9 234
goods when just needed. The suppliers of both privatised firms (Asmara Sweater
Factory and Asmara Milk Factory) reported the existence of inter-firm co-operation in
providing credit without discount and goods when just needed. No supplier of any
firm reported co-operation on exchanging skilled staff and on giving credit with
discounts.
7KHEHQHILWV RIFRRSHUDWLRQ The suppliers of both government firms responded that
the benefits they get as a result of their co-operation include decreasing the time
needed to sell the goods, as well as the costs of ordering and transportation. In
addition to this the suppliers of Keih Bahri Tannery and Barka Canneries believe
respectively that their inter-firm co-operation helps to decrease the carrying costs of
finished goods inventory and creates inter-firm trust. From the transition firms, the
suppliers of Asmara Textile Factory and Keih Bahri Tannery believe that their inter-
firm co-operation helps them to decrease the time needed to sell the goods, as well as
the costs of sales ordering and transportation. In addition, the supplier Asmara Textile
Factory reported that the inter-firm co-operation helps in decreasing the carrying cost
of inventories and creating inter-firm trust. From the privatised firms, both the
suppliers of Asmara Sweater Factory and Asmara Milk Factory believe that the inter-
firm co-operation helps to decrease the time and costs of selling, the costs of ordering
transportation and carrying the finished goods inventory as well as to create inter-firm
trust.
The suppliers of both government firms, the

6XSSOLHU UDWLQJ RI ILUP HIILFLHQF\
supplier of Asmara Textile Factory from the transition firms and the supplier of
Asmara Sweater Factory from the privatised firms rated their partners as efficient on
purchase order processing, bilateral communication, explanation to enquiries,
courtesy and payment habits. The suppliers of Keih Bahri Tannery from the transition
firms and the supplier of Asmara Milk Factory from the privatised firms rated their
partners poorly in all the issues except for the prompt payments and using supplier
services. The transition and privatised firms are rated as not satisfactory on their co-
operation on marketing suppliers products.
&RQFOXGLQJ UHPDUNV RQ ILUPVXSSOLHU FRRSHUDWLRQ We observed in most cases
that the transition firms agree with their suppliers on the lack of co-operation on all
primary activities as well as on sale/purchase and inventory management. However,
the responses of the privatised firms and their suppliers reveal that their suppliers do
not support the claim of the privatised firms’ co-operation on inbound activities and
production operations. The government firms’ claim of co-operation on inbound
activities also contradicts with that of their suppliers. Generally, according to the
responses of the suppliers on the firm-supplier co-operation on the primary activities,
sales/purchase operations and inventory management is very poor. As a result of
which we believe that all the firms are not efficiently managing their transaction costs
and that their value creation potential remains weak.
5HVSRQVHVRIWKHFHQWUDOILUPV
Comparatively, how efficient are the government, transition and privatised firms in
managing their customer linkages? We seek an answer to this question by asking the
general, financial and commercial managers of the firms about if and how they co-
operate with their customers on primary activities, sales operations and inventory
management. We also inquired what benefits they get as a result of their co-operation
or why they do not co-operate.
)LUPFXVWRPHU FRRSHUDWLRQ RQ WKH SULPDU\ DFWLYLWLHV Both government firms

reported that they co-operate with their customers on outbound activities, particularly
finished goods warehousing, delivery vehicle operation and order processing. In
addition to this Barka Canneries also co-operates on production operations of
equipment maintenance and product testing. From the transition firms, Lalmba Sack
Factory and Keih Bahri Tannery responded positively to the firm-customer co-
operation on outbound activities, specifically finished goods warehousing and
materials handling. Dahlak Shoe Factory and Keih Bahri Tannery also co-operate on
order processing. In the primary activity of production operations it is only Keih Bahri
Tannery that reported firm-customer co-operation on equipment maintenance, product
testing and facility operations. Asmara Textile Factory also co-operates with its
customer on packaging. In the case of the privatised firms Asmara Sweater Factory
and Asmara Milk Factory have firm-customer co-operation on all production
operations and outbound activities. Generally, all firms have very weak customer
linkages on all primary activities related to marketing and sales as well as after sales
service. No government or transition firm reported any co-operation on these primary
activities and it is only Asmara Milk Factory that claimed to have firm-customer co-
operation on marketing and sales, particularly promotion and sales channel selection.
As it is the case with the firm-supplier co-operation on primary activities, the

government firms reported that they have very little firm-customer co-operation with
the private sector on all primary activities. These firms co-operate mainly with fellow
government firms, which according to the interviews conducted is dictated by
government regulations. The transition firms have some firm-customer co-operation
with regard to outbound activities but not on the other primary activities such as
production, marketing/sales and after sale service. According to the response of the
managers, the firm-customer co-operation is observed to be the strongest among the
privatised firms (except for Eritrea Steel Sheets Factory). The two privatised firms
have revealed strong firm-customer co-operation on the production operation and
outbound activities. The weakest firm-customer co-operation with all the three groups
of firms is observed on the marketing and sales and after sale service. All firms trace
the weak firm-customer linkages to the lack of co-operation from the side of their
customers. The privatised firms also reported that they do not co-operate on some
specific primary activities because of their selective policy on inter-firm co-operation.
They do not see the benefit of having close co-operation with each customer.
)LUPFXVWRPHU FRRSHUDWLRQ RQ SXUFKDVHV DQG LQYHQWRU\ Both

PDQDJHPHQW
government and privatised firms (except Eritrea Steel Sheets Factory) reported that
they co-operate with their customers on the quality and quantity they have to sell to
Chapter 9 236
customers, on the terms of transportation and in providing the goods just in time for
production. However, the only co-operation that all transition firms reported is on the
quality and quantity of materials that they have to purchase. In addition to this Asmara
Textile Factory, Dahlack Shoe Factory and Keih Bahri Tannery co-operate on the
transportation terms, while it is only Keih Bahri Tannery that co-operates on
providing the goods just in time for the customers production. The government and
transition firms reported that the benefits they get as a result of their co-operation with
their customers include, minimising the cost of customer ordering and transportation
as well as the costs of carrying inventories as well as increasing sales. However, from
the privatised firms only Asmara Sweater Factory and Asmara Milk Factory claimed
to get the benefit of increasing sales because of their firm-customer co-operation. The
reason for the lack of co-operation according to the transition firms (except for
Asmara Textile Factory) and the privatised firms (except for Asmara Milk Factory) is
that their customers do not co-operate. For the government firms the reason for the
lack of co-operation is that they do not have the policy of co-operation. The reason for
non co-operation with customers for Keih Bahri Tannery from the transition firms and
Asmara Milk Factory from the privatised firms is because they do not see the benefit
of co-operation in some primary activities.
$VVHVVLQJ FXVWRPHU VDWLVIDFWLRQ According to the financial managers, all firms
except Dahlack Shoe Factory get feedback on their customers’ opinion on the quality
of their products and services by allowing them to return any product with inferior
quality and making strict quality control at the production floor. Only Barka
Canneries from the government firms, Sembel House Hold Factory and Keih Bahri
Tannery from the transition firms and privatised firms except Asmara Milk Factory
make periodic assessments of customer opinion. However, non of them grant credit to
customers or allow them to pay after they made sure that the products are as per their
expectation.
)LUPFXVWRPHUFRRSHUDWLRQUHVSRQVHVRIFXVWRPHUV
We approached the customers of the government, transition and privatised firms to

find their opinion on firm-customer relations and to study the value creation potential
of the forward linkages. We searched for the specific co-operation on the primary
activities as well as on their purchases and inventory management. We also studied
benefits of inter-firm co-operation as well as the customers’ evaluation of firm
efficiency. Appendix 9.3.3 contains detailed supporting data on customer responses
on firm-customer co-operation and Table 9-2 summarises our findings.
)LUPFXVWRPHUFRRSHUDWLRQRQWKHSULPDU\DFWLYLWLHV The customer of Keih Bahri

Tannery from the government firms replied that there is no activity related to the
primary or purchase and inventory management that it co-operates with its supplier.
Therefore the manager believes that there is no benefit that his firms gets as a result of
its co-operation. The only inter-firm co-operation reported by the customers of the
transition firms is that of Lalmba Sack Factory, Sembel House Hold Factory and Keih
Bahri Tannery on inbound activities of order processing. In addition to this the
customer of Lalmba Sack Factory also responded positively to the inter-firm co-
operation on distribution to production and inventory control and that of Sembel
House Hold Factory on advertising. The customers of both privatised firms also have
the opinion that they co-operate on inbound activities of order processing as well as
purchase and inventory management specifically in having credit agreements without
discounts. The customers of all three categories of firms reported that there is no
benefit that they get as result of inter-firm co-operation.
Appendix 9.3.3 shows, the response of the customers of all three categories of firms
on inter-firm co-operation is negative except for the customers of the transition and
privatised firms on inbound activities, particularly order processing. The customers
reported that they do not have any co-operation on the primary activities as well as
purchase and inventory management.
The response of the managers of the customers of the government, transition and
privatised firms to the question related to the benefits that they get as a result of their
co-operation is a direct reflection of their responses to the inter-firm co-operation.
They all believe that there is very little or no benefit that they get as a result of co-
operating with the firms. They specifically believe that there is no inter-firm co-
operation that helps in decreasing the cost of purchasing materials or the time needed
to purchase materials or the cost of holding their material inventory and this lack of
co-operation they believe does not help in developing inter-firm trust. The reason that
all customers gave for the lack of firm-customer co-operation is that their business
partners do no co-operate.
&XVWRPHU UDWLQJRI ILUP HIILFLHQF\ The only activity that all the customers of the
government, transition and privatised firms rated the firms as efficient is on cash
collection habits. In addition to this, the customers of the government and privatised
firms rated their partners as efficient on product quality, bilateral communication and
impartiality with other buyers. The customer of the government firm also rated its
partner as efficient on product costs, delivery, explanation to inquiries and knowledge
of customers. The rating of the customers of the transition firms was efficient on
product costs and quality, delivery, bilateral communication and impartiality with
other buyers. Moreover, the customers of the privatised firms also rated the firms as
efficient on their sales processing. All groups of firms are rated inefficient on their
marketing approach and providing customer services.
&RQFOXGLQJ UHPDUN RQ WKH RYHUDOO LQWHUILUP FRRSHUDWLRQ We now make some
concluding remarks with regard to the overall firm-supplier-customer co-operation

which is prevalent in the government, transition and privatised firm.
Overall, from the above empirical findings we can conclude that the government
firms’ relationship with their customers and suppliers is determined by government
regulations, which dictate how they have to co-ordinate their primary activities,
sales/purchase and inventory management related to both backward and the forward
linkage. So the firms’ management has serious lack of managerial empowerment. On
the other hand the transition firms have limited autonomy to manage their inter-firm
linkages but because of their limited market, managerial culture tailored to custodial
control and uncertain future with regard to their ownership and management’s job
security, they cannot design and implement dynamic approaches of firm-customer co-
operation. The firm-supplier-customer relation of the privatised firms is also not efficient
because of the non-customer oriented management culture, lack of managerial
experience with the private sector and non-existence of other competing private firms,
Chapter 9 238
which could provide for exemplary firm-customer co-operations. In general, most firms
do not use a particular approach to keep in touch with their suppliers and customers or
expedite their backward and forward linkages. When the responses of the firms and
their customers is compared, all firms and their suppliers and customers agree that
they have no co-operation in any of the marketing/sales and after sales services.
However, most firms have responded that they co-operate on sale/purchase operations
while their customers responded the lack of inter-firm co-operation on the same
activities. The privatised firms have also exaggerated their firm-supplier and customer
co-operation on their inbound and outbound and production activities in comparison
to the opinion of their customers.
7DEOH7KHHPSLULFDOILQGLQJVRQWKHH[WHUQDOZRUNLQJFDSLWDOPDQDJHPHQW

([WHUQDO
Supplier
linkages Co-operation depends on Most (except Keh Bahri Have strong firm-supplier
the basis of government Tannery and Asmara co-operation. Asmara Milk
regulations. Textile Factory) have weak Factory controls its
There is close inter- firm-supplier co-operation. suppliers through their
government firm co- There is no synchro– supply line and buys on
operation. Co-operation nisation among the policies credit. Asmara Sweater
with the private sector is of cash, pay–ables and Factory harmonises its
weak. inventories with the policies policies of working capital
Inter-government firms’ co- of suppliers. levels and operations with
operation enhanced the policies of its supplier.
purchases and minimised
the carrying costs of
inventories.
Customer The main customer and Most have very weak firm- Only one firms (Asmara
linkages supervising body is the customer co-operation. Milk Factory) has strong
Ministry of Defence and There is not firm-customer linkages
there is close inter- synchronisation among the with some synchronisation
government firm co- policies of cash, among the policies of
operation. With this closer receivables and inventories working capital levels and
firm- customer co-operation with the policies of operations with the policies
sales is enhanced and the customers. of its customers.
carrying costs of inventories
minimised.
(YDOXDWLRQ Evaluate their performance Evaluate their performance Evaluate their performance
using comparative analysis by comparing the past with by comparing past and
of past versus present, the present and actual with present as well as actual and
actual versus expected and expected results. Use no expected results. Do not use
inter-industry benchmarks. accounting and customer inter-industry benchmarks.
Use liquidity and activity satisfaction measures of Take care of customer
measures of accounting. performance. satisfaction by having fast
Use customer satisfaction response to inquiries and
criteria of fast response to quick delivery, by
inquiries and orders and minimising costs and
quick delivery time. charging lower prices and
decreasing defect rates.
7KHJHQHUDO(ULWUHDQFRQWH[W
In the interviews we conducted we asked the managers of the firms the effect of
ownership, government regulations, managerial empowerment and cultural factors on
the management of working capital. Our findings reveal these factors have substantial
influence on the managers. Table 9-3 summarised our findings.
2ZQHUVKLS With the government firms control by government regulations impaired

managerial empowerment. There is strong government interference through subsidies
and market protection. Competition is hindered by interference from the government
and the firms have similar objectives and control patterns which aim at enhancing
social objectives such as creating employment. Managers of the transition firms face
uncertain future due to the transition process. This has crippled their managerial
confidence and job security. Firms have similar objectives and control patterns with
the government firms in trying to enhance social and profit objectives and so reflect
characteristics of both government and privatised firms. Privatised firms reveal strong
resistance to new private business environment. Due to lack of efficient financial
institutions and capital markets they have no backup for investments and financing.
However, competition is not hindered by interference from the government. The
firms’ main aim is operational efficiency with a value creation as the ultimate
objective.
*RYHUQPHQW UHJXODWLRQV Managers of the government and transition are influenced

substantially by the government requirements and interference of higher government
bodies. Government regulations influence the type of business operations and inter-
firm linkages. Government also determines the rules and guidelines on how the firms
have to be managed. With the privatised firms government regulations have less
influence on the type of business operations, inter-firm linkages and the type of
competition.
0DQDJHULDO HPSRZHUPHQW With the government managers, lack of management
power has made an impact in the selection of alternative management approaches and
has played a role in the development, acquisition and adaptation to proper managerial
policies. Transition managers are also influenced substantially by the government
requirements and interference of higher government bodies. Government sets
guidelines on the type of business operations and how the firms have to be managed.
Privatised managers are fully empowered and free to select from alternative
management approaches. However, they made less visible change in the development,
acquisition and adaptation to proper managerial policies because of their historical
background as government firms, managerial experience in the private firms and lack
of financial institutions and capital markets.
&XOWXUDOIDFWRUV We did not find any cultural practices, believes, or norms that hinder
internal or external management of working capital levels and operations.
Chapter 9 240
7DEOH 7KHHPSLULFDOILQGLQJVRQWKHJHQHUDOLVVXHVLQWKH(ULWUHDQFRQWH[W

*HQHUDO
Ownership Control by government Managers’ uncertain future They reveal strong

regulations impaired position, due to the resistance to new private
managerial empowerment. transition process crippled business environment.
There is strong their managerial confidence Lack efficient financial
government interference and job security. Firms have institutions and capital
through subsidies and similar objectives and markets. Competition is
market protection. control patterns with the not hindered by political
Competition is hindered government firms. Try to interference from the
by political interference enhance political and profit government. Firms opt for
from the government. objectives and so reflect operational efficiency
Firms have similar characteristics of both with a firm’s value
objectives and control government and privatised creation as the ultimate
patterns. Firms enhance firms. objective.
political, and social
objectives.
Government Managers are influenced -Managers are influenced Government regulations

regulations substantially by the substantially by the have less influence on the
government requirements government requirements type of business
and interference of higher and interference of higher operations and inter-firm
government bodies. government bodies. linkages, the type of
Government regulations Government sets guidelines competition on how the
influence the type of on the type of business firms have to be managed.
business operations and operations and how the
inter-firm linkages, the firms have to be managed.
type of competition and
set rules and guidelines on
how the firms have to be
managed.
Managerial Lack of management Lack of management power Management is fully

empowerment power has an impact in has an impact in the empowered and is free to
the selection of alternative selection of alternative select from alternative
management approaches management approaches management approaches
and has played a role in and has played a role in the but has played less visible
the development, development, acquisition role in the development,
acquisition and adaptation and adaptation to proper acquisition and adaptation
to proper managerial managerial policies. to proper managerial
policies. policies.
There are no cultural There are no cultural There are no cultural

Cultural practices, believe, and practices, believe, and practices, believe, and
factors norms that hinder internal norms that hinder internal norms that hinder internal
or external working or external working capital or external working
capital management. management. capital management.
&RQFOXVLRQV
Here we present an overview of our findings on the comparative internal and external
management of working capital levels and operations in the government, transition
and privatised firms. Internally, we explored the firms’ objectives, the constraints they
encounter in achieving their objectives, their working capital management policy on
levels of investment and financing as well as operations of purchasing and selling. We
also covered the external management of working capital with regard to the firms’
supplier and customer linkages. Particularly, we investigated the firms’ supplier and
customer co-operation on primary activities, benefits of their co-operation or reasons
for non co-operation and customer ratings on firm efficiency.
2YHUDOO ZRUNLQJ FDSLWDO PDQDJHPHQW All managers believe that working capital
management can play a very important role in creating value for their firms, in terms of
both increasing sales and decreasing costs. However, we also find that all the firms lack
a clear objective in managing both working capital levels and operations. The
government and transition firms also believe that they are doing very little in
managing their working capital because they are not empowered. The managers are
restricted to the control function, which is evidenced by the strict control mechanisms
imposed over the levels of cash, receivables and inventory as well as operations of
cash collections, cash payments, purchases and sales. The privatised firms on the
other hand have relatively better stated and applied objectives and better working
capital management policies.
&RQVWUDLQWV The major constraint with the government and transition firms is
managerial empowerment and the imposition of government regulations, which are

implemented under the supervision of the Ministry of Defence with the government
firms and NASPPE (National Agency for Supervising and Privatising Public
Enterprises) with the transition firms. Policy decisions, which can have both short-
term and long-term effects depend on the decisions of these higher authorities. For the
privatised firms it is not the problem of managerial empowerment but the lack of
investment opportunities, financing sources, labour as well as lack of managerial
knowledge and experience, which constrains the achievement of objectives.
:RUNLQJ FDSLWDO LQYHVWPHQW All firms are excessively investing in current assets.
They keep cash and inventory only for transaction purposes with an emphasis on the
control aspect. Credit policy is not prevalent in any firms in the real business sense.
With the government and transition firms, the level of receivables is increasing mainly
because of the slow payment by the related (government) enterprises. While in the
transition firms, the inventory balance is increasing because of slower sales compared
to production. The cumulative effect of this lack of policy is the increase of both bank
overdrafts and creditors (owed mainly to related enterprises). Working capital levels
are also increasing because management has no opportunity or motive for investing
working capital or minimising its holding costs.
6KRUWWHUP ILQDQFLQJ The firms have no clear policy of managing the levels of
working capital financing. As a result most (except the government) firms are in a
serious problem of liquidity. Particularly, the transition firms and one of the privatised
firms have negative net cash flows that they finance with a bank overdraft, the annual
interest cost of which is a very large proportion of their total expenses. The finding on
Chapter 9 242
working capital level of investment and short-term financing signals that these firms
have to change their policy.
:RUNLQJ FDSLWDO RSHUDWLRQV The government and transition firms purchase and
sales policies are dictated by the government regulations, though the transition firms
have relatively more relaxed government policies applying to them. The managers of
the privatised firms are observed to lack the experience to apply a value creating
management system. Analysis of purchase and sales operations shows that the firms
have no policy on how to purchase their materials and sell their products.
Management of all the firms’ working capital operations is restricted only to the
application of clerical procedures of purchases and sales and they have no mechanism
of enhancing the contact, contract and control aspects of purchases and sales
transactions.
3HUIRUPDQFH HYDOXDWLRQ RI LQWHUQDO ZRUNLQJ FDSLWDO PDQDJHPHQW The study of
performance evaluation has indicated that most firms evaluate their performance by
comparing their past with the present and actual with the expected. Their financial
managers said that they apply some accounting, customer satisfaction and product
quality based performance measurement and evaluation criteria. However, they reported
also that they do not compare their performance with their competitors. Liquidity
analysis indicates that the transition and privatised firms are in immediate risk because
on the average all liquidity ratios are below the generally accepted global norms. The
exception is Keih Bahri Tannery from the transition firms and the Eritrea Steel Sheets
Factory from the privatised firms. Investment in current assets whose turnover is very
low make more than 90% of the total investment in assets in the government and 69%
and 68% in the transition and privatised firms respectively. When compared with the
global norm of 50%, this current to total assets ratio is extremely disproportionate
particularly with the government firms. The profitability ratios, particularly net profit and
return on assets indicate low levels, particularly in most of the transition firms and one
privatised firm. Overall performance findings suggest that the firms are doing very little
to create value by managing working capital levels of investment and short-term
financing as well as operations of purchasing and selling.
)LUPVXSSOLHUOLQNDJHV±WKHILUPV¶SRLQWRIYLHZ The response of the government

firms indicate that they co-operate with their suppliers only on the inbound activities,
particularly, shipment and storage. Privatised firms co-operate on inbound activities
and on production operations but to a lesser extent compared to that of the
government firms. The transition firms revealed the weakest firm-supplier co-
operation. Their response shows that they have moderate firm-supplier co-operation
only on the inbound activities particularly shipment. Generally, all firms have very
weak firm-supplier linkage on all marketing/sales and after sales services. Both
government and transition firms traced the reason for the lack of firm-supplier co-
operation to government regulations, which they believe are beyond their control. The
reason for the lack of firm-supplier co-operation according to the privatised firms is
for two reasons. First, they have not established proper policy on firm supplier co-
operation and second, their suppliers do not co-operate as well.
The suppliers of all firms reported

,QWHUILUP OLQNDJHV ± VXSSOLHUV¶ SRLQW RI YLHZ
that they have very little co-operation on all the primary activities. The suppliers
indicated that the only co-operation they have with the firms is on the outbound
activities’ order processing and particularly providing goods when just needed, in
addition to which the suppliers of the government firms also co-operate on delivery
vehicle operation. The privatised firms’ supplier response on inter-firm co-operation
with regard to all primary activities is very low. The main reason for this lack of co-
operation according to all the suppliers is that the central firms’ lack the willingness to
co-operate. Comparing the responses of the privatised firms and their suppliers
indicate that the privatised firms have exaggerated their firm-supplier and customer
co-operation on their inbound and outbound and production activities in comparison
to the opinion of their suppliers.
6XSSOLHUV¶ HYDOXDWLRQ The suppliers of both government and transition firms
nevertheless believe that their partners are very efficient in their purchase order
processing, bilateral communication, explanation to inquiries, courtesy and cash
payment habits. The suppliers of the privatised firms evaluated the firms on marketing
approaches as less efficient. The transition firms, according to their suppliers, are good
only at their payment habits.
)LUPFXVWRPHUOLQNDJHV±WKHILUPV¶SRLQWRIYLHZ The government firms revealed
the weakest firm-private-customer co-operation. Their responses show that they have
no firm-customer co-operation on any of the primary activities. The responses of the
transition firms indicate that they moderately co-operate with their customers only on
the outbound activities, particularly, finished goods warehousing and materials
handling. According to the privatised firms’ co-operation with their customers on all
activities of outbound activities and production operations is very strong. As it is the
case with the firm-supplier linkages, all firms have very weak firm-customer co-
operation on the activities related to marketing/sales and after sales services. The
reason for the lack of firm-customer co-operation according to all the firms is that
their customers do not co-operate. The government and privatised firms’ reason for
non-firm-customer co-operation was moreover reportedly due to a lack of policy on
firm-customer co-operation and they also do not see benefit in co-operating with their
customers.
,QWHUILUPOLQNDJHVFXVWRPHUV¶SRLQWRIYLHZ The customers of all firms reported
that they rarely have any co-operation agreement on the primary activities, working
capital levels and operations except the transition and privatised firms’ co-operation
on the outbound activities’ of order processing. The main reasons for this lack of co-
operation is that the central firms lack the willingness to co-operate. The managers of
the privatised firms have exaggerated their firm-customer co-operation on their
inbound, outbound and production activities in comparison to the opinion of their
customers.
&XVWRPHUV¶HYDOXDWLRQ All firms are evaluated by their customers as efficient on their

product quality, bilateral communication, impartiality with other buyers and cash
collection habits. In addition the customers of privatised firms rated their partners as
efficient on sales processing, delivery and knowledge of customers. The government and
transition firms were evaluated as efficient on their cost of products while the
government and privatised firms were rated as efficient on their explanation to inquiries.
On the other hand, all firms were rated as inefficient on their marketing approaches and
on their use of customer services.
Chapter 9 244
&RQFOXGLQJ UHPDUNV How close the firms co-operate with their suppliers and
customers is highly influenced by whether the supplier or customer is
government/transition or private/privatised firm. Generally, we observe that there is
close inter-firm co-operation between the government and transition firms. Though
they may not necessarily have a written instruction when it comes to inter-firm co-
operation, all government and transition firms give more priority to other “related“
firms. We argue here that there are three reasons for the inter-government firms co-
operation. First, the government and transition firms trust each other more than they
trust the private firms and therefore make transactions on credit basis. Second,
government regulations require them to transact among themselves and refer to
private firms only if they could not find a transaction partner within the government
firms. Third, traditionally the transition firms are used to making transactions among
themselves as government firms, so they cannot break with this culture, because even
though they were given limited managerial autonomy since 1996 (when they were set
for privatisation), they still stick to their old managerial habits and inter-firm relations.
Two of the privatised firms have also maintained their old managerial policy on inter-
firm linkages while the third is developing new inter-firm co-operation. We believe
that there are two main reasons for the later assertion. First, the two firms have
retained the top managers that existed before they were privatised who maintained
their former managerial policy, while the third has changed the management and
therefore its policy. Second, the two firms have not encountered any meaningful
competition in both the supply as well as the product markets, while the third is faced
with more open market.
A clear difference that we also observe among the government, transition and the
privatised firms is on the existence of a plan for the future. The privatised firms have a
clearer strategy to expand into new markets and to strengthen their existing supplier
linkages while the transition firms are waiting for new buyers to take over the
management. The government firms have no mandate to establish their own
managerial policy and they wait for the government to give them more autonomy or
to privatise them. It is observed that more inter-firm trust exists among the
government and transition firms. The fact that they are government firms has
increased trust among the firms and decreased the possibility of opportunistic
behaviour and the need for ex-ante safeguarding and ex-post control measures.
However, when it comes to the inter-firm linkages with the private firms we observe
that they apply collaborative incentives (such as Keih Bahri Tannery distributing
preservative chemicals to keep suppliers) or cohesive measures (such as Asmara Milk
Factory’s controlling the supply line of its suppliers). Moreover, we believe that the
inter-firm co-operation between Keih Bahri Tannery and its suppliers as well as
between Asmara Milk Factory and its suppliers has helped the firms to be the most
profitable among their group (see on profitability ratios on Appendices 7.2.3.5. and
8.2.3.5.repectively).
3$579
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&KDSWHU
&RQFOXVLRQVDQG5HVHDUFK,PSOLFDWLRQV
,QWURGXFWLRQ
In the previous four parts, first, we introduced the research objective and defined our
conceptual and empirical research problems. Second, we reviewed the theory from the
relevant literature. Third, based on the literature review, we developed our conceptual
framework and designed our research methodology. Fourth, based on our research
methodology and conceptual framework, we collected empirical data and analysed the
cases of two government, five transition and three privatised firms.
This chapter concludes the research by answering the third question: :KDW DUH WKH
FRQFOXVLRQV DQG IXWXUH UHVHDUFK LPSOLFDWLRQV RI WKH VWXG\"We address here the first
sub-question: :KDW DUH WKH FRQFOXVLRQV WKDW ZH FDQ PDNH IURP WKH VWXG\ RI ZRUNLQJ
FDSLWDO PDQDJHPHQW H[SHULHQFHV RI WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG
PDQXIDFWXULQJ ILUPV LQ (ULWUHD" We present evaluation of our research framework,

conclusions and implications of the study. This section (section 10.1) introduces the
chapter. Section 10.2 evaluates the research framework by comparing the expectations
with the empirical findings. Section 10.3 covers conclusions on the management of
internal and external working capital as well as general issues with regard to the
Eritrean context. Section 10.4 addresses the second sub-question (3b) stated as: :KDW
DUHWKHOLPLWDWLRQVDQGIXWXUHUHVHDUFKGLUHFWLRQWKDWFDQEHGUDZQIURPWKHVWXG\" It
deals with the implications of the empirical findings for the conceptual framework
(section 10.4.1), policy implications at the firm and government levels (section
10.4.2) and the limitations and future research directions (section 10.4.3).
7KHFRQFHSWXDOIUDPHZRUNH[SHFWDWLRQVDQGHPSLULFDOILQGLQJV
In order to develop a conceptual research framework we depended on relevant

literature well established in the western developed world. We believe that the
experiences in the developed world can be used as a point of experience for the
managers in the developing world so that the firms in the developing world need not
re-invent the wheel, they only have to learn from the experiences of the firms and
researchers in the developed world. These cuts the time and cost of research, provided
that the managers can adapt it to their situations by making some fine twinning and
thereby take advantage of the leap-frogging effect. With this effect in mind we
developed a conceptual framework after reviewing relevant literature on internal and
external working capital management. The conceptual framework helped us to define
a broad approach to working capital management, particularly to understand the
relationships among the factors of internal and external working capital management,
to design the data collection approaches and analyse the case study.
Moreover, an appropriate question to ask at this stage would be, GR WKH H[SHFWDWLRQV
? By
ZHKDGLQIRUPXODWLQJWKHFRQFHSWXDOIUDPHZRUNWDOO\ZLWKWKHHPSLULFDOILQGLQJV
getting an answer to this empirical sub-question we try to find out whether the
Chapter 10 248
working capital management models found in the literature are of relevance to the
financial management in developing countries, such as Eritrea. In order to answer this
question, we compare the expectations of our conceptual framework on the internal
and external working capital management (Table 5-2) against the corresponding
empirical findings on the internal (Table 9-1) and external (Table 9-2) working capital
management. We also compare the expectations on the general issues (Table 5-3) with
the findings on the Eritrean context (Table 9-3).
-
2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQW H[SHFWDWLRQVDQGILQGLQJV
The expectation of our conceptual framework with regard to the overall working
capital management is that (if there are no constraints) efficient internal working
capital management can be applied by management to create value by increasing sales
and decreasing costs (Table 5-2). With regard to this issue our empirical findings
indicate the following facts.
*RYHUQPHQW ILUPV Practically, the working capital management policy in the
government firms is tailored more to decrease costs but not to generate profit or to
remain liquid. The general managers of the two government firms believe that the factor
that is constraining firm objectives is mainly fixed capital investment. Keih Bahri Food
products has also problems with its production capacity and with skilled labour while
Barka Canneries has constraints of working capital financing. We have observed also
that there is problem of managerial empowerment due to the imposition of government
regulations, which are implemented under the supervision of the Ministry of Defence.
Policy decisions, which can have both short and long-term effect depend on the approval
of these higher government authorities. Moreover, the financial managers of the
government firms believe that overall working capital management has an important role
in value creation. Their responses indicate that working capital management, particularly
managing cash, receivables, inventory and purchase of materials is important for the
purpose of increasing sales and decreasing operating costs.
7UDQVLWLRQILUPVThe main objectives of the WUDQVLWLRQ firms include remaining liquid

and generating profit. However, objectives are constrained by the transition process
and lack of managerial empowerment.
Generally, since the transition firms are supposed to be privatised any time,
management is not encouraged to plan over a long-term period and as long as a buyer
is not found, the management of their working capital levels and operations will be
crippled and they will have no vision of the future. In addition, production capacity,
lack of managerial empowerment and the imposition of government regulations are
also found to be problems for most of the firms. As a result, we found that the firms
lack a clear objective and vision of managing both internal and external working
capital levels and operations. On the role of working capital management in the value
creation, all managers of the transition firms are of the opinion that overall working
capital management has an important role for value creation. It is particularly important
for the purpose of increasing sales by managing trade receivables, inventories, sales of
finished goods, purchase of materials and trade payables.
Conclusion and Research Implications 249
3ULYDWLVHG ILUPV The management policy of the SULYDWLVHG firms is tailored towards
increasing sales, decreasing costs and generating profit. In addition to these objectives
Eritrea Steel Sheet Factory also aims at remaining liquid.
Specific constraints in achieving firm objectives for Asmara Milk Factory and Asmara
Sweater Factory include working capital investment and financing as well as fixed
capital investment and financing. Asmara Sweater Factory also has a lack of production
capacity, labour availability, product demand and markets. Moreover, a major
constraint is also the lack of investment and financing opportunities, management
potential, management culture and clarity of objectives. Though the managers of the
privatised firms are fully empowered, we observe that they have no clearly defined
policy on how to manage their working capital levels and operations. Their working
capital management is restricted to the control function, which is evidenced by the
strict control mechanisms imposed over the levels of cash, receivables and inventories
as well as operations of purchasing and selling. However, the financial managers of the
privatised firms believe that working capital management has an important role in value
creation, particularly for the purpose of increasing sales by managing cash, trade
receivables, inventories, trade payables, sales of finished goods and purchase of
materials. They also believe that working capital management can be used to decrease
costs by managing purchase of materials, inventories, cash and receivables.
7KHLQWHUQDOZRUNLQJFDSLWDOPDQDJHPHQWH[SHFWDWLRQVDQGILQGLQJV
0DQDJLQJWKHOHYHOVRILQYHVWPHQWDQGILQDQFLQJ As we have indicated in chapter 5,

(Table 5-2),in our conceptual framework we expected that, in order to enhance value,
firms have to invest when there are surpluses and dis-invest when there are shortages.
Parallel to this they also have to take care of the carrying costs of surpluses and
shortage costs of deficits of working capital levels. Therefore, they have to harmonise
policies of cash levels with that of trade receivables and inventory of products so that
the balances are optimised. With regard to managing the levels of financing, the
expectation of our conceptual framework is that working capital financing policies
enhance value if firms take care of financing sources, costs and liquidity positions.
Therefore, firms have to harmonise policies of cash levels with that of trade payables
and inventory of materials so that the balances are optimised.
*RYHUQPHQW ILUPV Our empirical findings (Table 9-1) reveal that internally the
JRYHUQPHQW firms do not manage the carrying costs of surpluses and shortage costs of
deficits of cash, receivables and inventory levels. They do not try to harmonise policies
of cash levels with that of trade receivables and inventory of products. The empirical
findings also indicate that working capital investment is partially financed through
subsidies and the firms lack careful management of financing sources, costs and
liquidity positions. Moreover they do not harmonise policies of cash levels with that
of trade payables and inventory of materials.
Working capital investment levels for both Keih Bahri Food Products and Barka
Canneries aim at the transaction purpose and they do not keep levels of working capital
for speculative, precautionary or bank compensating balance purposes. This is mainly
because they have neither the opportunity nor the authorisation to make working capital
investments with a profit motive. On the financing side the government firms cannot
Chapter 10 250
expressly state their working capital financing policies. However, because of the
profitable operations (thanks to the subsidised costs and monopolised market, which
have resulted at net operating profits and positive net cash flows), the firms have no
problem of financing their working capital levels and operations.
7UDQVLWLRQ ILUPV Internally, the WUDQVLWLRQ firms do not manage the carrying costs of
surpluses and shortage costs of deficits of cash, receivables and inventory levels nor
do they try to harmonise policies of cash levels with that of trade receivables and
inventory (Table 9-1). On the financing side the management of the WUDQVLWLRQ firms is
restricted to the control function and the firms do not harmonise policies of cash
levels with that of trade payables and inventory of materials. Their main objective is
to remain liquid, which is constrained by lack of fixed capital investment, labour and
managerial empowerment and the problems of the transition process.
The management of the firms in transition to privatisation gives more emphasis to

controlling the physical safety of working capital investments. They have no short or
long-term vision on how to maximise the value of their investments. Government policy
does not allow the firms to accumulate inventory, or to buy or sell on credit whose cash
transaction extends over a log period. In general, the firms are not allowed to design and
implement short and long-term investment and financing policies. As one manager put it,
³WKH\KDYHEHFRPHKRVWDJHVRIWKHSULYDWLVDWLRQSURFHVV”. As a result, all firms (except
Keih Bahri Tannery) are in a serious problem of liquidity. They all (except Keih Bahri
Tannery) have negative net cash flows that they finance with a bank overdraft, the
annual interest cost of which is a very large proportion of their total costs.
Management has no opportunity or motive for investing working capital levels or
minimising related carrying costs as well.
3ULYDWLVHG ILUPV As it is indicated in (Table 9-1) SULYDWLVHG firms do not have strong
policy in managing the carrying costs of surpluses and shortage costs of deficits of
cash, receivables and inventory levels. The firms do not try to harmonise policies of
cash levels with that of trade receivables and inventory. In managing working capital
financing, the SULYDWLVHG firms do not have policy to harmonise the balances of cash
levels with that of trade payables and inventory of materials and their management is
restricted to the control of costs and physical safety.
Specifically, the purpose of managing working capital levels is restricted to the routine
transaction because after what has been spent to buy the firms from the government
during privatisation there is very little left for other purposes. The privatised firms
have borrowed heavily from the government banks in order to buy the firms, which has
resulted at problems of liquidity. The firms have been bought from the government in
the last couple of years and the managers said that the owners have exhausted their
financial resources and the firms’ investment capacity has been affected. So they are
concentrating on controlling the costs and physical safety of working capital levels of
investment and financing.
0DQDJLQJWKHRSHUDWLRQVRISXUFKDVLQJDQGVHOOLQJ We expected that if firms apply

efficient purchasing policies (cost minimising while at the same time maximise
quality and volume) they can enhance value (Table 5-2). They can implement this by
synchronizing cash payments with purchases and trade credits so that cash needed is
minimised and purchase and trade credits are maximised. In managing the operations
of selling, our conceptual framework assumes that if firms apply efficient sales
policies (sales and cash collection terms and standards) they can enhance value
creation. Particularly if credit sales and receivables are harmonised with cash
collections it is possible to increase sales and optimise the balances of receivables.
*RYHUQPHQW ILUPV The empirical findings with regard to JRYHUQPHQW firms reveal
that, government directives dictate their purchase terms and standards and the
management is restricted to the control function. So the management does not have
full authority to harmonise cash payments with purchases and trade credits. The two
government firms have different policies of purchasing materials but both have to
comply with the relevant government regulations. Barka Canneries purchase materials
from private suppliers on a bid basis to take advantage of quantity discounts and cash
discounts, to minimise inventory-holding costs and to meet seasonal customer demands.
The Eritrean Grain Board does Keih Bahri Food Products’ purchases. So the firm has
very little to do with the purchase policy of its materials.
In managing their sales operation they are required to sell their products mainly to the
Ministry of Defence (which supervises them) and Keih Bahri Food Products also sells
to authorised private firms. The empirical findings indicated that they have to comply
with the relevant government regulations, which dictate their policy on terms and
standards of sales and cash collection. So, both firms have very little to do with how
to sell their goods.
7UDQVLWLRQILUPV Though the WUDQVLWLRQ firms have more relaxed but limited authority
to set their own working capital management policies they do not have clear
managerial policy on purchase terms and standards. Management does not try to
harmonise cash payments with purchases and trade credits and it is more restricted to
the control function. Specifically, we found that the firms in transition to privatisation
have no clear policy on the purchase of their materials. It is only Keih Bahri Tannery that
manages its purchase of materials to take advantage of quantity and cash discounts,
while Dahlack Shoe Factory also reported that it has a policy of decreasing inventory
holding costs and meeting seasonal production requirements. They all purchase on cash
basis from the cheapest source. The reason why they do not buy on credit at least from
the local market with all the firms is because suppliers do not provide credit. Lamba
Sack Factory, Dahlack Shoe Factory and Keih Bahri Tannery also reported that there is
no tradition of buying and selling on credit.
In managing the sales operation, the WUDQVLWLRQ firms also lack clear policy on sales and
cash collection terms and standards because they have to comply with the relevant
government regulations. So, they do not try to harmonise cash collections with sales
and receivables or vice versa. Their sales policy aims at taking care of customer
demands and to meet seasonal sales requirements but not to decrease cost of inventory
holding or expand market share except for Keih Bahri Tannery. The transition firms
(except for Asmara Textile Factory and Lalmba Sack Factory) sell only on cash basis.
3ULYDWLVHG ILUPV 3ULYDWLVHG firms have comparatively better managerial policy on

purchase terms and standards. They also try to harmonize cash payments with
purchases and trade credits so that cash needed is minimised and purchase and trade
credits are maximised.
Chapter 10 252
Specifically, the managers of Asmara Sweater Factory and Asmara Milk Factory
reported that they purchase materials mainly to get cash discounts, while Eritrea Steel
Sheets Factory aims at getting quantity discounts and minimising the costs of
inventory holding. Asmara Sweater Factory and Asmara Milk Factory purchase both
on cash and credit terms while Eritrean Steel Sheet Factories purchase only on cash
basis because according to its commercial manager, the firm’s suppliers do not
provide credit. Asmara Milk Factory controls its suppliers by agreeing with the
suppliers of their suppliers (animal feed producing factories) such that they sell only
to those certified by Asmara Milk Factory.
Comparatively the SULYDWLVHG firms also revealed better managerial policy on sales
terms and standards. They try to harmonise cash collections with sales and
receivables. The privatised firms have different sales policies depending on whether
the customer is large or small and a government firm or a private firm. The cash sales
refer to smaller private firms while the credit sales refer to larger private and all
government firms. With regard to their private credit customers they apply credit
standards based on a repeat sale approach while Eritrean Steel Sheet Factory and
Asmara Milk Factory also use the five C’s (capital, character, collateral, capacity and
conditions) to evaluate credit applicants. In order to collect overdue receivables they
all make telephone calls and extend credit periods, but it is only Asmara Sweater
Factory, which makes personal visits and none of them employs collection agents or
takes legal action. However, the risk of bad debt is very low and none of them makes
allowances for it.
([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQWH[SHFWDWLRQVDQGILQGLQJV
0DQDJLQJLQYHVWPHQWDQGFXVWRPHUOLQNDJHV
With regard to managing the levels of investment, we expected that with closer firm-
customer co-operation sales can be enhanced and the carrying costs of inventories and
receivables can be minimised (Table 5-2). To implement this policy firms have to
harmonise the policies of cash, receivables and inventories with the policies of
customers’ cash, payables and inventories.
*RYHUQPHQW ILUPV The empirical findings in the JRYHUQPHQW firms revealed that the
main customer and supervising body is the Ministry of Defence. The findings on firm-
customer co-operation reveal very close inter-government firm co-operation, as a
result of which the firms have managed to increase sales as well as to decrease the
cost of transporting the sales and carrying inventories.
Externally, the cost of inventory levels are minimised because they closely co-operate
with their suppliers in managing their materials inventory and mostly purchase just in
time for production. According to the interview we conducted with the firm’s
commercial manager, Keih Bahri Food Products has an agreement with Eritrean Grain
Board (another government firm) to get the shipment of the materials as soon as it
orders a purchase. Barka Canneries enters into an annual contract with suppliers to get
materials periodically as needed. The main customer of both government firms is the
Ministry of Defence, which also happens to be their supervising government body.
Therefore, the cost of inventory levels are minimised because they closely co-operate
with their customer in managing their finished goods inventory and mostly sell just
after production. Keih Bahri Food Products also deals with the private businesses,
particularly bakeries and pastries to which it sells on government-subsidised prices. It
makes cash sales and supplies on a quota basis because the demand for its products by
far exceeds its production capacity. The inter-firm co-operation with these private
customers is not as efficient as that with the government firms.
7UDQVLWLRQ ILUPV The WUDQVLWLRQ firms’ customer linkages showed that most (except
Keih Bahri Tannery) have very weak firm-customer co-operation and there is no
harmonisation among their policies of cash, receivables and inventories with the policies
of their customers. Their very limited co-operation is on outbound activities, particularly
- order processing. Overall, private customers of the transition firms indicated that
their co-operation on the primary activities is low except for few technical activities
for control purposes.
3ULYDWLVHG ILUPV From the SULYDWLVHG firms only Asmara Milk Factory has strong
customer linkages and revealed some harmonisation among the policies of working
capital levels and operations with the policies of customers. The other two have weak
or not well defined firm-customer relations. On the issue of firm-customer co-
operation, comparatively, Asmara Milk and Asmara Sweater Factories have small but
numerous competitors, so both have demonstrated some effort to satisfy the demand
of their customers by developing linkages. The managers of both firms believe that
they co-operate with their customers on the primary operations particularly, outbound
activities and in some areas of production operation like packaging. However,
Eritrean Steel Sheet Factory is the only one in the country producing steel sheets. This
has enabled it to dominate the market as a result of which it does not bother to create
strong firm-customer co-operation.
0DQDJLQJILQDQFLQJDQGVXSSOLHUOLQNDJHV
In managing the levels of financing, we expected that co-operation with trade creditors
and banks can expedite the availability of financing sources and minimise the cost of
financing as well as the timing and ease of the medium of payment (Table 5-2). With
closer firm-supplier co-operation we also expected that firms can increase their volume
of purchases and at the same time decrease the transaction costs of ordering and
transporting purchases. Firms can apply this by harmonising their credit policies with
that of suppliers so that to maximise financing sources and minimise related costs. They
have also to harmonise their policies on purchases with supplier’s sales so that both are
maximised while at the same time the firm’s balances of cash and inventory of materials
and the supplier’s cash and inventory of products are optimised.
*RYHUQPHQW ILUPV The empirical findings on the JRYHUQPHQW firms indicated that
firm-supplier linkages and co-operation is made on the basis of government
regulations. Moreover, there is close inter-government-firms co-operation, which has
enhanced purchases and minimised the carrying costs of inventories. However, co-
operation with the private sector is weak.
Specifically, the firm-supplier co-operation of the two government firms differs

depending on whether they deal with fellow “related” government firms, (case for
Keih Bahri Food Products) or private firms (which applies to Barka Canneries). Keih
Chapter 10 254
Bahri Food Products deals with another government firm (Eritrean Grain Board) and
they manage their common transaction costs through co-operation on the basis of
government regulations and trust. This co-operation according to the commercial
manager of Keih Bahri Food Products has minimised the time needed to purchase
materials as well as the cost of ordering and transportation of purchasing materials.
Barka Canneries deals with private suppliers and it therefore requires them to deposit
cash at its bank account enough to pay for one month’s supply of materials as a form
of risk sharing.
7UDQVLWLRQILUPV Most of the WUDQVLWLRQfirms have weak firm-supplier co-operation and

they revealed little co-operation among their policies of cash, payables and inventories
and the policies of suppliers’ cash, receivables and inventories.
Three (out of the five) transition firms claimed that they co-operate with their suppliers
on primary activities particularly the inbound and two of which also co-operate in
production operations. However, none of the transition firms co-operate on marketing
and sales. Only Dahlack Shoe Factory and Keih Bahri Tannery reported that they have a
policy of firm-supplier co-operation on after sales service particularly parts supply and
product adjustment. The fact that they are in transition to privatisation has put their
managers into uncertain future managerial position and job security. This has crippling
their managerial confidence, as a result they do not pursue clearly stated short or long-
term objectives.
3ULYDWLVHG ILUPV The privatised firms responded differently to the questions on firm-
supplier co-operation. Asmara Milk and Asmara Sweater Factories co-operate with
their suppliers on most of the primary activities, particularly on inbound activities and
production operations. In addition Asmara Milk Factory also co-operates with its
suppliers on marketing and sales activities (except on advertisement), while Asmara
Sweater Factory also co-operates on after sales services. The managers of the privatised
firms believe that there is weak firm-supplier co-operation because the firms and their
suppliers lack specific policy and experience of inter-firm co-operation. We conclude
from the findings that it takes time for privatised firms to fully develop the efficiency
on inter-firm linkages exemplified by private firms. For example, Asmara Milk
Factory is still influenced by its historical legacy as government firm, particularly
with regard to its supplier linkages because the government has allowed the firm to
continue dominating the supply market since suppliers are indirectly obliged to sell to
the firm, else no animal feed. However, we find Asmara Sweater Factory breaking its
past experience as a government firm. It has shifted its source of supply from Keih
Bahri Tannery (a government firm in transition to privatisation) to Tesfagiorghis
Beatay Leather Factory (a private firm) because according to the general manager of
Asmara Sweater Factory the private firm has more flexible and efficient production
and better customer relations.
3HUIRUPDQFHHYDOXDWLRQH[SHFWDWLRQVDQGILQGLQJV
Internally, firms can evaluate the efficiency of their working capital management
decisions by comparing the best expected internal performances (forecasts and
budgets) with related outcomes using the accounting based performance measurement
and evaluation approaches (Table 5-2). Accordingly, operational efficiency can be
evaluated - using activity ratios, levels of investment and financing efficiency - using
asset structure and liquidity/leverage ratios and profitability - using gross profit and
net profit margins and return on assets. Externally, the firms can compare the best
practices of other firms (competitors in the same industry). They can also evaluate
customer and supplier satisfaction by examining their commitment, retention rates as
well as asking their opinion on quality of goods and the firm’s response to their
inquiries and speed in the delivery of goods.
*RYHUQPHQW ILUPV The empirical findings revealed that the JRYHUQPHQW firms
evaluate their performance using comparative analysis of past versus present, actual
versus expected and inter-industry benchmarks. They also use liquidity and activity
measures of accounting as well as customer satisfaction criteria, particularly fast
response to inquiries and orders and quick delivery time in their inter-government
firm relationships.
Financial statements reveal that the government firms have excessive current assets,
particularly cash balance. Investments in current assets make more than 90% of the total
investment in assets. Most of the working capital investments in Keih Bahri Food
Products is in receivables and cash while that of Barka Canneries is in cash and
inventories. Their current and quick ratios show differing liquidity positions. Keih
Bahri Food Products liquidity position is only marginal while Barka Canneries is
excessive. As reflected by the turnover ratios the activities of both government firms
show low asset turnovers and increasing receivables collection periods. When
compared with the global norms, all profitability ratios (gross profit, net profit and
return on assets), indicate positive results though those of Keih Bahri Food Products
are lower.
7UDQVLWLRQ ILUPV The transition firms (except Asmara Textile Factory) evaluate their
performance of working capital investment decision by comparing the past with the
present and actual with expected results. Except Lalmba Sack Factory (which reported
that it uses almost all the accounting and customer satisfaction measures of
performance), the other firms reported that they use no accounting and customer
satisfaction measures of performance.
Our analysis of the firms’ financial statements showed that investments in current
assets compared to the total investment in assets with all the transition firms is very
large. It range from 97% in Asmara Textile Factory to 64% in Lalmba Sack Factory
with an overall average of 86%. The greatest portion of the working capital
investments with all the transition firms is in inventories (an average of 81%), which
ranges from 95% for Sembel House Hold Factory to 56% for Keh Bahri Tannery. The
lowest working capital investment is on cash levels (an average of 5%), which ranges
from 19% for Keh Bahri Tannery to 0% for Asmara Textile Factory. It can easily be
observed that the firms’ cash position is very weak. Except for Keih Bahri Tannery,
they have deficit cash balance for almost all the years that we have studied. As
reflected by the turnover ratios their working capital activities also show low
turnovers. Liquidity analysis showed that the firms’ (except Keih Bahri Tannery)
liquidity ratios are below the generally accepted global range. Except for Keih Bahri
Tannery and Dahlack Shoe Factory, all profitability ratios (gross profit, net profit and
return on assets) also indicate very low levels.
Chapter 10 256
3ULYDWLVHG ILUPV The privatised firms evaluate performance of their working capital
decision by comparing past and present as well as actual and expected results (except for
Eritrea Steel Sheets Factory). However, none of them uses industry benchmarks to
compare their performance with other firms. They take care of their customer
satisfaction by applying communication based approaches, particularly by having the
policy of fast delivery. In addition to this, Asmara Sweater Factory and Eritrea Steel
Sheets Factory also take care of their customers’ interests by charging lower prices and
having a policy of fast responses, while Eritrea Steel Sheets Factory and Asmara Milk
Factory also try to decrease defect rates.
Our analysis of the privatised firms’ financial statements revealed that investments in
current assets are comparatively lower than that of the government and transition firms.
It makes 66% for Asmara Sweater Factory, 52% for Asmara Milk Factory, and 85% for
Eritrea Steel Sheets Factory. Most of the working capital investments for Asmara
Sweater Factory is in inventories (83%,), while that of Asmara Milk Factory and Eritrea
Steel Sheets Factory is in cash which respectively accounted for 49% and 39%.
Liquidity analysis for Asmara Sweater Factory indicates that both current and quick
ratios are below the generally accepted global norms and the other two firms are only
marginally liquid. The measures of working capital activities in the privatised firms
show low turnovers except for the relatively high receivables turnover for Asmara Milk
Factory. However, except for Asmara Sweater Factory, which made losses throughout
the years, the profitability ratios (gross profit, net profit and return on assets) of the
other two firms are positive.
7KHLVVXHVRQWKH(ULWUHDQFRQWH[WH[SHFWDWLRQVDQGILQGLQJV
We also made conceptual expectations with regard to the effect of ownership,

government regulations, managerial empowerment and background as well as cultural
factors in the management of working capital. A comparison between the expectations
and our empirical findings follow.
2ZQHUVKLS With regard to the effect of ownership, we expected that firms with
similar ownership status can have similar objectives and control patterns. We also
expected that competition in government and transition firms can be hindered by
political interference from the government because the government firms’ main
objective can be to enhance political and social objectives while the privatised firms
may opt for operational efficiency with a firm’s value creation as the ultimate
objective.
The empirical findings revealed that with the JRYHUQPHQW firms there is strong
government interference through subsidies and market protection and competition is
hindered by interference from the government. In addition to the profit motive the
government firms enhance political and social objectives. With WUDQVLWLRQ firms we
found that the managers’ uncertain future position, (due to the transition process)
crippled managerial confidence and job security. Moreover, the firms have similar
objectives and control patterns with the government firms and try to enhance political
and profit objectives. The SULYDWLVHG firms revealed strong resistance to new private
business environment. However, competition is not hindered by government
interference. Though they opt for operational efficiency with a firm’s value creation
as the ultimate objective, they lack efficient financial institutions and capital markets.
*RYHUQPHQW UHJXODWLRQ Our conceptual framework expected that government

regulations can influence the type of business operations and inter-firm linkages. We
also expected that, government can determine the type of competition and set
guidelines on how the firms have to be managed.
The empirical findings revealed that managers of theJRYHUQPHQW and WUDQVLWLRQ firms
are influenced substantially by the government requirements and interference of
higher government bodies. In these firms government regulations influence the type
of business operations, inter-firm linkages and competition. The government also sets
guidelines on how the firms have to internally be managed. However, with the
SULYDWLVHG firms, government regulations have less influence on the type of business
operations, on how the firms have to be managed as well as on the type of competition
and inter-firm linkages.
0DQDJHULDO HPSRZHUPHQW DQG EDFNJURXQG Our conceptual framework is based on

the expectation that managerial empowerment, practical experience and academic
background can determine the selection from alternative management approaches and
play a determining role in the development, acquisition and adaptation to proper
The empirical findings revealed that with the JRYHUQPHQW and WUDQVLWLRQ firms, control
by government regulations impaired managerial power. This lack of management
authority has an impact in the selection of alternative management approaches and has
played a role in the development, acquisition and adaptation to proper managerial
policies. With the SULYDWLVHG firms, management is fully empowered and is free to
select from alternative management approaches. However, this managerial freedom
has played less visible role in the development, acquisition and adaptation to proper
managerial policies due mostly to the lack of investment and financing opportunities
as well as availability of skilled labour and markets.
&XOWXUDOIDFWRUVwe expected that cultural factors also affect a firm’s working capital
management because transactions are made between people who contact, contract and
control each other’s behaviour on the basis of their cultural practices, believe, and
norms. However, we did not find cultural practice, believe or norm with any of the
government, transition or privatised firms that hinder internal or external working
capital management.
&RQFOXGLQJUHPDUNH[SHFWDWLRQVDQGILQGLQJV
Though the next section (section 10.3) deals with more specific conclusions of our study,
here we will try to summarise the result of the comparison between our expectations
and findings. The objective of comparing the expectations and findings of our
conceptual framework was to find out whether the working capital management models
found in the literature of the developed western world are applied by managers and
therefore are relevant to the financial management in developing countries, such as
Eritrea. Our findings revealed that the managers in the government, transition and
Chapter 10 258
privatised manufacturing firms in Eritrea used very little of the working capital models
found in the literature of the western developed world. The main reason, as we have tried
to summarise earlier (section 10.2.5) is mainly because the non-financial factors that
influence the managers mostly outweigh the financial factors. As a result of this we
propose future conceptual research frameworks to strongly consider the factors indicated
in the next section (section 10.3.1 - implications for the conceptual framework).
&RQFOXVLRQV
Here we start to answer the third research question: ³:KDW DUH WKH LPSOLFDWLRQV RI WKH
This section tries to answer the first sub-question:³:KDWFDQEHOHDUQHGIURPD
VWXG\³"
FRPSDULVRQRIWKHFRQFHSWXDOEDFNJURXQGDQGZRUNLQJFDSLWDOPDQDJHPHQWH[SHULHQFHV
We
RI WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG PDQXIDFWXULQJ ILUPV LQ (ULWUHD´"
compare the findings in the conceptual review (section 10.2) and empirical data analysis
(section 10.3) and come up with concluding remarks. We separate the conclusions that
refer to our conceptual framework in general (section 10.3.1), the internal working
capital management (section 10.3.2), external working capital management (section
10.3.3) and the general issues that affect working capital management decisions from the
Eritrean context (section 10.3.4).
,PSOLFDWLRQVIRUWKHFRQFHSWXDOIUDPHZRUN
The conceptual framework reflects both operations management view (the left-hand
side) and a financial management view (the right hand side). The operations view
focuses over operations management. The financial management side takes the notion
of shareholder value and the importance of generating a surplus over the cost of
shareholders’ funds. Our empirical findings indicate that the managerial policy in the
government, transition and privatised firms in Eritrea focuses on the operations view
more than the financial management view. The basis for this conclusion is that the
firms have applied stringent control measures over the operations of purchases, sales,
cash collections and payments while they have very little managerial policy to
maximise the benefits of investment and financing of working capital levels. The
main reason for the absence of the financial management option is the lack of
appropriate financial and capital markets. However, the poor background of the
general managers’ academic and practical experience, the firms’ historical
background and interference of government regulations (in the government and
transition firms) have played a role.
7KHSHUFHLYHGUROHRIZRUNLQJFDSLWDOPDQDJHPHQWDQGYDOXHFUHDWLRQ A reference
to the chapters sections 6.2, 7.2 and 8.2 reveals that all managers believe working
capital management practically creates value, because it helps in decreasing costs and
increasing sales. Empirically, we found out that, there is an absence of managerial
empowerment (in the government and transition firms) and lack of economic
opportunity (in the privatised firms) to deal with issues of strategic significance.
Therefore almost the entire managerial time is focused on issues related to working
capital levels and operations. Therefore the managers believe that the value created or
lost by the firms is mainly attributed to the efficiency of working capital management.
:H WKHUHIRUH FRQFOXGH WKDW WKH LQWHUQDO PDQDJHPHQW RI ZRUNLQJ FDSLWDO OHYHOV RI
LQYHVWPHQW DQG ILQDQFLQJ DV ZHOO DV RSHUDWLRQV RI SXUFKDVLQJ DQG VHOOLQJ LV
FRQVLGHUHGE\WKH PDQDJHUV WRKDYH DYHU\ UHOHYDQW UROH LQ FUHDWLQJ ILUP YDOXH 7KLV
EHFRPHV PRUH LPSRUWDQW SDUWLFXODUO\ LQ VLWXDWLRQV RI GHYHORSLQJ FRXQWULHV OLNH
(ULWUHD ZKHUH WKHUH DUH QR FDSLWDO PDUNHWV YHU\ OLPLWHG FDSLWDO LQYHVWPHQW DQG
Though the
WKHUHIRUH YHU\ OLWWOH RSSRUWXQLW\ WR PDQDJH ZLWK VWUDWHJLF REMHFWLYHV
managers consider working capital management has a role in value creation, they are
constrained to do so. In the government and transition firms the problem is mainly due
to managerial empowerment. In the privatised firms we trace this lack of value
management due to problems of liquidity, lack of investment opportunities and
financing sources.
3ROLF\REMHFWLYHVDQGZRUNLQJFDSLWDOPDQDJHPHQW : The empirical findings indicate

that all firms have only one working capital management objective - to manage levels
and operations for transaction purposes. :H FRQFOXGH WKDW WKH ILUPV WKDW ZH KDYH
VWXGLHG GRQRW KDYHDFOHDUO\ VHW SROLF\REMHFWLYH LQ PDQDJLQJZRUNLQJ FDSLWDOOHYHOV
DQG RSHUDWLRQV All firms practically do very little for precaution purposes because
they do not have such a purpose. The firms do not bother about precautionary cash
needs because either excess cash flow is deposited in the bank and is available any
time they need it, or the financing of their cash flow deficits is guaranteed with
overdraft from the government banks. No firm plans or controls its inventory levels
for precautionary purposes. The firms do neither have any motive of holding any
levels of working capital for speculative purposes. The managers responded that they
do not have any speculative opportunity in income generating business because there
are no financial or capital markets available while the government and transition firms
would not have been allowed even if the opportunity was there.
*RYHUQPHQW UHJXODWLRQVDQGZRUNLQJ FDSLWDO PDQDJHPHQW Our empirical findings
reveal that the management of working capital operations differs among government,
transition or privatised firms. In government and transition firms the directives from
higher government officials dictate their behaviour. Management in these firms
implement the regulations and the higher government bodies supervise their
implementation. The JRYHUQPHQW firms are therefore obliged to buy and sell as per the
government rules and cannot establish and follow their own purchase and sales
policies against the rules. The WUDQVLWLRQ firms are given a limited autonomy. They
have the option to transact on their own terms to a limited extent, for example they
cannot buy or sell on credit for a period longer than three months. +HQFHRQWKHEDVLV
RI RXU HPSLULFDO ILQGLQJV ZH FRQFOXGH WKDW JHQHUDOO\ WKH PDQDJHPHQW RI ZRUNLQJ
FDSLWDO RSHUDWLRQV LQ WKH JRYHUQPHQW ILUPV LV FULSSOHG E\ WKH JRYHUQPHQW UXOHV 7KH
PDQDJHPHQW RI WKH WUDQVLWLRQ ILUPV LV SDUWLDOO\ FRQWUROOHG E\ WKH JRYHUQPHQW
UHJXODWLRQV DQG SDUWLDOO\ YLFWLPLVHG E\ WKH WUDQVLWLRQ SURFHVV EHFDXVH RI WKH
XQFHUWDLQWLHV ZLWK UHVSHFW WR IXWXUH RZQHUVKLS FRQWLQXLW\ RI FXUUHQW PDQDJHPHQW
SROLF\DQGMREVHFXULW\
&RQWURO RYHU OHYHOV DQG RSHUDWLRQV FXVWRG\ RU PDQDJHPHQW RI LQYHVWPHQW DQG
ILQDQFLQJ9DOXHFUHDWLRQ: Value management presumes the management of working

capital levels to decrease the holding costs of cash, receivables and inventories,
Chapter 10 260
investing any short or long-term surplus cash as long as the firm does not use it. The
empirical findings indicate that even though most of the firms’ investments are tied-
up in working capital assets, their management is mainly concerned with the safety of
the assets and control of operations against theft and misappropriation (the custody
aspect). The main reason behind the managers’ concentration on the control aspect is
because of the lack of managerial empowerment, liquidity, investment opportunities
and financing sources. :H WKHUHIRUH FRQFOXGH WKDW QRW IXOILOOLQJ WKHVH FRQGLWLRQV
LPSOLHV WKDW PDQDJHUV ZLOO FRQWLQXH FRQFHQWUDWLQJ PDLQO\ RQ WKH FRQWURO DVSHFW RI
ZRUNLQJFDSLWDOOHYHOVDQGRSHUDWLRQV
9DOXH FKDLQ DSSURDFK DQG LQWHUILUP FRRSHUDWLRQ : In an inter-firm transaction

relation, there are two factors that both partners are affected by - the costs created as a
result of the transaction and the income generated in the transaction. The income
earned by one becomes the costs of the other. So, it becomes a zero sum when
considering both. However, the costs that both transaction partners may incur in order
to get into contact with each other, to design and agree a contract and thereafter to
control each other can decrease if firms co-operate.
Our empirical evidence shows that JRYHUQPHQW ILUPV closely co-operate with each
other on their primary activities because government regulations oblige them to work
together. For instance the supplier of Keih Bahri Food Products is Eritrean Grain
Board, which is another government firm. Keih Bahri Food Products cannot buy from
other sources. Though Barka Canneries has a more relaxed regulatory provision on its
purchases, the Ministry of Defence is the primary customer and the supervising
government body for the purchases and sales of both government firms. When it
comes to inter-firm transactions with non-government firms, as a rule, every time a
government firm is getting into a new agreement to buy materials, it repeats the same
purchase procedures (writing for bids, comparing bidders, selecting bidders, and
processing the purchase). This decreases trust and increases the costs of an inter-firm
transaction. The WUDQVLWLRQ ILUPV revealed the weakest inter-firm linkages. They have
autonomy to manage their business affairs to a certain extent. It did not work. As
result of which four out of the five firms have invested heavily in working capital
levels. The increase in working capital levels is mainly financed with bank overdraft
whose interest and bank service charge on the average amounted to a very large
proportion of the transition firms’ total expenses. From the three SULYDWLVHG ILUPV,
Asmara Milk Factory has established close inter-firm linkages with its suppliers and
customers. Eritrea Steel Sheets Factory has close inter-firm co-operation only with its
customers with no local supplier, while Asmara Sweater Factory has close supplier
linkages with no major customer linkage in the local market. The first two were
profitable while Asmara Sweater Factory has experienced losses.
Overall, the firms in Eritrea (with the exception of inter-government firms) have loose
inter-firm linkages with their suppliers and customers. We have selected the suppliers
and customers on the basis of their general managers’ choice. Therefore, we expected
the suppliers and customers to give some positive response in favour of the firms.
However, we found out that almost all the suppliers and customers (except for the
inter-government firms) were not satisfied with the co-operation that they get from
their partners. :HWKHUHIRUHFRQFOXGHWKDWZLWKWKHH[FHSWLRQRIWKHLQWHUJRYHUQPHQW
ILUPV WKH RWKHU ILUPV DUH QRW XVLQJ D YDOXH FKDLQ DSSURDFK WR PDQDJH LQWHUILUP
WUDQVDFWLRQFRVWVRIZRUNLQJFDSLWDORSHUDWLRQVDQGOHYHOV
,QWHUGHSHQGHQFH DQG LQWHUILUP FRRSHUDWLRQ Every firm does require a certain
amount of certainty of supply of its materials and of demand for its products and
interdependence enhances certainty. Our empirical evidence shows that the
government and transition firms have developed close inter-firm co-operation,
interdependence and therefore certainty of supply of materials and demand for their
products. But this is not the case for the privatised firms. The findings show that the
privatised firms have not approached such a situation of interdependence and co-
operation. There is very little mutual interdependence existing between the privatised
firms and their suppliers and buyers. We believe that this is a legacy of the mode of
ownership in the firms’ history. The privatised firms were government owned and
there is no exemplary culture of private firm management that the privatised firms can
learn from. The firms’ transactions were conducted mainly with fellow government
firms, and they are having problems to adapt to the new environment of risk
management and of trusting the private sector (and vice versa). :HWKHUHIRUHFRQFOXGH
WKDW WKH SULYDWLVHG ILUPV DUH EHLQJ VORZ LQ GHYHORSLQJ QHZ OLQNDJHV EHFDXVH LW WDNHV
WLPH DQG XQWLO WKHQ WKH PXWXDO LQWHUGHSHQGHQFH ZKLFK PD\ EH XVHG WR GHFUHDVH
WUDQVDFWLRQ FRVWV RI ZRUNLQJ FDSLWDO RSHUDWLRQV DQG OHYHOV ZLOO UHPDLQ ORRVH DW WKH
EHVWRUQRQH[LVWHQWDWWKHZRUVW
&XVWRPHUVSHFLILFDWLRQDQG LQWHUILUP FRRSHUDWLRQJob order production enhances

inter-firm co-operation and value chain linkages more than custom production or
production for the market. If the customer determines the product specification in
terms of quantity, quality and costs, the supplying firm has a higher likelihood to use
the value chain management. The relationship between Keih Bahri Tannery and its
customer Dahlak Shoe Factory is evidence for this conceptual background. The firm
has close linkages with its customers because as its commercial manager says, ³,W
SURGXFHVDFFRUGLQJWR WKHRUGHU RILWVFXVWRPHUV”. This helps Keih Bahri Tannery to
use value chain management and to decrease the holding costs of its working capital
levels and the transaction costs of inter-firm relations. +HQFH WKH PRUH SURGXFW
VSHFLILFDWLRQV DUHGHWHUPLQHG E\WKH FXVWRPHUWKH PRUH OLNHO\ WKDW ILUPV ZLOO XVH WKH
YDOXHFKDLQPDQDJHPHQWDSSURDFK
: The longer the experience between the

([SHULHQFH DQG LQWHUILUP FRRSHUDWLRQ
firm and others linked to it - both backward and forward, the more likely the use of a
value chain management to minimise transaction costs of working capital operations.
A firm's historical experience of interacting with others results in a learning
experience, which has a lasting effect on the firm's behaviour because trust develops
over time, as does mutual understanding. The government and transition firms have a
very long experience of inter-firm co-operation with each other. Almost all the firms
were nationalised in the seventies and the central command economy influenced them
to work together as planned. The government firms still have no problem to co-
operate because they are applying the same managerial practice. However, the
privatised and transition firms (as much as their autonomy permits) are expected to
interact with a new environment – the private business world, with which they have
no experience of co-operation. 7KHUHIRUH ZHFRQFOXGH WKDW WKLV ODFNRIH[SHULHQFHRI
FRRSHUDWLRQLQ WKHSULYDWLVHG VHFWRU KDVKLQGHUHG WKH WUDQVLWLRQ DQGSULYDWLVHG ILUPV
Chapter 10 262
IURPKDYLQJFORVHLQWHUILUPUHODWLRQVKLSVDQGKDVSUHYHQWHGWKHPIURPXVLQJDYDOXH
FKDLQDSSURDFK .
*HQHUDOLVVXHVLQWKH(ULWUHDQFRQWH[W
Our conceptual background suggests market

)LUP RZQHUVKLS DQG YDOXH FUHDWLRQ
competition enhances performance in the form of operational efficiency while

government ownership is more efficient in achieving the objective of equitable
allocation of government resources. When there is competition, prices will tend
towards marginal costs and resources will be allocated to their highest value. The
possibility that government and transition firms can retain their ownership status and
at the same time be competitive may be hindered by political interference from the
government.
Our empirical evidence indicates that - as a result of their ownership - the government
firms have a dominant position on both the supplier and customer linkages. This
according to both private suppliers and customers has decreased the possibility of fair
competition to develop. The lack of competition, government subsidies and a
protected government market enabled the government firms to earn profit more that
the privatised firms. However, when the government support is lifted (as with
transition firms), government firms are not better than the privatised firms.
Government gave the transition firms a limited autonomy to manage their affairs and
it withdrew its government market security. This exposed the transition firms to a
competition with privatised and private firms though still a in limited market. The
transition firms could not adapt to the new private managerial environment and their
value deteriorated as it is observed in their financial statements. Moreover, the
managers of the privatised firms believe that they are under imminent risk of
competition from local and imported goods. In order to protect themselves from the
intense competition they planned to diversify their products and enter into new
markets. One year after our data collection, we have learned that for example Asmara
Milk Factory has added Yoghurt and Eritrea Steel Sheets Factory has added Roof
Tiles to their production lines. However, both government and transition firms are not
showing any improvement as far as management potential, capacity building (fixed
assets investment) and product diversification is concerned. :H WKHUHIRUH FRQFOXGH
WKDW RZQHUVKLS VWDWXV KDV DQ HIIHFW RQ FRPSHWLWLRQ DQG WKHUHIRUH YDOXH FUHDWLRQ DQG
VR ORQJ DV JRYHUQPHQW ILUPV HQMR\ VXEVLG\ DQG SULRULW\ LQ WKH JRYHUQPHQW PDUNHW
WKHLUSURILWVJLYHDPLVOHDGLQJSLFWXUHRIFRPSDUDWLYHYDOXHFUHDWLRQ
*RYHUQPHQWUHJXODWLRQVDQGGHYHORSPHQWRIYDOXHFKDLQV Government policy has

always a bearing on every aspect of a firm’s activity. Government can determine the
type of firms that could get into any form of agreement, including creating (or not
creating) linkages and competition. It can introduce interventions to facilitate inter-
firm co-operation and networking or it can abstain itself from involving in these types
of interventions.
Empirically, we found that the regulations applying to the firms differ whether they are
government, transition or privatised. There are regulations that affect government and
transition firms, restricting them how to buy and sell as well as with whom to make
linkages. For instance government firms have strong inter-firm linkages with each other
because government regulations encourage this type of co-operation. On the other hand,
they have very weak inter-firm co-operation with the private firms. However, since there
is no government regulation applying to privatised firms restricting them on how to
establish inter-firm linkages, some privatised firms are observed to shift from one partner
to another depending on their preferences. An example of this is Asmara Sweater
Factory shifting from Keih Bahri Tannery to another supplier - Beatay Leather Factory.
We FRQFOXGH WKDW WKH PRUH UHJXODWLRQV DQG ODZV SURKLELWLQJ WKH GHYHORSPHQW RI YDOXH
FKDLQVWKHOHVVOLNHO\LWZLOOEHWKDWWKHILUPZLOOXVHDOWHUQDWLYHZKLFKFRXOGEHEHWWHU
YDOXH FKDLQ OLQNDJHV WR PDQDJH WUDQVDFWLRQ FRVWV RI ZRUNLQJ FDSLWDO OHYHOV DQG
RSHUDWLRQV
0DQDJHULDOHPSRZHUPHQWDQGYDOXHFUHDWLRQ The performance of firms depends

on management potential, degree of managerial empowerment and clarity of
objectives. The evidence on management potential and existence of clear policies and
objectives shows that the objectives are mostly vague in the privatised firms, and
contradictory with their lack of managerial empowerment in the government and
transition firms. Many of the general managers had little educational background and
practical experience in the area of managing business firms at an executive position
until they were assigned to the job of managing the firms. With regard to performance
evaluation, our study has indicated that some financial managers compute accounting
related performance measurements but they reported that they rarely use them for
managerial decision making. The basis for evaluating the operational efficiency in
government and transition firms is not related to value creation but to whether they
have applied the government rules properly. Almost all managers reported that they
do not apply customer satisfaction or quality based performance evaluation criteria.
Most of the firms do not evaluate their internal managerial decisions nor do they
evaluate their external linkages. :H WKHUHIRUH FRQFOXGH WKDW LQ DOO WKH ILUPV
PDQDJHPHQW SRWHQWLDO LV ZHDN WKDW WKHUH DUH QR FOHDU PDQDJHPHQW REMHFWLYHV DQG
WKDW WKH PDQDJHPHQW FXOWXUH GRHV QRW JLYH SURSHU HPSKDVLV WR YDOXH FUHDWLRQ
0RUHRYHU ZKLOH WKH PDQDJHUV RI WKH SULYDWLVHG ILUPV DUH IXOO\ HPSRZHUHG WKH
PDQDJHUV RI WKH JRYHUQPHQW DQG WUDQVLWLRQ ILUPV ODFN SURSHU PDQDJHULDO DXWKRULW\
DQG SRZHU WR HIILFLHQWO\ PDQDJH ERWK LQWHUQDO DQG H[WHUQDO RI ZRUNLQJ FDSLWDO OHYHOV
DQGRSHUDWLRQV .
&XOWXUDOIDFWRUV DQG LQWHUILUP FRRSHUDWLRQ: Culture can be an important driving
force behind the inter-firm communication and co-operation. Transactions are made
between parties, who contact, contract and control each other’s behaviour, not only on
the basis of business agreements but also on their cultural practices, believes, and
norms. With the government and transition firms, mainly it is the government
regulations and the trust that each will adhere to the regulations that influence the
inter-firm transactional relations. However, with the privatised firms, the main
influence in business dealing is the trust that they give to and receive from their suppliers
and customers. Our empirical findings show that these privatised firms rarely make any
written agreement with local suppliers and customers on the purchases and sales of
materials and products. Culturally, one general manager said that: ³:H(ULWUHDQVUHO\RQ
WUXVWDQG GR QRWHPSKDVLVHRQ OHJDO FRQWUDFWVDQG ZH KDYH QHYHU HQFRXQWHUHG PLVWUXVW
RU PLVFKLHI IURP DQ\ VXSSOLHU RU FXVWRPHU´As far as we know from our empirical
evidences, the firms have never had any history of bad debt and never have gone to the
court to enforce collection of debts from local customers. :HWKHUHIRUHFRQFOXGHWKDWWKH
Chapter 10 264
(ULWUHDQ FXOWXUH LV FRQGXFLYH HQYLURQPHQW IRU LQWHUILUP FRRSHUDWLRQ RQ WKH EDVLV RI
WUXVW
5HVHDUFKLPSOLFDWLRQV
We conclude our study by answering the last research question (3b), which states:
“WKDW DUH WKH FRQFHSWXDO DQG SROLF\ LPSOLFDWLRQV DV ZHOO DV OLPLWDWLRQV DQG IXWXUH
UHVHDUFK GLUHFWLRQ WKDW FDQ EH GUDZQ IURP WKH VWXG\´" We have studied the
conceptual aspects of managing the internal and external working capital levels and
operations. We have also described and explained working capital management
practices in the government, transition and privatised manufacturing firms in Eritrea.
We therefore conclude from our study that there are theoretical implications for our
conceptual framework (section 10.4.1) and policy implications (section 10.4.2) of
practical importance for the managers and the government. We also discus limitations
of the study (section 10.4.3), which give us directions for further research.
7KHLPSOLFDWLRQVRIWKHHPSLULFDOILQGLQJVIRUWKHFRQFHSWXDOIUDPHZRUN
The conceptual framework was designed on the basis of literature developed for
situations in the western world where we strongly assumed that the managers in
Eritrea could use the internal and external working capital management as exemplary
management approaches. Practically, they used very little of it because many factors
differ between the background under which the management approaches and therefore
the conceptual framework are developed and the practical background that the
managers in Eritrea find themselves. Hence because of the factors that prevail on the
ground, the Eritrean context influenced our empirical findings more than we expected
when we design the conceptual framework in chapter 5. These factors include, weak
managerial background, lack of financial institutions and markets as well as the firms’
historical background and strict legal requirements. 0DQDJHULDO EDFNJURXQG – very
few managers are academically and practically acquainted with the managerial
approaches of value creation and the modern management practice in the context of
developed world is still at its rudimentary stage in Eritrea. /DFNRIILQDQFLDOLQVWLWXWLRQ
DQGPDUNHWs – There are no financial institutions and markets that could facilitate the
value creation by managing working capital levels and operations. /HJDO DQG
KLVWRULFDOEDFNJURXQG – The management in government and transition firms is highly
influenced by government regulations and less attention is given to working capital

management for value creation. Moreover, the privatised firms are strongly influenced
by their historical background as government firms and still lack the experience in
managing private businesses.
Because of these reasons working capital management is not strongly underpinned by

the idea of value creation expected under conditions of developed western world. The
general theoretical implication of our empirical findings for the conceptual model is
therefore that the design of new conceptual framework for a case study in developing
countries should strongly consider the legal, historical, institutional and managerial
background in the countries under study. We believe a research framework can be
designed such that it focuses on these background contexts.
(a) Managerial empowerment – It is possible that further research is made with an

objective of studying the impact of managerial empowerment on the success of firms
to generate profit. This impact can be assessed in view of the operations management
(the left-hand side of our model) and financial management (the right hand side of our
model). Similarly, this conceptual model can be extended to study the effect of
managers’ academic and practical experience on the success of the firms in generating
profit.
(b) Legal context – future research framework could also focus on the effect of
subjecting managers to externally supervised regulations on both the effect of control
measures on the managers and in achieving the objectives of the control measures.
The effect of control measures on the managers may aim at whether the managers try
to follow or evade the rules and the ensuing effect on the firms’ success. The effect on
the achievement of the objectives of the control measures may concentrate on whether
control over the management helps to attain the stated objectives of the government
firms. This particularly may focus at the objectives such as minimising costs of the
products, minimise the costs of mischief, misappropriation or the decrease income lost
as a result of conflicting interests of the managers and the stated objectives of the
firms, increasing production volume. The hypothesis at this stage is that it may help
much.
(c) Historical context – It is possible to focus future research framed to assess the
extent of resistance of privatised firms to their new private business environment. It
could focus on comparing the managerial policies followed by the firms’ pre and post
privatisation period and study the impact on the firm’s profitability (value creation).
(d) Institutional context – The existence of efficient financial institutions like banks,
insurance, share markets is of paramount importance to firms to have access to
alternative opportunities to invest surplus working capital assets and financing by dis-
investing assets or borrowing from the financial institutions. Our findings show that
the firms in Eritrea are handicapped due to the absence of these opportunities.
However, detailed studies in a developing country and possible comparative study
with other developing countries could be made. The study could be framed with
particular emphasis on the specific problems faced and methods used (or they can use)
to alleviate the problems without waiting for the efficient (developed countries style)
financial institutions to emerge.
3ROLF\LPSOLFDWLRQV
This section contains the translation of our empirical results into practical implications
for decision-makers. It offers policy implications for both managers of the firms at the
micro level and the government at the macro level. The study results show that our
theoretical model can be used to study the intra and inter-firm management of
working capital levels and operations, which can be used to design internal and
external policies.
In the light of our conceptual background

0DQDJHULDO LPSOLFDWLRQV DW WKH ILUP OHYHO
and practical findings,the following points can be recommended at the firm level.
Chapter 10 266
First, since (in the absence of economic opportunity to deal with issues of strategic
importance) the managers believe the value created or lost by the firms is mainly
attributed to the efficiency of working capital management, they have to try to be as
efficient as possible at it. So they have to establish new policies and improve existing
policies and practices of their internal management of working capital levels and
operations. They should not only concentrate on the custody but also on the value
creation aspect of working capital management. Therefore, they have to identify
policies that can minimise the overall long-term cost of purchasing and selling
activities and at the same time minimise the carrying costs of the levels of cash,
inventories and receivables.
Specifically, the firms have to establish clear and practically operational policy for the
management of working capital levels of investment and financing as well as
operations of purchasing and sales. On working capital levels of investment, they
have to decrease the excessive investment in working capital assets in favour of long-
term investments, which have an impact on production capacity and long-term
profitability. They have to continuously evaluate the holding costs of working capital
levels and take corrective action to decrease the costs by expediting the turnovers of
inventory, receivables and cash. On working capital levels of financing, they have to
evaluate the costs of bank overdrafts to finance working capital investments. They
have to establish credit agreements with suppliers and use trade credit as an
alternative source of working capital financing. On the issue of working capital
operations of purchasing, they have to try to convince suppliers to co-operate in
providing credit with mutually beneficial terms. They should also establish
appropriate policies of contacting, contracting and controlling suppliers with an
objective of creating sustainable firm-suppler relationships and decreasing related
costs. On the management of working capital operations of selling, they have to
enhance sales using appropriate credit standards and establish policies of customer
contacts, contracts and controls measures that minimise the costs of inter-firm
transactional relation. The firms have to establish mechanisms to evaluate the
performance of their working capital decisions. Particularly, they have to
continuously follow-up their financial performance both internally using budgets and
accounting ratios and externally by comparing inter-firm benchmarks on financial
performance as well as using measures of supplier and customer satisfaction.
The second study implication for managers is to identify and then to initiate new
inter-firm relationships and strengthen existing ones. There is a need for inter-firm co-
operation in managing both levels of investment and financing as well as operations
of purchasing and selling. Firms could try to have co-operation with commitment
based on negotiation, co-ordination and mutual adjustment instead of - as the firms in
Eritrea are doing - by power and by enforcing government rules and contracts. Inter-
firm co-operation can better be governed by relationship development than by strict
and formal mechanisms of control. Thus firms may have to rely more on social
interaction and developing relationships and on maximising common performance
rather than to emphasise in increasing only their individual performance. A good
relationship can enhance inter-dependence and increase value of co-operation because
it decreases opportunistic behaviour and inter-firm transaction costs.
Some approaches may be recommended here. First, develop intentional trust by

means of habituation via frequent inter-firm contacts. This may increase mutual
dependence, customer commitment and supplier confidence. Second, create bondage

in a relationship using common investments, which increases dependence of both
supplier and customer to each other. Third, develop symmetric (in terms of power,
information and decision-making) inter-firm co-operation since it has a positive
impact in motivating co-operation and teamwork because the perception of negative
opportunism may be low. Otherwise trust cannot be build and inter-firm relationships
will be subject to negative reciprocal behaviour. The transaction partners may take
actions with only short-term objectives. Fourth, inter-firm transaction exchanges need
not be of equal value in the short-term because in a mutual co-operation inter-firm
transaction exchanges can be balanced out in the long-term.
In view of the increasing importance of inter-

,PSOLFDWLRQV DW WKH JRYHUQPHQW OHYHO
firm co-operation, government can play a significant role in creating and improving
institutions that reduce transaction costs (North 1990). In the light of this, the
following points can be implied at the government level.
First, the main reason that the government and transition firms give for not having
proper policies and practices of internal working capital management is due to the
restrictive government regulations. Government can remove its regulations on the
government firms and enable their managers to do business with full authority and
responsibility, else privatise the firms. Second, with regard to the external working
capital management, government can be instrumental in stimulating inter-firm
contacts and facilitate opportunities for inter-firm co-operation and networks.
Government institutions like the University of Asmara, The Chamber of Commerce
and other support organisations can play a more active role in enhancing information
flows and in building alignments among the business firms as well as between the
private and the public sectors. Third, the government can remove the protection it
renders to the government firms so long as they are competing with the private
business sector. Fourth, government can create a conducive environment for
competition through appropriate investment policies, liberalising the market and
establishing efficient financial institutions. Sixth, in co-operation with countries in the
region, it can also adopt a policy of finding ways to enhance investment opportunities
and financing sources through common financial system and regional stock market
similar to the BRVM in West Africa.
/LPLWDWLRQVRIWKHVWXG\DQGIXWXUHUHVHDUFKGLUHFWLRQV
Though this study addresses the internal and external management of working capital
and identifies value creation as revealed by performance measurements, its findings
should be evaluated in light of the following limitations.
)LUVWwe have used a case study with a small sample of firms. This shortens the time
needed to collect data and minimises the cost of the study but assumes that the
selected firms are representative of the government, transition and privatised
manufacturing firms. Future case research can be preceded with a survey in order to
get a more complete picture of the Eritrean situation.
6HFRQG, we selected the central firms’ local supplier and customer linkages based on
the frequency of the inter-firm transactional interaction as per the opinion of the
general managers of the firms. A more complete picture could be drawn if the firms’
Chapter 10 268
record on inter-firm transaction could be used to identify (and may be more

representative) transaction partners and research could be conducted to find the
opinion of partners both inside and outside the country.
7KLUG, in our study of inter-firm co-operation, we have taken the opinion of only one
supplier and one customer for each central firm. For a thorough study of inter-firm co-
operation the responses of more suppliers and customers will have to be researched.
)RXUWK , we have studied the cases of government, transition and privatised

manufacturing firms. However, we believe that it is possible to extend the case to, (a)
the service (or non-manufacturing) sector, (b) the purely private firms and (c) the
experience of the privatised firms post privatisation development, that is, if the
privatised firms have adapted to the private business management culture.
)LIWK, our case research is limited to the Eritrean situation. Because of this limitation it
is not possible to extend our findings and conclusions to situations in other developing
countries. Similar research could be made in other countries in order to have the
possibility of comparison.
6L[WK, in the transition and privatised firms, the speed and method of privatisation may
also affect their internal and external working capital management. Hence it may be
given attention for further research.
6HYHQWK, in view of our empirical findings on the success of the government firms in
creating closer inter-government firm co-operation, there are two basic considerations
for further research. (a) It may not be true that government firms are less desirable for
operational efficiency compared to private firms. (b) Whether restructuring of
government firms and market liberalisation or outright privatisation is the best answer
in all situations for competitive efficiency and profitability may not be taken for
granted. This can therefore be studied in both developed and developing countries.
%,%/,2*5$3+<
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$33(1',&(6
$33(1',;WR&KDSWHU&RQFHSWXDO)UDPHZRUNDQG0HWKRGRORJ\
$SSHQGL[0LVVLQJGDWDVXPPDU\
Two Government firms Five Transition firms Three privatized firms

Total Missing Total Missing Total Missing
2YHUDOOZRUNLQJFDSLWDO 82 0 205 14 123 9
PDQDJHPHQW
,QWHUQDOZRUNLQJFDSLWDO
PDQDJHPHQW
Investments’ management
Cash 50 0 125 14 75 1
Materials inventory 34 3 85 7 51 4
Finished goods inventory 38 10 95 3 57 2
Receivables 60 0 150 17 90 11
Finances’ management 26 1 65 0 39 5
Operations’ management
Purchases 70 3 175 12 105 4
Sales 82 11 205 28 123 7
Performance 26 5 65 3 39 6
([WHUQDOZRUNLQJFDSLWDO
PDQDJHPHQW
Firm-supplier linkages
Firm responses 52 7 130 12 78 9
Supplier responses 60 5 150 0 90 8
Firm-customer linkages
Firm responses 60 2 150 31 90 5
Customer responses 38 0 190 2 114 0
Appendices 286
$33(1',;WR&KDSWHU*RYHUQPHQWILUPV
$2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQW
KBFP BC
$3ROLF\RIZRUNLQJFDSLWDOPDQDJHPHQW –
responses of financial managers
Increase sales 5 4
Decrease costs 5 5
Remain liquid 1 2
Generate profit 1 1
%&RQVWUDLQWVLQDFKLHYLQJILUPREMHFWLYHV±
UHVSRQVHVRIJHQHUDOPDQDJHUV
Working capital investments 1 1

Working capital financing 1 4
Fixed capital investment 5 4
Fixed capital financing - 1
Production capacity 5 1
Product demand 1 1
Markets 1 1
Lack of skilled labour 5 1
&)DFWRUVGHWHUPLQLQJZRUNLQJFDSLWDOOHYHOV±
UHVSRQVHVRIILQDQFLDOPDQDJHUV
Seasonality of sales 1 5
Sales growth 5 5
Credit policy 2 1
Availability of credit 2 1
Price levels of inputs 5 5
Operating efficiency 4 4
'7KHUROHRIZRUNLQJFDSLWDOPDQDJHPHQW±
',QLQFUHDVLQJVDOHV
Cash management 4 5
Receivable management 5 4
Inventory management 4 5
Sales of finished goods management 5 5
Purchase of materials management 5 5
Trade payable management 4 1
Bank loans management 1 1
Liquidity management 2 1
',QGHFUHDVLQJFRVWV
Cash management 4 5
Receivable management 1 1
Inventory management 1 5
Sales of finished goods management 1 5
Purchase of materials management 5 5
Trade payable management 1 1
Bank loans management 1 1
Liquidity management 1 1
6RXUFH Based on data collected from firm managers using questionnaires.
/HJHQG The scaled numbers indicate how positive or negative the managers responses is:
(5) for very positive, 4) for positive, (3) for neutral, (2) for negative and (1) for very negative.
(-) Represents that the manager did not give an opinion. BC - Barka Canneries, KBFP – Keih Bahri Food Products.
Appendices 287
$,QWHUQDOZRUNLQJFDSLWDOPDQDJHPHQW
$0DQDJLQJZRUNLQJFDSLWDOLQYHVWPHQW
$&DVKPDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
KBFP BC
$0RWLYHVRIKROGLQJFDVKOHYHOV
Transaction 5 5
Speculative 3 1
Precautionary 1 1
Bank compensating 1 1
%3XUSRVHIRUFDVKEXGJHWIRUHFDVWV
Requirement 5 5
Control liquidity 1 1
Control cash 5 5
Plan short-term needs 4 4
Plan long-term needs 1 1
&)RUHFDVWLQJDSSURDFKHV
Past experience 5 5
Forecasted sales 4 1
Management opinion 4 4
Market research 1 1
'&DVKIORZDSSURDFKHV
Receipts and disbursements 5 5

Adjusted net income 1 1
(&DVKIORZSXUSRVH
Requirement 5 1
Improve cash forecast 5 5
Cash control 5 5
)&DVKFRQWURODSSURDFKHV
)3D\PHQW
Voucher system 5 5
Sequentially numbered checks 5 5
Bank reconciliation 5 5
Petty cash system 5 5
)&ROOHFWLRQ
Customers pay at the bank account 2 5

Collections deposited daily 5 5
Separate sequential operations 5 5
/HJHQG The numbers in parenthesis indicate how positive or negative the managers responses is:
(5) for very positive, (4) for positive, (3) for neutral, (2) for negative and (1) for very negative.
Appendices 288
$,QYHQWRU\PDQDJHPHQW
$0DWHULDOVLQYHQWRU\PDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
KBFP BC
$3XUSRVHRILQYHQWRU\PDQDJHPHQW
Reduce holding costs 4 5

Reduce ordering costs 4 5
Safeguard against shortages 4 5
Keep production running 5 5
%&RVWVRIKROGLQJLQYHQWRU\RIPDWHULDOV
Power (heat and light for storage space) 2 1

Opportunity cost of capital invested 2 3
Deterioration 3 2
Insurance 4 4
Property taxes 3 2
Handling 4 5
Security 3 2
Clerical costs for record keeping 4 4
&6LJQLILFDQFHRIKROGLQJFRVWRIPDWHULDOV 4 4
'0DQDJLQJFRVWVRIPDWHULDOVLQYHQWRU\
Minimise inventory level 4 5

Buy just in time for production 4 4
Use economic order 2 4
(&RVWLQJPHWKRGRIPDWHULDOVLQYHQWRU\
First-in-first-out 1 1
Last-in-first-out 1 1
Average costing 5 5
)9DOXDWLRQPHWKRGRIPDWHULDOVLQYHQWRU\
Average cost 5 5
Market or replacement cost 1 1
Lower of average cost or market 1 1
*%DVHVRIVHOHFWLYHFRQWURORIPDWHULDOVLQYHQWRU\
Cost 5 4
Usage rate 4 1
Scarcity in the market 2 2
Criticality in case of shortage 4 5
Appendices 289
$)LQLVKHGJRRGVLQYHQWRU\PDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
KBFP BC
$3XUSRVHRIPDQDJLQJLQYHQWRU\
Satisfy customer demand 1 5

Take advantage of economies of scale 1 1
Reduce holding costs 4 1
Keep safety stock 1 5
Meet seasonal high demand 1 5
%7KHFRVWVRIKROGLQJ
Power (heat and light for storage space) 3 2

Opportunity cost of capital 2 4
Deterioration 3 1
Insurance 4 5
Property taxes 2 1
Handling 3 4
Security 3 2
Clerical costs 2 4
&6LJQLILFDQFHRIKROGLQJFRVWRILQYHQWRU\ 5 5
'0DQDJLQJKROGLQJFRVWV
Hold only the minimum 5 4

Apply “just in time” 1 4
Establish long-term customer relations 1 1
Making customers pay the costs 2 1
(&RVWLQJPHWKRG
First-in-first-out 1 1
Last-in-first-out 1 1
Average costing 5 5
)9DOXDWLRQPHWKRG
Average cost 5 5
Market or replacement cost 1 1
Lower of average cost or market 1 1
*%DVHVRIVHOHFWLYHLQYHQWRU\FRQWURO
Average cost 2 5
Usage rate 4 1
Criticality in case of shortage 4 1
Appendices 290
$$FFRXQWVUHFHLYDEOHPDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
KBFP BC
$5HDVRQVIRUQRWVHOOLQJRQFUHGLW
Customers do not ask for credit 2 1

The firm does not want to extend credit 4 1
Lack of information on credit applicants 2 1
High uncertainty of pay back 4 1
%6RXUFHRILQIRUPDWLRQIRUVFUHHQLQJFUHGLWDSSOLFDQWV
Prior experience 1 1
Financial statements 1 1
Visits to customer 1 1
Personal contact with the applicant’s creditors 1 1
Customer’s payment history 1 1
&&UHGLWWHUPV
Open account no discount 1 1

Open account with discount 1 1
Promissory note 1 1
Seasonal dating 1 1
'6WDQGDUGVWRVFUHHQFUHGLWDSSOLFDQWV
The 5 C's - capital, character, collateral, capacity and conditions 1 1

One time sale approach 1 1
Repeat sale approach 1 1
Marginal accounts analysis 1 1
(0HDVXUHVWDNHQWRFROOHFWRYHUGXHUHFHLYDEOHV
Send reminder 1 1
Telephone call 1 1
Personal visit 1 1
Collection agent (employee) 1 1
Extend credit period 1 1
Take legal action 1 1
)5LVNRIXQFROOHFWDEOHV 1 1
*0RQLWRULQJFUHGLWFXVWRPHU
Using draft letters 1 1

Using letters of credit 1 1
Customers sign letters of credit 1 1
+5HGXFLQJOHYHORIUHFHLYDEOHV
Make customers pay outstanding debts 1 1

Stop selling on credit 1 1
Revise credit policy 1 1
Revise credit standards 1 1
/HJHQG The numbers in parenthesis indicate how positive or negative the managers responses is: (5) for very positive,
(4) for positive, (3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion.
BC - Barka Canneries, KBFP – Keih Bahri Food Products.
Appendices 291
$0DQDJLQJVKRUWWHUPILQDQFLQJUHVSRQVHVRIILQDQFLDOPDQDJHUV
KBFP BC
$6RXUFHVRIVKRUWWHUPILQDQFLQJ
Short-term debt - bank loans 1 1

Long-term debt 1 1
Retained earnings/Equity capital 5 5
Overdraft 1 1
Trade creditors 5 5
Secured borrowing 1 1
Accruals 1 1
%&RVWVRIILQDQFLQJ
Interest expenses 5 1
Bank service charges 1 1
&)DFWRUVLQIOXHQFLQJOHYHOVRIILQDQFLQJ
Seasonality of sales 1 1
Sales growth 5 1
Credit policy 2 1
Availability of credit 2 1
Price levels of inputs 5 1
Operating efficiency 4 1
Others- government subsidy 5 -
Appendices 292
$0DQDJLQJZRUNLQJFDSLWDORSHUDWLRQV
$3XUFKDVHPDQDJHPHQWUHVSRQVHVRIFRPPHUFLDOPDQDJHUV
KBFP BC
$3XUSRVHRISXUFKDVHSROLF\
Take advantage of quantity discounts 1 5

Take advantage of cash discounts 1 4
Decrease inventory holding costs 1 4
Decrease purchase ordering costs 4 2
Meet seasonal production requirements 1 5
%3XUSRVHRISXUFKDVHIRUHFDVW
Meet production demands 5 5

Determine inventory usage during lead-time 1 4
Know quantity on hand and on order 5 4
Get safety stock 5 4
&%DVHVXVHGWRIRUHFDVWSXUFKDVHV
Past experience 5 5
Forecasted sales volume - 4
Purchasing staff opinion - 4
'7HUPVRISXUFKDVLQJ
Cash 5 5
Credit - 1
(5HDVRQVIRUQRWSXUFKDVLQJRQFUHGLW
Suppliers do not provide credit 1 5

Firm does not have credit policy 5 2
Lack information on credit suppliers 1 1
No tradition of credit transaction 1 1
)0DQDJLQJSXUFKDVLQJFRVWVRI
)&RQWDFW
Choosing the cheapest channel 5 5

Employing purchasing agents 1 4
Managing by trust 5 2
)&RQWUDFW
Routine contract agreements 5 5

Employing lawyers 1 1
Terms known in advance 5 5
)&RQWURO
Routine control agreements 5 5

*5HOHYDQFHRISXUFKDVLQJFRVWVRI
Contacting suppliers 2 5
Contract with suppliers 2 5
Controlling suppliers 2 5
Appendices 293
$6DOHVPDQDJHPHQWUHVSRQVHVRIFRPPHUFLDOPDQDJHUV
KBFP BC
$6DOHVWHUPV
Cash 5 5
Credit 4 1
%&UHGLWVDOHVVWDQGDUGV
5 C’s 1 1
One time 1 1
Repeat sales 1 1
&3XUSRVHRIVDOHVSROLF\
Satisfy customer demands 1 5

Decrease inventory holding costs 1 -
Decrease inventory ordering costs 1 2
Meet seasonal sales requirements 1 4
Expand market 1 5
'3XUSRVHRIVDOHVIRUHFDVWLQJ
Forecast future demand 1 5

Forecast inventory usage 1 3
Forecast quantity on hand and on order - 5
Forecast safety stock needs 4 4
(%DVHVXVHGWRIRUHFDVWVDOHV
Past experience 4 4
Statistical forecast 1 4
Sales staff opinion 1 3
Others - production capacity 5 -
)0DQDJLQJVHOOLQJFRVWVRI
)&RQWDFW
Choosing the cheapest channel 5 5

Employing sales agents 1 2
Developing long-lasting relationship 5 2
)&RQWUDFW
Routine contract agreements 5 5

)&RQWURO
Routine control agreements 5 5

*5HOHYDQFHRIFRVWVRIFXVWRPHU
Contact - 1 1
Contract 1 1
Control 1 1
+&XVWRPHUVEDFNLQJGRZQ
Possibility 1 1
Difficulty in finding another customer - 2
Extent of loss if customers back-down 1 4
,0DQDJLQJLIFXVWRPHUEDFNVGRZQ
Negotiation 1 2
Court of law 1 1
Stop dealings until bills are settled 1 2
/HJHQG The scaled numbers indicate how positive or negative the managers responses is:
Appendices 294
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KBFP BC
$6SHFLILFFULWHULDDSSOLHG
Comparing past with the present performance 5 5

Comparing actual with the expected performance 5 4
Comparing inter-firm benchmarks 5 5
%&XVWRPHUVDWLVIDFWLRQEDVHGSHUIRUPDQFHHYDOXDWLRQ
%&RVWPLQLPLVDWLRQ
Charging lower prices 4 4

Allowing quantity discounts 1 1
Allowing cash discounts 1 1
%4XDOLW\RISURGXFWV
Decrease defect rates 4 1

Higher customer retention rates 1 1
Higher customer’s perceived value of goods 4 1
%&RPPXQLFDWLRQ
Faster responses time 4 5

Faster delivery time 4 5
&$FFRXQWLQJEDVHGSHUIRUPDQFHHYDOXDWLRQ
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Current ratio 4 5
Quick ratio 4 5
&$FWLYLW\
Inventory turnover 4 5
Receivables turnover 4 5
Overall working capital ratio 4 1
&$VVHWVWUXFWXUH
Cash to working capital 1 1

Inventory to working capital 1 1
Receivables to working capital 1 1
Working capital to total assets 4 1
&6KRUWWHUPGHEWOHYHUDJH
Current debt to total debt 4 1

Total debt to total equity 4 1
&3URILWDELOLW\ 1
Gross profit margin 4 1
Net profit margin 4 1
Return on working capital investment 4 1
Return on total assets investment 4 1
''HWHUPLQDQWVRISHUIRUPDQFH
Fixed asset investment 1 1

Fixed asset financing 1 1
Working capital investment 1 1
Short-term financing 1 1
Availability of skilled labour 4 5
$)LQDQFLDOSHUIRUPDQFH.HLK%DKUL)RRG3URGXFWV
$0HDVXUHPHQWRISHUIRUPDQFH 1994 1995 1996 1997 1998 1999 2000 Average

$$VVHWVWUXFWXUHDQG67GHEWOHYHUDJH
Current asset to total assets 88% 91% 94% 94% 94% 92% 95% 93%
Short-term debt to total assets 62% 77% 82% 72% 80% 67% 74% 73%
$/LTXLGLW\
Current ratio 1.4 1.2 1.1 1.3 1.2 1.4 1.3 1.3
Quick ratio 1.2 0.4 0.6 1.3 1.0 1.4 1.2 1.0
$$FWLYLW\
Inventory turnover 6.8 2.2 0.8 1.4 2.9 3.2 6.7 3.4
Account Receivable turnover 11.4 9.0 6.0 2.7 2.4 2.6 2.1 5.2
Working capital turnover 1.1 0.9 1.6 1.6 1.2 1.8 1.3 1.4
$3URILWDELOLW\
Gross profit margin 11% 8% 6% 4% 5% 5% 3% 6%

Net profit margin 6% 5% 3% 2% .8% 1% 0% 3%
Return on total assets 5% 4% 5% 3% 1% 0% 2% 3%
%:&±,QYHVWPHQWFRPSRVLWLRQ
Stocks (Inventories) 14% 65% 47% 4% 18% 2% 8% 22%

Debtors (Accounts receivable) 19% 6% 49% 67% 51% 65% 69% 47%
Cash at Bank 67% 30% 4% 29% 31% 33% 23% 31%
&67ILQDQFLQJFRPSRVLWLRQ
Trade creditors 91% 86% 96% 91% 92% 96% 92%

Others 9% 14% 4% 9% 8% 4% 8%
6RXUFH computed from annual accounts received on request by the courtesy of the firms
/HJHQG BC - Barka Canneries, KBFP – Keih Bahri Food Products. Current ratio = current assets/current liabilities. Quick ratio = (current assets-inventory)/current liabilities.
Inventory turnover = cost of goods sold/average inventory. Accounts receivable (A/R) turnover = total sales/average receivables. Working capital turnover = sales/current assets.
Current assets to total assets = current asset /total assets. Short-term debt to total assets = Short-term debt/total assets. Gross profit margin = gross profit/sales.
Net profit margin = net profit (after tax)/sales. Return on total assets = net profit (after tax)/total assets.
$)LQDQFLDO3HUIRUPDQFHDYHUDJH±±*RYHUQPHQWILUPV
$0HDVXUHPHQWRISHUIRUPDQFH KBFP BC Average

$$VVHWVWUXFWXUHDQG67'HEWOHYHUDJH
Current asset to total assets 93% 92% 92%

Short-term debt to total assets 73% 33% 53%
$/LTXLGLW\
Current ratio 1.3 4.4 2.8

Quick ratio 1.0 2.6 1.8
$$FWLYLW\
Inventory (stock) turnover 3.4 1.3 2.4

Account Receivable (Debtors) turnover 5.2 5.3 5.2
Working capital turnover 1.4 0.9 1.1
$3URILWDELOLW\
Gross profit margin 6% 15% 10%

Net profit margin 3% -4% 0%
Return on total assets 3% 10% 6%
%:&,QYHVWPHQWFRPSRVLWLRQ
Stocks 22% 41% 32%

Debtors 47% 19% 33%
Cash at Bank 31% 40% 35%
Trade creditors 92% 37% 65%

Others 8% 73% 40%
/HJHQG BC - Barka Canneries, KBFP – Keih Bahri Food Products. Current ratio = current assets/current liabilities.
Quick ratio = (current assets-inventory)/current liabilities. Inventory turnover = cost of goods sold/average inventory.
Accounts receivable (A/R) turnover = total sales/average receivables. Working capital turnover = sales/current assets.
Current assets to total assets = current asset /total assets. Short-term debt to total assets = Short-term debt/total assets.
Gross profit margin = gross profit/sales. Net profit margin = net profit (after tax)/sales.
Return on total assets = net profit (after tax)/total assets.
Appendices 297
$([WHUQDOZRUNLQJFDSLWDOPDQDJHPHQW0DQDJLQJYDOXHFKDLQOLQNDJHV
$0DQDJLQJILUPVXSSOLHUOLQNDJHV5HVSRQVHVRIWKHFHQWUDOILUPV
KBFP BC
$FRRSHUDWLRQRQSULPDU\DFWLYLWLHVUHVSRQVHVRIJHQHUDO
PDQDJHUV
$,QERXQGDFWLYLWLHV
Shipment 5 5
Storing 5 5
Distributing to production 1 5
Inventory control 1 5
$3URGXFWLRQRSHUDWLRQV
Machining 1 3
Packaging 1
Assembling 1 3
Equipment maintenance 1 3
Product testing 1 4
Facility operations 1 5
$0DUNHWLQJDQGVDOHV
Advertising 1 1
Promotion 1 1
Sales force 1 1
Channel selection 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1 1
Repair 1 4
Customer training 1 1
Parts supply 1 4
Product adjustment 1 4
%&RRSHUDWLRQRQSXUFKDVHVDQGLQYHQWRU\PDQDJHPHQW
Quality and quantity of materials 5 5

Terms of transportation 5 5
Time ( just on time basis) 4 5
&%HQHILWVRIILUPVXSSOLHUFRRSHUDWLRQUHVSRQVHVRI
FRPPHUFLDOPDQDJHUV
Decrease the time needed to purchase materials 5 5

Decrease cost ordering materials 5 4
Minimising the costs of carrying inventories 5 5
Create trust of your suppliers 5 5
'5HDVRQVIRUQRQFRRUGLQDWLRQUHVSRQVHVRI
FRPPHUFLDOPDQDJHUV
You don have a policy 1 1

Suppliers do not co-operate 1 1
You do not see the benefits 1 1
Appendices 298
$0DQDJLQJILUPFXVWRPHUOLQNDJHV5HVSRQVHVRIWKHFHQWUDOILUPV
KBFP BC
$FRRSHUDWLRQRQSULPDU\DFWLYLWLHVUHVSRQVHVRIJHQHUDOPDQDJHUV
Machining 1 1
Packaging 1 1
Assembly 1 1
Product testing 1 4
$2XWERXQGDFWLYLWLHV
Finished goods warehousing 5 5

Materials handling 1 1
Delivery vehicle operation 5 5
Order processing 5 4
$0DUNHWLQJDQGVDOHV
Advertising 1 1
Promotion 1 1
Sales force 1 1
Sale/purchase channel selection 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1 1
Repair 1 1
Parts supply 1 1
%&RRSHUDWLRQRQVDOHVDQGLQYHQWRU\PDQDJHPHQWUHVSRQVHVRI
ILQDQFLDOPDQDJHUV
Quality and quantity of materials to be purchased; 5 5

Terms of transportation of materials to be purchased 5 5
Time (on just on time basis); 4 5
&%HQHILWVRIILUPFXVWRPHUFRRSHUDWLRQUHVSRQVHVRIFRPPHUFLDO
PDQDJHUV
Minimising the cost of ordering and transportation 4 4

Minimising the costs of carrying inventories 5 4
Increasing sales 4 5
'5HDVRQVIRUQRQFRRSHUDWLRQUHVSRQVHVRIFRPPHUFLDOPDQDJHUV
Firm does not have policy 5 5

Customers do not co-operate 1 1
Firm does not see the benefits 1 2
(&XVWRPHUDVVHVVPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
Return any product with inferior quality 4 5

Pay only if the products are as per their expectation 1 1
Making strict quality control at the production floor 4 5
Making periodic assessment of customers opinions 3 5
/HJHQG The numbers in parenthesis indicate how positive or negative the managers responses is: (5) for very positive, (4) for
positive, (3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion. BC -
Barka Canneries, KBFP – Keih Bahri Food Products.
Appendices 299
$0DQDJLQJILUPVXSSOLHUOLQNDJHV5HVSRQVHVRIVXSSOLHUV
Eritrean Gejeret Carton

Grain Board Factory
$FRRSHUDWLRQRQSULPDU\DFWLYLWLHV
$3URGXFWLRQ2SHUDWLRQ
Machining 1 1
Packaging 1 1
Assembly 1 1
Product testing 1 1
$2XWERXQGDFWLYLWLHV

$0DUNHWLQJDQGVDOHV
Advertising 1 4
Promotion 1 1
Sales force 1 4
$$IWHUVDOHVVHUYLFHV
Installation 1 1
Repair 1 1
Parts supply 1 1
%&RRSHUDWLRQRQVDOHVDQGLQYHQWRU\PDQDJHPHQW
Exchanging skilled staff 1 1

Credit transaction without discounts 5 1
Credit transaction with discounts 1 1
Providing goods when just needed 5 5
&%HQHILWVRIFRRSHUDWLRQ
Decrease cost of selling goods 5 4

Decrease the time needed to sell goods 5 5
Decrease the carrying cost of finished goods inventory 4 1
Create trust of your customers 1 5
'5HDVRQVIRUQRQFRRSHUDWLRQ
Do not have the specific policy of co-operation 1 1

Central firm does not co-operate 1 5
Do not see the benefits 1 1
(6XSSOLHUUDWLQJRIILUPHIILFLHQF\RQ
Marketing approach 4 4
Purchase order processing 5 5
Bilateral communication 4 5
Explanation to inquiries 5 5
Courtesy 4 5
Using supplier services - -
Payment habits 5 5
positive, (3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion. ASF –
Asmara Sweater Factory, ESSF – Eritrea Steel Sheets Factory, AMF –Asmara Milk Factory. Eritrean Grain Board is supplier of
Keih Bahri Food Products and Gejeret Carton Factory is supplier of Barka Canneries.
Appendices 300
$0DQDJLQJILUPFXVWRPHUOLQNDJHV5HVSRQVHVRIFXVWRPHU
$&RRSHUDWLRQRQSULPDU\DFWLYLWLHV Asmara Pastry

$,QERXQGDFWLYLWLHV
Order processing 2
Receiving 1
Storing 1
Distributing to production 1
Inventory control 1
Materials handling 1
Delivery vehicle operation 1
$3URGXFWLRQRSHUDWLRQ
Machining 1
Packaging 1
Assembly 1
Equipment maintenance 1
Product testing 1
Facility operations 1
$0DUNHWLQJDQGVDOHV
Advertising 1
Promotion 1
Sales force 1
Sale/purchase channel selection 1
$$IWHUVDOHVVHUYLFHV
Installation 1
Repair 1
Supplier training 1
Parts supply 1
Product adjustment
Exchanging skilled staff 1

Credit transaction without discounts 1
Credit transaction with discounts 1
Providing goods when just needed 1
Decrease cost of purchasing 1

Decrease the time needed to purchase 1
Decrease the carrying cost of inventory 1
Create trust of your supplier 1
Do not have the specific policy of co-operation 1

Central firm does not co-operate 5
Do not see the benefits 1
(&XVWRPHUUDWLQJRIILUPHIILFLHQF\RQ
Marketing approach 2
Sales processing 2
Product quality 4
Cost of products 5
Delivery 3
Bilateral communication 5
Impartiality with other buyers 5
Explanation to your inquiries 5
Knowledgeability of customers 5
Using customer services 1
Cash collection habits 5
/HJHQG The scaled numbers indicate how positive or negative the managers responses is: (5) for very positive,
Appendices 301
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ATF LSF SHHF DSF KBT

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Increase sales 1 4 3 5 -
Decrease costs 4 5 5 5 4
Remain liquid 5 2 5 5 4
Generate profit 1 4 5 4 4
Working capital investments 5 4 - 1 1

Short-term financing 4 4 - 1 1
Fixed capital investments 5 4 - 1 5
Fixed capital financing 5 4 - 1 1
Production capacity 4 5 - 1 4
Product demand 2 4 - 1 1
Markets 3 4 - 1 1
Lack of skilled labour 5 5 - 1 4
&)DFWRUVGHWHUPLQLQJ:RUNLQJ&DSLWDOOHYHOV
±UHVSRQVHVRIILQDQFLDOPDQDJHUV
Seasonality of sales 3 5 4 5 4
Sales growth 2 3 1 4 4
Credit policy 2 4 1 2 3
Availability of credit 5 4 1 2 3
Price levels of inputs 4 3 1 2 4
Operating efficiency 4 3 1 5 2
'5ROHRI:RUNLQJ&DSLWDO0DQDJHPHQW±
',QLQFUHDVLQJVDOHV
Cash management - 5 1 2 4
Receivable management - 4 4 2 4
Inventory management - 4 1 5 4
Sales of finished goods management 4 4 4 5 4
Purchase of materials management 4 5 5 2 4
Trade payable management 3 3 1 2 4
Bank loans management 2 4 1 2 3
Liquidity management - 3 1 5 3
',QGHFUHDVLQJFRVWV
Cash management 2 5 5 5 4
Receivable management 4 4 2 2 3
Inventory management 2 4 5 2 3
Sales of finished goods management 3 4 5 2 3
Purchase of materials management 2 4 5 - 3
Trade payable management 2 3 2 2 3
Bank loans management - 3 5 2 3
Liquidity management 5 3 2 4 3
/HJHQG The scaled numbers indicate how positive or negative the managers responses is: (5) for very positive, (4) for positive,
(3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion. ATF – Asmara
Textile Factory, LSF – Lalmba Sack Factory, SHHF – Sembel House Hold Factory, DSF – Dahlak Shoe Factory, KBT – Keih
Bahri Tannery.
Appendices 302

Transaction 5 5 5 5 5
Speculative 3 2 - 2 1
Precautionary 1 - - 1 1
Bank compensating 1 2 - 1 1
Requirement 4 3 - 5 4
Control liquidity 4 3 - 5 1
Control cash 2 3 - 4 4
Plan short-term needs 4 3 - 5 3
Plan long-term needs 1 1 - 1 1
Past experience 5 5 - 5 2
Forecasted sales 4 - - 4 2
Management opinion 2 3 - 5 2
Market research 1 1 1 2 2
'&DVKIORZDSSURDFKHV
Receipts and disbursements 5 5 5 5 4

Adjusted net income 1 3 1 1 1
(&DVKIORZSXUSRVH
Requirement 5 3 5 5 4
Improve cash forecast 4 5 - 5 1
Cash control 1 4 - 5 4
)3D\PHQW
Voucher system 5 5 5 5 4
Sequentially numbered checks 4 5 5 5 4
Bank reconciliation 5 5 5 5 4
Petty cash system 5 5 5 5 4
)&ROOHFWLRQ
Customers pay at the bank account 5 3 5 5 1

Collections deposited daily 4 5 5 5 5
Separate sequential operations 5 2 5 5 4
Bahri Tannery.
Appendices 303

Reduce holding costs 2 5 5 5 4

Reduce ordering costs 2 5 4 2 4
Safeguard against shortages 5 2 5 5 4
Keep production running 5 3 5 5 -
Power 2 4 2 5 2
Opportunity cost of capital invested 5 4 5 2 2
Deterioration 4 5 1 5 4
Insurance 2 3 2 1 2
Property taxes - 3 1 4 2
Handling 1 2 4 4 2
Security 1 1 - 5 2
Clerical costs 1 1 5 - 2
&6LJQLILFDQFHRIKROGLQJFRVWRIPDWHULDOV 2 4 3 2 2
Minimise inventory level 5 5 4 5 4

Buy just on time for production 1 2 1 4 4
Use economic order 1 3 1 1 4
First-in-first-out - 1 1 1 1
Last-in-first-out - 1 1 1 1
Average cost 5 5 5 5 5
Market or replacement cost 1 1 1 1 1
Lower of average cost or market 1 1 1 1 1
*%DVHVRIVHOHFWLYHFRQWURORILQYHQWRU\
Cost - 5 1 2 4
Usage rate - 4 1 5 1
Scarcity in the market - 3 4 5 1
Criticality in case of shortage - 4 5 4 1
Bahri Tannery.
Appendices 304

Satisfy customer demand 5 1 5 4 1

Take advantage of economies of scale 4 2 5 5 1
Reduce holding costs 1 3 1 2 1
Keep safety stock 1 5 4 2 1
Meet seasonal high demand 4 4 1 1 1
%7KHFRVWVRIKROGLQJ
Power (heat and light for storage space) 1 2 2 2 3

Opportunity cost of capital invested 5 3 3 2 3
Deterioration 3 3 1 2 3
Insurance 1 2 4 4 3
Property taxes 1 2 1 1 2
Handling 1 2 1 4 1
Security 1 2 1 - 1
Clerical costs of record keeping 1 2 1 4 1
&6LJQLILFDQFHRIKROGLQJFRVWRILQYHQWRU\ 2 4 2 2 2
Hold only the minimum 5 2 5 4 1

Apply “just in time” 1 2 1 1 4
Establish long-term customer relations 1 2 1 1 1
Making customers pay the costs 1 3 1 1 1
(&RVWLQJPHWKRG
First-in-first-out - 1 1 1 1
Last-in-first-out - 1 1 1 1
Average costing 5 4 5 5 4
)9DOXDWLRQPHWKRG
Market or replacement cost 1 1 1 1 1
Lower of average cost or market 1 1 1 1 1
Usage rate 4 2 5 5 1
Criticality in case of shortage - 4 1 1 1
Bahri Tannery.
Appendices 305

Customers do not ask for credit 1 - 1 1 1

The firm does not want to extend credit 5 - 4 1 5
Lack of information on credit applicants 1 - 1 1 1
High uncertainty of pay back 1 - 5 1 5
Other factors - No tradition - - 5 - 5
Prior experience 5 4 - 1 1
Financial statements 1 4 - 1 1
Visits to customer 1 3 - 1
Personal contact with the applicant’s creditors 1 1 - 1 1
Customer’s payment history 3 5 - 1 1
&&UHGLWWHUPV
Open account no discount 4 1 1 1 -

Open account with discount 1 1 1 1 -
Promissory note 5 1 1 1 -
Seasonal dating 3 - 1 1 -
The 5 C's - capital, character, collateral, capacity, conditions 3 - 1 1 1

One time sale approach 1 3 - 1 1
Repeat sale approach 5 3 1 1 1
Marginal accounts analysis 1 2 1 1 1
Send reminder 4 - 1 1 1
Telephone call 5 4 1 1 1
Personal visit 1 2 1 1 1
Collection agent (employee) 1 1 1 1 1
Extend credit period 4 2 1 1 1
Take legal action 1 2 1 1 1
)5LVNRIXQFROOHFWDEOHV 2 2 1 1 1
Using draft letters - 1 1 1 1

Using letters of credit - 2 - 1 1
Customers sign letters of credit 5 1 - 1 1
Others - promissory notes - 4 1 - -
Make customers pay outstanding debts 5 4 1 1 1

Stop selling on credit 3 3 - 1 1
Revise credit policy 1 4 1 1 1
Revise credit standards 1 2 1 - 1
Bahri Tannery.
Appendices 306

Short-term debt – bank loans 5 4 5 1 1

Long-term debt 1 3 1 1 1
Retained earnings/Equity capital 1 5 1 1 1
Overdraft 5 5 5 5 2
Trade creditors 1 1 1 1 1
Secured borrowing 1 1 1 1 1
Accruals 1 1 2 2 1
%&RVWVRIILQDQFLQJ
Interest expenses 5 2 5 5 2
Bank service charges 4 2 5 5 1
Seasonality of sales 1 5 1 2 3
Sales growth 1 4 1 - 3
Credit policy 1 4 1 2 3
Availability of credit 1 3 5 2 3
Price levels of inputs 4 3 1 2 3
Operating efficiency 1 3 1 2 3
ATF – Asmara Textile Factory, LSF – Lalmba Sack Factory, SHHF – Sembel House Hold Factory, DSF – Dahlak Shoe Factory,
KBT – Keih Bahri Tannery.
Appendices 307

Take advantage of quantity discounts - - 3 - 4

Take advantage of cash discounts - 3 3 - 5
Decrease inventory holding costs - 3 3 5 3
Decrease purchase ordering costs - 2 3 3 2
Meet seasonal production requirements - 1 3 5 1
Meet production demands 4 - 5 5 3

Determine inventory usage during lead-time 5 5 3 4 4
Know quantity on hand and on order 3 5 5 2 5
Determine safety stock 3 5 5 2 2
Past experience 3 - 3 4 5
Forecasted sales volume 5 5 5 5 2
Management opinion 3 4 2 2 4
Purchasing staff opinion 3 5 2 4 3
'7HUPVRISXUFKDVLQJ
Cash 5 5 5 5 5
Credit - 1 1 - 3
Suppliers do not provide credit 5 5 5 5 4

Firm does not have credit policy 1 1 1 5 3
Lack information of credit suppliers 2 2 1 5 2
No tradition of credit transaction 1 5 1 5 5
)0DQDJLQJSXUFKDVLQJWUDQVDFWLRQFRVWVRI
)&RQWDFW
Choosing the cheapest channel 5 5 5 5 5

Employing purchasing agents 1 1 1 1 2
Managing by trust 4 5 3 4 4
)&RQWUDFW
Routine contract agreements 5 4 5 5 4

Employing lawyers 1 1 1 1 3
Terms known in advance 4 4 4 4 5
)&RQWURO
Routine control agreements 4 4 5 5 4

)5HOHYDQFHRISXUFKDVLQJFRVWVRI
Contacting suppliers 2 - 2 1 4
Contract with suppliers 2 - 1 1 4
Controlling suppliers 2 - 1 3 4
Bahri Tannery.
Appendices 308

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Cash 5 5 5 5 5
Credit 4 5 1 1 1
5 C’s 3 - - 1 1
One time 1 3 1 1 1
Repeat sales 5 3 - 1 1
Satisfy customer demands - 5 5 5 5

Decrease inventory holding costs - - 2 2 3
Decrease inventory ordering costs - 1 2 1 2
Meet seasonal sales requirements - 5 4 5 1
Expand market - 1 4 - 4
Forecast future demand 5 5 5 5 4

Forecast inventory usage 5 2 1 3 4
Forecast quantity on hand and on order 1 5 1 5 5
Forecast safety stock needs 1 1 1 3 5
Past experience - 5 5 4 -
Statistical forecast 5 5 5 4 -
Management opinion 2 2 3 4 -
Sales staff opinion 2 4 1 1 -
Others - production capacity - - - - 5
)0DQDJLQJVDOHVWUDQVDFWLRQFRVWVRI
)&RQWDFW
Choosing the cheapest channel 4 4 5 4 5

Employing sales agents 1 1 1 1 3
Developing long-lasting relationship 5 1 3 4 4
)&RQWUDFW
Routine contract agreements 4 3 4 5 4

)&RQWURO
Routine control agreements 4 1 1 4 4

Contact 2 - 2 1 4
Contract 2 - 1 1 4
Control 2 - 1 3 4
Possibility 2 2 1 2 4
Difficulty in finding another customer 1 3 1 3 4
Extent of loss if customers backs down 2 2 1 2 3
Negotiation - 4 4 - 4
Court of law - 5 5 - 2
Stop dealings until bills are settled - 3 2 - 3
Bahri Tannery.
Appendices 309

Comparing past with present performance 2 5 5 5 4

Comparing actual with expected performance 2 5 1 5 4
Comparing inter-firm benchmarks 1 3 1 2 4
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Charging lower prices 1 5 5 1 1

Allowing quantity discounts - 4 1 1 1
Allowing cash discounts 1 3 1 1 1
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Decrease defect rates 1 4 5 1 1

Higher customer retention rates 1 3 1 1 1
Higher customer’s perceived value of goods 1 3 1 1 1
%&RPPXQLFDWLRQ
Faster responses time 4 5 5 5 1

Faster delivery time 4 5 5 5 1
&/LTXLGLW\
Current ratio 2 4 - 1 2
Quick ratio 2 4 - 1 2
&$FWLYLW\
Inventory turnover 2 4 - 1 2
Receivables turnover 2 4 1 2
Overall working capital ratio 1 4 - 1 1
&$VVHWVWUXFWXUH
Cash to working capital 1 4 - 1 2

Inventory (stock) to working capital 1 4 - 1 1
Receivables (debtors) to working capital 1 4 - 1 1
Working capital to total assets 1 4 - 1 1
Current debt to total debt 1 4 - 1 -

Total debt to total equity 1 4 - 1 -
&3URILWDELOLW\ 1 4 - 1 1
Gross profit margin 1 4 - 1 1
Net profit margin 1 4 - 1 1
Return on working capital investment 1 4 - 1 1
Return on total assets investment 1 4 - 1 1
Fixed asset investment 4 5 1 1 4

Fixed asset financing 4 4 1 1 4
Working capital investment 4 4 1 1 4
Short-term financing 4 4 1 1 4
Availability of skilled labour 5 4 1 1 4
Bahri Tannery.
$)LQDQFLDOSHUIRUPDQFH±.HLK%DKUL7DQQHU\
$0HDVXUHPHQWRISHUIRUPDQFH 1994 1995 1996 1997 1998 1999 2000 Average

$$VVHWVWUXFWXUHDQGVKRUWWHUP
GHEWOHYHUDJH
Short-term debt to total assets 47% 47% 36% 42% 42% 44% 44% 43%
$/LTXLGLW\
Current ratio 1.9 2.0 2.7 2.3 2.3 2.2 2.3 2.2
Quick ratio 1.0 0.8 0.8 1.1 1.2 1.0 1.0 1.0
$$FWLYLW\
$3URILWDELOLW\
Net profit margin -5% 23% 21% 17% 18% 18% 16% 15%
Return on total assets -4% 26% 13% 19% 12% 18% 15% 14%
Stocks (inventories) 51% 60% 70% 53% 51% 56% 54% 56%
Debtors (Accounts receivables) 25% 20% 23% 32% 29% 24% 22% 25%
Cash at Bank 25% 20% 7% 15% 21% 19% 23% 19%
Trade creditors 76% 56% 52% 62% 70% 63% 72% 64%
Others 24% 44% 48% 38% 30% 37% 28% 36%
$)LQDQFLDOSHUIRUPDQFHDYHUDJHIRU\HDUV±±7UDQVLWLRQILUPV
$0HDVXUHPHQWRISHUIRUPDQFH ATF LSF SHHF DSF KBT Average

$$VVHWVWUXFWXUHDQGVKRUWWHUP
GHEWOHYHUDJH
Current assets to total assets 97% 64% 92% 86% 91% 86%
Short-term debt to total assets 117% 33% 65% 57% 43% 63%
$/LTXLGLW\
Current ratio 0.7 1.8 1.4 1.5 2.2 1.5

Quick ratio 0.1 0.4 0.1 0.3 1.0 0.4
$$FWLYLW\
Inventory turnover 0.7 0.4 0.3 0.5 0.8 0.6

Account Receivable turnover 1.2 0.7 10.4 2.0 1.3 3.1
Working capital turnover 1.2 0.7 0.6 0.9 1.0 0.9
$3URILWDELOLW\
Gross profit margin -8% 11% 20% 13% 34% 14%

Net profit margin -11% -20% -22% 4% 15% -7%
Return on total assets -13% -5% -2% 4% 14% 0%
Stocks (inventories) 88% 80% 95% 84% 56% 81%

Debtors (accounts receivable) 10% 18% 5% 11% 25% 14%
Cash at Bank 1% 2% 0% 5% 19% 5%
Trade creditors 53% 76% 47% 58% 64% 59%

Short-term bank loans 5% 5% 0% 0% 0% 5%
Bank overdrafts 38% 18% 25% 19% 0% 25%
Others 4% 4% 29% 23% 36% 19%
/HJHQG ATF – Asmara Textile Factory, LSF – Lalmba Sack Factory, SHHF – Sembel House Hold Factory, DSF – Dahlak Shoe
Factory, KBT – Keih Bahri Tannery. Current ratio = current assets/current liabilities. Quick ratio = (current assets-
inventory)/current liabilities. Inventory turnover = cost of goods sold/average inventory. Accounts receivable (A/R)
turnover = total sales/average receivables. Working capital turnover = sales/current assets. Current assets to total assets
= current asset /total assets. Short-term debt to total assets = Short-term debt/total assets. Gross profit margin = gross
profit/sales. Net profit margin = net profit (after tax)/sales. Return on total assets = net profit (after tax)/total assets.
Appendices 312

$&RRSHUDWLRQRQSULPDU\DFWLYLWLHV
$,QERXQGDFWLYLWLHV
Shipment 5 1 1 5 5
Storing 5 1 1 5 3
Distributing to production 4 1 1 5 5
Inventory control 4 1 1 4 4
Machining - 1 1 - 4
Packaging - - - - -
Assembling 4 1 1 - 5
Equipment maintenance - 1 1 - 5
Product testing 4 1 1 - 5
Facility operations 4 1 1 - 5
$0DUNHWLQJDQGVDOHV
Advertising 3 1 1 - 1
Promotion 3 - 1 - 1
Sales force 3 1 1 - 2
Sale/purchase channel selection 3 1 1 - 4
$$IWHUVDOHVVHUYLFHV
Installation - 1 1 3 4
Repair - 1 1 2 3
Customer training 1 1 1 - 3
Parts supply - 1 1 5 5
Product adjustment 2 1 1 4 4
%&RRSHUDWLRQRQSXUFKDVHVDQGLQYHQWRU\
PDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
Quality and quantity of materials 5 5 - 5 4

Terms of transportation 5 4 - 5 4
Time (on just on time basis); 1 4 - 5 4
&%HQHILWVRIILUPVXSSOLHUFRRSHUDWLRQ
UHVSRQVHVRIFRPPHUFLDOPDQDJHUV
Decrease the time needed to purchase materials 5 4 3 5 5

Decrease cost ordering materials 4 4 1 5 5
Minimising the costs of carrying inventories 5 3 1 4 4
Create trust of your suppliers - 4 2 4 4
'5HDVRQVIRUQRQFRRUGLQDWLRQUHVSRQVHV
RIFRPPHUFLDOPDQDJHUV
You do not have a policy 1 4 1 1 1

Suppliers do not co-operate 1 4 1 1 5
You do not see the benefits 1 1 1 1 4
ATF – Asmara Textile Factory, LSF – Lalmba Sack Factory, SHHF – Sembel House Hold Factory, DSF – Dahlak Shoe Factory,
KBT – Keih Bahri Tannery.
Appendices 313
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$&RRSHUDWLRQRQSULPDU\DFWLYLWLHVUHVSRQVHVRI
JHQHUDOPDQDJHUV
Machining - 1 1 - 5
Packaging 5 1 1 - 3
Assembly - 1 1 - 2
Equipment maintenance - 1 1 - 4
Product testing 3 1 1 - 4
Facility operations 3 1 1 - 4
$2XWERXQGDFWLYLWLHV
Finished goods warehousing 1 5 1 5 4

Materials handling 2 5 1 5
Delivery vehicle operation 3 1 1 5 2
Order processing 3 1 1 4 4
$0DUNHWLQJ VDOHV
Advertising - 1 1 - 1
Promotion - 1 1 3
Sales force - 1 1 - 2
Sale/purchase channel selection - 1 1 - 1
$$IWHUVDOHVVHUYLFHV
Installation - 1 1 1
Repair - 1 1 - 1
Customer training 1 1 1 - 1
Parts supply 1 1 1 - 1
Product adjustment 1 1 1 - 3
%&RRSHUDWLRQRQVDOHVDQGLQYHQWRU\
PDQDJHPHQWUHVSRQVHVRIFRPPHUFLDOPDQDJHUV
Quality and quantity of goods to be produced and sold 5 4 5 5 4

Transportation terms of finished goods to sold 5 2 1 5 5
Time ( just on time basis) 1 2 1 1 4
&%HQHILWVRIILUPFXVWRPHUFRRSHUDWLRQ
Minimising the cost of ordering and transportation 5 4 5 4 5

Minimising the costs of carrying inventories 5 4 5 4 4
Increasing sales 5 5 1 5 4
'5HDVRQVIRUQRQFRRSHUDWLRQUHVSRQVHVRI
FRPPHUFLDOPDQDJHUV
Firm does not have policy 1 1 1 1 1

Customers do not co-operate 1 5 4 4 5
Firm does not see the benefits 1 1 1 1 4
(&XVWRPHUDVVHVVPHQWUHVSRQVHVRIFRPPHUFLDO
PDQDJHUV
Return any product with inferior quality 5 5 4 1 5

Pay only if the products are as per their expectation 1 1 1 1 1
Making strict quality control at the production floor 4 5 1 5 4
Making periodic assessment of customers opinion 2 3 5 1 4
Others- Market research - - 5 - -
Bahri Tannery.
Appendices 314
AAP KBT AHS

(ATF) (DSF) (KBT)
Machining 1 1 1
Packaging 1 1 1
Assembly 1 1 1
Equipment maintenance 1 1 1
Product testing 1 1 1
Facility operations 1 1 1
$2XWERXQGDFWLYLWLHV
Finished goods warehousing 1 1 1

Inventory control 1 1 1
Delivery vehicle operation 1 1 5
Order processing 1 4 4
$0DUNHWLQJDQGVDOHV
Advertising 1 2 1
Promotion 1 4 1
Sales force 1 1 1
Sale/purchase channel selection 1 1 2
$$IWHUVDOHVVHUYLFHV
Installation 1 1 1
Repair 1 1 1
Customer training 1 1 1
Parts supply 1 1 1
Product adjustment 1 1 1
%&RRSHUDWLRQRQVDOHVRSHUDWLRQ DQGLQYHQWRU\PDQDJHPHQW
Exchanging skilled staff 1 1 1

Credit transaction without discounts 5 1 1
Credit transaction with discounts 1 1 1
Providing goods when just needed - 5 1
Decrease cost of selling goods 5 1 5

Decrease the time needed to sell goods 5 1 4
Minimising the cost of ordering and transportation 5 1 5
Decrease the carrying cost of finished goods inventory 5 2 2
Create trust of your customers 5 4 1
'6XSSOLHUUHDVRQVIRUQRQFRRSHUDWLRQ
Do not have the specific policy of co-operation 1 1 1

Central firm does not co-operate 1 5 4
Do not see the benefits 1 1 1
Marketing approach 4 1 2
Purchase order processing 5 1 2
Bilateral communication 5 1 3
Explanation to inquiries 5 1 3
Courtesy 5 1 1
Using supplier services 1 1 4
Payment habits 5 5 5
/HJHQG The numbers in bracket indicate how positive or negative the managers responses is: (5) for very positive, (4) for
positive, (3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion. AAP-
(Alighider Agricultural Project) supplier of (ATF) - Asmara Textile Factory, KBT- (Keih Bahri Tannery) supplier of DSF -
(Dahlak Shoe Factory), AHS – (Asmelash Hides and Skins) supplier of KBT- (Keih Bahri Tannery).
Appendices 315
$0DQDJLQJILUPFXVWRPHUOLQNDJHV5HVSRQVHVRIFXVWRPHUV
$&RRSHUDWLRQRQSULPDU\DFWLYLWLHV MOD TI THH MHH SSF

(ATF) (LSF) (SHHF) (DSF) (KBT)
$,QERXQGDFWLYLWLHV
Order processing 1 4 5 1 5
Receiving 1 1 1 1 1
Storing 1 5 1 1 1
Distributing to production 1 1 1 1 1
Inventory control 1 5 1 1 1
Materials handling 1 1 1 1 1
Delivery vehicle operation 1 1 1 1 1
Machining 1 1 1 1 1
Packaging 1 1 1 1 1
Assembly 1 1 1 1 1
Equipment maintenance 1 1 1 1 1
Product testing 1 1 1 1 1
Facility operations 1 1 1 1 1
$0DUNHWLQJDQGVDOHV
Advertising 1 1 1 1 1
Promotion 1 1 1 1 1
Sales force 1 1 1 1 1
Sale/purchase channel selection 1 1 1 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1 1 1 1 1
Repair 1 1 1 1
Supplier training 1 1 1 1 1
Parts supply 1 1 1 1
Product adjustment - 1 1 1 1
%&RRSHUDWLRQRQSXUFKDVHVDQGLQYHQWRU\PJW
Exchanging skilled staff 1 1 1 1 1

Credit transaction without discounts 1 1 1 1 1
Credit transaction with discounts 1 1 1 1 1
Providing goods when just needed 1 3 1 1 1
Decrease cost of purchasing 1 1 1 1 1

Decrease the time needed to purchase 1 1 1 1 1
Decrease the carrying cost of inventory 1 1 1 1 1
Create trust of your supplier 1 1 1 1 1
Do not have the specific policy of co-operation 1 1 1 1 1

Central firm does not co-operate 5 5 4 5 4
Do not see the benefits - 1 1 1 1
(&XVWRPHUUDWLQJRIILUPHIILFLHQF\
Marketing approach - 3 1 2 2
Sales processing 3 4 1 2 4
Product quality 3 5 4 5 2
Costs of products 5 4 4 4 3
Delivery 3 5 5 2 4
Bilateral communication 3 4 2 2 5
Impartiality with other buyers 3 1 5 5 4
Explanation to inquiries 3 1 2 4 4
Knowledgeability of customers 3 1 1 1 5
Using customer services 3 1 1 - 1
Cash collection habits 4 4 5 4 4
/HJHQG MOD (Ministry of Defence) customer of Asmara Textile Factory, TI (Testec-Impex) customer of Lalmba Sack Factory,
THH (Tesfai House Hold) customer of Sembel House Hold Factory, MHH (Mulugeta House Hold) customer of Dahlack Shoe
Factory, SSF (Selamawit Shoe Factory) customer of Keih Bahri Tannery.
Appendices 316
$33(1',;WR&KDSWHU35,9$7,6('),506
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ILQDQFLDOPDQDJHUV
AS F ESSF AM F
$3ROLF\RIZRUNLQJFDSLWDOPDQDJHPHQW±UHVSRQVHV
RIILQDQFLDOPDQDJHUV
Increase sales 5 5 5
Decrease costs 4 5 4
Remain liquid 1 4 1
Generate profit 3 4 5
Working capital investments 4 - 5

Short-term financing 4 - 4
Fixed capital investments 4 - 5
Fixed capital financing 4 - 4
Production capacity 5 - 1
Product demand 4 - 3
Markets 4 - 1
Lack of skilled labour 5 - 3
&)DFWRUVGHWHUPLQLQJZRUNLQJFDSLWDOOHYHOV±
Seasonality of sales 1 5 -
Sales growth 5 5 5
Credit policy 1 4 2
Availability of credit 3 4 -
Price levels of inputs 2 4 1
Operating efficiency 4 4 4
'7KHUROHRIZRUNLQJFDSLWDOPDQDJHPHQW±
',QLQFUHDVLQJVDOHV
Cash management 5 5 5
Receivable management 3 4 4
Inventory management 4 4 4
Sales of finished goods management 4 4 4
Purchase of materials management 5 4 4
Trade payable management 3 4 4
Bank loans management 4 2 -
Liquidity management 4 2 -
',QGHFUHDVLQJFRVWV
Cash management 3 3 5
Receivable management 3 2 5
Inventory management 4 5 5
Sales of finished goods management 4 4 5
Purchase of materials management 5 5 5
Trade payable management 3 3 1
Bank loans management 4 3 1
Liquidity management 4 2 1
ASF – Asmara Sweater Factory, ESSF – Eritrea Steel Sheets Factory, AMF –Asmara Milk Factory.
Appendices 317
AS F ESSF AM F
Transaction 5 5 5
Speculative 1 5 2
Precautionary 1 5 1
Bank compensating 3 2 1
Requirement 1 1 1
Control liquidity 1 1 5
Control cash 1 1 5
Plan short-term needs 1 1 5
Plan long-term needs 1 1 4
Past experience 1 1 4
Forecasted sales 1 1 4
Management opinion 1 1 4
Market research 1 1 1
'&DVKIORZDSSURDFKHV
Receipts and disbursements 5 5 5

Adjusted net income 1 1 1
(&DVKIORZSXUSRVH
Requirement 4 1 1
Improve cash forecast 5 5 4
Cash control 5 4 5
)3D\PHQW
Voucher system 5 5 5
Sequentially numbered checks 5 5 5
Bank reconciliation 5 5 5
Petty cash system 5 5 5
)&ROOHFWLRQ
Customers pay at the bank account 1 3 1

Collections deposited daily 5 5 5
Separate sequential operations 5 4 5
Appendices 318
AS F ESSF AM F
$3XUSRVH RILQYHQWRU\PDQDJHPHQW
Reduce holding costs 5 5 5

Reduce ordering costs 5 4 5
Safeguard against shortages 5 5 4
Keep production running 4 5 4
Power (heat and light for storage space) 1 1 1

Opportunity cost of capital invested 4 4 1
Deterioration 4 3 1
Insurance 5 5 1
Property taxes 5 2 1
Handling 5 2 4
Security 5 - 1
Clerical costs of record keeping - 2 4
&6LJQLILFDQFHRIKROGLQJFRVWRIPDWHULDOV 3 3 1
Minimise inventory level 5 4 4

Buy just in time for production 4 4 4
Use economic order 4 5 1
First-in-first-out 1 1 1
Last-in-first-out 1 1 1
Average costing 5 5 5
Average cost 5 5 5
Market or replacement cost 1 1 1
Lower of average cost or market 1 1 1
Cost 5 4 5
Usage rate 3 4 4
Scarcity in the market 4 4 1
Criticality in case of shortage 3 4 1
Appendices 319
AS F ESSF AM F
Satisfy customer demand 4 5 4

Take advantage of economies of scale 3 5 1
Reduce holding costs 1 2 1
Keep safety stock 2 4 5
Meet seasonal high demand 4 4 5
%7KHFRVWVRIKROGLQJ
Power (heat and light for storage space) - 2 1

Opportunity cost of capital invested 5 4 1
Deterioration, obsolescence, shrinkage, depreciation and 3 3 4
pilferage costs
Insurance 4 5 1
Property taxes 1 1 1
Handling 1 1 1
Security 1 1 1
Clerical costs of record keeping 1 1 1
&6LJQLILFDQFHRIKROGLQJFRVWRILQYHQWRU\ 4 3 1
Hold only the minimum 5 4 1

Apply “just in time” 4 3 1
Establish long-term customer relations 1 1 1
Making customers pay the costs 4 1 1
(&RVWLQJPHWKRG
)9DOXDWLRQPHWKRG
Average cost 5 5 5
Average cost 5 4 5
Usage rate 2 4 4
Criticality in case of shortage 1 3 5
Asmara Sweater Factory, ESSF – Eritrea Steel Sheets Factory, AMF –Asmara Milk Factory.
Appendices 320
AS F ESSF AM F
Customers do not ask for credit 5 - -

The firm does not want to extend credit 1 - -
Lack of information on credit applicants 2 - -
High uncertainty of pay back 1 - -
Prior experience 5 5 5
Financial statements 1 4 1
Visits to customer 4 3 -
Personal contact with the applicant’s creditors 4 - 1
Customer’s payment history 3 3 1
&&UHGLWWHUPV
Open account no discount 5 4 5

Open account with discount 1 4 1
Promissory note - 4 1
Seasonal dating - - 1
The 5 C's - capital, character, collateral, capacity and conditions - 5 4

One time sale approach 1 3 1
Repeat sale approach 4 4 5
Marginal accounts analysis 1 2 -
Send reminder 5 4 2
Telephone call 4 5 4
Personal visit 3 3 2
Collection agent (employee) 1 2 1
Extend credit period 4 4 4
Take legal action 1 2 2
)5LVNRIXQFROOHFWDEOHV 5 1 -
Using draft letters 1 4 1

Using letters of credit 5 4 5
Customers sign letters of credit 5 1 1
Make customers pay outstanding debts 5 4 -

Stop selling on credit 5 3 1
Revise credit policy 1 4 1
Revise credit standards 4 2 1
Appendices 321
AS F ESSF AM F
Short-term debt - bank loans 4 5 1

Long-term debt 1 2 1
Retained earnings/Equity capital 4 2 1
Overdraft 5 5 -
Trade creditors 1 1 1
Secured borrowing 1 1 1
Accruals 1 1 1
%&RVWVRIILQDQFLQJ
Interest expenses 5 5 -
Bank service charges 3 3 -
Trade credits - - -
Seasonality of sales 2 1 1
Sales growth 4 2 1
Credit policy 1 2 1
Availability of credit 3 2 1
Price levels of inputs 4 5 1
Appendices 322
AS F ESSF AM F
Take advantage of quantity discounts 3 4 3

Take advantage of cash discounts 5 2 5
Decrease inventory holding costs 3 4 1
Decrease purchase ordering costs 3 5 1
Meet seasonal production requirements 3 1 5
Meet production demands 4 5 4

Determine inventory usage during lead-time 5 2 3
Know quantity on hand and on order 4 5 4
Get safety stock 4 4 4
Forecasted sales volume 5 5 3
Purchasing staff opinion 3 4 2
'7HUPVRISXUFKDVLQJ
Cash 4 5 5
Credit 4 2 5
Suppliers do not provide credit 4 5 -

Firm does not have credit policy 1 2 -
Lack information on credit suppliers 1 5 -
No tradition of credit transaction 1 5 -
)&RQWDFW
Choosing the cheapest channel 4 4 5

Employing purchasing agents 1 1 1
Managing by trust 4 1 4
)&RQWUDFW
Routine contract agreements 4 4 5

Employing lawyers 1 1 1
Terms known in advance 5 4 4
)&RQWURO
Routine control agreements 4 4 4

Terms known in advance 4 4 4
Contacting suppliers 2 1 4
Contract with suppliers 2 1 4
Controlling suppliers 2 1 4
Appendices 323
ASF ESSF AMF

$6DOHVWHUPV
Cash 5 5 5
Credit 4 5 4
5 C’s - 5 4
One time sales 1 3 1
Repeat sales 4 4 5
Satisfy customer demands 5 5 5

Decrease inventory holding costs 4 5 1
Decrease inventory ordering costs 4 5 1
Meet seasonal sales requirements 5 2 1
Expand market 5 5 3
Forecast future demand 4 5 3

Forecast inventory usage 4 4 2
Forecast quantity on hand and on order 4 5 2
Forecast safety stock needs - 4 4
Statistical forecast 4 5 4
Sales staff opinion 1 5 1
)&RQWDFW
Choosing the cheapest channel 1 4 5

Employing sales agents 1 1 1
Developing long-lasting relationship 1 1 4
)&RQWUDFW
Routine contract agreements - 4 4

Terms known in advance - 4 4
)&RQWURO
Routine control agreements - 4 4

Terms known in advance - 4 4
Contact - 2 1 1
Contract 2 1 1
Control 2 1 -
Possibility 2 1 1
Difficulty in finding another customer 2 1 1
Extent of loss if partners back-down - 1 2
Negotiation 2 3 1
Court of law 2 1 1
Stop dealings until bills are settled - 1 1
Appendices 324
$3HUIRUPDQFHPDQDJHPHQWRIZRUNLQJFDSLWDOGHFLVLRQVUHVSRQVHVRIILQDQFLDOPDQDJHUV
AS F ESSF AM F
Comparing your past with the present performance 4 5 4

Comparing the actual with the expected performance 4 2 4
Comparing inter-firm benchmarks 1 1 1
%&XVWRPHUVDWLVIDFWLRQSHUIRUPDQFHEDVHGHYDOXDWLRQ
%&RVWPLQLPLVDWLRQ
Charging lower prices 5 5 2

Allowing quantity discounts 1 1 1
Allowing cash discounts 1 1 1
%4XDOLW\RISURGXFWV
Decrease defect rates 1 4 4

Higher customer retention rates 1 1 1
Higher customer’s perceived value of goods 1 4 1
%&RPPXQLFDWLRQ
Faster responses time 5 5 1

Faster delivery time 5 5 5
&/LTXLGLW\
Current ratio 5 5 1
Quick ratio 5 5 1
&$FWLYLW\
Inventory (stock) turnover 5 5 1

Receivables (debtors) turnover 5 4 1
Overall working capital ratio 5 3 1
&$VVHWVWUXFWXUH
Cash to working capital 2 5 1

Inventory (stock) to working capital 4 2 1
Receivables (debtors) to working capital 5 2 1
Working capital to total assets 4 3 1
Current debt to total debt 1 4 1

Total debt to total equity 5 4 1
&3URILWDELOLW\
Gross profit margin 5 4 1

Net profit margin 2 1 1
Return on working capital investment 5 4 1
Return on total assets investment 5 4 1
Fixed asset investment 5 4 4

Fixed asset financing 4 4 4
Working capital investment 5 4 4
Short-term financing 1 4 1
Availability of skilled labour 5 5 1
$)LQDQFLDOSHUIRUPDQFH±$60$5$0,/.)$&725<
$0HDVXUHPHQWRISHUIRUPDQFH 1996 1997 1998 1999 2000 Average Pre - priv Post priv.
$$VVHWVWUXFWXUHDQGVKRUWWHUP (as 2000)
GHEWOHYHUDJH
Short-term debt to total assets ratio 31% 32% 38% 30% 32% 32% 33% 32%
$/LTXLGLW\
Current ratio 2.0 2.2 2.1 0.0 1.0 1.5 1.6 1.0
Quick ratio 1.3 1.8 1.9 0.0 0.4 1.1 1.3 0.4
$$FWLYLW\
$3URILWDELOLW\
Net profit margin 9% 12% 13% 7% 3% 9% 10% 3%
Return on total assets 16% 21% 21% 4% 5% 13% 15% 21%
Stocks (inventories) 18% 10% 55% 57% 57% 40% 35% 57%
Debtors (Accounts receivable) 4% 11% 22% 10% 10% 11% 12% 10%
Cash at Bank 78% 79% 23% 33% 33% 49% 53% 33%
Trade creditors 38% 34% 28% 41% 44% 37% 35% 44%
Short-term bank loans 0% 0% 0% 51% 42% 19% 13% 42%
Bank overdrafts
Others 62% 66% 72% 8% 14% 44% 52% 14%
Appendices 326
$)LQDQFLDODQDO\VLVDYHUDJH3ULYDWLVHGILUPV
Pre privatisation Post privatisation

$0HDVXUHPHQWRISHUIRUPDQFH ASF AMF ESSF Average ASF AMF ESSF Average ASF AMF ESSF Average
$$VVHWVWUXFWXUHDQG67GHEWOHYHUDJH
Current asset to total assets 66% 52% 85% 68% 74% 57% 82% 71% 57% 32% 88% 59%
Short-term debt to total assets 113% 56% 46% 72% 159% 274% 48% 160% 53% 83% 44% 60%
$/LTXLGLW\
Current ratio 0.7 1.5 2.2 1.4 0.6 1.6 2.0 1.4 0.8 1.0 2.4 1.4
Quick ratio 0.2 1.1 1.3 0.9 0.0 1.3 0.6 0.6 0.4 0.4 2.1 0.9
$$FWLYLW\ 0.0
Inventory turnover 0.7 4.8 1.4 2.3 0.6 4.7 1.1 2.1 0.6 5.3 1.3 2.4
Account Receivable turnover 8.6 38.4 2.3 16.4 12.7 36.2 1.5 16.8 3.0 47.4 2.3 17.6
Working capital turnover 0.7 3.1 0.9 1.6 0.6 2.8 0.8 1.4 0.8 4.7 0.7 2.0
$3URILWDELOLW\
Gross profit margin 22% 17% 19% 19% 10% 18% 13% 14% 32% 10% 25% 22%
Net profit margin -35% 9% 6% -7% -19% 10% 7% 0% -57% 3% 5% -16%
Return on total assets -19% 13% 10% 3% -12% 15% 15% 8% -29% 21% 4% -1%
Stocks (inventories) 83% 40% 39% 54% 92% 35% 60% 63% 70% 57% 18% 48%
Debtors (accounts receivable) 17% 11% 33% 20% 5% 12% 1% 6% 26% 10% 66% 34%
Cash at Bank 2% 49% 24% 25% 0% 53% 39% 31% 4% 33% 1% 13%
Trade creditors 13% 37% 33% 28% 14% 35% 34% 28% 11% 44% 33% 29%
Short-term bank loans 2% 19% 14% 11% 1% 13% 5% 4% 42% 27% 24%
Bank overdrafts 77% 22% 49% 85% 0% 6% 30% 66% 0% 37% 34%
Others 8% 44% 32% 28% 0% 52% 60% 37% 18% 14% 3% 12%
/HJHQG: As in Appendix 8.2.3.4
Note: ASF (Asmara Sweater Factory), privatised privatised as of May 1998, financial statements included for seven years (1994-2000)
AMF (Asmara Milk Factory), privatised as of August 1999, financial statements included for the five years (1996-2000)
ESSF (Eritrea Steel Sheets Factory) privatised as of April 1998, financial statements included for the five years (1996-2000)
ASF ESSF AMF

$FRRSHUDWLRQRQSULPDU\DFWLYLWLHV±UHVSRQVHVRI
JHQHUDOPDQDJHUV
$,QERXQGDFWLYLWLHV
Shipment 4 1 5
Storing 4 1 5
Distributing to production 4 1 5
Machining 4 1 5
Packaging 5
Assembling 4 1 5
$0DUNHWLQJDQGVDOHV
Advertising 2 1 1
Promotion 3 1 4
Sales force 3 1 4
$$IWHUVDOHVVHUYLFHV
Installation 3 1 1
Repair 4 1 1
Parts supply 3 1 1
Product adjustment 4 1 1
%&RRSHUDWLRQRQSXUFKDVHVDQGLQYHQWRU\
PDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
Quality and quantity of materials 5 2 5

Terms of transportation 4 1 5
Time (on just on time basis) 4 1 5
&7KHEHQHILWVRIILUPVXSSOLHUFRRSHUDWLRQ
Decrease time needed purchase materials 4 1 1

Decrease cost of ordering materials 4 1 1
Minimising the costs of carrying inventories - - -
Create trust of your suppliers 4 1 1
'5HDVRQVIRUQRQFRRUGLQDWLRQUHVSRQVHVRI
FRPPHUFLDOPDQDJHUV
You do not have a policy 4 4 5

Suppliers do not co-operate 5 2 4
You do not see the benefits 4 4 1
6RXUFHBased on data collected from firm managers using questionnaires.
positive, (3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion.
1RWH ASF – Asmara Sweater Factory, ESSF – Eritrea Steel Sheets Factory, AMF –Asmara Milk Factory.
Appendices 328
$0DQDJLQJILUPFXVWRPHUOLQNDJHV5HVSRQVHVRIWKHFHQWUDOILUPV
AS F ESSF AM F
JHQHUDOPDQDJHUV
Machining 4 1 5
Packaging 4 1 5
Assembly 4 1 5
$2XWERXQGDFWLYLWLHV

Materials handling 4 1 5
Delivery vehicle operation 3 1 5
Order processing 4 1 4
$0DUNHWLQJDQGVDOHV
Advertising 3 1 1
Promotion 3 1 4
Sales force 3 1 3
$$IWHUVDOHVVHUYLFHV
Installation 4 1 1
Repair - 1 1
Parts supply - 1 1
Product adjustment - 1 1
Quality and quantity of goods 5 3 5

Terms of transportation 4 2 5
Time ( just on time basis) 4 2 5
&7KHEHQHILWVRIILUPFXVWRPHUFRRSHUDWLRQ
Minimising the cost of ordering and transportation 3 1 1

Minimising the costs of carrying inventories 3 1 1
Increasing sales 4 1 5
FRPPHUFLDOPDQDJHUV
Firm does not have policy 3 4 -

Customers do not co-operate 4 4 -
Firm does not see the benefits 2 4 -
(&XVWRPHUDVVHVVPHQWUHVSRQVHVRIILQDQFLDO
PDQDJHUV
Return any product with inferior quality 4 4 5

Pay only if the products are as per their expectation 2 2 1
Making strict quality control at the production floor 5 4 5
Making periodic assessment of customers opinions 4 4 1
1RWH ASF – Asmara Sweater Factory, ESSF – Eritrea Steel Sheets Factory, AMF –Asmara Milk Factory.
Appendices 329
TBLF UoA- DAS

Machining 1 3
Packaging 1 3
Assembly 1 1
Product testing 1 1
$2XWERXQGDFWLYLWLHV

$0DUNHWLQJDQGVDOHV
Advertising 1 2
Promotion 1 2
Sales force 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1 1
Repair 1 1
Parts supply 1 1

Decrease cost of selling goods 4 2

Decrease the time needed to sell goods 5 5
Decrease the carrying cost of finished goods inventory 5 5
Create trust of your customers 5 4

Purchase order processing 5 2
Explanation to inquiries 5 3
Courtesy 5 -
Using supplier services - 4
Payment habits 5 5
1RWH TBLF (Tesfagiorgis Beatay Leather Factory) is supplier of Asmara Sweater Factory and UoA- DAS
(University of Asmara – Department of Animal Science) is supplier of Asmara Milk Factory.

Appendices 330
Segen Construction Berhane Frafre

$,QERXQGDFWLYLWLHV
Receiving 1 1
Storing 1 1
Distributing to production 1 1
Materials handling 1 4
Machining 1 1
Packaging 1 1
Assembly 1
Product testing 1 1
$0DUNHWLQJDQGVDOHV
Advertising 1 1
Promotion 1 1
Sales force 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1
Repair 1 1
Supplier training 1 1
Parts supply 1 1

Decrease cost of purchasing 1 1

Decrease the time needed to purchase 4 1
Decrease the carrying cost of inventory 1 1
Create trust of supplier 4 1

Sales processing 3 5
Product quality 4 4
Cost of products 4 2
Delivery 4 5
Impartiality with other buyers 5 5
Explanation to your inquiries 3 5
Knowledgeability of customers 4 3
Using customer services 1 1
Cash collection habits 5 5
/HJHQG The numbers in parenthesis indicate how positive or negative the managers responses is: (5) for very positive, (4) for positive,
(3) for neutral, (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion.
1RWH Segen Construction is customer of Eritrea Steel Sheet Factory and Berhane Frafre is customer of Asmara Milk Factory
Appendices 331
$33(1',;WR&KDSWHU*RYHUQPHQW7UDQVLWLRQDQG3ULYDWL]HG)LUPV
$2YHUDOOZRUNLQJFDSLWDOPDQDJHPHQWUHVSRQVHVRIILQDQFLDOPDQDJHUV
$3ROLF\RIZRUNLQJ Government Transition Privatised

FDSLWDOPDQDJHPHQW±
UHVSRQVHVRIILQDQFLDO
PDQDJHUV
Increase sales 4.5 3.3 5

Decrease costs 5 4.6 4.3
Remain liquid 1.5 4.2 2
Generate profit 1 3.6 4
%&RQVWUDLQWVLQ
DFKLHYLQJSROLF\±
UHVSRQVHVRIJHQHUDO
PDQDJHUV
Working capital investments 1 2.8 4.5

Short-term financing 2.5 2.5 4
Fixed capital investments 4.5 3.8 4.5
Fixed capital financing 1 2.8 4
Production capacity 3 3.5 3
Product demand 1 2 2
Markets 1 2.3 2.5
Lack of skilled labor 3 3.8 4
&)DFWRUVGHWHUPLQLQJ
ZRUNLQJFDSLWDOOHYHOV±
UHVSRQVHVRIILQDQFLDO
PDQDJHUV
Seasonality of sales 3 4.2 3

Sales growth 5 2.8 5
Credit policy 1.5 2.4 2.3
Availability of credit 1.5 3 3.5
Price levels of inputs 5 2.8 2.3
'5ROHRI:&0RQYDOXH Government Transition Privatised
FUHDWLRQ±UHVSRQVHVRI
ILQDQFLDOPDQDJHUV
Increase Decrease Increase Decrease Increase Decrease

Sales costs Sales costs Sales Costs
'0DQDJLQJZRUNLQJ
FDSLWDOLQYHVWPHQW
Cash management 4.5 4.5 3 4.2 5 3.7

Receivable management 4.5 1 3.5 3 3.7 3.3
Inventory management 4.5 3 3.5 3.2 4 4.7
'0DQDJLQJVKRUWWHUP
ILQDQFLQJ
Trade payable management 2.5 1 3.3 2.4 3.7 2.3

Bank loans management 1 1 2.4 3.3 3 2.7
Liquidity management 1.5 1 3 3.4 3 2.3
'0DQDJLQJZRUNLQJ
FDSLWDOUHODWHGRSHUDWLRQV
Sales operation 5 3 4.2 3.4 4 4.3

Purchase operation 5 5 4 3.5 4.3 5
Appendices 332
$0RWLYHVRIKROGLQJFDVKOHYHOV Government Transition Privatised

Transaction 5 5 5
Speculative 2 2 2.7
Precautionary 1 1 2.3
Bank compensating 1 1.3 2
Requirement 5 4 -
Control liquidity 1 3.3 2.3
Control cash 5 3.3 2.3
Plan short-term needs 4 3.8 2
Plan long-term needs 1 1 2
Forecasted sales 2.5 3.3 2
Market research 1 1.5 1
'&DVKIORZDSSURDFKHV
Receipts and disbursements 5 4.8 5

Adjusted net income 1 1.4 1
(&DVKIORZSXUSRVH
Requirement 3 4.4 2
Improve cash forecast 5 3.8 4.7
Cash control 5 3.5 4.7
)3D\PHQW
Voucher system 5 4.8 5

Sequentially numbered checks 5 4.6 5
Bank reconciliation 5 4.8 5
Petty cash system 5 4.8 5
)&ROOHFWLRQ
Customers pay at the bank account 3.5 3.8 1.7

Collections deposited daily 5 4.8 5
Separate sequential operations 5 4.2 4.7
Appendices 333

Reduce holding costs 4.5 4.2 5

Reduce ordering costs 4.5 3.4 4.7
Safeguard against shortages 4.5 4.2 4.7
Keep production running 5 4.5 4.3
Power (heat and light for storage space) 1.5 3 1

Opportunity cost of capital invested 2.5 3.6 3
Deterioration 2.5 3.8 2.7
Insurance 4 2 3.7
Property taxes 2.5 2 2.7
Handling 4.5 2.6 3.7
Security 2.5 3 3
Clerical costs of record keeping 4 2.3 3
&6LJQLILFDQFHRIKROGLQJFRVWRIPDWHULDOV 4 2.6 3
Minimise inventory level 4.5 4.6 4.3

Buy just on time for production 4 2.4 4
Use economic order 3 2 3.3
Average cost 5 4.8 5

Cost 4.5 3 4.7

Usage rate 2.5 2.8 3.7
Scarcity in the market 2 3.3 3
Criticality in case of shortage 4.5 3.5 2.7
Appendices 334

Satisfy customer demand 3 3.2 4.3

Take advantage of economies of scale 1 3.4 3
Reduce holding costs 2.5 1.6 1.3
Keep safety stock 3 2.6 3.7
Meet seasonal high demand 3 2.2 4.3
%7KHFRVWVRIKROGLQJ
Power (heat and light for storage space) 2.5 2 1

Opportunity cost of capital invested 3 3.2 3.3
Deterioration 2 2.4 3.3
Insurance 4.5 2.8 3.3
Property taxes 1.5 1.4 1
Handling 3.5 1.8 1
Security 2.5 1 1
Clerical costs of record keeping 3 1.8 1
&6LJQLILFDQFHRIKROGLQJFRVW 5 2.4 2.6
Hold only the minimum 4.5 3.4 3.3

Apply “just in time” 2.5 2 3.7
Establish long-term customer relations 1 1.2 1
Making customers pay the costs 1.5 1.4 2.5
(&RVWLQJPHWKRG
Average costing 5 3.6 4
)9DOXDWLRQPHWKRG
Average cost 5 4.2 5

Lower of average cost or market 1 1 1.7
Average cost 3.5 1.8 4.7

Usage rate 2.5 3.4 3.3
Lower of cost or market 2.5 1.4 3
Appendices 335

Customers do not ask for 1.5 1 5

The firm does not want 2 3.8 1
Lack of information 1.5 1 2
High uncertainty pay back 2.5 3 1
Others - No tradition - 5 -
Prior experience 1 3.7 5

Financial statements 1 2.3 2
Visits to customer 1 1.8 3.5
Personal contact with the Applicant’s creditors 1 1 3
Customer’s payment history 2.5 2.3
&&UHGLWWHUPV
Open account no discount 1 1.8 4.7

Open account with discount 1 1 2
Promissory note 1 2.3 2.5
Seasonal dating - 1.3 1
The 5 C's - capital, character, collateral, capacity, conditions 1 1.5 4.5

One time sale approach 1 1.5 1.7
Repeat sale approach 1 2.2 4.3
Marginal accounts analysis - 1.2 1.5
Send reminder 1 1.8 3.7

Telephone call 1 2.4 4.3
Personal visit 1 1.2 2.7
Collection agent (employee) 1 1 1.7
Extend credit period 1 1.8 4
Take legal action 1 1.2 1.7
)5LVNRIXQFROOHFWDEOHV 1 1.4 3
Using draft letters 1 1 2

Using letters of credit 1 1.3 4.7
Customers sign letters of credit 1 2 2.3
Others - promissory notes - 4 -
Make customers pay outstanding debts 1 2.4 4.5

Stop selling on credit 1 2 3
Revise credit policy 1 1.6 2
Revise credit standards 1 1.3 2.3
Appendices 336

Short-term debt - bank loans 1 3.2 3.3

Long-term debt 1 1.4 1.3
Retained earnings/Equity capital 5 1.8 2.3
Overdraft 1 4.4 5
Trade creditors 5 1 1
Secured borrowing 1 1 1
Accruals 1 1.4 1
%&RVWVRIILQDQFLQJ
Interest expense 1 3.8 5

Bank service charges 1 3.4 3
Seasonality of sales 1 2.4 1.5

Sales growth 3 1.8 2.3
Credit policy 1.5 2.2 1.3
Availability of credit 1.5 2.8 2
Price levels of inputs 3 2.6 3.3
Operating efficiency 2.5 2 3
Others- Government subsidy 5 - -
Appendices 337

Take advantage of quantity discounts 3 3.5 3.3

Take advantage of cash discounts 2.5 3.7 4
Decrease inventory holding costs 2.5 3.5 2.7
Decrease purchase ordering costs 3 2.5 3
Meet seasonal production requirements 3 2.5 3
Meet production demands 5 4.3 4.3

Determine inventory usage during lead-time 2.5 4.2 3.3
Know quantity on hand and on order 4.5 4 4.3
Get safety stock 4.5 3.4 4
&%DVHVXVHGWRIRUHFDVW
Past experience 5 3.8 4.3

Forecasted sales volume 4 4.4 4.3
Management opinion 4.5 3 4
Purchasing staff opinion - 3.4 3
'7HUPVRISXUFKDVLQJ
Cash 5 5 4.7
Credit 1 2.3 3.7
Suppliers do not provide credit 3 4.8 4.5

Firm does not have credit policy 3.5 2.2 1.5
Lack information of credit suppliers 1 2.4 3
No tradition of credit transaction 1 3.4 3
)&RQWDFW
Choosing the cheapest channel 5 5 4.3

Employing purchasing agents 2.5 1.2 1
Managing by trust 3.5 4 3
)&RQWUDFW
Routine contract agreements 5 4.6 4.3

Employing lawyers 1 1.4 1
Terms known in advance 5 4.2 4.3
)&RQWURO
Routine control agreements 5 4.4 4

Terms known in advance 5 4.2 4
Contacting suppliers 3.5 2.3 2.3

Contract with suppliers 3.5 2 2.3
Controlling suppliers 3.5 2.5 1.3
Appendices 338
Government Transition Privatized

$6DOHVWHUPV
Cash 5 5 5
Credit 3 2.4 4.3
5 C’s 1 1.7 4.5

One time 1 1.4 1
Repeat sales 1 2.5 4.3
Satisfy customer demands 3 5 5

Decrease inventory holding costs 1 2.3 3
Decrease inventory ordering costs 1.5 1.5 3
Meet seasonal sales requirements 2.5 3.8 2.7
Expand market 3 3 4.3
Forecast future demand 3 4.8 4

Forecast inventory usage 2 3 3
Forecast quantity on hand and on order 5 3.4 3.6
Forecast safety stock needs 4 2.2 4
Past experience 4 4.7 4.3

Statistical forecast 2 4.8 4.3
Management opinion 4 2.8 4
Sales staff opinion 2 2 2.3
Production capacity/Customer demands 5 - -
)&RQWDFW
Choosing the cheapest channel 5 4.4 3.3

Employing sales agents 1.5 1.4 1
Developing long-lasting relationship 3.5 3.4 3
)&RQWUDFW
Routine contract agreements 5 4 4

Terms known in advance 4.5 4 4
)&RQWURO
Routine control agreements 5 2.8 4

Terms known in advance 4.5 3.2 4
Contact 1 2.2 1.3

Contract 1 2 1.3
Control 1 2.5 1.5
Possibility 1 2.2 1.3

Difficulty in finding another customer 2 2.4 1.3
Extent of loss if customers back-down 2.5 2 1.5
Negotiation 1.5 4 2
Court of law 1 4 1.3
Stop dealings until bills are settled 1.5 2.7 1
Appendices 339

Comparing past with present performance 5 4.2 4.3

Comparing actual with expected performance 4.5 3.4 3.3
Benchmarking 5 2.2 1
%&XVWRPHUVDWLVIDFWLRQEDVHG
%&RVWPLQLPLVDWLRQ
Charging lower prices 4 2.6 4

Allowing quantity discounts 1 1.8 1
Allowing cash discounts 1 1.4 1
%4XDOLW\RISURGXFWV
Decrease defect rates 2.5 2.4 3.3

Higher customer retention rates 1 1.4 1
Higher customer’s perceived value of goods 2.5 1.4 2
%&RPPXQLFDWLRQ
Faster responses time 4.5 4 5

Faster delivery time 4.5 4 5
&$FFRXQWLQJEDVHG
&/LTXLGLW\

&$FWLYLW\
Inventory turnover 4.5 2.3 3.7

Receivables turnover 4.5 2.3 3.3
Overall working capital ratio 2.5 1.4 3
&$VVHWVWUXFWXUH
Cash to working capital 1 2 2.6

Inventory to working capital 1 1.8 2.3
Receivables to working capital 1 1.8 3.3
Working capital to total assets 2.5 1.8 2.7
Current debt to total debt 2.5 2 2

Total debt to total equity 2.5 2 3.3
&3URILWDELOLW\
Gross profit margin 2.5 1.8 3.3

Net profit margin 2.5 1.8 1.3
Return on working capital investment 2.5 1.8 3.3
Return on total assets investment 2.5 1.8 3.3
Fixed asset investment 1 3.2 4.3

Fixed asset financing 1 2.8 4.3
Working capital investment 1 2.8 4.3
Short-term financing 1 2.8 2
Availability of skilled labour 4.5 3 3.7
Appendices 340
$)LQDQFLDOSHUIRUPDQFHDYHUDJH±DOOILUPV
$0HDVXUHPHQWRISHUIRUPDQFH Government Transition Privatised

$$VVHWVWUXFWXUHDQG6KRUWWHUPGHEWOHYHUDJH
Current asset to total assets 92% 69% 68%

Short-term debt to total assets ratio 53% 63% 72%
$/LTXLGLW\

$$FWLYLW\
Inventory (stock) turnover 3.4 0.6 2.3

Account Receivable (debtors) turnover 5.2 3.1 16.4
Working capital turnover 1.4 0.9 1.6
$3URILWDELOLW\
Gross profit margin 14% 14% 19%

Net profit margin 8% -7% -7%
Return on total assets 9% 0% 1%
%:&,QYHVWPHQWFRPSRVLWLRQ
Stocks 22% 81% 54%

Debtors 47% 14% 20%
Cash at Bank 31% 5% 25%
Trade creditors 92% 59% 28%

Short-term bank loans 0% 2% 11%
Bank overdrafts 0% 20% 49%
Others 8% 19% 28%
/HJHQG Current ratio = current assets/current liabilities. Quick ratio = (current assets-inventory)/current liabilities. Inventory
turnover = cost of goods sold/average inventory. Accounts receivable (A/R) turnover = total sales/average receivables. Working
capital turnover = sales/current assets. Current assets to total assets = current asset /total assets. Short-term debt to total assets =
Short-term debt/total assets. Gross profit margin = gross profit/sales. Net profit margin = net profit (after tax)/sales. Return on
total assets = net profit (after tax)/total assets.
$&RPSDUDWLYHSHUIRUPDQFHHYDOXDWLRQ$OOILUPV
$3HUIRUPDQFHLQGLFDWRUVRIZRUNLQJFDSLWDOLQYHVWPHQW
1994 1995 1996 1997 1998 1999 2000 Average

$$VVHWVWUXFWXUH
&XUUHQWDVVHWWRWRWDODVVHWV
Government 92% 94% 94% 94% 91% 90% 91% 92%

Transition 91% 87% 75% 85% 88% 77% 80% 83%
Privatised 43% 54% 77% 51% 82% 50% 54% 59%
$&RPSRVLWLRQ
6WRFNVLQYHQWRULHV
Government 28% 53% 44% 18% 35% 19% 25% 28%

Transition 72% 82% 89% 79% 81% 84% 80% 81%
Privatised 31% 31% 35% 35% 47% 41% 38% 37%
'HEWRUVDFFRXQWVUHFHLYDEOH
Government 10% 23% 35% 46% 43% 35% 37% 39%

Transition 17% 14% 10% 18% 15% 12% 11% 14%
Privatised 2% 0% 6% 5% 17% 40% 48% 17%
&DVKDW%DQN
Government 62% 24% 20% 35% 22% 46% 38% 35%

Transition 4% 2% 4% 5% 4% 8% 5% 5%
Privatised 0% 47% 26% 8% 15% 11% 18% 25%
Appendices 342
%3HUIRUPDQFHLQGLFDWRUVRIVKRUWWHUPILQDQFLQJ
%/LTXLGLW\ 1994 1995 1996 1997 1998 1999 2000 Average

&XUUHQWUDWLR
Government 2.9 3.5 3.6 3.7 3.5 1.4 1.2 2.7

Transition 1.5 1.5 1.6 1.7 1.6 1.5 1.5 1.6
Privatised 0.7 1.2 1.4 0.8 1.2 1.2 1.8 1.2
4XLFNUDWLR
Government 2.0 2.7 1.9 1.2 1.0 1.7

Transition 1.2 0.8 0.6 1.1 1.0 0.7 0.8 0.9
Privatised 0.2 0.0 0.8 0.6 1.0 1.0 1.3 0.7
%6KRUWWHUPGHEWOHYHUDJH
67GHEWWRWRWDODVVHWVUDWLR
Government 42% 47% 49% 44% 48% 66% 76% 56%

Transition 66% 61% 61% 65% 69% 57% 62% 63%
Privatised 42% 56% 84% 98% 57% 42% 31% 59%
%67)LQDQFLQJFRPSRVLWLRQ
7UDGHFUHGLWRUV
Government 96% 63% 58% 71% 59% 47% 58% 59%

Transition 80% 50% 53% 56% 51% 63% 62% 59%
Privatised 39% 6% 16% 15% 22% 29% 31% 23%
6KRUWWHUPEDQNORDQV
Government
Transition 1% 2% 2% 1% 8% 0% 0% 2%
Privatised 0% 1% 0% 0% 11% 29% 22% 9%
%DQNRYHUGUDIWV
Government
Transition 2% 23% 23% 27% 25% 21% 25% 21%
Privatised 24% 35% 31% 30% 43% 19% 41% 32%
2WKHUV Government 4% 39% 42% 29% 41% 53% 42% 41%
Transition 12% 22% 24% 21% 18% 19% 17% 19%
Privatised 3% 25% 53% 22% 24% 17% 12% 22%
Appendices 343
&3HUIRUPDQFHLQGLFDWRUVRIZRUNLQJFDSLWDORSHUDWLRQV
1994 1995 1996 1997 1998 1999 2000 Average

&$FWLYLW\UDWLRV
,QYHQWRU\VWRFNWXUQRYHU
Government 3.7 1.3 1.4 1.3 2.6 2.5 3.9 2.3

Transition 1.2 1.0 0.8 0.3 0.2 0.2 0.2 0.6
Privatised 0.6 0.0 2.4 1.7 3.6 1.3 2.1 1.7
$FFRXQW5HFHLYDEOHGHEWRUVWXUQRYHU
Government 19.1 5.2 3.5 2.0 1.7 2.1 3.1 2.5

Transition 5.6 6.7 2.9 2.2 1.2 8.2 2.7 4.2
Privatised 6.7 6.5 19.9 21.2 10.8 6.8 16.0 12.5
:RUNLQJFDSLWDOWXUQRYHU
Government 0.6 1.0 1.4 1.4 1.2 1.4 1.1 1.3

Transition 1.0 1.1 1.1 1.0 0.6 0.8 0.6 0.9
Privatised 0.4 0.0 1.7 1.1 1.3 1.9 1.9 1.2
&3URILWDELOLW\
*URVVSURILWPDUJLQ
Government 18% 14% 11% 16% 5% 13%

Transition 19% 15% 11% 16% 10% 20% 14%
Privatised -5% 17% 15% 35% 14% 22% 16%
1HWSURILWPDUJLQ
Government 10% 8% 8% 7% 0% 6%
Transition 9% 3% -5% -7% -15% -22% -6%
Privatised -28% -10% 30% -51% 4% 3% -8%
5HWXUQRQWRWDODVVHWV
Government 17% 13% 16% 11% 1% 12%

Transition 8% 2% 2% 0% -3% -3% 1%
Privatised 5% 1% 5% -20% 8% 8% 1%

JHQHUDOPDQDJHUV
$,QERXQGDFWLYLWLHV
Shipment 5 3.4 3.3

Storing 5 3 3.3
Distributing to production 3 3.2 3.3
Inventory control 3 2.8 3.3
Machining 2 2 3.3
Packaging 1 - 3.3
Assembling 2 2.8 3.3
Equipment maintenance 2 2.3 3
Product testing 2.5 2.8 3
Facility operations 3 2.8 3
$0DUNHWLQJDQGVDOHV
Advertising 1 1.5 1.3

Promotion 1 1.7 2.7
Sales force 1 1.8 2.7
Sale/purchase channel selection 1 2.3 3
$$IWHUVDOHVVHUYLFHV
Installation 1 2.3 1.7

Repair 2.5 1.8 2
Customer training 1 1.5 1.7
Parts supply 2.5 3 1.7
Product adjustment 2.5 2.4 3
%&RRSHUDWLRQRQSXUFKDVHVDQGPDWHULDOV
LQYHQWRU\PDQDJHPHQWUHVSRQVHVRIILQDQFLDO
PDQDJHUV
Quality and quantity of materials to be purchased; 5 4.8 4

Terms of transportation 5 4.5 3.3
Time (on just on time basis) 4.5 3.5 3.3
&7KHEHQHILWVRIILUPVXSSOLHUFRRSHUDWLRQ
Decrease time needed to purchase materials 5 4.4 2

Decrease cost of ordering materials 4.5 3.8 2
Minimising the costs of carrying inventories 5 3.4 -
Create trust of your suppliers 5 3.5 2
FRPPHUFLDOPDQDJHUV
You do not have a policy 1 1.6 4.7

Suppliers do not co-operate 1 2.4 3.7
You do not see the benefits 1 1.6 3
/HJHQG The numbers in parenthesis indicate how positive or negative the managers responses is: (5) for very positive. (4) for
positive. (3) for neutral. (2) for negative and (1) for very negative. (-) Represents that the manager did not give an opinion.
Appendices 345
$0DQDJLQJILUPFXVWRPHUOLQNDJHV±5HVSRQVHVRIWKHFHQWUDOILUPV

JHQHUDOPDQDJHUV
Machining 1 2.3 3.3

Packaging 1 3.3 3.3
Assembly 1 1.3 3.3
Equipment maintenance 2.5 2 3.3
Product testing 2.5 2.3 3.3
Facility operations 1 2.3 3.3
$2XWERXQGDFWLYLWLHV
Finished goods warehousing 5 3.2 3.3

Materials handling 1 3 3.3
Delivery vehicle operation 5 2.4 3
Order processing 2.5 2.6 3.3
$0DUNHWLQJDQGVDOHV
Advertising 1 1 1.7
Promotion 1 1.7 2.7
Sales force 1 1 2.3
Sale/purchase channel selection 1 2 2.7
$$IWHUVDOHVVHUYLFHV
Installation 1 1 2
Repair 1 1 1
Parts supply 1 1 1
Product adjustment 2.5 1.5 1
Quality and quantity of goods to be produced 5 4.6 4.3

Terms of transportation 5 3.6 3.7
Time (on just on time basis) 4.5 1.8 3.7
&7KHEHQHILWVRIILUPFXVWRPHUFRRSHUDWLRQ
UHVSRQVHVRIFRPPHUFLDOILQDQFLDOPDQDJHUV
Minimising the cost of ordering and transportation 4 4.6 1.7

Minimising the costs of carrying inventories 4.5 4.4 1.7
Increasing sales 4.5 4 3.3
FRPPHUFLDOPDQDJHUV
Firm does not have policy 5 1 3.5

Customers do not co-operate 1 3.8 4
Firm does not see the benefits 1.5 1.6 3
(&XVWRPHUDVVHVVPHQWUHVSRQVHVRIILQDQFLDO
PDQDJHUV
Return inferior quality product 4.5 4 4.3

Pay if products as per expectation 1 1 1.7
Making strict quality control 4.5 3.8 4.7
Assess of customers opinions periodically 4 3 3
Appendices 346

Machining 1 1 1
Packaging 1 1 1
Assembling 1 1 1
$2XWERXQGDFWLYLWLHV

Delivery vehicle operation 5 2.3 2.5
Order processing 5 3 2.5
$0DUNHWLQJDQGVDOHV
Advertising 2.5 1.3 1.5

Promotion 1 2 1.5
Sales force 2.5 1 1
Sale/purchase channel selection 3 1.3 1.5
$$IWHUVDOHVVHUYLFHV
Installation 1 1 1
Repair 1 1 1
Parts supply 1 1 1
Product adjustment 2.5 1 1
%2QVDOHVRSHUDWLRQ DQGLQYHQWRU\
PDQDJHPHQW

Credit transaction without discounts 3 2.3 5
Credit transaction with discounts 1 1 1.5
Providing goods when just needed 5 3 5
Decrease costs of selling 4.5 3.7 3

Decrease the time needed to sell 4 3.3 5
Decrease cost of ordering and 5 3.7 3
transportation
Decrease the carrying cost 2.5 3 5
Create trust 3 3.3 4.5
You do not have the policy 1 1 1

The customer firm lacks co-operation 3 3.3 5
You do not see benefit 1 1 1
Marketing approach 4 2.3 3

Purchase order processing 5 2.7 3.5
Bilateral communication 4.5 3 4
Explanation to inquiries 5 3 4
Courtesy 4.5 2.3 5
Using supplier services - 2 4
Payment habits 5 5 5
Appendices 347

$,QERXQGDFWLYLWLHV
Order processing 2 3.2 4.5

Receiving 1 1 1
Storing 1 1.8 1
Distributing to production 1 1 1
Inventory control 1 1.8 1
Material handing 1 1 2.5
Delivery vehicle operation 1 1 2.5
Machining 1 1.8 1
Packaging 1 1 1
Assembly 1 1 1
$0DUNHWLQJDQGVDOHV
Advertising 1 1 1
Sales force 1 1 1
$$IWHUVDOHVVHUYLFHV
Installation 1 1 1
Repair 1 1 1
Parts supply 1 1 1
Product adjustment
%3XUFKDVHRSHUDWLRQ DQGLQYHQWRU\PDQDJHPHQW

Credit transaction without discounts 1 1 4
Credit transaction with discounts 1 1 1
Providing goods when just needed 1 2 1.5
Decrease costs of purchasing 1 1 2.5

Decrease the time needed to purchase 1 1 1
Decrease the carrying cost 1 1 1
Create trust 1 1 2.5
You do not have the policy 1 1 1

Supplier does not co-operate 5 4.6 5
You do not see the benefit 1 1 1
Marketing approach 2 2 3
Sales processing 2 2.8 4
Product quality 4 3.8 4
Cost of products 5 4 3
Delivery 3 3.8 4.5
Bilateral communication 5 3.2 4
Impartiality with other buyers 5 3.6 5
Explanation to enquiries 5 2.8 4
Knowledge of customers 5 2.2 3.5
Using customer services 1 1.2 1
Cash collection habits 5 4.2 5
6800$5<
6800$5<
,QWURGXFWLRQ
In this book we go into the concepts of internal and external working capital
management. The research focuses specifically at the government, transition and
privatised manufacturing firms in Eritrea. The objective of this research is to study the
working capital management practices of these firms and to forward possible areas of
improvement.
We have categorised this book in to five parts: introduction, literature review,

conceptual framework, empirical study and conclusion. Part I contains chapter 1 and
introduces the research. Part II contains chapters 2-4 with the literature review. Part
III contains chapter 5 where we present our research approach and develop a
conceptual framework. Part IV incorporates chapters 6-9 in which we analysed the
empirical data in view of the literature reviewed and the conceptual framework
developed. Part V includes chapter 10, which concludes the research and forwards
future research implications.
/LWHUDWXUHUHYLHZHGRQZRUNLQJFDSLWDOPDQDJHPHQW
We reviewed literature on relevant research methods, approaches of working capital

management and related theories that can be used as a background. We introduced our
research by highlighting the relevance of working capital management and the
benefits and costs of internal and external working capital management.
The literature on LQWHUQDO working capital management focuses on the management of

working capital levels of investment in cash, receivables and inventories as well as on
operations of purchasing and selling. We highlight the need for designing and
implementing proper objectives for holding the optimum levels based on transaction,
precautionary or speculative purposes. In order to maximise the benefits of working
capital firms can plan their periodic requirements using budgeting approaches,
optimality models and by hedging for uncertain outcomes. There are also control
mechanisms that the firms can apply in order to safeguard against the physical decay
and improper handling. An important objective of working capital management is
therefore to determine and maintain an optimum level. The level of raw material
inventories can also be improved by co-ordinating a firm’s purchases and production
and that of finished goods by co-ordinating the operations of production and sales.
([WHUQDO working capital management focuses on the management of inter-firm co-

operation among firms, their suppliers and customers. Efficient management of
working capital levels and operations would depend not only on co-ordination
between the firm’s internal operations but also between the firm and its suppliers and
customers. If there is a close co-operation between the firm and its supplier, a small
raw materials inventory could be maintained more easily while production needs
could still be met. With closer firm-supplier co-operation, it is also possible for the
firm to get credit purchase, which minimises cash needs. It may then, moreover,
receive both quantity and cash discounts. With a close co-operation between the firm
and its customers, it is possible to know early when goods will be needed. Therefore,
Summary 352
a small finished goods inventory could be maintained and customers’ needs could still
be met. Close firm-customer co-operation also enhances credit sales and may increase
revenues, while at the same time it may minimise uncollected receivables and increase
cash levels. A co-operation among a firm, its suppliers and its customers can also
minimise their inter-firm transaction costs.
The achievement of firm objectives can be measured and evaluated using internal
financial performance measures and non-financial measures, such as supplier and
customer evaluations on various inter-firm activities.
7KHRUHWLFDOEDFNJURXQG
According to Rayan, Scapens and Theobald (1992), theory is useful as a background

to decide on what research approaches to follow and what data to collect. Having this
objective in mind, we used three interconnected theories as a background:
Rappaport’s (1986) value network model, Porter’s (1985) value chain model and
Williamson’s (1985) transaction costs theory.
We applied Rappaport’s (1986) value network model to explain the relation between
the corporate objective of value creation and its drivers. This model helped us to focus
on how value can be created with particular reference to working capital levels and
operations. Based on Rappaport’s argument we divided the conceptual framework of
our study into internal and external working capital operations of purchases and sales
as well as levels of investment and financing. We used Porter’s (1985) value chain
model to study the management of value drivers in an inter-firm co-operation. Porter
divides value drivers into primary and support activities which are inter connected by
internal linkages to each other and external linkages to buyers and suppliers. We used
this value chain linkage model as an input to study inter-firm transactional relations
useful to create value. Exploiting the benefits of value chain approaches require that
firms co-operate with each other so that all players connected to the chain apply well
co-ordinated and cohesive management of working capital. Therefore, value creation
can be enhanced if a firm manages its internal activities efficiently and co-ordinates it
with its external supplier-customer value chains. This requires that the transaction
costs that originate as a result of inter-firm transactional relations be properly
managed. We used Williamson’s (1986) theory on transaction cost to argue that the
managerial approaches designed to efficiently reduce these costs primarily contribute
to the creation of value. We argue that if firms co-operate on activities related to
working capital operations and levels, they can minimise the inter-firm transaction
costs and create value more than they would create individually.
Lastly, we covered the debate on ownership and operational efficiency based on the
theoretical arguments of Shirley and Walsh (2000). The arguments of Shirley and
Walsh helped us to categorise our study into government, transition and privatised
firms. We compared the potential for operational efficiency between government and
private firms and discussed the characteristics of privatised and transition firms. We
centred our discussion on the effect of ownership on competition and value creation.
We argued that, it is the competition that determines how firms can efficiently create
value. However, ownership determines the potential for competition and managerial
efficiency, therefore the ability to create firm value.
Summary 353
7KHFRQFHSWXDOIUDPHZRUN
Our conceptual framework takes the issues of internal and external working capital
management in the Eritrean context. Using the insights of Rappaport’s (1986) value
network model we argued that for a firm to create value, management decisions have
to concentrate on three main decision categories, operating decisions, investment
decisions and financing decisions. 2SHUDWLQJ GHFLVLRQV include the decisions on the
purchase of materials, production process and sales of finished goods. ,QYHVWPHQW
GHFLVLRQV refer to capital tied-up in cash, receivables and inventories. )LQDQFLQJ
GHFLVLRQV are concerned with the sources and the management of financing.
The conceptual framework of this research study uses these internal working capital
management categories also as building blocks for the analysis of external
management of working capital, which firms may implement in co-operation with
their suppliers and customers. Inter-firm co-operation can create a tripartite value
network with the firm and its suppliers and customers making a chain. It can help firms,
their suppliers and customers to decrease the common transaction costs of working
capital operations and the carrying costs of their working capital levels. If the firm’s
purchase and suppliers’ sales operations are co-ordinated their inter-firm transaction
costs and amount of cash needed by the firm as well as the carrying costs of suppliers’
inventory of finished goods and the firm’s inventory of materials can be minimised. Co-
operation with the supplier can also help a firm to increase the use of payables as a
financing source. The firm’s sales operations and customers purchase operations can also
be co-ordinated so that their inter-firm transaction costs and the carrying costs of
customer’s inventory of materials and the firm’s levels of finished goods inventory,
receivables and cash are minimised. The cumulative effect is that all three parties - the
firm, its suppliers and customers can enhance their respective value more than they could
without co-ordinating the management of their operations and levels.
The main factors of our conceptual framework may not explain everything and other
factors may determine the way the internal and external working capital operations
and levels are managed to create firm value. To take care of these eventualities we
have considered the influences of ownership, government regulations, management-
potential, and cultural factors.
Finally, we highlighted the importance of performance evaluation of working capital

decisions. Performance evaluations are made to check if the firm's internal and
external management of working capital operations and levels are creating value.
There can be financial and non-financial performance measurements and evaluation
systems. The financial performance evaluation is using the accounting based financial
information and the non-financial uses the evaluations of managers and –for the
external aspects- the evaluations of suppliers and customers.
7KHUHVHDUFKPHWKRGRORJ\
Yin (1994) described five alternative research approaches: case research, experiment,
survey as well as history and analysis of archival information. Because of the
differentiating characteristics we argued that the case research method properly fits
Summary 354
into our research problem and objective. Accordingly, we sub-divided the design of
the case research into overall case study, the field research or data collection, data
analysis and criteria used to ensure the credibility of the findings.
We have focused on the GHVFULSWLYH and H[SODQDWRU\ case study approaches. We have
described and H[SODLQHG the cases of the government, transition and privatised firms.
We have used the qualitative and quantitative data analysis. Our research approach
requires us to use the qualitative data analysis, which according to Miles and
Huberman (1994), refers to essences of people, objects and situations and is expressed
in terms of words based on observations, interviews and documents. Our quantitative
data analysis refers to the evaluation of working capital decisions using financial
performance ratios.
7KHHPSLULFDOILQGLQJV
We have used the empirical data to analyse the practices of internal and external
working capital management in the government, transition and privatised firms.
2YHUDOO ZRUNLQJ FDSLWDOPDQDJHPHQWSROLF\ *RYHUQPHQWDQG WUDQVLWLRQ ILUPV lack a

clear objective and vision of managing both internal and external working capital.
Though the managers believe that managing working capital operation and level plays
a very significant role in creating value to their firms they are not empowered due to
the imposition of government regulations. According to the managers, government
regulations, implemented under the supervision of the Ministry of Defence in the
government and NASPPE (National Agency for Supervising and Privatising Public
Enterprises) in the transition firms restrict their managerial power. Other than the
problem of managerial empowerment working capital investment and financing,
production capacity and labour are also constraints. The problem with the SULYDWLVHG
ILUPV is not managerial empowerment but management potential, culture and clarity
of objectives and lack of skilled labour, which are the major constraints.
,QYHVWPHQW DQG ILQDQFLQJ Both JRYHUQPHQW ILUPV that we have studied have
excessive levels of cash and receivables. However, inventories of material are kept to
a lower level due to the close relationship of inter-government firms. The inventory of
finished goods is also minimised due to the excessive demands of the Ministry of
Defence and monopolised food market in both firms. The government firms have no
problem of financing their working capital levels and operations because of their
profitable operations as a result of the subsidised costs and monopolised market. All
7UDQVLWLRQ firms except Keih Bahri Tannery are in a serious problem of liquidity. The
firms have financed their working capital needs with overdraft facilities. The level of
receivables is high because of the slow paying related (government) enterprises.
While inventory balance is also increasing due to mainly lack of sales. The owners of
the SULYDWLVHGILUPV have borrowed heavily from the government banks in order to buy
the firms. So, they reported that they are getting problems of liquidity because there is
very little left for other purposes. The lack of investment and financing opportunity
due to the absence of markets for financial titles is also a main factor that contributes
to the inefficient management of working capital in the privatised firms.
Summary 355
2SHUDWLRQVRISXUFKDVHVDQGVDOHV The sales of both JRYHUQPHQW firms are driven by
the Ministry of Defence, which is also their supervising body. The Ministry of
Defence simply forwards purchase orders based on which the firms supply whatever
is requested. Both government firms have very little to do with how to purchase their
materials and to produce and sell their finished goods. The purchase and sales policies
of the WUDQVLWLRQ ILUPV are more or less dictated by government regulations though
they have relatively more relaxed government policies applying to them in
comparison to government firms. Because the firms are supposed to be privatised any
time, management is not encouraged to plan into long-term period and so long as a
buyer is not found, the management of their operations is crippled. The SULYDWLVHG
firms’ management of working capital operations is also found to be restricted only to
the application of clerical procedures of purchases and sales. Analysis of purchase and
sales operations showed that there is no mechanism of enhancing the important
aspects of purchase and sales transaction operations.
3HUIRUPDQFH HYDOXDWLRQ RI ZRUNLQJ FDSLWDO PDQDJHPHQW Analysis of performance

evaluation has indicated that though most firms claim to use accounting and customer
satisfaction based performance measurement, practically they rarely use any for
managerial decision making purposes. We, nevertheless, computed accounting based
performance analysis to study the firms’ asset composition, liquidity position as well
as efficiency of their working capital activities and overall profitability. The
evaluation based on the data collected from the financial statements reveals that the
JRYHUQPHQW ILUPV have excessive surplus cash balance, marginal profits and liquidity
as well as very low turnovers. Except for Keih Bahri Tannery, the WUDQVLWLRQ firms’
financial analysis reveals that they have excessive liquidity problems, very low
turnovers and poor cash positions. The financial analyses of the SULYDWLVHG firms
indicate that they have liquidity problems, low asset turnovers and marginal profits
(except for Asmara Sweater Factory).
The response of the government

)LUPVXSSOLHU OLQNDJHV ± WKH ILUPV¶ SRLQW RI YLHZ
firms indicate that they co-operate with their suppliers only on the inbound activities,
particularly, shipment and storage. Privatised firms co-operate on inbound activities
and on production operations but to a lesser extent compared to that of the
government firms. The transition firms revealed the weakest firm-supplier co-
operation. Their response shows that they have moderate firm-supplier co-operation
only on the inbound activities particularly shipment. Generally, all firms have very
weak firm-supplier linkage on all marketing/sales and after sales services. Both
government and transition firms traced the reason for the lack of firm-supplier co-
operation to government regulations, which they believe are beyond their control. The
reason for the lack of firm-supplier co-operation according to the privatised firms is
for two reasons. First, they have not established proper policy on firm supplier co-
operation and second, their suppliers do not co-operate.
,QWHUILUPOLQNDJHV±VXSSOLHUV¶SRLQWRIYLHZ The suppliers of all firms reported that

they have very little co-operation on all the primary activities. The suppliers indicated
that the only co-operation they have with the firms is on the outbound activities’ order
Summary 356
processing and particularly providing goods when just needed. The response of the
suppliers of the privatised firms on inter-firm co-operation with regard to all primary
activities is very low. The main reason for this lack of co-operation according to all
the suppliers is that the central firms’ lack the willingness to co-operate. Comparing
the responses of the privatised firms and their suppliers indicate that the privatised
firms have exaggerated their firm-supplier co-operation on their inbound activities in
comparison to the opinion of their suppliers.
6XSSOLHUV¶ HYDOXDWLRQ The suppliers of both government and transition firms

nevertheless believe that their partners are very efficient in their purchase order
processing, bilateral communication, explanation to inquiries, courtesy and cash
payment habits. The transition firms, according to their suppliers, are good only at
their payment habits. The suppliers of the privatised firms evaluated the firms on
marketing approaches as less efficient.
)LUPFXVWRPHU OLQNDJHV ± WKH ILUPV¶ SRLQW RI YLHZ The government firms revealed
the weakest firm-private-customer co-operation. Their responses show that they have
no firm-customer co-operation on any of the primary activities. The responses of the
transition firms indicate that they moderately co-operate with their customers only on
the outbound activities, particularly, finished goods warehousing and materials
handling. According to the privatised firms’ co-operation with their customers on all
activities of outbound activities and production operations is very strong. As it is the
case with the firm-supplier linkages, all firms have very weak firm-customer co-
operation on the activities related to marketing/sales and after sales services. The
reason for the lack of firm-customer co-operation according to all the firms is that
their customers do not co-operate. The government and privatised firms’ reason for
non-firm-customer co-operation was moreover reportedly due to a lack of policy on
firm-customer co-operation and they also do not see benefit in co-operating with their
customers.
,QWHUILUP OLQNDJHV FXVWRPHUV¶ SRLQW RI YLHZThe customers of all firms reported
that they rarely have any co-operation agreement on the primary activities, working
capital levels and operations except the transition and privatised firms’ co-operation
on the outbound activities’ of order processing. The main reasons for this lack of co-
operation is that the central firms lack the willingness to co-operate. The managers of
the privatised firms –again- have exaggerated their firm-customer co-operation on
their inbound, outbound and production activities in comparison to the opinion of
their customers.
&XVWRPHUV¶HYDOXDWLRQ All firms are evaluated by their customers as efficient on their

product quality, bilateral communication, impartiality with other buyers and cash
collection habits. In addition the customers of privatised firms rated their partners as
efficient on sales processing, delivery and knowledge of customers. The government
and transition firms were evaluated as efficient on their cost of products while the
government and privatised firms were rated as efficient on their explanation to
inquiries. On the other hand, all firms were rated as inefficient on their marketing
approaches and on their use of customer services
Summary 357
)XWXUHUHVHDUFKLPSOLFDWLRQV
&RQVHTXHQFHVIRUWKHFRQFHSWXDOIUDPHZRUN The conceptual framework helped us to

define a broad approach to working capital management, particularly to understand
the relationships among the factors of internal and external working capital
management, to design the data collection approaches and analyse the case study. The
aim of our conceptual framework is to have a case study of the government, transition
and privatised manufacturing firms with regard to three main issues - the internal
working capital management, the external working capital management and overall
Eritrean context. Practically, our findings reveal that the government, transition and
privatised firms have more similarities than differences and that the managers
concentrate on the control aspect of internal working capital levels and operations
while they disregard the financial management aspect of working capital investment
and financing. With regard to external working capital management the empirical
findings show close co-operation on side of inter-government and transition firms,
while the co-operation of all the firms with their private suppliers and customers is
very weak. Empirical findings reveal that the issues related the overall Eritrean
context have more impact on how the firms manage their internal and external
working capital. The factors including government regulations, managerial
empowerment, management potential and culture have primary role in how the firms
manage their working capital. Because of these factors working capital management
is not underpinned by the idea of value creation expected under conditions of
developed western world. The general theoretical implication of our empirical
findings for the conceptual model is therefore that the design of new conceptual
framework for a case study in developing countries should strongly consider the legal,
historical, institutional and managerial background in the countries under study.
3ROLF\ LPSOLFDWLRQV IRU WKH PDQDJHUV DQG WKH JRYHUQPHQW In the light of our
conceptual background and practical findings, the following points can be
recommended at the firm and government level. At the firm level managers have to
try to be as efficient as possible at the internal working capital management by
establishing new policies and improve existing ones. They should not only
concentrate on the custody but also on the value creation aspect of working capital
management. Managers in the government and transition firms) have to be
empowered to make decisions on working capital on behalf of the firms that they
manage. Managers have to identify and then initiate new inter-firm relationships and
strengthen existing ones. They must have a policy of co-operation with commitment
based on negotiation, co-ordination and mutual adjustment instead of by power and by
enforcing government rules and contracts as well as manage inter-firm co-operation
by relationship development than by strict and formal mechanisms of control.
Government can play a significant role in creating and improving institutions that
reduce inter-firm transaction costs. So we have the opinion that the government
remove its regulations on the government firms and enable their managers to do
business with full authority and responsibility. The government can also be
instrumental in stimulating inter-firm contacts and facilitate opportunities for inter-
firm co-operation and networks. It can also remove the protection it renders to the
government firms so long as they are competing with the private business sector and
create a conducive environment for competition through appropriate investment
policies, liberalising the market and establishing efficient financial institutions. In co-
operation with countries in the region, it can also find ways to enhance investment
Summary 358
opportunities and financing sources by establishing a common financial system and

regional stock market similar to –for example- the BRVM in West Africa.
/LPLWDWLRQV RI WKH VWXG\ DQG IXWXUH UHVHDUFK GLUHFWLRQV In order to further the
study of internal and external working capital management we would propose that:
(a) Future case research be preceded with a survey in order to get a more
complete picture of the Eritrean situation.
(b) The firms’ record on inter-firm transaction be used to identify transaction
partners and research could be conducted to find the opinion of partners both
inside and outside the country.
(c) The responses of more suppliers and customers could be researched.
(d) The privatised firms post privatisation development, that is, if the privatised
firms have adapted to the new private status.
(e) Similar research be made in other countries in order to have the possibility of
comparison.
(f) Further research be made on the speed and method of privatisation of the
transition and privatised firms, because it may also affect their internal and
external working capital management.
(g) When it refers to developing countries, it may not be true that government
firms are less desirable for operational efficiency compared to private firms.
This can therefore be studied further
Summary 359
6$0(19$77,1*
,QOHLGLQJ
In dit proefschrift wordt ingegaan op de begrippen intern en extern werkkapitaal

management. Het onderzoek richt zich in het bijzonder op overheidsbedrijven,
bedrijven in de overgangsfase naar privatisering en geprivatiseerde productiebedrijven
in Eritrea. Het doel van dit onderzoek is het bestuderen van de manier waarop deze
bedrijven het werkkapitaal managen alsmede om adviezen te geven over mogelijke
verbeteringen.
Het proefschrift bestaat uit vijf delen: de inleiding, een literatuuroverzicht, het
conceptueel raamwerk, het empirische onderzoek, en de conclusies. Deel I bevat
hoofdstuk 1 en geeft een inleiding op het onderzoek. Deel II bestaat uit de
hoofdstukken 2 tot en met 4 met een literatuuroverzicht. Deel III betreft hoofdstuk 5,
waarin de onderzoeksmethode wordt uiteengezet en een conceptueel raamwerk wordt
gepresenteerd. Deel IV behandelt de hoofdstukken 6 tot en met 9 en geeft een analyse
van de empirische gegevens tegen de achtergrond van het literatuuroverzicht en het
conceptuele raamwerk. Deel V bevat hoofdstuk 10 met de conclusies en met
suggesties voor toekomstig onderzoek.
/LWHUDWXXURYHU]LFKW
We bestudeerden literatuur over relevante onderzoeksmethoden, benaderingen van

werkkapitaal management en gerelateerde achtergrondtheorieën. We beginnen met
een weergave van de relevantie van het managen van werkkapitaal en met en
weergave van de voordelen en de kosten van intern en extern werkkapitaal
management.
De literatuur over LQWHUQ werkkapitaal management richt zich op het niveau van de
investeringen in werkkapitaal met betrekking tot debiteuren, voorraden, en op inkoop-
en verkooptransacties. We belichten de noodzaak van het formuleren en het toepassen
van de goede doelstellingen met betrekking tot het optimale niveau op grond van
transactie-, voorzorgs- en speculatiemotieven. Om zoveel mogelijk profijt te kunnen
hebben van het werkkapitaal kunnen bedrijven hun behoeften plannen door middel
van budgettering, optimaliseringsmodellen en hedgingtechnieken. Tevens zijn er
controlemechanismen die de bedrijven kunnen toepassen om fysieke verliezen tegen
te gaan en onjuiste handelwijzen te voorkomen. Het werkkapitaal management heeft
dan ook als belangrijke doelstelling het bepalen en handhaven van een optimaal
niveau. Ook kan een bedrijf door een juiste coördinatie van inkoop en productie het
niveau van de voorraden grondstoffen verbeteren en dat van de eindproducten door
een coördinatie van de productie en de verkoop.
([WHUQ werkkapitaal management richt zich op de coördinatie van de samenwerking

tussen bedrijven, hun leveranciers en klanten. Een efficiënt management van de
activiteiten op het gebied van werkkapitaal hangt niet alleen af van de coördinatie
tussen de interne activiteiten van het bedrijf, maar ook van de samenwerking van het
bedrijf met zijn leveranciers en klanten. Indien er een nauwe samenwerking is tussen
Summary 360
het bedrijf en zijn leveranciers kan gemakkelijker worden volstaan met een kleine
grondstoffenvoorraad, terwijl er toch voldoende geproduceerd kan worden. Ook heeft
het bedrijf bij een nauwe samenwerking met zijn leverancier meer kans om bij zijn
aankopen krediet te krijgen, waardoor er over minder contant geld hoeft te worden
beschikt. Tevens kan het bedrijf dan eerder korting voor contante betaling of
kwantumkorting krijgen. Bij een nauwe samenwerking tussen het bedrijf en zijn
klanten kan vroegtijdig worden vastgesteld of er vraag is naar bepaalde goederen. Zo
kan een kleine voorraad eindproducten voldoen en er toch worden voldaan aan de
behoeften van de klanten. Bij een nauwe samenwerking tussen het bedrijf en de klant
zal op grotere schaal op rekening worden gekocht en zal de omzet kunnen stijgen.
Door samenwerking tussen een bedrijf, zijn leveranciers en klanten kunnen ook
transactiekosten tussen bedrijven onderling worden teruggebracht.
De mate waarin bedrijfsdoelstellingen zijn bereikt kan worden gemeten en

geëvalueerd door middel van financiële en niet-financiële prestatiemaatstaven, zoals
evaluaties door leveranciers en klanten van de diverse activiteiten tussen bedrijven.
7KHRUHWLVFKHDFKWHUJURQG
Volgens Rayan, Scapens en Theobald (1992) vormt theorie een hulpmiddel bij de
keuze van de toe te passen onderzoeksmethode(n) en het soort gegevens dat
verzameld dient te worden. Met deze doelstelling in het achterhoofd hebben wij ons
onderzoek gebaseerd op drie op elkaar aansluitende theorieën: het
waardenetwerkmodel van Rappaport (1986), het waardeketenmodel van Porter
(1985), en de transactiekostentheorie van Williamson (1985).
In ons onderzoek hebben wij het waardenetwerkmodel van Rappaport (1986)

toegepast om de relatie te verklaren tussen de bedrijfsdoelstelling om waarde te
creëren en de waardestuwers. Dit model heeft ons in staat gesteld de manier te
bestuderen waarop waarde kan worden gecreëerd op diverse werkkapitaalniveaus en
ten aanzien van verschillende activiteiten. Naar Rappaport’s voorbeeld hebben wij in
ons conceptuele raamwerk een scheiding aangebracht tussen interne en externe
werkkapitaalactiviteiten op het gebied van inkopen en verkopen, alsmede op de
niveaus van investeringen en financiering. Verder hebben wij Porter’s (1985)
waardeketenmodel gebruikt bij het bestuderen van het management van
waardestuwers in de samenwerking tussen bedrijven. Porter verdeelt waardestuwers
in primaire en ondersteunende activiteiten die op intern niveau met elkaar en op
extern niveau met kopers en leveranciers zijn verbonden. Het waardeketenmodel is
gebruikt voor het bestuderen van transactierelaties tussen bedrijven die waardecreatie
stimuleren. Om maximaal van de waardeketenbenadering te kunnen profiteren dienen
bedrijven op een zodanige manier samen te werken, dat zij als onderdelen van de
keten een goed gecoördineerd en samenhangend werkkapitaal management toepassen.
De waardecreatie kan dan ook worden verbeterd wanneer een bedrijf zijn interne
activiteiten op een efficiënte manier beheert en deze coördineert met zijn leveranciers
en klanten in zijn waardeketen. Het is in dit verband belangrijk dat de transactiekosten
die voortkomen uit de transactierelaties tussen bedrijven op een juiste manier worden
gemanaged. Wij hebben gebruik gemaakt van de transactiekostentheorie van
Williamson (1986) om aan te geven dat benaderingen, die zijn ontworpen om de
Summary 361
kosten op een efficiënte manier te verminderen, in de eerste plaats bijdragen aan de

creatie van waarde. Wij stellen dat bedrijven door samen te werken op de
verschillende niveaus van het werkkapitaal management hun onderlinge
transactiekosten kunnen verminderen en meer waarde kunnen creëren dan wanneer zij
alleen zouden opereren.
Tenslotte geven wij een beschrijving van het debat over eigendom en operationele
efficiëntie op basis van de theoretische argumenten van Shirley en Walsh (2000). Met
behulp van hun argumenten hebben wij ons onderzoek onderverdeeld in de
categorieën overheidsbedrijven, bedrijven in de overgangsfase en geprivatiseerde
bedrijven. Wij vergelijken de mate van operationele efficiëntie van de
overheidsbedrijven met die van de geprivatiseerde bedrijven en geven een overzicht
van de kenmerken van geprivatiseerde bedrijven en bedrijven in de overgangsfase.
Hierbij richten wij ons vooral op het effect van het eigendom op concurrentie en
waardecreatie. Naar onze mening bepaalt de concurrentie de efficiëntie waarmee
bedrijven waarde kunnen creëren. Echter, ook het eigenaarschap blijkt bepalend te
zijn voor het concurrentiepotentieel, de mate van managementefficiëntie, en het
creëren van waarde in het bedrijf.
+HWFRQFHSWXHOHUDDPZHUN
Ons conceptuele raamwerk plaatst het interne en externe werkkapitaal management in

de Eritrese context. Met Rappaport (1986) beweren wij dat de beslissingen van het
management zich moeten concentreren op drie hoofdcategorieën: de beslissingen over
de activiteiten, de beslissingen over de investeringen en die over de financiering. Wat
de DFWLYLWHLWHQ betreft gaat het om beslissingen over de aankoop van materialen, het
productieproces, en de verkoop van eindproducten. De beslissingen omtrent
LQYHVWHULQJHQ hebben betrekking op kapitaal in de vorm van contanten, debiteuren, en
voorraden. De ILQDQFLHULQJVbeslissingen betreffen de keuze van de financiële bronnen

en het beheren van de financiën.
Het conceptuele raamwerk van dit onderzoek gebruikt de interne werkkapitaal

categorieën ook als bouwstenen voor de analyse van het externe management van het
werkkapitaal. Samenwerking tussen bedrijven kan resulteren in een drieledig
waardenetwerk waarin het bedrijf, zijn leveranciers en de klanten een keten vormen.
Samenwerking kan het bedrijf, zijn leveranciers en de klanten helpen om de
gemeenschappelijke opslagkosten te verminderen die voortkomen uit de activiteiten
met betrekking tot het werkkapitaal management op de verschillende niveaus. Als de
inkoopactiviteiten van het bedrijf goed gecoördineerd worden met de
verkoopactiviteiten van de toeleverancier zullen de transactiekosten, de benodigde
hoeveelheid aan contanten, de opslagkosten van de eindproductenvoorraad van de
leveranciers en de voorraad grondstoffen van het bedrijf zelf kunnen worden
verminderd. Samenwerking met de leverancier kan het voor een bedrijf ook
gemakkelijker maken om meer kredietfaciliteiten te verkrijgen. Verder kunnen de
verkoopactiviteiten van het bedrijf en de aankoopactiviteiten van de klant zodanig
worden gecoördineerd dat de onderlinge transactiekosten tussen het bedrijf en de
leveranciers, de opslagkosten van de eindproducten voor de klant, en de hoeveelheid
debiteuren en contanten kunnen worden verminderd. Het effect hierbij is cumulatief;
Summary 362
de drie partijen: het bedrijf, zijn leveranciers, en de klanten kunnen meer waarde
creëren dan wanneer zij hun activiteiten niet op elkaar hadden afgestemd.
Het is mogelijk dat er nog andere factoren zijn die de manier bepalen waarop het
interne en externe werkkapitaal en daaruit voortvloeiende activiteiten worden beheerd
met het doel waarde te creëren voor bedrijven. Daarom hebben wij ook rekening
gehouden met de volgende zaken: de invloed van het eigenaarschap, regels van de
overheid, managementpotentieel, en culturele factoren.
Tenslotte geven we ook het belang van performance metingen aan bij de beoordeling
van werkkapitaal beslissingen. Performance metingen worden gedaan om te
bestuderen of een bedrijf met het intern en extern managen van werkkapitaal waarde
creëert. Er zijn financiële en niet-financiële performance maatstaven en
beoordelingssystemen. De financiële performance beoordeling gebruikt financiële
accounting informatie en de niet-financiële de oordelen van managers en voor de
externe aspecten ook de oordelen van toeleveranciers en afnemers.
'HRQGHU]RHNVPHWKRGRORJLH
Yin (1994) beschrijft vijf mogelijke onderzoeksbenaderingen: onderzoek door middel

van case research, experimenten, vragenlijsten, historische bronnen, en analyse van
gegevens uit archieven. Op basis van de kenmerken van de genoemde soorten
onderzoek, is onze voorkeur uitgegaan naar de case research methode als meest
geschikte voor onze onderzoeksvraag en –doelstelling. Wij hebben bij de case
research methode een onderverdeling gemaakt in: de globale case research, het
veldonderzoek oftewel gegevensverzameling, gegevensanalyse en criteria voor het
toetsen van de geloofwaardigheid van onze bevindingen.
Wij hebben ons gericht op de EHVFKULMYHQGH en YHUNODUHQGH case research

benaderingen. Wij hebben overheidsbedrijven, bedrijven in de overgangsfase naar
privatisering, alsmede geprivatiseerde bedrijven als casussen gebruikt. Wij hebben
gebruik gemaakt van zowel kwalitatieve als kwantitatieve gegevensanalyse. Volgens
Miles en Huberman (1994) geeft kwalitatieve gegevensanalyse door middel van
observaties, interviews en rapportages de “essentie” van mensen, objecten en situaties
weer. Bij de kwantitatieve gegevensanalyse hebben wij in ons onderzoek gebruik
gemaakt van financiële kengetallen.
'HHPSLULVFKHEHYLQGLQJHQ
Wij hebben onze empirische bevindingen als basis gebruikt voor het analyseren van
zaken die betrekking hebben op het interne en externe werkkapitaal management.
Summary 363
,QWHUQZHUNNDSLWDDOPDQDJHPHQW
*OREDDO EHOHLG WHQ DDQ]LHQ YDQ ZHUNNDSLWDDO Het ontbreekt overheidsbedrijven en
bedrijven in de overgangsfase aan een duidelijke doelstelling en visie ten aanzien van
het interne en externe werkkapitaal management en de daarmee samenhangende
activiteiten. Hoewel managers wat betreft de waardecreatie in hun bedrijven wel
degelijk het belang onderschrijven van een goed werkkapitaal management op alle
niveaus, hebben zij als gevolg van door de overheid opgelegde regels niet zoveel
speelruimte. De managers zijn van mening dat de overheidsregels, die zijn ingesteld
onder toezicht van het Ministerie van Defensie en NASPPE (National Agency for
Supervising and Privatising Public Enterprises), hun eigen gezag in de bedrijven in de
overgangsfase beperken. Behalve het gebrek aan gezag vormen de investering in en
de financiering van het werkkapitaal, de productiecapaciteit en de factor arbeid ook
een beperking. De problematiek rond de geprivatiseerde bedrijven wordt echter niet
veroorzaakt door het gebrekkige gezag van het management, maar door een gebrek
aan managementpotentieel, heldere doelstellingen en gekwalificeerd personeel.
,QYHVWHULQJ HQ ILQDQFLHULQJ Beide RYHUKHLGVEHGULMYHQ die wij hebben bestudeerd

hebben te maken met excessieve hoeveelheden contanten en debiteuren. Maar door
hun onderlinge nauwe relaties kunnen zij de voorraden materiaal op een laag niveau
houden. De voorraad eindproducten wordt tevens op een laag peil gehouden door de
excessieve vraag vanuit het Ministerie van Defensie en het monopolie dat beide
bedrijven hebben op hun markt voor voedingsproducten. Ook hebben de
overheidsbedrijven geen problemen met het financieren van hun werkkapitaal
management en de daaruit voortvloeiende activiteiten, aangezien deze activiteiten
winstgevend zijn door de kostensubsidies en de gemonopoliseerde markt. Alle
bedrijven in de RYHUJDQJVIDVH, behalve Keih Bahri Tannery, verkeren in zware
liquiditeitsproblemen. Deze bedrijven hebben hun werkkapitaalbehoefte gefinancierd
door middel van rekening courant faciliteiten. Het debiteurenniveau is hoog doordat
de overheidsbedrijven traag zijn met betalen. Hierbij komt nog dat het voorraadniveau
ook toeneemt als gevolg van geringe verkopen. De eigenaren van de JHSULYDWLVHHUGH
bedrijven hebben zware leningen lopen bij overheidsbanken waarmee ze de bedrijven
hebben gekocht. Zij geven aan liquiditeitsproblemen te hebben, aangezien zij niet veel
financiële ruimte meer hebben voor andere zaken dan hun afbetalingen. Het gebrek
aan investerings- en financieringsmogelijkheden als gevolg van de afwezigheid van
markten voor vermogenstitels is tevens een belangrijke factor die bijdraagt tot het
inefficiënte management van het werkkapitaal in de geprivatiseerde bedrijven.
De verkopen van beide RYHUKHLGVEHGULMYHQ worden

,QNRRS HQ YHUNRRSDFWLYLWHLWHQ
gedreven door het Ministerie van Defensie, dat tevens fungeert als toezichthouder.
Het Ministerie van Defensie geeft eenvoudigweg de verkooporders door op basis
waarvan de bedrijven leveren wat is verzocht. Beide bedrijven hoeven zich nauwelijks
bezig te houden met het bedenken van strategieën voor het aankopen van materialen
en het produceren en verkopen van hun eindproducten. Het aankoop- en
verkoopbeleid van de EHGULMYHQ LQ GH RYHUJDQJVIDVH wordt min of meer door de
overheid opgelegd, alhoewel dit beleid relatief soepel is in vergelijking met de
overheidsbedrijven. Aangezien van deze bedrijven wordt aangenomen dat ze binnen
Summary 364
niet al te lange termijn zullen worden geprivatiseerd, wordt het management niet
gestimuleerd om aan lange termijn planning te doen en zolang er dus nog geen koper
voor het bedrijf is gevonden, is het management van de activiteiten gebrekkig. De
JHSULYDWLVHHUGH EHGULMYHQ blijken zich bij hun werkkapitaal management te beperken
tot aan administratieve procedures ten aanzien van inkopen en verkopen. Analyse van
inkoop- en verkoopactiviteiten heeft uitgewezen dat deze bedrijven geen
mechanismen aanwenden om de belangrijke aspecten van inkoop- en
verkooptransacties optimaal te benutten.
(YDOXDWLHYDQSUHVWDWLHVYDQZHUNNDSLWDDOPDQDJHPHQW Alhoewel managers beweren

gebruik te maken van prestatiemeting gebaseerd is op onder andere accounting
informatie, blijkt dat men hiervan nauwelijks gebruik maakt bij het nemen van
beslissingen. Desalniettemin hebben wij door middel van accounting informatie de
samenstelling van de activa van bedrijven bestudeerd alsmede de liquiditeitspositie,
de efficiëntie van hun activiteiten die verband houden met het werkkapitaal
management, en de globale winstgevendheid. De evaluatie die gebaseerd is op de
gegevens uit de jaarrekeningen geeft aan dat de RYHUKHLGVEHGULMYHQ beschikken over
zeer grote kasoverschotten, marginale winsten en liquiditeiten, en te maken hebben
met een lage omloopsnelheden. Financiële analyse van de EHGULMYHQ LQ GH
RYHUJDQJVIDVH geeft aan dat zij, met uitzondering van Keih Bahri Tannery, kampen
met zeer grote liquiditeitsproblemen, een lage omzetsnelheid en een ongunstige

liquiditeitspositie. De financiële analyse van de JHSULYDWLVHHUGHEHGULMYHQlaat zien dat
zij te maken hebben met liquiditeitsproblemen, lage omloopsnelheden en marginale
winsten (met uitzondering van Asmara Sweater Factory).
([WHUQZHUNNDSLWDDOPDQDJHPHQW
Overheidsbedrijven geven
%DQG EHGULMIOHYHUDQFLHU ± GH RSYDWWLQJ YDQ GH EHGULMYHQ
aan dat zij met hun leveranciers slechts samenwerken bij de binnenkomst van
goederen, zoals verzending en opslag. Geprivatiseerde bedrijven werken samen bij
zowel ingaande als productie-activiteiten, echter in mindere mate dan de
overheidsbedrijven. De bedrijven in de overgangsfase werken slechts op een
bescheiden manier samen met hun leveranciers, alleen bij ingaande activiteiten en in
dan het bijzonder de verzending. In het algemeen kan gesteld worden dat wat betreft
de marketing/verkoop en service alle bedrijven nauwelijks samenwerken met hun
leveranciers. Zowel overheidsbedrijven als bedrijven in de overgangsfase schrijven dit
gebrek aan samenwerking toe aan regels van de overheid waarop zij geen grip
hebben. De geprivatiseerde bedrijven dragen twee redenen aan: ten eerste bestaat er
geen gericht beleid ten aanzien van dit soort samenwerking, en ten tweede werken
hun leveranciers in het algemeen niet samen.
De leveranciers van alle

%DQG WXVVHQ EHGULMYHQ ± GH RSYDWWLQJ YDQ GH OHYHUDQFLHUV
bedrijven hebben aangegeven dat er wat betreft de primaire activiteiten een zeer
geringe samenwerking plaatsvindt. Zij werken slechts samen bij uitgaande activiteiten
zoals het verwerken van orders en in het bijzonder het aanleveren van goederen
wanneer nodig. Er vindt bijzonder weinig samenwerking plaats tussen geprivatiseerde
bedrijven en hun leveranciers wat betreft alle primaire activiteiten. Volgens de
Summary 365
leveranciers komt dit gebrek aan samenwerking door het feit dat de bedrijven hier niet
toe bereid zijn. Wanneer wij de reacties van de geprivatiseerde bedrijven vergelijken
met die van hun leveranciers kunnen wij constateren dat voor wat betreft de
samenwerking tussen bedrijven en toeleveranciers, de geprivatiseerde bedrijven een
veel rooskleuriger beeld geven dan de leveranciers.
(YDOXDWLHYDQGHOHYHUDQFLHUV De leveranciers van zowel de overheidsbedrijven als de
bedrijven in de overgangsfase zijn van mening dat hun samenwerkingspartners zeer

efficiënt functioneren als het gaat om de verwerking van inkooporders, bilaterale
communicatie, het geven van inlichtingen, hoffelijkheid en betaling in contanten.
Verder zijn volgens de leveranciers de bedrijven in de overgangsfase slechts efficiënt
als het gaat om hun betalingsprocedures. De leveranciers van de geprivatiseerde
bedrijven beoordelen hun samenwerkingspartners als minder efficiënt als het gaat om
marketingtechnieken.
Van alle bedrijven is gebleken

%DQG EHGULMINODQW GH RSYDWWLQJ YDQ GH EHGULMYHQ
dat de overheidsbedrijven het minst samenwerken met hun klanten. Wat betreft de
primaire activiteiten vindt er helemaal geen samenwerking plaats. Voor de bedrijven
in de overgangsfase geldt dat zij slechts in geringe mate samenwerken met hun
klanten bij uitgaande activiteiten, in het bijzonder de opslag van eindproducten en het
hanteren van materialen. De geprivatiseerde bedrijven hebben aangegeven dat er een
nauwe samenwerking met de klant plaatsvindt op het gebied van uitgaande
activiteiten en productie-activiteiten. Evenals bij de samenwerking tussen bedrijf en
leverancier, is de samenwerking tussen het bedrijf en de klant wat betreft
marketing/verkoop- en serviceactiviteiten en -diensten zeer gering. De reden die de
bedrijven geven voor de geringe samenwerking tussen bedrijven en de klanten is dat
klanten niet bereid zijn tot samenwerking. Bovendien hebben overheidsbedrijven en
geprivatiseerde bedrijven aangegeven dat de slechte samenwerking tussen bedrijven
en klanten komt doordat er geen beleid bestaat ten aanzien van een dergelijke
samenwerking, en dat de bedrijven zelf geen heil zien in een samenwerking met hun
klanten.
De klanten van alle bedrijven

%DQG WXVVHQ EHGULMYHQ ± GH RSYDWWLQJ YDQ GH NODQWHQ
hebben aangegeven dat er nauwelijks sprake is van enige vorm van

samenwerkingsovereenkomst met betrekking tot de primaire activiteiten en de diverse
werkkapitaalactiviteiten op de diverse niveaus. De bedrijven in de overgangsfase en
de geprivatiseerde bedrijven werken wat betreft de orderverwerking wel samen met de
klanten. De belangrijkste reden voor het gebrek aan samenwerking is dat bedrijven
hier niet toe bereid zijn. De managers van de geprivatiseerde bedrijven geven
wederom een rooskleuriger beeld dan hun klanten over de mate waarin zij
samenwerken wat betreft uitgaande en ingaande activiteiten, alsmede productie-
activiteiten.
%HRRUGHOLQJ GRRU GH NODQWHQ Alle bedrijven worden door hun klanten als efficiënt
beoordeeld wat betreft de kwaliteit van het product, de bilaterale communicatie, hun
onpartijdigheid ten opzichte van andere kopers, en het innen van rekeningen. Verder
Summary 366
beoordelen klanten de geprivatiseerde bedrijven als efficiënt voor de verwerking van

verkopen, de leveringen en de klantenkennis. De overheidsbedrijven en bedrijven in
de overgangsfase worden als efficiënt beoordeeld op de kosten van hun producten, en
de overheidsbedrijven en geprivatiseerde bedrijven op het geven van inlichtingen.
Aan de andere kant zijn alle bedrijven als inefficiënt beoordeeld op het gebied van
marketingtechnieken en klantenservice.
&RQVHTXHQWLHVYRRUWRHNRPVWLJRQGHU]RHN
&RQVHTXHQWLHVYRRU KHW FRQFHSWXHOH UDDPZHUN Het conceptuele raamwerk heeft ons

in staat gesteld om het begrip werkkapitaal management in een breder kader te
plaatsen en in het bijzonder inzicht te krijgen in de relatie tussen de diverse
componenten van het interne en externe werkkapitaal management. Ook hebben wij
met behulp van het raamwerk benaderingen geformuleerd ten aanzien van de
gegevensverzameling en analyse van de case-studies. Het conceptuele raamwerk heeft
als instrument gediend bij het bestuderen van de cases betreffende overheidsbedrijven,
bedrijven in de overgangsfase en geprivatiseerde bedrijven met betrekking tot drie
hoofdaspecten: het interne werkkapitaal management, het externe werkkapitaal
management, en deze geplaatst in de algehele Eritrese context. Onze bevindingen
laten zien dat in de praktijk de overheidsbedrijven, de bedrijven in de overgangsfase
en de geprivatiseerde bedrijven meer overeenkomsten dan verschillen vertonen.
Managers richten zich in het algemeen op het beheersen van het interne werkkapitaal
en niet zozeer op de financiële aspecten van investeringen in werkkapitaal en evenmin
op de financiering ervan. Wat betreft het externe werkkapitaal management blijkt uit
de empirische gegevens dat er een nauwe samenwerking plaatsvindt tussen de
overheidsbedrijven en de bedrijven in de overgangsfase, maar dat de samenwerking
tussen alle bedrijven en hun private toeleveranciers als afnemers zeer gering is. Het
blijkt dat vooral de algehele Eritrese context bepalend is voor de manier waarop
bedrijven hun interne en externe werkkapitaal managen. Zo spelen regels van de
overheid, machtspositie van het management, managementpotentieel en cultuur hierin
een primaire rol. Door deze factoren wordt aan het concept van de waardecreatie veel
minder betekenis toegekend dan in de ontwikkelde Westerse wereld. Voor toekomstig
case research in ontwikkelingslanden betekent dit dan ook dat het theoretische
conceptuele model zou kunnen worden aangepast door ook juridische, historische en
institutionele aspecten in te calculeren en aandacht te besteden aan de achtergronden
van het management van de bedrijven.
%HOHLGVFRQVHTXHQWLHV YRRU PDQDJHUV HQ GH RYHUKHLG Met het oog op onze
conceptuele achtergrond en praktijkbevindingen kunnen de volgende aanbevelingen
worden gedaan op bedrijfs- en overheidsniveau.
Op bedrijfsniveau zullen managers zo efficiënt mogelijk hun werkkapitaal
management moeten uitvoeren door het ontwikkelen van nieuw beleid en het
verbeteren van bestaand beleid. Verder zouden zij zich naast het werkkapitaal
management als zodanig ook moeten richten op het aspect van de waardecreatie.
Managers van de overheidsbedrijven en de bedrijven in de overgangsfase zouden de
ruimte moeten krijgen om namens hun bedrijven beslissingen te maken op het gebied
van het werkkapitaal. Zij dienen bestaande banden tussen bedrijven in kaart te
brengen en te versterken en nieuwe banden aan te gaan. Verder is het nodig dat de
Summary 367
managers een samenwerkingsbeleid voeren gebaseerd op onderhandeling, coördinatie

en wederzijdse aanpassing in plaats van op macht en het toepassen van
overheidsregels en -contracten. Verder dienen zij de samenwerking tussen bedrijven
te coördineren door middel van het ontwikkelen van de onderlinge relaties en niet met
behulp van strikte en formele controle mechanismen. De overheid kan een belangrijke
rol spelen in het creëren en verbeteren van instituties die de transactiekosten tussen
bedrijven verminderen. Naar onze mening zou de overheid haar regelgeving met
betrekking tot overheidsbedrijven kunnen opheffen en hun managers in staat moeten
stellen te handelen met volledig gezag en verantwoordelijkheid. De overheid kan
tevens een rol spelen in het stimuleren van contacten tussen bedrijven en faciliteiten
bieden voor samenwerking en het opzetten van netwerken. Ook zou zij de
bescherming kunnen opheffen die zij geeft aan de overheidsbedrijven voor zover zij
concurreren met de privé-sector en een bevorderlijk concurrentieklimaat kunnen
trachten te creëren door middel van een goed investeringsbeleid, het liberaliseren van
de markt en het oprichten van efficiënte financiële instellingen. In samenwerking met
landen in de regio zou de overheid de investeringsmogelijkheden en financiële
bronnen kunnen uitbreiden door het opzetten van een gemeenschappelijk
financieringssysteem en een regionale effectenmarkt zoals bijvoorbeeld de BRVM in
West-Afrika.
%HSHUNLQJHQYDQKHWRQGHU]RHNHQULFKWOLMQHQYRRUWRHNRPVWLJRQGHU]RHN
Met betrekking tot de voortzetting van onderzoek op het gebied van het interne en
externe werkkapitaal management stellen wij het volgende voor:
a) Toekomstig case research wordt voorafgegaan door een survey om zo een
completer beeld te krijgen van de situatie in Eritrea.
b) De documentatie van bedrijven over hun transacties met andere bedrijven te
gebruiken om transactie-partners te identificeren en onderzoek te doen naar de
opvattingen van partners zowel in binnen- als buitenland;
c) Ook zou bij meer leveranciers en klanten onderzoek kunnen worden gedaan.
d) Er zou onderzoek kunnen worden gedaan naar de ontwikkeling van de
bedrijven nadat ze geprivatiseerd zijn en gewend zijn aan hun nieuwe
privéstatus.
e) Een onderzoek als dit zou ook kunnen plaatsvinden in andere landen om zo de
mogelijkheid te hebben vergelijkingen te maken.
f) Verder onderzoek kan worden gedaan naar het tempo van het
privatiseringsproces van de geprivatiseerde bedrijven en de bedrijven in de
overgangsfase, aangezien dit proces hun interne en externe werkkapitaal
management kan beïnvloeden.
g) Er kan –tenslotte- niet met zekerheid beweerd worden dat in
ontwikkelingslanden overheidsbedrijven minder wenselijk zijn om
operationele efficiëntie te bereiken dan geprivatiseerde bedrijven. Hiernaar
zou ook verder onderzoek kunnen worden gedaan.

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University of Groningen

Working capital management

Link to publication in University of Groningen/UMCG research database

Citation for published version (APA):

Download date: 03-08-2018

Ter verkrijging van het doctoraat in de

geboren op 13 February 1957

Co-promotor: Dr. J. H. von Eije

Beoordelingscommissie: Prof.dr. R. W. Scapens

My wife and my children

Sebhatleab Tewolde Groningen, September 2002

1.1. Relevance of working capital ............................................................................... 3

2.1. Introduction ........................................................................................................ 19

3.1. Introduction ........................................................................................................ 45

4.1. Introduction ........................................................................................................ 69

5.1. Introduction ........................................................................................................ 85

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6.1. Introduction ...................................................................................................... 113

6.3.3. Managing working capital operations............................................................ 123

7.1. Introduction ...................................................................................................... 147

7.3.4.4. Working capital performance - comparison of transition firms . 165

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8.1. Introduction ...................................................................................................... 179

8.4.2.2. Firm-customer co-operation – comparison of privatised firms 205

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9.1. Introduction ...................................................................................................... 213

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10.1 Introduction ..................................................................................................... 247

10.3.2. Internal working capital management.......................................................... 258

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Figure 2.1: Working capital cycle.............................................................................. 20

value. Operations are results of inter-firm transactions. Therefore, managing working

Under the value measurement approach working capital management concentrated on

Investments in working capital assets can be financed by VKRUWWHUP GHEWV which

7KHYROXPHRIZRUNLQJFDSLWDOLQYHVWPHQW The importance of working capital also

7KHPDQDJHPHQW WLPH ZRUNLQJ FDSLWDO RSHUDWLRQV WDNH Most business operations

:RUNLQJ FDSLWDO PDQDJHPHQW LQ GHYHORSLQJ HFRQRPLHV the importance of

*RYHUQPHQW UHJXODWLRQV DQG FXOWXUDO IDFWRUV Government policy has always an

determine practical management approaches. The study of working capital

:RUNLQJ FDSLWDO PDQDJHPHQW DQG WUDQVLWLRQ WR SULYDWLVDWLRQ Working capital

7KH UHVHDUFK SUREOHP Research begins when a researcher’s curiosity is aroused

we considered to be less relevant where found to be of more importance in the

In order to search adequate answers to the problems we sub-categorise our objectives

working capital management in the context of a developing economy, specifically

YDOXH" This question requires answers to the following four sub-questions:

) Chapter 4 covers this issue. Section 4.2 covers the debate on

ownership, market competition and operational efficiency. Section 4.3 is devoted to

G The fourth conceptual sub-question that we addresses is: :KDWLVWKHDSSURSULDWH

RXUUHVHDUFKTXHVWLRQV" Chapter 5 combines the internal and external working capital

ZRUNLQJ FDSLWDO? By getting an answer to this empirical sub-question we try to find

Chapter 7 deals with this research

working capital management, including firm-supplier linkages (8.4.1) and firm-

The third sub-question assesses the lessons that

H[SHULHQFHV RI WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG PDQXIDFWXULQJ ILUPV LQ

Research is a process - a series of linked activities moving from a beginning to an end

Case research studies can be H[SORUDWRU\, GHVFULSWLYH K\SRWKHVLV WHVWLQJ or

of organisational research by making a complete investigation. It is used when the

Traditionally, it is believed that objectives of managing working capital can be achieved

globalisation, managers concentrating only on the efficiency of their internal operations

'RFXPHQWDU\ LQIRUPDWLRQ – includes letters, memoranda and other internal

Asmara Milk Factory and other privatised firms.

&KDSWHU  includes a cross-sectional and comparative data analysis of the empirical

&KDSWHU winds-up the thesis by presenting comparison between the expectations of

present the general introduction and background of working capital management in

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&+$37(535,9$7,6('),506

75$16,7,21$1'35,9$7,6('),506

&+$37(5&21&/86,216$1'5(6($5&+,03/,&$7,216

6800$5<,1(1*/,6+$1''87&+

Investments in working capital assets can be financed by VKRUWWHUP GHEWV which

G The fourth conceptual sub-question that we addresses is: :KDWLVWKHDSSURSULDWH

H[SHULHQFHV RI WKH JRYHUQPHQW WUDQVLWLRQ DQG SULYDWLVHG PDQXIDFWXULQJ ILUPV LQ

Case research studies can be H[SORUDWRU\, GHVFULSWLYH K\SRWKHVLV WHVWLQJ or

&KDSWHU includes a cross-sectional and comparative data analysis of the empirical

&KDSWHU winds-up the thesis by presenting comparison between the expectations of

:RUNLQJ FDSLWDO PDQDJHPHQW DQG SURILWDELOLW\ OLTXLGLW\ ULVN WUDGHRIIfrom the

3ODQQLQJFDVKUHTXLUHPHQWVWKHFDVKEXGJHW A cash forecast or cash budget is a

:RUNLQSURFHVV inventories are needed because there is no perfect synchronisation

6KRUWWHUPEDQNORDQV When the bank loan is approved, the agreement is executed

&XUUHQW DVVHWV ILQDQFLQJ SURILWDELOLW\ULVN WUDGHRII The short and long-term

6KRUWDQGORQJWHUPGHEWPL[ The financing logic is that, temporary current assets

6SHHGLQJXSFDVKFROOHFWLRQV A firm has to speed-up the collection of sales so that