Optimalization Profitability through Working Capital ... - Titik et.al - Capital... · Optimalization Profitability through Working Capital Management and Capital ... Profitability

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Optimalization Profitability

through Working Capital Management and Capital Structure:

Evidence from Indonesian Banking Industry1

Titik Agus Setiyaningsih2

Siti Hamidah Rustiana

Siti Jamilah

Andi M. Alfian Parewangi

Abstract

This paper analyze the impact of working capital management particularly working

capital and capital structure on banking profitability. We apply panel estimation on

monthly data over 105 banks during the period of 2003 – 2013, covering State-owned

Bank, Foreign Exchange Public Bank, Non Foreign Exchange Public Bank, Regional

Development Bank, Foreign Bank and Mix Bank. The result shows a significant positive

effect of capital structure on banking profitability. The working capital also affect the

banking profitability positively. These findings emphasize the importance of the third

party fund for the bank, and the neeed to better manage their working capital.

Key words : Capital Structure, Working Capital, Bank Performance

JEL Classification: G32, C33

1 This paper is prepared for Economic Modelling Conference 16 – 18 July, Bali, Indonesia.

Author thanks to University of Muhammadiyah Jakarta for the funding. We also thank to Bank Indonesia

and EcoMod Network for hosting the conference. 2 Titik Agus Setyaningsih (Corresponding Author; [email protected]) is a Master from University of

Muhammadiyah Jakarta. Siti Hamidah Rustiana ([email protected]) is a lecturer at Postgraduate

Program, University of Muhammadiyah Jakarta; Siti Jamilah ([email protected]) is a lecturer at

University of Muhammadiyah Jakarta; Andi M. Alfian Parewangi ([email protected]) is a

editor on Bulletin of Monetary Economics and Banking and lecturer at Postgraduate Program, University

of Muhammadiyah Jakarta.

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1 INTRODUCTION

The monetary crisis on July 1997 caused the banking crisis and made banking industry to

plunge. Started from the Rupiah exchange value toward USA Dollar which depreciated

sharply, many activities in real sector and banking which earned loan in foreign

currencies experienced a difficulty to return the loan. This affected to the difficulties of

liquidity on baking sector, thus, it forced banks to increase their saving interest rate for

more than 70% in order to be able to attract the society’s fund and to fulfill the liquidity

needs. (Wardiah, 2013).

At that time, there were 38 liquidated banks, 9 banks were the private national

bank which followed recapitulation program and 73 private national banks which did not

follow the recapitulation program (Iskandar, 2013). Therefore, the government issued a

Law No. 10 Year 1998 about banking, as banking restructurization program. The Bank

Indonesia as the monetary authority also constructs the Indonesian Banking Architecture

as the base frame of the banking system in Indonesia, which strengthening the public

bank’s capitalization in order to increase the ability of bank to manage work and risk, to

develop the information technology, and to increase its work scale.

A good working capital management will help the firm to reach their goal on

maximizing profit. Profitability is one of the measurements of the firm’s performance.

To draw the ability of firm to gain profit, a ratio to is used to measure it.In banking

industry, the ratio to measure the ability of a bank to earn profit (profitability) is on asset

(ROA) and return on equity (ROE).

Some researches which focused on capital structure were Velnampy and Niresh

(2012), Taani (2013), Uniariny (2012), Sri Wahyuni (2012) and Mas’ud, Subroto, Salim

and Sutrisno (2013). Meanwhile, researches focused on Working capital were conducted

byAgyei and Yeboah (2011), Raheman, Afza, QoyyumdanBodla (2010), Vourikari

(2012) and Ganesan (2007). Velnampy and Niresh (2012) founded that 89% of the total

assets on banking sector in Sri Lanka was funded by debt. Whereas Taani (2013) founded

that net profit, return in capital employedand net interest margin influenced significantly

and positively toward the total debt, and it also found that the total debt was not a

significant determiner factor toward return on equity in banking industry in Jordan.

In Indonesia, the research about working capital and capital structure toward the

profitability in banking sector was conducted by Uniariny (2012) which found that capital

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structure influence significantly toward the firm value while the intellectual capital did

not influence positively toward the firm value. Marberya and Suaryana showed that the

profit growth influenced toward the relation between Debt To Equity Ratio (DER) and

profitability.

Assessing the impact of working capital toward the banking performance becomes

the background of this paper. For banking industry, the role of working capital and its

management are different from any other industry. This is because the elements of

working capital of banking industry are different. The need of the management of

working capital and capital structure for banking industry is really important because until

today, banking industry has yet to play an optimum role in the economy of Indonesia.

Previous research studied more on manufacturing industry with little samples. Whereas

the samples use by the researcher are for about 105 conventional public banks which

operate all over Indonesia and has been registered on the website of Bank Indonesia.

The writer hopes that this paper can give reference on management of working

capital, capital structure, and profitability in banking industry in Indonesia. The next of

this paper outline capital structure, working capital, profitability and the role of external

toward Firm, section three metodology, section four analyses and discussion, section five

conclusions and suggestion.

2 THEORETICAL FRAMEWORK

2.1 Profitability

In general, profitability is used to measure firm performance ratio management activity

comprehensively based on the amount of earned profit as returning of capital working,

sales, and investment, expressed in percentage. Profitability can describe how well

company prospect in maintaining life continuity and developing its business in the future.

This situation assumes that company can retain its prospect in order to earn profit for

lives moreover expand the brighter business. This sort of good company will attract

investors to invest.

Profitability ratio applied in general namely Net Profit Margin = Earning After

Tax / Sales, Return on Investment = Earning After Tax / Asset in Total, or Return on Net

Worth = Earning After Tax / Equity (Tampubolon, 2005 : 39). Analogue with that,

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rentability ratio also used often to analyze or appraise endeavor efficiency level and

profitability achieved by the relevant bank. (Dendawidjaya ; 2001 ; 119-122).The

Rentability ratio commonly used is Return on assets (ROA), measured the ability of bank

management related to gain profit and Return on Equity (ROE), which constitutes as

important indicator for stock holders and investor to determine bank proficiency

concerned with competence of earning after tax linked to dividend pay out.

Another rentability ratio is Operational Expense Ratio, measured the efficiency

grade and bank capability to conduct its operational activities. This ratio calculated as

percentage of operational cost to operational revenue (BOPO). Net Profit Margin (NPM)

is also rentability ratio estimated as earning after tax ratio to operational revenue. This

ratio refers to bank operational revenue especially from credit provision work, which

practically has several risks.

There are many factors influencing the firm’s profitability. Among those

determiner factors, this research focuses on the influence of structure, quantity and capital

management have by the financial institution bank. The next session from this chapter

will discuss one by one the factors which influence the firm’s performance.

2.2 Capital Structure

The analysis of capital structure is one of the elements of solvability analysis, and DER is

one of the indicators of the solvability. This ratio of solvability measures the ability of a

bank to fulfill its long term liability or the ability of a bank to fulfill its liabilities if bank

liquidation occurs (Dendawidjaya:2001: 122).

In this research Debt to Equity Ratio (DER) is used as the proxy of capital

structure. DER reflects the ability of firm to meet all its liabilities which are shown by

some parts of its capital used to pay the debt (Riyanto, 2005). The greater Debt To Equity

Ratio (DER) shows that the structure of financing relies much on relative debts toward

equity. The size of the ratio of capital structure relates the component of capital structure

from one to the other or with its total (Subramanyam:2010:270-271). Besides DER, the

other indicators of capital structure are Capital Adequency Ratio (CAR); Long Term Debt

to Assets Ratio; Total Debts to Total Capital; Total Debts to Equity Capital; and long

term debt toward equity.

According to Margaretha (2007:219) the capital structure presents the firm’s

permanent financing which consists of long term debt and capital. The capital structure is

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the balance of the total of short term debt which is stable, long-term debt, preference

stock and stock (Halim, 2007). Other definition of capital structure is that the equity

financing and debt on a firm is sometimes counted based on the relative quantity as the

source of financing (Subramanyam, 2010:263). The capital structure of firm is influenced

by many factors in which mainly are rate interest, stability of the income, assets

composition, assets risk rate, total capital needed, stock market condition, management

characteristic and the firm size (Riyanto, 2001; 297-299).

The capital structure of the financial institution is fundamentally different from

non-financial firm, because the business characteristic or its operational activity is

different. Furthermore a bank has to have buffer based on the policy or regulation of the

supply of minimum core capital estimated by the monetary authority in which in this case

is the central bank, so that it will be able to protect its depositor’s fund (Saunders in

Siringgoringo,2012).

One of them is the capital structure was developed by Franco Modiglani and

Merton Miller in 1958, or more known as the theory of MM. It states that the firm value

depends on the future earning streams, and therefore, it does not depend on the capital

structure. Modigliani and Miller built their model with assumption that every firm had the

expectation of certain cash flow. When firm chose certain portion of debt and equity to

finance its assets, it meant as dividing cash flow across the types of investor. Investor and

firm were assumed to have the same access toward the financial market and possible them

to determine the leverage.

The other approach is dividend theory. This theory is also developed by

Modiglani and Miller, it stated that the dividend policy did not influence the firm value,

because every Rupiah of the dividend payment will lessen the retained profit used to buy

new assets.

Harry Markowitz (1990) proposed portofolio theory and capital asset pricing

model. Portofolio theory explained that risk can be decreased by combining some types of

risk assets rather by holding one type of asset only. This model, then, was developed by

Sharpe, John Litner and Jan Moissin became Capital Asset Pricing Model that separately

show that the level of profit signalized to certain risk assets was the function of three

factors, which were (i) the non-risk Profit Level; (ii) Profit Level on Portofolio signal

with average risk; and (iii) Volatility risk assets profit level.

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Other theory about capital structure is Agency Theory. This theory is developed

by Michael C, Jensen and Wiliam H. Meckling. This theory emphasized the separation

between the owner and management. Agency problem arise when an individual (owner)

pays an individual (agen) to perform by his name, delegates his authority to make

decision to agent or its worker.

Husnan and Pudjiastutik (2008) propose pecking order theory, which based on the

asymmetric information, where management has more information (about prospect, risk,

and firm value) than what capitalist have. Besides, Brealey and Myers (1996) in Husnan

and Pudjiastutik (2008) implied that firm prefer internal financing. This is also supported

by Sebayang and Putra (2013) which state that firm gives priority to internal equity

financing (using retained profit) rather to external financing (publishing new stock)

Those capital structures theories above are applicable for non-financial firm and

also for banking industry (Marques and Santos in Siringgoringo, 2012). These capital

structure theories can be the first step to analyze the performance of banking in Indonesia.

If the influence of this capital structure is significant, then, probably there is the best

capital structure. Empirically, there are three indicators of capital structure (i) profit

before interest and tax; (ii) net profit before tax; and (iii) traditional approach, (Halim,

2007).

2.3 Working Capital Management

The working capital management related to the management of current asset elements and

current liabilities elements. The system of working capital management have five parts

that are related each others.

Figure 1 . Management System of Working Capital

Management

Goal

Bussiness

Environment

Management

Policy

Management

Mode

Performance

Evaluation

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Firm effectiveness in managing its working capital can be measured by using

working capital turnover ratio. Working capital turnover period is started from when cash

is invested in working capital components to when it is come back again becoming cash.

The shorter the period, the faster the turnover.

Working capital policy is a strategy that is implemented by firm in order to fulfill

the needs of working capital with the alternative of funding source. Working capital

policy that could be taken by firm according to Sutrisno (2012:42-44) are:

a. Conservative policy; the plan for fulfilling working capital funding by using

more the long term funding source than the short term funding source.

b. Moderate policy; firm finances every asset with similar period with its assets

turnover period.

c. Aggressive policy; firm prefers to a more secured factor so that it result a

really big security margin, however it will cause profitability level becomes

low.

The chosen magnitude of working capital refer to the turnover period or working

capital period and the mean of daily cash period (Sjahrial, 2006:107). The working capital

period is the period needed for a cash invested into working capital elements to be a cash

again. Longer working capital period will increase the number of required working

capital and vice versa. The other factors that can influence the size of working capital are

the projection of daily cash needs on average and the implemented method of working

capital turnover.

Working capital management in service industry and manufacture are different

because the elements of its working capital are different. Working capital management is

the element management of current asset and current liabilities. The elements of current

asset are cash, negotiable papers, accounts receivable, treasury and financing (Harjito,

2006). Services industry used as analysis unit in this research is banking. The element of

working capital that is different from banking industry is treasury because banking

industry result services instead of product as the last result or output.

2.4 The Role of External Factor toward Firm Profitability

Industry Characteristic

Based on the capital intensify, it can be divided into two; first, intensive capital industry

is an industry that is built in a great number of capitals to conduct its operational activity.

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Second; intensive capital industry is an industry emphasizing in the number of resources

belong to it in constructing and conducting this industry.

The industry type defines firm based on the scope of operation, firm risk and

ability in facing business challenge. Industry type is measured by dividing into high

profile and low profile industry. According to Novita Indrawati (2009), in general, high

profile companies are firm that get attention from the society because its operational

activity has potency to be touched with a wide interest. In other hand, low profile firm is a

firm that does not really get a wide attention from the society whenever its operation get

failed or miss in specific aspect in its process or production result (Sari,2012).

Monetary Policy

Capital management in banking is influenced by monetary policy. Monetary policy may

influence the real economy activity and price through the real economy (Ascarya:2012).

Other literatures explained by Ariccia et all (2010) states that monetary policy changes

the bank supervision (risk taken measurement) which depends on the stability of interest

rate, shifted risk and leverage.

The direct monetary policy is commonly used by central bank or monetary

authority in developing countries. Policy that is classified as direct can be in the form of

credit ceiling or credit influence the operational target by central bank as monetary

authority and the shapes are in the form of minimum liquidity, discount facility, open

market operation (OMO), the deposit facility of Bank Indonesia (FASBI), the re discount

facility which is funding facility provided by bank Indonesia for bank that need funding

through rediscounting its negotiable papers .

3 METHODOLOGY

3.1 Population and Samples of Research

The population used in this study was Conventional Banks listed in the publications data

of Bank Indonesia during the period of November 2003 to October 2013. As such, the

samples taken were around 105 conventional banks operating in Indonesia from 6 types

of banks, namely: state-owned banks, foreign exchange banks, non-foreign exchange

banks, regional development banks, foreign banks and mix banks.

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Table1. the Descriptive Statistic of Mix Bank

ASSET NWC EQUITY DEBT ROE DER

Mean 12691236 990245 1010971 11108093 0.278349 23.7952

Median 5542661 467956.5 403043 4460898 0.090672 11.02673

Maximum 1.24E+08 20282269 17876900 1.13E+08 4.49549 294.2438

Minimum 12909 -7974424 50000 67 -0.60469 0.00022

Std. Dev. 18121865 2824080 1811215 16478740 0.534258 43.04028 Data source :Processed Data

Table 2 .The Descriptive Statistic of Foreign Exchange Bank

ASSET NWC EQUITY DEBT ROE DER

Mean 29034680 -649504 1741041 25911342 0.170717 16.68423

Median 5368401 -108125 460000 4076008 0.079458 11.69051

Maximum 4.80E+08 40622913 13313348 4.21E+08 8.011549 306.5337

Minimum 262959 -7E+07 20000 -107566 -0.88106 -0.86978

Std. Dev. 57744014 8829741 2650985 52022722 0.359749 21.89921 Data source :Processed Data

Table 3. The Descriptive Statistic Non- Foreign Exchange Bank

ASSET NWC EQUITY DEBT ROE DER

Mean 1355967 -36861.7 143746.6 1187591 0.184031 8.789547

Median 592925 -27981 92750 487464 0.032933 7.377772

Maximum 16491563 1944707 1229175 14898493 13.29888 47.04909

Minimum 186 -1714443 10000 -41548 -0.89522 -1

Std. Dev. 2003313 212680.9 191516.8 1814716 1.023297 6.897122 Data source :Processed Data

Table 4. the Descriptive Statistic of State-owned bank

ASSET NWC EQUITY DEBT ROE DER

Mean 2.10E+08 4982749 12828419 1.92E+08 0.211163 16.70863

Median 1.97E+08 6267184 9998432 1.79E+08 0.131921 14.08607

Maximum 6.16E+08 45584351 63935703 5.42E+08 2.024405 57.79661

Minimum 525062 -38021367 48000 486432 0 1.602301

Std. Dev. 1.42E+08 11566598 7153956 1.26E+08 0.290257 10.24409 Data source: Processed Data

Tabel 5. The Descriptive Statistic of BPD

ASSET NWC EQUITY DEBT ROE DER

Mean 9991416 -1864383 460207.2 8789913 0.289176 18.17012

Median 5299636 -865208 292225 4605600 0.248509 17.63283

Maximum 4.23E+08 11802909 5319778 3.75E+08 2.209267 79.72961

Minimum 214440 -7E+07 12551 -2413415 -0.5807 -2.28277

Std. Dev. 26211305 4141143 631245.1 23705125 0.234134 7.499295 Data source :Processed Data

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Table 6. The Descriptive Statistic of Foreign Bank

ASSET NWC EQUITY DEBT ROE DER

Mean 19052982 2120863 403692.4 17550508 128.2605 17400.62

Median 11657381 447412.5 140210 11209206 0.739437 274.8471

Maximum 87006417 49035837 1942569 78378989 71200.6 12561177

Minimum 285794 -8175992 -8297 -6049 -477.031 -59285.1

Std. Dev. 19443828 6148036 597342.2 18085993 2179.459 383337.7 Data source :Processed Data

3.2 Empirical Model, Variables and Proxy

The empirical model estimated in this thesis is as follows:

ln ROEit =β0 + β1*NWCit + β2*lnASSETit +β3

*DERit+ β4

*DIVit+β5

*SIZE +

β6*GDPit +β7

*Inflationit+eit

The dependent variable in this study is the performance of banks measured by Return on

Assets (ROE). This bank performances are influenced by a range of independent

variables (independent), including Net Working Capital (NWC), Debt to Equity Ratio

(DER), bank size (SIZE), the diversification of income sources (DIV), and

macroeconomic conditions (GDP and inflation).

Table7. Variables, Operational Definitions and Indicators

No Variables Definitions Sub

variables Indicators Scales

1 ROE bank's ability to obtain

net income attributed to

the dividend payment.

Profitability

x

100 %

Ratio

2 DER bank's ability to cover

part or all of its debts,

both long term and short

term, with funds derived

from the bank 's own

capital

Solvability

x

100 %

Ratio

3 NWC current assets nett of their

current liabilities or

short-term debts

Liquidity

Nominal

Source: Dendawidjaya (2001)

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4 ANALYSIS AND DISCUSSION

4.1 Estimation Result

We estimate 4 (four) model specification, to test the sensitivity of estimation result

toward the specification of model. The estimation result of these four models shown on

Table 8. The Selection Test between Generalizes Least Square (GLS), Fixed Effect

Model (FEM) and Random Effect Model (REM) shows that the specification of FEM is

more precise relative to GLS or REM.

As what have been mentioned before, variables used on those four models above

include ROE or Return on Equity, DER or Debt Equity Ratio; NWC or Net Working

Capital; EQTA or Equity Quality to Total Asset; LOTA or Loan to Total Asset; PRTO

or Provision to Total Asset; DETA or Debt to Total Asset; NETA or Non interest

Expense to Total Asset; TOPB or Taxes Over Operating Profits Before Tax; DIV

or Diversification; Size or the size of Bank; INFL or Inflation; and GDP or Gross

Domestic Product. This research focuses on three (3) main variables: profitability (ROE),

capital structure (DER), and working capital (NWC).

Generally, the performance of Model 1 and Model 3 which are measured by R-

square (each is for about 99%), are better than that of Model 2 and Model 4 (each is for

about1,1% and 31,78%). Model 1 and Model 3 use variable of Debt to Equity Ratio

(DER) to represent the capital structure. On Model 2 and Model 4, Debt and Equity are

included separately on the model, as the ratio toward the total assets of bank.

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Table8. The Estimation Result

Variable Model – 1 Model - 2 Model – 3 Model - 4

C 1.287653 -89.90701 -4.592682 9.402949

(0.669145)* 101.5718 (0.533973)* (0.578340)*

DER? 0.005668 0.005668

(4.81E-08)* (5.69E-08)*

9.21E-09

NWC? 7.96E-09 1.09E-06 (1.54E-09)* 8.35E-09

(1.50E-09)* (1.27E-06)*** (1.87E-09)*

EQTA? 2.202004 -0.434889

(0.989936)** (0.073326)*

LOTA? 0.03228

(0.006100)*

PRTO? 0.02738 0.004564

(0.029598)*** (0.024902)***

DETA? -1.730145 -0.406766

(0.769939)** (0.098346)*

NETA? 3.394978 61.20638 8.73039 4.436916

(1.368043)* (38.19654)*** (0.345636)* (0.592147)*

TOPB? 0.000477 0.001868

(0.000557)***

(0.001318)***

DIV? -0.606539 78.89704 -0.591068 -0.350748

(0.149493)* (102.1682)*** (0.116953)* (0.189849)**

SIZE? 0.062728 0.082743

(0.013778)* (0.021830)*

INFL -0.363561 -11.27557 0.594322 0.290967

(0.193711)** (21.24857)*** (0.403514)*** (0.208682)***

GDP 0.119163 7.150147 0.47198 0.199536

(0.050121)* (7.225000)*** (0.040960)* (0.032628)*

R-squared 0.999985 0.011889 0.999985 0.317799

Sum squared resid 946389.3 5.05E+09 9.997831 1.83E+08

F-statistic 5452356 1.296241 5452356 38.34899

(9.997831)* 0.020069 (9.997831)* (138.9384)*

Durbin-Watson stat 0.507371 2.042707 0.507371 0.975631

Note: dependent variableisReturn on Equity (ROE). The number in the bracket below the coefficient shows the standard error*)

significanton1%, **) significanton 5%, ***) significant on 10%.

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4.1.1 The Influence of Capital Structure to Profitability

The estimation result shows a significant influence of capital structure toward

profitability of bank. Every 1 (one) percent of increase of Debt to Equity Ratio will cause

the increase of banking profitability for about 0,0056 percent (see Model 1 and Model 3).

This means that banking which tend to rely on external capital source in the form of debt

tend to have a greater performance.

On model 2 and 4, the variable of Debt to Equity Ratio (DER) is divided based on

its components which are debt and equity. The estimation result shows that DETA (Debt

to Total Assets) and EQTA (Equity Quality to Total Assets), in fact , cannot really

explain its dependent variables because the result of R2

are 0.011889 and 0.317799.

Besides, the divide of this variable components result an inconsistent estimation result

parameter toward hypothesis, in which the influence of the addition of debt capital will

only decrease the performance (-1,7 on Model 2 and -0,4 on Model 4).3

Back to Model 1 and Model 3, the estimation result gained is in a line with the

research conducted by Abor (2005) in Subhita & Asawalhah (2012) which states that

there is positive and significant influence of capital structure to profitability proxied by

ROEon the firm listed in Ghana Stock Exchange. The research conducted by Taani

(2013) on banking industry in Ghana also supports that statement. Saeed et.al. (2013)

support the statement that there are significant and positive between capital structure and

profitability on the banking industry in Pakistan. On the case in Indonesia, Wahyuni

(2012) also finds that the capital structure (DER) has positive and significant toward

profitability (ROE).

From six groups of bank (Shareholder, BPD, Foreign Exchange, Non-Foreign

Exchange, Mix, and Foreign), the debt of foreign banks are relatively high. The highest

debt within the group of state-owned bank is Bank Mandiri, with the value of debt Rp

542.000.000 (in thousands), while the lowest one is Regional Development Bank of

North Sulawesi.

3The reason of this specification is to seen the individual influence of every source of financing of capital of

bank.

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Figure1. Bank Capital based on group

Figure 2 shows the capital invested by every group of banks to run its operation,

the capital in this case is the invested besides debt. Maximum capital expends within the

state-owned bank group which is Bank BNI on Rp 63.935.703 (in thousands). For the

group of foreign bank, the biggest proportion of debt in the capital structure belongs to

The Hongkong& Shanghai B.C. and Citi Bank, Deutche Bank is the third. Figure 2

illustrate the ability of the Hongkong & Shanghai BC and Citi bank on collecting thierd

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03

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07

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11

2011M

03

2011M

07

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11

2012M

03

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ou

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ds Capital of Foreign Exchange Bank

Bank NISP Bank Niaga

Bank Panin Bank BCA

Bank Danamon

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ANZ Panin Bank

Rabobank International Indonesia

Bank Mizuho Indonesia

Bank Resona Perdania

Bank Sumitomo Mitsui

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BPD Papua Bank SULUT

BPD Kalteng BPD Kaltim

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s Capital of Non Foreign Exchange Bank

Bank Yudha Bhakti Bank Alfindo

Bank Ina Perdana Prima Master Bank

Bank Artos Ind

Page 15

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party fund in Indonesia, since January 2006. Starting from October 2011, the Hongkong

& Shanghai BC exceeded the Citi Bank

Figure2. The Debt of Foreign Bank

4.1.2 The influence of Working Capital toward Profitability

The estimation result shows that Net Working Capital (NWC) influence positively and

significantly the performance of bank, with coefficient of about 7. 96E-09. Thus, it can be

concluded that the improvement of working capital for about Rp1 billion, will result an

increase of ROE for about 7,9 per cent.

The positive influence of this working capital is supported by Agyei &Yeboah

(2011) which state that the elements of working capital influence significantly and

positively the profitability of the banking industry in Ghana. The research conducted by

Raheman, et al (2010) also supports that elements of working capital influence positively

and significantly toward the manufacturing sector in Pakistan.

However, the research conducted by Ganesan (2007) states that working capital

influence negatively and insignificantly toward the profitability of telecommunication

firm. This is supported by the research conducted by Saghir, et al (2011) on textile firm

in Pakistan that there is a negative but significant relation between the elements of

working capital and profitability.

As the illustration, on the group of state-owned bank, the biggest working capital

of state-owned bank belongs to BRI which is Rp1,43x108. Seen from figure 3 and 4 the

-10000000

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2013M

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Th

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ds

Americans Express Bank Ltd Citibank NA

The Bangkok Bank Comp LTD The Hongkong & Shanghai BC

Korea Exchange Bank Danamon Deutsche Bank AG

Page 16

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assets and liabilities on state-owned banks, bank mandiri greater than the value of their

assets bank bri, in terms of current debts when seen in the figure also shows the bank

mandiri debts greater than other similar banks. But the graph in Figure 8 shows that

working capital Bank BRI better than Bank Mandiri in terms of working capital

management. On November 2003 working capital Bank Mandiri has shown a great value

compared to Bank BRI, December 2005 to October 2010 Bank Mandiri working capital

and Bank BRI almost the same but after that Bank Mandiri increased working capital

compared to Bank BRI more stable. Adequate working capital make the firm to survive

during crisis, besides to meet up its current liabilities on time.

Figure3. The Graph of Assets of State-owned Bank

Figure4. The Graph of Debt of State-owned bank

0

100000

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Bank BRI Bank Mandiri Bank BNI Bank Tabungan Negara

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Bank BRI Bank Mandiri Bank BNI Bank Tabungan Negara

Page 17

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Figure5. The Graph of NWC of State-owned bank

Picture 6 shows the dynamics of working capital of state-owned bank, where the

net working capital of Bank Rakyat Indonesia tends to be more stable relative to other

bank on the group. This is supported by Picture 4 and 5 where the assets of BRI

experience an increase for the last 10 years; therefore BRI can cover his current liability,

even the debt of this bank also increase. Thus, the indicate of the liability is balanced by

the increase of its current assets, and even though its current liability goes up, the

management of Bank Rakyat Indonesia can manage its working capital so that it can save

its adequacy of working capital.

4.1.3 The Impact of External Factors on Profitability

Based on table 8 of estimation result, showing that SIZE (the bank size) has a positive

and significant influence on the model 3 and 4. It means that the greater the bank size the

greater the bank profit and vice versa. This statement is propped by Omar and Mutairi

(2008) assert that the bank size has positive effect. Moreover the researchers who support

this analysis result are Akhavein, Berger & Humhfrey, 1997; Bourke, 1989; Molyneux &

Thornton, 1992; Bikker & Hu, 2002; Goddard, Molyneux & Wilson, 2004 in Sufian &

Chong (2008). Whereas the research conducted by Athanasoglou et.al. in Omar &

Muatiri (2008) states that SIZE of bank does not affect on profitability.

On table 8 indicates that GDP has positive and not significant impact on model 2,

on the other hand model 1, 3, and 4 have positive and significant effect. These things are

driven by study of Sufian & Chong (2008) that do research on banking in Philipines and

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Bank Tabungan Negara Bank BNI

Bank Mandiri Bank BRI

Page 18

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also Roman & Danileteu (2013) executes case study on Romania banking which supports

model 1,3, and 4. Roman & Daniteleu research (2013) describe that GDP variable affects

positively and significantly at 1 % on profitability of Romania banking. Picture 12 shows

GDP graph that increases during research period from 2003 until 2013. This thing

represents that economic growth in Indonesia has increased from year to year and turned

out to be a positive impact on the profitability of banks in Indonesia.

The research result illustrates graph of fluctuate inflation movement from 2003

until 2013, i.e. in 2004 there is president election induces inflation increase from 0.36 in

March becomes 0.97 and 0.88 in April and May. The sharp Inflation fluctuation increase

occurs in 2005, which amounted to 17.11%. This year, the President of the Republic of

Indonesia established the reduction of subsidies for fuel oil so that the price of fuel has

increased. In May year of 2006 there was an earthquake in Central Java and Jogjakarta, so

that inflation increased from 0.05 in April to 0.37 in May. Fluctuations occurred in 2008

because of the global crisis ensued in the United States that ultimately affect the exchange

rate of Rupiah against Dollar.

Based on the estimation results of external factors variable, it can be concluded

that GDP variable effect on profitability which is supported by former research on

banking sector in various countries, as Philippines, Romania, Pakistan, Ghana, and

Tunisia. Most research conducted in several countries showed GDP variable is economic

growth variable in a country influence positively and significantly to profitability.

5 CONCLUSION

The aim of this research is to find out the influence of capital structure and working

capital toward the profitability of banking industry. By the samples of research are 105

conventional banks listed in the website of Bank Indonesia.

The result of the research concludes that the capital structure proxied by Debt to

Equity Ratio (DER)gives a positive and significant impact toward the variable of Return

On Equity (ROE),which means that the greater fund from debt (Debt to Equity Ratio), the

greater profitability(Return On Equity). This occurs because most of the capital used in

banking industry is debt or the third-party fund. And also the working capital which is

proxied by Net Working Capital (NWC) results a positive and significant influence

toward variable Return On Equity (ROE).This shows that the greater the value of Net

Page 19

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Working Capital, the greater profitability (ROE) of banking industry, which means that

the management is successfully managed the elements of working capital to have faster

turnover. Based on the results of the estimation of the variable Gross Domestic Product

(GDP) showed a positive and significant impact while the Inflation variables (INFL)

showed insignificant influence on almost all models tested so that it can be concluded that

external variables affect the profitability of variable is GDP.

It is hoped that banking industry pays attention to its capital management and to

improve its management and supervision on current assets and current liabilities in an

effective and efficient way to create a fast capital turnover so that it can improve its

profitability. Moreover, the fund source from debt is also needed to be noticed so that

banking will not experience a financial difficulty abd it can meet up its short-term and

long-term liability.

For the next research, it is hoped that it can make different model of variation so

that more external variables influence profitability are known and it can add more

samples number because in this research there are still many Islamic banks which have

yet to be included as the sample of the research.

Page 20

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