Business Focus vs Diversification: Impact on Cash Conversion Cycle

Objective: The life and continuity of a business unit significantly depends on its cash flow management. A business unit may have considerable liquidity when it is making a loss, and on the other hand, it may face a lack of liquidity while making a profit. Therefore, if a company is free of liquidity, it is deteriorating, even if the business unit does not have profit, it does not have the necessary health to continue life and survive in a competitive environment. Correct corporate management includes working capital management, which is interpreted as a powerful tool behind the performance of a business unit and constitutes the most basic function. It is important to acknowledge the fact that working capital is a necessity for any organization because it maintains the level of liquidity of the organization, increases the chances of the organization's survival in highly competitive environments, and ensures the solvency of the business. Recently, there are challenges that have plagued business units in trying to create a proper balance between surplus and shortage of working capital. In addition, financial professionals have concluded that traditional liquidity measures such as the current ratio are consistent in meeting current obligations. The cash conversion cycle is a more useful and dynamic way to assess a company's liquidity because it measures liquidity from a company's perspective as a going concern. The cash conversion cycle measures the time between the cash outflows for inventory purchases and employee costs and the cash inflows from sales revenue.

In the meantime, the studies conducted indicate that the cash assets of American companies have been growing over time. The growth in cash holdings is equally impressive. This is while American companies keep so much cash that as a group they can settle all their debts and still have cash left over. As the significant increase in cash holding has been noticed, another unknown and observable pattern is also noticeable in this regard. The average cash assets of focused companies are almost twice the cash assets of diversified companies. From 1990 to 2013, the difference in liquidity between diversified and focused companies was 15.8% of assets. In contrast, diversified companies have much lower cash balances than focused companies.

Although there is an extensive literature on diversification and cash holdings, the relationship between diversification and cash remains relatively unknown. It can be said that diversified companies are able to reduce dependence on a single sector or a group of related sectors by expanding to different business sectors. Finally, due to diversified companies having suitable investment opportunities and cash flows, such companies will have less cash balance. On the other side of the spectrum, focused companies have significantly more liquidity than diversified companies because these companies have much less diversity in investment positions and cash flows.

Therefore, if the diversity in cash flows is effective through the correlation between investment opportunities and cashflows, it can be effective on the cash conversion cycle. Therefore, the purpose of the current research is to investigate and find the appropriate answer to this basic question whether the cash conversion cycle is different in diversified and focused companies.

Methods: In order to carry out the present research, a 12-year period from 2009 to 2020 has been considered. However, due to the calculation of the variance in a 3-year cycle to measure the variable of cash flow fluctuations, the years 2009 and 2010 were not included in the estimation of the final results of the models. Therefore, the number of evaluated companies in the final sample of the current research has been reduced to 112 companies (1120 years of company data).

In the current research, cash conversion cycle, receivables period, inventory turnover period and payable period are considered as dependent variables. Also, the independent variable of the upcoming study is the number of segments, the values of this variable have been taken into account according to the number of segments of the companies each year, which was measured using related diversification.

For this reason, the companies are divided into two separate segments, and the companies that have one segment are placed in group1, and the companies that have more than one segment are grouped in group2. The companies classified in group 1 are focused companies and the companies grouped in group 2 are diversified companies.

Results: The results of the research show that the increase in the amount of diversification has an inverse and significant relationship with the cash conversion cycle. In addition, with the increase in the amount of diversification, the receivables period decreases. Also, with the increase in the diversification rate, the inventory turnover period will decrease, and with the increase in the diversification rate, the payable period will increase.

In addition, the increase in the amount of diversification, which will result in a decrease in the period of inventory turnover and a lengthening of the payable period, is statistically insignificant.

Conclusion: Based on the results, the cash conversion cycle in focused companies is significantly higher than diversified companies. This is because focused companies have less diversity in investment opportunities and cash flows. Therefore, such companies have a higher precautionary demand for cash. Finally, focused companies have significantly more liquidity than diversified companies.

On the other hand, the diversification strategy will directly lead to a decrease in the cash balance of the companies. Because diversified companies reduce savings to finance the large investment required to create capital in a new industry and also to pay the costs of diversification.

Therefore, based on the obtained results, diversified companies have a shorter cash conversion cycle than focused companies. Because diversified companies have good opportunities in suitable investment situations and cash flows. In this case, both the opportunities and the results of their divisions are completely independent of each other. In other words, interdependence has been increasingly reduced. As a result, this makes the cash conversion cycle shorter in diversified companies than in focused companies. Finally, it can be mentioned that diversified companies have less balance than focused companies