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THE IMPACT OF FINANCIAL RATIO TOWARD STOCK PRICE:

EVIDENCE FROM BANKING COMPANIES

Marvin Wijaya1
Andi Ina Yustina2
1,2
Accounting Study Program, Faculty of Business, President University, Indonesia

Abstract

Once company stock listed in IDX it means the stocks will be control by the market. We
would like to analyzed the factors that impact stock market in listed companies in ISX. The
samples will be coming from Banks Companies. There are many factor that impact stock
market, but the researcher only analyzed three of those. The first is dividend policy using
dividend payout ratio. The second is profitability ratio using return on assets ratio and
return on equity ratio. the last but not lease is solvency ratio using debt to equity ratio.
The researcher used multiple regression analysis to create the research equotion. After
that, in order to test the hypothesis the researcher using coefficient (R2) testand t test.
Through all the test, this research present the dividend policy using dividend payout ratio
and profitability ratio using return on asset ratio has significant correlation with stock
price. Then, solvency ratio using debt to equity ratio and profitability using return on
equity has in significant correlation with stock price.

Key words: Dividend Policy, Profitability Ratio, Solvency Ratio

Introduction
Nowadays, most of the economy activities are investing and on of the requirement to
develop society is investing (Mohemi et al. 2013). To gain a lot of investors, company has
perspective to be listed company. By listed on stock market it will be a solution to get
more fund as additional capital expenditure, to pay off existing debt, to doing research and
development, and etc. In listed and published their stocks on the market or Initial Public
Offering (IPO), company may expand their business bigger and bigger without worry
about interest debt.
Being a listed, the company will issue its shares. According to Brecket & Essen (2002)
if there are 100,000 shares issued by the company and someone having 10,000 of them, it
means she or he owns tenth of the company because Investor are not lenders; they are the
owner. All of the shares from listed company will be traded in stock exchange. Stock
exchanges around the world contribute in considerable manpower, technological effort,
and promote market efficiency & integrity (Cumming et al. 2009).
One of the most well known sectors in stock exchange is financial sector. The financial
index contains all listed companies that are engaged in Indonesia‟s financial sector, it
consist of banking, financing institutions, securities companies, insurance, and others.

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Even though there are many finance company criteria include in this sector, the majority
one is banking company 39 out of 85 companies. After private company being a listed
company and issuing their share in stock exchange, the shares of the company will be
controlled by the market with several factors that affect the volatility of the stock price.
One of the factor that affect a company‟s share price on the stock exchanges is the
dividend policy, especially around the announce date and the ex-dividend date (Sularso,
2013). Masum (2014) announcement dividend has significant positive effect on stock price
volatility. It occurs because the investor usually look for information on a company before
they decide to invest their capital in the company or not, either in the form of shares or in
other forms of investment (Novianti et al. 2013). Agency cost and the free cash flow
hypothesis said that empirical evidence shows the firm‟s stock price typically move in the
same direction as that of the dividend change, according to the free cash flow model, the
market reacts to the news of dividend increase or decrease because the potential for
manager to misuse excess funds decreases or increases (Baker, 2009).
The other factor that affects stock price is profitability ratio. Profitability ratios can be
tough of as the combination of many of the other specific to figure out the ability of a
company to generate profits (Rist & Pizzica, 2015). Common profitability ratios are
current yield, profit margin, return on asset (ROA), return on net asset (RONA), return on
equity (ROE), and return on investment (ROI). Regarding to the Weygandt et al. (2013),
profitability has classify into seven types such as profit margin, asset turnover, return on
asset (ROA), return on ordinary shareholders‟ equity, earnings per share (EPS), price-
earnings ratio, and payout ratio.
One of the criteria to evaluate management power for gaining return is rate of return on
asset, if the company has a good earning for them it can bring more interest for the
company, then it proved direct relationship between stock return and assets return rate or
return on asset (ROA) which is one of the ratio in profitability ratio (Saeidi & Okhli,
2012). In other opinion Rist & Pizzica (2015) said that the king of all ratios is return on
equity (ROE).
Furthermore, the factor that affects stock price volatility is solvency ratio. These ratios
indicate the extent to which the business is able to meet all its debt obligations from
sources other than cash flow. In essence, it answers the question: if the business suffers
from reduced cash flow, will it be able to continue to meet the debt and interest expense
obligations from other sources. One of the solvency ratios is debt to shareholders‟ equity
(Lee, 2012).
In line with the statement above, Australia Shareholders' Association (2010) said that
contrary to what many believes, debt is not necessarily a bad thing. Debt can be positive. If
it is use for productive purposes such as purchasing assets and improving processes to
increase net profits. Acceptable debt to equity ratios may also vary across industries.
Generally, companies that are capital intensive tend to have higher ratios because of the
requirement to invest more heavily in fixed assets. In contrary, the other financial
statements state that debt to equity ratio give users a general idea of the company‟s overall
debt load as well as its mix of equity and debt, it can be used to determine the overall level
of financial risks a company and its shareholders face, because the greater amount of debt
held by a company the greater the financial risk of bankruptcy.

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Literature Review and Hypothesis Development
Dividend Policy

Baker (2009) states that evolution of dividend policy was growing up until now. The
first corporations were short-term ventures that ended in full liquidation. As corporations
became longer lived, managers faced the issue of how to make distributions to
shareholders, and numerous firm-specific policies as well as laws developed to address
how much corporations could pay shareholders. From the seventeenth to the nineteenth
century, managers used dividends to influence share prices and to attract new capital. In
the twentieth century, researchers developed various hypotheses to explain dividend
policies. An overview of recent surveys and observed firm reactions to changes in tax laws
provide additional insights in to current dividend policies.
Dividend decision are a type of financing decision that affects the amount of earnings
that a firm distributes to shareholders versus the amount it retains and reinvests these
activities refers to the payout policy that a firm follows in determining the size and pattern
of cash distribution to shareholders over time (Baker, 2009). Dividend policy has long
been a subject of interest to financial researcher because corporate dividend policy is still a
complex topic for financial researcher. The controversial of dividend policy are divided
into two controversial aspects. The first is dividend policy affecting the investment
decision of company because the distribution of profits reduces internal sources and
increase the need for external resources. Unfortunately, on the other side, many
shareholders demanding cash dividend, hence a managers must always achieve a balance
between their holders interests and the opportunities for profitable investment with the aim
maximizing shareholder wealth, that‟s why the dividend decision which are taken by the
corporate executives are very sensitive and important (Mohemi, Lari, Jafari, & Hosseini,
2013).
One type of dividends is a cash dividend which is calculated with dividend payout ratio.
Weygandt et al. (2013) state the payout ratio is one of the ratios that attracts the investor.
Payout ratio is the ratio of cash dividend to net income. Masum (2014) add some point
with state that dividend policy is important for investor, managers, lenders, and for other
stakeholder, it is important for investors because investor consider dividends not only the
source of income but also a way to assess the firms from investment point of view, because
every firm operating in a given industry follows some sort dividend pattern or dividend
policy and obviously it is a financial indicator of the firm.

Profitability Ratio

The key elements of economic decision is the prediction because the investor, creditors,
managers, and other users rely on the prediction and expectation in their economic
decision, this prediction depends on the combination of the stable and unstable
characteristics of the earnings, the firm with higher stable items in the financial statements
have more earning persistence, therefore the investors are interested in predicting the
perspective of the future profitability (Heirany et al. 2014). The profitability can be
measured by profitability ratio. Because of the Profitability ratios measure a company
ability to generate earnings contra with expenses.
Commonly the profitability is divided into two ratios, which is return on asset (ROA)
and return on equity (ROE). Rist & Pizzica (2015) said that the return on assets shows how

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profitable asset are in generating revenue a ratio of 25% means that for every $100 of
investment in assets, net income of $25 is generated. On the other article state that, return
on asset (ROA) measure how efficiently a company use the firm assets to generate
operating profits, in general return-on assets ratio means that a company‟s assets are
productive and well managed, likewise some company may have assets level that are,
“under-stated”. But it‟s doesn‟t mean the company is bad, instead it happen because the
company have high levels of intangible assets then intangible assets are non-monetary
assets that can cot be seen, touched, or physically measured, such as trademarks, brand
names, and patents therefore a company like Microsoft will have far fewer assets on its
balance sheet that Ford.
The next ratios is return on equity (ROE), Bulll (2008) said that the return on equity
(ROE) ratio presents a broader measure than the return on capital assets ratio. In other
definition, return on equity (ROE) measures how much net income was earned as a
percentage of shareholder‟s equity, more simply its can show how much profit a company
generates with the money shareholder has invested, it is calculate as net income divided by
common equity, return on equity helps to assess how efficient a company to generate
profits, then the firm with consistently high return on equity, especially relative to industry
norms, typically have some type of competitive advantage.

Solvency ratio

Reeve et al. (2007) said that the ability of a business to meet its financial obligations
(debts) is called solvency. A business that has bad history in paying their debts or
obligation will have difficulty in obtaining credit. A lack of available credit may, lead to a
decline in the business‟ profitability. Eventually the business may be forced into
bankruptcy. Likewise, a business that is less profitable than its competitors is also refers to
the at disadvantage in obtaining credit or new capital from stockholder Solvency assessed
by examining balance sheet relationship using many ratios, and one of the ratios is the
ratio of debt to equity.
Australia Shareholders' Association (2010) state that, the debt to equity ratio provides
an indication of company‟s capital structure and whether the company is more reliant on
borrowings (debt) or shareholder capital (equity) to fund assets and activities. In line with
it, Rist & Pizzica (2015) said that the debt to equity ratio measures how much of the
company financed by its debt holders compared with its owners and is another measure of
financial health, a company with a large amount of debt will have a very high debt to
equity ratio, whereas on with little debt will have a low debt to equity ratio.

Stock Price

Based on the styles of the stocks types, stocks are divided into four categories. The first
is aggressive growth stock which is the stocks that have rapidly expanding, company
believed to have the greatest growth prospects in the marketplace, the lure of the of
aggressive growth stocks is the idea of getting early on the next big thing and those
aggressive growth stocks that fulfill the hopes of investor of large return. The second is
growth stocks, it is shares of corporations that have above-average prospects but whose
potential is not quite as dramatic as aggressive growth stocks, the value of this stock
typically offer fairly modest dividends and as profits usually are still being reinvested back
into the business at a fairly high rate. The third is value stocks, it is shares that are

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considered to be selling below their true worth, considering their existing operations,
future growth prospects, or current assets. It may offer above-or below-market dividend
yields but generally don‟t fall into the top tier of dividend paying companies. The last is
income stocks which is stocks that has been offered by the companies with highest
dividend yields in the stock market. Many conservative investors also invest in income
stocks because they want the potential for capital appreciation and increase those
dividends (Broadridge Investor Communication Solutions. Inc, 2015). According to the
types of the stocks above, each of type will represent the stock price with different way
and value.
Stock price change every day as a result of market volatility, it change because of
demand and supply, if more people want to buy a stock (demand) than sell it (supply), then
the price moves up and conversely if more people wanted to sell a stock than buy it the
greater supply than demand will make the price fall down. The variation in price among
common stocks is of considerable interest for the discovery of profitable investment
opportunities, for the guidance of corporate financial policy, and for the understanding of
the psychology of investment behavior (Gordon, 2009). This statement is supported by
Hill & Irwin (2008), the simplest way of understanding how stocks can make returns goes
by the old saying “buy low and sell high”. It is the investor‟s objective to purchase shares
of a firm at a value which they expect to appreciate in the future, the returns on common
shares can be made in two ways: capital appreciation and/or through dividends which are
capital appreciation basically means that the stock‟s price rise in value over the duration
that the investor owned the stock.

Hypothesis Development

The relationship between Dividend policy and Stock Price

Announcement of dividend payment has significant return to the market when

providing information. In contrary, when the dividend announcement did not provide
significant abnormal return because if it doesn‟t contain of any information. Information
on dividend announcement will be mirrored by the capital market reaction immediately
after the announcement of the dividend, both positive and negative reaction (Novianti et al.
2013). In line with Novianti et al. (2013), DeAngelo & DeAngelo (2005) showed that
dividend policy is related to the fluctuation of the stock price because dividend policy
contains information which gives message about the status of the company to shareholders.
The status or the message is going to be a signal for the shareholder or investor to invest in
some company or firm. It might be happen because Investor usually looks for information
on a company before they decide to invest their capital in the company or not, whether it is
in the form of shares or other forms of investment (Novianti et al. 2013). This reason
declaration of dividend sometimes leads to reduction, and it is occasionally leads to
increase in stock price (Mohemi et al. 2013). Therefore, Masum (2014) state that dividend
policy decision affects a firm‟s stock price is a widely researched topic in the field of
investment and finance.
Research about the effect of dividend announcement on stock price changes (returns)
before and after the ex-dividend date on the IDX in the period January to December 2010
Novianti et al. (2013) state that announcement of dividend increases influence on stock
return before and after the ex-date dividend in Indonesia Stock Exchange (IDX), it is
characterized by the average significant positive abnormal return on day T-4, then the

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dividend reduction announcement doesn‟t affect the stock returns before and after the ex-
dividend date on the Indonesia Stock Exchange (IDX) and it is shown by the presence of a
significant negative abnormal return on day T+9. Baker (2009) Said the notion that
dividends affect the value of a firm‟s share is not new. Sularso (2013) also support this
research, he said that basically a lot of factors that affect a company‟s shares price on the
stock exchange, one with the announcement of the dividend will impact the company stock
price, especially around the announcement date and the ex-dividend date.
H1: Dividend policy has correlation with stock price

The relationship between Profitability Ratio and Stock Price

The investors are interested in predicting the perspective of the future (Heirany et al.
2014). Investor persuading to gain further profits tries to get the most return on assets. It
has made a good proportion of financial researched oriented toward predicting price or
return of stocks in different markets (Saeidi & Okhli, 2012). By using profitability ratio,
the investor can know how the company runs their business. Two well-known profitability
ratios are return on asset (ROA) and return on equity (ROE), both describe how a
company‟s ability to generate earnings from their investment, but they don‟t exactly
represent the same things.
Dadrasmoghadam & Akbari (2015) in his research the relationship between financial
ratios in the stock prices of agriculture-related companies accepted on the stock exchange
for Iran emphasize that the profitability ratio positively and significantly related to stock
exchange agriculture of industry. It is also support in Heirany, Moeinadin, & Nazemizadeh
(2014) research that state the investor has been highly considered about income, the
predicted earnings are published extensively because when the earning are lower than the
expected level, the stock will decrease.
H2: Profitability ratio has correlation with stock price

The Relationship between Solvency Ratio and Stock Price

Drake (1998) said that, the main focuses of solvency ratios are the entity‟s ability to
repay the debts. The creditors and the shareholders are equally interested in these ratios.
These ratios indicate the entity‟s ability to withstand relatively for business conditions
without suffering net losses or insolvency. Although, these ratios should not be taken at
face value since they are dependent on many factors, these ratios are most useful for
making apple-to-apple comparisons in the industry.
The way to calculate solvency ratio is using debt to equity ratio. Ratio of debt to equity
is a solvency measure that indicates the margin of safety for creditors. It also indicates the
ability the business to withstand adverse business conditions. When the claims of the
creditors are large in relation to the equity of stockholders‟, it is usually significant interest
payments. If earning decline to the point where the company is unable to meet interest
payments, the business may be taken over by the creditors. The relationship between
creditor and stockholders‟ equity is shown in the vertical analysis of the balance sheet
(Reeve et al. 2007).
Solvency ratios means that the ability of a company to survive over long period of time.
It will give impact to the company to get fund from creditors, stockholders‟, or investors.
Especially for the listed company because high debt to stockholders‟ equity also can give
impact to their stock price because according to the Rist & Pizzica (2015) companies with

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lower debt to equity ratios are generally less risky than those with higher debt to equity
ratios. And there no people want to lose or risky their money.
H3: Solvency ratio has correlation with stock price

Research Method
Sample

This method focused on several criteria and requirements to selection the data, whether
it is proper for the research or not. We used sample only come from listed bank company
in Indonesia, and those data taken from IDX and have duration starting from 2010 – 2014.

Variable

Dividend policy is the first independent variable which describe how company
determining the proper amount of dividends to pay. To measure dividend policy by
dividing cash dividends by net income. Companies that have high growth rates generally
have low payout ratios because they reinvest most of their net income into the business
(Weygandt et al. 2013).

Dividend Payout Ratio=

Profitability Ratio

The second independent variable is profitability ratio. This ratio measures the income or
operating success of a company for a given period of time. Analysts frequently use
profitability as the ultimate test of management‟s operating effectiveness (Weygandt et al.
2013).

Return On Asset (ROA)

Reeve et al. (2007) define Return on assets (ROA) as a measurement for the
profitability of total assets, without considering how the assets are finance, this rate
therefore not affected by whether the assets are financed primarily by creditor or
stockholder. An overall measure of ability is return on assets. It is computed by dividing
net income by average assets (Weygandt et al. 2013).

ROA =

Return On Equity (ROE)

Return on equity was measures from the ordinary shareholder‟s viewpoint. We compute
it by dividing net income available to ordinary shareholders by average ordinary
shareholders‟ equity (Weygandt et al. 2013).

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 ROE =

Solvency Ratio

The third independent variable in our study is solvency ratio also called as leverage
ratio, which means how the long-term funds are used in the business concern (Paramasivan
& Subramanian, 2009). Debt to stockholders‟ equity (leverage or gearing) ratio indicates
the extent to which the business is reliant on debt financing versus equity to fund the assets
of the business.

Debt to stockholders „equity ratio =

Stock Price

Our dependent variable in this study is stock price which is coming from bank
companies‟ stock price during 2010 – 2014. The data will be using monthly average price
that convert as annual average price.

Analysis Method

Multiple regressions also calculate the error term or random variable which appear (ϵ)
between dependent and independent variable, therefore the idea comes out with multiple
regression equation that the mean or expected value of ϵ is zero. Whereas the distraction
variable in this research are assuming as zero or neglected. Then a consequence of this
assumption is that the mean or expected value of y, denoted E(y), is equal to β0 + β1 x1 +
β2 x2 + . . . + βp xpand the mean value of y is related to x1 ,x2 , . . . , xp (Anderson et al.
2014).

Multiple Regression Equation:

E(y) = β0 + β1 x1 + β2 x2 + . . . + βp xp

Result
Samples that have been used by the researcher are the companies in Indonesia which is
listed in Indonesia Stock Exchange (IDX) started from 2010 until 2014 Companies in this
research refer to bank companies which is include in finance sector stock in Indonesia
Stock Exchange (IDX). Not all the bank companies can be a sample in this research, the
bank companies have fulfill the sample requirements. This is stated in the table below:

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 Table 1.
Sample
No Description Amount
1 All of the company in finance sector who listed in Indonesia 85
Stock Exchange
2 Other companies in finance sector which is not banking (44)
companies.
3 The companies who listed after 2010 (2)
4 The companies who have incomplete and sufficient data (10)
Total sample of the company 29

Multivariate Analysis

Multiple Linear Regression

In this research we using three independent variables which multiple linear regression
analysis below:

SP = DPR + ROA + ROE + DER

Numerical Descriptive Statistic Measurement

Numerical descriptive statistic measurement will present the total samples (N),
minimum value (minimum), maximum value (maximum), and mean value (Mean), of each
variable in this research. After that it is also state the valid total samples of this research
(Valid N), here are the result;

Table 2.
Numerical Descriptive Statistic Measurement
N Minimum Maximum Mean
SQRTSP 29 7.07 95.26 25.96996
DER 29 4.78 23.45 1.96508
DPR 29 .00 .98 .21462
ROA 29 -.02 .03 .01115
ROE 29 -.11 3.05 .55050
VALID N (listwise) 29

Data Analysis

Normality Test

Based on the histogram graphic and P-Plot of regression standardized residual, it can be
assumed the data have normal distribution. Even though in the graphic histogram show
little bit positive skewness pattern because of some outlier on the data, it still not far from
the center or 0 in X pivots. After that the plots on the P-Plot are spread not far from
diagonal line.

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Multicollinearity Test

Based on the amount of the correlation between each independent variables, the
researcher know that the biggest correlation amount‟s is occurred between DPR and ROA
variables which is -.490 or 49,0%. Because the entire correlation amount is under 90%
between each independent variable, therefore it‟s assume there is no serious
multicollineriaty in this research. Below is the result of multicollinearity test:

Table 3.
Multicollinearity Test
Model ROE DPR DER ROA
Correlations ROE 1.000 .149 .097 -.203
DPR .149 1.000 .18 -.409
DER .097 .018 1.000 .187
ROA -.203 -.490 .187 1.000

Based on the amount of the tolerance and Variance Inflation Factor (VIF) it can be
assumed there is no multicollinearity in this research. The lowest and the highest value of
tolerance and VIF is .699 and 1.430. All of the tolerance value more than .10 and VIF
value still less than 10.

Table 4.
Multicollinearity Test 2
Unstandardized Standardized T Sig. Collinearity
Coefficient Coefficien Statistics
t
Model B Std. Beta Tolerance VIF
Error
(Constant) 34.973 18.982 1.842 .078
DER -2.215 1.936 -.168 -1.145 .264 .932 1.073
DPR 45.129 19.778 .373 2.282 .032 .747 1.339
ROA 969.806 406.529 .404 2.386 .025 .699 1.430
ROE -2.604 6.883 -.044 -.300 .767 .938 1.066

Autocorrelation Test

The result of autocorrelation test will be show on the table below, which is consist of
several information:
Table 5.
Autocorrelation Test
Model R R Square Adjusted R Std. Error of the Durbin – Watson
Square estimate
1 .721a .520 .440 19.43417 2.672

DW value is 2.672, this value will compare with the value from 5% significance value
on the table. Amount of the sample and independent variables are 29 (n) and 4 (k=4),
therefore the Durbin Watson table‟s will be:

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 Table 6.
Durbin – Watson Test
K=4
N Du
DI
15 0.69 1.98
. . .
. . .
29 1.124 1.74

Because of the value of DW is 2.672 which is more than (du) 1.74 and less than 4 – 1,
74 (4 - du), therefore H0 (there is no autocorrealation positive or negative) is rejected or it
can be assume there is no autocorrelation is this research.

Hypothesis Test

Coefficient (R2) Test

The value of adjusted R square is .440, it means 44% stock price variation can be
explained by the variation of independent variables which are Debt to equity ratio (DER),
Dividend Payout Ratio (DPR), Return On Asset (ROA), and Return On Equity (ROE). On
the other hand the rest of percentage which is 56% will be explained by other variables
outside the model research.

Table 7.
Coefficient (R2) Test
Model R R Square Adjusted R Std. Error of the
Square estimate
1 .721a .520 .440 19.43417

Statistic F Test
The criteria for the F test are:
If the F formula > F table, means that Hais supported and H0 is rejected.
If the F formula < F table, means that H0 is supported and Ha is rejected.

Table 8.
Statistic F Test
Model Sum of Df Mean F Sig.
Square Squar
e
1 Regression 9819.286 4 2454.821 6.500 .001a
Residual 9064.487 24 377.687
Total 18883.773 28

Based on the F test above, F formula show 6.500 with .001 profitability value. Because of
the value of F formula is more than F table value which is 2.78 (k=4, df 29 – 4 - 1 = 24, and α
= 5%). Therefore the Ha is supported and the H0 is rejected, whereas the independent
variables (DPR, ROA, ROE, and DER) as group have significant correlation with
dependent variable (Stock Price of banking companies in Indonesia during 2010 – 2014).

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Statistic t Test

The criteria for the t are:

If the t formula > t table, means that Ha is supported and H0 is rejected.
If the t formula < t table, means that H0 is supported and Ha is rejected.

Table 9.
Statistic t Test
Unstandardized Standardized t Sig. Collinearity
Coefficient Coefficien Statistics
t
Model B Std. Error Beta Tolerance VIF

(Constant) 34.973 18.982 1.842 .078

DER -2.215 1.936 -.168 -1.145 .264 .932 1.073

DPR 45.129 19.778 .373 2.282 .032 .747 1.339

ROA 969.806 406.529 .404 2.386 .025 .699 1.430

ROE -2.604 6.883 -.044 -.300 .767 .938 1.066

In this research it is important to testing partial hypothesis of each independent variable

which are ROA, DPR, DER, and ROA. T test in this research will look the level of
significance with standard error < 5%. Steps to conduct the test are to determine t formula
and t table whereas t table show 2.06 (k=4, df 29 – 4 - 1 = 24, and α = 5%). From the result
above, the researcher will try to figure out whether the Ha or H0 is supported in this
research for each independent variable.
- DER = t formula <table (-1.145 < 2.06), means that H0 is supported and Ha is rejected.
Debt to equity ratio has insignificant correlation with Stock Price of banking
companies in Indonesia during 2010 – 2014.
- DPR= t formula > t table (2.282 > 2.06), means that Ha is supported and H0 is rejected.
Debt payout ratio has significant correlation with Stock Price of banking companies in
Indonesia during 2010 – 2014.
- ROA = t formula > t table (2.386 > 2.06), means that Ha is supported and H0 is rejected.
Return on assets ratio has significant correlation with Stock Price of banking
companies in Indonesia during 2010 – 2014.
- ROE = t formula < t table (-.300 < 2.06), means that H0 is supported and Ha is rejected.
Return on equity ratio has insignificant correlation with Stock Price of banking
companies in Indonesia during 2010 – 2014.

Multiple Regression Equation

Based on the test that has been done. We will create the multiple regression equation:

SP = DPR + ROA + ROE + DER

SP = 45.129 + 969.806 -2.604 - 2.215

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Means:
DPR : Dividend Pay-Out Ratio
ROA : Return on Assets Ratio
ROE : Return on Equity Ratio
DER : Debt to stockholders‟ Equity Ratio
SP : Stock Price

The Correlation between Dividend Policy With Stock Price

The result of the t test for dividend policy (dividend payout ratio) will be shown the
table below, which is consist of several information that will be explain more by the
researcher;

Table 10.
t Test for DPR
Unstandardized Standardized t Sig. Collinearity
Coefficient Coefficient Statistics
Model B Std. Beta Tolerance VIF
Error

(Constant) 34.973 18.982 1.842 .078

DPR 45.129 19.778 .373 2.282 .032 .747 1.339

From the result, it can be seen the result of DPR t formula value is more than the t table
(2.282 > 2.06).It means that Ha is accepted and H0 is rejected. Dividend pay-out ratio has
significant correlation with stock price in banking companies in Indonesia during 2010 –
2014. This is supported with profitability ratio which is calculated using dividend payout
(DPR) ratio show .032, because of the significant value of DPR ratio is below .05, It
proves Ha is accepted and H0 is rejected.
Dividend Payout ratio explain the ability of a company to pay dividends compare with
the amount of net income. Because of the H1 has been proven, which is Dividend policy
has correlation with stock price of banking companies in Indonesia during 2010 - 2014
through dividend payout ratio. If the company has good ability to pay their dividend or the
company has big dividend payout ratio. The stocks of those companies will be attracted by
the investor, after that this condition will be impact the stock price of those companies.
This result is consistent with Novianti et al. (2013) and DeAngelo & DeAngelo (2005)
study.

The Correlation between Profitability Ratio With Stock Price

The result of the t test for profitability (return on assets and return on equity) ratio will
be show on the table below, which is consist of several information that will be explain
more by the researcher:

13
 Table 11.
t Test for ROA & ROE
Unstandardized Standardized t Sig. Collinearity
Coefficient Coefficient Statistics
Model B Std. Error Beta Tolerance VIF

(Constant) 34.973 18.982 1.842 .078

ROA 969.806 406.529 .404 2.386 .025 .699 1.430

ROE -2.604 6.883 -.044 -.300 .767 .938 1.066

From the result, it can be seen the result of ROA t formula value is more than the t table
(2.386 > 2.06).It means that Hais supported and H0 is rejected. Return on assets ratio has
significant correlation with stock price of banking companies in Indonesia during 2010 –
2014. This is supported with profitability ratio which is calculated using return on asset
(ROA) ratio show .025, because of the significant value of ROA ratio is below .05, it
proves Ha is supported and H0 is rejected.
On the other side the result above show ROE t formula value is less than the t table (-.300 >
2.06).It means that Ha is rejected and H0 is supported. Return on an equity ratio has
insignificant correlation with stock price of banking companies in Indonesia during 2010 –
2014. This is supported with profitability ratio which is calculated using return on equity
(ROE) ratio show .767, because of the significant value of ROA ratio is above .05, it
proves Ha is rejected and H0 is accepted.
Return on assets (ROA) ratio present the ability of some companies to generate income
from their own assets. It is calculated from net income divided by total assets. After that,
high ROA ratio represent high value of total assets that company own. It will increase the
value of company stock price. Company can get high profit through their assets, therefore
the investor not to be worry about the going concern of that company.
Besides that, the investor also can get dividend or profit sharing. Another thing is, if the
company is settled, it will be more attracting for investor to invest in that company. This
condition will make the market price of the company stocks increase, then give benefits to
their current investor. It show H2 has been accepted which is Profitability ratio has
correlation with stock price of banking companies in Indonesia during 2010 – 2014
through return on asset (ROA). This result is consistent with Dadrasmoghadam & Akbari
(2015) study.

The Correlation between Solvency Ratio With Stock Price

The result of the t test for solvency (debt to equity) ratio will be show on the table
below:

14
 Table 12.
t Test for DER
Unstandardized Standardized t Sig. Collinearity
Coefficient Coefficient Statistics
Model B Std. Beta Tolerance VIF
Erro
r

(Constant) 34.973 18.982 1.842 .078

DER -2.215 1.936 -.168 -1.145 .264 .932 1.073

From the result, it can be seen the result of DER t formula value is less than the t table (-
1.145 < 2.06). It means that Hais rejected and H0 is supported. Debt to Equity ratio has
insignificant correlation with stock price in banking sector during 2010 – 2014 in
Indonesia.This is supported with profitability ratio which is calculated using return on
equity (ROE) ratio show .264, because of the significant value of ROA ratio is above .05,
it proves Ha is rejected and H0 is accepted.
Solvency ratio is the ratio that has been used to assess the ability of a company to pay
their liabilities, whether it is short-term liabilities or long-term liabilities. If some
companies have high solvency ratios, the companies have to maximize their income to
cover up their liabilities. It show H3 is rejected which is solvency ratio has correlation with
stock price of banking companies in Indonesia during 2010 - 2014.

Conclusion and Limitation

This research is conduct to analyze the impact of dividend policy (dividend payout
ratio), profitability (return on asset and return on equity) ratio, and solvency (debt to
equity) ratio toward stock price of banking companies in Indonesia during 2010 – 2014.
Dividend policy (dividend payout ratio) has significant correlation stock price. This result
is consistent with Novianti et al. (2013) and DeAngelo & DeAngelo (2005). Profitability
ratio which is calculated using dividend payout ratio proves H1 is supported. Profitability
ratio through return on asset ratio has significant correlation with stock. This result is
consistent with Dadrasmoghadam & Akbari (2015). Return on a equity ratio has
insignificant correlation with stock price. This is supported with profitability ratio which is
calculated using return on equity (ROE) ratio show above the standard, it proves H2 is
rejected.
Solvency (debt to equity) ratio has insignificant correlation with stock price of banking
companies in Indonesia during 2010 – 2014. DER t formula value is less than the t table,
which is means that H3 is rejected. Return on equity ratio has insignificant correlation with
stock price of banking companies in Indonesia during 2010 – 2014. This is supported with
profitability ratio which is calculated using return on equity (ROE) ratio show .264,
because of the significant value of ROA ratio is above .05, it proves Ha is rejected and H0
is supported.
Dividend policy (dividend payout ratio), profitability (return on asset and return on
equity) ratio, and solvency (debt to equity) ratio as a group has significant correlation the
stock price of banking companies in Indonesia during 2010 – 2014. F test result show

15
6.500 with significant value .001. Based on the result, H4 is supported because of the value
of F formula is more than F table value.
Here are some limitations in this research that we found during the research period. The
small amount of Bank Companies in Indonesia who listed in ISX. It refers to the amount of
the samples in this research. The amount of independent variables is too small. Therefore
the result of this research not specific yet. The research conduct based on the duration that
has been set which is ± 4 months, the researcher only can focus direct to the 3 independent
variables. Since there are no “total debt” in financial reporting of banking companies. The
researcher uses “total liabilities” as a base calculation in calculate debt to equity ratio of
solvency ratio. The amounts of the independent variables in this research have to be
increase in the next research. To gain more variety result to explain the dependent variable.
For the next research, insignificant variables which are solvency (debt to equity) ratio and
profitability (return on equity) ratio can be measured with another calculation in order to
give clear presentation of those variables. Demography also become limitation of this
research. The research was conduct in Indonesia, for some references that researcher
cannot find through the internet. The researcher has to use the references that are provided
near the research area (JABODETABEK). Explore the research with increasing the
amount of the samples to gain clear information or figure of the real condition. Therefore
the research will be more supported.

References
Anderson, D. R., Sweeney, D. J., Williams, T. A., Camm, J. D., & Cochran, J. J. (2014).
Statistics For Business Economics. Canada: South-Western Cenage Learning.
Australia Shareholders' Association. (2010). The Top 15 Financial Ratios. Australia:
Lincoln Indicator Pty Ltd.
Baker, H. K. (2009). Dividend And Dividend Policy. Canada: John Wiley & Sons.Inc.
Becket, M., & Essen, Y. (2002). How The Stock Market Works A Beginner's Guide to
Investment (3rd ed.). London: Bell & Brain Ltd.
Becket, M., & Essen, Y. (2002). How The Stock Market Works A Beginner's Guide to
Investment. Bell & Brain Ltd.
Berenson, M. L., Levine, D. M., & Krehbiel, T. C. (2009). Basic Busniess Statistics
Concept and Application. New Jersey: Pearson.
Broadridge Investor Communication Solutions. Inc. (2015). Types of Stocks.
Bulll, R. (2008). Financial Ratios: How to Use Financial Ratios To Maximise Value and
Success to Your Business. UK: CIMA.
Creswell, J. W. (2010). Qualitative, Quantitative, and Mixed Methods Approaches.
Cumming, D., Johan, S., & Li, D. (2009, October). Exchange Trading Rules and Stock
Market Liquidity.
Dadrasmoghadam, A., & Akbari, S. M. (2015). Relationship Between Financial Ratios in
The Stock Prices of Agriculture-Related Companies Accepted on The Stock Exchange
For Iran. Authors and American-Eurasian Network For Scientific Information .
Damodaran, A. (2006). Damodaran on Valustion: Security Analysis for Investment and
Corporate Finance (2nd ed.). Wiley Finance.
Damodaran, A. (2006). Damodaran on Valustion: Security Analysis for Investment and
Corporate Finance. Wliey Finance.

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DeAngelo, H., & DeAngelo, L. (2005, march). The Irrelevance of The MM Dividend
Irrelevance Theorem.
Drake, W. (1998). A Financial Analysis of Southwest Airlines Co.
Financial Ratio Tutorial. (2010). Retrieved from www.Investopedia.com.
Fundamental Focus. (2010). Retrieved from www.Morningstar.com.
Ghozali, I. (2013). Aplikasi Analisa Multivariate DEnagn Program IBM SPSS 21 Update
PLS Regresi. Badan Penerbit Universitas Diponegoro.
Gordon, M. J. (2009). Dividend, Earnings, and Stock Prices. The Review of Economics
and Statistics, 42.
Hair, J. F., Black, W. C., Babin, B. J., & Anderson, R. E. (2010). Multivariate Data
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Hartono, J. (2010). Studi Peristiwa: Menguji Reaksi Pasar modal Akibat Suatu Peristiwa.
BPFE Yogyakarta.
Heirany, F., Moeinadin, M., & Nazemizadeh, M. (2014). The Role of Accrual
Decomposition in Increasing The Information Value. International Journal of
Academic REsearch inAccounting, Finance and Management Sciences, 4.
Hill, M., & Irwin. (2008). Stock and Bond Basics. Florida International University .
Ignat, G., Brezuleanu, C. O., & Prigoreanu, A. (2012). some consideration of the analysis
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Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2011). Intermediate Accounting. United
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Masum, A. A. (2014). Dividend Policy and Its Impact on Stock Price - A Study on
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Mohemi, M., Lari, M., Jafari, E., & Hosseini, S. (2013). The Relationship Between
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Novianti, M., Medyawati, H., & Yunanto, M. (2013). Changes of Return of Shares Before
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Petersen, M. A., Raubenheimer, H., & Van Der Walt, M. (2005). Stochstic Spproach to
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17
The Working Capital Management and ProfitabilityAnalysis on
The Leading Dairy Food Industries in Indonesia

Anita Munir
Management Department, Faculty of Business, President University

Abstract

The main purpose of this study is to analyze trends in the working capital management that
impact the profitability of those Indonesian dairy food companies with the highest levels of
sales revenue which is listed in Indonesian stock exchange.Working capital management is
one of the most important financial decisions in the company that can increase the
company’s value. The test was adopted to examine return on equity as the dependent
variable and average collection period, day payables outstanding, current ratio as the
independent variables. The data were taken by using purposive sampling method with level
significant of 5%. The result of multiple linear regression analysis indicated there was a
positive significant impact of day payables outstanding and current ratio on return on
equity Meanwhile for the average collection period was insignificant negatively impact on
the return on equity. Further, in this resarch is suggested that managers in dairy food
industries can optimal their return on equity by balancing between profitability and
liquidity, and paying more attention on effectiveness of working capital management. In
any case, working capital is a particularly important topic in industry due to the
continuous development of technology and rapid changes in business environment.

Keywords: Average Collection Period, Current Ratio, Day Payables Outstanding,

Effectiveness, And Return On Equity

Introduction
Working capital is the total current assets of the company as should be available to
finance operations company everyday (Agnes, 2015). Company basically requires
sufficient capital in conducting its operational activities. It is the company‟s assets that are
rotated continuously in accordance with company objective.Working capital management
is also important financial decisions in the company that can increase the company‟s value.
Efficient working capital management involves planning and controlling current assets and
liabilities that eliminates risk of inability to meet short term commitments and avoids
extensive investment such assets (Lazaridis and Tryfondis, 2006). In the term of working
capital, high levels of current assets may decrease risk of liquidity related to cash
opportunity cost that invest in long term assets. However, high levels of current assets may
affect negatively profitability of the company whereas low level of current assets may
result in decreased liquidity and problems in operations (Afza and Nazir, 2009). This study
analyzed whether working capital management is able to influence the important variables
ofdairy food companies profit.

18
 Profitability is one of the most important factors for company to maintain in a
competitive environment. It refers to the possibility that the company will be successful
financially. In order to measure the profitability of company‟s performance, return on
equity has been used in this study. Return on equity is the amount of net income returned
as a percentage of shareholder equity. Return on equity measures a corporation‟s
profitability by revealing how much profit a company generates with the money
shareholders have invested (Gibson, 2011).
The researcher used the data from ten dairy and food companies listed on the
Indonesian Stock Exchange and have the largest total assets of food manufacturers in last
five years from 2012 until 2016. The study is focused on the average collection period, the
day payables period, and the current ratio that represent the working capital management
in this research to see how much influence the average collection period, account payable
period, and current ratio to the return on equity.

Literature Review
In the relation to the subject matter, we shall put into consideration the previous
researches. The previous research (Akoto et al. 2013) studied relation between working
capital management and profitability of thecompany. It showed average collection period
has a negative and relationship toward return on equity, day payables period has positive
but insignificant toward return on equity, and current ratio has a positive and statically
significant toward return on equity. By choosing a company listed in capital market of
India during 2000-2009. Rajesh and Reddy (2011) studied the effect of working capital
management on profitability. Results indicated that components of working capital
management are effective on performance of companies. Moreover, Gill (2010) provided
the result that average collection period has negatively correlated with profitability, and
day payables period has no significant effect on return on equity. Besides, Azeez et al.
(2016) resulted average collection period has negative significant effect toward
profitability, and day payable outstanding has positive significant effect toward
profitability.

Return on Equity

The dependent variable in this research is profitability or return on equity. Itis an ability
of a company or institution to make a profit within a specified period by using the asset,
and the amount of net income returned as a percentage of equity‟s holder. Return on equity
has been expressed as one of a good measurement of profitability, therefore many
researchers are used this method (Akoto et al. 2013).
Graph 1.
Return on Equity

0,20

0,15

0,10

0,05

0,00
Year 2012 Year 2013 Year 2014 Year 2015 Year 2016

(source: secondary data from idx that has been processed by author)

19
From graph1,it can be seen that the industries‟ average of return on equity increased from
14% in 2012 to 19% in 2014, then back to 14% in 2016.
Average Collection Period

The average collection period is contrary with the day payables outstandingin short-run
activities. It is an account offered by the firm or a company to their consumers. By having
good management in collecting receivable are intended to reduce the length of time
between the sale and the time of cash payment received. Moreover, it will be undertaken
by the customers to the firm or company that give the goods or services. The aim is to
reduce the arrears payment by costumers (Majeed et al. 2013).

Graph 2.

Average Collection Period

60,00
50,00
40,00
30,00
20,00
10,00
-
Year 2012 Year 2013 Year 2014 Year 2015 Year 2016

(source: secondary data from idx that has been processed by author)

From graph 2, it showed that the industries‟ average of average collection period is
increase since 2013 from 41.23 to 46.02 in 2016.

Day Payables Outstanding

Day payables outstanding is to find how long for a firm or a company can pay their
account payable (Gill, 2010). It describes how long it takes a company to pay its invoices
from trade creditors, such as supplier.

Graph 3

Days Payable Outstanding

60,00

40,00

20,00

0,00
Year 2012 Year 2013 Year 2014 Year 2015 Year 2016

(source: secondary data from idx that has been processed by author)

From graph 3, it showed that this ratio in period 2012-2016 was fluctuated and finally
increase to 46.59.
Current Ratio

Current Ratio is to measure of a company‟s liquidity or ability to payoff short-term

liabilities, it is calculated by dividing current assets by current liabilities (Usama, 2012).

20
 Graph 4

Current Ratio
2,50
2,40
2,30
2,20
2,10
2,00
1,90
Year 2012 Year 2013 Year 2014 Year 2015 Year 2016

(source: secondary data from idx that has been processed bt author)

From graph 4, it indicated the ratio decrease to 2.07 in 2014 and increase to 2.28 in 2016.
The availability of data and limitation of time the researchers focus on conducting
period 2012-2016. Based on the background above, the author decides to conduct further
research with the title “The Working Capital Management and profitability Analysis on
The Leading Dairy Food Industries in Indonesian During 2012-2016”.

Research Method
Three main hypotheses have been formulated in order to test the main research
question. They were testedin all companies involved by using descriptive analysis and
statistical analysis to interpret the data. The purpose of descriptive analysis is to define the
condition of the company from the data acquired by the researchers. Statistical analysis is
to process the data with the assist of SPSS 23 as statistical tool to run the data. Based on
the statement of problem and theoretical framework above, the hypothesis that tested in
this research can be stated as follows:
Hypothesis 1: there is a significant relation between average collection period and return
on equity of the companies
Hypothesis 2: there is a significant relation between day payable outstanding and return on
equity of the companies
Hypothesis 3: there is a significant relation between current ratio and return on equity of
the companies
Hypothesis 4: average collection period, day payable outstanding, current ratio have
simultaneous influence toward return on equity of the companies

Data Analysis

In this research, the population is taken from ten leading dairy food companies in
Indonesia that listed in Indonesian stock exchange that have met the requirement by
applying purposive sampling technique. It used cross-sectional data was taken from
secondary data that published in IDX that cover the period from 2012-2016.
The method of present study is correlation to determinethe relation between different
variables using correlation coefficient. The determination of square of correlation
coefficient is a standard that describes the relation between independent and
dependentvariable. The value of this coefficient indicates how many changes in dependent
variable can be explained byindependent variable. Descriptive statistic has been used to
analyze data including central and scatter indices.It is statistic of data analysis that explain

21
with description or data picture that already submitted and make it with conclusion that
applies to public or generalization.

Multiple Regression

Based on the result of assumption classic tests result itfound that the data on this
research has resulted normally and indicated no multicollinearity, heteroscedasticity, and
autocorrelation problems that happened. Thus it meets the requirements to perform
multiple regression analysis and perform hypothesis testing. The equation formula is:

Y = a + β1X1 + β2X2 + β3X3 + . . . + βnXn

From table 1, it conclude the multiple regression equation for the dairy food companies as
follows,
ROE = 0.20 - 0.1644E5ACP + 0.01DPO + 0.043CR
Where,
ACP = Average collection period
DPO = Day payable period
CR = Current ratio

Result
T-test and F-test are used in this research to conduct a hypothesis testing. The purpose
of T test is to define whether each independent variable has partial significant influence
toward dependent variable. The purpose of F-test is to define whether all independent
variables have simultaneous influence toward dependent variable (Ghozali, 2005).

Significant Simultaneous Test (F Test)

Significant Simultaneous Test is taken by comparing the significance value of Ftable and
Fcount. The results: if Fcount ≤ Ftable, Ho accepted Ha rejected, for α ≥ 0.05, and if Fcount ≥
Ftable, Ho rejected Ha accepted, for α ≥ 0.05
Where:
Ho: there is no significant impact of independent variables toward dependent variable
Ha: there is significant impactof independent variables toward dependent variable
Table 1
Anova
F = 12,280
Sig = 0.000
Source: Adjusted by Authors, processing result on secondary data SPSS 23

Based on the table 4.7 result the Fcount 12.280> Ftable 4.76with the sig. value of F test
is 0.000 which is <0.05. The researcher can reject Ho and accept Ha. It means all
independent variables affect significantly toward dependent variable.

22
Significant Partial Test (T Test)

Table 2. Multiple Regression

Coefficientsa

Unstandardized Coefficients Collinearity Statistic

Mpdel B Std Error t Sig Tolerence VIF
1 (constant) .020 .029 .694 .491
ACP -.1.644E5 .001 -.031 .975 .840 1.191
DPO .001 .000 3.141 .003 .990 1.010
CR .043 .010 4.491 .000 .836 1.196
a. Dependent Variable ROE
Source: Adjusted by Author, processing by SPSS 23

The first hypothesis states that average collection period has negative insignificant
toward return on equity. It can be seen from table 1 that the sig. value 0.975 > 0.05 which
means Ho was accepted and Ha was rejected. Compare to graph 1and 2, it can be
concluded the small increasing of average collection period on companies has no
significant impact to return on equity.However the higher number of average collection
period will decrease the profitability or return on equity of the company so the lower ratio
is the better performance of the company.
The sig. value of day payable outstanding 0.003 < 0.05 which means Ho was rejected
and Ha was accepted. It means day payable outstanding has positive significant impact
toward return on equity. In this result find out that if payment to suppliers will take more
time, the profitability will increase, because they can use the cash to pay other liabilities or
purchase assets. Besides, the sig. value of current ratio 0.000 < 0.005 which means Ho was
rejected and Ha was accepted. It also has positive significant impact toward return on
equity. Therefore, the higher number of day payables outstanding and current ratio will
increase the return on equity of company so the higher ratio is the better performance of
company.This result is in accordance with the result of Azeez et al. (2016).

Coefficient Multiple Determination Test (R2)

R2 is adoptedto show how far the independent variables used in the regression equation
which is able to interpret a dependent variable, and r square that has been corrected called
adjusted r square will adjust if there is an additional independent variable (Ghozali, 2005).

Table3. Auto correlation Test

b
Model Summary
Adjusted R Std. Error of the
Model R R Square Square Estimate Durbin-Watson
a
1 .675 .456 .419 ,06801 1.349
a. Predictors: (Constant): ACP. DPO, CR
b. Dependent Variable ROE
Source: Adjusted by Author, processing by SPSS 23

For the coefficient of determination, the R Square show 0.456 that means that all
independent variables which are average collection period, days payable outstanding, and
current ratio 45.6% influence simultaneously toward return on equity. The rest is
influenced by other variables which are not examined in this research.

23
Conclusion and Recommendation
Working capital management is one of the most important decisions in financial
management. The development of working capital of dairy and food leading companies in
Indonesia during 2012-2016 experience fluctuation with increasing trend. In this research,
average collection period has insignificant and negative relationship toward return on
equity. The higher number of average collection period will decrease the profitability or
return on equity of the company so the lower ratio is the better performance of the
company. Current Ratio has positive significant impact toward return on equity. Therefore,
the higher number of current ratio will increase the return on equity of company so the
higher ratio is the better performance of company. Overall the working capital of the
company is the position of positive current assets which are greater than the current
liabilities. If the proportion of the use of current assets in working capital is lower compare
to the use of current liabilities used to cover debt, it has the potential to reduce the sales
and as the result it can reduce the return on equity of the companies. Besides, the result of
day payable outstanding has positive significant impact toward return on equity. It means
if payment to suppliers will take more time, the profitability will increase. However high
day payable outstanding may indicate the companies have significant financial problem. It
might be happened because the management is poor and has the cash flow problem.
It is suggested that companies‟ manager can obtain an optimal working capital
management by balancing between profitability and liquidity. Moreover, they have to use
proper strategies to manage current liabilities and assets. Managers can have appropriate
policies and methods to control average collection period, day payable outstanding, and
increase company‟s cash and to improve working capital of the company. The companies
should use working capital according to business activity by selecting a funding source
long term debt properly and to manage the operation of business efficiently.
Generally, managers can improve working capital of the companyand increase
companies‟ profitability using these strategies that have been mentioned above.

References
Afza,T and M . Nazir, 2009. Impact of aggressive working capital management policy on
firms profitability” .The IUP Journal of Applied Finance, 15 (8):20-30.
Akoto, R. K., Vitor, A. D., & Angmor, P. L. (2013). Working capital management and
profitability: Evidence from Ghanaian listed manufacturing firms. . Journal of
Economics and International Finance. , Vol. 5(9), pp. 373-379.
Azeez, O., Abubakar, M. A., & Olamide, F. T. (2016). Analysis of the Effects of Working
Capital Management on Profitability of Listed Nigerian Conglomerate Companies.
FWU Journal of Social Sciences, Summer 2016,, Vol.10, No.1.
Ghozali, I. (2005). Aplikasi Analisis Multivariate Dengan Program SPSS. Semarang:
Badan Penerbit Universitas Diponegoro.
Gibson, C. H. (2011). Financial Reporting and Analysis, 13th Edition. University of
Toledo.
Gill, A., N. Biger and N. Mathur, 2010. The relationship between working capital
management and profitability: Evidence from the United States “. International
Research Journal of Finance and Economics .

24
Lazaridis, J and D.Tryfondis, (2006). Relationship between Working Capital Management
and profitability of listed companies in the Athenes Stock
Exchange.J.Finan.Manage.Anal., 19:26-35.
Majeed, S., Makki, M. A., Saleem, S., & Aziz, T. (2013). The Relationship of Cash
Conversion Cycle and Profitability of Firm: An Empirical Investigation of Pakistani
Firms. . Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB) an
Online International Monthly Journal, , 1(1), 35-51.
Rajesh, M and V. Reddy, (2011). Impact of working capital management on firms
profitability”. Global Journal of Finance and Management. 3(1): 151-158.
Sawir Agnes, (2015). Analisa Kinerja Keuangan dan Perencanaan Keuangan Perusahaan
PT Gramedia Pustaka, 2005:129.
Usama, M. (2012). Working Capital Management and its effect on firm‟s profitability and
liquidity: In Other food sector of (KSE) Karachi Stock Exchange. . Arabian Journal of
Business and Management Review (OMAN Chapter) , Vol. 1, No.12.

25
 The Ethics of Professional Skepticism: A Study in Indonesia
Supreme Audit Institution

Supeni Anggraeni Mapuasari

Accounting Department, Faculty of Business, President University

Abstract

This research elaborated the influence of ethics to government’s external auditor

professional skepticism. Ethics has been argued as one important variable affecting
auditor professional skepticism. Components of ethics being tested in this research are
moral reasoning and perceived importance of moral intent. Theory of cognitive dissonance
was utilized to operationalize the hypothesis analysis of this research. The respondents of
this research are auditors of Indonesian Supreme Audit Institution (SAI). Questionnaries
were spread of in the SAI training institution and being analyzed with regression analysis
by SPSS. The result of this study found a positive relationship between moral reasoning
and auditor professional skepticism. However, it failed to proof the relationship between
moral intent and auditor professional skepticism. This result gives a practical and
theoritical contribution to the development of auditor skepticism in public sector.

Keywords: Moral Reasoning, Perceived Importance of Moral Intent, Auditor

Professional Skepticism, Theory of Cognitive Dissonance.\

Introduction

Auditor professional skepticism is a crucial concept in every independent audit

engagement ( Nelson, 2009). Lack of professional skepticism may cause an audit failure
(Beasley et al. 2001 and Nolder, 2012). Security Exchange Commission (SEC) stated that
60% of audit failures came from the lack of audit profesional skepticism. In Indonesia, the
Indonesian Supreme Audit Institution (SAI) mentions the importance of auditor skepticism
in its audit standard 2007.
Skepticism is closely related to fraud detection and it has been a core concept in audit
(Hurt, 2010). A lot of big scandals commercial sectors audit were caused by the lack of
auditor skepticism and low auditor moral hazard. Less skeptical auditor will be les able to
detect material misstatement and fraud (Bernardi, 1994). However, auditors face
multicultural working environment which requires a good ability to handle ethical
dilemmas (Friedman, 2005; Sharp, 2006; Ho, 2007).
Auditors have taken a part on many big financial scandals both in private sectors and in
public sectors. Many financial cases in private sectors may cause bankruptcy. The example
works on the cases of On-Tel, HIH in Australia, Waste Management dan Xerox in
America, Permalat in Italia, Harris Scarfe, and many more (Cohen & Bennie, 2006). In
Indonesia, the annual potential loss of the Government is around 100 trillion rupiah. It is
caused by system inefficiency and fraud. This data was published by SAI.

26
 In those cases, auditor morality and auditor skepticism must be questioned. One of the
major causes of financial scandals is an unethical behavior of auditors (McPhail and
Walters, 2009). From the side of skepticism, the failure to gather enough evidences may
cause the failure to make a right audit judgement. (Beasley et al. 2001). Audit profession is
always linked with ethics and professional skepticism. However, there is still little research
conducted to analyse the relationship between ethics and skepticism in public sector audit.
It is important to conduct research about ethics and auditor professional skepticism in
public sector as difference culture may cause difference phenomenon (Cohen, 2006).
Government auditors are paid with the public fund, so they face a big responsibility to
public (Metzger, 2002). Moral pressure of government auditors relatively bigger than
private sector auditors (Metzger, 2002). Government auditors must have hold their
professionalism to meet public expectation. Nevertheless, friendship and hierarchy often
prevents auditors from being professional.
This research is aimed to find the relationship between two components of ethics and
government auditors‟ professional skepticism. The two components being tested are moral
reasoning and moral intensity. Moral reasoning was one of the traits to professional
skepticism (Nelson, 2009), while Jones (1991) argued that moral reasoning is not enough
to explain why people behave ethically. Jones (1991) found that moral intensity is
influencing ethical decision-making. Moral intensity covers six characters of moral issue
during audit engagement.
This research gives theoretical and practical contributions on auditor professional
research, especially in government sector. If this research success to proof the relationship
between moral reasoning and professional skepticism, it inspires the SAI to put attention to
their auditors‟ moral reasoning during periodical training or during recruitment. The
importance of moral intensity may inspire the SAI to train its auditor on how to face such
types and characteristics of issues.

Literature Review
Theory of Cognitive Dissonance

This research use theory of cognitive dissonance to explain the logical reason of its
hypothesis. It explains that every person has cognitions which can be a belief, behavior,
feeling, and perception about him/her self and the surrounding environment. Elements of
cognitions can interact each other or it can interact with environment. When there is an
inconsistency during the interaction, it causes dissonance. Dissonance makes
psychological discomfort, so people tend to reduce the dissonance in many ways (Killian,
1957 and Pepitone, 1959).
There are three common ways to reduce dissonance. First of all, people reduce
dissonance by changing their cognition. Second, people may face dissonance by adding a
cognition and leave the other cognitions. Majority of people face dissonance by changing
their interest and then choose the more important cognition. However, reducing dissonance
is neither simple nor easy.

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Professional Skepticism

Professional skepticism is a willingness to postpone judgement until getting sufficient

audit evidences (Hurt, 2010). There are six components of it, which are questioning mind,
suspicion of the judgement, search for knowledge, interpersonal understanding, self
respect, and autonomy (Hurt, 2010). Questioning mind and suspicion of the judgement are
widely used in research ( Bunge 1991; Kurtz 1992; Fogelin 1994; Nelson 2009). Auditor
reduces dissonance by gathering as much as possible related evidence in order to satisfy
their cognition.
Skepticism itself can be viewed from neutral or bias poin of view. From neutral view,
auditor may not being skeptic to client. Auditor should be critical, but still positive
thinking. On the bias side, auditor must be skeptic and believe on the possibility of any
material misstatements done by clients (Nelson, 2009; Brown-Liburd, 2013). The more
skeptical, the more willingness to gather related evidence (Peecer, 1996; Turner 2001;
Nelson, 2009). Highly skeptical auditor convince their assertion and minimize the failure
of detecting error (McMillan & White, 1993).
Skepticism can be a trait or a state. As a trait, it is an individual variable that relatively
stable (Nelson, 2009; Robinson, 2011), but a state, it is a behaviour influenced by the
situation (Cohen and Bennie, 2006; Nelson, 2009; Hurtt, 2010; Robinson, 2011; Brown
Liburd et al, 2013). Personality, moral reasoning, problem solving ability, and self
confidence are the example of traits (Nelson, 2009). Profesional skepticism is an
individual variable that contains traits inside (Beeler and Hunton 2002); Grambling 1999;
Houston, 1999; Hackenberk, 1992; Nelson, 2009; Robinson, 2011). On the state side,
professional skepticism can be difference from one to another situation (Robinson, 2011).

Ethics

Ethics comes from greece language ethos which means culture, character, and behavior
(Northouse, 2004). Ethics is a philosophical study of morality (Mappes, 1988; Page, 2005;
Ho, 2007). Kohlberg (1969) stated that ethics is a moral concept to judge right and wrong.
While moral reasoning is the abilty to judge right and wrong when facing ethical dilemmas
(Kolhberg, 1958; Rest, 1983). Ethical dilemmas contain situation that requires several
alternative of actions and none alternative is either wrong or correct (Thorne, 2000).
Accountant often faces ethical dilemmas in their working environment. The ethical
dilemmas asks accountant to take some action or decision. Moral reasoning give a
guidelines on how to behave ethically in accordance with professional codes of ethics such
as; due care, independency, objectivity, skepticism, and integrity (Thorne, 1998; Jones
and Ponemon, 1993).

Moral Intensity

Moral intensity is being constructed in by Jones (1991). It argues that individual

variable will not be sufficient enough to explain the process on which people face ethical
dilemmas (John, 1991). Jones modify previous research by introducing six characteristic of
issues as a variable that may influence ethical decision making (Ferrel and Gresham, 1985;
; Rest, 1986).
Those six characteristic is called moral intensity. They are the nature of effects, social
consensus, probability of effects to be occured, temporal immediacy, concentration of

28
effects, and proximity. Temporal immediacy reflects how fast the effect will come.
Concentration of effects reflect the numbers of people will be suffering from effects.
Proximity means the closeness of the decision maker to effect.

Hypothesis Development

Based on cognitive dissonance theory, when auditor found a misstatement, he/she will
face a dilemma whether to dislose or not, how detail the disclosure, and what is the right
audit judgement. Auditor may face the dissonance with keeping in a silent, not dislosing
the finding. The second choice is to keep attention to the issue by gathering additional
evidence or procedures. Those actions done with a purpose of being able to take the best
judgement. Taking the best judgement from valid and complete evidence will reduce the
auditor dissonance.
As Arnold dan Ponemon (1991) linked moral reasoning to due care, moral reasoning is
closely linked to the ability and willingness to detect finding in misstatement (Bernardi,
1994). Auditor with higher score of moral reasoning will act in accordance to the
professional standard (Arnold dan Ponemon, 1991). As the moral reasoning score is
higher, the less possibility to disobey audit codes of ethics (Bernardi, 1996). In this case,
skepticism is a crucial component of audit codes of ethics. Thus, higher moral reasoning
auditor will be more skeptical. Previous research done by Rahman (2012) and Sitanala
(2010) found evidence that moral reasoning is positively related to auditor professional
skepticism.
Auditor with higher moral reasoning score has a better ability to make a better
judgement in audit dilemma (Page, 2005). They act carefully and tend to ensure that the
evidence gotten is sufficient. Then, this carefull act is identically recognized as being
skeptical. From above explanation, the first hypothesis in this research is:
H1 : Auditor with higher level of moral reasoning will be more skeptical than auditor with
lower level of moral reasoning.
Jones (1991) argued that individual variable will not be sufficient enough to explain
the process on which people face ethical dilemmas (John, 1991). Thus, high moral
reasoning will not guarantee better ethical decisions when facing dilemma. Moral intensity
is more influencing in ethical decision making process (Haines, et al., 2008; Kelley and
Elm, 2003). From cognitive dissonance theory point of view, auditor who realize the
importance of moral intensity understands the consequence of audit issue. He/she also
realized the consequences of audit action taken. Because of this awareness, he/she will be
more carefull to judge. This carefullness will force him/her to be more skeptical. The
auditor will be more willing to add evidence searching and procedures if it is needed.
Thus, the second hypothesis is:
H2 : Auditor with higher level of perceived moral intensity will be more skeptical than
those with lower level of perceived moral intensity.

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Research Method
Data Gathering Technique

This research use survey method. Questionnaires were spread of in SAI Training
Institution Yogyakarta. The respondent criteria of this research is auditor who is currently
active in audit engagement. The repondents are auditor from various provinces. From 96
questionnaires, 71 numbers were back, but only 65 were pass the validity and reliability
test. The response rate is 67,7%.

Operational Variable Definition and Its Instrument

Moral reasoning is the abilty to judge right or wrong when facing ethical dilemmas
(Kohlberg, 1969; Rest, 1969; Rest, 1999). It is measured with accounting context defining
issues test (ADIT). It was developed by Thorne (2000). ADIT score calculation has the
same mechanism with the traditional DIT. P-score is only calculated from respons in
stages ke 5a, 5b, and 6.
Professional skepticism is a willingness to postpone judgement until getting sufficient
audit evidences (Hurt, 2010). The indicators used in this research is suspicion of the
judgement and questioning mind. It is being measured with Hurt (2010) instrument to
measure professional skepticism and measured with likert scale .
Moral intensity is dimensions contained in the ethical issues that consist of the nature of
effects, social consensus, probability of effects to be occured, temporal immediacy,
concentration of effects, and proximity (Jones, 1991). The respondents were asked to what
extent the understanding on those dimensions will influence their decision making.
Instrument was measured with likert scale.

Common Method Bias

There are several ways to reduce bias. First, predictor variable is psychologically
separated with the criteria variable. Scenario use third party‟s name. It can minimize self
serving bias. Second, researcher guarantee the confidentiality of all information given by
respondents. Third, researched is not directly interacted with the respondent. Fourth, the
arrangement of questions follow the most convenience sugestion. The most important part
was put at first. The hardest part was in midlle. The easiest part is at last (Jogiyanto, 2011).

Data Analysis

Validity test is utilized by factor analysis in order to measure the unobservable

construct of professional skepticism (Gudono, 2012). Reliability test is performed to
measure the accuracy of measurement procedures (Cooper and Schindler, 2011).
Hypothesis testing was perfomed by simple regression.

SP = α + β1 MR + β2 MI+ e

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SP = professional skepticism
A= intercept
β1, β2= regression coeficient
MR= moral reasoning
MI= Moral Intensity
e=error

Result and Discussion

Demography of the Respondents
From the education level, there are 77% undergraduates, 20% master graduates, and 3%
diploma 3. From gender side, 37% woman and 63% man. Majority of ages is on the range
of 30-39 years old, which is 55%. The range 20-29 years old are 23% and the rest is
between 40-49 years old.
From the analysis of descriptive statistic, the means of Professional Skepticism is 22.94
with deviation standard 3.53, the means of moral reasoning is 38.76 with deviation
standard 12.02, and moral intensity score‟s mean is 3.86 with deviation standard 0.92.
The respondent‟s profile was gathered based on the information of gender, education
level, age, and period years of working in the SAI. Majority respondents are holding
bachelor degree and having 6-10 years of working. Based on the gender, 37% are female
and 63% are male. Their age is ranged from 20-29 years old (37%), 30-39 years old (55%),
and 40-49 years old (8%).

Tabel 1
Descriptive Statistics

Validity and Reliability Test

Based on the result of factor analysis, KMO test showed 0.817 or 81,7% which means
good sample adequacy (Hair et al., 2010; Gudono, 2012). Bartlett's Test of Spericity is
significant 0.000. It means the matrix is a correlation matix, not identity matrix, so factor
analysis can be used.

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 Tabel 2
Test of Sampling Adequcy

Test of reliability reflects the consistency of professional skepticism instrument

(Sekaran, 2003; Hurt, 2010; Cooper and Schindler, 2011). It is measured by cronbach
alpha. It must be more than 0.60 (Nunally, 1994 dalam Ghozali, 2011). The cronbach
alpha is 0.857. It passes the criteria.

Test of reliability reflects the consistency of professional skepticism instrument

(Sekaran, 2003; Hurt, 2010; ; Cooper and Schindler, 2011). It is measured by cronbach
alpha. It must be more than 0.60 (Nunally, 1994 in Ghozali, 2011). The cronbach alpha is
0.857. It passes the criteria.
The test of validity used in moral reasoning is face validity. It is based on the DIT
manuals issued by the University of Minnesota. It is used because it involves
psychological feeling. The respondent who choose the meaningless answer more than 8
score will be dropped. To test the reliability, respondent who give the same rates more than
9 from 12 statements does not passed the reliability test. Six questionnaires or 8,4% were
dropped. Rest (1986b) and Thorne (2000) allowed 5% to 15% dropped questionnaires.

32
Regression Analysis

From regression analysis performed with SPSS, adjusted R-Square is 0.453. The model
may explain 45,3% variation of professional skepticism model. The F value gotten is 27,
472 significance at alpha 0.000 which indicates excellent goodness of fit. Second step,
variable can be supported if the t-score must be more than the t-table. The t-score of moral
reasoning is more than t-table, which is 7.409 from t-table 1.686. It has p-values
significance at 0.000. In conclusion, first hypothesis is supported. On the other hand, moral
intensity has t-score 0.349 which is far lower than 1.686. The p-value is 0.729 and it is
higher than the significance criteria. The second hypothesis is not supported.
The first hypothesis is supported. It means that moral reasoning is positively related to
government auditors‟ professional skepticism. It confirms previous research done in
Indonesia by Sitanala (2010) and Rahman (2012) that stated the positive relationship
between auditor moral reasoning and auditor professional skepticism. It also supported
Nelson (2009) model on professional skepticism. Moral reasoning is one of traits in
professional skepticism. The higher the moral reasoning level, the less possibility to
disobey the ethical conduct and it results on the more skeptical mind (Bernardi, 1994).
However, this research failed to proofany relationship between morale intensity and
professional skepticism. However, the result of descriptive statistic give a quite small
standard deviation of the means. It can be concluded that almost all respondent put
attention to moral intensity when facing audit dilemma. It confirms the arguments of Jones
(1991) and Cohen and Bennie (2013) which said moral intensity influence the audit
decision-making.

Conclusion
This research has answer the research question which asking the relationship between
ethics and skepticism. Based on the cognitive dissonance theory, auditor with higher moral
reasoning tends to decrease dissonance by gathering more evidence and willing to
postpone judgement until getting enough evidence. The auditor does not want to make a
wrong judgement. He or she tends to obey the audit codes of ethics. Thus, the auditor
poses higher skepticism too. It is also concluded that the lower the level of moral
reasoning indicates the lower score of professional skepticism.
There are two implications for the SAI. First, it is important for the SAI to pay attention
to its auditors‟ moral reasoning level because it will influence their professional
skepticism. The SAI may put ethics as one of training materials. The SAI may also put
moral reasoning score as one of recruitment criteria. The second implication, moral
intensity is assumed to be importantly used when making audit decision. The SAI may
gather more research on the details types of moral intensity and how it influence ethical
decision-making.
This research failed to find evidenceon whether the better the understanding on moral
intensity will create better skepticism. Moral intensity is a state variable. The practice is
depending much on the situation. It is suspected to influence ethical decision making, but
it can not be captured simply with a perception quessionaire. This research leave an
unanswer gap to find another instrument and research method to capture auditor‟s response
toward moral intensity. Probably, the most suitable method is experiment, since

33
experiment allows researcher to make a unique context and manipulation that enable
researcher to deliver more comprehensive situation representing the real condition.
This research has many constraints in term of sampling size, the difficulty level of
moral reasoning scenario. In addition, it takes quite long time to finish the questionnaires.
It can cause psychological bias. Next research may use traditional DIT rather than
accounting context DIT because of the difficulties in understanding the context of
scenario. It is indicated by 6 respondents do not passed the meaningless test. Future
research could be more understandable if using an indonesian addapted instruments to
improve respondents understanding.

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