Financial Risk and Cost Stickiness: Evidence From Egypt

Mohamed Mandour

doi:10.5296/ijafr.v11i2.18751

Abstract

This study seeks to investigate whether the cost of goods sold (COGS) behaves asymmetric to change in sales, and examines the effect of financial risk on asymmetric cost behavior of COGS in the Egyptian manufacturing firms. The financial data of this study were collected from the published annual reports for a sample of 65 Egyptian listed manufacturing firms during the period (2006-2015) with total observations 530 firm-year. The analysis of this paper is based on Anderson et al.’s (2003) cost stickiness model. The findings indicate that the COGS is sticky to change in sales, it rises more when sales increase than when it falls for equivalent sales decrease and the degree of cost stickiness increases with a firm’s financial risk. This study is the first attempt to examine the direct effect of financial risk on the COGS behavior using Altman Z-score model as a proxy for financial risk, which may affect the accuracy of the results. By focusing on this proxy, the study identifies a significant relationship, which was not adequately addressed in previous studies. Therefore, this study extends the cost behavior literature by examining the impact of financial risk on managers' decisions to amend the resources.

Highlights

The results show a positive direct effect of financial risk on the flexibility of the cost structure, which means that the greater the financial risk, the more flexible the cost structure; which in turn decreases the degree of asymmetric cost behavior
The adjusted R2 value equals 66.5%, which means that approximately 66.5% of the variance in cost of goods sold (COGS) was accounted for the independent variables in the model and remaining percentage, 33.5%, is explained by other factors
These results indicate that when sales increase by 1%, the COGS increases by 1.064%, while when sales decrease by 1%, the COGS decreases by (1.064% - 0.363%) 0.701%

Summary

Introduction

Decision makers at all levels are in need of appropriate and accurate information to be provided at the right time; cost is one of the most important information that managers need in response to increasing and intensive competition. Managerial accountants use multiple methods that depend on identifying cost behavior, such as: estimating the cost and the analysis of the relationship among cost, volume and profit. 2021, Vol 11, No 2 to their relationship with activity levels, into fixed cost and variable cost. It is assumed that the total fixed costs do not change with the change in activity levels within a certain range called the relevant range. While variable cost behavior is a linearly symmetrical behavior; meaning that the total variable cost varies proportionally with changes in activity levels, regardless of the direction of this change - increase or decrease - compared to the prior period. The proportion of cost increase with the increase in the activity by a specific amount is the same as the proportion of cost decrease if there was an equivalent decrease in the activity (Noreen, 1991)

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Results