Working Capital Management Among Listed Companies of Pakistan

[Hassan et. al., Vol.5 (Iss.
2): February, 2017] ISSN- 2350-0530(O), ISSN- 2394-3629(P)

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Management
WORKING CAPITAL MANAGEMENT AMONG LISTED COMPANIES

OF PAKISTAN
Waqar-ul-Hassan*1, Mohsin Zubair2, Zeeshan Hasnain3, Shahbaz Hussain4

*1, 3
Institute of Banking & Finance, Bahauddin Zakariya University (Multan)Pakistan
2
Department of Management Sciences, National University of Modern Languages (Multan)
Pakistan
4
Faculty of Management & Economics, Dalian University of Technology, China
DOI: https://doi.org/10.5281/zenodo.345448
Abstract
The study aims to investigate the strength of working capital management for measuring the
financial performance of listed stocks. The study incorporates descriptive statistics, Pearson
correlation, and multiple regression models for interpretation and execution of data. Five years
(2006-11) panel data of 125 listed companies of Pakistan stock exchange (PSX) is selected in
accordance to sample selection criterion. Results of regression analysis supported an inverse
relationship between firm`s profitability and working capital management. Return on asset and
Gross operation income are taken as indicators of profitability. Inventory turnover in days,
Average age of A/R, Average payable period and Cash conversion cycle are considered as
independent variables to measure firm’s profitability. Firm size, Sales growth, and financial debt
ratio are favored as control variables. Overall Return on asset models indicated poor values of R-
square`s and Gross operating income models showed robustness.
Keywords: Working Capital Management; Firm Performance; Panel Data Analysis.
CITE THIS ARTICLE: Waqar-ul-Hassan, Mohsin Zubair, Zeeshan Hasnain, and Shahbaz
Hussain (2017). “WORKING CAPITAL MANAGEMENT AMONG LISTED COMPANIES
OF PAKISTAN” International Journal of Research - Granthaalayah, 5(2), 80-91.
https://doi.org/10.5281/zenodo.345448.
1. Introduction
Corporate finance generally relies on the empirical analysis or investigation of long-term
monetary settlements. Academicians and institutional analysts have especially proposed theories
for capital structure, investment considerations, the organizational value in terms of dividend
policies and market earnings. Short-term investments normally have the life of one year and also
symbolize the most important portion of balance sheet analysis and require sensible attention
because of their meaningful and valuable contribution toward firm`s profitability (Smith, 1980).
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[Hassan et. al., Vol.5 (Iss.2): February, 2017] ISSN- 2350-0530(O), ISSN- 2394-3629(P)
Working capital management is all about allocation and monitoring of short-term corporate
financial decisions (Gitman, 2005). Management arms should always strive to maintain the
perfect level of working capital, in order to perform the business operation more efficiently
(Howorth &Westhead 2003).
An investment concerning working capital develops a linkage between risk and return. Firm’s
decision to make a contribution for higher returns will also expand risk factors and the attempts
to minimize risk will also lead toward lower returns. Raheman and Nasr, (2007) stated that
efficacy in short-term financial decisions is the most important component because a major
portion of firm’s assets consists of fixed assets. Samiloglu and Dermigunes, (2008) discussed
working capital management in relation to the financial health of corporations. They also suggest
that an improper proceeding of working capital management may lead towards bankruptcy.
Likewise, ignoring liquidity for generating greater profits can cause harmful results. Therefore, it
is important for a firm to create a balance between profitability and liquidity. Furthermore,
Gitman, (1974) stated cash conversion cycle as a major element for managing working capital.
Firm`s planning including how much they have to invest for customer accounts and inventory,
how the amount of credit they have to accept from the vender, these are the situations which are
highly mirrored in firm`s cash conversion cycle, which also indicates the average days between
accounts payable to receivable’s. Prior studies used cash conversion cycle as a base for firm`s
profitability. Similarly, research studies on working capital management and firm`s profitability
indicate that aggressive working capital strategies lead towards profitability; Jose et al., (1996);
Shin and Soenen, (1998); Wang, (2002); Deloof, (2003).
Working capital management is required to attain an optimal level of organization`s profitability

and liquidity. Higher current asset ratio lowers the inadequacy of cash, implying that all key
participants of working capital including inventories, securities, cash, and receivables have a
strong influence on firm`s management, which may add value to shareholders attraction and
retention (Eljelly, 2004). Several researchers Afza & Nazir, (2007); Samiloglu & Dermigunes,
(2008); Ali & Ali, (2012) and Padachi, (2006) examined the statistical relationship between
working capital management and firm’s profitability, findings of the study acknowledge the
importance of this relationship for a modern firm.
2. Review of Literature
2.1.Working Capital Management Concept
Working capital management is declared as the most important tool for firm`s financial
management. Proper concentration of working capital may help organizations to stay healthy, in
financial terms (Shin & Soenen, 1998). It is the responsibility of firm’s management to gauge
trade-off among proposed earnings and risk, prior to making a decision on the amount of current
asset investment. There are two basic ways for managing working capital i.e. either by reducing
working capital investment or by designing strategies for boosting sales volume. Adopting
aggressive policies (reducing working capital investment) generally positively affect firm`s
profitability.

According to Wang, (2002) handsome reduction in corporate inventory and customer credit
requirements may lower down sales volume, on the other hand expanding suppliers financing
may decline discount percentage. Opportunity cost exceeds up to 20 percent, depending on the
granted period and discounted percentage Wilner, (2000). Contrary to conventional theories,
adopting conservative policies (healthier investments) towards firm`s working capital may also
result in firm`s financial benefits. Maintaining huge volume of inventory minimizes the possible
intrusion cost during the production process and business loss caused by products deficiencies
minimizes the cost of supply, and product price fluctuations (Blinder & Maccini, 1991).
Awarding trade credits may support organizations in multiple ways. Petersen & Rajan, (1997);
Brennan et al. (1988) stated that trade credit is an effective tool for price cut, to provide
monetary benefits to customers for collecting products at low demand times (Emery, 1987), to
confess customers in order to investigate and ensure that delivered products meet the agreed
quantity and quality (Smith, 1987), which advice organization`s to establish long-term
relationships with customers (Ng et al., 1999). Though, these advantages required proper
attention for preventing a decline in profitability due to increase in short-term investments.
Empirical research works regarding working capital management and firm`s profitability
encourage aggressive working capital policies for strengthening financial viability. Jose et al.
(1996) support the role of aggressive working capital approaches for enhancing firm`s
profitability by providing empirical evidence from listed companies of United States. Shin and
Soenen (1998) proved the strong positive impact of trade credit reduction on firm`s profitability
by taking a sample from US capital market for the period ranges from 1974 to 1994, though this
relationship seems to be poor while conducting analysis at the industry level (Soenen, 1993).
Deloof, (2003) studied Belgian firm`s for the period of 1992 to 1996, for the purpose of
investigating relationship between average age of accounts receivable and firm`s financial
performance, study indicated that reduction in average age of accounts receivable improves
firm`s profitability, additionally it was stated that low profitable firms require long time
durations to settle down their outstanding claims. However, Wang, (2002) took a sample of
Taiwanese and Japanese firm`s for the period ranges from 1985-1996, results of the study
supported short cash conversion cycle is relatively better for firm`s operational achievements.
Theoretical findings defined the fact that designing working capital strategies requires following
some industry specific benchmarks which organizations have to maintain (Hawawini et al.,
1986). Hence, firm`s speed up their amount of profitability by reducing inventories and accounts
receivables to a minimal level, as per their given benchmarks. Moreover, Soenen, (1993) stated
that management should struggle to collect cash inflows as soon as possible, on the other hand,
delay the cash outflows as longer as possible. This strategy will shorten the age of cash
conversion cycle, which will ultimately lead towards organizational long-term financial benefits.
2.2.Earlier Studies on Working Capital Management
Although numerous studies have already been conducted to evaluate the impact of working
capital management on firm`s financial viability, some of the empirical findings are discussed
here to design research gaps and objectives.

Samiloglu & Dermigunes (2008) examined the impact of firm`s working capital on their
profitability by taking a sample from Turkish capital market. The objective of the study was to
undercover the strength of statistical relation among components of cash conversion cycle and
firm`s profitability. In order to reach empirical findings, study carried sample for the period
ranges from 1998 to 2007. Multiple linear regression analysis demonstrates the negative
behavior of accounts receivable, leverage and inventory period, while the positive attitude of
sales growth toward firm`s profitability.
Pooled OLS, fixed effect panel regression models were adopted by Mathuva, (2010) in order to
measure the performance of working capital management on listed stocks of Kenya. The study
took a sample of 30 firm`s over the period ranges from 1993 to 2008. Regression results
indicated the negative relationship among firm`s profitability and average time duration required
to convert stock into cash. Furthermore, there exist positive association among average time
firm`s required to meet their financial obligations.
Akinlo, (2011) explore the impact of working capital management on the profitability of listed
Nigerian stocks, with the panel data statistical techniques. Eight years data of Nigerian stocks
were gathered for the period of 1999 to 2007. Results proved positive linkage among firm`s
financial performance and sales growth. Moreover, there exist negative harmony among firm`s
leverage and profitability. Moreover, firm`s average collection period and leverage also indicated
positive behavior for each other.
Textile sector of Pakistan was studied in order to analyze the impact of working capital
management on firm`s profitability. Average time duration required to convert stock into cash,
average days for working capital and operating cycle were selected as independent variables to
study the efficacy of firm`s working capital system, while return on equity, return on asset, profit
margins and economic value additions were favored as firm`s profitability indicators. Six years
data of 160 textile firm`s for the period of 2000 to 2005 was selected as a sample to reach
empirical findings. Ordinary least square and fixed effect regression equations were applied for
analyzation and interpretation of collected data sets. Results highlighted significant and inverse
relationship among average age of accounts receivables, average payable period and return on
assets, while positive significant association exists between return on asset and the average age
of inventory. Furthermore, a positive association was found among return on asset and cash
conversion cycle of textile sector of Pakistan (Ali, 2011).
Sharma & Kumar (2011) studied the impact of working capital management for identifying the
performance of Indian listed stocks. Panel data consisting of 263 non-financial Bombay stock
exchange indexed firms was collected as a sample of the study. The study used Ordinary least
square regression analysis to make conclusive statements about the hypothesized relationships.
Results proved significant and positive association with working capital management and Indian
listed firms. Cash conversion cycle and the average age of accounts receivables showed positive
correlation toward profitability, while average life of inventory and accounts payable indicated
negative behavior for gauging profitability. The study concluded that expanding cash conversion
cycle and average receivable period will help Indian organization`s to boost profitability.

Firm`s financial performance and working capital management have significant positive relation
with one another. Abuzayed, (2012) proved this statistical relation by conducting a research in
Jordan. Eight years panel data for the period ranges from 2000-2008 was collected from listed
firms of Amman stock exchange. The major interest of shareholders is to gain handsome profit
margins on their investments so that both financial and marketing measures were adopted. Most
advanced panel data techniques random effect, fixed effects and generalized movement methods
were favored for analysation and interpretation of data sets. Findings suggested creating
equilibrium among profitability and liquidity, in order to operate business affairs more efficiently
and effectively.
Five-panel regression models were developed by Vural et al. (2012) to examine the nature of the
relationship among firm`s performance of Istanbul stock exchange-listed stocks and working
capital management. Seven years data of 75 traded stocks, ranges from 2002 to 2009 was
gathered from a sample of the study. Operating profit and Tobin`s Q are favored as profitability
indicators for measuring Istanbul stocks performance. Regression findings showed the
insignificant relationship between profitability and firm`s working capital management, only
cash conversion cycle and average collection period indicated strength for measuring firm`s
profitability. Results revealed that reduction in average collection period and cash conversion
cycle will enhance firm`s profitability.
2.3.Research Gap
Malik and Bukhari, (2014) selected ROE as an indicator of profitability and five years data of 38
KSE listed companies from Cement, Chemical and Engineering sectors to study working capital
management. Qazi et al. (2011) limited their research work by taking 20 Oil & Gas companies
listed on KSE from 2004 to 2009 and net income for measuring profitability. Asad, (2012)
studied working capital management by gathering data of 30 textile listed firms as a sample and
EPS for symbolizing profitability.
Forwarding with the concept of working capital management, Ahmad and Bano, (2015) used six
years data of 115 KSE listed textiles companies while taking ROA as profitability measure. Raza
with his research colleagues in 2015, favored three indicators of profitability; ROE, ROI, and
ROA for measuring working capital management of KSE listed Oil & Gas companies. Iqbal and
Zhuquan, (2015) also selected ROA as a measure of profitability and 85 non-financial KSE firms
for studying working capital management.
Ary et al. (2002) stated that larger sample size helps to control regression errors and stabilizes
the relationships between Y and X variables. Scholars in developed economies take multiple
indicators of firm`s profitability like; ROE, ROA, ROI, EPS, GOI, Net Income for better
estimation of results. Previous studies conducted in Pakistan on working capital management,
ignore to synergize larger sample size and multiple profitability indicators for estimation of
working capital determinants toward firm`s performance.

2.4.Research hypothesis
Persistent with the working capital theories, studies indicated that average collection period and
average age of inventory have negative association towards firm`s profitability; (Rehman &
Nasr, 2007); (Charitou et al. 2010); (Deloof, 2003); (Karaduman et al. 2010); Deloof, (2003)
stated that poor financial firm`s required longer time span to pay-off their liabilities, Flope and
Ajilore, (2009) negate earlier theories and support Deloof findings by proving negative
association among DPO and profitability. On the basis of earlier theories and research studies,
following hypotheses are being proposed to reach empirical findings;
H1: Average collection period is negatively related to profitability.
H2: Average age of inventory is negatively related to profitability.
H3: Average payment period is negatively related to profitability.
H4: Cash conversion cycle is negatively related to profitability.
2.5.Objectives of the Study
The present study aims to explore the impact of specific components of working capital
management including; the average age of accounts payable, the average age of accounts
receivable, the average age of inventory and cash conversion cycle on the financial performance
of the listed companies of Pakistan. In order to present a comprehensive analysis, firm size,
annualized sales growth and financial debt-ratio have been taken to control un-wanted effects of
other variables in the regression equation.
3. Research Methodology
3.1.Sample Selection
The study gathered five years panel data (2006-11) of 125 textile firms. Textile is amongst one
of the largest sectors of Pakistan`s economy, as it contributes about 60% to total national exports
and 9.5% of GDP (Pakistan bureau of Statistics, 2012). A sample of 125 textile firms is selected
from a total of 155 listed textile firms at KSE, study based data availability and listing criteria for
selection of sampled firms, in order to avoid missing values.
3.2.Variables Measurement
3.2.1. Dependent Variable
Return on asset (ROA) and Gross operating income (GOI) are taken as measures of firm’s
profitability (dependent variable). ROA is defined as net profit divided by total assets; while GOI
is measured as sales minus cost of goods sold, wholly divided by total assets minus financial
assets.
3.2.2. Independent Variables
DSI act as a tool for firm`s inventory management. It measures the average number of days from
delivery of raw materials to the sale of finished goods. It is calculated as inventory divided by

cost of goods sold, multiplied by an annual number of days. DSO indicates the average
collection period, it measures an average number of days a firm required to collect its bills. It is
computed by dividing accounts receivable to sales and multiplied with an annual number of
days. DPO shows the average payment period. It is measured as accounts payable to cost of
goods sold, and multiplied by an annual number of days.
CCC is an indicator of working capital management that quantifies the average time period
between cash outflow for inventories or resources and cash inflow from sales. CCC is measured
as DSO plus DSI minus DPO. Firm size, sales growth, and financial debt ratio are taken as
control variables.
4. Statistical Analysis
Working capital management among listed companies of Pakistan is examined with the help of
panel regression models using SPSS 16.0. Following regression equations have been designed to
test hypothesized relationships.
Profitability = β0 + β1DSI + β2FS + β3SG + β4FDR + εit (1)

Profitability = β0 + β1DSO + β2FS + β3SG + β4FDR + εit (2)
Profitability = β0 + β1DPO + β2FS + β3SG + β4FDR + εit (3)
Profitability = β0 + β1CCC + β2FS + β3SG + β4FDR + εit (4)
Profitability = β0 + β1DSI + β2DSO + β3DPO + β4CCC + β5FS + β6SG + β7FDR + εit (5)
Where;
Profitability = 1. ROA = Net profit divided by total assets
= 2. GOI = Sales minus cost of goods sold, whole divided by total assets minus
financial assets
DSI = Inventory turnover in days

DSO = Average age of accounts receivables
DPO = Average age of accounts payables
CCC = Sum of DSI and DSO, minus DPO
FS = Natural log of sales
SG = Current year sale minus previous year sale, divided by previous year sale
FDR = Financial debts divided by total assets
Study employed descriptive statistics to examine the temporal properties of given variables,
Pearson correlation analysis to study the amount of relationships among studied variables and
OLS regression analysis to measure the strength of independent variables for gauging dependent
variable.

5. Empirical Results
5.1.Descriptive analysis
Table 4.1 describes mean, standard deviation and number of observations against each studied
variable. Five years panel data of 125 textile firm`s is studied, so a number of observations for
each variable are 625. Standard deviation is the amount of dispersion or variance of studied
variable from its mean. ROA showed 6% greater deviation as compare to GOI. The average
ROA and GOI is 0.19% and 11.21% respectively.
Table 4.1: Descriptive Statistics

Variable Description Mean Standard Deviation Observations
ROA Return on Assets 0.0019 0.1822 625
GOI Gross Operating Income 0.1121 0.1212 625
DSI Days sales inventory 1.1900 926.11 625
DSO Days sales outstanding 40.823 65.808 625
DPO Days payable outstanding 2.6600 1821.9 625
CCC Cash conversion cycle -1.0600 983.57 625
FS Firm size 14.303 1.3868 625
FG Firm growth 0.2624 1.2019 625
FDTAR Financial debt to total asset ratio 0.7022 0.2467 625
Table 4.2 presents correlation coefficients of all selected variables of the study. DSI and CCC
showed weaker positive correlation for ROA and GOI, on the other hand, DSO and DPO
presented poor negative association for measuring ROA and GOI. DSI, DSO and DPO and
positively related to each other, while DSI, DPO showed strong negative behavior for CCC and
DPO indicated weaker inverse role toward CCC.
Table 4.2: Pearson Correlation Matrix

ROA GOI DSI DSO DPO CCC FS FG FDTAR
ROA 1
GOI 0.282 1
DSI 0.000 0.064 1
DSO -0.006 -0.036 0.024 1
DPO -0.018 -0.020 0.950 0.051 1
CCC 0.033 0.094 -0.816 -0.006 -0.955 1
FS 0.165 0.409 0.005 -0.090 -0.057 0.105 1
FG 0.049 0.032 -0.014 -0.077 -0.009 -0.002 0.021 1
FDTAR -0.218 -0.215 -0.037 -0.092 -0.018 -0.008 -0.144 -0.090 1
5.2.Analysis and Discussion
In this study, the researchers have conducted tests with five regression panel equations to
determine the strength of working capital management elements, for measuring firm`s
profitability by taking ROA and GOI as indicators of profitability. Table 4.3 and table 4.4
presents ROA and GOI results respectively. R-square of ROA models showed the value of
0.067, which means poor robustness of ROA equations. DSI, DSO, DPO and CCC all studied
variables indicated insignificant and negative behavior for measuring dependent variable. DPO is
omitted in equation (5) while regressing with other variables.
Table 4.3: Multiple regression models on Return on Assets (ROA)

Column 1 2 3 4 5
WCM Elements DSI DSO DPO CCC Full Model
(DPO Omitted)
Constant 0.055*** 0.064*** 0.058*** 0.062*** 0.082***
(-0.153) (-0.150) (-0.151) (-0.150) (-0.143)
DSI 0.837 0.768
(-1.570) (-3.970)
DSO 0.81 0.8
(-2.622) (-2.766)
DPO 0.723 Omitted
(-1.380)
CCC 0.653 0.618
(-3.246) (-6.338)
FS 0.001* 0.001* 0.001* 0.001* 0.001*
(-0.018) (-0.018) (-0.018) (-0.018) (-0.017)
FG 0.466 0.478 0.466 0.463 0.472
(-0.004) (-0.004) (-0.004) (-0.004) (-0.004)
FDTAR 0.000* 0.000* 0.000* 0.000* 0.000*
(-0.145) (-0.146) (-0.145) (-0.145) (-0.145)
R-Square 0.067 0.067 0.067 0.067 0.067
N 625 625 625 625 625
Notes: *p<0.01; **p<0.05; ***p<0.1
GOI regression equations showed R-squares ranges from 0.192 to 0.220, presenting robust
models for measuring relationships between firm`s profitability and working capital
management. DSI, DSO, DPO and CCC showed insignificant and negative attitude for firm`s
profitability calculation in equations (1), (2), (3) and (4) respectively. DPO is omitted in equation
(5), while DSI, DSO, and CCC remained significant and negative for measuring dependent
variable.
Table 4.4: Multiple regression models on Gross Operating Income (GOI)

Column 1 2 3 4 5
WCM Elements DSI DSO DPO CCC Full Model
(DPO Omitted)
Constant 0.000* 0.000* 0.000* 0.000* 0.000*
(-0.317) (-0.312) (-0.316) (-0.308) (-0.274)
DSI 0.119 0.000*
(-7.356) (-4.021)
DSO 0.672 0.529
(-2.854) (-4.162)
DPO 0.994 Omitted
(-1.853)
CCC 0.145 0.000*
(-6.521) (-3.778)
FS 0.000* 0.000* 0.000* 0.000* 0.000*
(0.034) (0.034) (0.034) (0.033) (0.031)
FG 0.776 0.826 0.797 0.793 0.7
(-0.001) (-0.001) (-0.001) (-0.001) (-0.001)
FDTAR 0.000* 0.000* 0.000* 0.000* 0.000*
(-0.077) (-0.079) (-0.078) (-0.078) (-0.075)
R-Square 0.196 0.193 0.192 0.195 0.220
N 625 625 625 625 625
Notes: *p<0.01; **p<0.05; ***p<0.1
Negative relationships of working capital management elements in both ROA and GOI models
for measuring firm`s profitability proved all four hypothesis of the study. Inverse relationships of
ROA equations supported the earlier studies; (Ahmad & Bano, 2015); (Rahman & Nasr, 2007);
(Deloof, 2003), while GOI findings encourage the works of; (Eljelly, 2004); (Sharma & Kumar,
2011) and Shin and Soenan, (1998).
6. Conclusion
Efficient management of working capital is an important tool for achieving organizational

profitability. The purpose of the present study was to test the performance of working capital
management for measuring firm`s profitability. Findings of the present study support the work of
prior researches. This study indicated that ROA as is a poor indicator of firm`s profitability,
moreover GOI is a better explanatory measure for organizational performance. Results of the
current study will help organizations to improve their effectiveness by managing their working
capital.
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*Corresponding author.
E-mail address: [email protected]

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[Hassan et. al., Vol.5 (Iss.

2): February, 2017] ISSN- 2350-0530(O), ISSN- 2394-3629(P)

WORKING CAPITAL MANAGEMENT AMONG LISTED COMPANIES

Waqar-ul-Hassan*1, Mohsin Zubair2, Zeeshan Hasnain3, Shahbaz Hussain4

Keywords: Working Capital Management; Firm Performance; Panel Data Analysis.

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Working capital management is required to attain an optimal level of organization`s profitability

2.1.Working Capital Management Concept

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2.2.Earlier Studies on Working Capital Management

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2.5.Objectives of the Study

3.2.1. Dependent Variable

3.2.2. Independent Variables

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Profitability = β0 + β1DSI + β2FS + β3SG + β4FDR + εit (1)

DSI = Inventory turnover in days

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Table 4.1: Descriptive Statistics

Table 4.2: Pearson Correlation Matrix

5.2.Analysis and Discussion

Table 4.3: Multiple regression models on Return on Assets (ROA)

Table 4.4: Multiple regression models on Gross Operating Income (GOI)

Efficient management of working capital is an important tool for achieving organizational

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