research papers on working capital management

The Impact of Working Capital on the Profitability: Evidence from the Indian Firms

74 Pages Posted: 8 Aug 2012

Saswata Chatterjee

Date Written: August 6, 2012

In order to run the company successfully, the fixed and the current assets play a commendable role. Managing the working capital is mandatory because, it has a major significance on profitability and liquidity of the business concern. Usually, it was observed that, if firm wants to take a bigger risk for bumper profits and losses, it minimises the dimension of its working capital in relation to the revenues it generates. If it is willing to improve its liquidity, that in turn raises the level of its working capital. Nevertheless, this technique might tend to reduce the sales volume and consequently, it would affect the profitability. Thus, a company needs to have a striking balance between the liquidity and the profitability. This research has analysed the impact of working capital on the profitability for a sample of 100 Indian companies listed in the Bombay Stock Exchange for a period of 2 years from 2010-2011. The various components for measuring the working capital management include the Receivable days, Inventory turnover days, Payable days, Cash conversion cycle, Current ratio and Quick ratio on the Net operating profitability of the Indian companies. The controlled variables like; Fixed assets on total assets, the Debt ratio and the size of the firm (measured in terms of natural logarithm of sales) have also been used for measuring of the working capital management. Descriptive Statistics, Pearson’s Correlation, Regression Analysis are used for analyzing this research. All these tests are used so as to correlate the theories contributed by the literature by several authors with the statistical results. The results depict that, there is a strong negative association between the components of the working capital management and the profitability ratios of the Indian firms which indicates that, as the cash conversion cycle increases it would tend to reduce the profitability of the company, and the managers might increase the the shareholder’s value by shortening this cash conversion cycle to a minimum level. It is also observed that the negative association also persists between the liquidity and the profitability of the Indian firms. Nevertheless, there is a positive relationship between the size and the profitability of the firm. This indicates that, as the size of the firm increases the profitability of the firm also increases. Finally a negative relationship is observed between the debt and profitability of the Indian firms. The results derived from this research signify that, the managers might able to raise their profits by diminishing the time period for the debtors and inventories so that, time period for payables would increase.

Keywords: Working Capital Management

Suggested Citation: Suggested Citation

Saswata Chatterjee (Contact Author)

University of wales - prifysgol cymru ( email ).

King Edward VII Avenue Cardiff, CF10 3NS United Kingdom

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A RESEARCH PAPER ON "THE IMPACT OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY"

2012, Independent University, Bangladesh

Abstract Companies can use working capital management as an approach to influence their profitability. This paper studies the impact of working capital management and its components upon the profitability of Bangladeshi pharmaceuticals companies. Cash Conversion Cycle, Average days of collection period, inventory turnover period, Deferred payables Period are used as a comprehensive measure for working capital management and Gross Operating Profitability used as a measure for profitability. The purpose of this study is to analyze the impact of working capital management on companies’ profitability from Bangladesh County. The relation between the components of the working capital management and profitability is examined using Pearson correlation analyses and using a sample of 14 annual financial statements of companies covering period 2009-2010. The conclusion to our study is that there is a positive relationship among deferred payables period, inventory turnover period and corporate profitability. On the other hand, there is a negative relationship among cash conversion cycle, average days of collection periods and corporate profitability. Keywords: Working Capital Management, Corporate Profitability, Cash Conversion Cycle, Average days of collection period (AR turnover Period), Inventory turnover period, Deferred payables Period, Liquidity.

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Alagathurai Ajanthan , Virgil N Abedana

This research work carry out a comparative analysis on working capital management of brewery companies in Nigeria. The study aimed to examine the cost of working capital and the effect on firm performance and to take a critical view of the adopted liquidity measures of the Nigeria firm and attempt to see how it has been achieved. Secondary data were employed in this study from journals, textbooks and annual reports of the selected companies. How-ever, ratio analysis was used to analyze the data collected which is the best statistical techniques for working capital man-agement. The result of the test analyzed indicates Guinness Nigeria possessed huge amounts of current assets than Consolidated breweries. It was also deduced that inventories and debtors were very high in case of the Guinness Nigeria whereas current liabilities where still on the moderate level except in 2013 which recorded a higher current liabilities than the current asset. Cash balances were comparatively high in both cases. On the behalf of Receivable Management for the companies, it can be concluded that, undoubtedly, the Guinness Nigeria was much more efficient in the management of cash as compared to the Consolidated breweries which was laming in this regard and was way behind it. On the behalf of study of payables management it was observed and concluded that the consolidated breweries was better off than Guinness Nigeria as re-gard liquidity and payment to creditors as their credit periods were much shorter than the Guinness Nigeria, nevertheless the Guinness Nigeria derived benefits from the massive credit periods. The major recommendation of this study is that working capital management should be the concern of all the manufacturing sectors firms and need to be given due importance. The collection and payment policies of the firms in manufacturing sectors, in general, need to be thoroughly reviewed. It is generally argued that firms need to accelerate their cash collections and slowdown their payments. This can only be possible with some professional advice and supervision. The findings indicate that firm managers/executives can enhance performance of the firms by reducing the number of days in inventories, Cash Conversion Cycle and Net Trade Cycle to a reasonable minimum.

Ponsian P R O T Ntui , Gwatako Tago

The purpose of this study is to find out the effect of working capital management on company profitability. The study aims at examining the statistical significance between company’s working capital management and profitability. In light of this objective the study adopts quantitative approaches to test a series of research hypotheses. A sample of three (3) manufacturing companies listed on the Dar es Salaam Stock Exchange (DSE) is used for a period of ten years (2002-2012) with the total of 30 observations. Data is analyzed on quantitative basis using Pearson’s correlation and Regression analysis (Ordinary Least Square). The key findings from the study are; Firstly, there exists a positive relationship between cash conversion cycle and profitability of the firm. This means that as the cash conversion cycle increases it will lead to an increase in profitability of the firm, and managers can create a positive value for the shareholders by increasing the cash conversion cycle to a reasonable level; Secondly, there is a negative relationship between liquidity and profitability showing that as liquidity decreases, the profitability also increases; Thirdly, there exists a highly significant negative relationship between average collection period and profitability indicating that a decrease in the number of days a firm receives payment from sales affects the profitability of the firm positively; Fourthly, there is a highly significant positive relationship between average payment period and profitability. This implies that the longer a firm takes to pay its creditors, the more profitable it is.; and Fifthly, there exists a highly significant negative relationship between inventory turnover in days and profitability hinting that firms which maintain sufficiently low inventory levels reduce the cost of storing the inventory which results to higher profitability.

Habib Ahmad

A research conduct on topic "IMPACT OF WORKING CAPITAL MANAGEMENT ON PROFITABILITY OF THE FOOD AND PERSONAL CARE PRODUCTS SECTOR IN PAKISTAN" From above stated purpose, succeeding exact research questions were framed to investigate: 1: “What factors affect a performance of firm’s working capital management?” 2: “How efficiently a firm converting its working capital into ready money?” 3: “How company value enhances through efficient working capital management?” Scope of Study: The scope of study considers the selected Food and Personal care products companies listed in Karachi Stock Exchange of Pakistan. Four companies are selected for the study purpose as random sampling. The selected companies are: 1) Unilever Pakistan Ltd. 2) Nestle Pakistan Ltd. 3) Mitchell’s Foods Farm Pakistan. 4) National Foods Pakistan Ltd. The scope of this study includes the relationship b/w independent variables & dependent variable. Independent Variables are: 1) Average collection Receivable Period. 2) Average Inventory Conversion Period. 3) Average Payment Period. 4) Cash Conversion Cycle. While dependent variable is 1) Return on Asset

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Working Capital Management

Background information.

Working capital refers to the funds that are used to meet short-term responsibilities or the funds used to carry out the day-to-day activities of an organization. The management of these resources is equivalently important as the management of the long term finance funds. The management of the working capital is fundamental in making sure that the operations of the organization are smooth. This is mainly because the management of these funds ensures that there is effective use of resources (Lazaridis & Tryfonidis, 2006).

In every business, working capital is an important and critical part of an investment because it is impossible for an organization to run without these funds. Organizations requires adequate raw materials, finances to pay for labor, funds to create a stock to meet the demands of the consumers and the ability to provide goods on credit for its customers. All these are financed by working capital. Subsequently, working capital can be defined as the major determinant of the organizations survival or it can also be defined as the lifeblood of an organization’s operations (Juan García-Teruel & Martínez-Solano, 2007). Businesses are unable to operate without adequate working capital. This necessitates the research on the management of these funds in an organization.

Working capital has been an area of interest to many researchers, particularly because of the effect of the funds on the operations of an organization. During the times of recession organizations seek strategies that can be helpful in the improving the chances survival of the organization. External market factors play a role in the organization operations and the organization has minimal or no control of these factors.

This makes it important and critical to manage the working capital to facilitate and allow the organization to survive and increase their performance in these conditions. This is particularly important in large organizations where the management of working capital prevents liquidity problems and improves the capacity of the organization to manage in severe financial problems or any other unexpected change (Padachi, 2006).

Working capital is important because it allows the organization to maintain a production schedule and maintain sales, which are the major concerns of an organization. These are also the major determinants of an organization’s survival. The lack of a proper working capital interrupts the production process andincapacitates the organization, which may lead to the foreclosure of the business. The capacity to provide credit sales to the market is important in sales promotion, without adequate working capital, the organization is unable to provide credit sales since it is dependent on the available funds for the production process (Nazir& Afza, 2009).

This limits the number of sales that the organization can make and collectively this reduces the chances for the organization’s survival or demise. Poor management of the working capital impairs the operations of an organization and affects the profitability and the survival of the organization. This necessitates the research on proper mechanisms to manage these funds to ensure that the management of the organization pays the issue enough emphasis.

Working capital is important in maintaining sound profitability and liquidity levels. The current economy has made an increase the cost of capital and subsequently, this has necessitated more emphasis to be placed on working capital management. Increase in the working capital allows the organization to run with minimal external funding. This use of working capital in the day-to-day operations is efficient and affordable as compared to external funding.

This has made the management of working capital important to the management to ensure that the organization is profitable and maintains a high level of liquidity (Samiloglu & Demirgunes, 2008).The management main role is to ensure that a business is profitable and is in a capacity to meet its obligations. This makes the study and research on working capital management important to facilitate the achievement of the goals.

Investors play a vital part in financing the operations of an organization. The rate at which investors find an organization or investment to be attractive is determined by the risk and the profitability of the organization. The working capital is major determinant of the risk of an organization or an investment. An increase in the working capital of an organization indicates that investing in the organization is not risky because the organization has a greater chance of survival as compared to a similar investing operating on a lower working capital. The working capital of an organization is also a major determinant of the profitability of the organization (Boisjoly,2009) Consequently, the determination of strategies to manage the working capital effectively is very important to ensure that the organization attracts investors by increasing its profitability and reducing its risk.

According to Boisjoly (2009), working capital management refers to the ability of the management of an organization to manage the short-term capital available to operate the day-to-day activities effectively. Proper management of the organization’s working capital allows the organization to gain a higher market share and maintain good liquidity levels. The author describes the major components of working capital as cash received, receivables, and inventory. The management of the three components ensures that the organization is operating on a favorable working capital.

Growth of a business is a major concern for the stakeholders of the organization. The growth of an organization is characterized by its profitability and ability to survive and gain more market share. The study and evaluation of working capital management is very important because these funds play an important role in determining the profitability, survival, and ability of the organization to gain more market share. It is also vital in the declaration of dividend, evaluation of the employees’ remuneration and the development of a new product line. Collectively, working capital affects all the stakeholders in an organization. This makes the management of these funds important to ensure that every need of the stakeholders is met sufficiently.

Problem Statement

Working capital is established as an important part of an organization. It is a major determinant of the organization’s profitability and liquidity levels. Research indicates that a high number of the US startup Companies with an increased capital had dropped 744 in the 1990’s to 526 in 2001-2011(Mulcahy, Jobs, Zuckerberg, &Brin, 2013). Many businesses are finding it hard to manage their working capital, which is a major influence in the foreclosure of businesses. This is as reported by Security exchange commission, which published a report indicating that fifty percent of the businesses fail due to lack of proper and effective working capital management strategies (United State Securities and Exchange Commission, 2013). The overall problem is the lack of profitability and growth among organizations because of poor management of the working capital of organizations, which results to customer dissatisfaction, and the decreased sales of the company.

Purpose Statement

The study seeks to evaluate the importance of working capital in the profitability of an organization. It also identifies the various components that make up the working capital. The study seeks to identify strategies that may be adopted to manage the working capital. To establish the study adopts a qualitative and research methodology. This allows the study to develop concepts that can be utilized to manage capital. The variables that are studied in the research include working capital management techniques and profitability.

The study seek to identify the working capital management techniques that will improve the management of these funds and lead to increased performance in terms of profitability and the growth of the organization. The study will use two companies in the service and manufacturing industries. This will provide a wide perspective on ways to manage capital and raise funds in the two types of industries. The study will help improve the performance of organization facing working capital management problems. The study seeks to identify the mechanism that can be adopted by the managers in these businesses, which will contribute the survival and performance of organizations subsequently leading to an improved economy.

Research questions

1. What is the role of working capital in the operations of an organization?

2. What are the effects of poor working capital management strategies?

3. What are the strategies adopted in the management of the working capital in an organization or business?

4. What is the relationship between the performances of an organization to the implementation of effective working capital management strategies?

Theoretical and conceptual framework

Working capital management can be classified into four the management of the inventory, receivables, and cash received and accounts payable in an organization. Inventory is the stocks available in an organization. Working capital management requires that the inventory‘s ordering and holding cost are minimized. Subsequently this will reduce the stock out cost(Deloof, 2003).Cash received is a major factor in the working capital. This is very important in the daily operations of the business. The proportions of assets that are in cash in most cases are very small however, it is very important to manage this asset for the solvency of the business(Jeng-Ren & Han-Wen, 2006).

Receivables management is very important in maintain an effective working capital. Organizations sell their products and services on credit basis to increase the sales of the organization. Investment in this type of current assets requires that the proper and effective management of the costs that may arise. The management of the resource requires that the management maintain a level of credit that will generate more income than the cost and risk of issuing this credit. This also ensures that the gap between the cost of the products and the sale are high to ensure that there are increased profits (Eljelly, 2004).

The objective of working capital management is to create a balance between the current assets and liabilities of an organization. This balance should be favorable to the company and ensure that the company will gain the most value. This balance should ensure that the company increases its profitability and the liquidity is desirable (Uyar, 2009).Finally, there is the management of accounts payables. The payables are major determinants of the working capital in an organization. An increase in the accounts payable leads to the depletion of the working capital. The management of working capital entails the management of the timing of payments.

Significance of the study

The study defines working capital and elaborates on the importance of these funds in the performance of an organization. It elaborates on the way in which the management of working capital influences the performance and profitability of the organization. It emphasizes on the review and analysis of tan organizations working capital. This allows the management of an organization to identify the relationship between working capital and the profitability and overall performance of an organization. Subsequently motivating the managers to invest time into the field, this would later lead to improved performance.

The study will play a vital role in businesses. This is because it offers strategies that will be adopted in the management of the working capital of an organization. Working capital is established to influence the profitability and growth of an organization, which are the major objectives of the organization. Subsequently the study provides mechanisms that will be adopted to improve the profitability and overall performance of the organization.

The study contributes to the theoretical framework and acts as a reference points for future studies in the field. Working capital is a broad area that affects the performance of an organization. Consequently, it attracts many researchers to identify various problems in the field and develop possible solutions. The study will act as a reference point to various studies and contributes to the theories available in the field.

Bellouma, M. (2011). The impact of working capital management on profitability: The case of small and medium-sized export companies in Tunisia. Management international/International Management/Gestiòn Internacional, 15, 71-88.doi: 10.7202/1005434ar.

Deloof, M. (2003). Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30(3/4), 573-587.

Eljelly, A.M.A. (2004). Liquidity – profitability tradeoff: An empirical investigation in an emerging market. International Journal of Commerce & Management, 14(2), 48- 60.

Jeng-Ren, C., Li, C., & Han-Wen, W. (2006). The determinants of working capital management. Journal of American Academy of Business, Cambridge, 10(1), 149- 155.

Juan García-Teruel, P., & Martínez-Solano, P. (2007). Effects of working capital management on SME profitability. International Journal of Managerial Finance, 3(2), 164-177.

Lazaridis, I., & Tryfonidis, D. (2006). Relationship between working capital management and profitability of listed companies in the Athens stock exchange. Journal of financial management and analysis, 19(1).

Lazaridis, I., & Tryfonidis, D. (2006). Relationship between working capital management and profitability of listed companies in the Athens stock exchange. Journal of Financial Management and Analysis, 19(1), 26-35.

Mulcahy, D., Jobs, S., Zuckerberg, M., & Brin, S. (2013). Six myths about venture capitalists. Harvard Business Review.

Nazir, M. S., & Afza, T. (2009). Impact of aggressive working capital management policy on firms’ profitability.

Padachi, K. (2006). Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms.International Review of business research papers, 2(2), 45-58.

Samiloglu, F., & Demirgunes, K. (2008). The effect of working capital management on firm profitability: Evidence from Turkey.

Untied State Securities and Exchange Commission (2013) The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation. Retrieved from Unites State Securities and Exchange commission: http://www.sec.gov/about/whatwedo.shtml#.VMWdrf7F9dQ.

Uyar, A. (2009). The relationship of Cash Conversion Cycle with Firm Size and Profitability: An Empirical Investigation in Turkey, International Research Journal of Finance and Economics, 24, 186-192.

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Qualitative Research in Financial Markets

ISSN : 1755-4179

Article publication date: 29 July 2014

The purpose of this paper is to review research on working capital management (WCM) and to identify gaps in the current body of knowledge, which justify future research directions. WCM has attracted serious research attention in the recent past, especially after the financial crisis of 2008.

Design/methodology/approach

Using systematic literature review (SLR) method, the present study reviews 126 articles from referred journal and international conferences published on WCM.

Detailed content analysis reveals that most of the research work is empirical and focuses mainly on two aspects, impact of working capital on profitability of firm and working capital practices. Major research work has concluded that WCM is essential for corporate profitability. The major issues with prior literature are lack of survey-based approach and lack of systematic theory development study, which opens all new areas for future research. The future research directions proposed in this paper may help develop a greater understanding of determinants and practices of WCM.

Practical implications

Till date, literature on classification of WCM has been almost non-existent. This paper reviews a large number of articles on WCM and provides a classification scheme in to various categories. Subsequently, various emerging trends in the field of WCM are identified to help researchers specifying gaps in the literature and direct research efforts.

Originality/value

This paper contains a comprehensive listing of publications on the WCM and their classification according to various attributes. The paper will be useful to researchers, finance professionals and others concerned with WCM to understand the importance of WCM. To the best of the authors’ knowledge, no detailed SLR on this topic has previously been published in academic journals.

Pratap Singh, H. and Kumar, S. (2014), "Working capital management: a literature review and research agenda", Qualitative Research in Financial Markets , Vol. 6 No. 2, pp. 173-197. https://doi.org/10.1108/QRFM-04-2013-0010

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Research Paper on Working Capital Management

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Working capital management and its impact on firms’ performance: an empirical analysis on ethiopian exporters.

Companies may have their level of optimal working capital that maximizes their values through the effective management of current liabilities and assets. Previously, many studies were made on the impact of working capital management on the company’s performance in different sectors; however, its impact on the performance of firms that are engaged in export activities was not given any consideration and this particular study has attempted to investigate the fundamental impact of working capital management on the export firm’s performance in Ethiopia. To analyze this particular study, a total of 164 exporters operating in Ethiopia have been taken as a sample and both primary and secondary data collection methods were used. The data gathered from the sample of the study were analyzed using a multiple linear regression model and the result reveals that working capital management which was measured by account receivables period, cash conversion cycle, and accounts payable period has a statistically significant and positive correlation with the performance of exporting firms in Ethiopia which was measured by both return on assets and return on investment. However, working capital management which was measured by the inventory conversion period has a statistically significant and positive impact on return on investment, but it has an insignificant impact on the performance of sampled export firms in Ethiopia which was measured by return on assets. Based on the result of the study, firms may need to extend credit terms for customers, may prolong their cash conversion cycle, may need an extended payment period, and may or may not hold a high volume of inventory. All extending periods and cycles shall be made up to the extent of attaining an optimal level of working capital and better to implement a conservative policy of working capital management. Thus, it is advisable to consider the result of this study while making decisions regarding their working capital management to support their performance.

1. Background of the Study

Today's financial management, specifically the management of and control of working capital, needs huge attention and it is a difficult task due to the existence of a high portion of working capital in a business. The administration of current assets which has an accounting year to convert into cash and current liabilities which is payable within a year and the relationship among the two may be considered as working capital management [ 1 ].

As it is known, both the current assets and current liabilities are presented in a given business. The current assets and current liabilities are vital for the operation of different businesses. However, the working capital has also a significant role in the ongoing operations of firms operating in different activities. Working capital is a circulating capital and the business's life will not exist when its circulation has stopped [ 2 ].

The level of current assets and current liabilities may have a different impact on the performance or the profitability of a given firm. Too much level of current assets may harm the performance of the firm; however, a lower level of current assets may forward to a decreased level of liquidity and stock-outs which poses challenges in maintaining an optimal working capital [ 3 ]. Traditionally, the conception of working capital is the offset balance of assets and current liabilities. As a result, working capital management is an effort to administrate, control, and manage the current assets and the current liabilities in a given business firm to maximize the profitability or performance and to maintain a proper level of liquidity.

The proper implementation of financial management specifically working capital management is vital for the success of firms. Inefficiency in the financial management of a given firm may harm its performance [ 4 ]. When the financial management of a business firm is efficient, it will create a shareholder's value and it is a fundamental element in the overall strategy of the firm [ 5 ]. Besides, the performance and liquidity of a firm are affected by the level of working capital management and it is crucial for the firm [ 6 ].

Appropriate management of working capital is an essential portion of the whole corporate strategy to add stockholder's worth [ 5 ]. Besides, well-organized working capital management helps to advance the operating performance of the firm motives and it helps to attain short-range liquidity [ 6 ]. Hence, firms make an effort to preserve an optimum level of working capital that maximizes their worth [ 7 ]. Besides, proper working capital management is very vital for firms since it has a significant impact on the performance and liquidity of firms [ 8 ]. The key aim of working capital management is to attain the optimal balance between its components [ 9 ].

For instance, one of the components of working capital is inventory; huge inventory and liberal trade credit policy may result from huge sales and huge inventory may also diminish the risk of a stock-out. Trade credit may motivate sales since it permits a business firm to get product quality before disbursing [ 10 ]. The other component of working capital is accounts payable; deferring disbursement of accounts payable to vendors lets firms get the quality of procuring products and can be cheap and dynamic means of financing [ 10 ]. Instead, differing of such payables can be costly if a firm is provided a discount for prompt payment. Another component of working capital management is accounts receivable; uncollected accounts receivables can result in cash inflow difficulties for the firm [ 11 ].

Also, the other major component of working capital is cash; the well-known measure of working capital management is the cash conversion cycle, that is, the period between the disbursement for the procurements of raw materials and the collection of sales of finished products. The prolonged the time spans, the greater the investment in working capital, and also a prolonged cash conversion cycle may escalate profitability since it leads to huge sales [ 7 ]. Nevertheless, corporate profitability may diminish with the cash conversion cycle, if the expenses of huge investment in working capital grow quicker than the benefits of holding additional inventory stocks or yielding more trade credit to customers [ 12 ]. Besides, the major source of the failure of a business enterprise has been the shortage of working capital, their improper holding, mismanagement of working capital, and underemployment of capacity [ 3 ]. Overall, not only is working capital management helping the performance of firms in the current cash-strapped and uncertain economy, but it is the query of attaining the firm's day-to-day operation. Consequently, it is vital to identify and recognize the issue of working capital management and its impact on firms’ performance.

Certain investigations have been made in identifying the impact of working capital management on the performance of some firms (local manufacturing firms and banks); however, there was no empirical study done on the impact of working capital management on the performance of exporting firms in Ethiopia. Thus, the absence of investigations made on the impact of working capital management on the exporting firms’ performance leads this investigation to be undertaken. As a result, the ultimate purpose of the study was to examine and investigate the impact of working capital management on the performance of exporting firms operating in Ethiopia. To reach this objective, the following hypothesizes was developed and tested: account receivables period, cash conversion cycle, inventory conversion period, and accounts payable period have a significant and positive impact on exporting firms' performance. The account receivables period measured the receivables management of the firm, the cash conversion cycle measured the cash management of the firm, the inventory conversion period measured the inventory management of the firm, and the accounts payable period measured the payables management of the firm.

2. Statement of the Problem

In today’s business environment, firms needed an adequate resource to assure the going concern of their business activities, and the resources are optimally employed to improve the overall performance [ 13 ]. The impact of working capital management on the performance of firms has been investigated by many investigators.

According to the empirical works of literature of this study, the relationship that exists between working capital management and the firms’ performance was significant. Though according to [ 14 ], some methods employed by the managers in practice to make working capital decisions did not depend on the principles of finance, rather they used their experiences which are weakly made models. This may result in firms to overcapitalization or undercapitalization and then this makes managers ineffectively manage the various combination of working capital features [ 15 ].

The investigation made by Boisjoly et al. [ 11 ] found that incompetency or incapability of financial managers to design and manage the working capital of the firm may lead to their failure. Firms can have abundant resources and profitability, but they may face illiquidity as their assets are not ready to transform into cash [ 16 ]. Thus, we cannot surely say that profitable firms have effective management of working capital. Also, the reason behind having extensive debtors' collection period and narrowed creditors' payment period is that managers disregard their firms' operating cycle [ 17 ].

Considering the result of having ineffective management of working capital, the area needs huge investigations and it attracts the attention of different investigators in Ethiopia. However, there are no or few studies that were made on the issue and the problem is almost less investigated and there is a research gap on this part. The managers of different firms operating in Ethiopia are managing the working capital of their firm traditionally which is practically considered as narrowing the cash conversion cycle for the increment of the firm's profitability or performance.

The awareness of Ethiopian firm managers regarding the working capital management of their firm to maximize the profitability or the performance is limited and this is because there are no sufficient and appropriate researches done in Ethiopia regarding the issue. Thus, to fill the research gap in this particular study, the impact of working capital management on the performance of exporting firms in Ethiopia was investigated.

3. Research Objectives

The main objective of this empirical study is to examine the impact of working capital management on the performance of exporting firms in Ethiopia. Considering the main objective, the following are the specific objectives for this investigation: (i) To examine the impact of account receivables period on exporting firms’ performance (ii) To examine the impact of the cash conversion cycle on exporting firms’ performance (iii) To examine the impact of inventory conversion period on exporting firms’ performance (iv) To examine the impact of accounts payable period on exporting firms’ performance

4. Literature Review

Working capital management is an essential part of financial management in all business operations. It is mainly concerned with the management of the liquidity components of companies’ short-term current assets and current obligations [ 18 – 21 ]. The most familiar current assets are cash, account receivables, inventory stock and current liabilities consisting of account payables, accrued expenses, and tax liabilities, short-term debt such as commercial bills, and provisions for current liabilities such as dividends declared but not yet paid [ 21 – 24 ].

The main purpose of working capital management is to reduce the volume of capital hold in the current asset portion of a firm which is implied to the cash conversion cycle [ 25 ]. Handling and monitoring receivables and their collection issues and managing the investment in the inventory stock are the typical emphasis parts of working capital management. Diverse business presences, sustainability, and performance may be influenced by the proper handling and control of working capital in a particular firm [ 21 ].

The working capital policy can be better explained as an approach that offers the parameter to handle the current assets and current liabilities in such a way that it diminishes the risk of failure to pay [ 4 ]. The working capital policy is primarily concentrating on the liquidity of current assets to encounter current liabilities. Liquidity is more significant, since if the level of liquidity is excessively high, then a firm has a lot of idle capital, and it has to accept the cost of these idle capitals [ 25 ]. Conversely, if liquidity is excessively low, then it will face a deficiency of resources to encounter its current financial obligations [ 26 ]. Current assets are a basic factor of working capital and working capital management is also determined by the level of current assets as compared to the level of current liabilities [ 4 ]. In this regard, the theoretical aspects of finance categorize working capital policy into three types as defensive or hedging, aggressive, and conservative working capital policy [ 1 ].

4.1. Defensive Policy

Firms employ defensive policy by utilizing long-term debt and equity to finance their fixed assets and main parts of current assets. In this policy, the firm concern can implement a financial plan which best fits the estimated life of assets with the anticipated life of the sources of funds gained to finance assets [ 27 ]. Inventory stocks that are considered to be traded in 30 days could be funded with a 30-day bank credit, a machine estimated to last for 5 years could be funded with a 5-year credit, a 20-year building could be funded with a 20-year mortgage bond, and so forth [ 20 ].

Defensive policy shrinks the risk by decreasing the current liabilities but it also touches profitability since long-term debt provides a higher interest rate which will escalate the cost of funding [ 26 ]. This indicates that a firm is not agreeable to accept the risk and sense it is proper to have cash or near cash balances, higher inventory stocks, and liberal credit terms. Typically, firms that are functioning in an uncertain situation choose to implement such a policy since they are not certain about the impending prices, demand, and short-term interest rate [ 9 ]. In such cases, it is good to have a higher level of current assets. This indicates maintaining a higher level of inventory in the stock to attain an unexpected increase in demand and evade the risk of work stoppage in operation and production. This policy provides an elongated cash conversion cycle for the firm [ 11 ]. Likewise, it offers protection towards the financial difficulties generated by the shortage of funds to attain the short-term liability but as it was explained earlier, long-term debt has a higher interest rate which will escalate the cost of funding [ 12 ]. Correspondingly, resources are tied up in a firm due to the liberal credit policy of the firm and it also has an opportunity cost. Hereafter, this policy may diminish the profitability and the cost of employing this policy may surpass the benefits of the policy [ 26 ].

4.2. Aggressive Policy

Firms can employ aggressive policy by financing their current assets with short-term debt since it provides a low-interest rate. Though, the risk related to the short-term debt is more than the long-term debt [ 15 ]. In this policy, the whole expected necessity of current assets should be funded from short-term sources, and even a portion of fixed assets financing should be funded from short-term sources [ 27 ]. This policy leads the finance mix to being highly risky, less costly, and highly profitable. Moreover, some finance managers accept even high risk by funding a long-term asset with short-term debts and this method drives the working capital on the adverse side [ 16 ].

Managers make an effort to boost the profitability by paying a lower interest rate, but this method can bring greater risk if the short-term interest rate varies or the cash inflow is not adequate to meet the current liabilities [ 20 ]. Consequently, such a policy is implemented by the firm which is functioning in a steady economy and is fairly certain about impending cash flows [ 13 ]. A firm with an aggressive working capital policy provides a short credit period to clients, holds smaller inventory stock, and has a lesser level of cash in hand [ 14 ]. This policy raises the risk of failure to pay debt since a firm may face a lack of funds to fulfill the short-term liabilities but it also provides a huge return as the high return is connected with taking a high risk [ 26 ].

4.3. Conservative Policy

Certain firms want neither to be aggressive by decreasing the level of current assets under current liabilities nor to be defensive by intensifying the level of current assets over the current liabilities [ 28 ]. Hence, balancing the risk and return firms are employing the conservative strategy. It is also a combination of defensive working capital policy and aggressive working capital policy. In this method, provisional current assets, assets that exist on the balance sheet for short period will be funded by the short-term obligations and long-term debts have to finance the fixed assets and enduring current assets [ 20 ]. Therefore, the implementer of this method discovers a reasonable level of working capital with reasonable risk and return. It is considered a “low-profit low-risk” conception [ 27 ]. Besides, this approach not only diminishes the risk of failure to pay the debt but also decreases the opportunity cost of extra investment in the current assets. Conversely, apart from the above arguments, the amount of working capital is also based on the level of sale since sales are the source of revenue for all firms [ 17 ]. Sales can affect working capital in three potential ways; as sales grow, the working capital will also rise with the same fraction, so the span of the cash conversion cycle remains the same; as the sales rise, the working capital grows in a slower proportion; as the sales grow, the level of working capital increases in a misappropriate level; that is, the working capital may increase in a proportion more than the proportion of growth in the sale [ 26 ].

Firms with a steady sale of rising sale can implement the aggressive approach since it has confidence on its upcoming cash inflows and is certain to disburse its short-term liabilities at maturity [ 18 ]. In contrast, a firm with an unbalanced sale or with instability in the sale cannot consider implementing the aggressive approach since it is not certain about its future cash inflows. In such cases, the implementation of an aggressive approach is like committing suicide [ 22 ]. Therefore, browsing and utilizing other bests approach may be a wise choice.

Some studies are investigated in different parts of the world regarding the impact of working capital management on the performance of firms. For instance, according to the study made by Lazaridis and Tryfonidis [ 29 ], there is a negative association between the performance of the firm which is measured by gross operating profit and the cash conversion cycle. The study implies that to generate higher profit, firms need to narrow the cash conversion cycle. Also, in a study made by Izadi and Taaki [ 6 ] on the big and small firms operating in Iran, the performance of firms which is measured by return on asset, and the cash conversion has a significant and inverse relationship. Besides, an investigation which was made by Eljelly [ 30 ] also implies that there is a significant and negative correlation between the performance of the firm and the level of liquidity with a long cash conversion cycle. However, the study made by Gitman [ 21 ] shows that there is a significant positive correlation between the firms’ performance which is measured by return on asset and the management of working capital which is represented by the net liquid balance of firms.

An investigation by Lazaridis and Tryfonidis [ 29 ] shows that there is a negative correlation among the performance of the firm which is measured by gross operating profit and the inventory period; however, it is not statistically significant. Furthermore, the study made by Samiloglu and Demirgunes [ 31 ] on the listed manufacturing companies in Istanbul Stock Exchange shows that the inventory period has a significant and negative correlation with profitability which is measured by return on asset. Besides, the empirical result of Deloof [ 7 ] shows that there is a statistically significant and negative correlation between the inventory period and the gross operating income of firms. This indicates that companies may experience lower profit due to a decrease in sales since the increasing volume of inventory means a decrement in the sales of the firm. Besides, the study made by Boisjoly [ 32 ] implies that an improvement of firms' inventory management can be explained by the growth of inventory turnover over fifteen years. Also, the study of Rahman and Nasr [ 10 ] on the performance of the firm which is measured by the return on assets of firms shows that there is a significant and negative correlation with the inventory period.

Based on the study of Lazaridis and Tryfonidis [ 29 ], there is a negative correlation among the profitability of firms which is measured by gross operating profit and the receivables collection period. The result of the study implies that by diminishing the credit terms given for customers, firms can incise their profitability. Moreover, the investigation of Deloof [ 7 ] shows that there is a significant and negative correlation among profitability which is measured by gross operating income and the average accounts receivable period. Also, the study of Boisjoly (2009) implies that the improvement of account receivables management has been given a considerable focus by different firms since over the 15 years their accounts receivable turnover has been increased. Besides, the findings of Raheman and Nasr [ 10 ] show that the accounts receivable which were used as a measure of liquidity and the profitability of firms have a significant and negative correlation. Furthermore, the result of the study made by Nuru [ 33 ] shows that there is a negative correlation between profitability and the average collection period.

A study was undertaken by Raheman and Nasr [ 10 ] regarding the relationship that exists among working capital management and the profitability of small and medium enterprises in Spain, profitability which is measured by the return on assets has a significant and negative relationship with the account payables period. Moreover, the study of Nuru [ 33 ] on the manufacturing private limited companies in the Tigray region of Ethiopia shows that there is an inverse correlation between the profitability measure and the accounts payable period; however, the variable has no statistically significant correlation with operating profit margin which was used as one of the measures of profitability. Furthermore, the investigation made by Deloof [ 7 ] shows that there is an inverse correlation between the profitability and the average accounts payable period which implies that a firm with weak profit needs an extended payment period and the accounts payable policy can be affected by firms’ profitability. However, the study of Lazaridis and Tryfonidis [ 29 ] revealed that there is a significant and positive correlation between the accounts payable period and the profitability of firms which is measured by gross operating profit.

5. Research Methodology

In this particular study, the researcher made an investigation on the impacts of working capital management on the performance of exporting firms in Ethiopia. Considering the aim of the study, it was critical to select the best research methods to be employed in undertaking the investigation. For this study, a quantitative method has been utilized since the quantitative method was necessary to make and analyze different correlations and for statistical techniques used by the study. To reach the ultimate objective of the study, mainly explanatory/casual type of research was engaged and in some parts of the study descriptive research type was used.In this particular study, those exporting firms which are currently operating in Ethiopia were considered as the population, and those firms are involved in different exporting activities such as exporting coffee; pulses, oilseeds, and spices; vegetables and fruits; flowers; Tanners, footwear and leather; natural forest and forest products; cotton; meat; live animals; textile and garments; tea; and other agricultural-related products. For the sake of sampling, a list of all major exporting firms registers by the Ministry of Trade [ 36 ] was considered and the total number of exporting firms was 277 which are involved in exporting different outputs. To drive a sample from the population, a formula which is provided by Yemane [ 37 ] was used since the population was homogeneous, that is, exporting firms, and this research was conducted on 164 sampled exporting firms that are operating in Ethiopia during the investigation. In determining the sample size, the following formula was used by considering the significance level ( α ) at 5%; hence the confidence level was 95%, where n = sample size:

According to Adam [ 38 ], it is possible to approximate the sample size of 163.66 to 164. After determining the sample size, it was critical to determine which sample selection techniques have to be employed. For this study, a stratified sample selection technique was used in the selection of exporting firms and strata of exporting firms for each type of business activities were taken (coffee exporters; Ethiopian pulses, oilseeds, and spices processors exporters; vegetables and fruit exporters; flower exporters; tanners, footwear, and leather products exporters; natural forest and forest products exporters; cotton exporters; exporters of meat; live animal exporters; textile and garment exporters; other agricultural-related exporters; and tea exporters) and randomly sampling units were selected from each stratum. Finally, to investigate the impact of working capital management on the performance of Ethiopian exporting firms, the following two multiple linear regression models were formulated.

Model 2: where ROTA stands for return on asset and RTOI stands for return on investment, which are the two dependent variables of the study (RTOI = net income/total assets and RTOA = (earnings available for common stockholders/total asset) ∗ 100). Besides, the independent variables for the two models are account receivables period (ARVP) which measures the firms’ receivable management (ARVP = average accounts receivables/net sales) ∗ 365), cash conversion cycle (CHCS) which measures the firms’ cash management (CHCS = average account receivables + average inventories − Average Account Payable), inventory conversion period (IVCP) which measures firms’ inventory management (IVCP = (average inventory/net sales) ∗ 365), and accounts payable period (APYP) which measures the firms’ payables management (average accounts payables/net sales) ∗ 365), and ɛ represents the random error of the model.

6. Result and Discussion

After collecting all data from the sample of the study and by considering the two formulated models, the following analysis was made, and in this part, the descriptive statistics and the regression analysis (based on the formulated models) made for the study are presented. In this study, 164 exporting firms operating in Ethiopia are included as a sample, and they were investigated to determine the impact of working capital management on exporting firms’ performance. While making the regressions for the study, many tests have been conducted to test the OLS assumptions, and all tests, descriptive statistics, and study results are presented in this section.

As shown in Table 1 for the two models, the average return on asset and return on investment of exporting firms in Ethiopia are 0.14 and 0.18, respectively. Also, the minimum value of return on asset is −0.19 and its maximum value is 0.47, and the minimum value of return on investment is −0.15 and its maximum value is 0.65. This implies that exporting companies have to get satisfactory returns from their operations.

To test the normality of the data the Shapiro–Wilk W test was used and based on the test result shown in Table 2 , the values for the first model (RTOA) are ≤ 0.4 and for the second model (RTOI) are ≤ 0.08, which are greater than 0.05 and the graph of Kernel density is bell-shaped for the two models; this implies that the data is normal. Besides, to test the reliability of variables in the study Cronbach’s alpha test of reliability was used and the scale reliability coefficients in Table 2 for the first model (RTOA) is 0.9628 and for the second model (RTOI) is 0.9628, which are greater than 0.7; this indicates that all variables used in the study are reliable.

The tests depicted in Table 3 are used to test multicollinearity, autocorrelation, and heteroscedasticity problems. Accordingly, the results show that the mean value of VIF for the two models (RTOA and RTOI) is 7.52, the d-statistics of the Durbin–Watson test for the first model is 1.42 and for the second model is 1.34 which are close to 2, and the value of Breusch–Pagan/Cook–Weisberg for the first model (RTOA) is ≤ 0.7 and for the second model (RTOI) is ≤ 0.08. Thus, the results imply that there is no collinearity, no autocorrelation, and no heteroscedasticity problem. The benchmarks for those tests were derived from Gujarat [ 39 ].

Based on the regression results displayed in Tables 4 and 5 , account receivables period (ARVP), cash conversion cycle (CHCS), inventory conversion period (IVCP), and accounts payable period (APYP) are explained about 98.99% ( R 2 = 0.9899) and 98.62 ( R 2 = 0.0.9862) of export firms’ performance in Ethiopian which is measured by return on asset and return on investment, respectively.

The regression outputs in Table 4 and Table 5 imply that the payables management which was measured by the account receivables period (ARVP) has a highly significant and positive relationship with the performance of exporting firms (Coef. = 0.0019619 and 0.0026233, and ≤ 0.001). The result implies that the changes made on exporting firms' account receivables period have a direct impact on their performance. This result is contradicted with the study made by Chen and Kieschnick [ 14 ], Lazaridis and Tryfonidis [ 29 ], Deloof [ 7 ], Raheman and Nasr [ 10 ], Enqvist et al. [ 25 ], and Nuru [ 33 ] who concluded that there is a negative correlation between the performance of firms and the receivables collection period. The result implies that giving higher credit terms to customers of exporting firms may increase their performance.

Moreover, as is shown in the regression output of Tables 4 and 5 , the cash management which was measured by the cash conversion cycle (CHCC) has a highly significant and positive relationship with the performance of exporting firm's (Coef. = 0.0020022 and 0.0017141, and ≤ 0.001). However, this result was contradicted with the study made by Peng and Zhou [ 13 ], Lazaridis and Tryfonidis [ 29 ], Izadi and Taaki [ 6 ], and Eljelly [ 30 ] who concluded that there is a negative relationship between the performance of firms and the cash conversion cycle. On the other hand, the study results made by Gitman [ 21 ], Ukaegbu [ 16 ], and Delsing et al. [ 9 ] are the same as this study result showing there is a positive relationship between the cash conversion cycle and the performance of firms. The result implies that firms may need to prolong their cash conversion cycle to increase their performance.

Besides, the regression output in Table 5 shows that the inventory management which was measured by inventory conversion period (IVCP) has a highly significant and positive relationship with the performance of exporting firm’s which was measured by return on investment (Coef. = 0.0006118 and ≤ 0.000).

However, the regression output shown in Table 4 implies that the inventory conversion cycle has an insignificant impact on the performance of exporting firms which was measured by return on asset (Coef. = 0.0001359 and ≤ 0.052). This result is similar to Aktas et al. [ 18 ], Boisjoly et al. [ 11 ], and Lazaridis and Tryfonidis [ 29 ] since they found that there is insignificant relation between inventory period and firms performance; however, the sign of the relationship is not the same. On the contrary, the study made by Dhole et al. [ 15 ], Samiloglu and Demirgunes [ 31 ], Deloof [ 7 ], Apaka et al. [ 28 ], and Raheman and Nasr [ 10 ] clearly shows that there is a statistically significant and negative correlation between the performance of firms and the inventory conversion period. The result implies that companies may experience higher performance since the increasing volume of inventory may not mean a decrement in the sales of the firm.

Likewise, the result of the regression output in Tables 4 and 5 shows that the payables management which was measured by accounts payable period (APYP) has a significant and positive impact on the performance of exporting firms (Coef. = 0. 0002701 and 0.0003393, and ≤ 0.052). However, this result is contradicted with the study made by Chauhan [ 12 ], Raheman and Nasr [ 10 ], Nuru [ 33 ], Kasirana et al. [ 17 ], and Deloof [ 7 ] which concluded that the payable period harms a firm's performance. On the other hand, the result of this study was the same as the study of Mun and Jang [ 22 ], Lazaridis and Tryfonidis [ 29 ], and Banos-Caballero et al. [ 1 ] which revealed that there is a significant and positive correlation between the accounts payable period and the profitability of firms. The result implies that a firm with strong performance may need an extended payment period and the accounts payable policy can affect the firms’ performance.

Finally, by considering the multiple regression analysis results of the study which are shown in Tables 4 and 5 , account receivables period (ARVP), cash conversion cycle (CHCS), and accounts payable period (APYP) have a statistically significant and positive correlation with the performance of exporting firms in Ethiopia which is measured by both returns on asset and return on investment. However, the inventory conversion period has a statistically significant and positive correlation with the performance of exporting firms in Ethiopia, which was measured by return on investment, but it has a statistically insignificant correlation with the performance of exporting firms in Ethiopia which was measured by return on asset.

Overall, as it is shown in the above analysis, the performance of Ethiopian exporting firms was positively and significantly influenced by the major components of working capital management (which was measured by return on asset and return on investment) such as cash conversion cycle, account receivables period, and account payables period mainly. Exporting firms' performance which was measured by return on investment was also significantly and positively influenced by the inventory conversion period. Hence, exporting firms in Ethiopia shall consider the result of this study while making decisions regarding their working capital management to support their performance. For instance, firms may need to extend credit terms for customers, may prolong their cash conversion cycle, and may need an extended payment period.

7. Conclusion and Recommendation

The ultimate objective of this empirical study was to examine the impact of working capital management on the performance of exporting firms in Ethiopia. Using the quantitative approach, the cross-sectional data was analyzed through the multiple regression models. To undertake this study, 164 exporting firms operating in Ethiopia were included as the study sample. Based on the results of the regression analysis account receivables period, cash conversion cycle, inventory conversion period, and accounts payable period have a statistically significant and positive correlation with the performance of exporting firms in Ethiopia. However, the inventory conversion period has an insignificant correlation with the performance of exporting firms which was measured by return on an asset in Ethiopia. By noticing the outcomes of the study, we can conclude that exporting firm's managers in Ethiopia need to refer to the influencing factors which positively and significantly correlate with their performance. In conclusion, the following recommendations are posted given the results of the study. (i) As the working capital management which was measured by the account receivables period, cash conversion cycle, and accounts payable period have a statistically significant and positive correlation with the performance of exporting firms in Ethiopia which was measured by return on asset and return on investment, exporting firms may need to extend credit terms for their customers, may prolong their cash conversion cycle, and may need an extended payment period to the extent of the number of their debts. However, all the extended periods and cycles have to be made up to the optimum level of working capital management. Also, the inventory conversion period has a statistically significant and positive correlation with the performance of exporting firms in Ethiopia, which was measured by return on investment, but it has an insignificant correlation with return on asset. As a result, firms may or may not hold a high volume of inventory. Thus, it is advisable to consider the result of this study while making decisions regarding their working capital management to support their performance; specifically they have to maintain an optimal level of working capital in their operations. For instance, to attain a high volume of sales, they may need to provide extended credit terms for their customers, to use their debit fiancé optimally, and to secure their payment potential they may need to extend their payment periods by dealing with their creditors. Indeed, according to this study result, exporting firms is better to implement a conservative policy of working capital management. (ii) The outcome of this investigation is almost contradicted with the investigations which were made by other researchers related to the study area. Thus, it is better to make further investigations by future researchers in this regard. Also, future researchers are recommended to give attention to the statistically insignificant variable in this study. (iii) Besides, it is better to make further studies on the factors which are contributed to the high performance of exporting firms since there are diversities in the method, subject area, and understandability of works of literature from country to country.

Data Availability

The data of this study were collected from the sample of the study and it is available online.

Conflicts of Interest

The author declares that there are no conflicts of interest.

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Economic Research-Ekonomska Istraživanja

Open access

Working capital management and business performance: evidence from Latin American companies

1. Introduction

2. review of the literature, 3. data and methodology, 4. descriptive statistics and results, conclusions, disclosure statement.

Abstract Formulae display: ? Mathematical formulae have been encoded as MathML and are displayed in this HTML version using MathJax in order to improve their display. Uncheck the box to turn MathJax off. This feature requires Javascript. Click on a formula to zoom.

Working capital management is one of the most important decisions that affect an organisation’s financial performance. Despite the importance of this topic, the empirical evidence for emerging economies is scarce; therefore, this research attempts to estimate and compare how investment in working capital impacts the financial performance of companies listed on the stock exchanges in Chile, Mexico, Peru, and Brazil for the years 2000 to 2018. This study uses panel data methodology, and the results show the existence of a positive and significant but non-linear relationship between investments in working capital and firm performance. However, there are mixed results for different countries and industries that could be explained by macroeconomic variables that favour access to financing for such investments. Furthermore, the results show that investments in working capital perform better for larger companies than smaller companies.

Research on working capital management has found that efficient investment in and management of working capital can enhance profitability and increase firm value (AlShubiri, Citation 2011 ; Boțoc & Anton, Citation 2017 ; Jeng-Ren & Han-Wen, Citation 2006 ; Le, Citation 2019 ). In other words, efficient management of working capital contributes to developing and maintaining a competitive advantage (Aktas et al., Citation 2015 ; Baños-Caballero et al., Citation 2014 ; Boisjoly et al., Citation 2020 ; Deloof, Citation 2003 ; Padachi, Citation 2006 ; Reason, Citation 2002 ). Thus, working capital management is relevant due to the sustained increase in competitive pressure (Baños-Caballero et al., Citation 2012 ).

Consequently, this topic is one of the most important topics in corporate finance (Baños-Caballero et al., Citation 2012 ) because of the effect on firm liquidity (Enqvist et al., Citation 2014 ). Thus, the challenge for companies in terms of managing working capital is to develop a culture that allows them to increase profitability (Anton & Afloarei Nucu, Citation 2020 ). There is evidence of a positive and significant relationship between working capital and financial performance because working capital supports increases in sales (Aktas et al., Citation 2015 ; Baños-Caballero et al., Citation 2020 ; Mun & Jang, Citation 2015 ). An increase in sales permits better management of commercial credit and inventories and helps firms avoid immobilisation of resources and price fluctuations (Mahmood et al., Citation 2019 ).

Seth et al. ( Citation 2021 ) and Li et al. and ( Citation 2014 ) recognise that investments in working capital increase a company’s negotiating power with its providers, allowing it to obtain larger discounts for bulk and down payments, thus increasing an organisation’s value (Aktas et al., Citation 2015 ; Deloof, Citation 2003 ; García-Teruel & Martínez-Solano, Citation 2007 ). However, over-investment in working capital increases financing costs, reducing an organisation’s value (Baños-Caballero et al., Citation 2014 ; Chang, Citation 2018 ; Zeidan & Shapir, Citation 2017 ). Research has made it possible to assume the existence of an optimal level of investment in working capital (Aktas et al., Citation 2015 ; Baños-Caballero et al., Citation 2012 ; Citation 2014 ; Khan & Ghazi, Citation 2013 ), as studies have identified a non-linear relationship between investment in working capital and financial performance (Ding et al., Citation 2013 ; Seth et al., Citation 2021 ). This non-linear relationship suggests the existence of an optimum investment in working capital (Mahmood et al., Citation 2019 )

Numerous studies have been conducted in developed economies to estimate the true relationship between investment in working capital and financial performance, but it is possible that these results cannot be extrapolated to emerging economies due to their different social, political, and economic contexts (Seth et al., Citation 2021 ). Mielcarz et al. ( Citation 2018 ) find evidence confirming that the existence of restrictions on financing markets in developing countries can significantly affect decisions about investment in and financing of working capital, as well as the fluctuations. In this vein, Latin American companies face a greater level of uncertainty than companies in developed countries in terms of determining their investment in working capital and its components (Bellouma, Citation 2011 ; Li et al., Citation 2014 ; Mongrut & Wong, Citation 2005 ; Seth et al., Citation 2021 ).

In spite of the importance of the topic, the evidence from emerging economies, especially Latin American economies, is inconsistent due to exposure to certain macroeconomic variables in Latin American countries, such as interest rates, economic growth, and exchange rates (Pérez Artica et al., Citation 2018 ). This combination of scarce evidence and the presence of inconclusive results (Le, Citation 2019 ) motivates this research. This study’s goal is to estimate and compare the effects of investment in working capital on financial performance for a sample of Latin American companies. In addition, it provides updated and relevant literature on managing working capital in emerging economies, while considering the importance of macroeconomic factors such as exposure to exchange rates, gross domestic product (GDP) growth, balance of payments, and active interest rates.

Using a dataset of Latin American countries and panel data methodology, our main empirical finding indicates that there is a true relationship between working capital and financial performance. Furthermore, the relationship is non-linear, which is congruent with the literature. The remainder of this paper is organised into five sections. An introduction is provided in section one, while a review of literature and the development of hypotheses is presented in section two. The data and methods are described in section three, and the descriptive statistics and results are reported in section four. Finally, the conclusions are discussed in section five.

Latin American companies face riskier macroeconomic surroundings than companies in developed economies, and this affects investment in working capital (Baum et al., Citation 2006 ; López Pérez et al., Citation 2018 ). The evidence shows that, in countries with restrictions in their balance of payments, commercial surpluses, and capital inflow, companies have greater access to credit, which encourages economic growth, and drives new investment opportunities (Médici & Panigo, Citation 2015 ).

All organisations must maintain a level of investment in working capital that allows them to adequately manage their operations while balancing their decisions between liquidity and financial performance (García-Teruel & Martínez-Solano, Citation 2007 ; Pass & Pike, Citation 1984 ). Because of the flexibility of this type of investment and its low cost of transformation into cash (Mielcarz et al., Citation 2018 ), adequate management of working capital permits a company to have liquidity available in case of cash deficits or, on the contrary, reduce its level of investment (Bates et al., Citation 2009 ; Belghitar & Khan, Citation 2013 ; Fazzari & Petersen, Citation 1993 ; Opler et al., Citation 1999 ).

We define working capital as the excess of current assets over current liabilities; its components include cash, accounts receivable, inventories, accounts payable, and current debt (García-Teruel & Martínez-Solano, Citation 2007 ; Mun & Jang, Citation 2015 ). Other measures of working capital refer to the cycle of cash conversion and assess the time it takes to convert the net investment in accounts receivable, inventories, and accounts payable into cash. This measure is related to a business’s operations (Baños-Caballero et al., Citation 2012 ; Chang, Citation 2018 ; Raheman & Nasr, Citation 2007 ) and is associated with a firm’s level of operational efficiency (Mun & Jang, Citation 2015 ).

Over-investment in working capital can generate adverse effects and diminish company performance, as investments in working capital require additional financing and greater opportunity cost. Deloof ( Citation 2003 ), García-Teruel and Martínez-Solano ( Citation 2007 ), Ebben and Johnson ( Citation 2011 ), Baños-Caballero et al. ( Citation 2012 ), Kieschnick et al. ( Citation 2013 ), and Afrifa and Padachi ( Citation 2016 ) find a negative relationship between investment in working capital and company performance, as larger investments increase the probability of bankruptcy (Baños-Caballero et al., Citation 2014 ; Humphrey, Citation 2017 ; Le, Citation 2019 ; Maheshwari, Citation 2014 ).

Li et al. ( Citation 2014 ) and Panigrahi ( Citation 2017 ) recognise that investment in working capital increases a company’s negotiating power with its providers, allowing it to obtain greater discounts, reduce supply costs, provide a hedge against input price fluctuations, and minimise loss of sales due to potential stock-outs, thus increasing the organisation’s value (Aktas et al., Citation 2015 ; Baños-Caballero et al., Citation 2020 ; Deloof, Citation 2003 ; García-Teruel & Martínez-Solano, Citation 2007 ). Therefore, maintaining an adequate investment in working capital allows for better company performance (Ukaegbu, Citation 2014 ). Based on this discussion, we expect a negative relationship between investment in working capital and company performance and formulate our first hypothesis as follows:

Hypothesis 1. There is a positive relationship between investment in working capital and company performance.

The literature shows that larger companies with solid market reputations and more assets to invest can enjoy better access to and lower cost of financing (Fazzari & Petersen, Citation 1993 ; Mahmood et al., Citation 2019 ). As a result, larger companies use short-term financing to fund their investments in working capital due to its advantages (Fazzari & Petersen, Citation 1993 ; Niskanen & Niskanen, Citation 2006 ) and thus have lower risk of bankruptcy (Baños-Caballero et al., Citation 2010 ; Mahmood et al., Citation 2019 ). This indicates that firm size has a moderating and differentiating effect. This discussion suggests there is a positive relationship between investment in working capital and firm size, leading to the following hypothesis:

Hypothesis 2. There is a positive relationship between investment in working capital and firm size.

In terms of financing working capital, the literature recognises two strategies: conservative and aggressive (Baños-Caballero et al., Citation 2016 ). Financing the investment in working capital with long-term debt is considered a conservative strategy, while primarily using short-term debt to finance the investment is considered an aggressive strategy (Baños-Caballero et al., Citation 2016 ).

Companies that use conservative financing strategies show an inverted U-shaped relationship between investment in working capital and financial performance, while companies that adopt aggressive strategies show a U-shaped relationship, as short-term financing is more flexible and cheaper than long-term financing (Baños-Caballero et al., Citation 2016 ; Jun & Jen, Citation 2003 ).

Another advantage of short-term financing is its easy adaptation to new financing needs, facilitating control between the company and those who finance its operations and diminishing agency problems; however, evidence shows that these benefits grow to a maximum level and later disappear (Jun & Jen, Citation 2003 ). Baños-Caballero et al. ( Citation 2016 ) find an inverted U-shaped relationship for a group of Spanish companies when a conservative financing strategy is utilised. In accordance with this, it is possible to observe a U-shaped non-linear relationship between investment in working capital and a company’s performance (Afrifa & Padachi, Citation 2016 ; Altaf & Shah, Citation 2018 ; Baños-Caballero et al., Citation 2014 ; Boțoc & Anton, Citation 2017 ; Mun & Jang, Citation 2015 ). From this discussion, we expect companies will have an inverted U-shaped relationship between working capital and financial performance, leading to the following hypothesis:

Hypothesis 3. There is an inverted U-shaped relationship between working capital and financial performance with a break-even point.

3.1. Data base, variables, and methodology

The sample for the current study was obtained from Thomson Reuters Eikon, which provides information about non-financial 461 companies; 80 Mexican, 120 Chilean, 78 Peruvian, and 183 Brazilian companies were selected for this research. We used the World Bank database for macroeconomic variables and examined the years from 2000 to 2018. The data collected correspond to consolidated financial statements for these companies and years.

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3.2 Measurement of variables and descriptive statistics

To reduce bias in the estimation of the relationship between investment in working capital and company performance, we propose the following control variables: leverage (LEV), company size (SIZE), tangible assets (TANG), capital expenditures (INV), operational cash flow (CASH), company liquidity and dividends (LIQ and DIV), and finally, company growth (GROW) (Ahmed & Hamdan, Citation 2016 ; Guney et al., Citation 2020 ; Jara et al., Citation 2019 ; Li et al., Citation 2020 ; Mardones & Cuneo, Citation 2020 ).

Another aspect to consider and one that can induce errors in inferences relates to endogeneity problems that arise when one or more of the independent variables are determined simultaneously with the dependent variable or when the independent variable correlates with the error term. Because the literature recognises endogeneity problems between performance variables and the proposed control variables, we use lagged variables as valid instruments (Arias et al., Citation 2014 ; Blundell & Bond, Citation 1998 ; Bond, Citation 2002 ). We also use a fixed effects model, as it allows us to further reduce endogeneity problems (Li, Citation 2016 ). To classify the firms as large or small, the sample was divided into two subsamples, with those larger than the average classified as large companies and those below the average classified as smaller sized companies (Mahmood et al., Citation 2019 ). Details on each of the variables are found in Table 1 .

Published online:

Table 1. variable definitions..

The summary of the descriptive statistics for all variables (see Table 2 ) shows that the average profitability of the sample firms, measured using ROE, is 0.0310 and Tobin’s Q is 1.3260. ROE is the variable with the largest standard deviation. The average leverage of the sample companies is 0.5247 (LEV), which reveals the importance of using external financing sources. The average size of the companies (SIZE) 13.3780, and, on average, tangible assets (TANG) represent 37.44% of a firm’s total assets. This is explained by the fact that, on average, companies invest amounts equal to 5.66% of total assets in capital expenditures (INV).

Table 2. Descriptive statistics.

The sample companies generate average operating cash flow equal to 8.61% of total assets (CASH), while company liquidity or the level of average investment in cash and its equivalents is 8.75% of total assets (LIQ). The mean return to shareholders (dividends divided by the closing share price) is 1.8547 (DIV), and we observe negative growth in sales (GROW) for companies of 33.88%. Finally, our variable of interest, the average investment in working capital, represents, on average, 14.99% of a company’s total assets, revealing the magnitude and importance of this investment for company operations. Gross domestic product growth of 3.11% was observed for the countries of the companies included in the study. We also observe an average active interest rate of 22.5% and an average deficit or surplus of −1.6855 for gross domestic product. Finally, there are no significant statistical differences between the countries.

In terms of the behaviour of our variable of interest, we observe a positive correlation between WKM and ROE of 0.07 and Tobin’s Q of 0.05. Mixed correlations are observed between the control variables and the proposed performance variables. Problems of multicollinearity between the variables are not observed, as there are low correlation coefficients between the variables (see Table 3 ).

Table 3. Correlation matrix.

We use Eq. (1) to estimate the relationship between investment in working capital and company performance, and the results are shown in Table 4 . We find a positive and significant relationship between performance and ROE and Tobin’s Q with coefficients of 0.2546 and 0.5371, respectively. This indicates that companies with a higher level of investment in working capital achieve better performance, suggesting this investment constitutes a competitive advantage. This is consistent with the findings of Aktas et al. ( Citation 2015 ), Baños-Caballero et al. ( Citation 2020 ), Deloof ( Citation 2003 ), García-Teruel and Martínez-Solano ( Citation 2007 ), Humphrey ( Citation 2017 ), and Li et al. ( Citation 2014 ). Consequently, H1 is supported.

Table 4. Relationship between working capital investment and financial performance.

In addition, the coefficients of economic growth (GDP) are 0.0088 and 0.0243 when the performance measures are ROE and Tobin´s Q, respectively; this indicates economic growth positively affects financial performance, as it implies better opportunities for investment and greater demand for working capital (López Pérez et al., Citation 2018 ). A positive and significant relationship is observed for a surplus in the net balance of payments (BP) (0.0176) when the performance measure is Tobin´s Q; this result is consistent with those reported by Médici and Panigo ( Citation 2015 ) and López Pérez et al. ( Citation 2018 ). With respect to the interest rate (INT), the results show a negative relationship with financial performance of −0.0077, which can be understood as a proxy for the opportunity costs of private funding, which negatively affects the demand for working capital (López Pérez et al., Citation 2018 ; Médici & Panigo, Citation 2015 ).

In the analysis by country, for Eq. (1) , we find a positive and significant relationship for each of the countries considered in the sample when the performance variable is ROE. For Chile, a positive and significant relationship is observed for the variables GDP and BP, which can be attributed to its context of an economy that is open and dependent on the international market. Additionally, the performance of the companies from Peru and Brazil is also associated with economic growth in those countries (see Table 5 ).

Table 5. Relationship between working capital investment and ROE by country.

The results show a positive and significant relationship between working capital and Tobin´s Q for each country, in addition to the positive effects of the macroeconomic variables of economic growth, GDP, and the balance of payments (BP), while the negative effect of interest rates on performance persists for all countries. However, this effect was not significant for Chile (see Table 6 ).

Table 6. Relationship between working capital investment and Tobin´s Q by country.

To simplify and establish the relationships between company performance and investment in working capital, four types of industry were defined: IND 1, Agriculture and mining; IND 2, Construction and manufacturing, IND 3, Commerce and IND 4, Services. The results show that investment in working capital is relevant for each of these industries when the performance measure is ROE. However, in the services industry, IND 4, it is significant at the 10% level, which, consistent with their business models, illustrates that the other industries demand greater investments in working capital (see Table 7 ). Similar results are observed when the performance measure is Tobin´s Q (see Table 8 ).

Table 7. Relationship between working capital investment and ROE by industry.

Table 8. relationship between working capital investment and tobin´s q by industry..

Eq. (2) was estimated to evaluate the effects of size on investment in working capital and its relationship with company performance. The results show that company size affects investment in working capital and, therefore, its relationship with financial performance. When the performance measure is ROE, a positive and significant coefficient of 0.3874 is observed for larger companies; for smaller companies, this relationship is positive, but not significant (see Table 9 ). When Tobin’s Q is used as the performance measure, the results are similar, as only larger companies show a positive and significant relationship (0.6852), which confirms their access to better financing. Because of this result, H2 is supported.

Table 9. Relationship between working capital investment and financial performance by effect size.

To estimate whether the relationship between investment in working capital and company performance is non-linear and U-shaped, we estimate Eq. (3) ; the results are shown in Table 10 . Mixed results are observed for the proposed performance measures. In detail, a negative and significant relationship is observed when ROE is utilised as the performance measure (−0.0560). These results allow us to suggest there is an optimal level of investment in working capital, in agreement with the proposal of Altaf and Shah ( Citation 2018 ); Baños-Caballero et al. ( Citation 2014 ); Boțoc and Anton ( Citation 2017 ); Mun and Jang ( Citation 2015 ). Therefore, H3 is supported when the performance measures used is ROE.

Table 10. Non-linear relationship between the investment in working capital and financial performance.

On the other hand, when Tobin´s Q is used as the performance measure, a positive and significant relationship is observed (0.9311). These results are consistent with those found by Baños-Caballero et al. ( Citation 2016 ) and Panda and Nanda ( Citation 2018 ), who highlight the benefits of short-term financing. Short-term financing allows companies to increase their performance due to lower financing costs, greater flexibility, and lower agency costs (Mahmood et al., Citation 2019 ).

To evaluate the effects of the non-linear relationship for each country, we estimate Eq. (3) . The summarised results for the variables are shown in Table 11 . Mixed results are observed for the proposed performance measures. Specifically, it is not possible to identify a significant non-linear relationship when analysing firms in Mexico or Brazil. However, a positive and significant relationship is observed for Chilean firms when Tobin´s Q is utilised as a performance measure (1.439); however, when the proposed performance measure is ROE, the relationship is not significant.

Table 11. Non-linear relationship between investment in working capital and financial performance by country.

For Peruvian companies, we observe a non-linear relationship between investment in working capital and financial performance for both measures. When ROE (Tobin’s Q) is used, the effect is −0.863 (−1.158).

Working capital management is one of the decisions that have the greatest impact on the financial performance of organisations. The scarcity of evidence for emerging economies, specifically for Latin American companies, was the motivation for this research.

The evidence shows that investment in working capital positively and significantly affects company performance, but mixed results are observed depending on the industry, country, and size of firms. In terms of the industry effect, the greatest impact was observed in the agricultural and mining sectors, followed by the construction and manufacturing sectors, with the least effect in the service sector. This could be explained by the type of business developed in each industry. In terms of country effects, a positive and significant relationship was observed for most countries. In addition, estimations of the effect of size were incorporated, and as indicated before, there are benefits associated with company size. The results confirm that larger companies can increase their performance by making the most of scale and scope economies, as well as lower costs of financing due to greater control by their interest groups.

Specific aspects of the companies were controlled by incorporating the macroeconomic variables that characterise emerging economies, such as interest rate levels, which undoubtedly affect access to short-term or long-term financing. We also observe the existence of a non-linear relationship, which allows us to suggest the existence of an optimum investment in working capital. For future research, we propose to identify and consider a set of macroeconomic variables by country, allowing an adequate comparison between them.

Source: Author’s elaboration.

Source: Author’s computation using STATA 14 software.

* p < 0.1; ** p < 0.05; *** p < 0.01.

* p < 0.1; ** p < 0.05; *** p < 0.01 and standard deviation in parentheses.

No potential conflict of interest was reported by the authors.

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