Working capital requirement and the unemployment volatility puzzle

This paper investigates the relation between the financing strategies of working capital requirement and firm performance for the period 1997 to 2012. Using the two-step generalized method of moments estimator, we find that a suitable financing strategy can help firms improve their performance. Moreover, the results indicate that the working capital requirement financing-performance relation changes during a financial crisis. Finally, we also find that this relation depends on a firm’s financial flexibility. The findings are of interest for managers and researchers and show that managers should not only be concerned about investing in working capital requirement but also consider how this investment is to be financed. To the best of our knowledge, this is the first paper to analyse how the financing strategy selected by firms to finance their working capital requirement affects their performance.

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Working capital financing and corporate profitability of Indian manufacturing firms

Management Decision ◽

10.1108/md-07-2017-0698 ◽

2018 ◽

Vol 56 (2) ◽

pp. 441-457 ◽

Cited By ~ 7

Author(s):

Ajaya Kumar Panda ◽

Swagatika Nanda

Keyword(s):

Linear Relationship ◽

Capital Requirement ◽

Working Capital ◽

Short Term ◽

Financial Flexibility ◽

Content Type ◽

Indian Economy ◽

Manufacturing Sectors ◽

Non Linear ◽

Capital Financing

Purpose The purpose of this paper is to provide empirical evidence about the relationship between working capital financing (WCF) and firm profitability in six key manufacturing sectors of Indian Economy. It also aims to capture the change in the financing of working capital requirement over different scenarios of price-cost margin and financial flexibility. Design/methodology/approach The study is undertaken on a sample of 1,211 firms from 6 key manufacturing sectors of Indian economy from 2000 to 2016. The non-linear relationship between WCF and profitability is studied using two-step generalized model of moments (GMM) estimator. Findings The study finds a convex relationship between WCF and profitability among firms in chemical, construction, and consumer goods sectors. Firms in these sectors can finance larger portion of their working capital requirements through short-term debt without negatively impacting profitability. However, a concave pattern of relationship for firms in machinery, metal, and textile industries implies increasing debt financing of working capital requirement would increase profitability for the firms who have financed lower portion of their working capital by short-term bank borrowing. But when a higher proportion of working capital requirements are already financed by short-term debt, a further increase in debt financing may impact profitability negatively. Moreover, the study finds that firms with high financial flexibility and high price-cost margin (except textile) can increase profitability by financing larger portion of working capital requirement through short-term debts and the continuation with risky WCF could increase profitability. Originality/value The study contributes to the literature on working capital in a number of ways. First, no previous study has been undertaken to explore the non-linear relationship between WCF and corporate profitability over a large sample of firms from six key manufacturing sectors of Indian economy. Second, the study uses a quadratic function to explore the non-linear relationship between WCF and profitability. Third, the study explores the relationship between WCF and profitability with respect to the price-cost margin and financial flexibility of firms under different manufacturing sectors of Indian economy. Finally, the study uses advanced two-step GMM, the panel data techniques to handle unobservable heterogeneity and issues of endogeneity within the data sample.

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