Does working capital management affect firm profitability? Evidence from European Union countries

Abstract

PurposeThe paper aims to investigate the dynamic relationship between working capital management and firm profitability for a sample of firms from eight European Union (EU) countries for the period 2006–2015.Design/methodology/approachThe panel regression model is used in the study. Firm profitability is measured using the return on assets (ROA) ratio, whilst cash conversation cycle, financial leverage, size, tangibility and cash flow ratio are used as independent variables. The novelty of this study is the use of cash flow ratio to develop the analysis firms by dividing them as healthy and nonhealthy.FindingsThe paper reveals that working capital management affects firm profitability, and a positive relationship exists between them. The paper shows differences of working capital management and firm profitability across countries. The striking result of this study is that an inverted U-shape relationship exists between working capital management and firm profitability. Whereas the findings suggest that firms should be as close as possible to the optimal length of cash cycle to increase profitability, and managers should give a priority to working capital optimization.Originality/valueThe authors consider results of this study relevant to both researchers and business policymakers in the field of working capital management policies.

Does the Cash Conversion Cycle Affect Firm Profitability? Some Empirical Evidence from Listed Firms in North Macedonia

“…First of all, our findings denote that firms with shorter CCC have higher profitability as indicated by an estimated negative relationship. Moreover, in contrast to some previous contributions in which the relationship between CCC and firm profitability follows an inverted U-shaped pattern (see e.g., Deari et al, 2022;Altaf and Shah, 2018), our analysis suggests that such relationship is decreasing and convex, since the estimated coefficient related to CCC2 is positive and significant.…”

“…For example, Deari et al (2022) investigated the dynamic relationship between CCC and firm profitability for a sample of firms from eight EU countries for the period from 2006 to 2015 and find a positive relationship between WCM and profitability. Also, Prempeh and Peprah-Amankona (2020) establish a significant positive linear relationship.…”

“…However, despite the sign of WCM's influence on profitability, some studies have found a linear relationship (e.g., Deloof, 2003), while other studies investigated the such influence through a non-linear function relationship (e.g., Deari et al, 2022;Afrifa and Padachi, 2016;Fernandes et al, 2021;Baños-Caballero et al, 2012).…”

“…In this article we examine the relationship between short-term liquidity and profitability, following Deari et al (2022), Altaf and Shah (2018) or Deloof (2003) who used the CCC as an inclusive measure of WCM efficiency.…”

Examining the Moderating Effect of Earnings Management on the Association between Working Capital Management and Firm’s Financial Performance: Evidence from Egypt

“…Consequently, some previous studies concluded a non-linear association between WCM measured by CCC and firm's FP. For instance, Deari et al (2022) examined the dynamic association between WCM and firm profitability measured by ROA using a sample of eight European Union countries covering 10 years from 2006 to 2015. The findings of the study indicated that there is a significant positive association between WCM and ROA.…”