Effects of Working Capital Management on the Profitability of Portuguese Manufacturing Firms

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Effects of working capital management on the profitability of Portuguese manufacturing firms

Sónia Silva*
sonia@eeg.uminho.pt

Florinda Silva**
fsilva@eeg.uminho.pt
July 2012
Abstract
This study provides empirical evidence about the effects of working capital management on the profitability of Portuguese manufacturing firms. A database covering the period 1996-2006, collected from Portuguese Statistical Office, is analyzed under panel data methodology. In line with previous research, our empirical results show a negative linear relationship between profitability and net trade cycle. Moreover, a reduction in the average number of days of accounts receivable and in the average number of days of inventories leads to an increase in firms' profitability. Also a decrease in the average number of days of accounts payable tends to increase profitability. Additionally, this study contributes by testing a non-linear relation between profitability and working capital management in Portuguese firms. Our results suggest a non-linear relationship between these two variables, which indicates there is an optimum net trade cycle level that maximizes firms' profitability.

Keywords Working capital management Profitability Net trade cycle Manufacturing Firms
JEL Classifications

G30

G31

G32

G39

*Corresponding author
School of Economics and Management
University of Minho
Campus de Gualtar, 4710-057 Braga, Portugal
Tel: +351 253 604510
Fax: + 351 253 601380
**NIPE - Economic Policies Research Unit
School of Economics and Management
University of Minho
Campus de Gualtar, 4710-057 Braga, Portugal
Tel: +351 253 604564
Fax: + 351 253 601380

Effects of working capital management on the profitability of Portuguese manufacturing firms

Abstract
This study provides empirical evidence about the effects of working capital management on the profitability of Portuguese manufacturing firms. A database covering the period 1996-2006, collected from Portuguese Statistical Office, is analyzed under panel data methodology. In line with previous research, our empirical results show a negative linear relationship between profitability and net trade cycle. Moreover, a reduction in the average number of days of accounts receivable and in the average number of days of inventories leads to an increase in firms' profitability. Also a decrease in the average number of days of accounts payable tends to increase profitability. Additionally, this study contributes by testing a non-linear relation between profitability and working capital management in Portuguese firms. Our results suggest a non-linear relationship between these two variables, which indicates there is an optimum net trade cycle level that maximizes firms' profitability.

1 Introduction

Most of the studies in corporate finance have focused on long-term financial decisions. However, short-run financial decisions, namely, working capital management (WCM) decisions (how much to invest in inventories and how much trade credit extend to customers or accept from suppliers)1 take up most of the time of financial managers (Richards and Laughlin 1980). As it is widely recognized, the operating cycle, which combines the basic activities related with production, distribution and collection from customers, is the main source of firms' cash inflows. This suggests that a significant part of firms' balance sheets are current assets and current liabilities. For the United States (US) market, Fazzari and Petersen (1993) report that firms' investment in currents assets are of the same order of magnitude as fixed assets and, in manufacturing firms, working capital is more than half as large as the fixed assets. Also García-Teruel and Martínez-

1
The main drivers of working capital are accounts receivable, inventories and accounts payable, commonly called working capital accounts.

1

Solano (2007) stand out that current assets of small and medium-sized enterprises...
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