Working Capital Management and Profitability: Evidence from an Emergent Economy

Abstract

The purpose of this paper is to study the impact of working capital management on the profitability of Argentine manufacturing firms, using the main theoretical framework suggested by the literature. Many studies have addressed this problem in developed economies, but such studies are quite rare in emerging and developing economies. The companies analyzed were selected using a stratified sampling technique based on an economic criterion. The data cover a time horizon of three years and were collected through a questionnaire. To achieve the study objectives, we used a fixed-effects regression model, which proved to be reliable to explain the effect of working capital management on profitability. The results highlighted a positive and statistically significant relationship between all components of working capital and profitability, suggesting that an increase in each variable considered determines an improvement in performance in terms of ROA and ROE. Conversely, leverage has shown a statistically significant negative relationship to profitability, suggesting that an increase in debt has a negative impact on firm performance.

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ISSN: 2278-3369
International Journal of Advances in Management and Economics
Available online at: www.managementjournal.info
RESEARCH ARTICLE
©2012-2021, IJAME. All Rights Reserved 32
Working Capital Management and Profitability: Evidence from an
Emergent Economy
Thiago Alvarez1, Luca Sensini2, Maria Vazquez1*
1. BE Lab, Buenos Aires-Argentina.
2. Department of Management and Innovation Systems, University of Salerno-Italy.
*Corresponding Author Email: mariavazquez.baires@gmail.com
Abstract: The purpose of this paper is to study the impact of working capital management on the
profitability of Argentine manufacturing firms, using the main theoretical framework suggested by the
literature. Many studies have addressed this problem in developed economies, but such studies are
quite rare in emerging and developing economies. The companies analyzed were selected using a
stratified sampling technique based on an economic criterion. The data cover a time horizon of three
years and were collected through a questionnaire. To achieve the study objectives, we used a fixed-
effects regression model, which proved to be reliable to explain the effect of working capital
management on profitability. The results highlighted a positive and statistically significant relationship
between all components of working capital and profitability, suggesting that an increase in each
variable considered determines an improvement in performance in terms of ROA and ROE. Conversely,
leverage has shown a statistically significant negative relationship to profitability, suggesting that an
increase in debt has a negative impact on firm performance.
Keywords: Working Capital Management, Profitability, SMEs, Emerging Economy, Leverage.
Article Received: 30 Oct. 2020 Revised: 19 Nov. 2020 Accepted: 18 Dec. 2020
Introduction
Working capital management (WCM) is
considered fundamental for the financial
performance of companies, as it represents
the link between liquidity and profitability
[1, 2, 3, 4]. Consequently, firms must
constantly monitor the relationships between
assets and short-term liabilities, to favour
the survival and development of the company
and reduce the risk of financial distress [5, 6,
7, 8, 9].
Working capital management is even more
important in developing and emerging
economies, where the unstable conditions of
the financial markets and the uncertainties
linked to the economic situation lead to
severe turbulence and general price
instability [10]. Considering the current
Argentine economic context, SMEs encounter
considerable difficulties in accessing the
credit market, which is strongly centred on
the banking system, and in finding the
sources necessary to finance their
investments. These difficulties are even more
evident in the manufacturing sector, where
companies tend to have a greater need for
capital. In emerging economies, the literature
has highlighted that the efficient
management of working capital by companies
is fundamental to favour profitability and
productivity and, at the same time, to favour
employment and economic stability [11].
Many previous studies have extensively
investigated the relationship between
working capital and profitability in developed
economies [2, 12, 13, 14, 15, 16].
Only in recent years, literature has begun to
pay attention to emerging countries [17, 18,
19, 20, 21, 22]. However, the results are still
controversial and require further
investigation to provide more empirical

Thiago Alvarez et. al.| International Journal of Advances in Management and Economics | 2021| Vol. 11 | Issue 01| 32-39
©2012-2021, IJAME. All Rights Reserved 33
evidence. In this perspective, the objective of
the paper is to examine the effects produced
by capital management on the profitability of
Argentine SMEs. This topic is particularly
relevant for several reasons. First, SMEs
represent the backbone of the country's
economy, contributing significantly to
employment and social well-being.
Consequently, an in-depth study of this topic
can provide useful information to verify the
health and competitive capacity of these
companies. Secondly, given that the financial
system is mainly centred on banks and SMEs
have strong financial constraints [23, 24, 25].
The results can provide useful information to
their owners and managers to make
financing decisions appropriate to the
characteristics of their business and the
specific reference environment. The rest of
the paper is organized as follows. Section two
develops the literature review, while the next
section describes the methodology used. The
fourth section analyzes the findings and,
finally, the last section contains the
concluding remarks.
Literature Review
The management of working capital concerns
the company's current assets and liabilities,
representing the link between liquidity and
profitability. The effective and efficient
management of working capital facilitates
the continuity of company operations, as it
favours the company's ability to have a cash
flow to pay short-term obligations [26, 27, 28,
29, 30].
However, the optimal size of working capital
is conditioned by the operational
characteristics of the company and by the
reference economic context. Therefore,
especially in environments characterized by
high environmental variability, identifying
the optimal size is complex and requires
continuous monitoring, to make the
necessary adjustments.
Over the last few years, as previously
mentioned, several studies have analyzed the
relationship between working capital
management and profitability in developing
economies. In Nigeria, Falope and Ajilore [17]
found a negative relationship between
profitability and average collection period,
inventory turnover, cash conversion cycle and
average payment period. Bagchi and
Khamrui [31] analyzed Indian companies,
finding a negative relationship between
working capital and profitability. In Iran,
Abbasi and Bosra [32] have found that the
cash conversion cycle and the number of days
of holding stocks have no significant effect,
while account receivables and account
payables have a significant negative effect on
the ratio of gross operating profit to assets.
Ahmed [33] analyzed the balance sheet data
of Pakistani companies, suggesting that
working capital has a positive impact on the
performance of the company. In the same
economic context.
Tufail and Khan [34] analyzed textile
companies, finding a positive relationship
between size and profitability and a negative
relationship between working capital and
performance. Similar results were
highlighted by Rehman and Anjum [35] in
Pakistani cement companies. In Kenya,
Stephen ed Elvis [36] found that trade
receivables and inventory period negatively
impact the profitability of manufacturing
SMEs.
The study by Prempeh and Peprah-
Amankona [37] analyzed manufacturing
companies listed on the Ghana Stock
Exchange, highlighting a positive
relationship between working capital
management and profitability. Several
studies have also been made in the Latin
American context. Ribeiro de Almeda and Eid
[22] found that investments in working
capital are less profitable than a cash
investment and that increasing working
capital at the beginning of the year reduces
the value of the Brazilian firms.
In the same economic context, Nakamura
and Palombini [38] highlighted that the level
of debt, size and growth rate have a
significant impact on the management of
working capital. Vazquez Carrazana et al.
[39] studied Brazilian agri-food companies,
suggesting a positive and significant
correlation between profitability and
liquidity.
Arcos and Benavides [40] have found that in
Colombian companies, the CCC was
inversely proportional to the profitability.
Mandujano Herrera and Navarro Orihuela
[41] studied manufacturing firms in Peru and
Chile, highlighting a negative relationship
between the cash conversion cycle and
working capital requirement with
profitability.

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©2012-2021, IJAME. All Rights Reserved 34
Vélez-Pareja et al. [42] found that Latin
American companies have an excess of
liquidity which leads to a destruction of
value. In the same context, Payne and Bustos
[43] highlighted that firms have used
inadequate working capital management
policies, highlighting that companies have
excess liquidity. Terrain et al. [44] studied
Argentine companies listed on the Buenos
Aires Stock Exchange, noting that companies
with higher working capital have higher
profitability.
Furthermore, empirical findings contradict
the literature that supports a negative
relationship between liquidity and
profitability, highlighting a negative
relationship between liquidity and debt, and
a positive relationship between changes in
current capital and long-term debt. As is
evident, the brief examination of the studies
conducted in emerging and developing
economies has shown conflicting results
regarding the relationship between the
management of working capital and
profitability.
According to the prevailing literature, to
adequately address this issue, it is necessary
to simultaneously investigate the
relationship between all the determinants of
working capital and profitability, as there are
reciprocal influences between each of its
elements [45, 46]. Therefore, any decision
that impacts one of its values necessarily
affects others. Based on the theoretical
reference framework suggested by the main
literature, this study examines the individual
components that make up the working
capital (inventory, account receivables,
account payables, cash conversion cycle),
using the current ratio, the size of the
business and financial leverage. The
variables just mentioned representing the
independent variables that influence
profitability, while the latter represents the
dependent variable. The profitability of
companies highlights the company's ability to
use its resources and is measured through
two indicators: ROA and ROE [47, 48, 49].
Methodology
The purpose of this paper is to investigate
the influence of working capital components
on the profitability of Argentine
manufacturing SMEs. The firms were
selected using a stratified random sampling
technique based on an economic criterion
[21,50]. We chose this approach to improve
the efficiency of the estimates [51] and to
ensure that the sample was made up of
sufficiently different companies in terms of
turnover, number of employees and assets.
The data were collected through a
questionnaire divided into two sections. The
first contained general information regarding
the company and its ownership. The second
required all the balance sheet data necessary
to calculate the indicators envisaged in our
analysis. To neutralize the effects of inflation,
we have normalized the balance sheet data.
The time horizon analyzed is three years
(2016-2018). We excluded all companies that
submitted incomplete data from the analysis.
At the end of the survey, 177 SMEs
completed the questionnaire. The variables
used to investigate the relationship between
the determinants of working capital and
profitability were calculated as shown in
Table 1.
Table 1: Variables
Dependent Variable
ROA
Ratio EBITDA/Total Assets
ROE
Ratio Net Income/Total Equity
Independent Variables
IN
Inventory/Cost of Sales x 365
AR
Accounts Receivables/Sales x 365
AP
Accounts Payables/Sales x 365
CCC
(Receivables collection period + Inventory conversion period) – Payables deferrals
period
CR
Ratio Current Assets/Current Liabilities
SIZE
Natural Log Total Assets
LEV
Ratio Total Liabilities/Total Assets
In line with other previous studies, this study uses a fixed-effects model. The regressions developed for each dimension of
profitability are as follows:
(1)

Thiago Alvarez et. al.| International Journal of Advances in Management and Economics | 2021| Vol. 11 | Issue 01| 32-39
©2012-2021, IJAME. All Rights Reserved 35
(2)
Where
αi = Constant (the intercept)
β = Regression coefficient
β0 = Constant
αi = Firm-specific effect variable
εit = Within-firm error
i = Firm
t = time
Results and Discussion
The descriptive statistics of the analyzed variables are shown in Table 2.
Table 2: Descriptive Statistics
Mean
Median
Max
Min
St Dev
ROA
0.215
0.171
0.987
0.027
0.173
ROE
0.379
0.337
0.914
0.019
0.476
IN
7.873
8.156
19.967
0.413
4.791
AR
6.769
4.785
12.893
4.273
3.105
AP
1.467
1.483
3.567
1.065
1.119
CCC
12.108
11.783
18.287
4.986
3.876
CR
7.782
7.200
12.180
6.100
1.925
SIZE
7.231
8.164
10.987
0.981
4.228
LEV
9.176
8.129
16.975
5.482
2.903
Table 3 shows the correlation analysis between
the variables
investigated, to verify any collinearity problems.
Table 3: Correlation Analysis
ROA
ROE
IM
AR
AP
CCC
CR
SIZE
LEV
ROA
1
ROE
0.571
1
IN
0.389**
0.479**
1
AR
0.478**
0.401**
0.031
1
AP
0.516**
0.517**
0.337**
-0.327*
1
CCC
0.139*
0.359**
0.029
0.263*
0.029
1
CR
0.399**
0.423**
0.041
0.019
0.057
0.129
1
SIZE
0.371**
0.112*
0.048
-0.221*
0.129
0.218
0.139
1
LEV
-0.462**
-0.459**
-0.031
0.143
-0.331
-0.187
0.047
0.327
1
*, ** and *** show significance at 10%, 5% and 1%, respectively
The correlation coefficients between both
profitability indicators (ROA and ROE) and
IM, AR, AP, CCC, CR and SIZE are
significant and positive, suggesting that
increasing each independent variable
determines a positive effect on the
performance of firms. Financial leverage
(LEV) on the other hand has a negative effect
on profitability, highlighting that an increase
in debt determines a worsening of the
company's performance. The correlation
between the independent variables is zero or
has minimal levels of significance. Table 4
shows the development of the fixed effects
regression model, highlighting the impact
produced by the individual determinants of
working capital on ROA and ROE.
Table 4: Panel Fixed Effects Regression
ROA
ROE
IN
2.576
(0.000)***
4.009
(0.000)***
AR
0.516
(0.000)***
0.081
(0.037)**
AP
0.663
(0.021)**
0.131
(0.000)***
CCC
0.089
(0.000)***
0.257
(0.000)***

Thiago Alvarez et. al.| International Journal of Advances in Management and Economics | 2021| Vol. 11 | Issue 01| 32-39
©2012-2021, IJAME. All Rights Reserved 36
CR
0.437
(0.000)***
0.291
(0.002)***
SIZE
0.141
(0.000)***
0.119
(0.023)**
LEV
-0.049
(0.004)***
-2.983
(0.000)***
Hausman test
0.002
0.012
R2
0.768
0.731
Adjusted R2
0.745
0.712
*, ** and *** show significance at 10%, 5% and 1%, respectively
Control variables indicate that the model is
reliable in explaining variations in ROA.
Both profitability variables, ROA and ROE,
are positively and significantly correlated
with IN, AR, AP, CCC, CR and Size.
Therefore, increasing each of these
independent variables has a positive impact
on profitability. Financial leverage (LEV), on
the other hand, has a negative and
significant impact on both performance
indicators, highlighting that an increase in
debt produces a negative effect on
profitability.
The measures that can be taken from Table 4
indicate the impact of each variable on ROA
and ROE. The results of this paper are
consistent with some of the literature
[37,43,50,51,52,53, among others], but
diverge from the empirical findings of other
studies [31,32,54,55 among others],
highlighting that the results may be
conditioned by the specific characteristics of
the company, by the sector and by the
reference economic context.
Concluding Remarks
This paper aimed to investigate the impact of
working capital management on the
profitability of Argentine manufacturing
firms, using the main theoretical framework
suggested by the literature. Studies that
have addressed this issue are widespread in
developed economies but are quite rare in
emerging and developing economies. The
companies analyzed were selected using a
stratified sampling technique based on an
economic criterion.
The data concern the period 2014-2016 and
were collected through a questionnaire.
Overall, 194 companies were analyzed. To
achieve the objectives of the study, we used a
fixed-effects regression model. Tests carried
out on the estimates suggested that the
model is reliable in explaining the effect of
working capital management on profitability.
The results showed a positive and
statistically significant relationship between
all components of working capital and
profitability, showing that an increase in
each variable considered determines an
improvement in performance in terms of
ROA and ROE.
Conversely, leverage has shown a negative
and statistically significant relationship with
profitability, suggesting that an increase in
debt has a negative impact on firms'
performance. The results of this study have
several theoretical and practical implications.
First, empirical findings contribute to the
existing literature, providing further
evidence on the relationship between
working capital management and
profitability in the context of an emerging
economy. Secondly, the results can help
business managers to manage the various
components of working capital more
effectively and efficiently, by acting on the
variables can improve performance.
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