Effect of working capital policies on firms’ financial performance

Abstract

This study focuses on short-term investment and financing decisions influenced by a firm’s working capital policy and the effect of working capital policies on the financial performance of manufacturing firms in Malaysia. Working capital policies were measured by working capital financing and investment policies. Working capital investment policy was measured by the ratio of current assets to total assets. Working capital financing policy was categorized as conservative working capital financing policy, aggressive working capital financing policy, and matching working capital financing policy. This study considered matching working capital financing policy, which was not considered in previous empirical studies. The data included 147 firms with 1470 firm-year observations for the period from 2010 to 2019. The results revealed that the current asset to total asset ratio significantly negatively affected firms’ financial performance. Meanwhile, a conservative working capital financing policy was positively and significantly related to a firm’s financial performance. The finding implies that Malaysian manufacturing firms can increase their operating income by adopting an aggressive working capital investment policy. The finding also implies that Malaysian manufacturing firms can increase their operating income by implementing a conservative working capital financing policy rather than a matching or an aggressive working capital financing policy.

Keywords:

• Conservative
• aggressive
• matching
• working capital financing policy
• Malaysia
• manufacturing firms

Public interest statement

Regardless of the kind of firm or the nature of business, maximizing the firms’ performance is the main goal for all business firms. So, leaders and decision-makers of an organization are concerned about looking for the best policies and procedures that achieve the organization’s goals and maximize its value. Working capital is considerably important in all sectors of economic activity due to its direct impact on firm’s liquidity and financial performance. This study is interesting because it aims to analyze the effect of working capital policies on the financial performance of manufacturing firms in Malaysia. The manufacturing sector plays an important role in the growth of the Malaysian economy since it is the second largest contributor to the Malaysian GDP after the service sector. Examining the effect of working capital policies on firms’ financial performance could help financial managers develop an appropriate working capital strategy that would contribute to further improvements and growth in the Malaysian manufacturing sector.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Previous studies also used net operating working capital, which is the variance between the sum of accounts receivables and inventories minus account of payable, to measure the WCP (see for example: Aktas et al., 2015; Baños- Caballero et al., 2013; Kieschnick et al., 2013; Le, 2019).

2. (See for example: Al-Mawsheki et al., 2019; Farhan et al., 2021; Javid & Zita, 2014; Kaddumi & Ramadan, 2012; Mohamad, 2018; Mohamad & Saad, 2010; Nazir & Afza, 2009; Ng et al., 2017; Rozari et al., 2015; Shan et al., 2015; Sudiyatno et al., 2017; Vahid et al., 2012).

Additional information

Funding

The author received no direct funding for this research.

Notes on contributors

Randa Mohammed Shams Addin Al-Mawsheki

Randa Mohammed Al-Mawsheki is an assistant professor in finance at the Department of Finance and Banking, Taiz University, Yemen. She taught some subjects such as corporate financial management, financial risk management, investment and financing, financial markets, and financial statement analysis. Her research interests include financial economics, corporate finance, investment, and risk management.