Abstract

The literature on working capital management (WCM) provides mixed evidence on the effect of working capital on firm profitability and performance. We use firms from developed and emerging economies to explore how working capital and its components relate to firms’ performance while controlling for firm-specific and macroeconomic factors. The findings show that the cash conversion cycle (CCC) is inversely related to firm performance in developed and emerging economies—however, there are differences in the CCC’s components. While firms in developed economies exhibit higher firm performance with longer days’ inventory on hand, firms in emerging economies have lower firm performance with longer days’ inventory on hand, extended collection periods, and longer payable periods. Company-specific factors, such as firm size, growth, profitability, and leverage, influence the efficiency of WCM. We also find that country-specific variables such as gross domestic product (GDP), interest rate, and inflation have varying impacts on a firm’s WCM.

Introduction

Working capital management is a critical aspect of financial management that is pivotal in determining a firm’s overall performance and sustainability. It entails managing payables and receivables and reducing inventory. The working capital cycle encompasses the conversion of raw materials into finished goods, the sale of goods, and the subsequent collection of receivables, known as the cash conversion cycle. Effectively managing this cycle is essential for maintaining liquidity, supporting day-to-day operations, and ultimately influencing a firm’s financial health. A company’s liquidity management is becoming increasingly complex with the rise of digital transformation, ever-changing market conditions, globalization, and geopolitical uncertainty.

The literature on WCM holds two opposing views about the impact of working capital investment on firm profitability. One view advocates that an extended cash conversion period and a relaxed receivable collection period increase sales and firm performance (i.e., Deloof, 2003; Sharma and Kumar, 2010; Charitou et al., 2012). Another view documents a negative association between higher working capital and profitability because additional working capital requires more financing, which increases financing and opportunity costs (i.e., Alipour, 2011; Ren et al., 2019; Kayani et al., 2019a; Banerjee and Deb, 2023; Kamlesh et al., 2023). So, having excessive working capital may drag a firm’s financial performance because of the high cost of carrying working capital.

Conclusion

Our research examines the impact of working capital management on corporate performance for a group of firms in developed and emerging economies. We find statistically significant differences between developed and emerging economies concerning working capital and firm-specific and country-specific variables. For example, the CCC is significantly higher for emerging economies than developed ones. Similarly, DSO and DSI are considerably higher for emerging economies, while there is no statistically significant difference in DPO. In our further analysis, we note the following similarities and differences between developed and emerging economies concerning the impact of working capital management on firm performance. First, CCC is a significant determinant of firm performance for both developed and emerging economies. Notably, a longer cash conversion cycle is associated with lower firm performance. These findings are supported by Jose et al. (1996), Kayani et al. (2019a), Kayani et al. (2019b) and Deloof (2003) for developed economies and by Lin and Wang (2021), Garg and Meentu (2022), and Jaworski and Czerwonka (2022) for emerging economies. We find significant differences between developed and emerging economies for the components of CCC. For example, only the DSI component of CCC has a statistically significant direct impact on firm performance in developed economies. For emerging economies, all components of CCC (i.e., DSI, DSO, and DPO) have a statistically significant impact on firm performance. In particular, a higher inventory holding period, receivable collection period, and days’ payables are associated with lower firm performance.