An profitability of the firms and reduction in number

An extensive body of research examines
individual components of working capital in segregation. The dependent variable
is the WCR, which focuses the study on the drivers of working capital behavior
and accounts for the joint effect of receivables, inventory, and payables. Filbeck
and Krueger (2005) analyzed the working capital management policies of 32
non-?nancial industries in the United States (US). According to results, firms
within the industries preferred different working capital practices over time.The traditional belief about working capital
and profitability supported by most of the empirical studies is reducing
working capital investment which would positively affect the profitability of
firm (aggressive policy) by reducing proportion of current assets in total
assets. Wang (2002) analyzed a sample of Taiwanese and Japanese firms, and
Deloof (2003) analyzed a sample of Belgian firms, emphasized that the way of working
capital management has a significant impact on the profitability of the firms
and reduction in number of day’s accounts receivable and reduction in
inventories will increase profitability. However, opposite to traditional
belief, profitability can also be increased by more investment in working
capital (conservative approach). When large number of inventory is maintained,
it reduces the cost of interruptions in the production process, decrease in
supply cost and protection against price fluctuation (Blinder and Maccini,
1991). There are few studies about working capital
management in Pakistan like Afza and Nazir (2008), who studied the factors
determining the working capital requirements for a large sample of 204 firms in
sixteen manufacturing sub sectors during 1998-2006 and in an another study by
Afza and Nazir (2007) explored the relationship between conservative and
aggressive working capital policies for a large sample of 205 firms in 17
sectors listed on Karachi Stock Exchange during 1998-2005 and found a negative
relationship between the degree of aggressiveness of working capital investment
& financing policies and profitability measures of firms.Atanasova (2007) and Molina and Preve (2009)
researched that most firms demand and supply trade credit simultaneously; firms
with better access to trade credit find it easier to finance inventory and
receivables. A positive WCR, or conservative working capital policy, requires
additional capital that firms can finance externally using commercial paper or
lines of credit or via internally using free cash flow. Thus, conservative
working capital policies involve either explicit financing costs or opportunity
costs. While, a negative working capital means the firm’s net working capital
provides financing for long-term assets and this strategy is known as
aggressive strategy. Sales are another important factor. Growing
firms might need to invest in ?xed assets to be able to sustain growing
production and sales. This will increase investment in current assets to support
enlarged scale of operations. In the period of economic boom, a firm’s
investment in inventories and debtors will increase because sales will increase
and ?rms might need to make additional investment in ?xed assets to increase
their productive capacity. This action of the ?rm will demand increasing their
level of working capital. When there is a decline in the economy, sales will
fall and thus the levels of inventories and debtors and consequently ?rms will
limit short-term borrowings and hence their requirements of funds for working
capital. Pandey (2006) researched that seasonal ?uctuations affect working
capital requirement and they also create production problems for the ?rm. In
the periods of peak demand, increasing production may be expensive for the ?rm
and firms may face more expensive production during the slack period as they
may have to maintain a large workforce and physical facilities without adequate
production and sales (Pandey, 2006). The increasing level of inventories during
the slack season will require increasing funds tied up in the working capital
for some months.One thing that reduces the working capital
need of a ?rm is the availability of credit from its suppliers. Credit uses for
financing the ?rm’s inventories and also reduces the cash conversion cycle.
Where a ?rm is unable to have credit from the suppliers but has favorable bank
credit (i.e., the interest rate is at a reasonable cost), the difficulty of
?nancing its inventories and debtors is removed because the working capital
policy of the ?rm will be greatly in?uenced. The previous results show strong
relationships between working capital and operating conditions (e.g., sales
volatility and sales growth). As we early discussed, positive WCR must be
financed and management must create a strategy to attain funds internally or
externally. Accordingly, the results indicate that the WCR depends on external
financing costs, internal financing resources, capital market access, financial
distress, and negotiating ability. Molina and Preve (2009) find approved trade
credit is inversely related to lagged sales growth, and they suggest that firms
with greater prior period growth tighten credit policy as they achieve planned
levels of sales growth. With respect to the spontaneous sources of funds
generated by sales growth, Petersen and Rajan (1997) and Deloof and Jegers
(1999) indicate that payables are directly related to growth. Since the WCR is
the net result of the firm’s working capital behavior, and the effect of sales
growth on inventory is not clear from the previous literature.Higher deviations in demand make the optimal
inventory level more difficult to determine. Emery (1987) confirms that not all
firms will find it advantageous to increase inventory in response to increased
sales volatility.A positive WCR can be financed by positive
operating cash flow, it will allowing a more conservative working capital
strategy which facilitate future sales growth. Firms with superior capital
market access and more credit worthiness are more capable of financing the
working capital gap externally.Wasiuzzaman and Arumugam (2013) made an
effort to determine the effect of fundamental factors on the level of
investment in working capital. They used eight years (i.e. 2000-2007) panel
data of 192 Malaysian public listed firms. The results of their panel data
regression confirmed that tangibility, size, age, earning volatility and
leverage are positively related to working capital investment. In addition to
this growth, operating cash flow and profit are found to be inversely related
to working capital investment. 3. Data and
Methodology3.1 Data

The purpose of this study is twofold. First,
to investigate the impact of firm-specific (i.e. firm size, sales growth,
earnings volatility, capital structure, and asset structure etc.) and macro
economic variables (i.e. GDP growth, inflation and market-interest rate etc.)
on working capital. Secondly, to investigate the impact of working capital on financial
performance measured as return on assets (i.e. accounting-based) and Tobin’s Q
(i.e. market-based). Data relevant to manufacturing firms listed on Pakistan
Stock Exchange during 2007-2016 will be collected from annual reports.
Moreover, data relevant to market price of common stocks will be collected from
the publications of Pakistan Stock Exchange (formerly Karachi Stock Exchange). Finally, data relevant to
macroeconomic variables will be collected either from Economic Survey of
Pakistan or from the website of World Bank during the study period.  

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