Abstract
We evaluated the moderating effects of firm size and leverage on the working capital finance (WCF)–profitability relationship among Chinese companies during 2000–2017. Applying the generalized method of moments (GMM) technique on panel data, we observed that firm size and leverage have strong moderating roles in the WCF–profitability relationship. We observed that small or low-leverage firms have an inverted U-shaped WCF–profitability relationship. However, this relationship is U-shaped for large or high-leverage firms. We report break-even points in these relationships that show the portion of short-term debt in working capital financing. The results reveal that the break-even point for all subgroups (small, large, low-leverage, and high-leverage firms) decreases compared to the break-even point of the full sample. This study shows how the break-even point of the WCF–profitability relationship shifts when a company expands or its leverage level changes. Managers can use this information for profit maximization.
Highlights
The relationship between profitability and working capital has remained a critical issue since the late 1990s
The break-even point in the working capital finance (WCF)–profitability relationship of low-leverage firms is higher than the break-even point of the full sample
We evaluated the influence of firm size on the WCF–profitability break-even point
Summary
The relationship between profitability and working capital has remained a critical issue since the late 1990s. Short-term financing reduces possible agency problems between creditors, shareholders, and managers of the firm [24] All these factors support that both short- and long-term debts should be used to finance working capital. Against this background, their best combination should be determined for maximal profit. Banos et al [23] analyzed Spanish companies regarding short-term financing with working capital and reported an inverted U-shaped relationship between WCF and profitability. If a firm finances its working capital by short-term borrowing, a positive WCF–profitability relationship exists, where WCF affects profit positively. We considered a long time period of 18 years with a large number of observations (12,610) This is the first study in China to evaluate the WCF–profitability relationship in the context of firm size and leverage.
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