Abstract
The main aim of this paper is to evaluate the impact of working capital policies on firms’ profitability. The study uses a panel data set of 829 manufacturing firms for the period from 2011 to 2017. Data is extracted from Prowess IQ database. An empirical model is used for testing research hypotheses. The results show that all firms across Indian states follow conservative financing and investment policy. The conservative investment policy positively affects return on assets, whereas the conservative financing policy negatively affects return on assets and therefore firms’ financial sustainability. Regulators, policymakers, investors, and financial managers in Indian manufacturing companies are advised to follow a conservative investment and financing policy, which is effective and efficient in boosting firms’ profitability for attaining financial sustainability. Therefore, manufacturing firms should invest more in current assets, because they need to expand both inventories and trade credit to their customers. Moreover, financial managers are advised to favor a low level of debt in financing assets. Apart from previous literature, which was either descriptive or based on a small sample size, the present study makes a novel and significant contribution by bridging an existing gap through applying a panel fixed- and random-effect model for a large sample: 829 firms. Furthermore, the business environment in India is somewhat different from that of other countries around the globe, which makes investigating working capital policies in the Indian contexts an interesting endeavor.
Highlights
The results indicated that conservative financing policy followed by Indian firms negatively affects firms’ profitability measured by return on assets
The mean value of the same ratio for the whole sample is 0.38. These results indicate that approximately one third of total assets in Indian firms are financed by short-term debt
This means that Indian manufacturing firms are adopting conservative financing policy, which is expected to have a positive effect on the profitability of the firms and their financial sustainability
Summary
The Modigliani and Miller capital structure theory is based on the view that firm’s value does not get affected by the method of financing inefficient markets where bankruptcy cost, taxes, cost of information, and agency cost is absent [1]. Smith [2] introduced a new thought by highlighting the effect of working capital on firms’ performance sustainability such as firms’ risk, value, and profitability. Working capital management has been gaining considerable importance because of its contribution toward enhancing financial sustainability and shareholders’ value by making a proper tradeoff between risk and profitability [3,4,5,6]. Working capital is directly connected to the firm’s liquidity and Sustainability 2021, 13, 4516.
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