Effects of Working Capital Management on Firm Performance: An Empirical Study of Non-financial listed Firms in Pakistan

The purpose of this paper is to investigate whether working capital management affect the performance of non-financial listed firms in Pakistan. Panel econometric technique namely pooled ordinary least squares is used to estimate the relationship between working capital and firm performance. Data were taken from the annual reports of non-financial firms listed on the Karachi Stock Exchange Pakistan during 2007-2010. Three performance measures namely gross profit margin, return on asset, and return on equity are used to estimate the impact of working capital variables such as average age of inventory, average collection period, and average payment period. Empirical results indicate that average age of inventory is positively related to gross profit margin and return on asset, whereas it is negatively related to return on equity but the relationship is found insignificant. Although the relationship is insignificant but positive sign may be because of increasing sales which leads to higher profit and thus fewer inventories. Average collection period is significantly and positively related to gross profit margin and return on assets. This finding shows that management of receivables has a positive impact on firm performance. Moreover, it confirms the prediction that reduction in average collection period improves the accounts receivable turnover which in turn positively affects the firm’s profitability. Although average collection period is positively related to return on equity but the relationship is found insignificant. Average payment period is positively related to gross profit margin and negatively related to return on asset but the relationship is found insignificant. However, average payment period is positively and significantly related to return on equity. This finding indicates that stretching the payment period increases the firm’s ability to utilize creditors’ money in their operation which in turn enhances the firm value. As far as control variables are concerned, a significant positive relationship is observed between firm size and two performance measures such as gross profit margin and return on asset. Alternatively, firm size is negatively related to return on equity but the relationship is found insignificant. Leverage is negatively and significantly related to gross profit margin and return on asset. Alternatively, an insignificant and positive relationship is observed between leverage and return on equity. The negative relationship between leverage and profitably confirms the predictions of the pecking order theory which suggests that profitable firms tend to borrow less due to their ability generate funds from internal sources. Finally, firm age is negatively related to gross profit margin and return on asset whereas it is positively related to return on equity. However, the relationship is found insignificant. In sum these empirical findings indicate that management of working capital has material affects of firm performance.