Working Capital Management And Financially Constraint Firms In Pakistan

ABSTRACT
Working capital management is a daily activity crucial for determining the availability of resources for a company. This paper explores the dual impacts of increasing working capital, highlighting both positive and negative effects, as well as the existence of an optimal degree that varies depending on financial conditions. The study aims to assess how non-linear changes in working capital influence firm performance and to investigate the differences in ideal level of working capital between financially constrained and unconstrained firms. This study employed a mixed- methods approach, collecting primary data through questionnaires from board of investment, while secondary data was obtained from the official websites of manufacturing firms listed on the Pakistan Stock Exchange, from their annual financial reports spanning from 2011 to 2022. The sample consists of 238 firms. The empirical analysis employs panel data methodologies including Hausman tests, fixed effects, and random effects models, utilizing the general-to-specific model approach for model selection. Return on asset is used to assess firm performance, which is dependent variable. The independent variables include net trade cycle and its square, indicating working capital management. Control variables are firm size, financial leverage. The empirical study reveals a positive and significant association between net trade cycle and return on asset, and a negative and significant relationship between net trade cycle squared and return on asset. These results clearly indicate that investment in working capital and firm performance have an inverted U-shaped relationship, indicating that there is an ideal level of working capital investment that strikes a balance between costs and benefits in order to maximize a firm’s value. The findings suggest that managers should take steps to prevent lost sales, overlooked early payment discounts, or increased financing costs from having a negative effect on the performance of the firm. Additionally, the study investigates whether various financial constraint measures have an impact on the ideal working capital level. The results indicate that firms with higher likelihood of encountering financial constraints have a lower optimal level.

Meta Data

Author: Siddiqa Athar
Supervisor: Ahmed Faraz
Keywords : Financial Constraints, Firm Performance, working capital management
Internal Examiner: Usman Qadir
External Examiner: Aijaz Mustafa Hashmi

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