Microsoft Word - 02_22_Working_Capital_Management_Hernandez_Alvarez_Roscigno_Piluso.docx American Interdisciplinary Journal of Business and Economics ISSN: 2837-1909| Impact Factor : 4.6 Volume. 9, Number 3; July-Sept, 2022; Published By: Scientific and Academic Development Institute (SADI) 8933 Willis Ave Los Angeles, California https://sadipub.com/Journals/index.php/aijbe 1 American Interdisciplinary Journal of Business and Economics | https://sadipub.com/Journals/index.php/aijbe INVESTIGATING THE FACTORS INFLUENCING WORKING CAPITAL AND PROFITABILITY IN CHILEAN SMES: A STATISTICAL ANALYSIS Santiago Chalmers Department of Management and Innovation Systems, University of Salerno Abstract: This study investigates the relationship between working capital and profitability of Chilean companies. A sample of manufacturing companies from the metropolitan region of Santiago was selected for the survey. The data covered five years to allow a sufficiently significant observation time horizon. The generalised least squares method was used to develop the analysis to obtain more reliable results. The empirical results suggest that the relationship between the single elements of working capital and firms' profitability presents a non-linear trend, confirming the results obtained in previous research. Therefore, for Chilean manufacturing companies, it is worth investing in the individual elements of working capital until the optimal size is reached, as the investment positively impacts profitability. After exceeding the optimal threshold, the ratio reverses, increasing the risks of financial difficulties. Keywords: working capital, profitability, manufacturing companies, Chile, non-linear trend, financial difficulties. INTRODUCTION The management of working capital (WCM) has become increasingly important for companies of all sizes due to the various crises of a financial and non-financial nature that have occurred globally in recent decades. The short-term financial equilibrium can affect the medium and long-term financial management and economic stability, affecting the firm's ability to survive. In the context briefly outlined, the management policy of each component of working capital determines an impact on short-term financial flows, affecting - at the same time - the future economic-financial equilibrium. The literature has extensively studied the issue of working capital management. However, scholars have focused mainly on companies in developed economies. Over the last decade, the literature has shifted the focus on companies in emerging economies. Therefore, studies on working capital management in SMEs in emerging economies deserve attention from researchers. Furthermore, the SMEs of these economies often represent the backbone of the country's economic and social development, making a significant contribution to employment and GDP. In the context outlined, this research analyses the relationship between the determinants of working capital and profitability in the context of Chilean SMEs to enrich the literature on the subject and provide helpful Santiago Chalmers (2022) 2 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep information to the managers of these companies. The paper is organised as follows. The second section develops the literature review. The third section illustrates the research methodology, while the next section highlights and analyses the results. Finally, the last section contains the concluding remarks. 1. LITERATURE REVIEW The general business and financial literature investigating the relationship between working capital and business performance are extensive (Fazzari and Petersen, 1993; Deloof, 2003; Filbeck and Krueger, 2005; Gill et al., 2010; Bagchi and Khamrui, 2012; Sensini, 2020; Chalmers et al., 2020; Hernandez et al., 2021). The researchers focused their attention on different aspects in different economic contexts, depending on the research perspective sought. However, the prevailing literature has highlighted the need to focus attention on its determinants, namely liquidity, credits, inventories and debts (Chen et al., 2014; Sanchez and Sensini, 2017; Mannetta et al., 2013; Kumar and Sun, 2022). The management of these variables affects the short-term financial equilibrium, also affecting the future survival prospects of the company. In any case, the efficient and effective management of working capital requires that current assets content the company with sufficient cash flows to pay short-term debts, aiming to optimise the relationship between risk and profitability (Mannetta, 2014; Chalmers et al., 2020). Any choice regarding any variable of working capital necessarily impacts all the others, influencing the financial and economic dimension of the company and, therefore, the risk of financial difficulties and, more generally, the business risk (Sen and Oruc, 2009; Alipour, 2011; Alvarez et al., 2021). Increasing sales through a longer extension to customers can help increase turnover and profitability. However, the possible consequences of this expansionary policy must also be carefully considered. Extending customer collection times can cause economic tensions if actions are not taken to balance the extension of the entry financial cycle. Furthermore, the shift in sales collection times can lead to an increase in the level of risk due to possible financial difficulties for customers (Mannetta et al., 2013; Sensini, 2016; Diaz and Vazquez, 2019; Shan et al., 2019; Chalmers and Diaz, 2022; Kumar and Sun, 2022). This reasoning can also be extended to the other components of working capital. For example, warehouse management policies, which represent the link between production and sales (Sensini, 2020), also significantly impact the company's financial flows. Consequently, the choice of greater or lesser supplies in specific periods and the stock management policy must be carefully considered. Likewise, debt management deserves the same attention. The extension of the payment time of debts, if on the hand it can favour the availability of more significant financial resources in the short term; on the other hand, it can worsen relations with suppliers (Campos et al., 2014; Chalmers et al., 2014; Chen et al., 2014; Chalmers and Diaz, 2022). Concerning each of the working capital variables mentioned, the literature has often found conflicting results. The company's size, the different economic contexts, and the different survey perspectives used from time to time are the cause of these divergences in the corporate and financial literature. In this regard, scholars have suggested that negative, positive and non-linear relationships can emerge between the individual determinants of working capital and profitability. In particular, some authors have suggested a negative relationship between the Cash Conversion Cycle (CCC) and profitability, measured by ROA and ROE, also finding a negative relationship between the CCC and the other determinants of working capital. (Wang, 2002; Nobanee et al., 2011; Tauringana and Afrifa, 2013; Ching et al., 2011; Mannetta and Zhang, 2014: Chalmers and Diaz, 2022). Other studies have suggested a positive relationship between working capital management and corporate profitability (Gill et al., 2010; Sharma and Kumar, 2011). Santiago Chalmers (2022) 3 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Finally, other studies have highlighted a non-linear relationship between the determinants of working capital and profitability, suggesting identifying an optimal level of working capital (Diaz and Vazquez, 2019). 2. RESEARCH METHODOLOGY To achieve our research objectives, we have selected a sample of manufacturing companies with registered offices in the metropolitan region of Santiago. We have chosen this region because it is the most representative of the economic and social dimensions of the country. The sample was drawn with a random sampling technique. Overall, 200 manufacturing companies were selected. The data was collected through a questionnaire to gather the financial information necessary to calculate the individual components of working capital. The survey refers to 5 years and covers the years from 2015 to 2019. A total of 120 companies participated in the survey. This level of participation can be considered satisfactory. Table 1 shows how we determined the individual variables under investigation. Tab. 1 –Variables of interest Dependent Variable Profitability ROA Net income/Average Total Assets Independent Variables Inventory INV Log (Average ages of inventories x 365/Cost) Account Receivables AR Log (AR x 365/Turnover) Account Payables AP Log (AP x 365/Cost) Cash Conversion Cycle CCC Log (INV + AR) - AP Control Variables Current Ratio CR Total Current Assets/ Total Current Liabilities Assets Turnover Ratio ATR Total Fixed Assets/Total Assets We developed the research using two different models. The first model (1) was developed to investigate the influence of every single element of working capital on profitability. The model assumes the individual determinants as independent variables and profitability as a dependent variable, as highlighted below: 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐼𝑁𝑉!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (1a) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐴𝑅!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (1b) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐴𝑃!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (1c) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐢𝐢𝐢!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (1d) The model just highlighted (1) allows us to identify only linear relationships between the individual elements of working capital and profitability. Therefore, we have developed a second model (2) to verify whether there are non-linear relationships between the variables under study. The second model (2) uses a quadratic relationship and is highlighted below: 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐼𝑁𝑉!" + 𝛽%𝐼𝑁𝑉(2)!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (2a) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐴𝑅!+ 𝛽%𝐴𝑅(2)!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (2b) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐴𝑃!+ 𝛽%𝐴𝑃(2)!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (2c) 𝑅𝑂𝐴!" = 𝛽# + 𝛽$𝐢𝐢𝐢!+ 𝛽%𝐢𝐢𝐢(2)!" + π‘Ž%𝐢𝑅!" + π‘Ž&𝐴𝑇𝑅!"+πœ–!" (2d) Santiago Chalmers (2022) 4 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep The analysis was developed with the generalised least squares method. We have chosen this set because this method gives more reliable results. Table 2 shows the results derived from this method. Table 2 – Descriptive statistics Variables Mean Std. Dev. Min Max ROA 0.063 0.079 -0.194 0.384 INV 4.175 1.876 -4.437 6.163 AR 4.356 1.212 1.243 7.571 AP 3.436 1.131 -3.918 5.918 CCC 4.987 1.154 -3.363 7.633 CR 2.108 1.901 0.345 14.845 ATR 0.211 0.223 0.001 0.959 Next, we developed the correlation analysis. As is evident from table 3, there are no multicollinearity problems; therefore, the results are reliable. Table 3 – Correlation matrix ROA INV AR AP CCC CR ATR ROA 1 INV -0.231 1 AR -0.310 0.235 1 AP -0.291 0.291 0.475 1 CR 0.291 -0,121 -0.041 -0.027 0.027 1 ATR 0.049 -0.257 -0.291 -0.012 0.031 -0.141 1 3. RESEARCH RESULTS AND DISCUSSION After verifying the results of the descriptive statistics and their reliability, in this section, we first developed the first regression model 1. The results of the first regression model are highlighted in Table 4. Table 4 – Model 1 Variables 1a 1b 1c 1d INV -0.00459*** - - - AR - -0.0194*** - - AP - - -0.0919*** - CCC - - - -0.0136*** CR 0.00155*** 0.00185*** 0.00009 0.00217*** ATR 0.00000 -0.0218*** 0.0007 0.0221*** C 0.0343** 0.0843*** 0.0431*** 0.0618*** Significance levels: * < 0.05; **p < 0.01; ***p < 0.001. The results showed that the individual determinants and working capital have a negative and significant impact (1%) on the profitability of companies. In this regard, the Cash Conversion Cycle suggests that companies that manage to reduce working capital management times perform better than other companies. These results are consistent with those obtained in previous studies (Wang, 2002; Dang and Tran, 2019). In line with the chosen research methodology, we subsequently developed model 2 to verify the presence of any non-linear relationships between the elements of working capital and the performance of companies. The results of the first regression model are highlighted in Table 5. Santiago Chalmers (2022) 5 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Table 5 – Model 2 Variables 2a 2b 2c 2d INV 0.00116** - - - INV(2) -0.00693*** - - - AR - 0.0137*** - - AR (2) - -0.0371*** - - AP - - 0.00583*** - AP (2) - - -0.00251*** - CCC - - - 0.0119*** CCC(2) - - - -0.00289*** CR 0.00169*** 0.00187*** -0.00105** 0.00229*** ATR -0.00579 -0.0235*** -0.00541 -0.0267*** C 0.0231 0.0122 0.0251 -0.00493 Significance levels: * < 0.05; **p < 0.01; ***p < 0.001. The quadratic variables of the model show a non-linear relationship between the individual components of working capital and profitability. This circumstance indicates that an investment in working capital produces a positive effect until the optimal level is reached, which corresponds to the curvature point evaluated at –β1 / 2Ξ²2. After exceeding this level, the investment in working capital produces an opposite effect, negatively affecting the performance of the firm. Therefore, the results suggest that expansionary policies produce positive effects until working capital reaches its optimal size. After this threshold, investments in current assets negatively affect company performance, leading to an increase in costs and greater sensitivity to risk. (Peterson and Rajan, 1997; Emery, 1984; Kim & Chung, 1990; Amendola et al., 2020). 4. CONCLUDING REMARKS This paper aimed to investigate the relationships between working capital, its components and the profitability of companies, taking as a study reference the business context of an emerging economy, such as the Chilean one. To carry out the survey, we selected a sample of manufacturing companies from the metropolitan region of Santiago, the liveliest area of the country, from both an economic and social point of view. The data covered five years to allow a sufficiently significant observation time horizon. We used the generalised least squares method to develop the analysis. This method has the advantage of obtaining more reliable results than other methodologies. The empirical results suggest that the relationship between the single elements of working capital and firms' profitability presents a non-linear trend, confirming the results obtained in previous research. Therefore, it is worthwhile for Chilean manufacturing companies to invest in the individual elements of working capital until the optimal size is reached, as the investment positively affects profitability. After exceeding the optimal threshold, the relationship is reversed, leading to an increase in the risks of financial difficulties. The results of this research contribute first to enriching the existing literature, broadening the view on the companies of an emerging economy that is still little studied. Furthermore, the results can provide helpful food for thought for business managers, helping guide their management choices. REFERENCES Afeef, M. (2011). Analyzing the Impact of Working Capital Management on the Profitability of SME’s in Pakistan, International Journal of Business and Social Science 2 (22): 175-183. Santiago Chalmers (2022) 6 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Afrifa, G.A. (2013). Working Capital Management Practices of SMEs: The Role of Education and Experience, International Journal of Academic Research in Accounting, Finance and Management Sciences 3 (4): 185-196. Alipour, M. (2011). Working capital management and corporate profitability: Evidence from Iran. World Applied Sciences Journal, 12(7), 1093–1099. Alvarez, T., Sensini, L., & Vazquez, M. (2021). Working Capital Management and Profitability: Evidence from an Emergent Economy. International Journal of Advances in Management and Economics, 11(1), 32-39. Aktas, N., Croci, E., Petmezas, D. (2015). Is working capital management value-enhancing? Evidence from firm performance and investments, Journal of Corporate Finance, 30, 98-113. Amendola A., Boccia M., Mele G., Sensini L. (2017). An Assessment of the Access to Credit-Welfare Nexus: Evidence from Mauritania, International Journal of Business and Management, 12 (9), 77- 93. Amendola A., Candila V., Sensini L., Storti G. (2020). Corporate Governance, Investment, Profitability and Insolvency Risk: Evidence from Italy, Advances in Management and Applied Economics, Vol. 10 (4), 185-202. Amendola A., Boccia M., Mele G., Sensini L. (2021). Tax policy and firms' financing decisions: empirical evidence from the Dominican Republic, WSEAS Transactions on Business and Economics, Vol. 18, 732-749. Bagchi, B., Khamrui, B. (2012). Relationship between working capital management and profitability: A study of selected FMCG companies in India, Business and Economics Journal, Vol. 2012: BEJ-60. Boisjolya, R.P., Conine Jr, T.E., McDonald IV, M.B. (2020). Working capital management: Financial and valuation impacts, Journal of Business Research, (108), 1- 8. Bunte, J. (2011). Why Does the Severity of the Dutch Disease Vary across Countries ? in International Political Economy Society Conference, 1-29. Campos A., Chen J., Ferri G., Parisi M., Sanchez J.A., Sensini, L. (2014). Business risk prediction models: an empirical analysis, International Conference on Accounting and Management Research, 426- 445. Chalmers D.K., Mannetta E.W., Zhang W. (2014). Impact of Working Capital Management Policies on Corporate Performance, ICEFR. Chalmers D.K., Sensini L., Shan A. (2020b). Working Capital Management (WCM) and Performance of SMEs: Evidence from India, International Journal of Business and Social Science, 11 (7), 57-63. Chalmers D.K., Diaz E. (2022), Relationship Between Working Capital Policies and Firm Performance: an empirical analysis, Management Business & Economics. Santiago Chalmers (2022) 7 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Chen, J., Hughes, C., Sensini, L. (2014). Credit risk measurement of SMEs, International Conference on Economics, Finance and Risk, 139-163. Chen Y., Diaz E., Sensini L., Vazquez M. (2020). Working Capital Management and Quality Management Systems: evidence from an emerging economy, International Journal of Business Management and Economic Research, Vol. 11, 4, pp. 1861-1868. Ching H. Y., Novazzi A., Gerab F. (2011). Relationship between working capital management and profitability in Brazilian listed companies. Journal of Global Business and Economics, 3(1), 74-86. Dang H. N., & Tran D. M. (2019). Relationship between Accrual Anomaly and Stock Return: The Case of Vietnam. The Journal of Asian Finance, Economics and Business (JAFEB), 6(4), 19-26. Deloof, M. (2003), Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30 (4), pp. 573-587. Dhole, S., Sagarika, M., Pal, A.M. (2019), Efficient working capital management, financial constraints and firm value: A text-based analysis, Pacific Basin Finance Journal, (58), 101212. Diaz E., Vazquez M. (2019). Relationship between WCM and Profitability: first empirical evidence from an emergent economy, DIAF. Diaz E., Sensini L. (2020). Quality Management Practices, Innovation and Profitability of SMEs: Evidence from Argentina, International Business Management, 14 (9), 328-336. Fazzari, S., Petersen, B. (1993). Working Capital and Fixed Investment: New Evidence on Financing Constraints, RAND Journal of Economics 24, 328-342. Filbeck, G., Krueger, T. (2005). Industry Related Differences in Working Capital Management, Journal of Business, Vol. 20 (2), 11-18. Gill, A., Biger, N., Mathur, N. (2010). The Relationship Between Working Capital Management and Performance: Evidence from the United States.” Business and Economics Journal (10), 1-9. Haq, I., Sohail, M., Zaman, K., Alam, Z. (2011). The relationship between working capital management and profitability: a case study of cement industry in Pakistan, Mediterranean Journal of Social Sciences, 2, 365-372. Hernandez, S., Migliaro, D., Suarez, P., & Arnaldi, A. (2021). Working Capital Determinants and Profitability: Empirical Evidence from an Emergent Economy. IAR Journal of Business Management, 2(2). Karaduman, H. A., Akbas, H. E., Caliskan, A. O., & Durer, S. (2011). The relationship between working capital management and profitability: Evidence from an emerging market. International Research Journal of Finance and Economics, 62(6), 61–67. Kim Y.H. Chung K.H. (1990). An integrated evaluation of investment in inventory and credit: a cash flow approach, Journal of Business Finance and Accounting, Vol. 17 No. 3, 381-389. Santiago Chalmers (2022) 8 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Kumar A., Sun Y. (2022), The impact of age and age on working capital management: empirical evidence, Management Business & Economics. Mannetta E.W., Peel M.J., Williams A.N. (2013). Credit Management in the Small Firm Sector: Empirical Evidence, International Conference on Accounting, Finance and Risk Management Perspective. Mannetta E.W., Zhang W. (2014). Working capital management and performance in emerging economies, International Conference on Accounting and Management Research, ICAMR. Mannetta E.W., Jordan J.K., Zhang W. (2020). Working capital management and performance: an empirical study, ACMRC, 137-155. Musso, P., Schiavo, S. (2008). The impact of financial constraints on firm survival and growth, Journal of Evolutionary Economics, 18 (2), 135-149. Nazir, M. S., Afza, T. (2009). Impact of Aggressive Working Capital Management Policy on Firms’ Profitability, Journal of Applied Finance, 15, 19–31. Nobanee H., Abdullatif M., AlHajjar M. (2011). Cash conversion cycle and firm's performance of Japanese firms. Asian Review of Accounting, 19 (2), 147-156. Parisi M., Sanchez J.A., Sensini L., Vicente L. (2014). Valuing Private Companies: A Data Envelopment Analysis Approach. Academic Conference on Risk Management and Complexity, ACRMC, 426- 439. Petersen M. A., Rajan R. G. (1997). Trade credit: theories and evidence. The review of financial studies, 10 (3), 661-691. Sanchez J.A., Sensini L. (2013), Predicting corporate bankruptcy and financial distress: a critical overview, International Conference on Accounting, Finance and Risk Management Perspectives, pp. 508-526. Sanchez J.A., Sensini L. (2017). Small Firms and Demand for Credit. Evidence from Europe, ICAFR, pp. 124-144. Scognamillo A., Mele G., Sensini L. (2016). Non-Renewable Resources, Income Inequality and per capita GDP: An Empirical Analysis. World Bank Policy Research Working Paper No. 7831. Sen, M., Oruc, E. (2009). Relationship Between Efficiency Level of Working Capital Management and Return on Total Assets is ISE, International journal of Business and Management 4 (10), 109-114. Sensini L. (2015). Selection of Determinants in Corporate Financial Distress, European Journal of Business and Management, Vol. 7 (2), 73-82. Sensini L. (2016), An empirical analysis of Financially Distressed Italian Companies, International Business Research, 9 (10), 75-85. Santiago Chalmers (2022) 9 Interdisciplinary Journal of Educational Practice | https://sadipub.com/Journals/index.php/ijep Sensini, L. (2020). Working capital management and performance: evidence from Italian SME’s. International Journal of Business Management and Economic Research (IJBMER), 11(2), 1749- 1755. Sensini, L., & Vazquez, M. (2021). Effects of Working Capital Management on SME Profitability: Evidence from an emergent economy. International Journal of Business and Management, 16(4), 85-95. Shan, A., Mueller, A., & Zhang, W. (2019). Effects of Working Capital Management on Firm Performance, DIAF, 87-99. Sharma A., Kumar S. (2011). Effect of working capital management on firm profitability: Empirical evidence from India. Global Business Review, 12(1), 159-173. Tauringana, V., Afrifa, G. (2013). Relative Importance of Working Capital Management and its Components to SMEs Profitability, Journal of Small Business and Enterprise Development 20 (3), 453-469. Ukaegbu B. (2014). The significance of working capital management in determining firm profitability: Evidence from developing economies in Africa. Research in International Business and Finance, 31, 1–16. Wang, Y.J. (2002). Liquidity management, operating performance, and corporate value: evidence from Japan and Taiwan, Journal of Multinational Financial Management, Vol. 12 No. 2, 159-169. Wilner, B.S. (2000). The exploitation of relationship in financial distress: the case of trade credit, The Journal of Finance, Vol. 55 No. 1, 153-178. Zariyawati, M.A., Annuar, M.N., Taufiq, H. and Rahim, A.S.A. (2009). Working capital management and corporate performance: case of Malaysia, Journal of Modern Accounting and Auditing, Vol. 5 No. 11, 47-54.