Nonlinear relationship between investment in

working capital and performance: innovative

evidence from food and beverages industry
Nurein S. A.1, Hj Din M. S.2, Md Rus R3.
1,2
School of Business Innovation and Technopreneurship,
Universiti Malaysia Perlis, Kangar, Perlis, Malaysia.
1
saheed_nurein@yahoo.com, 2sallehdin@unimap.edu.my
3
School of Economics, Finance and Banking,
Universiti Utara Malaysia, Sintok, Kedah, Malaysia.
rohani@uum.edu.my
 Abstract— One of the vital issues that must be vividly considered
before making financial decision is the working capital; because it is
an integral part of the investment and has a direct effect on the
liquidity cum the performance of the firm. The purpose of this
paper is to give an innovative empirical evidence of a nonlinear
relationship between investment between working capital and
performance which resulted in an inverted U-shaped relationship in
the food and beverages industry. The study was carried out on the
basis of the listed food and beverages firms in Bursa Malaysia. The
data for this study was retrieved from the DataStream, consisting of
73 firms for the period 2009-2013. Tobin’s Q is used as a proxy for
corporate performance, while cash conversion cycle (CCC), CCC 2,
inventory, accounts receivables, account payable cycle are used as
proxies for working capital management. Other variables applied
are firm size, leverage, growth opportunity and return on assets
(ROA). The study provide innovative evidence that an inverted U-
shaped relationship exist between investment in working capital and
performance that indicates the presence of an optimal investment
level in working capital which stabilizes costs and benefits and
ensure maximization of firms’ value. This study also proved that
higher performances were achieved with the shortest working
capital cycles and an encouraging impact of working capital cycles
on performance was verified through the use of a panel data
methodology with GLS estimation. This study suggests that
maintaining an efficient and effective working capital should be a
priority for managers because of its effect on overall firm
performance and due to the costs that could be incurred if optimal
working capital level is not achieved by the firm.
Keywords— Corporate performance, working capital
management, cash conversion cycle, shareholder’s value
I. INTRODUCTION
One of the vital issues that must be vividly considered before
making financial decision is the working capital; because it is an
integral part of the investment and has a direct effect on the
liquidity cum the performance of the organization (Ray, 2012).
Though, working capital encompasses short term financing and
investments, it is always overlooked when making financial
decisions (Ray, 2012). Furthermore, its lack of contribution to
return on equity makes it work as a hold back for financial
performance (Sanger, 2001). Managing an efficient and effective
working capital needs proper plan and control of firm’s current
assets and its liabilities in such a way that it will reduce the
incapability risk of meeting short term commitments in one hand,
and the avoidance of investing excess in the assets in the other
hand (Ray, 2012; Eljelly, 2004). Managing an efficient and
effective working capital contributes a vital role in the general
corporate strategy of a company towards creating shareholder
wealth. Working capital can be referred to as outcome of time
interval that exists between expenditure for purchasing raw
material and collection of sales of finished goods (Ray, 2012).
The approach towards managing working capital of a firm can
result in a significant influence on both its profitability and
liquidity (Shin and Soenen, 1998).
According to Ganesan (2007), optimizing the balance of
working capital means minimizing the requirements of working
capital and realizing maximum probable revenues. Furthermore,
companies’ free cash flow is increased by managing an efficient
and effective working capital, which has positive influence on the
shareholders wealth and the companies’ growth opportunity.
Thus, companies always try to maintain the working capital at an
optimal level in order to maximize their targeted value (Afza and
Nazir, 2007), and while managing working capital efficiently is
likely to provide a positive significant results, neglecting it can
lead to highly dangerous situation to any company (Christopher
and Kamalavalli, 2009).
There are two competing views on investment in working
capital management. The first view argues that increase in sales
and higher discounts for early payment will be achieved by
companies with high level of working capital and this will
increase the value of the firm (Deloof, 2003). The other view
argues that financing is required to achieve a high level of
working capital; hence firms will incur extra financing expenses
to achieve this and subsequently, will increase the probability of
bankruptcy (Kieschnick et al., 2011). Therefore, a nonlinear
relation will be achieved between investment in working capital
and firm value through the combination of both the positive
effects of working capital, which is higher working capital levels
increases sales and higher early payments discounts (Deloof,
2003), and the negative effects of working capital, which is
financing is required to achieve higher levels of working capital
(Kieschnick et al., (2011), and this may resulted into an inverted
U-shaped relationship if they both have sufficiently strong impact
(Baños-Caballero S., et al., 2013). This indicates that inefficient
and ineffective working capital management processes may also
result into bankruptcy, even if the company continues to have
positive profitability (Samiloglu and Demirgunes, 2008).
Precisely, an investment in working capital encompasses a
trade-off between risk and profitability because it has effects on
the firm performance and firm value (Sharma and Kumar, 2010).
Increased risk is caused by corporate decisions that wish to
increase profitability, while reduced of potential profitability is
caused by corporate decisions that has its focus on reduction of
risk (Sharma and Kumar 2010). However, most study have
focused on the influence of additional working capital investment
on firm value, the form of the relationship that exist between
performance and working capital , and evidence of an innovative
inverted U-shaped relation between investment in working capital
and firm performance of food and beverages industry is examined
by this study.
II. LITERATURE
Previous studies that found negative significant relationship
between working capital management and firm performance
indicate that the reduction in working capital will increase firm
performance through improving their stock returns, and also
indicate that managing working capital efficiently will increase
firms’ market value (Shin & Soenen, 1998; Deloof, 2003; Eljelly,
2004; Padachi, 2006; Lazaridis and Tryfonidis, 2006; Garcia-
Teruel & Martinez-Solano, 2007; Raheman & Nasr, 2007; Anand
& Malhotra, 2007; Samiloglu & Demirgunes, 2008; Zariyawati
et al., 2009; Mohamad & Saad, 2010; Ching et., 2011; Bagchi et
al., 2012; Baños-Caballero, S., et al., 2013). This implicates that
there can be improvement in the performance of firms if the time
span of tying up working capital in the company is reduced
(Garcia, 2011). These negative relationship is found in all
markets, such as developed markets (Shin & Soenen, 1998;
Deloof, 2003; Lazaridis and Tryfonidis, 2006; Garcia-Teruel &
Martinez-Solano, 2007; Nobanee and Al-Hajjar, 2009; Gill et al.,
2010; Garcia, 2011; Baños-Caballero, S., et al., 2013), emerging
markets ( Shah & Sana, 2006; Anand & Malhotra, 2007;
Raheman & Nasr, 2007; Samiloglu & Demirgunes, 2008;
Zariyawati et al., 2009; Mohamad & Saad, 2010; Ching et al.,
2011; Bagchi et al., 2012; Ray, 2012; Tufail et al., 2013; Golas et
al., 2013), and developing markets (Eljelly, 2004; Padachi, 2006;
Dong, 2010; Saghir et al., 2011; Napompech, 2012). However,
the reliability on the negative relationships found in these
markets is only based on the presence and the level of capital
market imperfection (i.e., agency costs and informational
asymmetries), internal finance availability, financing costs, or
accessibility to capital markets (Baños-Caballero, S., et al., 2013;
Fazzari et al., 1988; Myers & Majluf, 1984; Greenwald et al.,
1984; Stiglitz & Weiss, 1981; Jensen & Meckling, 1976).
Meanwhile, studies that found positive relationship between
working capital management and firm performance indicate that
firm with higher working capital will achieve higher firm value
(Lyroudi & Lazaridis, 2000; Mathuva, 2009; Rimo &
Panbunyuen, 2010; Abuzayed, 2011; Vural et al., 2012; Ali &
Ali, 2012). The implication of this positive relationship on the
stock market is that investors do not base their firm selection on
firms with efficient and effective working capital, and also
ignores liquidity as a crucial factor in evaluating companies’
performance (Abuzayed, 2011). A positive relationship also
shows that firms that are more profitable are less driven to
manage working capital efficiently; the letdown of the financial
market to penalize these companies with managing working
capital inefficiently leads to such positive relationship. Though,
investors realized that companies practicing and formulating
efficient and effective working capital management merit more
value, the financial market show less reaction in providing
evidence of negative significant relation between cash
conversion cycle and market valuation of firm (Abuzayed,
2011).
However, the study of Baños-Caballero, S., et al., (2013) on UK
non-financial firms found that while Net Trade Cycle is
positively related with corporate performance, its square is
negatively related with corporate performance. This is
confirming a huge and statistically significant inverted U-shaped
relationship between corporate performance and working capital.
The implication of their finding is that the results of higher sales
couple with early payments discounts arises when working
capital level is below the optimal level, therefore, firm
performance is positively influenced by working capital. On the
contrary, the financing cost as well as the opportunity cost effects
arises when the level of working capital of the firm is above this
optimum and, as a result, corporate performance and working
capital management will be negatively related. Therefore, since
there are mixed results regarding the relation between corporate
performance and managing of working capital, there is need to
examine the influence of requirements of working capital
management on firm performance to ascertain an improvement
in the market value of the firm, which the firm’s operational and
strategic thinking relies on for efficient and effective operation
(Mohamad and Saad, 2010).
The majority of the findings on the study of the relation between
corporate performance or profitability and working capital
management have been able to give an evidence of their
relativity through findings of their respective measurements.
The combination of Tobin’s q as a proxy of firm performance or
profitability and cash conversion cycle (CCC) as a proxy of
working capital management to find the relationship between
firm performance and working capital management is expected
to show either a negative or positive significant relationship.
Tobin’s q developed by Tobin (1969) is expected to have a
negative sign because it gives a comparison to the value of the
firm provided by financial markets and the value of its assets
(Nasir and Afza, 2009). CCC is used as a comprehensive of
working capital because it gives details of the time frame amidst
the disbursement that is made for the procuring of raw materials
and the assorting of sales of finished products. Thus, the longer
this time frame, the larger is the investment in working capital
blocked (Bagchi et al., 2012).
Inventory turnover cycle describes the number of days cash is
tied up in the inventory or the numbers of days it takes the firm
to refresh the inventory. Receivable cycle describes the number
of days it takes a company to receive payment from its
customers. Account payable cycle is the number of days a
company is granted to pay for the trade goods bought on credit
(Bieniasz & Golas, 2011). Both receivables cycle and inventory
turnover cycle are the determinant of the span of operating cycle
which describes the time frame from the purchase of trade
materials to the day of collecting account receivables through the
sale of finished goods or products. There is need to shorten these
periods so as to reduce cost of capital as well as increasing its
rotation (Bieniasz & Golas, 2011). Deloof (2003) also suggests
that managers can achieve shareholder values through
plummeting receivable cycle and inventory turnover cycle.
Meanwhile, extending account payable cycle will benefit the
firm in regards to liquidity risk because it reduces the demand of
working capital. However, well-organized firms should not
unnecessarily extend but synchronized together with operating
cycle (Bieniasz & Golas, 2011). A positive relationship between
account payable cycle and firm’s profitability indicates that
companies that achieve higher profits will use shorter period to
settle their creditors (Baños-Caballero, S., et al., 2013).
A positive significant firm size influences firm’s profitability
since firms that possess higher credit worthy can assess capital
through the stock market more easily, which will make them
always keep cash at low level (Abuzayed, 2011; Su, 2001; Peel
& Wilson; 1996; Chan, 1993). On the side of the growth
opportunity, it has been also demonstrated by previous studies
that short-term investment and cash holding of a firm will
increase when there is more future cash flow fluctuations and
more opportunities for growth (Abuzayed, 2011; Opler et al.,
1999; Kim et al., 1998); this growth would increase performance
of firms. On leverage, the perking order theory stated that a firm
that lack funds will like to raise funds internally before
attempting to borrow externally or issue new stocks (Myers,
1984). Hence, firms keep their own available capital for internal H1: There is an inverted U-shape relationship between
utilization and /or for debt payments. Firms with more debt will investment in working capital and performance.
have low internal capital for their business operations, which will Therefore, the following model was estimated:
increase firm risk, while the projected debt ratio and market Qit = βo + β1CCCi,t + β2CCC2i,t + β3INVi,t + β4RECi,t + β5PAYi,t +
value are negatively related. However, this may persuade the β6SIZEi,t + β7LEVi,t + β8GROWTHi,t + β9ROAi,t + εi
capability to raise fund and improve profitability (Abuzayed,
2011). Return on assets (ROA) has been widely used as a
measure in determining the intensity and level of returns IV. ANALYSIS AND FINDINGS
generated by a firm through engaging its total assets (Rehn, The analysis of this study started with the summary of the
2012). Firms are comfortable when they are able to attract more descriptive statistics.
lenders and investors, but in distress if there is necessity for them TABLE 2: Summary statistics
to raise the funds needed for capital projects and growth, or if Mean Std. Dev Median Variance Std.
their level of ROA could not convince or attract financiers. The Error
earnings acquired through capital invested reflected on ROA. TOBIN's Q 1.4455 2.0341 0.9292 4.1377 0.1065
CCC 50.7421 25.4888 34.4642 2546.82 2.4514
Thus, the asset turnover ratio of a firm increases when there is INV 43.5440 31.5210 39.4312 993.57 1.6499
reduction in investment in working capital, which will in turn REC 56.1318 42.0961 45.0135 1772.08 2.2034
increases ROA. PAY 27.6599 24.0810 21.2978 579.8966 1.2605
SIZE 12.4850 1.7930 12.5154 3.2149 0.0939
III. METHODOLOGY LEV 0.1812 0.1741 0.1499 0.0303 0.0091
GROWTH 0.0349 0.0722 0.0055 0.0052 0.0038
The data for this study is collected from the DataStream. The ROA 0.1010 0.3009 0.0821 0.0905 0.0157
sample comprises of firms in Food and Beverages industry listed
at the Bursa Malaysia stock exchange for the period of 2009 -
2013. This consists of 73 firms, making up a total of 365 firm- The descriptive statistics for firm performance, working
year observations. This study used Tobin’s Q as a measure for capital variables and the control variables are reported in table 2
firm performance, while cash conversion cycle (CCC), square of above. Market to book ratio is on average of 145%, while the
cash conversion cycle, inventory cycle, accounts receivables median is 92%. This indicates that the firms in food and
cycle, and account payable cycle are used as proxies for working beverages have strong market value during this periods
capital management. Control variables applied are firm size examined. The average days for CCC are 50.74 days, while the
(SIZE), leverage (LEVERAGE), growth opportunity median is 34.46 days. The average days to turnover inventory are
(GROWTH) and return on assets (ROA). The measurements for 43.54 days, while the median is 39.43 days. These companies
the variables are depicted in table 1 below. use averagely of 56.13 days to receive payment from their trade
debtors while the median is 45.01 days. In addition, averagely
Table 1: Variables Measurement 27.66 days is used to pay their trade creditors, while the median
No Variables Connotation Method of Measurement is 21.30 days. The size of the firms averagely increases to
1. Tobin’s Q Q (market value of equity + book 12.49% with a median of 12.52%. The leverage shows that
value of liability)/ total assets 18.12% of the total assets are averagely financed with financial
2. Cash CCC (Acct rec/sales) x 365 + debt. The GROWTH opportunity for the firms is averagely
Conversion (inv/COGS) x 365 – (Acct 3.49%, while the median is 0.55%. However, the ROA that
Cycle pay/COGS) x 365 shows an average of 10.10% (and median of 8.21%) indicates
3. Square of Cash CCC2 {(Acct rec/sales) x 365 + that 10.10% of total assets of these companies are generated
Conversion (inv/COGS) x 365 − (Acct
pay/COGS) x 365}2
from earnings.
4. Inventory INV (Average inventories/sales) x
TABLE 3: Correlation Matrix
turnover cycle 365 Q CCC INV REC PAY SIZE LEV GRO ROA
5. Receivables REC (Average receivable/sales) x
Q 1.000
cycle 365 CCC 0.046b 1.000
6. Account payable PAY (Average payable/sales) x 365 INV -0.057c 0.143 1.000
cycle REC -0.129 -0.004a 0.313 1.000
7. SIZE SIZE Natural logarithm of sales PAY 0.044b 0.114 0.071c 0.285 1.000
8. LEVERAGE LEV Total debt / total assets SIZE 0.371 0.179 0.205 -0.119 -0.033 1.000
LEV -0.081c 0.104 0.262 0.191 0.255 0.178 1.000
9. GROWTH GROWTH Book value of intangibles GRO -0.003a -0.019b -0.068c 0.034b 0.074c 0.052 -0.059c 1.000
assets/ total assets ROA 0.178 0.020b 0.065c -0.011b -0.052c 0.082 -0.137 -0.017b 1.000
10. ROA ROA Earnings before interest and Note: a, b, c indicate significant at 1%, 5% and 10% respectively.
taxes / total assets.
Table 3 shows the correlations that exist among the variables.
Correlation coefficient is applied to measure the degree of linear
The relationship between the dependent and the independent
relationship that exists between two or more variables. A formal
variables is examined through applying correlation and the use of
test was used to ascertain that multicollinearity is not present in
a regression analysis with GLS estimation. The hypothesis
this analysis by using variance inflation factor (VIF) for each
developed for this study goes thus:
independent variable in the models. The largest VIF is 1.224
(LEV), confirming that multicollinearity is not present in the
sample, because it is not up to 5 (Studenmund, 1997), and less
than 10 (Hair et al., 2006). The result indicates that Tobin’s Q has
a positive correlation with CCC (0.0456) and PAY (0.0437) at
5% significant level and a negative correlation with INV (-
0.0570), LEV (-0.0812) and GROWTH (-0.0026) at 10%, 10%
and 1% significant level respectively.
TABLE 4: Regression analysis using GLS estimation
Variable Coefficient Std. Error
C -3.1182 0.3318
CCC -0.1399 0.4356
CCC2 6.5511 3.3411
INV 0.2874 0.0749
REC 0.0081 0.0030
PAY 0.0127 0.0061
SIZE 0.6922 0.0524
LEV -1.5761 0.2846
GROWTH -1.3317 1.0399
ROA 0.9181 0.1630
Wald chi2(9) 1716.27
Prob > chi2 0.0000
Observations 365
Note a,b,c indicate significant at 1%,5% and 10% respectively.
The results of the regression analysis applying GLS estimation is
depicted in table 4. The CCC is negatively significant with
Tobin’s Q at 1% significant level while CCC2 is positively
significant with Tobin’s Q at 5% significant level. This indicates
a statistically significant inverted U-shaped relationship between
working capital and firm performance, since the CCC coefficient
is negative (β1<0) and for CCC2 is positive (β2>0). This implies
that the impact of higher sales and discounts for early payments
in this industry can only dominate when working capital level is
above the nominal level and consequently, working capital has a
negative influence on firm performance. On the other hand, the
impact of financing cost and opportunity cost can only dominate
when the firms in this industry have a working capital below the
nominal level and, hence, the relationship between performance
and working capital is positive. This findings is related with the
study of Baños-Caballero, S., et al. (2013) by proofing evidence
of a huge and statistically significant inverted U-shaped
relationship between working capital and corporate performance,
but different from their study in terms of the working capital
variables applied and the sign of the coefficient. Inventory cycle
has a positive relationship with Tobin’s Q at 1% significant level,
indicating that increase in inventory cycle which is related with
increase in sales resulted to increase in firms performance.
Receivable cycle has positive significant relationship with firm
performance at 1% significant level, indicating that the higher
profits generated by the firms in this industry led to higher
account receivables since firms that generate higher profits have
more cash to lend to their customers (Deloof & Jegers, 1996).
Accounts payable is positively related with firm performance at
5% significant level; the plausible reason for this is that more
profitable firms pay their bills in short period. Size is positively
related with firm performance at 1% significant level. The
plausible reason for this is that larger firms that possess higher
credit worthy were able to assess capital through the stock
market more easily, which make them keep cash at low level to
increase their operating income. Meanwhile, Growth opportunity
is negatively related with Tobin’s Q at 5% significant level
because the firms were not able to capitalize on the future cash
flow fluctuations and more opportunities for growth to increase
their short-term investment and cash holding. ROA is positively
related with firm performance at 1% significant level, indicating
that the reduction in investing in working capital of these firms
increases their asset turnover ratio which then increases their
ROA. Thus, the hypothesis of this study that stated that there is
z Prob. an inverted U-shape relationship between investment in working
-9.40 0.000 capital and performance is accepted.
-3.21 0.001a
1.96 0.049b
-3.84 0.000a
0.27 0.006a V. CONCLUSION
2.09 0.036b Theoretical and empirical evidence have been provided by this
13.20 0.000a
-5.54 0.000a
study to justify the relationship that exists between corporate
-1.28 0.024b performance and managing of working capital. The objective of
-1.28 0.000a this study is to examine a nonlinear relationship between
investment between working capital and performance which
resulted in an innovative inverted U-shaped relationship in the
food and beverages industry. The data for this study is collected
from the DataStream. The sample comprises of firms in food and
beverages industry listed at the Bursa Malaysia stock exchange.
The data for 73 firms was analyzed from the period of 2009 -
2013. A regression analysis was applied through GLS estimation.
The study provide evidence that an innovative inverted U-shaped
relationship exist between investment in working capital and
performance that indicates the presence of an optimal investment
level in working capital which stabilizes costs and benefits and
ensure maximization of firms’ value. Therefore, for a firm to
maintain and improve shareholder value it must achieve a better
working capital with a shorter CCC as well as meeting its short-
term obligations. This study implies that maintaining an efficient
and effective working capital should be a priority for managers
because of its effect on overall firm performance. In addition,
working capital should be of concern to managers due to the
costs that could be incurred if optimal working capital level is
not achieved by the firm. Moreover, negative impact on
corporate performance can arise through early payments lost
discounts, lost sales, or through incurring additional financing
expenses. However, there is need focus on optimal level of
working capital and control of financial constraints, and also the
effect of financial constraints on the optimal level of working
capital because they hinder firm performance at the long-run.
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