Working Capital Approaches and Firm's Returns in Pakistan

This study investigates the relationship between the aggressive/conservative working capital policies for seventeen industrial groups of public limited companies listed at Karachi Stock Exchange for a period of 1998-2003. The ordinary least square regression model has been used to investigate into the relationship of working capital approaches and the returns of firms. The study found significant differences among their working capital investment and financing policies across different industries. Moreover, these significant differences are remarkably stable over the period of six years. The aggressive investment working capital policies are accompanied by aggressive working capital financing policies. Finally, we found a negative relationship between the profitability measures of firms and degree of aggressiveness of working capital investment and financing policies. The study would contribute a better understanding of working capital management policies in an emerging market like Pakistan. A firm may adopt an aggressive working capital management policy with a low level of current assets as percentage of total assets. Moreover, an aggressive working capital management policy may be used for the financing decisions of the firm with high level of current liabilities as percentage of total liabilities. Excessive levels of current assets may have a negative effect on the firm's profitability whereas a low level of current assets may lead to lower level of liquidity and stockouts resulting in difficulties in maintaining smooth operations (Van Horne and Wachowicz 2004). Working capital management is very important for the success of a business. The optimal level of working capital is determined to a large extent by the methods adopted for the management of current assets and liabilities. It requires continuous management to maintain proper level in various components of working capital i.e. cash receivables, inventory and payables etc. In general, current assets represent important component of total assets of a firm. A firm may be able to reduce the investment in fixed assets by renting or leasing plant and machinery, whereas, the same policy cannot be followed for the components of working capital. The high level of current assets may reduce the risk of liquidity associated with the opportunity cost of funds that may have been invested in long-term assets. The above discussion highlights the significance of working capital management in a business. The impact of working capital policies is highly important, however, no empirical research has been carried out to examine the impact of working capital policies on profitability and risk of firm in Pakistan. This study will contribute to better understand these policies and their impact especially in the emerging markets like Pakistan. The present study investigates the relationship of the aggressive and conservative working capital investment and financing polices. Following are the main objectives of the present study: