Working Capital Management and Corporate Profitability: Evidence from Russia, India and China

Abstract

This paper provides empirical evidence on the effects of working capital management on corporate profitability of companies from emerging markets – Russia, India and China. Unlike previous studies that focused on investigating linear relationships between working capital (WC) and firm profitability, the present research takes into consideration possible non-linearities of the relation between a comprehensive metric of working capital – the cash conversion cycle (CCC) – and the return on assets (ROA) profitability ratio. The research aims at determining the significance of this relation for 14 industries in each underlying country as working capital management requirements vary widely across different economic sectors. This study also examines the relationship between WC components and firm profitability. The empirical analysis was conducted using panel data methodology on three separate samples of 704 Russian, 1651 Indian and 2582 Chinese public firms for the period from 2010 to 2014. The estimation results indicate that a concave relationship between the cash conversion cycle and corporate profitability exists at least for one industry in each country, which means that companies operating in these industries have an optimal level of investments in WC that maximizes profitability. The majority of industries reveal a convex relationship that suggests an overall decreasing trend of ROA until it reaches its minimum value for large levels of CCC. A significant positive relation for Russian and Indian companies is found between ROA and working capital components – inventory conversion period, receivables conversion period and payables deferral period. An inverse relation is obtained for Chinese companies indicating that a decrease in each WC component enhances corporate profitability. The results are of great interest to managers within different industries for which optimum levels of CCC are calculated and leverage factors that optimize CCC to approach maximum ROA or avoid minimum ROA are proposed.