WORKING CAPITAL MANAGEMENT EFFICIENCY AND FIRM PROFITABILITY ACROSS DIVERSE BUSINESS CYCLES
Keywords:
working capital management; cash conversion cycle; profitability; business cycle; financial constraints; manufacturing firmsAbstract
Working capital management (WCM) determines how quickly a firm turns its investment in receivables and inventories back into cash, but it is not clear whether efficient WCM matters equally for profitability in good and bad times. This study examines the relationship between WCM efficiency and firm profitability in expansion, moderate growth, and contraction phases of the business cycle. Using a panel calibrated to 160 manufacturing firms listed on the Indonesia Stock Exchange over 2010 to 2025 (2,428 firm years), it estimates two way fixed effects models with firm clustered standard errors, with the cash conversion cycle (CCC) and its components as efficiency measures. A longer CCC is associated with lower profitability: a 10 day increase reduces return on assets (ROA) by 0.15 percentage points, driven by longer receivable and inventory periods. The penalty is larger in contraction (0.21 points) than in expansion (0.12 points), but this amplification is not robust to alternative specifications. It is concentrated in small, financially constrained firms, for which a 10 day longer CCC reduces ROA by 0.39 points in contraction against 0.15 points for larger firms, a result that holds in most robustness tests. Net working capital has an inverted U shaped relation with ROA, with an optimum of about 20% of total assets in normal periods and about 25% in contraction, and almost two thirds of observations lie below the optimum. The findings suggest that WCM should be managed counter cyclically: shortening receivable and inventory periods while preserving a liquidity buffer before and during downturns, especially in smaller firms.
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