Does an Optimal Working Capital Exist? The Role of Financial Constraints

Abstract

The aim of the present study is to examine the linkage between working capital management, financial constraints, and profitability of the listed textile firms of Pakistan during 2005-2014. The outcomes of panel models reveal that more (less) financially constrained firms to have smaller (longer) net trade cycle. Moreover, the study found an inverted U-shaped relationship between investment in working capital and firm performance. Based on the empirical results of this study it is suggested that financial managers should try to maintain an optimal level of working capital to optimize the profit performance of the firm, as an investment in working capital above that optimal point will negatively affect the corporate profitability.

Keywords: Working Capital, Firm Performance, Financial Constraints, Pakistan.