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The Impact of Working Capital Management Policies on Firm's

Profitability and Value: The Case of Jordan

Mona Al$-$Mwalla

Associate Professor, Department of Banking & Finance

Faculty of Economics & Administrative Sciences, Yarmouk University, Irbid$-$Jordan

E$-$mail: malmwalla@yu$.$edu.jo

Abstract

The main objective of this study is to investigate the impact of working capital

management policies $($aggressive and conservative policies$)$ on the firms$$ profitability and

value. Using annual data for $57$ industrial firms listed in Amman Stocks Market for the

period of $2001$ to $2009,$ the results show that following a conservative investment policy

has a positive impact on a firm$$s profitability and value. However following the aggressive

financing policy has a negative impact on the firm$$s profitability and value. Finally, this

study finds that firm Size, firm Growth and GDP Growth has a positive impact on the

firm$$s profitability and value with no effect of financial leverage.

Keywords: Working capital management policies, firm profitability, firm value, Amman

stock Exchange, aggressive investment policy, aggressive financing policy.

The Impact of working capital management policies on firms$$ profitability and value: the case of

Jordan.

$1.$ Introduction

The effect of working capital on the firm profitability has been introduced by many researchers. The

importance of the working capital stems from the fact that working capital level has an impact on the

firm profitability and risk level that the firm can carry, which in turn has an effect on the value of the

firm, $($Smith$,1980).$ The management of working capital is considered as one of the most important

strategy that the firm should take into consideration, and that firms should maintain adequate level of

the working capital to meet its current obligations. This implies that firms should not hold an excess

amount of current assets because that will have an effect on its investment opportunity. Generally,

firms can follow one of the tow $($policies$)$ in managing working capital; a conservative policy where

the ratio of current assets to total assets is minimized or the aggressive policy by holding high level of

current liabilities relative to total liabilities, the policies that the firm adopt can have a n impact on the

firm liquidity, hence on firms' profitability $($Van Horne and Wachowicz, $2004).$ In Jordan most of the

companies are small to medium size companies, they really heavily on short term loans, especially in

the absence of well developed bond market, therefore firms' are expected to pay attention to their

liquidity position by optimally managing their working capital through efficient investment and

financing policies. For this reason, this research is designed to help fill the gap in the literature and to

help financial manager to set their optimal financing and investment policies by introducing them to

theoretical and empirical test of this subject. The current paper, therefore, is organized as follows:

International Research Journal of Finance and Economics $-$ Issue $85(2012)148$

Section $2$ introduces the related literature. Section $3$ discusses the data and methodology. Empirical

results are presented in Section. $4.$ Section $5$ Provides the Summary and Conclusions.

$2.$ Literature Review

Many studies attempt to investigate the relationship between working capital levels and firms'

profitability, few studies however, investigate the impact of working capital policies on a firms'

performance.

Using a sample that consists of $1,009$ large non$-$financial firms listed in Belgium Market,

Deloof investigates the relationship between working capital management by calculating the cash

conversion cycle and corporate profitability. His results indicate that gross operating income and cash

conversion cycle are negatively correlated, He also observed negative relationship between firm

average collection period and firms, he pointed out that the longer the inventory conversion period the

lower will be the firm's profitability.

Rehman $(2006)$ investigates the relationship between the ability of firms to effectively manage

its working capital components and their profitability; he examines the effect of the average collection

period, inventory turnover in days, average payment period and the cash conversion cycle on the firms'

profitability. Using a sample consist of $94$ Pakistani firms, he found a negative relationship between

working capital components and firm profitability impaling that a firm' profitability is largely affected

by the length of its cash conversion cycle.

Lazaridis and Tryfonidis $(2006)$ Using panel data analysis for a sample of $131$ corporations

listed in Athens Stock