Does working capital management affect firm profitability? Evidence from European Union countries

Purpose The paper aims to investigate the dynamic relationship between working capital management and firm profitability for a sample of firms from eight European Union (EU) countries for the period 2006–2015. Design/methodology/approach The panel regression model is used in the study. Firm profitability is measured using the return on assets (ROA) ratio, whilst cash conversation cycle, financial leverage, size, tangibility and cash flow ratio are used as independent variables. The novelty of this study is the use of cash flow ratio to develop the analysis firms by dividing them as healthy and nonhealthy. Findings The paper reveals that working capital management affects firm profitability, and a positive relationship exists between them. The paper shows differences of working capital management and firm profitability across countries. The striking result of this study is that an inverted U-shape relationship exists between working capital management and firm profitability. Whereas the findings suggest that firms should be as close as possible to the optimal length of cash cycle to increase profitability, and managers should give a priority to working capital optimization. Originality/value The authors consider results of this study relevant to both researchers and business policymakers in the field of working capital management policies.