Net Operating Working Capital Behavior

Net Operating Working Capital Behavior: A First Look
Net operating working capital captures multiple dimensions of firms’ adjustments to

operating
and financial conditions. Sales growth, uncertainty of sales, costly external financing,
and
financial distress encourage firms to pursue more aggressive working capital strategies.
Firms
with greater internal financing capacity and superior capital market access employ more
conservative working capital policies. Results are robust to unobserved heterogeneity
and
industry effects. The evidence suggests that operating and financing conditions should
be
considered when evaluating working capital behavior, not just industry averages.
Additionally,
industry concentration magnifies the effect of sales growth.
Matthew D. Hill, CTP, is an Assistant Professor of Finance at the University of
Mississippi in
Oxford, Mississippi.
G. Wayne Kelly is an Associate Professor of Finance at Mississippi State University in
Starkville, Mississippi.
Michael J. Highfield, CFA, is an Assistant Professor of Finance and Interim Robert W.
Warren
Chair of Real Estate at Mississippi State University in Starkville, Mississippi
We appreciate the helpful comments from the editors, two anonymous referees, Dan
Bradley,
Ken Cyree, Corie Hulen-Hill, Julia Ingram, Mark LaPlante, Bonnie Van Ness, Robert
Van Ness,
Jim Washam, and John Zietlow as well as session participants at the 2007 Southern
Finance
Association Annual Meeting and the 2008 Financial Management Association Annual
Meeting.
Financial support and research assistance for this project was provided by the College of
Business and Industry and the Warren Chair of Real Estate at Mississippi State
University. A
previous version of this paper was titled “Determinants of Operating Working Capital
Policy: A
First Look.” All errors remain the sole property of the authors.
A substantial body of research examines individual components of operating working
capital in isolation. Long, Malitz, and Ravid (1993), Deloof and Jegers (1996), and Ng,
Smith,
and Smith (1999) study trade credit policy and find support for the contracting cost
motive with
receivables used as a product quality indicator. Petersen and Rajan (1997) demonstrate
that
receivables are directly tied to profitability and capital market access, and Deloof and
Jegers
(1999) study the demand side of trade credit and illustrate that payables are directly
related to
financing deficits.1
An examination of the motives behind operating working capital strategy accounting for
the net influence of receivables, inventory, and payables, is absent from the finance
literature.2
While existing studies typically focus on individual components of working capital, we
integrate
the components to investigate factors influencing the net investment in operating
working capital
using the working capital requirement (WCR), defined as the sum of accounts
receivable and
inventories net of accounts payable.3 Operating assets and liabilities ultimately must be
managed
in concert rather than individually, a condition this paper attempts to reflect.
As discussed by Atanasova (2007) and shown by Molina and Preve (2008), most firms
supply and demand trade credit simultaneously; firms with better access to trade credit
find it
easier to finance receivables and inventory. We use the working capital requirement as
it is
comprehensive. By focusing on the operating component of working capital, the results
and
1 Please see the following for a full review of the trade credit literature: Melzer (1960); Smith (1987);
Mian and
Smith (1992); Lee and Stowe (1993); Biais and Gollier (1997); Emery and Nayar (1998); Frank and
Maksimovic
(1998); Burkart and Ellingsen (2003); Atanasova (2007); Love, Preve, and Sarria-Allende (2007); Cunat
(2007); and
Molina and Preve (2008).
2 Theoretical integrative working capital studies include Richards and Laughlin (1980); Sartoris and Hill
(1983); and
Gentry, Vaidyanathan, and Lee (1990).
3 Shulman and Cox (1985) define the working capital requirement as current assets net of cash minus
current
liabilities net of notes payable and current long term debt due; thus including prepaid expenses and
accruals. We use
the modified version of the working capital requirement for two reasons. First, the simplified version
parallels the
cash conversion cycle. Second, theoretical implications of holding prepaid expenses and accruals are not
well
developed in the extant literature.
Net Operating Working Capital Behavior 2
implications are clearly distinguishable from those presented in corporate cash holdings
research
which is necessarily limited to the causes and consequences of holding cash.4 A positive
working
capital requirement, or conservative working capital policy, indicates a need for
additional
capital that firms can finance internally using free cash flow, or externally via
commercial paper
or lines of credit. Thus, conservative working capital policies imply either opportunity
costs or
explicit financing costs. Alternatively, a negative working capital gap means the firm’s
net
operating working capital provides financing for long-term assets, an aggressive
strategy.
Using a sample of 20,710 firm-year observations for 3,343 companies over the 1996 to
2006 period, we find that the mean working capital requirement is $296 million, or 23
percent of
capital structure, on average. This statistic suggests that working capital behavior
deserves closer
scrutiny, particularly in light of Fazzari and Petersen’s (1993) finding that increased net
working
capital reduces fixed-investment and evidence that profitability and risk-adjusted returns
are
negatively related to the cash conversion cycle (e.g., Shin and Soenen (1998) and
Deloof and
Jegers (2003)). 5
The dependent variable across all models is the working capital requirement, which
focuses the study on the drivers of net operating working capital behavior and accounts
for the
joint effect of receivables, inventory, and payables. The results provide evidence of
strong
relationships between net operating working capital and operating conditions (e.g., sales
growth
and sales volatility). Since a positive working capital requirement must be financed,
management
must devise a strategy to acquire funds internally or externally. Accordingly, the results
indicate
that the working capital requirement depends on internal financing resources, external
financing
4 Kim, Mauer, and Sherman (1998), Opler, Pinkowitz, Stulz, and Williamson (1999), Ozkan and Ozkan
(2004), and
Dittmar and Mahrt-Smith (2007) exemplify typical methods and findings of corporate cash holdings
research.
5 Specifically, Shin and Soenen (1998) use the net trade cycle, a variation of the cash conversion cycle,
while Deloof
and Jegers (2003) use the cash conversion cycle. Also, Kieschnick, LaPlante, and Mousawwi (2008)
estimate the
value of net operating working capital.
costs, capital market access, negotiating ability, and financial distress. Additionally, by
adjusting
the dependent variable by the annual mean industry-level working capital requirement-
to-sales
ratio, we confirm that the results are robust to industry effects. Finally, we present
evidence
regarding the relation between working capital behavior and the degree of industry
competitiveness. The results are robust to econometric specification, firm-specific
heterogeneity,
and time effects.
Our results suggest that operating conditions and financing ability influence the working
capital requirement even after adjusting for industry working capital norms, and we
infer that
quantifying the efficiency of working capital management using traditional methods,
such as
industry-level ratio comparisons, may lead to questionable inferences and should be
accompanied by even greater caveats than is typical. Hence, the models presented here
provide
an improved method to benchmark operating working capital behavior.
The remainder of the paper is organized as follows. Section I discusses the hypothesized
relationship between the working capital requirement and various corporate financial
characteristics. Section II describes the sample and descriptive statistics and specifies
the model.
Section III presents the results and Section IV provides our conclusions.
I. Hypothesis Development
A. Operating Conditions
1. Sales Growth
Sales growth affects working capital behavior, but the relationship between the working
capital requirement and sales growth is complicated by potential endogeneity problems.
For
example, relaxed credit and inventory policies can stimulate sales causing reverse
causality when
using contemporaneous sales growth as an independent variable. Similar to Love et al.
(2007)
and Molina and Preve (2008), we mitigate this problem by lagging sales growth.6
Molina and Preve (2008) find trade credit granted is inversely related to lagged sales
growth, and they suggest that firms with greater prior period growth tighten credit
policy as they
achieve planned levels of sales growth. With respect to the spontaneous sources of
funds
generated by sales growth, Petersen and Rajan (1997) and Deloof and Jegers (1999)
indicate that
payables are directly related to growth, supporting the expected relation between the
variables.
Since the working capital requirement is the net result of the firm’s operating working
capital
behavior, and the effect of sales growth on inventory is not clear from the previous
literature, we
expect an inverse relationship between the working capital requirements and lagged
sales
growth. Lagged sales growth is defined as the lagged percentage change in sales over
the period
t-1 to t.
2. Contribution Margin
Over the typical operating cycle, firms acquire and finance inventory via payables and
then finance the marked up product to customers through receivables before collecting
on the
sale. Since the dollar value of a good in terms of receivables generally exceeds the
dollar value
of a good in payables, each unit sold contributes to an increased working capital
requirement.
Thus, we expect the working capital requirement and contribution margin are directly
related.
Since most sampled firms sell multiple products or are conglomerates, the lagged gross
profit
6 When applicable, in an effort to mitigate endogeneity concerns, we lag all independent variables used in
this study.
margin, defined as the ratio of sales minus cost of goods sold to sales, is used to proxy
contribution margin.7
3. Sales Volatility
Higher deviations in demand make the optimal inventory level more difficult to
determine making increased inventory a rational response to sales volatility. Emery
(1987)
confirms that not all firms will find it advantageous to increase inventory in response to
increased sales volatility. For example, firms with cost advantages in financing
receivables may
find it optimal to extend additional credit to customers. That is, to avoid the buildup of
inventory
due to decreased demand, firms can move inventory by offering more attractive credit
terms.
Widespread access to financial innovations such as asset backed commercial paper
affords cost
advantages in financing receivables, meaning receivables would be cheaper to finance
than
inventory for many firms. Empirical findings are mixed. Using a sample of industrial
firms,
Long et al. (1993) provide empirical support for Emery’s (1987) operational view of
trade credit.
In contrast, Deloof and Jegers (1996) find no relation between receivables and sales
volatility for
a sample of Belgian industrial and wholesale firms. Also, results presented by Ng et al.
(1999)
suggest that firms generally do not respond to deviations in demand by altering credit
terms.8
Spontaneous financing demanded by firms should relate directly to sales volatility;
firms
with more unpredictable revenues have greater difficulty forecasting day-to-day
liquidity needs
and subsequent funding. Thus, firms with volatile sales tend to rely on payables to
enhance cash
flow. Due to conflicting empirical evidence reported by Long et al. (1993), Deloof and
Jegers
(1996), and Ng et al. (1999), the link between the net investment in operating working
capital
7 Gross profit margin aggregates contribution margins for individual product, and Compustat offers no
way to
individualize these margins by product/division.
8 Ng et al. (1999) use survey data for firms in various industries.
and sales volatility is an empirical question; therefore, we do not predict the sign of the
sales
volatility variable.
Sales volatility is the standard deviation of a firm’s annual net sales over a rolling
fiveyear
period prior to each of the sample years. For example, the standard deviation of sales for
2006 is calculated over the five-year period of 2001-2005. Firm-year observations are
included
in the sample for a given year if the firm has at least three observations during the
previous fiveyear
period. Thus, sales volatility is designed as a backward looking measure alleviating
endogeneity concerns. The sales variability measure is scaled by net assets, defined as
total
assets minus cash and short-term investments.
B. Ability to Finance Operating Working Capital
1. Operating Cash Flow
Positive operating cash flow enables firms to finance a positive working capital
requirement allowing a more conservative operating working capital strategy, thereby
facilitating
future sales growth. However, firms with negative operating cash flows must finance a
positive
working capital requirement through other sources. Love et al. (2007) estimate a direct
correlation between net trade credit and cash flow for a sample of firms in emerging
market
countries. Consequently, we expect a positive association between working capital
requirements
and cash flow. To relieve endogeneity concerns, cash flow is measured as lagged
operating
income before depreciation minus income taxes scaled by net assets.
2. Asymmetric Information and Costs of External Financing
Myers and Majluf (1984) demonstrate that capital markets extract a premium for the
external financing of firms with greater informational asymmetries as such firms’
projects and
cash flows are more difficult to value leading firms to follow a financing pecking order
and
exhausting the lowest cost sources of capital first. A positive working capital
requirement must
be financed. We expect less transparent firms to have a reduced working capital
requirement
since firms with greater informational asymmetries typically pay greater rates to
borrow. The
lagged market-to-book ratio is used as a proxy for the degree of asymmetric
information, where
market-to-book is defined as the sum of market value of equity and total liabilities
minus
payables scaled by net assets. We expect an inverse relation between the working
capital
requirement and the market-to-book ratio.
3. Capital Market Access
Creditworthy firms with superior capital market access are more capable of financing
the
working capital gap externally. Brennan and Hughes (1991) argue that larger firms are
covered
more intensely by analysts, whose increased monitoring reduces informational
asymmetries,
implying that larger firms enjoy ready access to capital relative to smaller firms. Since
this study
examines the determinants of net operating working capital, we emphasize commercial
paper
issues and bank debt.
While larger firms find it easier to finance relaxed credit and inventory policies, smaller
firms are less able to issue commercial paper or negotiate lines of credit. With fewer
ways to
finance receivables, smaller firms rely on factoring more than large firms.9 Whited
(1992) finds
that larger firms face fewer borrowing constraints than smaller firms since the former
have better
capital market access.10 Petersen and Rajan (1997) suggest that receivables are directly
related to
size and Deloof and Jegers (1999) report that payables are insignificantly related to size.
9 Factoring
is not explicitly accounted for and so its influence is not observed here due to data availability.
10 Manystudies use size as an inverse proxy of financial constraint (Fazzari, Hubbard, and Petersen, 1988;
Almeida,
Campello, and Weisbach, 2004; Faulkender and Wang, 2006).
Accordingly, we expect a direct relationship between the net investment in operating
working
capital and size. We use the natural logarithm of the lagged annual inflation-adjusted
market
value of equity to proxy size.
4. Market Power
The length of trade credit terms are directly related to market power as more valuable
customers can negotiate more generous credit terms with suppliers. Additionally, firms
with
greater market share can stretch the credit terms offered by suppliers with little
repercussion as
contracts with industry leaders are critical to the viability of smaller suppliers.
Similarly, strong
relationships with vendors allow firms with greater market power to hold less inventory.
Suppliers with more market power relative to customers can negotiate shorter terms
with
customers for at least two reasons. First, the level of competition from rival firms is
reduced for
firms with large market share decreasing the likelihood of losing customers over a
reduction in
credit terms. Second, suppliers with greater market share are more likely to have forged
longer
relationships with clients implying higher costs of switching suppliers. These switching
costs
include learning and transactions costs as documented by Klemperer (1987) and
Chevalier and
Scharfstein (1996). Molina and Preve (2008) indicate that, when compared to firms in
competitive industries, firms in concentrated industries tighten credit policies to a
greater extent
when facing financial distress.
Overall, we expect firms with greater negotiating power to have more payables, fewer
receivables, and less inventory. That is, the net impact of increased market power is a
reduced
working capital requirement. We measure market power as the lagged ratio of a firm’s
annual
sales to the total annual sum of sales in a given industry with greater ratios implying
increased
negotiating ability. Industries are defined by the Fama-French (1997) classifications.
We expect
working capital requirements to be inversely related to market power. Market power is a
firmspecific
proxy for the firm’s ability to negotiate bilaterally as both client and supplier.
5. Financial Distress
Distressed firms have limited financial slack and cash generating ability, and the strain
of
financial distress may cause firms to reduce investment in operating working capital by
collecting on receivables, tightening credit terms, liquidating existing inventory, and
stretching
credit terms granted by suppliers. Molina and Preve (2008) demonstrate that financially
distressed firms have significantly reduced levels of trade credit relative to their non-
distressed
counterparts. We expect the working capital requirement to correlate inversely with
financial
distress.
Following Molina and Preve (2008), a firm must satisfy two criteria to be classified as
financially distressed: 1) the firm must have difficulty covering interest payments and 2)
be overleveraged.
The first component is having a coverage ratio calculated as operating income before
depreciation divided by interest expense less than one for two consecutive years or less
than 0.80
in any given year. Second, a firm is considered over-leveraged if its leverage ratio is in
the top
two deciles of its industry’s leverage ratio in a given year. If a firm meets both
conditions in a
given year, then Distresst-1, an indicator variable, equals one, and zero otherwise.11
11 Molina and Preve (2008) use three proxies for financial distress. First, FINDIST is a binary variable
equal to one
if a firm’s coverage ratio, calculated as operating income before depreciation divided by interest expense,
is less
than one for two consecutive years, or if the coverage ratio is less than 0.80 in any given year. Second,
FDLEV is a
binary variable equal to one if the firm is in the top two deciles of industry leverage in a given year and
meets the
conditions described by FINDIST above. Third, the authors define financial distress as a firm that has had
three
consecutive years of losses, LOSSFD. We consider FDLEV the most stringent of the distress measures
and we use
this definition as the variable Distress.
II. Data and Methods
A. Data Source and Description
The initial sample includes all non-financial, non-utility, non-ADR, and SIC-classifiable
firms covered by the COMPUSTAT database over the period 1991-2006.12 We
eliminate firmyears
with missing financial data, non-positive assets, non-positive sales, negative market
value
of equity, negative interest expense, and duplicate values. We include firm-years in the
sample if
the firm makes at least three appearances in the panel during the five-year period
preceding a
given year. Thus, observations from the first five years, while not directly studied in the
analysis,
are necessary to construct the first cross-sectional set in 1996.13 Finally, to mitigate the
influence
of outliers, firm level ratios are winsorized at the 1% level. The final sample consists of
20,710
firm-year observations for 3,343 companies from 1996-2006, an unbalanced panel
dataset with
maximum, minimum, and mean number of individual firm appearances equal to 11, 1,
and 6.20
panels, respectively.
The descriptive statistics for the variables used to estimate the determinants of operating
working capital behavior are displayed in Table I. The mean working capital
requirement to sales
ratio (WCR) is approximately 19.8%. Thus, approximately $0.20 of each dollar in sales
is tied up
in net operating working capital equating to just over $296 million, a non-trivial amount
given
the reduction in free cash flow and market value this represents.
Insert Table I about here.
12 The Compustat mnemonic and codes for variables used in the analysis are as follows: Sales growth
(SALECHG1,
none), Sales (SALE, A12), Operating Income Before Depreciation (OIBDP, A13), Income Taxes-Total
(TXT, A16),
Total Assets (AT, A6), Cash and Short-Term Investments (CHE, A1), Receivables (RECT, A2),
Inventory (INVT,
A3), Accounts Payable (AP, A70), Market Value of Equity (MKTVALF, none), Total Liabilities (LT,
A181),
Interest Expense (XINT, A15), Cost of Goods Sold (COGS, A41), Preferred Stock (PSTK, A130),
Deferred Taxes-
Income Account (TXDI, A50), and Debt-Convertible Total (DCVT, A79).
13 The use of lagged variables does not constrain the dataset since the first three observations for each firm
are lost
due to the methodology used to estimate sales volatility.
Though unreported, the mean working capital requirement-to-total assets ratio is 22.7%
illustrating the magnitude of a firm’s capital structure devoted to operating working
capital. This
statistic is as striking as the mean cash-to-total assets ratio of 22.0% reported by Dittmar
and
Mahrt-Smith (2007), yet the financial component of working capital receives much
more
attention than its operating component. Given the size and implications of the reported
average
working capital requirement-to-total assets ratio, it is hard to rationalize the relative lack
of
attention devoted to the operating component of working capital.
Although discussed in more detail later, we use several measures of the working capital
requirement. WCRq is the ratio of the average end of quarter working capital
requirement to end
of year sales. IndAdj WCR is the difference between the firm’s annually reported WCR,
and the
firm’s industry average annual WCR for the respective year. IndAdj WCRq is the
difference
between the firm’s WCRq and the firm’s industry average annual WCR for the
respective year.14
Summary statistics for the remaining variables are similar to prior studies. The average
lagged annual sales growth rate is 14.4% with a median of 8.7%. Mean lagged gross
profit
margin is 32.4%, and the average standard deviation of sales to net assets is 31.2%.
Sales
volatility exhibits substantial skewness. Lagged operating cash flow is negatively
skewed
indicating that many firms have weak operating cash flows or operating losses. The
mean lagged
market-to-book ratio is 2.3. While this value may seem large, it should be noted that the
base is
net assets defined as total assets minus cash. Mean and median lagged market
capitalizations in
the sample are $2.0 billion and $252 million, respectively. Also, the average of the
lagged
market share variable is 1.4%. Finally, 5.1% of the observations qualify as financially
distressed.
14 Were-estimate the models after scaling all WCR measures by net assets. The results are robust.
Table II provides the distribution of the sample across time. The maximum and
minimum
number of observations for a given year is 2,278 and 1,152 occurring in 2005 and 1996,
respectively. Column 3 illustrates a general downward trend in the working capital
requirement
as the mean WCR decreases by 18.8% from 1996-2006. This decline suggests that firms
have
become more efficient in managing working capital.
Insert Table II about here.
Table III provides the distribution of WCR by industry affiliation consistent with the
Fama and French (1997) 4 -industry classification system. Business Services has the
most firmyear
appearances with 1,976. Restaurants, hotels, and motels have the smallest mean WCR.
The
maximum industry level WCR is Agriculture with a mean of 44.0%. The substantial
variation of
operating working capital behavior across industries echoes the findings of Hawawini,
Viallet,
and Vora (1986) and suggests that working capital behavior is at least partly industry
specific.
Insert Table III about here.
Certain firms have non-positive positions in net operating working capital. The WCR is
not a use of funds for these firms, but instead finances long-term assets. Table IV
provides
univariate comparisons of firm characteristics to gain a better understanding of the
differences in
firms having positive and non-positive working capital requirements. Roughly 6.8% of
the
observations have non-positive WCR during the sample period. This subset consists of
520
unique firms, 306 of which appear at least twice in the non-positive WCR subset.
Figures in the
table are variable means for each subset. The last column provides t-statistics testing for
differences in mean firm characteristics.
Insert Table IV about here.
The mean WCR for the non-positive WCR subset is –11.3% while the average is 21.8%
for the positive WCR subset. The WCR is significantly different across subsets of firms.
Further,
the positive and non-positive WCR subsets are significantly different at the 1% level for
each of
the financial characteristics considered except lagged size. With respect to operating
conditions
variables, the positive WCR firms have lower growth rates, sales variability, and greater
contribution margins. Firms with conservative working capital policies (again, the
positive WCR
subset) have greater cash flows, size, market power, smaller market-to-book ratios, and
are less
likely to be in distress. These comparisons support several of the hypotheses as the non-
positive
WCR subset is more restricted in terms of internal financing ability and capital market
access,
have greater costs of external capital, and are more likely to be in financial distress.
Only lagged
market share is opposite our expectations. Overall, these results suggest that a non-
positive WCR
is not necessarily obtained by design. In fact, it may be forced on struggling firms.
Table V displays the matrix of Pearson correlation coefficients for the variables in this
study. The correlations are largely consistent with our expectations. The WCR is
negatively
correlated with lagged sales growth and sales variability, but directly related to lagged
gross
profit margin. The WCR is negatively associated with lagged values of market-to-book,
size,
market share, and financial distress and is directly related to lagged cash flow. Most
correlation
coefficients are significant at the 1% level. Only size deviates from our expectations.
Although
many of the independent variables are significantly correlated, none of the correlation
coefficients are of sufficient magnitude to suggest a collinearity problem.
Insert Table V about here.
B. The Determinants of WCR
Our primary variable of interest is the working capital requirement-to-sales ratio
measured as the ratio of the annual sum of accounts receivable and inventory minus
accounts
payable to sales. We estimate the following empirical model:
, 0 1 ,1 2 ,1 3 , 4 ,1
5,16,17,18,1, /,
ititititit
ititititjiti
WCR Growth GPM SaleVAR OCF

M B Size MktShare Distress Controls





     (1)
where sales growth, Growth, is the annual percentage change in sales during the
previous year.
Gross profit margin, GPM, is the ratio of sales minus cost of goods sold to sales. Sales
volatility,
SaleVart, is the ratio of the standard deviation of sales to net assets. Operating cash
flow, OCF, is
operating income before depreciation minus income taxes, scaled by net assets. The
market-tobook
ratio, M/B, is the ratio of the sum of market value of equity and total liabilities minus
payables to net assets. Firm size, Size, is the natural logarithm of market value of equity
in
inflation-adjusted 2006 dollars. The ability to negotiate credit terms, MktShare, is the
ratio of
annual firm level sales to the industry’s annual sum of sales. Finally, Distres equals one
if the
firm is in financial distress, and zero otherwise.
The variables SalesVar, OCF, and M/B, are scaled by total assets net of cash as it is
likely
that cash and the WCR are jointly determined as increased receivables and inventories
reduce
internally generated cash. By construction, this joint determination can lead to a
negative
correlation between WCR and variables divided by total assets when cash is included;
hence,
total assets net of cash is preferred. Equation (1) also includes a set of annual binary
variables to
control for time specific macroeconomic factors influencing WCR.
III. Empirical Results
A. Panel Model Results: WCR Specification
The variation in WCR across firms may be a result of firm specific unobservable
factors,
which, if correlated with the independent variables, can cause pooled OLS regression
results to
suffer from heterogeneity bias. A Breusch and Pagan (1980) Lagrange multiplier test
rejects the
use of pooled OLS with a single intercept. Next, a Hausman’s (1978) test determines
whether the
unobservable heterogeneity is correlated with the independent variables by testing for
systematic
differences in the fixed and random effects coefficient vectors. The null hypothesis of
equality in
the fixed and random effects coefficient vectors is rejected suggesting that fixed effects
is the
preferred specification for these data.
Table VI presents fixed effects regression results for the determinants of net operating
working capital behavior analysis. Column 1 exhibits the estimates from Equation (1)
using the
working capital requirements-to-sales ratio (WCR) as the dependent variable. The
models
evaluate the factors influencing the WCR for the full sample of 20,710 firm-years for
3,343
unique firms over the 1996-2006 period. Annual binary variables are included in the
fixed effects
models.
Insert Table VI about here.
1. Results: Lagged Sales Growth
The fixed effects results for Equation (1) in Table VI demonstrate an inverse relation
between the WCR and lagged sales growth. The coefficient is statistically significant at
the 1%
level. The negative correlation between the WCR and sales growth is consistent with
Molina and
Preve’s (2008) finding that firms tighten their credit policy as they achieve planned
levels of
sales growth. Further, this result suggests that prior period sales growth provides net
financing.
As shown by Petersen and Rajan (1997) and Deloof and Jegers (1999), payables are
directly
correlated with growth as suppliers are willing to offer more credit with better terms to
high
growth firms in hopes of building relationships. High growth firms need not relax trade
credit
terms as sales are already growing. Molina and Preve (2008) confirm that receivables
are
negatively related to lagged sales growth. These initial results suggest that, on average,
lagged
sales growth provides financing.15
2. Results: Lagged Gross Profit Margin
Although Petersen and Rajan (1997) find that receivables are directly related to gross
profit margin, we find that lagged gross profit margin has no statistically distinguishable
effect
on the WCR after controlling for other independent variables. Since we use gross profit
margin
to proxy contribution margin, the lack of a significant relationship is unexpected as
greater
contribution margins should mechanically increase the working capital requirement. It
is feasible
that the explanatory power of gross profit margin is captured by the fixed effect.
Alternatively,
15 We also estimate the model using conditional growth variables as in Petersen and Rajan (1997) and
Molina and
Preve (2008). The results further reiterate the aforementioned result and accompanying theory as firms
with lagged
positive sales growth reduce their investment in net operating working capital, while negative sales
growth has a
positive effect on the WCR. To check robustness, we also used the growth of market share in place of
sales growth,
but due to low cross-sectional variation, particularly for competitive industries, the results are negative,
yet
insignificant. Both sets of alternative results are available upon request.
lagged gross profit margin may be a poor proxy for the contribution margin since most
of the
sampled firms sell multiple products or are conglomerates.
3. Results: Sales Volatility
The WCR is negatively associated with sales volatility with a t-statistic of –19.40. Since
sales volatility represents expected deviations in demand, the inverse correlation
between WCR
and sales volatility suggests that managers react to greater sales volatility by managing
working
capital more aggressively. This finding is consistent with Deloof and Jegers (1996) and
Ng et
al.'s (1999) view that receivables policy is largely unaffected by deviations in demand
and the
intuition that sales variability should increase a firm’s dependence on payables. This
result does
not invalidate Emery’s (1987) hypothesis that firms with superior ability to finance
receivables
will loosen credit policy in response to variable demand; however, it implies that
increased sales
volatility causes firms to reduce their net investment in operating working capital.
Plausibly, the
incremental cash flow provided by reducing the working capital gap is needed most by
firms
with volatile sales.
4. Results: Lagged Operating Cash Flow
The estimated correlation between the WCR and lagged operating cash flow is positive
and significant at the 1% level suggesting that firms with greater operating cash flows
manage
working capital more conservatively. Similarly, Love et al. (2007) report a direct
association
between net trade credit and cash flow. A potential benefit of a conservative working
capital
approach is increased profitability. Looser inventory policies and more lenient credit
standards
can be associated with increases in sales and profits. The direct relationship between the
WCR
and operating cash flow indicates that firms with stronger operating cash flows are more
likely to
enjoy the benefits of a less restrictive working capital policy than firms with weaker
cash flows,
as a positive working capital requirement must be financed. Conversely, firms for which
internal
cash flow matters most (i.e., those with reduced internal financing ability) manage
operating
working capital more aggressively.
5. Results: Lagged Market-to-Book Ratio
The association between the WCR and the lagged market-to-book ratio is negative and
significant at the 1% level. Taking the market-to-book ratio as the degree of asymmetric
information faced by firms in capital markets, hence a proxy for the cost of external
finance, the
estimated inverse relationship between the WCR and market-to-book supports the view
that
firms with greater costs of external finance seek to reduce the working capital
requirement,
probably to avoid costly external financing. Alternatively, the market-to-book ratio
proxies for
investment opportunities; firms with superior prospects will strive to reduce their net
investment
in operating working capital to unlock cash flow needed to invest in positive NPV
projects.
Further, this result complements the estimated inverse connection between the WCR
and sales
growth, as high growth firms typically have greater market-to-book ratios.
The negative correlation between WCR and the market-to-book ratio parallels the
positive relation between cash and market-to-book ratio presented in the cash literature
in that
cash provides financing, while the WCR requires financing (Kim, Mauer, and Sherman,
1998;
Opler, Pinkowitz, Stulz, and Williamson, 1999; Ozkan and Ozkan, 2004). Thus, for high
marketto-
book ratio firms, cash reduces external financing needs. For these firms, external
financing
needs increase with an increased WCR.
6. Results: Lagged Firm Size
WCR varies directly with lagged firm size and the association is significant. We expect
this relationship as size is a proxy for capital market access. Smaller firms are limited in
their
choices for financing a positive working capital requirement as they are less able to
issue
commercial paper or obtain lines of credit. In the research examining corporate cash
holdings,
Opler et al. (1999) indicate that cash and size are inversely related since larger firms
have less
need to hold cash as they have better access to short-term debt markets. Since a positive
WCR
must be financed, smaller firms will more closely monitor operating working capital
strategies
since they have fewer alternatives available to finance the working capital gap relative
to larger
firms. Also, the direct correlation between the WCR and size supports prior working
capital
results such as Petersen and Rajan (1997) and Deloof and Jegers (1999).
7. Results: Lagged Market Share
WCR and lagged market share are not significantly related. Firms with greater
negotiating ability have superior bargaining position regarding credit terms extended to
customers and received from suppliers. Since we believe market share proxies
negotiating
ability, the lack of an affiliation between working capital requirements and market share
is
unexpected. As with lagged gross profit margin, it is possible that the firm-specific
heterogeneity
absorbed the effect of negotiating ability.16
16 Inlater regressions, the relation between operating working capital behavior and negotiating
ability/market
concentration is more fully analyzed using industry concentration.
8. Results: Lagged Financial Distress
WCR is negatively related to lagged financial distress. Molina and Preve (2008)
demonstrate that financially distressed firms have significantly reduced levels of trade
credit
relative to their non-distressed counterparts.17 We infer that distressed firms manage
operating
working capital more aggressively than non-distressed firms. A more restrictive
working capital
policy is a rational response to financial distress due to the limited financial slack and
cash
generating ability of distressed firms. As such, distressed firms are likely to reduce
investment in
operating working capital by collecting on receivables, tightening credit terms,
liquidating
inventory, and stretching supplier credit.
This result has additional economic meaning. The average WCR of distressed firms is
1.6% lower than that of non-distressed firms. This implies that non-distressed firms
have a $31
million additional investment in net operating working capital relative to their distressed
counterparts, on average.18
9. Summary of Initial Results
The results indicate that the WCR is inversely related to sales growth, uncertain
demand,
cost of external financing, and financial distress and is directly related to operating cash
flow and
capital market access. Next, we discuss two potential problems with our dependent
variable
specification. The first deals with variation in ending fiscal years, and the second
concerns
industry effects. To this point, we have allowed the fixed effect to absorb the industry
effect on
working capital behavior, a matter discussed in more detail below.
17 We also estimate the models using Molina and Preve’s (2008) other measures of financial distress. The
results are
quantitatively and qualitatively similar and are available upon request.
18 The mean sales level for sampled firms is $1.94 billion.
B. Additional Results: Averaged Quarterly WCR Specification
A potential problem with the measurement of working capital requirements is that not
all
firms use the same fiscal year end date for their annual financial statements introducing
arbitrary
differences in the WCR for firms in the same industry.19 To attenuate this concern,
sample firms’
quarterly receivables, inventory, and payables data are averaged, smoothing variations
in
operating cycles caused by varying fiscal year ends.
The results using the quarterly averaged WCR (WCRq) as the dependent variable appear
in Column 2 of Table VI. Overall, the results are consistent with the earlier results in
that WCRq
is inversely related to lagged sales growth, sales volatility, lagged market-to-book ratio,
and
lagged financial distress and directly related to lagged operating cash flow and size. As
before,
lagged market share is insignificant. One difference is that lagged gross profit margin is
positive
and significant for the quarterly averaged model. We expect this result since gross profit
margin
proxies contribution margin and increased contribution margins imply greater
receivables
relative to payables. This finding echoes Petersen and Rajan’s (1997) result of a direct
correlation between receivables and gross profit margin.
C. Additional Results: Industry Adjusted WCR Specification
Hawawini et al. (1986) indicate that working capital behavior is industry dependent. For
example, operating working capital policies of manufacturing firms are markedly
different from
service firms since the former typically carry substantial inventory levels and the latter
carry
virtually no inventory. Industry effects would ordinarily be captured by indicator
variables, but
the time invariant nature of these variables precludes them from fixed effects
estimation. In
Columns 1 and 2 of Table VI, we assume the industry effect loads on the fixed effect.
To
19 Wethank an anonymous reviewer for bringing this point to our attention.
explicitly control for industry effects, the annual industry average WCR is netted from
the
preceding versions of the WCR where industries are defined according to the Fama and
French
(1997) 48 industry classifications.20 Columns 3 and 4 report results using deviations
from
industry averages as dependent variables. Column 3 illustrates the estimates of Equation
(1)
using the annual WCR minus the industry averaged WCR as the dependent variable
(IndAdj
WCR), while Column 4 shows the estimates of Equation (1) using the quarterly
averaged WCR
minus the industry average WCR as the dependent variable (IndAdj WCRq).
The results in Column 3 echo many of the findings in Columns 1 and 2. Similar to
Column 1, lagged gross profit margin is not significant. A notable difference is lagged
market
share, which is negative and significant suggesting that firms with greater market share
have
lower net investment in operating working capital. This finding meets our expectations
because
firms with increased market share are in an improved position to negotiate more
generous credit
terms with suppliers, as well as stretch the terms offered by those suppliers. Likewise,
increased
market share implies improved relationships with vendors allowing for lower inventory
levels.
Finally, increased market share implies a reduced need to offer generous credit terms. In
all, the
benefits of increased market share yield a reduced net investment in operating working
capital.
Results in Column 4 are similar to our previous results. Two exceptions include lagged
gross profit margin, which is positive and significant as in Column 2, and lagged market
share,
which is not significant as in Column 3. Results from Columns 3 and 4 suggest that
even after
controlling for industry level working capital benchmarks, certain firm level financial
characteristics strongly influence operating working capital behavior. This is worth
emphasizing
as it reinforces a frequently voiced, but often ignored caveat against the exclusive use of
means
20 We use 43 of the 48 Fama-French (1997) industry classifications in the study as utility and financial
firms are
discarded from the sample. The Fama-French industry classifications are taken from Kenneth French’s
web page at
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/.
of industry ratios as benchmarks for financial analysis. Insightful analysis should
encompass
firm level operating conditions, financing ability, and managerial decision making at the
most
fundamental level available given the purpose of the analysis.21
To better understand the variation in factors influencing working capital behavior across
industries, we estimate Equation (1) separately for firms classified as Manufacturing,
Service,
and Retail appearing in Columns 5-7, respectively, of Table VI. The results are
generally
consistent with those in Column 1. In fact, the sign of the coefficients and significance
level for
the Manufacturing subsample (Column 5) are identical to those in Column 1 except for
the
market share variable, which is negative and significant. The results for Service and
Retail firms
in Columns 6 and 7, respectively, vary from those reported in Column 1; however, the
significant
coefficients’ signs are consistent with theory.
The models in Table VI account for firm specific heterogeneity as well as time effects.22
The estimated coefficients are generally robust across dependent variable specifications
as
subsequent models account for the variation in fiscal year ends and industry
benchmarks.
Overall, the fixed effects results strongly support many of the hypotheses.
D. Additional Results: Industry Competitiveness/Concentration
The degree of market concentration within an industry influences management of
operating working capital in response to operating conditions and financing ability.
Firms in
concentrated industries have improved negotiating ability; thus, they are able to dictate
trade
credit terms granted and received, and inventory policies. As a result, the effects of the
independent variables in Equation (1) could depend on the degree of concentration
within the
21 Forexample, CFO.com produces an annual working capital benchmarking analysis that relies on
industry level
means.
22 We note that the results are robust to scaling all variables, including dependent variables, by net assets.
industry. Molina and Preve (2008) demonstrate that the effect of financial distress on
credit
policy is most pronounced for firms in concentrated industries.
To determine whether the results vary according to degree of industry competitiveness,
regression models presented in Columns 1-4 of Table VI are estimated separately for
firms in
competitive and concentrated industries in Table VII. Similar to Molina and Preve
(2008), we
define a concentrated industry as one whose Herfindahl index exceeds the median
industry
Herfindahl index for the year; otherwise, the industry is considered competitive. As
before, the
models account for fixed and time effects.
Insert Table VII about here.
The results in Table VII generally echo those in Table VI with a few important
distinctions. Sales volatility, operating cash flow, size, and financial distress retain the
same
signs and general significance as the results in Table VI. However, the significance of
market-tobook
varies across dependent variable specification. While the market-to-book coefficient is
negative in all models, it is significant only in the quarterly averaged results (WCRq and
IndAdj
WCRq). Another interesting result concerns market share. Firms in concentrated
industries with
greater market share should be able to reduce WCR, but this is not supported by the
results.
A few other findings deserve note. First, sales growth is negative and marginally
significant for one competitive subsample (Column 3), but negative and significant at
the 1%
level for each concentrated subsample. This suggests that sales growth for firms in
concentrated
industries, those with presumably more market power, generates more spontaneous
financing
than spontaneous uses of funds. That is, sales growth provides net financing for firms in
concentrated industries. Second, gross profit margin (GPM) is positive and significant
for each
concentrated subsample. This has intuitive appeal in that firms in concentrated
industries
typically enjoy greater profit margins which by definition lead to a higher WCR.
Although the results in Table VII provide valuable insights, it would be helpful to know
the marginal effects of industry concentration on the WCR. As illustrated in Table VIII,
we
interact each independent variable in Equation (1) with an indicator variable for
concentration,
where the indicator variable equals one if the firm is in a concentrated industry, and
zero
otherwise. The results in Table VIII are derived from estimating Equation (1) plus an
industry
concentration dummy variable and the aforementioned interaction terms using the four
dependent variables described earlier. As before, the models account for fixed and time
effects.
Insert Table VIII about here.
The relation between the WCR and the interaction between lagged sales growth and the
industry concentration dummy variable is negative and significant for each model
suggesting that
sales growth causes a greater reduction in net investment in operating working capital
for
concentrated firms. Thus, sales growth provides net financing for firms in concentrated
industries. This significant negative interaction between lagged sales growth and
industry
concentration is consistent with our expectations. Growing firms in concentrated
industries have
less need to loosen credit and inventory policies to facilitate increases in sales.
Meanwhile,
suppliers are more likely to offer increases in credit and better terms to these firms.
Columns 1 and 3 of Table VIII demonstrate that the marginal effect of lagged gross
profit
margin on the WCR is greater for concentrated firms. Firms in concentrated industries
are more
likely to have greater contribution margins increasing their WCR. The results in
Columns 2 and
4 indicate that firms in concentrated industries finance less of their net investment in
operating
working capital with operating cash flow. This is likely due to concentrated firms
receiving
additional trade credit from suppliers. Contrary to expectations, the interaction between
industry
concentration and lagged market share is insignificant for each model. However, the
results in
Column 3 confirm that the industry adjusted WCR is negatively related to market share,
whereas
this variable was insignificant for each model in Table VI. This finding is not robust
across the
dependent variable specifications presented in Table VIII. Another result worth noting
is that the
industry concentration indicator variable has no distinguishable effect on the WCR.
In summary, the results in Table VIII echo many of those in Tables VI and VII as the
WCR is inversely related to lagged sales growth, sales volatility, lagged market-to-
book, and
lagged financial distress and is directly related to operating cash flow and size. The
interaction
between industry concentration and lagged sales growth is the only significant
interaction that is
robust across the models in Table VIII. We conclude that the effects of the other
independent
variables are not significantly different for concentrated and competitive firms.
IV. Conclusion
Firms adopt working capital policies to address market imperfections over the operating
cycle and incur costs and accrue benefits that affect cash flow and ultimately
shareholder wealth.
This study seeks a better understanding of the factors influencing working capital
behavior as
reflected in the working capital requirement.
For our sample of firms, the average working capital requirement represents $296
million
in untapped cash. Our empirical models relate the working capital requirement ratio
(WCR) to
operating conditions and financing ability. Concerning the operating conditions
variables, our
results indicate that increases in sales growth and sales volatility cause firms to manage
operating
working capital more aggressively. We find limited support for a direct correlation
between
gross profit margin and WCR. The results also indicate that working capital behavior is
influenced by financing capabilities. Specifically, WCR is directly related to operating
cash flow
and size and is inversely related to the market-to-book ratio and financial distress. A
weak
negative correlation exists between WCR and market share; however, the result is not
robust.
Together, these outcomes suggest that firms with weaker internal financing ability,
limited
capital market access, and greater costs of external financing will more aggressively use
payables
relative to receivables and inventory. These results are consistent after using a quarterly
averaged
WCR and they are robust to unobserved heterogeneity.
The results are also robust after industry adjusting WCR and highlight the need to
consider financial characteristics besides industry affiliation when examining working
capital
levels for optimality. The implication is that factors other than just industry benchmarks
should
be considered when setting or evaluating working capital behavior. Finally, we examine
the
effect of industry level concentration on working capital behavior and find that the
interaction
between lagged sales growth and industry concentration reduces firms’ net investment
in
operating working capital.
Our models should be helpful to future research since they are the first to investigate the
factors influencing the determinants of the net investment in operating working capital.
Furthermore, these models can be employed to benchmark optimal working capital
levels since
they jointly control for operating conditions and the ability to seek and acquire capital.
A
question left to future research considers the impact of changes in working capital
holdings on
changes in market value. The corporate cash holdings literature demonstrates that the
marginal
value of cash varies according to various financial characteristics such as the degree of
financial
constraint and corporate governance. Similar arguments may apply to the value of a
marginal
dollar in net operating working capital.
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Table I. Descriptive Statistics
This table provides the sample characteristics of 20,710 firm-years across 3,343 unique companies over the period
1996-2006.
WCR is the ratio of receivables plus inventory minus payables to sales at the end of each year. WCRq is the ratio of
the average
end of quarter WCR to end of year sales. IndAdj WCR is the difference between the annual WCR and industry
average annual
WCR for the respective year. IndAdj WCRq is the difference between the quarterly WCR and industry average
quarterly WCR
for the respective year. Growth is the percentage change in sales over the previous year. GPM is the ratio of sales
minus cost of
goods sold to sales. SalesVAR is the standard deviation of sales. OCF is operating income before depreciation minus
taxes scaled
by net assets. M/B is the ratio of market value of equity plus total liabilities minus payables to net assets. Size is the
market value
of equity in 2006 dollars. MktShare is firm sales as a percentage of aggregate sales in the firm’s industry. Distress
equals one if a
firm meets Molina and Preve’s (2008) definition of financial distress and zero otherwise. Industry dependent
calculations follow
the Fama and French (1997) 48 industry classification system.
Variables N Mean Standard
Deviation Minimum Median Maximum
WCR (%) 20,710 19.785 17.336 –163.256 18.895 95.964
WCRq (%) 20,710 19.258 16.287 –156.184 18.236 98.369
IndAdj WCR (%) 20,710 0.001 14.574 –181.776 0.998 81.301
IndAdj WCRq (%) 20,710 –0.312 13.917 –171.784 –1.341 84.521
Growtht-1 (%) 20,710 14.372 35.085 –70.86 8.694 321.508
GPMt-1 (%) 20,710 32.412 33.962 –78.193 32.688 87.983
SalesVar (%) 20,710 31.168 44.326 1.361 18.427 571.823
OCFt-1 (%) 20,710 5.153 29.938 –353.085 11.054 46.635
M/Bt-1 (Ratio) 20,710 2.324 2.919 0.481 1.493 37.716
Sizet-1 ($M) 20,710 1,957.146 5,605.622 0.789 252.138 65,449.510
MktSharet-1 (%) 20,710 1.407 3.334 0.000 0.215 29.349
Distresst-1 (Binary) 20,710 0.051 –– 0.000 0.000 1.000
Table II. Time Distribution of Sample
This table provides the distribution of the sample across time for 20,710 firm-years across 3,343 unique companies
over the
period 1996-2006. WCR is the ratio of receivables plus inventory minus payables to sales at the end of each year.
WCRq is the
ratio of the average end of quarter WCR to end of year sales. IndAdj WCR is the difference between the annual WCR
and
industry average annual WCR for the respective year. IndAdj WCRq is the difference between the quarterly WCR and
industry
average quarterly WCR for the respective year. Mean values of IndAdj WCR and IndAdj WCRq are not reported since
they
approximate zero by construction.
Mean Values Median Values
Sample Year N
WCR WCRq WCR WCRq IndAdj
WCR
IndAdj
WCRq
1996 1,152 21.657 20.883 20.719 20.314 –0.831 –1.564
1997 1,516 21.342 20.874 20.308 19.962 –1.411 –1.545
1998 1,616 21.697 21.246 20.702 20.202 –1.187 –1.152
1999 1,783 21.202 21.106 20.207 19.995 –1.333 –1.581
2000 1,871 21.165 20.798 20.153 20.032 –1.232 –1.467
2001 1,924 19.438 20.164 18.582 19.363 –0.617 –0.037
2002 2,042 19.211 19.602 17.928 17.956 –1.345 –1.059
2003 2,128 18.252 17.999 17.333 16.787 –0.834 –1.159
2004 2,232 18.583 17.566 17.638 16.617 –1.192 –2.053
2005 2,278 17.754 17.196 17.228 16.793 –0.695 –1.219
2006 2,168 17.594 16.953 16.819 16.172 –0.667 –1.357
Observations 20,710 19.785 19.258 17.336 16.287 0.053 –0.312
Unique Firms 3,343
Table III. Industry Distribution of Sample
This table provides the distribution of the sample across industries for 20,710 firm-years across 3,343 unique
companies over the
period 1996 to 2006. Industry classifications follow the Fama-French (1997) 48-industry classification system.
Utilities, Banking,
Insurance, Real Estate, and Trading firms are omitted. WCR is the ratio of receivables plus inventory minus payables
to sales at
the end of each year. WCRq is the ratio of the average end of quarter WCR to end of year sales. IndAdj WCR is the
difference
between the annual WCR and industry average annual WCR for the respective year. IndAdj WCRq is the difference
between the
quarterly WCR and industry average quarterly WCR for the respective year. Mean values of IndAdj WCR and IndAdj
WCRq are
not reported since these approximate zero by construction.
Industry Focus N
WCR
IndAdj
WCRq
Agriculture 57 44.004 42.505 48.623 49.444 4.824 3.089
Food Products 487 14.976 15.903 13.568 14.656 –1.321 –0.376
Candy and Soda 69 9.251 8.618 8.044 8.005 –0.724 –0.781
Beer and Liquor 73 27.760 27.188 15.486 15.226 –4.622 –7.450
Tobacco Products 23 19.799 19.566 17.490 16.553 0.000 1.147
Recreation 296 28.502 28.831 26.891 27.768 –0.836 –0.732
Entertainment 350 2.228 2.079 0.602 0.614 –1.532 –1.624
Print. & Publishing 255 14.292 13.758 11.983 12.000 –2.093 –2.131
Consumer Goods 514 25.997 26.145 23.763 23.620 –2.157 –2.310
Apparel 491 27.856 28.998 25.553 27.610 –1.872 –0.191
Healthcare 471 14.391 13.591 13.905 13.015 –0.142 –0.994
Medical Equip. 778 30.971 29.942 30.478 29.303 –0.324 –1.675
Pharmaceutical 895 18.306 17.201 20.592 19.367 2.672 1.467
Chemicals 590 22.143 21.782 21.209 20.817 –1.050 –1.161
Rubber & Plastic 290 19.915 19.543 19.415 19.551 –0.721 –0.930
Textiles 111 25.093 26.452 23.408 24.675 –1.774 –0.214
Const. Materials 555 22.284 22.163 22.255 21.545 0.111 –0.784
Construction 357 28.436 26.935 20.740 18.987 –7.306 –8.698
Steel Works 476 22.871 22.574 21.909 21.644 –1.329 –1.472
Fabricated Prod. 99 23.195 23.098 22.678 22.630 –0.232 0.604
Machinery 1,066 30.074 30.007 27.757 28.024 –2.050 –1.997
Electrical Equip. 544 29.449 29.570 27.048 27.201 –2.210 –2.267
Autos & Trucks 446 20.889 20.643 18.270 18.187 –2.562 –2.632
Aircraft 150 33.202 32.495 27.719 28.170 –4.144 –4.900
Shipbuilding 52 17.984 18.252 13.882 14.441 –4.055 –3.611
Defense 40 23.189 23.754 21.640 21.829 –1.958 –0.517
Precious Metals 80 18.843 20.104 19.088 18.829 –2.909 –1.962
Mining 96 21.478 21.402 19.569 19.089 –1.749 –1.523
Coal 31 21.478 2.678 7.228 7.249 0.000 –0.454
Oil and Nat. Gas 971 4.587 5.887 6.648 5.960 0.386 –0.188
Communication 602 6.239 8.203 8.376 8.154 0.369 –0.104
Personal Services 273 8.487 11.974 10.201 9.164 –0.830 –2.460
Business Services 1,976 12.639 14.697 14.940 14.317 –0.129 –0.870
Computers 820 21.444 21.964 20.193 19.820 –0.584 –0.813
Electronic Equip. 1,602 25.813 25.348 24.222 23.487 –1.469 –1.963
Table III. Industry Distribution of Sample (Continued)
Industry Focus N
WCR
IndAdj
WCRq
Measuring Equip. 614 32.664 31.998 30.892 30.279 –1.426 –2.066
Business Supplies 397 17.773 16.937 16.729 15.580 –1.057 –1.684
Shipping Cont. 87 16.579 16.180 16.729 15.580 –1.057 –1.684
Transportation 706 7.983 7.452 16.729 15.580 –1.057 –1.684
Wholesale 973 20.016 19.858 16.729 15.580 –1.057 –1.684
Retail 1,243 15.610 15.451 15.169 14.545 –1.275 –1.724
Restaurants, Etc. 515 1.494 0.761 7.495 7.116 –0.593 –1.003
Other 189 12.939 12.675 18.262 17.948 –1.527 –1.916
Observations 20,710 19.785 19.258 17.336 16.287 0.053 –0.312
Unique Firms 3,343
Table IV. Differences in Means: Positive WCR vs. Non-Positive WCR Firms
This table provides the sample characteristics of 20,710 firm-years across 3,343 unique companies over the period
1996-2006.
Positive WCR firms report a WCR greater than zero. Non-Positive WCR firms report a WCR less than or equal to
zero. All t-tests
invoke the assumption of unequal variances and Satterthwaite's approximation formula. WCR is the ratio of
receivables plus
inventory minus payables to sales at the end of each year. WCRq is the ratio of the average end of quarter WCR to
end of year
sales. IndAdj WCR is the difference between the annual WCR and industry average annual WCR for the respective
year. IndAdj
WCRq is the difference between the quarterly WCR and industry average quarterly WCR for the respective year.
Growth is the
percentage change in sales over the previous year. GPM is the ratio of sales minus cost of goods sold to sales.
SalesVAR is the
standard deviation of sales. OCF is operating income before depreciation minus taxes scaled by net assets. M/B is the
ratio of
market value of equity plus total liabilities minus payables to net assets. Size is the market value of equity in 2006
dollars.
MktShare is sales divided by industry sales. Distress is one if a firm meets Molina and Preve’s (2008) definition of
financial
distress, and zero otherwise. Industry dependent calculations follow the Fama and French (1997) 48 industry
classification
system.
Positive WCR Non-Positive WCR Difference in Means
Variables (Pos.) – (Non Pos.)
N Mean N Mean Difference T-Stat
WCR (%) 19,295 21.835 1,415 –11.314 33.149*** 56.928
WCRq (%) 19,295 21.274 1,415 –8.226 29.501*** 55.217
IndAdj WCR (%) 19,295 1.568 1,415 –21.386 22.955*** 35.072
IndAdj WCRq (%) 19,295 1.007 1,415 –18.299 19.306*** 32.768
Growtht-1 (%) 19,295 13.998 1,415 19.474 –5.476*** –4.127
GPMt-1 (%) 19,295 33.534 1,415 17.110 16.424*** 7.809
SalesVar (%) 19,295 30.289 1,415 43.143 –12.853*** –6.837
OCFt-1 (%) 19,295 6.651 1,415 –15.268 21.919*** 13.230
M/Bt-1 (Ratio) 19,295 2.249 1,415 3.344 –1.095*** –8.393
Sizet-1 ($M) 19,295 1,975.065 1,415 1,712.798 262.267* 1.781
MktSharet-1 (%) 19,295 1.452 1,415 0.792 0.660*** 11.732
Distresst-1 (Binary) 19,295 0.046 1,415 0.159 –0.113*** –11.503
*** Significant at the 0.01 Level.
** Significant at the 0.05 Level.
* Significant at the 0.10 Level.
Table V. Pearson Correlation Coefficients
This table provides Pearson correlation coefficients for the 20,710 firm-years across 3,343 unique companies over the
period 1996-2006. WCR is the ratio of receivables plus
inventory minus payables to sales at the end of each year. WCRq is the ratio of the average end of quarter WCR to
end of year sales. IndAdj WCR is the difference between the
annual WCR and industry average annual WCR for the respective year. IndAdj WCRq is the difference between the
quarterly WCR and industry average quarterly WCR for the
respective year. Growth is the percentage change in sales over the previous year. GPM is the ratio of sales minus cost
of goods sold to sales. SalesVAR is the standard deviation of
sales. M/B is the ratio of market value of equity plus total liabilities minus payables to net assets. Size is market value
of equity in 2006 dollars. OCF is operating income before
depreciation minus taxes as a percentage of net assets. MktShare is sales divided by the aggregate sales in the firm’s
industry. Distress is one if a firm meets Molina and Preve’s
(2008) definition of financial distress, and zero otherwise.
Variables WCR Growtht-1 GPMt-1 SalesVar MBt-1 Sizet-1 OCFt-1 MktSharet-1
Growtht-1 –0.0314*
GPMt-1 0.1420* 0.0242*
SalesVar –0.1451* –0.0709* –0.0712*
MBt-1 –0.0702* 0.1417* –0.0954* 0.0925*
Sizet-1 –0.0260* 0.0954* 0.0848* –0.2712* 0.0120*
OCFt-1 0.1248* 0.0426* 0.3468* –0.2465* –0.3915* 0.2669*
MktSharet-1 –0.0327* –0.0195* –0.0008 –0.1146* –0.0703* 0.4686* 0.1088*
Distresst-1 –0.1164* –0.0383* –0.0928* 0.2136* 0.1078* –0.2745* –0.3562* –0.0815*
Table VI. Fixed Effects Results
This table presents firm fixed effects regressions with WCR, WCRq, IndAdj WCR, and IndAdj WCRq as dependent
variables. WCR is the ratio of receivables plus inventory minus
payables to sales at the end of each year. WCRq is the ratio of the average end of quarter WCR to end of year sales.
IndAdj WCR is the difference between the annual WCR and
industry average quarterly WCR for the respective year.
Estimates for WCR are recalculated based on Retail, Service, and Manufacturing industry subsamples as defined in
Fama-French (1997). Growth is the percentage change in sales
over the previous year. GPM is the ratio of sales minus cost of goods sold to sales. SalesVAR is the standard deviation
of sales. OCF is operating income before depreciation minus
taxes as a percentage of net assets. M/B is the ratio of market value of equity plus total liabilities minus payables to
net assets. Size is the market value of equity in 2006 dollars.
MktShare is sales divided by the aggregate sales in the firm’s industry. Distress is one if a firm meets Molina and
Preve’s (2008) definition of financial distress, and zero
otherwise. Industry dependent calculations follow the Fama and French (1997) 48 industry classification system.
Annual binary variables (not reported) control for time effects.
The sample consists of 20,710 firm-years across 3,343 unique firms over the period 1996-2006. T-values are in
parentheses below coefficients.
WCR (%): Industry Subsample
Variables WCR (%) WCRq (%) IndAdj WCR
(%)
IndAdj WCRq
(%) Manufacturing Service Retail
Growtht-1 (%) –0.010***
(–5.000)
–0.008***
(–4.430)
–0.010***
(–4.85)
–0.008***
(–4.240)
–0.015***
(–5.330)
–0.018***
(–3.130)
0.001
(0.140)
GPMt-1 (%) 0.001
(0.031)
0.007**
(2.140)
0.002
(0.44)
0.008**
(2.280)
–0.004
(–0.830)
0.046***
(3.720)
0.073*
(1.650)
SalesVar (%) –0.040***
(–19.400)
–0.018***
(–9.410)
–0.039***
(–19.180)
–0.017***
(–9.010)
–0.043***
(–15.100)
–0.039***
(–7.870)
–0.047***
(–7.420)
OCFt-1 (%) 0.023***
(5.470)
0.037***
(9.730)
0.022***
(5.300)
0.036***
(9.520)
0.034***
(5.830)
–0.010
(–1.160)
–0.027**
(–2.110)
MBt-1 (Ratio) –0.128***
(–3.510)
–0.339***
(–10.300)
–0.135***
(–3.750)
–0.347***
(–10.560)
–0.179***
(–3.910)
0.121
(1.420)
0.035
(0.200)
Sizet-1 (Ln($M)) 0.490***
(4.590)
1.001***
(10.420)
0.496***
(4.690)
1.011***
(10.510)
0.599***
(3.970)
0.682**
(2.110)
–0.115
(–4.000)
MktSharet-1 (%) –0.089
(–1.350)
0.091
(1.540)
–0.129**
(–1.970)
0.052
(0.880)
–0.246***
(–2.670)
0.205
(0.580)
0.569
(0.960)
Distresst-1 (Binary) –1.621***
(–4.450)
–1.690***
(–5.140)
–1.534***
(–4.250)
–1.602***
(–4.890)
–2.169***
(–4.320)
–2.834***
(–2.780)
–0.512
(–0.570)
Observations 20,710 20,710 20,710 20,710 11,730 2,249 1,243
R-Square 0.14 0.10 0.15 0.11 0.13 0.20 0.09
Table VII. Fixed Effects Results: Conditional on Industry Concentration
This table presents firm fixed effects regressions using WCR, WCRq, IndAdj WCR, and IndAdj WCRq as dependent
variables. These results are similar to Columns 1-4 presented in
Table VI, but this table controls for the competitiveness/concentration of the industry by sub-setting the sample into
concentrated and competitive industries. A competitive
(concentrated) industry is the half-sample of firms in industries whose Herfindahl Index is below (above) the year
median. WCR is the ratio of receivables plus inventory minus
payables to sales at the end of each year. WCRq is the ratio of the average end of quarter WCR to end of year sales.
IndAdj WCR is the difference between the annual WCR and
industry average quarterly WCR for the respective year.
Growth is the percentage change in sales over the previous year. GPM is the ratio of sales minus cost of goods sold to
sales. SalesVAR is the standard deviation of sales. OCF is
operating income before depreciation minus taxes as a percentage of net assets. M/B is the ratio of market value of
equity plus total liabilities minus payables to net assets. Size is
the market value of equity in 2006 dollars. MktShare is sales divided by the aggregate sales in the firm’s industry.
Distress is one if a firm meets Molina and Preve’s (2008)
definition of financial distress, and zero otherwise. Industry dependent calculations follow the Fama and French
(1997) 48 industry classification system. Annual binary variables
(not reported) control for time effects. The sample is 20,710 firm-years across 3,343 unique firms over the period
1996-2006. T-values are in parentheses below coefficients.
WCR (%) WCRq (%) IndAdj WCR (%) IndAdj WCRq (%)
Variables
Competitive Concentrated Competitive Concentrated Competitive Concentrated Competitive
Concentrated
Growtht-1 (%) –0.004
(–1.520)
–0.017***
(–5.690)
–0.005*
(–1.930)
–0.010***
(–3.950)
–0.003
(–1.090)
–0.017***
(–5.560)
–0.004
(–1.460)
–0.010***
(–3.710)
GPMt-1 (%) –0.008*
(–1.760)
0.041***
(5.530)
–0.001
(–0.050)
0.035***
(5.400)
–0.008*
(–1.800)
0.041***
(5.540)
–0.001
(–0.080)
0.035***
(5.230)
SalesVar (%) –0.041***
(–14.030)
–0.040***
(–12.900)
–0.020***
(–7.630)
–0.014***
(–5.210)
–0.040***
(–13.720)
–0.040***
(–13.110)
–0.019***
(–7.250)
–0.014***
(–5.230)
OCFt-1 (%) 0.020***
(3.590)
0.014*
(1.940)
0.036***
(7.260)
0.020***
(3.320)
0.018***
(3.390)
0.015**
(2.180)
0.035***
(7.030)
0.022***
(3.570)
MBt-1 (Ratio) –0.059
(–1.260)
–0.029
(–0.047)
–0.257***
(–6.070)
–0.302***
(–5.490)
–0.063
(–1.370)
–0.037
(–0.590)
–0.262***
(–6.200)
–0.310***
(–5.640)
Sizet-1 (Ln($M)) 0.334**
(2.120)
0.475***
(3.020)
0.869***
(6.070)
1.047***
(7.630)
0.287*
(1.830)
0.455***
(2.940)
0.822***
(5.760)
1.028***
(7.510)
MktSharet-1 (%) 0.071
(0.450)
–0.088
(–1.180)
0.256*
(1.790)
0.041
(0.064)
–0.126
(–0.810)
–0.079
(–1.090)
0.059
(0.420)
0.050
(0.770)
(–3.110)
–2.768***
(–5.320)
–1.930***
(–__________4.120)
–2.710***
(–5.960)
–1.535***
(–2.990)
–2.851***
(–5.560)
–1.864***
(–3.980)
–2.792***
(–6.160)
Observations 10,862 9,848 10,862 9,848 10,862 9,848 10,862 9,848
R-Square 0.10 0.15 0.10 0.08 0.11 0.16 0.11 0.09
Table VIII. Fixed Effects Results: Marginal Effect of Industry Concentration
This table presents firm fixed effects regressions using interaction terms to test for differences between concentrated
and
competitive industries. A competitive (concentrated) industry is the half sample of firms in industries whose
Herfindahl Index is
below (above) the year median. WCR is the year-end ratio of receivables plus inventory minus payables to sales.
WCRq is the
ratio of the average end of quarter WCR to end of year sales. IndAdj WCR is the difference between the annual WCR
and
industry average annual WCR for the respective year. IndAdj WCRq is the difference between the WCR and industry
average
WCR for the respective year, quarterly. Growth is the percentage change in sales over the previous year. GPM is the
ratio of sales
minus cost of goods sold to sales. SalesVAR is the standard deviation of sales. OCF is operating income before
depreciation
minus taxes as a percentage of net assets. M/B is the ratio of market value of equity plus total liabilities minus
payables to net
assets. Size is the market value of equity in 2006 dollars. MktShare is sales divided by aggregate industry sales.
Distress is one if
a firm meets Molina and Preve’s (2008) definition of financial distress, and zero otherwise. IndCon is binary and
equal to one if
the firm is in a concentrated industry, and zero otherwise. A multiplication symbol (×) indicates interaction terms.
Annual binary
variables (not reported) control for time effects. Industry dependent calculations follow the Fama and French (1997)
48 industry
classification system. The sample is 20,710 firm-years across 3,343 unique firms over the period 1996-2006. T-values
are in
parentheses below coefficients.
Variables WCR (%) WCRq (%) IndAdj WCR (%) IndAdj WCRq (%)
IndCon (Binary) –1.517
(–0.790)
–2.081
(–1.190)
–0.910
(–0.480)
–1.474
(–0.850)
Growtht-1 (%) –0.005**
(–2.030)
–0.006***
(–2.580)
–0.005*
(–1.810)
–0.005**
(–2.320)
Growtht-1 × IndCon –0.013***
(–3.250)
–0.006*
(–1.660)
–0.013***
(–3.380)
–0.006*
(–1.770)
GPMt-1 (%) –0.003
(–0.790)
0.005
(1.380)
–0.002
(–0.560)
0.006*
(1.650)
GPMt-1 × IndCon 0.015**
(2.280)
0.007
(1.150)
0.013**
(1.990)
0.005
(0.810)
SalesVar (%) –0.041***
(–16.550)
–0.019***
(–8.510)
–0.040***
(–16.200)
–0.018***
(–8.000)
SalesVar × IndCon 0.004
(1.060)
0.006
(1.550)
0.003
(0.680)
0.004
(1.120)
OCFt-1 (%) 0.026***
(5.290)
0.044***
(9.940)
0.024
(4.920)
0.042
(9.520)
OCFt-1 × IndCon –0.011
(–1.350)
–0.024***
(–3.240)
–0.007
(–0.890)
–0.020***
(–2.730)
MBt-1 (Ratio) –0.129***
(–3.120)
–0.328
(–8.780)
–0.136***
(–3.300)
–0.335***
(–8.980)
MBt-1 × IndCon –0.002
(–0.030)
–0.044
(–0.720)
–0.004
(–0.006)
–0.046
(0.760)
Sizet-1 (Ln($M)) 0.459***
(4.010)
0.961***
(9.290)
0.481***
(4.240)
0.983***
(9.530)
Sizet-1× IndCon 0.070
(0.680)
0.122
(1.310)
0.025
(0.250)
0.077
(0.830)
MktSharet-1 (%) –0.116
(–1.290)
0.087
(1.06)
–0.163*
(–1.830)
0.039
(0.490)
MktSharet-1× IndCon 0.029
(0.410)
–0.004
(–0.006)
0.046
(0.650)
0.013
(0.210)
(–3.280)
–1.515***
(–3.670)
–1.327***
(–2.930)
–1.344***
(–3.270)
Distresst-1× IndCon –0.366
(–0.520)
–0.506
(–0.790)
–0.596
(–0.850)
–0.736
(–1.160)
Observations 20,710 20,710 20,710 20,710
R-Square 0.14 0.11 0.15 0.12

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Net Operating Working Capital Behavior: A First Look

Net operating working capital captures multiple dimensions of firms’ adjustments to

WCR Growth GPM SaleVAR OCF

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