Relationship between the profitability and working capital policy of Swedish companies

Abstract: Over the years there has been a big debate on the effect of working capital policy on theprofitability. Few researchers argue that working capital is just an idle resource with ahigh cost and low benefit associated with it so, companies should follow zero workingcapital policy but such a policy is very risky because it reduces the liquidity and it mightleads to a default. Other researchers support companies to have a working capital policybecause they believe that proper management of components of working capital canbalance cost and benefits of the company and it will reduce the risk of default by raisingthe level of liquidity. Companies can choose among three different types of workingcapital i.e. aggressive, conservative and moderate but their choice depends on their desirelevel of liquidity and risk.Researchers realize the importance of the topic and lot of research has been carried out allover the world especially in developing countries like Pakistan, India, and Taiwan etc.Despite the importance of topic we were unable to find any research carried out inSweden or in any other Scandinavian country. So, this study is conducted with thepurpose to explore the relationship between working capital policy and profitability ofSwedish firms. Furthermore this study also investigates the nature of relationshipbetween working capital policy and component of cash conversion cycle. For the purposeof our study we used the sample of 37 listed companies in the OMX Stockholm stockexchange over the period of five years (2004-2008).The study has been conducted in a natural environment and it follows the explanatoryresearch strategy. Moreover it is a quantitative study which follows the deductiveapproach and it is longitudinal in nature.We used GOP as a measure to profitability and CCC is used as a gauge to measure theaggressiveness of working capital policy. We used the secondary data, which has beenextracted from the annual financial reports of the companies, to calculate the GOP,financial debt, firm size, fixed financial asset, component of CCC and CCC.In this study, six regressions were run on 185 observations in SPSS software. In eachregression analysis dependent variable (GOP), independent variable firm size, financialdebt ratio, and fixed financial asset ratio remains the same but independent variableCCCS, CCCA, CCCD, day’s inventory held, days account receivable and days accountpayable replace each other. The reason for this replacement of independent variables is tofind out that how CCC and component of CCC affects the GOP.The result of regression analysis shows that managers can’t change the level ofprofitability by adopting any of the working capital policy i.e. there exist no relationshipbetween working capital policy and profitability. Furthermore profitability is directlyassociated with days inventory held and days account payable but it is in inverse relationwith days account receivables.