Working Capital Investing Policy under a Economic Recession: Focusing on a small-medium size companies. Lawrence, Assistant Professor

Transcription

1 Working Capital Investing Policy under a Economic Recession: Focusing on a small-medium size companies 1 Lawrence, Assistant Professor Department of Accounting School of Business and Management University of Arkansas at Pine Bluff Pine Bluff, Arkansas 71601, USA Tel: awopetul@uapb.edu Peter Y. Wui Assistant Professor Department of Business Administration School of Business and Management University of Arkansas at Pine Bluff Pine Bluff, Arkansas 71601, USA Tel: wuiy@uapb.edu

2 2 Abstract Based on the theory of net-working capital, this paper investigated whether a change in the working capital assets structure has an impact on the level of profitability of small nonfinancial firms, an under researched topic in the financial literature. The working capital policy s relationship with profitability strategy was tested through multi-variable regressions. The return on assets was regressed with the working capital investment policy as an independent variable and the firm s size, growth, and financial leverage as control variables. Data were collected from the financial statements of 100 companies through their Form 10-K submitted to the Securities and Exchange Commission. The findings indicated that working capital variables and profitability are statistically significant predictors of corporate working capital policy decisions. Firms will have more profit if more current assets fund working capital investment. The size, growth, and financial leverage ratio are potent tools that mitigate risk of achieving profitability in companies. Key words: working capital policy, profitability, current assets.

3 3 Introduction The effect of the United States economic contrasts of the last decade ( ) has created a condition of uncertainty among firms. The United States economic environment has transitioned from growth in its many industrial sectors to recession within the ten year period (Elwell, 2011, p. 1). The earlier part of the decade helped to boost both domestic and global demand for products that originated from the United States. Mitigating the robust growth of the period (2002 to 2007) were the policy options that were limited by political factors that restrain further fiscal stimulus, and market responses to debt distress (Arieff, Weiss, & Jones, 2010, p.1). By early 2007, the U.S. economy showed signs of distress by way of crises among banks and financial institutions (Liberals & Democrats workshop, 2008, p.10). The financial distress resulted in credit restrictions for manufacturing and other business entities in the nation. By the end of 2008, the economic situation had worsened, and firms of different size and reputations suffered loss of profit and employment because of limited or lack of working capital funding. The bad economic situations of 2008 lead to government bailout of some popular finance and manufacturing firms in the nation. In February 2009, Martin Felstein, a member of the National Bureau of Economic Research (NBER) Business Cycle Dating Committee argued that the massive downturn in the U.S. economy was driven by an unprecedented loss of household wealth.. Likewise, many of the firms that existed in the period between had problems of survival because of poor profitability performances. Those that survived were barely

4 4 making ends meet; studies have shown that many companies had to go bankrupt because of the weak WC investment strategies (Filbeck et al, 2007, p. 4). Nevertheless, WC is critical to a company as blood is critical to a human being to maintain life (Padachi, 2006, p. 47). However, a global market competition, uncertainty of funding, financial restrictions, new regulations, new technology, and high funding costs are some of the constraints faced by WC (Filbeck& Krueger, 2005, p. 17). Also, Filbeck, Krueger and Preece (2007) argued that the constraints of WCI have made the job of a manager more difficult and have decreased the efficiency of WC strategies. As a result of the economic inconsistency faced by the United States firms/industries in the period between 2002 through 2011, this paper is investigating whether a change in working capital assets structure has an impact on the level of a firm s profitability. This paper explored the impact of WCI policy on the firm s profitability in the United States, and we evaluated the impact of a company s working capital assets structural changes, and made recommendations on how to overcome its pitfalls. Literature Review Stickney & Weil, (2008) demonstrated that WC is an active player in the process of a firm making a reality of its profitability goal. Weirnraub and Visscher and Nazir and Afza (2009) said profitability is driven by Working Capital Management Policies, which is characterized by its investing and financing decisions, the firm s size, sales growth, and financial leverage. Padachi (2006) argued that the nature of working capital allows for

5 5 changes or adjustment to policies that can work better for a firm to achieve its objectives. In other words, a firm can change a policy to benefit the users of financial reports. Furthermore, a firm may adopt an aggressive investing policy to achieve its profitability target (Nazir&Afza, 2009; Weinraub&Visscher, 1998). A situation where the firm s management lay down rules which allows for minimization of current assets for operations is referred to as investing strategies. The theory allows for inventories to be monitored and controlled with the use of basic policies and technologies that set guidelines on safety stock, reorder point, and periodic inventory system. The aggressive approach to WC minimizes the financing period on inventories eases the value of uncollectible debts, reduces inventory stock piling and most importantly increases profitability. Nazir & Afza (2009) emphasized that total current assets divided by total assets is a good measure of WCIP. In contrast, the conservative theorists believe in high level of investment in current assets where there will be enough inventories to sell (Weinraub&Visscher, 1998, p. 12). The conservative approach creates a sense of security on liquidity, meaning that more goods will be available to sell and cash will eventually be exchanged for goods. Although, this approach still carries the burden of inventory pileup, increase in uncollectible debt, increased accounts payable, and theft, which may ultimately reduce profitability. The theoretical background of this paper is the net working capital concept. The application on firms financial ratio is the use of nontraditional financial ratios such as the aggressive investment ratio to measure the working capital liquidity and

6 6 profitability of a firm. Nazir and Afza (2009) studied the impact of aggressive WCM policy on a firm s profitability in Pakistan. Their study applied multiple-regression analysis to investigate the traditional relationship between WC policies and a firm s profitability in 204 nonfinancial firms from 1998 to The result of the study revealed that when firms utilize an aggressive approach to acquire working capital assets, the outcome may not necessarily increase the profit level. However, the research also concluded that investors are found to be more disposed to firms that have an aggressive approach to WC because they feel the stock value of such a firm is more rewarding in the market. Comparatively, Weinraub and Visscher (1998) explored the practice relating to aggressive and conservative WC policies. The study utilized quarterly financial reports of 10 diverse industrial groups made of 126 industrial firms in the United States market. They reported that industries WC policies are not consistent in practice. Furthermore, it was mentioned that when firms engage in aggressive investing policies, firms always balance it with conservative policies. There are few studies on WCM of firms in the United States; the existing methodologies are not consistent in the use of financial ratios. To sidetrack the inconsistency in the measurement, and bring a level of stability to working capital measurements, Nazir&Afza, (2009, p.22) advocated the use of total assets. Appuhami, (2008) stated that current assets of a firm cannot contribute to profitability by itself; it requires the support of long lived assets (, p.8). Likewise, it is difficult to measure the

7 7 impact of working capital investment policy without long-term liability. The use of total assets in measuring WC investment policy of a firm will answer the neglect of the continuity concept of a business. Theoretically, the WC is a management phenomenon that enables a firm to fund the gap that exists between its short-term assets and short-term liabilities (Nazir&Afza, 2009, p. 19). Therefore, cash, receivables, marketable securities and inventories, are critical elements of a firm s WCI that requires daily attention of management. Nazir and Afza (2009) argued that low-level WC assets will reduce waste of resources, eliminate inventory pile-up, and stock-outs, decrease receivables turnover, and ultimately increase a firm s profit. Filbeck and Krueger (2005) demonstrated benefits of working capital investment in a firm when they used financial ratios to study 32 nonfinancial industries in the United States. Their findings showed significant differences among industries in WCI practices over time, and concluded that WCI practices change significantly within industries overtime. Model Hypothesis : Statement on the working capital investing policy (WCIP). This study examines the impact of a firm s working capital investment policy ratio on profitability performance measures. Specifically, the research question asked if there is a relationship between a firm s aggressive investment policy and profitability. This hypothesis was to find out if a firm uses an aggressive investment policy, through

8 8 the use of minimal level of investment in current assets then the expected outcome will be an increase in profitability for the firm. This approach, along with other control variables, will assist managers to avoid waste of resources and keep the firm s profit up. However, use of the conservative approach to investment decisions emphasized that a greater proportion of capital be placed on liquid assets. This approach do not encourage for high growth in a firm s profitability. Therefore, the above statement is tested by a hypothesis analysis as follows: Ho: Ha: lowwcip lowwcip highwcip highwcip Where lowwcip represents profitability of low level of WCIP firms, and highwcip represents profitability of high level of WCIP firms. The above null and alternative hypothesis are testing whether low level of WCIP firms are not making higher profitability when compared to the profitability of high level WCIP firms. Further tests were done through the regression equations. Calculated ratios were analyzed with the use of STATA. This hypothesiswas tested through solving the regression equations below: ROAt=α+βı(CA/TAt)+β2(SIZEt)+β3(GROWTHt)+β4(LVRGt)+ε. Tobin s qt=α+βı(ca/tat)+β2(sizet)+β3(growtht)+β4(lvrgt)+ε. Where, ROAt = Return on Assets.

9 9 Tobin s qt = Value of q. α = the working capital management intercept of the regression surface. β = the responsiveness of profitability to the risk factor, independent and control variables ratio. TCA/TAt = Total current assets to total assets ratio. TCL/TAt = Total current liabilities to total assets ratio. SIZEt = Natural log of firm size. GROWTHt = Growth of sales. LVRGt = Financial leverage of firms ε = Error term of the regression model Dependent variable. The impact of working capital management policies on the profitability of firms was analyzed through accounting, and market performances. The dependent variable, profitability, was measured by Return on Asset (ROA) and Tobin s q ratios. The Return on Assets (ROA) is measured as net earnings after taxes divided by total assets. The Tobin s q, is a market value test of a company s equity. Tobin s q is used as a profitability measure because of its ability to compare the firm's market value with the book value of its assets. Tobin s q ratio is calculated as Market value of firm (MVF) divided by Book Value of Assets (BVA). Independent variables. This paper independent variable is the Working Capital Investment Policy (WCIP), which, stipulates that when a firms' policy supports the use of low investment in current assets, as against long-term assets, that investment policy is

10 10 aggressive. On the other hand, conservative investment policy is when a firm allows for more capital in liquid assets. The aggressive / conservative investment policy approaches are strategies that enable the management to use funding in the most efficient manner. When a firm finances its working capital assets at the minimal level, it reduces the risk of overstocking, theft and the rising cost of sales. A firm that efficiently controls inventory, account receivable and cash, will have the opportunity to increase its profitability. In the case of the conservative approach, the expectation is the availability of abundant cash to meet working capital needs of the firm. The conservatives preach more liquidity for a firm, forgetting that money is useless if it cannot be used to create more opportunity for growth and prosperity. A firm's investment strategy was measured through the financial ratio of Total Current Assets (CA) divided by Total Assets (TA). Control variables. This paper identifies firms size; growth, and financial leverage, has factors that impact WCM policies of companies. A company size was measured by the logarithm of its total assets. Teruel and Solano (2005), argued that control variables like sales growth, size of the firm, and level of debt are integral factors that can ensure high profitability for a firm. Also, financial leverage is an indication of the extent to which a firm is using borrowed funds to acquire assets. Financial leverage is a motivating factor that stimulates a firm s purchasing power to acquire more assets than the stockholders are able to pay for through their own investment (Stice&Stice, 2011, p ). Assumptions, Limitations, Scope and Delimitations Assumptions

11 11 This research rests on three assumptions. First, it was assumed that aggressive and conservative working capital investing policies as the working capital management policies are used to gauge firm s profitability. Second, it was assumed that a firm s profitability is not dependent on WCI policies alone but other factors as well, such as the financing policies, a firm s size, growth of sales, and firm s financial leverage. Third, though nonfinancial publicly traded firm s data are used for this study, the findings of this study are assumed to have implication for other firms that are privately owned. Limitations A quantitative design was used with available data from the sample firms. The operational definitions of the concepts and the way they are measured have significant effects on the findings of this study. The WC investing policy are used as independent variables of WCM. Furthermore, the profitability proxy (return on assets) represents the nominal values disclosed in the annual financial statements of firms that serve as samples. This study data were extracted from the Form 10-K that sample companies had submitted to the U. S. SEC for the period under investigation. Scope and Delimitations Empirically, the scope of WCI policies entail all firms factors based on industry attributes. This includes the nature of business and their cyclical needs. Also, it includes procurement of assets and their leverage positions. Thus, it was not practically possible to collect data and test the WCI policies for the entire population of small nonfinancial firms (public and private), nor was such an attempt ever made. In this paper, unlike many

12 12 studies on WCI policies, the target population was confined to a sample of small nonfinancial publicly traded firms in the United States. Private firms were not included in this study due to the possibility of non-availability of adequate financial data. Also, financial firm s data were not analyzed for use in this study because financial services were not considered cyclical, and their balance sheets components are different from that of nonfinancial firms. Data This study s population is based on small nonfinancial firms in the United States, and the study period is from 2002 to The 10-year study period is suitable because it relates to a decade of expansion and contraction in the United States economy (NBER, 2008, p. 1). For example, the first 6 years ( ) are significant because they constituted a period of economic growth, whereas, the later 4 years ( ) were recession years, when the United States economy witnessed financial crisis, high unemployment, and loss of household savings (Elwell, 2011, p. 1). Thus, in this paper, we explored the relationship between the aggressive WCI policies of firms and their profitability during the period 2002 to It was also designed to compare the impact of a firm size, sales growth, and financial leverage on the profitability mall non-financial firms. This data driven study used samples of a cross-section of 100 firms that Forbes enterprise surveyed in the 2011 America s best small companies (Forbes.com, 2011). We applied data from the sample company s financial statements starting from the calendar year 2002 to 2011.

13 13 The data information came from the actual financial information prepared by the management of the sampled firms, and published for external users. The prepared data was used because it helps to make a better decision on firm s strategies, and also such data are often precise, and never useless (Acsel&Sounderpandian, 2009, p. 4). Quantitative research design is used to verify data through prescriptive testing, hypothesis testing, correlations and sometimes descriptions (Nachmias&Nachmias, 1976, p. 11). The information gathered through the systematically assigned symbols will be formulated into tables and graphs. Therefore, this numerically designed study lays emphasis on relationships among the independent variables of WCI policies and the dependent variable profitability. The measurement of investment decisions involved the calculation for the ratio of total current assets divided by total assets (Nazir&Afza, 2009, p. 23). Finally, this research evaluated the impact of control variables like the firm s growth, size, and financial leverage on the firm s profitability. Research population. The target population for this study is made up of nonfinancial small firms that exist in the United States economy. The population consisted of small firms that are registered with the United States Securities and Exchange Commission (SEC). A total of 100 small firms (derived from Forbes.com database) represented the business category of small American companies in this paper. These set of firms are in compliance with the

14 14 registration and reporting criteria set by the SEC. We applied a survey sampling method to analyze the impact of aggressive WCI policies on a firm s profitability. This process surveyed financial data that is within the prescribed limits of the firm s distinguishing factors. In 2011, the list of 100 best small American companies was published by Forbes.com, a financial investment and analyzing firm. The list ranks small U.S. firms on the bases of their sales revenue, sales growth, earnings per share, and returns on equity. The sample firms that made the list were segmented into seven different industrial groups in the American economy. The number of firms in each industry range between five and 27. The breakdown of this surveyed list will be displayed in tables and graphs in the next section. In all, the 100 firms that were surveyed served as a subset of the target population. The 100 companies that represent the nonfinancial firms in the study have been grouped in their respective industries. Table 1 shows the industries represented in this study. Table 1: Sample of US Small nonfinancial Firms Number 10 yrs. Av Sales Sample Industry sampled sales $ 000 (%) Bus Services& Sup. 27 $250, % Capital Goods 12 $342, %

15 15 Health Care Equipt. 7 $321, % Chemicals 6 $142, % Retailing 15 $330, % Software Services 28 $221, % Telecommunications 5 $194, % Total 100 $1,804, % Analysis In this section, necessary descriptive statistics are calculated, presented in tables, and the results of the test are reported below. Table 2 is the outcome of the regression statistics performed on a sample population of 1,000 data sets of all participating firms through STATA. The table shows single effect of profitability performances on different variables that was used for the purpose of this study. The total 1,000 financial data analysis was processed under fixed effects of companies and years. From the data sets, unrealistic, extreme data were excluded so that only 983 data sets were included for the analysis. Only for the growth rate of sales, one previous year data should be dropped for all the companies and only 886 observations are included. In all, the results show a positive ROA at 8.9% on the whole average. In order words, the results reject the hypothesis that when an aggressive investment policy is adopted by firms it will increase a firm s profitability. The outcome of this result clearly identifies with the working capital conservative theorists (Weinraub,

16 ), who believe in an investment policy that keeps a high level of current assets as a component of total assets will have a positive impact on a firm s profitability. Table 2 The Basic Statistics of the Data Sets Variable Obs Mean Std. Dev. Min Max currentassets currentliabilities totalassets revenue totalliabilities netincome ownerequity mve mvf cata clta tobinsq ROA Size Growth FinancialLeverages

17 17 Testing Hypothesis on WCI policies The first step in measuring WCIP was to calculate the profitability performance of the firms based on the accounting (ROA), as well as the market measurements (Tobin s q) of the companies in the sample. The second step was to organize the sample industry in the hierarchy of the calculated ratio. That is, the industry with the lowest ratio of CA/TA was ranked first, while the industry with the highest CA/TA was ranked at the bottom of the list. The regression analysis was performed by comparing the industry means on a paired sample basis. The next segment in this analysis compared the effect of WCIP (CA/TA) on the firm s profitability measures. Profitability was measured through (a) the accounting Return on Assets (ROA), and (b) the market value of firms (Tobin s q). First analysis is on CA/TA and ROA. CA/TA versus ROA Figure 1, the ROA fitted value, shows a linear line that has a slight increasing trend of return as the current assets of a firm increases. The result of this test was against the prediction that a low level of current assets will command higher return on assets.

18 ROA Fitted values CA/TA Figure 1. ROA shows an increasing trend as CA/TA increases.

19 19 Table 3 Regression Analysis of Performance Measures and Working Capital Investment Policy Variables ROA (I) ROA (II) β p-value β p-value Intercept CA/TA Year Year Year Year Year Year Year Year Ln(Total Assets) Sales Growth FFL Χ2-value N Table 3 is in two parts, each showing the ROA effects on alternative variables. The first part (ROA 1) excludes the control variables. The ROA (I) estimated equation shows that as the average percentage of current assets out of total assets increases 1% more, ROA increases 6.02% with a significant statistical confidence of about 3%.

20 20 The second part of Table 3 shows the ROA 11 that includes the control variables; where a company size as a logarithm of total assets, sales growth and the financial leverage ratios were correlated with the CA/TA ratio. However, when these control variables are considered together, the table 3, ROA (II) equation shows much lower partial impacts of 2% without a statistical significance. That is, the firms performance impacts of working capital investment policy have disappeared under the company size, sales growth rate, and the financial leverage. The results on ROA (11) justify the inclusion of the control variables in this study, which, generally shows that the variance of ROA is more explained by other factors except CA/TA with higher significant confidence. A company size has a negative impact on ROA, just like the financial leverage that was shown at -.4%. However, sales growth has a positive impact on ROA. A 1% sales growth of a firm will increase its ROA by an average of 1.98%. CA/TA Versus Tobin s q: Figure 2 represents the CA/TA s Tobin s q fitted line. The Tobin s q linear line rises slow and steadily has the CA/TA ratio increases. Therefore, the graph can be interpreted as when there is an increase in the operational current assets of a firm there may also be an increase in the market value of the firm.

21 Tobin's q Fitted values CA/TA Figure 2. Firm s market value slightly increases as the proportion of current assets out of total assets (WCIP) increases. Table 4 shows the regression analysis of CA/TA on a firm s market value (Tobin s q). The table is divided into two parts Tobin s q 1, and Tobin s q11. The Tobin s q 1 segment excludes the control variables. Like the ROA findings, the finding of Tobin s q 1 shows a significant result, especially at negative ends through the study period. However, when the control variables are factored into the mix (Tobin s q11), there was a level of significance (p-value) on a yearly basis. At 6.2% level of significance, the correlated volatility of current assets to total assets is estimated at The same negative trend was observed on all variables, except that of FFL in the study period.

22 Table 4 Regression Analysis of Performance Measures and Working Capital Investment Policy on Tobin s Q 22 Variables Tobin s Q (I) Tobin s Q (II) β p-value β p-value Intercept CA/TA Year Year Year Year Year Year Year Year Ln(Total Assets) Sales Growth FFL Χ2-value N

23 23 Table 4 result was based on 983 observations out of total samples of 1000 data set. A comprehensive result of this investigation shows there was no significant statistical relationship on the average of the whole industry between the ratio of current assets and total assets (WCIP) and the firms performances based on market value measures (Tobin s q). However, when the variables of company size, sales growth, and the financial leverage are controlled, the companies showed a negative relationship with a statistical significance of 6%. Furthermore, when the CA/TA was increased by 1%, then market value of firms (Tobin s q) decreases around 4.6%. Hypothesis Two Likewise, variables of size, growth, and financial leverage were independently correlated against the performance measures. The comparisons were made with the return on assets (ROA) and (Tobin s q).the calculations of ROA and Tobin s q were the same as was used in Table 3 and 4. The size was calculated on the basis of the logarithm of total assets that were collated in this research period. Also, the sales growth was derived based on the differences in the growth rate in each year from 2002 to Year 2002 was taken as the base year, and it determined the growth rate for the next (2003) year. This growth rate was calculated for all the years that ended with the Financial leverage is the last control variable used in this research. It was calculated by dividing the firm s total debt with its total equity.

24 24 The figures in this section represent the findings of the statistical regression (Tables 3 and 4). The impacts of the results are expressed on six figures; two scattered diagrams applied to each control variable. One figure represents the ROA fitted value, and the second figure represents the Tobin s q value. A descriptive graph of control variables namely size, growth, and financial leverage were compared with ROA and Tobin s q of industries and exhibited in the tables below: SIZE: First is the impact of size on ROA (Figure 3), although, the finding of this statistical data was heavily clustered, the line shows a very flat trend on asset returns as the company size increases. However, Tobin s q linear line on Figure 4 decreases as the company size increases. This negative reflection shows that the size of a firm has no influence on the market value of a firm.

25 ROA Fitted values size Figure 3. Is the linear relationship of a firm s Size on its ROA Tobin's q Fitted values size Figure 4.Shows a firm s size relationship with Tobin s Q. Conclusively, the result of the regression analysis demonstrated the effect of company size on a firm s profit. On Tables 3 and 4, the effect of the company size shows a negative impact on ROA and Tobin s q significantly. That is, when a company size

26 increases by 1%, ROA decreases around 3-3.6%, and the Tobin s q decreases around times. GROWTH: A company s growth level was evaluated based on the variation in the firm s annual sales value in reference to its previous year s sales. The result shows that the ROA increases (Figure 5) as sales grow. This assertion was corroborated with the Tobin s q result (Figure 6), which implies, the market value of firms increases as the sales of a company increases under fundamentally high variances. 26 ROA Fitted values growth Figure 5. Shows the relationship between a firms s Growth and the ROA.

27 Tobin's q Fitted values growth Figure 6. Shows the relationship between a firm s Growth and Tobin s q Conclusively, the firm s growth regression results from tables 3 and 4 clarified the above graphical explanation in a better way. As sales revenue of firms grow at a rate of 1%, the ROA increases by 2% at around 9-10% statistical significance, but Tobin s q decreases at about times without a statistical significance. Financial Leverage The total debt of the firm was equally paired with the profitability performances of ROA and Tobin s q. The findings are shown in Figure 7 (ROA) and Figure 18 (Tobin s q). The impact of financial leverage on ROA was negative because an increasing total debt in the financing of a firm will result in a decreasing return on assets. This makes economic sense because high long term debt will be supported with high and

28 long term cost of capital. On the other hand, the market value (Tobin s q) of a firm shows a result of linear line at an increasing trend as the total debt increases (Figure 8). The increasing trend in Tobin s q could be due to the confidence of business creditors on the firm/industry. Figures 7 and 8 depict the effect of financial leverage on return on assets, and Tobin s q below: ROA Fitted values leverage Figure 7. Is the relationship between financial leverage and the ROA.

29 Tobin's q Fitted values leverage Figure 8. Is the linear line that shows the relationship between a firm s financial leverage and the Tobin s q. Conclusively, the data set on financial leverage analyzed through the regression from Tables 3 and 4 shows the financial leverage increases at 1%, and decreases at % of ROA. Also, the financial leverage increases at times of Tobin s q at statistical significances. Furthermore, the effect of the outliers on the result of this study was analyzed. The additional test was to knockout the outliers on Figures 5, 6, 7, and 8. The findings after the outliers were removed remain the same as they were before factoring the outliers. This in my opinion means the outliers identified in this study did not have any significant impact on the results.

30 30 Summary Hypothesis one was on the proposition that the use of a small amount of current assets would be better for a company to increase its profitability, than when a high proportion of current assets are used. However, the test result of this hypothesis was not true. The result indicated when more current assets are used in funding working capital investment, the profitability of the company increases (Figure 7 and 8), than when less current assets are used. Hypothesis 2 proposed that size, growth, and financial leverage of a firm contribute positively to its profitability. The findings of this studies indicated that the size of a company can have a slight positive impact on the return on assets, while the result of its Tobin s q is negative at a significant level. Likewise is the firm's growth: When the firm s growth was paired with company profitability the result shows that the return on assets and market value of the firm increase as the company sales grow. In the case of firms financial leverage, the result was mixed. Return on sales reported a significant decrease as the firm increases its financial leverage (Figure 7). However, Tobin s q (Figure 8) shows that more total debt in the capital structure of a company will increase the market value of the company. Discussion and Summary of Findings The first hypothesis was designed to test the significance of working capital investment policy (CA/TA) on profitability measures (NEAT/TA, and MVF/BVA) of small nonfinancial companies. On an average, the results of the F-test for the two

31 31 population means did not show that a firm with low, working capital investment policy (CA/TA) ratio is highly profitable than a firm that has a high, working capital investment policy (CA/TA) ratio. This paper tested the significance of size, growth, and financial leverage as risk factors in determining the profitability of companies. The size of a company was taken as the logarithm of its total assets. The results of tests on a firm s size, growth, and financial leverage variables were measured individually. Company size was measured with regression analysis through the STATA. On an average, the size of the firm is not significantly related to its profitability performance. Company s growth was another risk factor. It was measured by the growth rate of its sales in each year of this study. The base year was 2002, and 2011 was the last year for this ratio computation. This position was measured with regression analysis through the STATA. Generally, the result on whether the sales growth of a firm significantly improves its profitability rate is not significantly related to high profitability. A company s financial leverage was another risk factor. It was measured by the total debt/total assets ratio of the companies for this study. The result of the STATA regression analysis for the relationship between financial leverage and a firm s profitability mean did not confirm that high borrowing to fund working capital will bring more profitability to a firm than that of a company with low borrowing ratio.

32 32 The multifactor model was also tested in this study. Accordingly, the multifactor model proposed that the profitability of every firm is linearly dependent on the four variables; the company s working capital investment policy ratio, working capital financing policy ratio, the firm s size ratio, the firm s growth ratio, and the firm s financial leverage ratio. The multiple regressions model was tested at 5% level of significance. The regression test results confirmed that the five variables coefficient estimates were significant (p =.00), which conformed to the expectation from the model based on the previous Hypotheses 1 and 2. In summary, this study on working capital management policy has identified four important variables that can determine the profitability performance of a firm. In line with the ideas that have been tested in this study, all the variables were significant at 5% levels. This researcher confirmed that the investment policy, firm s size, growth, and financial leverage are important drivers of profitability, and firms should, therefore, consider these factors in their management decisions when making working capital policies. Contributions and Recommendations Several specific actions can be used as follow up from the results emanating from this study, which have used working capital investment policy, working capital financing policy, firm s size, growth, and financial leverage as variables that are positioned to improve wealth in small nonfinancial companies. I plan to create public awareness on working capital policy by writing academic articles that will be disseminated and

33 33 published in peer-reviewed journals. Also being an academician in accounting and finance in a regional university, I will in the course of student instructions refer to the findings of this study in my career endeavors. More training in the form of conferences, seminars, or handouts is recommended on the importance of efficient management of working capital of small companies. This project could be undertaken by the Small Business Administration (SBA) of each U.S. state and commonwealth. A small business owner needs to be aware of how to control assets of cash, account receivable, supplies, and most important, inventory so that fraud, theft, waste, and risks can be decreased in the business.risks, in particular financial risks, can be avoided; therefore, finance executives of small companies should update the firm s risk portfolio, make a full disclosure of the risks, and recommend working capital policy strategies in their firms. Three areas of further studies are recommended. 1. We did not use the national gross domestic product (GDP) as a control variable. However, it is a widely known fact that the GDP is a predictor of the economic environment in a country. If a country enjoys a high level of production and reasonably high employment level, then the GDP will be high. High GDP dictates how buoyant the economy is growing. The degree of growth in the national economy is a factor in the profitability measurements of a country.

34 34 2. Working capital policy impact on the company s profitability is not dictated exclusively by the ratios enunciated in this study. Other factors that could have an impact on a business achieving profitability are management style, legal environment, and population demography. These newly introduced factors are generally difficult to measure quantitatively; however, a mixed study can answer some pertinent questions that will be useful in advancing the course of working capital policies to pursue higher profitability in a company. 3. This study has used seven categories of industries to analyze the impact of working capital policies on the firm s profitability. The number of industry categories to be sampled can be expanded because small companies are the most numerous in the United States. Furthermore, the sample firms in this study were technically referred to as small, but their operational activity can qualify for medium and in some instances large firms. Therefore, further studies on small companies with different parameters can be sampled to judge the effect of working capital policies on their profitability. The United States economy has benefited from the small companies that span geographical areas of the country. These companies are owned by individuals, partners, and corporations. They contribute to U.S. coffers in the form of taxes and decreased unemployment and contribute positively to the nation s gross domestic product. Therefore, this category of the American business economy was the focus of this study, and productivity through excellent management of working capital was the major objective that engineered the study.

35 35 Financial stability is a major aim of establishing a company. A firm must make a profit, and be able to pay its debts, in order to have financial stability. An important aspect of sustaining financial stability is the working capital. This study analyzed working capital policies and their relationships to the firm s profitability. In recent years, the instability in the economic environment of the country as caused small businesses to lose profitability. However, effective working capital policies can improve a firm s profit. Finally, this study was an attempt to identify and measure the factors involved in working capital policies of small companies in the United States. Prior to this studies no other study on working capital policies in the United States had applied the same model, nor the ratios, except in theory, through the financial books, authored and published in the United States. Therefore, small companies of America should evaluate and incorporate the models of this study to their business thinking.

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