The Impact of Firm Characteristics on the Relationship between Working Capital Financing and Financial Performance

ObjectiveThe main purpose of this research is to examine the relationship between working capital financing and financial performance, emphasizing the role of company characteristics, in companies listed on the Tehran Stock Exchange. This study aims to contribute to the existing literature on working capital management in the following ways. First, unlike most previous studies that have examined the relationship between working capital management and firm performance, this study examines the effect of working capital financing on firm performance using a quadratic function. Secondly, it empirically examines the effect of company characteristics (company size, financial leverage, and financial constraints) on the relationship between working capital financing and company performance. MethodsThis research is applied in purpose and adopts a causal-correlational approach. The library method was used to gather information on the theoretical foundations. To achieve the research objectives, data from 1,034 companies from 2012 to 2022 were utilized. Arellano and Bond's two-step Generalized Method of Moments (GMM) was applied to estimate the research models and mitigate potential endogeneity issues. ResultsThere is a non-linear U-shaped relationship between working capital financing and financial performance. Additionally, company size, financial leverage, and financial constraints influence this relationship. In other words, changes in company size, financial leverage, and financial constraints alter the level of the break-even point. Also, the relationship between working capital financing and financial performance in large companies, high leverage and high financial constraint is inverted U-shaped. However, the relationship is U-shaped for small firms with low leverage and low financial constraints. ConclusionThe research findings indicate that working capital financing is a key factor influencing the financial performance of companies. Moreover, company managers do not necessarily employ a uniform strategy when making decisions regarding working capital financing. Managers of small companies with low leverage and low financial constraints can enhance company performance by adopting an aggressive working capital financing strategy. In contrast, managers of large companies with high leverage and high financial constraints can improve performance by following a defensive working capital financing strategy. It means that when companies cover a large part of their working capital needs through short-term loans, the performance of the company improves, but when a small part of the working capital needs is covered through short-term loans, the company's performance decreases. In other words, using an aggressive working capital strategy can increase the company's performance without hurting the company's performance. However, the defensive strategy may not increase the performance of the companies appropriately. Also, the results show that company size, financial leverage, and financial constraints affect the relationship between working capital financing and financial performance.