Operating risk and financing working capital strategies in SMEs

Purpose The objective of this study is to analyse the effects of operating risk on SMEs' working capital requirements (WCR) financing strategies. Since the literature has previously stated that operating and financial risk are compensated and that financial risk is related to debt maturity, our main research answers the question: Which strategies for financing WCR (greater use of short-term or long-term debt) should firms use based on their operating risk? Design/methodology/approach We measure firm's operating risk as the standard deviation of ROA (SD_ROA), and the financing strategy of WCR as the ratio of short-term debt to WCR (FWCR). We conduct econometric analyses using firm-, sector- and year-fixed effects. We also employ one-way clustered standard errors to control for unobserved heterogeneity and control for other factors that may affect operating risk, following previous literature. Findings Our results indicate a negative linear relationship between operating risk and the proportion of WCR financed with short-term debt, suggesting that firms with higher operating risk tend to adopt more conservative financing strategies (a higher proportion of long-term debt) in an attempt to limit their overall risk exposure. Originality/value This work provides several contributions to the literature on WCR management. It explores a topic that has not received enough attention in the debt maturity and working capital literature: the relationship between a firm's WCR financing and its operating risk. To the best of our knowledge, this is the first article to link both topics in the financial literature. As it focuses on SMEs, which are the backbone of the economy, the issue addressed is particularly important. Furthermore, Spain has a banking-oriented financial system, so these results can be extrapolated to countries with similar characteristics.