**1. Introduction**

Working capital management is one of the most important issues in corporate finance due to its effects on the profitability, liquidity, and risk of firms. When the literature on working capital management is reviewed, it can be seen that many of the studies are generally focused on the investment in working capital requirement (WCR) and firm performance [1–7].<sup>1</sup> While studies

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<sup>1</sup> In this study working capital requirement (WCR) is defined as the difference between current assets and accounts payable.

show that investment in WCR has an important effect on the profitability of firms, another issue, at least as important as investment in WCR, is the linkage between profitability and WCR financing. Since the types and maturities of financing sources have a direct impact on the costs and the risks of firms, it is expected that how WCR is financed will also have an effect on profitability. The literature on the relationship between WCR financing and profitability is very limited (i.e., there is only one study by Banos-Caberollo, Garcia-Teruel, and Martinez-Solano [8]). To the best of our knowledge, there is no study in Turkey related with this subject.<sup>2</sup>

Financial managers consider the general economic conditions, industrial factors, legal regulations, firm-specific factors, and the reaction of the lenders when deciding on the maturity and the type of the financing instruments they choose. At the same time, appropriateness, risk, cost, the financial leverage effect, flexibility in usage, timing, and the possible claims on management are also taken into account in the selection processes [10].

There are many advantages of using short-term debt in financing WCR. The most important advantage of short-term debt is its cost advantage. Normally, short-term debt is less costly than long-term debt. In addition, compared with long-term debt, short-term debt is easier to obtain and provides more flexibility over spending. But, short-term funds are riskier than long-term funds. This risk is due to the immediate payment of the short-term obligations, the refinancing requirement, and the uncertainty in interest rates when refinancing requirement arises. It is known that firms may face bankruptcy when they have difficulties in payment of short-term funds and when these funds are not renewed [11]. Due to these risks, the cost advantage of short-term debt is not limitless.

As stated by Banos-Caberollo, Garcia-Teruel, and Martinez-Solano, usage of short-term funds provides a cost advantage to the firms when a low percentage of WCR is financed by shortterm debt. However, if a high percentage of WCR is financed by short-term debt, an additional increase in short-term debt will increase the risk of repayment as well as the risk of renewing the funds and will cause the lenders to demand higher interest rates from the firms. Therefore, at lower levels of short-term debt-to-WCR ratios, the expected relationship between the proportion of short-term funds used to finance WCR and profitability is positive, but at higher levels of the short-term debt-to-WCR ratios, the expected relationship is negative [8].

The first aim of this study is to reveal the relationship between the proportion of short-term funds used in WCR financing and profitability in the Borsa Istanbul chemical, petroleum, rubber, and plastic sector. If the relationship turns out to be as expected, then the level at which the short-term debt-to-WCR ratio turns from positive to negative will also be investigated. To do this, the firms operating in the chemical, petroleum, rubber, and plastic sector in Borsa İstanbul over the 2005–2015 period are analyzed using two-step GMM method. This study finds a concave-shaped relation between the proportion of short-term financial debt that is used to finance WCR and profitability. The ratio of short-term financial debt increases profitability up to the breakpoint, but the effect of short-term debt on profitability turns to negative above this point.

<sup>2</sup> In Turkey, Poyraz analyzed the effects of working capital financing strategies on a single bank using multiple regression analysis [9]. Their methodology and scope are very different from our study.

Another important point regarding this issue is whether the WCR financing and profitability relationship of financially flexible firms show differences in comparison to other firms. Compared with the other firms, financially flexible firms can obtain credit more easily and in better terms, and their refinancing risk is lower as well. Therefore, it is expected that for these types of firms, the breakpoint of WCR financing and profitability relation occurs at higher levels of short-term debt-to-WCR ratios. The second aim of this study is to determine whether the breakpoint of financially flexible firms and other firms differs or not.

The remainder of the study is organized as follows. The first part gives a review of the literature; WCR financing and profitability relationship is explained in the second part. Data and methodology are described in the third part, and the findings are explained and evaluated in the fourth part. The conclusion is presented in the last part of the paper.
