**4. Findings**

that is financed with short-term debt and profitability, β<sup>1</sup>

**Variable Definition Calculation**

182 Financial Management from an Emerging Market Perspective

ROEi,t−1 Return on equity Net Profiti,t−1/Total Equityi,t−1

SIZEi,t−1 Size Ln(Total Assets i,t−1) GROWTHi,t−1 Growth (Salest− Salest−1)/Salest−1 LEVi, t−1 Leverage Total Debtt−1/Total Assett−1

WCFi, t−1 Working capital financing Short Term Financial Debti,t−1/Working Capital

i,t−1 The square of working capital financing Short Term Financial Debti,t−1/Working Capital

requirementi,t−1

Requirementi, t−1)2

greater than the breakpoint; otherwise, WCFH i,t-1 takes the value of zero.

After the calculation of breakpoint using Model 1, dummy variables WCFLi,t−1 and WCFLi,t−1 are added to the Model 1 for the firms that have low and high WCFi,t−1 values. If the value of WCFi,t−1 is between zero and the breakpoint, the dummy variable WCFLi,t−1 takes the value of WCFi,t−1; otherwise, WCFLi,t−1 takes the value of the breakpoint. The other dummy variable WCFHi,t−1, takes the value of the difference between WCFi,t−1 and breakpoint if WCFi,t−1 is

Following Ghosh and Moon, Banos-Caballero, Garcia-Teruel, and Martinez-Solano, the robustness of the findings in Model 1 is checked by utilizing the following model [8, 26]:

ROEi,<sup>t</sup> = β<sup>0</sup> + β<sup>1</sup> WCFLi,t−<sup>1</sup> + β<sup>2</sup> WCFHi,t−<sup>1</sup> + β<sup>3</sup> SIZEi,t−<sup>1</sup> + B<sup>4</sup> GROWTHi,t−<sup>1</sup> + β<sup>5</sup> LEVi,t−<sup>1</sup> + εi,<sup>t</sup> (2)

Many studies pointed out the importance of low leverage ratios in providing financial flexibility (see [27–29]), while many others stated the importance of holding medium or high levels of cash [30–32]. Some studies showed that both leverage and cash ratios have a role in providing financial flexibility ([21, 33, 34]). In this study firstly firms are grouped according to their cash ratios. The firms that have cash ratio above the median value are accepted as "financially flexible." Secondly, the firms are grouped based on their leverage ratios. The firms that have leverage ratios below the median value are accepted as "financially flexible." In the third categorization, we combined the cash and leverage ratios. The firms that have leverage ratios in the bottom 75% of all firms and cash ratios in the top 75% of all firms are accepted as financially flexible. The dummy variables take the value of 1 if a firm is financially flexible;

ROEi,<sup>t</sup> = β<sup>0</sup> + (β<sup>1</sup> + δ<sup>1</sup> DUMi,t−1)WCFi,<sup>t</sup> + (β<sup>2</sup> + δ<sup>2</sup> DUMi,t−1)WCF<sup>2</sup>

The breakpoint is determined by using the equation −(*β*<sup>1</sup> <sup>+</sup> *<sup>δ</sup>*<sup>2</sup> )/2(*β*<sup>2</sup> <sup>+</sup> *<sup>δ</sup>*<sup>2</sup>

B<sup>4</sup> GROWTHi,t−<sup>1</sup> + β<sup>5</sup> LEVi,t−<sup>1</sup> + εi,<sup>t</sup> (3)

).

is expected to be negative.

Datasource: Datastream.

**Table 1.** Variable definitions.

otherwise, they take the value of zero:

β2

WCF<sup>2</sup>

is expected to be positive, whereas

<sup>i</sup>,t−<sup>1</sup> + β<sup>3</sup> SIZEi,<sup>t</sup> +

**Table 2** presents the descriptive statistics on profitability, the proportion of short-term financial debt in WCF financing, size, growth, and leverage ratios.

As seen in **Table 2**, the average return on equity (ROE) of the chemical, petroleum, rubber, and plastic sector firms over the period of analysis is 6.6%. The mean value of WCF is 0.29, which means that 29% of the working capital requirement is financed by short-term financial debt. The average size of the firms is 13.15, and the average sales growth is 22%. Leverage, which shows the proportion of total debt in total assets, is 19% on average. The standard deviations of ROE, WCF, GROWTH, and LEV ratios are 0.21, 0.23, 1.14, and 0.14, respectively.

The first column of **Table 3** shows the estimation results of Model 1. The coefficient of WCFi,t−1 variable is positive and statistically significant at the 1% significance level. The coefficient of WCFi,t−1 2 is negative and is also statistically significant but at the 5% significance level. Utilizing equation <sup>−</sup>*<sup>β</sup>* \_\_\_1 2 *β*<sup>2</sup> , the breakpoint is found to be 0.52. With the control variables, only the result of the growth variable is found to be statistically significant, but the coefficient of this variable is negative.

The breakpoint of 0.52, which is found by utilizing Model 1, is used for classifying the firms as WCRL and WCRH. In Model 2, if WCRi,t−1 is between 0 and 0.52, WCRLi,t−1 takes the value of WCRi,t−1; otherwise, if WCRi,t−1 is greater than 0.52, it takes the value of 0.52. WCRHi,t−1 variable takes the value of the difference between WCFi,t−1 and 0.52 when WCFi,t−1 is greater than 0.52; otherwise, it takes the value of zero. The estimation results of Model 2 show that the coefficients of WCFLi,t−1 and WCFHi,t−1 are positive and negative, respectively. Both are statistically significant. The concave-shaped relationship between WCF and profitability is also supported by the findings of Model 2.

**Table 3** presents the results of Model 1 and Model 2.

In **Table 4**, firms are categorized according to their leverage ratios in column 1, cash ratios in column 2, and leverage and cash ratios in column 3. In the first column, the firms which have cash ratios (cash/total assets) are above the median value and are accepted as "financially flexible." In the second column, the firms that have leverage ratios (total debt/total assets) under


**Table 2.** Descriptive statistics.


The results of Model 1 estimation are presented in the first column. The results of Model 2 estimation are presented in the second column. Standard errors are presented in parentheses. \*\*\*p < 0.01, \*\*p < 0.05.

**Table 3.** WCF and profitability relation.


**Table 4.** Financial flexibility, WCF and profitability.

the median are accepted as "financially flexible." In the third column, the firms that have cash ratios in the top of 75% of all firms and have leverage ratios in the bottom 75% of all firms are accepted as financially flexible. Dummy variables are used to discriminate the financially flexible firms. The dummy variable takes the value of 1 if the firm is financially flexible; otherwise, it takes the value of zero. For the firms that are financially flexible, the breakpoint is found by the equation of −(*β*<sup>1</sup> <sup>+</sup> *<sup>δ</sup>*2)/2(*β*<sup>2</sup> <sup>+</sup> *<sup>δ</sup>*<sup>2</sup> ), whereas the breakpoint is calculated by utilizing −β\_\_\_1 2 β<sup>2</sup> equation for the other firms. When the firms are categorized according to their leverage ratios, the breakpoint of financially flexible firms is found to be 0.74, and it is 0.41 for the others. When the categorization is based on cash ratios, the breakpoint for financially flexible firms is found to be 0.57, while it is 0.52 for the other firms. As for the last classification, which is based on cash and leverage ratios, the results show that the breakpoint for financially flexible firms is 0.65, while it is 0.51 for the other firms. These results show that financially flexible firms can finance a greater portion of WCR to increase their profitability, WCF.

The results of financial flexibility, WCF, and profitability are presented in **Table 4**.

#### **5. Conclusion**

In this study, the relationship between the proportion of short-term financial debt used to finance WCR and profitability is investigated. To do this the firms that are quoted on Borsa Istanbul chemical, petroleum, rubber, and plastic sector over 2005–2015 period are analyzed using a two-step GMM method. The results showed that WCR financed with short-term financial debt has a positive effect on profitability up to a breakpoint. Above this point the effect on profitability is found to be negative. In other words, the relationship between shortterm financial debt used to finance WCR and profitability is a concave-shaped relationship. The firms with low short-term financial debt-to-WCR ratios can increase their profitability by increasing the proportion of WCR that is financed with short-term financial debt, whereas the firms with high short-term financial debt-to-WCR ratios will harm their profitability by increasing the proportion of short-term financial debt in WCR financing. Further analysis also revealed that the breakpoint for financially flexible firms occurs at higher levels of short-term financial debt-to-working capital requirement ratios.

In the working capital literature, studies are generally focused on the relationship between investment in WCR and profitability. But the results of this study revealed that the financing of WCR is at least as important as the investment in WCR in terms of profitability. This study also sheds light about the benefits and limits of using short-term financial debt in WCR financing for managers.

Since there may be sectoral differences among different sectors that may affect the results, further research may be conducted on other sectors to reveal these differences.

### **Author details**

Burcu Dinçergök

the median are accepted as "financially flexible." In the third column, the firms that have cash ratios in the top of 75% of all firms and have leverage ratios in the bottom 75% of all firms are accepted as financially flexible. Dummy variables are used to discriminate the financially flexible firms. The dummy variable takes the value of 1 if the firm is financially flexible; otherwise,

0.308 0.185 0.12

**Variables LEV (1) CASH (2) LEV + CASH (3)** ROEi,t −0.182\*\*\* (0.0254) −0.222\*\*\* (0.0184) −0.185\*\*\* (0.0205) WCFi, t−1 0.604\*\*\* (0.132) 0.623\*\*\* (0.121) 0.528\*\*\* (0.127) WCFi,t−1\*D −0.306\*\*\* (0.0824) −0.190\*\* (0.0938) −0.260\*\* (0.116)

The results of Model 1 estimation are presented in the first column. The results of Model 2 estimation are presented in

**(1) (2)**

ROEi,t −0.205\*\*\* (0.00777) −0.208\*\*\* (0.0103)

WCFLi,t−1 0.232\*\*\* (0.0725) WCFHi, t−1 −0.344\*\*\* (0.0819) SIZEi, t−1 0.00835 (0.0104) 0.00164 (0.0146) GROWTHi,t−1 −0.00260\*\*\* (0.000615) −0.00281\*\*\* (0.000566)

LEVi, t−1 −0.150 (0.0946) −0.125 (0.101) OROEi,t −0.364\*\*\* (0.0143) −0.369\*\*\* (0.0130) Constant −0.00410 (0.129) 0.0883 (0.185)

Observation 161 161 Number of firms 25 25

the second column. Standard errors are presented in parentheses. \*\*\*p < 0.01, \*\*p < 0.05.

<sup>2</sup> −0.739\*\*\* (0.125) −0.604\*\*\* (0.107) −0.520\*\*\* (0.145)

 \*D 0.536\*\*\* (0.113) 0.226 (0.152) 0.314\* (0.175) SIZEi, t−1 −0.0285 (0.0244) 0.0285\* (0.0150) −0.000461 (0.00971) GROWTHi, t−1 −0.00342\*\*\* (0.000774) −0.00336\*\*\* (0.000590) −0.00153\*\* (0.000654) LEVi,t−1 −0.159 (0.123) −0.264\*\* (0.118) −0.143\* (0.0760) OROEi,t −0.333\*\*\* −0.381\*\*\* −0.392\*\*\* Constant 0.463 −0.270 0.119

WCFi,t−1

WCFi, t−1

WCFi, t−1 2

\*\*\*p<0.01, \*\*p<0.05, \*p<0.1.

**Variables ROE**

**Table 3.** WCF and profitability relation.

WCFi, t−1 0.376\*\*\* (0.138)

<sup>2</sup> −0.363\*\* (0.149)

184 Financial Management from an Emerging Market Perspective

**Table 4.** Financial flexibility, WCF and profitability.

Address all correspondence to: burcu.dincergok@atilim.edu.tr

Atılım University Management Department, Ankara, Turkey
