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Working Capital, Financial Constraints, and Firm Value: Evidence of Indonesia Manufacturing Firm

Ester Gracia

Graduate, Universitas Indonesia



This study examines the effect of working capital management and financial constraints (which proxied by size, cash flow, leverage, and Z-score) to the firm value in manufacturing listed on the Indonesia Stock Exchange during the period of 2012-2016. The research uses multiple regression data panel with fixed effect model of 110 firms. Data processing is statistical software Eviews 9. The results show that working capital and financial constraints affect the firm value.


In theory, maximizing shareholder wealth by the company is clearly explained, but in real life sometimes it is complicated. The shareholder wealth is related to the value of the company. The latter, the value of a company can be viewed both as a long-term value of the company. The difficulty of corporate management in the decision-making process arises when this linkage does not exist, that is when shareholder wealth is only considered in terms of financial performance generated in the short term. The value of the firm is based on some of the same basic concepts that are reflected in the financial statements (Johnson, 1999).

Each industry has different working capital characteristics. In practice, the manufacturing sector has a more complex working capital component than others, because the manufacturing industry sector has the process of producing raw materials into intermediate goods to finished goods that require payment several months before the goods sold to customers or so-called accrual payment.

Working capital management related to cash flow is one of the challenges for manufacturing companies. In general, working capital describes the current situation, while cash flow is a measure of a company's ability to generate cash over a given period of time. In accounting, the calculation of working capital is expressed as net working capital which equals to current assets minus current liabilities. If net working capital is negative (debt is greater than the asset), it will affect short-term cash flow. According to Pimplapure and Pushparaj (2011), if the company has negative working capital, there will be liquidity problems that cause disruption of the company's operations so that the income becomes decreased. As a result, the value of the company will also decrease.

However, the optimal level of working capital depends heavily on the company’s financial condition. This financial condition described by financial constraints. The optimal level of working capital with financial constraints is lower than the optimal level of working capital with no financial constraint (Banos et al, 2014). Financial constraints are a condition where companies have limited money-making ability, which may cause companies to reduce their investment in working capital by collecting receivables, tightening credit terms, liquidating existing inventories, and easing credit requirement supplied (Hill et al, 2010). Molina and Preve (2009) conducted a study showing the result that companies experiencing financial constraints have significantly reduced the rate of trade credit compared to growing companies. Thus, overall working capital is inversely correlated with financial constraints. Typically, investors tend to avoid companies that have a high financial constraint. According to Douglas (1997), a company has financial constraints when the company has significant problems in repaying debt. The variables used to prohibit the existence of financial constraints of a company according to Banos et al (2014) are size, cash flow, leverage, and Z-Score.

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