Cash flow management and manufacturing firm financial performance: A longitudinal perspective

Abstract

A firm's cash flow policies, which manage working capital in the form of cash receivables from customers, inventory holdings, and cash payments to suppliers, are inexorably linked to the firm's operations. Building on earlier research, this study: (i) extends prior studies by examining the relationships between changes in cash flow measures and changes in firm financial performance using a longitudinal sample of firm data; and (ii) investigates the direction of the relationship between quarterly changes in cash flow positions and firm financial performance. This study is conducted using the Generalized Estimating Equations (GEE) methodology to analyze a longitudinal sample of eight quarters of cash flow and financial performance data from 1233 manufacturing firms. The analyses find that changes in the widely used Cash Conversion Cycle (CCC) metric do not relate to changes in firm performance; however, changes in the less used Operating Cash Cycle (OCC) metric are found to be significantly associated with changes in Tobin's q. This examination of how changes in specific cash flow measures relate to changes in Tobin's q shows that both reductions in Accounts Receivables (measured as Days of Sales Outstanding [DSO]) and reductions in Inventory (measured as Days of Inventory Outstanding [DIO]) relate to firm financial performance improvements that persist for several quarters. Endogeneity tests of whether a firm's cash flow management strategy leads to changes in firm performance or if the cash flow strategy is a byproduct of firm performance suggest that reductions in DSO lead to improved firm financial performance.

The relationship of operational innovation and financial performance—A critical perspective

Abstract
Operations management designs, schedules, and controls organizational processes to increase productivity by using methods such as Just-in-Time (JIT)/Lean Manufacturing, Total Quality Management (TQM) or Environmental Management Systems (EMS). Following implementation, managers generally want to determine the impact of such operational innovations on firm performance. Past studies analyzed financial ratios to prove the usefulness of the operational methods; however, findings are mixed. While some reported positive relationships between operational innovations and financial performance, others found no or inconsistent relationships. Motivated to uncover explanations for said inconsistencies, this paper takes a critical look at the appropriateness of the profitability ratios Return on Asset (ROA), Return on Equity (ROE) and Basic Earning Power (BEP) in determining the impact of a given operations strategy on firm performance. Focusing on JIT/Lean Manufacturing, the relationship between these ratios and inventory management ratios is analyzed. Fixed-effect regression shows that no consistent relationship between ROA, ROE, BEP and inventory management ratios exists. This result may be explained, as the profitability of a firm is affected by at least two factors: results from its operations, and how these are financed (e.g. usage of cheap debt, which enhances profitability). This paper suggests that the impact of an individual operations strategy is difficult to isolate from other firm activities, such as its financial management. Hence, profitability ratios such as ROA, ROE and BEP that aggregate all of a firm's activities may not be suitable metrics to determine the effect of JIT/Lean Manufacturing methods on financial firm performance.