Factors Associated with the Year-End Decline in Working Capital

Working capital is an important indicator of firm operational efficiency. All else being equal, lower levels signal greater efficiency. Managers are thus likely to be motivated to report lower levels of working capital at times of greater external attention. We find that working capital levels decrease in the fourth fiscal quarter significantly more than expected, conditional on seasonal changes in economic activity. The decrease subsequently reverses in the following first fiscal quarter. Evidence indicates that firms manage down year-end working capital through transactions that increase year-end operating cash flow and that firms spread this activity over all working capital accounts. Finally, the temporary decrease in year-end working capital is correlated with compensation benchmarks and analysts’ annual cash flow forecasts. The temporary drop is also more pronounced for firms with industry dominance.

This paper was accepted by Mary Barth, accounting.