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1. Introduction
The corporate finance literature has traditionally focused on the study of long-term financial decisions. Researchers have particularly offered studies analyzing investments, capital structure, dividends or company valuation, among other topics. But the investment that firms make in short-term assets, and the resources used with maturities of under one year, represent the main share of items on a firm's balance sheet. In fact, in the sample used in the present study, current assets of small and medium-sized Spanish firms represent 69 percent of their assets, and at the same time their current liabilities represent more than 52 percent of their liabilities.
Working capital management is important because of its effects on the firm's profitability and risk, and consequently its value ([21] Smith, 1980). Specifically, working capital investment involves a tradeoff between profitability and risk. Decisions that tend to increase profitability tend to increase risk, and, conversely, decisions that focus on risk reduction will tend to reduce potential profitability. [10] Gitman (1974) argued that the cash conversion cycle was a key factor in working capital management. Actually, decisions about how much to invest in the customer and inventory accounts, and how much credit to accept from suppliers, are reflected in the firm's cash conversion cycle, which represents the average number of days between the date when the firm must start paying its suppliers and the date when it begins to collect payments from its customers. Previous studies have used measures based on the cash conversion cycle to analyze whether shortening this cycle has positive or negative effects on the firm's profitability. Empirical evidence relating working capital management and profitability in general supports the fact that aggressive working capital policies enhance profitability ([13] Jose et al. , 1996; [19] Shin and Soenen, 1998; for US companies; [5] Deloof, 2003; for Belgian firms; [23] Wang (2002) for Japanese and Taiwanese firms). This suggests that reducing working capital investment is likely to lead to higher profits.
These previous studies have focused their analysis on larger firms. However, the management of current assets and liabilities is particularly important in the case of small and medium-sized companies. Most of these companies' assets are in the form of current assets. Also, current liabilities are one of their main sources of...