Working Capital Leverage: A Conceptual Critique and Modified Formulation

Abstract

This working paper elucidates that the term 'working capital leverage’ as per the traditional concept, i.e. the responsiveness of the return on investment (ROI) to changes in the level of current assets (CA) is a misnomer because the leverage effect does not exist for an increase in the level of current assets. Also, the correct term for the traditional 'working capital leverage' should be 'current asset elasticity of ROI' [or ‘gross working capital elasticity of ROI']. Lastly, the true connotation of the term ‘working capital leverage’ is manifested in a newly defined concept of 'net operating working capital leverage'.