Short-term financial constraints and SMEs’ investment decision: evidence from the working capital channel

This paper investigates the real effect of short-term financial constraints on small and medium-sized enterprises (SMEs). Under the working capital channel, cash credit constraints force entrepreneurs to forgo investment opportunities in order to finance their working capital needs. Building on survey data, I find that short-term credit constraints are as important as long-term ones in SMEs’ investment decisions. Besides, the detrimental effect of cash credit constraints on corporate investment is stronger for SMEs with higher increase in working capital needs but lower for liquid ones that are able to adjust their accounts receivable and inventories. My results suggest that short-term finance is a major issue for SMEs. Plain English Summary Short-term credit constraints turn out to be as important as long-term ones in SMEs’ investment decisions. Building on survey data, this paper investigates the real effects of short-term financial constraints on small businesses through an under-explored transmission mechanism. While the bulk of research on the effects of financial constraints focuses on long-term liabilities, I stress the importance of short-term finance. Owing to the competition between working and fixed capital in cash-flow uses, cash credit constraints force entrepreneurs to allocate additional cash-flow to finance the increase in their working capital needs to the detriment of long-term assets.The main implication of this work is that supports for short-term financing would provide a significant boost to long-term investment and economic growth.