Leverage Capability in Controlling Free Cash Flow to Improve Financial Performance

Abstract

Free Cash Flow, in general, being a problem for the company if it is not good in controlling. The manager can use free cash flow for actions that can harm the company. Leverage is a cost that can control the usage of free cash flow for the company's activity, which in turn can improve financial performance. The purpose of this study is to examine the role of leverage in mediating the relationship between free cash flow and financial performance. The research variable consists of Free Cash Flow as the independent variable, the Leverage as the mediator and Financial Performance as the dependent variable. The population of this research is manufacturing companies listed on the Indonesia Stock Exchange periods 2011-2015. The sampling method is purposive sampling with criteria, and the samples that meet the criterion are 70 manufacturing companies. The research model is used Warp PLS 3.0. The results show that free cash flow has an effect on financial performance, and Leverage mediates the relationships between free cash flow and financial performance. This research contribute a novelty of science in the field of management accounting, and has positive implications for companies in determining control strategies of free cash flow through the leverage could improve the financial performance.

Factors Affecting Free-Cash-Flow (FCF) with Dividend Policy as a Mediating Variable

“…This is related to the agency theory which explains the relationship between the principal (owner) and the agent (management), which is called the agency relationship. [1] Agency relationships occur when one or more people (principal) employ another person (agent) to provide a service and then delegate the decision making authority to the agent. Management tends to use this FCF to make investments to increase the company's financial strength, while shareholders want this cash to be distributed as dividends.…”

“…Likewise, with leverage, the high-debt policy within a period will make the dividend held by the company, and indirectly will make FCF at the end of the period to be high as well. [1] Agency Theory is the objective difference between the owner, or in this case it is called as principal, with management or agent. The relationship between the agency theory and the excess of FCF will increase managerial motivation and provide the managers incentives to pursue their own interests.…”

“…The limitations in this study are: (1) This research basically only had three independent variables consisting of board structure, board independence, and leverage. (2) This research focused only on the companies in manufacturing sector listed on the IDX.…”