EFFECTS OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF MANUFACTURING COMPANY
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EFFECTS OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF MANUFACTURING COMPANY
Chapter one
INTRODUCTION
1.1 Background for the Study
A company’s working capital has a significant impact on whether it is profitable or unprofitable. The majority of potential investors and others analyse position statements to evaluate working capital management. Net Working capital is comprised of current assets less short-term obligations.
Positive working capital indicates that the organisation is well-positioned to repay its short-term debt, whereas negative working capital indicates that the corporation’s most liquid assets are insufficient to meet its present monetary commitments. Any finance manager must maintain a highly favourable point of investment in the company’s most liquid assets.
Working capital is the amount of capital required for a business to operate on a daily basis. In manufacturing, it is the investment needed to convert raw materials into ready-to-sell products for the enterprise.
The most crucial items in determining working capital are the corporation’s inventories, accounts receivable, and payable. Working capital management is commonly viewed as a technique for sustaining the business’s competence within its operations.
Lenders frequently examine working capital to determine a company’s short-term ability to repay loans during challenging financial times.
The efficacy of the accounting and finance department or function is a critical predictor of modern organisations’ survival and long-term company growth (Eljielly, 2004).
Working capital management (WCM), among other things, is an area of accounting and finance that influences the effective operations of businesses in general (Eljielly, 2004; Shin & Soenen, 1998; Tauringana & Afrifa, 2013).
WCM is defined as the management of current assets and liabilities (Agyei & Yeboah, 2011; Tauringana & Afrifa, 2013). The concept of WCM focuses on how organisations manage their short-term capital
which is an important component of corporate financial management and has a direct impact on the profitability and liquidity of both small and large businesses (Agyei and Yeboah, 2011; Tauringana and Afrifa, 2013).
It has been widely acknowledged that small-scale industries make significant contributions to employment creation, fostering an entrepreneurial culture, and bringing up new economic options for a country’s development.
The current scarcity of cash and credit is threatening the survival of many businesses around the world, particularly in Nigeria, because it is considered the source of a company’s working assets and liabilities, also known as working capital.
It is an undeniable fact that corporations cannot exist without working capital. Finally, working capital management (WCM) entails making short-term decisions on working capital (WC) and financing all parts of both firms’ short-term assets and liabilities.
This explains why enterprises with insufficient working capital are in financial straits. As the name implies, working capital refers to the finances required for a firm’s day-to-day operations; it is the excess of current assets over current liabilities.
Working capital management refers to the relationship between a company’s short-term assets and short-term liabilities. The purpose of working capital management is to ensure that a company can continue to operate and that it has enough funds to cover both maturing short-term debt and anticipated operational needs.
As a result, working capital management has emerged as one of the most critical concerns in organisations, with many financial executives attempting to understand the fundamental working capital drivers and the optimum quantity of working capital (Lamberson 1995).
Working capital management includes inventory, account payables, account receivables, and cash. Many businesses fail because financial managers are unable to plan and handle their organisations’ present assets and liabilities. This explains why working capital management is critical for businesses with limited access to the long-term financing market.
Working capital reflects both a company’s efficiencies and its short-term financial health. It also gives investors an insight of the company’s fundamental operating efficiency.
Working capital demonstrates a company’s efficiency, financial strength, and cash flow health, which aids in estimating profitability, risk, and value (Smith 1980).
The importance of working capital has been highlighted in most of the WCM literature, e.g., EljeUy (2004) described that efficient WCM are engaged in planning and controlling current assets and liabilities in such a way that eliminates the risk of inability to meet short-term obligations in hand while avoiding excessive investments in these assets.
According to Siddiquee and Khan (2009), improper WC management not only affects profitability but may also lead to a financial catastrophe, therefore any organisation, regardless of profit orientation, size, or sort of business, requires the appropriate amount of WC.
As a result, effective WCM is the most important aspect in ensuring the existence, liquidity, solvency, and profitability of the business organisation. Thus, we may claim that the strategy to managing working capital has a significant impact on the firm’s performance.
The books emphasise the importance of working capital in a company’s day-to-day operations. Having mentioned that working capital is the lifeblood of a corporation
it is believed that successful provision of it will result in more success for a firm, but ineffective management of it will result in the final demise of what might otherwise be regarded a prosperous concern.
Working capital is critical to a company’s operations, but maintaining it is even more important. This is because excessive working capital means holding costs and idle funds that generate no profits for the firm
whereas insufficient working capital, which means not having enough funds, not only limits the firm’s profitability but also causes production interruptions, inefficiencies, and sales disruptions.
Over the previous five to ten years, the global beer market has become increasingly concentrated, with a wave of corporate combinations among brewery titans and diversification of investments beyond their geographical location.
All of this is aimed at dominating the market and increasing shareholder wealth. Increasing market dominance, which maximises shareholder wealth, is heavily reliant on firm-specific variables such as consistent profitability. Profit maximisation for any firm depends on the efficient management of costs.
Optimising the production process, as well as increased sales as a result of the firm’s market dominance. Working capital is thought to have a significant impact on corporate profitability.
Working capital is defined as stock that can be converted or resold for a profit. It is the most expensive aspect of a business, particularly in manufacturing. Working capital typically accounts for 30% to 40% of a firm’s overall investment.
Working capital investment has a significant impact on a company’s profits. Nonetheless, large quantities of current assets can easily result in a corporation receiving a poor return on investment, whilst firms with insufficient current assets may face shortages and issues sustaining efficient operations (Van Horne and Wachowicz, 2000).
As a result, working capital management is an important aspect of corporate finance because it has a direct impact on a company’s liquidity and profitability.
It focuses on the present assets and liabilities of a company. For example, current assets make up more than half of a typical manufacturing firm’s total assets (Abdul and Mohamed, 2007).
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