WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE
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WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE
ABSTRACT
This study looked at the relationship between working capital management as assessed by account receivable period (ACRP), inventory period (INVP), cash conversion cycle (CCC), sales growth (SG), and profitability as evaluated by returns on assets (ROA).
The study used secondary data gathered from the yearly financial statements of Nigerian manufacturing companies listed on the Nigerian Stock Exchange (NSE) from 2008 to 2012.
A multiple regression model was used to evaluate all assumptions, and the study found that there was a negative significant association between the account receivable period and the profitability of Nigerian manufacturing enterprises.
It also demonstrates that the number of days inventory was kept (INVP) has a considerable impact on profit, as does the cash conversion cycle (CCC). These findings indicate that appropriate policies for each component of working capital must be developed.
Furthermore, effective management and financing of working capital (current assets and liabilities) can improve manufacturing enterprises’ operating profitability.
Chapter one
INTRODUCTION
1.1 Background for the Study
Working capital management, which deals with the management of a company’s current assets and liabilities, is recognised as an important aspect of financial management. Working capital (WC) is the firm’s investment in short-term assets. Pandey (2005) divided working capital into gross and net concepts.
He defined gross working capital as the company’s investment in current assets. Current assets are those that can be converted into cash within an accounting year. Examples include cash, short-term securities, debtors, bills receivable, and stocks.
He defined net working capital as the difference between current assets and liabilities. Current liabilities are outsiders’ claims that are expected to mature and be paid within an accounting year.
These include trade creditors, bills payable, bank overdrafts, and short-term loans. Home van (2000) defined working capital management as the administration of these assets: cash, marketable securities, receivables, and inventory, as well as the administration of current liabilities.
The management of these short-term assets and liabilities is critical to the financial health of companies of all sizes. This significance stems from the fact that the quantities invested in working capital are frequently significant in proportion to total assets employed, necessitating a thorough analysis (Smith, 1980).
Working capital should therefore be neither too much nor too little, but just enough to keep a business functioning smoothly. While an excess of working capital reduces a firm’s profitability, an insufficient amount leads to reduced levels of liquidity and stock outs, making it difficult to sustain smooth operations (Krueger, 2002).
Business success, then, is significantly dependent on the ability of financial managers to efficiently manage accounts receivable, inventories, and accounts payable (which are components of working capital) (Filbeck and Krueger, 2005).
Firms can lower financing costs and/or enhance cash available for project expansion by reducing the amount of investment tied up in present assets (Home Van Wachowicz, 2004).
As a result, the majority of a financial manager’s time and effort is devoted detecting and correcting non-optimal levels of current assets and liabilities (Lamberson, 1995).
The optimal level of working capital is one that strikes a balance between risk and efficiency. Continuous monitoring is essential to keep the various components of working capital at their optimal levels.
Poor or inefficient working capital management causes funds to be tied up in idle assets, reducing a company’s liquidity and profitability (Reddy & Kameswar, 2004). According to Siddart and Das (1993), the most common reason for a project’s poor pace is a lack or improper management of working capital.
According to Deloot (2003, p. 573), “there is a significant relationship between gross operating income and number of days of account receivable, inventories and accounts payables” . The association between accounts payable and profitability supports the notion that less profitable enterprises take longer to pay their debts.
Considering the importance of working capital management, the researcher focused on examining the relationship between working capital management and profitability, like other similar works such as Uyar, 2009; Samiloglu and Demirgune 2008; Vishnani and Shah (2007); Tervel and Solano (2007);
Lazaridis and Tryfonidis (2006); Padachi (2006); Shin and Soenen (1998); Smith et al. (1997); and Jose et al. (1996). However, there are a few studies that mention Nigeria in relation to the subject. Examples are Akinsulire (2005), Falope (2009), and Ajilore (2009).
The majority of these research focused on Working Capital Management funding policies. Shah and Sana (2006) focused on the oil and gas sector, estimating the link with a small sample of seven enterprises.
Raheman and Masr (2007) used ordinary least squares and generalised least squares to analyse the profitability and working capital management performance of 94 enterprises listed on the Karachi Stock Exchange between 1999 and 2004.
However, because each organisation has distinct characteristics, this study neglected the fixed impact, as well as a sector-by-sector analysis of manufacturing enterprises’ Working Capital Management performance.
Inadequate evidence on business performance and working capital management in Nigeria provides a strong impetus for a thorough evaluation of the relationship between working capital management and company success.
This study investigates the various methods of assessing Working Capital components and how they relate to the performance of the Nigerian manufacturing sector.
1.2 Statement of the Problem
In recent years, a rising number of research have looked into the relationship between working capital and business profitability (Shin and Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; Jinadu, 2010).
The justification for these collaborative efforts focused on the relationship between working capital management efficiency and company profitability, as well as the consequences for shareholder value.
The majority of these studies, however, focused on large firms operating in well-developed money and capital markets in developed economies, and did not take into account the fact that the amount of working capital required varies across industries and firms depending on the nature of business, scale of operation, production cycle, credit policy, raw material availability, and so on (Ghosh and Maji; 2004).
It is disappointing to note that, despite the vast literature in this field, many enterprises have failed, particularly in the Nigerian manufacturing sector, where the use of working capital is more prevalent (Jinadu 2009). In addition, several prospective projects with high rates of return are faltering and going out of business due to a lack of operating cash.
Many factories had been temporarily or permanently shut down because they were unable to satisfy their financial obligations on time due to a lack of liquidity.
Many Nigerian workers had been forced into the unemployment market and had become hopelessly reliant on relationships as a result of their organization’s abandoned purpose due to a lack of attention paid to working capital management.
Unfortunately, Nigeria’s capital and money markets do not help to alleviate the situation; rather, they often exacerbate it by establishing bottlenecks with tough criteria that cannot be easily satisfied by enterprises on the edge of failure.
The question then becomes: how can managers of these manufacturing organisations be induced to pay more attention to working capital management? In other words, how can working capital be managed to favourably effect corporate performance?
1.3 Objectives of the Study
The primary goal of this research is to evaluate the relationship between working capital management and corporate performance (profitability) in Nigerian manufacturing enterprises. The study’s particular aims include:
i. Investigate the association between the accounts receivable period (a measure of WCM) and the profitability of Nigerian manufacturing enterprises.
ii. Investigate the association between inventory period (a metric of WCM) and profitability in Nigerian manufacturing enterprises.
iii. examine the association between the cash conversion cycle period (a comprehensive indicator of WCM efficiency) and the profitability of Nigerian manufacturing enterprises.
1.4 Research Questions.
In an effort to achieve the research objectives, the following research questions have been developed to serve as a guide in the researcher’s search for answers. The questions are:
i. What is the relationship between the accounts receivable period (ACRP) and profitability in Nigerian manufacturing companies?
ii. What is the relationship between inventory period (INVP) and profitability in Nigerian manufacturing companies?
iii. What is the relationship between the cash conversion cycle (CCC) and profitability in Nigerian manufacturing companies?
iv. What impact does good working capital management have on the profitability of Nigerian manufacturing companies?
v. What amount of working capital is optimal and desirable?
vi. To what extent has a lack of working capital affected the profitability of Nigerian manufacturing companies?
1.5 Research Hypotheses.
A hypothesis is a supposition or forecast about what can be seen in the real world, based on theory. It is a provisional assertion about the relationships that exist between two or more variables (Asika, 2005).
HO3:
HO2:
To offer empirical support for the relationship between working capital management and profitability of Nigerian manufacturing enterprises, three hypotheses have been developed and given in their null versions as follows:
HO1: No substantial association exists between the accounts receivable.
duration (ACRP) and profitability of Nigerian manufacturing businesses
The inventory period (INVP) has no meaningful link with the profitability of Nigerian manufacturing companies. There is no significant association between the cash convention cycle (CCC) and the profitability of Nigerian manufacturing companies.
1.6 Scope Of Study
The scope of the study allows the researcher to confine his or her research to a manageable area (Asika, 2005).
This study attempts to investigate the association between working capital management and business performance for twenty (20) manufacturing firms out of the 134 registered on the Nigerian stock exchange from 2008 to 2012. The twenty (20) manufacturing enterprises were chosen according to the following criteria:
Companies must remain listed on the Nigerian Stock Exchange (NSE) from 2008 to 2012.
Companies must have complete financial statements for the period being reviewed.
Companies must be operational during the term of investigation. Manufacturing organisations were given special consideration because they play a significant role in the Nigerian economy.
1.7 Significance of the Study
This study is critical because it will provide finance managers in these manufacturing organisations with improved insights into the importance of effective and efficient working capital management.
They will be in a better position to establish and implement strategies and policies aimed at stabilising and controlling the various components of working capital, particularly as they have a substantial impact on the primary goal of company, which is to create shareholder value.
The analysis would also help management determine how much liquidity they should increase to meet performance targets.
This is critical in enhancing their firms’ goodwill since companies who pay creditors on time are regarded creditworthy and develop a positive reputation.
And, for academic purposes, the research will add to the current body of information on working capital management and company performance. Finally, the study is planned to serve as a resource for future students conducting similar research.
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