WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE
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ABSTRACT
This study examined the correlation between working capital management as assessed by account receivable period (ACRP), inventory period (INVP), cash conversion cycle (CCC), and sales growth (SG) and profitability performance as measured by returns on assets (ROA). The study employed secondary data gathered from the yearly financial statements of Nigerian manufacturing firms registered on the Nigerian Stock Exchange (NSE) from 2008 to 2012. All hypotheses were tested using a multiple regression model, and the findings indicate that there is a substantial negative correlation between the account receivable period and the profitability of Nigerian manufacturing firms. It also demonstrates that the profit is strongly impacted by the number of days inventory was kept (INVP) and that profitability performance is significantly and negatively correlated with the cash conversion cycle (CCC). These findings indicate that effective strategies must be developed for the various components of working capital. Moreover, effective management and financing of working capital (current assets and liabilities) can boost the operating profitability of manufacturing companies.
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FIRST PART
INTRODUCTION
1.1 Context Of The Study
Working capital management, which entails the management of a company’s current assets and current obligations, has been identified as an essential aspect of financial management. Working capital (WC) refers to a company’s short-term investments. Pandey (2005) distinguished between gross and net notions for working capital. Gross working capital was defined by him as the firm’s investment in current assets. Cash, short-term securities, debtors, accounts receivable, and stocks are examples of current assets, which are assets that can be converted to cash within one accounting year. Net working capital, as defined by him, is the difference between current assets and current liabilities. Current liabilities are claims owed to third parties that are projected to mature within one accounting year. These include trade creditors, payable debts, bank overdrafts, and short-term loans. Working capital management, according to Home van (2000), is the administration of these assets: cash, marketable securities, receivables, and inventory, as well as the administration of current obligations.
The management of these short-term assets and liabilities is crucial to the financial health of organizations of all kinds. This significance stems from the fact that the quantities invested in working capital are frequently disproportionately high to the total assets utilized, necessitating a thorough inquiry (Smith, 1980). Working Capital should therefore be neither excessive nor insufficient for the smooth operation of a business. While storing an excessive quantity of working capital reduces a company’s profitability, holding an inadequate amount of it reduces a company’s liquidity and causes stock-outs, resulting in operational challenges (Krueger, 2002).
The ability of financial managers to properly handle accounts receivable, inventory, and account payable (components of working capital) is crucial to the profitability of a business (Filbeck and Krueger, 2005). By limiting the amount of investment related to current assets, a company can minimize its financing costs and/or enhance the money available for expansion of a project (Home Van Wachowicz, 2004). As a result, the majority of a financial manager’s time and energy is devoted to identifying suboptimal levels of current assets and liabilities and bringing them to optimal levels (Lamberson, 1995). The optimal level of working capital is one that strikes a balance between risk and productivity. Continuous monitoring is essential to maintain the optimal amount of working capital’s diverse components (Afza and Nazir, 2009).
Unsuccessful or ineffective management of a company’s working capital causes funds to be encumbered in idle assets and decreases the company’s liquidity and profitability (Reddy & Kameswar, 2004). According to Siddart and Das (1993), the primary cause of a business’s poor success is a lack of or improper management of working capital. According to Deloot (2003:573), “there is a considerable relationship between gross operating income and the number of days of receivables, inventory, and payables.” The association between accounts payable and profitability supports the notion that less profitable companies have longer payment terms.
Considering the significance of Working capital management, the researcher evaluated the association between Working Capital Management and profitability, comparable to Uyar (2009) and Samiloglu and Demirgune (2009). 2008; Vishnani and Shah, 2007; Tervel and Solano, 2007; Lazaridis and Tryfondis, 2006; Padachi, 2006; Shin and Soenen, 1998; Smith et al., 1997; Jose et al., 1996. Nevertheless, there are few research pertaining to Nigeria on the subject. Like Akinsulire, 2005, Falope,, 2009, Ajilore,, 2009 etc.
The majority of these research focuses on the financing policies of Working Capital Management. Shah and Sana (2006) analyzed the interaction between the oil and gas industry and seven enterprises using a limited sample size. Using ordinary least square and generalized least square, Raheman and Masr (2007) studied the profitability and Working Capital Management performance of 94 enterprises listed on the Karachi Stock Exchange between 1999 and 2004. In addition, sector-specific analysis of the Working Capital Management performance of manufacturing enterprises has been disregarded. Insufficient evidences on the firm’s success and Working Capital management in Nigeria provide a strong impetus for a comprehensive evaluation of the relationship between working capital management and firm performance. This study investigates the various methods of calculating Working Capital components and compares them to the performance of the Nigerian manufacturing industry.
1.2 Description Of The Problem
In recent years, a rising number of studies have studied the connection between working capital and corporate performance (Shin and Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; .Jinadu, 2010). The rationale for these coordinated efforts relied on the correlation between working capital management efficiency and a company’s profitability and its consequences for shareholder value. The majority of these studies, however, focused on large firms operating within the well-developed money and capital markets of developed economies and did not take into account the fact that the amount of working capital required varies across industries and firms based on the nature of business, scale of operation, production cycle, credit policy, and availability of raw materials, among other factors (Ghosh and Maji; 2004).
Regrettably, despite the vast literature in this field, many companies have failed, particularly in the manufacturing sector of the Nigerian economy, where the application of working capital is more prominent (Jinadu, 2009). Additionally, some promising investments with a high rate of return are failing and going out of business due to insufficient working capital. Numerous factories had been either temporarily or permanently shut down due to their inability to satisfy their financial obligations on time since they lacked liquid assets. As a result of their organization’s unsuccessful purpose, which was caused by inattention to the administration of working capital, a large number of Nigerian workers were forcibly put into the jobless market and became frustratingly reliant on family. Unfortunately, Nigeria’s capital and money markets are not helping to alleviate the situation; rather, they frequently exacerbate it by establishing bottlenecks with stringent requirements that cannot be easily met by enterprises on the edge of failure.
The issue therefore becomes how to urge the managers of these manufacturing organizations to pay closer attention to the management of their working capital. In other words, how may working capital be managed to favorably affect a company’s performance?
1.3 Aims Of The Research
This study’s primary purpose is to examine the relationship between working capital management and the corporate performance (profitability) of Nigerian manufacturing firms. While the study’s specific objectives are to: –
i. examine the association between the accounts receivable period (as a metric of WCM) and the profitability of Nigerian manufacturing enterprises.
ii. examine the association between inventory period (as a metric of WCM) and the profitability of Nigerian manufacturing firms.
iii. analyze the association between the cash conversion cycle period (as a complete indicator of WCM efficiency) and the profitability of manufacturing enterprises in Nigeria.
1.4 Research Concerns
In an effort to achieve the study objectives, the following research questions have been developed to aid the researcher in his or her quest for answers. These questions are;
i. What is the significance of the accounts receivable period (ACRP) to the profitability of Nigerian manufacturing firms?
ii. What is the connection between the inventory period (INVP) and the profitability of Nigerian manufacturing firms?
iii. What is the relationship between cash conversion cycle (CCC) and the profitability of Nigerian manufacturing firms?
How does the management of working capital impact the profitability of Nigerian manufacturing firms?
v. What optimal and acceptable amount of working capital should be maintained?
vi. How has the inadequacy of working capital impacted the profitability of Nigerian manufacturing firms?
1.5 Scientific Hypotheses
A hypothesis is a theory-based speculation or forecast about what can be observed in the world of reality. It is a provisional assertion regarding the relationships between two or many variables (Asika, 2005).
HO3:
HO2:
To offer empirical support for the relationship between working capital management and profitability of Nigerian manufacturing firms, the following three null hypotheses have been developed and stated:
There is no major link between accounts receivable and accounts payable.
period (ACRP) and manufacturing company profitability in Nigeria
There is no correlation between the inventory period (INVP) and the profitability of Nigerian manufacturing firms. There is no correlation between the cash conventions cycle (CCC) and the profitability of Nigerian manufacturing firms.
1.6 Study Extent
The scope of the study permits the researcher to confine his or her investigation to a controllable scope (Asika, 2005).
In this study, the relationship between working capital management and business performance is investigated for twenty (20) manufacturing firms out of 134 manufacturing firms listed on the Nigerian stock exchange during the years 2008-2012. The selection of the twenty (20) manufacturing companies was based on the following criteria:
Companies must continue to be listed on the Nigerian Stock Exchange (NSE) between 2008 and 2012.
Companies are required to have complete financial statements for the period in question.
Companies must be operating during the investigating time. Since manufacturing firms play a vital part in the Nigerian economy, this factor was taken into account.
1.7 Importance Of The Research
This study is extremely important because it will provide financial managers of these industrial companies with a deeper understanding of the necessity to pay special attention to the effective and efficient administration of their working capital. They will be in a better position to establish and implement strategies and policies aimed at stabilizing and controlling the various components of working capital, which has a substantial impact on the primary objective of business, which is to create shareholder value.
The analysis would also assist management to determine how much they should enhance their liquidity in order to improve their performance.
This is crucial for enhancing their firms’ goodwill, as companies who pay their debtors on time are regarded as creditworthy and obtain a positive reputation.
In addition, the research will contribute to the current body of knowledge regarding working capital management and company success. Finally, it is expected that the study will serve as a source of information to students undergoing research work of this nature in the future.
WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE
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