WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE

Format: MS WORD |  Chapter: 1-5 |  Pages: 65-80 |  Price NGN3,000

ABSTRACT

This study investigated the relationship between working capital management measured by account receivable period (ACRP), inventory period (INVP), cash conversion cycle (CCC) and sales Growth (SG) and profitability performance measured by returns on assets (ROA). The study utilized secondary data obtained from the annual financial statements of Nigerian Manufacturing companies listed on the Nigerian Stock Exchange (NSE) for period 2008 – 2012. Multiple regression model were adopted for testing all the hypotheses and the study result reveals that there was a negative significant relationship between the account receivable period and profitability of the Nigerian Manufacturing companies. It also reveals that the profit is significantly influenced by the number of days inventory were held (INVP) and that the profitability performance negatively and significantly related to the cash conversion cycle (CCC). These results suggest that effective policies must be formulated for the individual components of working capital. Furthermore, efficient management and financing of working capital (current assets and liabilities) can increase the operating profitability of manufacturing firms.

CHAPTER ONE

INTRODUCTION

1.1 Background To The Study

Working capital management of a firm, which deals with the management of current assets and current liabilities, has been recognized as an important area in financial management. Working capital (WC) refers to the firm’s investment in short-term assets. Pandey, (2005) classified working capital into gross and net concepts. He defined gross working capital as the firm’s investment in current assets. Current assets are the assets which can be converted into cash within an accounting year and these include; cash, short-term securities, debtors, bills receivables and stocks. He described net working capital as the difference between current assets and current liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year. These include trade creditors, bills payable, bank overdraft and short- term loan. Home van, (2000) described working capital management as involving the administration of these assets namely cash, marketable securities, receivables and inventories and the administration of current liabilities.

Management of these short-term assets and liabilities is important to the financial health of business of all sizes. This importance is hinged on the fact that the amounts invested in working capital are often high in proportion to the total assets employed and therefore warrants a careful investigation (Smith, 1980). Working Capital therefore, should neither be more nor less, but just adequate for the smooth running of a firm. While excess amount of working capital results in the reduction of firm’s profitability, holding of inadequate amount of it leads to lower levels of the firm’s liquidity and stock outs resulting in difficulties in maintaining smooth operation (Krueger, 2002).

Business success, therefore, heavily depends on the ability of the financial managers to effectively manage accounts receivable, inventory and account payable (which are component of working capital) (Filbeck and Krueger, 2005). Firm can reduce their financing costs and or increase the funds available for expansion of project by minimizing the amount of investment tied up in current assets (Home Van Wachowicz, 2004). For this reasons, most of the financial manager’s time and efforts are spent in identifying the non-optimal levels of current assets and liabilities and bringing them to optimal levels (Lamberson, 1995). An optimal level of working capital is the one in which a balance is achieved between risk and efficiency. To maintain the optimal level of various components of working capital, continuous monitoring is required (Afza and Nazir, 2009).

A poor or inefficient working capital management leads to tie up funds in idle assets and reduces the liquidity and profitability of a company (Reddy & Kameswar, 2004). Siddart & Das (1993), states that the major reason for slow progress of an undertaking is shortage or wrong management of working capital. Deloot (2003: 573), states that “there is a significant relationship between gross operating income and number of days of account receivable, inventories and accounts payables”. The relationship between accounts payable and profitability is consistent with the view that less profitable firms wait longer to pay their bills.

Considering the importance of Working capital management therefore, the researcher focused on evaluating the Working Capital Management and profitability relationship 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 with reference to Nigeria in respect of the subject. Like Akinsulire, 2005, Falope,, 2009, Ajilore,, 2009 etc.

Most of these studies focused on the Working Capital Management financing policies. Shah and Sana (2006) concentrated on the oil and gas sector and estimated the relationship using small sample of 7 firms. Raheman and Masr (2007) analyzed profitability and Working Capital Management performance of 94 firms listed on Karachi Stock Exchange for the period 1999-2004 by using ordinary least square and generalized least square. However, this study ignored the fixed effect of each firm as each firm has its unique characteristics and also ignores sector-wise analysis of Working Capital Management performance of manufacturing firms. Insufficient evidences on the firm’s performance and Working Capital management with reference to Nigeria therefore, provide a strong motivation for evaluating the relationship between working capital management and firm’s performance in detail. This study therefore, explores the various way of measuring Working Capital components and relates them to the performance of the Nigerian manufacturing sector.

1.2 Statement Of The Problem

There has been a growing number of studies that examined the relationship between working capital and corporate profitability in the recent time (Shin and Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; .Jinadu, 2010). Justification for this common efforts centered on the relationship between efficiency in working capital management and firms profitability and its implications on shareholder’s value. Most of these studies were however, centered on large firms operating within well developed money and capital market of developed economies and did not consider the fact that the amount of working capital required varies across industries and indeed firms depending on the nature of business, scale of operation, production cycle, credit policy, availability of raw materials etc (Ghosh and Maji; 2004).

It is regrettable to note that in spite of these huge literatures in this area, many firms had crashed, more especially manufacturing sector of the Nigerian economy in which application of working capital is more pronounced (Jinadu, 2009). In addition, some promising investments with high rate of return are failing and being frustrated out of business because of inadequacy of working capital. Many factories had been either temporarily or completely shot down because they could not meet their financial obligations as at when due because they were not liquid. Many Nigerian workers had been forcefully thrown into unemployment market and frustratingly became dependent on relations as a result of the aborted mission of their organization caused by poor attention given to the management of working capital . Unfortunately, Nigeria capital and money markets are not really helping to ameliorate the problem, instead, more often than not; they compound the problem by creating bottleneck with harsh conditions that could not be easily met by the companies that are at the verge of collapse.

The problem then arises as to how managers of these manufacturing organizationcould be encouraged to pay more attention to the management of their working capital. In other words, how could working capital be managed in order to impact positively on firms performance.

1.3 Objectives Of The Study

The main objective of this study is to investigate the relationship between working capital management and the corporate performance (profitability) of the Nigerian manufacturing companies. While the specific objectives of the study are to: –

i. investigate the relationship between the accounts receivable period (as a measure of WCM) and profitability of manufacturing companies in Nigeria.

ii. investigate the relationship between inventory period (as a measure of WCM) and profitability of manufacturing companies in Nigerian.

iii. investigate the relationship between cash conversion cycle period (as a comprehensive measure of checking the efficiency of WCM) and profitability of manufacturing companies in Nigeria.

1.4 Research Questions

In a bid to actualize the research objectives, the following research questions have been formulated which serve as a guide in the researcher’s quest for answers. These questions are;

i. What is the significant relationship between the accounts receivable period (ACRP) and profitability of Nigerian manufacturing companies?

ii. What is the significant relationship between the inventory period (INVP) and profitability of Nigerian manufacturing companies?

iii. To what extent is the relationship between cash conversion cycle (CCC) and profitability of manufacturing companies in Nigeria?

iv. To what extent does the effective management of working capital affect the profitability of the Nigerian manufacturing companies?

v. What level of working capital is optimal and desirable?

vi. To what extent has the inadequacy of working capital affect the profitability of the Nigerian manufacturing companies.

1.5 Research Hypotheses

A hypothesis is a conjecture or a prediction of what can be seen in the world of reality and this prediction is made from the world of theory. It is a tentative statement about the relationships that exist between two or among many variables (Asika, 2005).

HO3:

HO2:

To provide an empirical support to the relationship between working capital management and profitability of the Nigerian manufacturing companies, three hypotheses have been formulated and stated in their null forms as follows:

HO1: There is no significant relationship between the accounts receivable

period (ACRP) and profitability of Nigerian Manufacturing Companies

There is no significant relationship between the inventory period (INVP) and profitability of Nigerian Manufacturing Companies There is no significant relationship between the cash conventions cycle (CCC) and profitability of Nigerian Manufacturing Companies

1.6 Scope Of Study

The scope of the study enables the researcher to circumscribe his/her research within a manageable limit (Asika, 2005).

In this research work, an attempt is made to explore the relationship between working capital management and firm’s performance for twenty (20) manufacturing firms out of the 134 manufacturing firms listed on the Nigerian stock exchange for the period 2008-2012. The twenty (20) manufacturing firms were selected based on the following criteria:

Companies must remain listed on the Nigerian Stock Exchange (NSE) during the 2008 – 2012 periods.

Companies must have complete financial statements for the period under review.

Companies must be operational within the period under investigation. Manufacturing organizations were so taken into consideration since they play a very important role in the Nigerian economy.

1.7 Significance Of The Study

This study is very crucial as it will give the financial managers of these manufacturing organizations, better insights on the need to pay particular attention to the effective and efficient management of their working capital. They will be in a better position to be able to design and implement strategies and policies that are aim at stabilizing and managing the various components of working capital especially as it significantly impact on the main aim of business which is creating shareholders’ value.

The study would further, enable the management to know at what extend they should increase their liquidity in order to make their performance up to the mark.

This is very important in improving the good will of their firms, since firms that pay creditors as at when due are considered credit worthy and gains a good reputation.

And for the academic purposes, the research work will contribute to the existing body of knowledge on working capital management and firm’s performance. 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.

REFERENCES

Afza, T. and Nazir, M. (2009). “Impact of aggressive working capital management policy on firm’s profitability”. The IUP Journal of Applied Finance, 15 (8), 20 – 30.

Akinsulire, O. (2005). Financial management. Lagos: El-Toda Ventures.

Deloof, M. (2003). “Does working capital management affect profitability of Belgium firms”? Journal of Business Finance and Accounting, 30 (3), 573-588.

Falope, O.I. and Ajilore, O.T. (2009). “Working capital management and corporate profitability: Evidence from Panel Data Analysis of selected quoted companies in Nigeria”. Research Journal of Business Management, 3(3)73-84.

Filbeck, G. and Krueger, T. (2005). “Industry related differences in working capital management”. Mid-American of Business, 20(2), 11-18.

Filbeck, G., Krueger, T. and Preece, D. (2007). “CFO magazine’s working capital surveys: Do selected firms work for shareholders”? Quarterly Journal of Business and Economics, 46(2)3-22.

Krueger, T. (2002). “An analysis of working capital management results across industries”. Mid-American Journal of Business, 20(2), 11 – 18.

Lamberson, M. (1995). “Changes in working capital of small firms in relation to changes in economic activity”. Journal of Business, 10(2), 45-50.

Lazaridis, I. and Tryfonidis, D. (2006). “Relationship between working capital management and profitability of listed companies in the Athens Stock Exchange”. Journal of Financial Management and Analysis, 19(1)26-35.

Ohikhena, P. (2006). Research methodology in the social and management sciences. Lagos, Nigeria: Bunmico Publishers.

Oxford (2005). A dictionary of accounting, 3 ed. Oxford University Press.

Pandey, I.M. (2005). Financial management, 9 ed. New Delhi Vikas Publishing House PVT Ltd.

Padachi, K. (2006). “Trends in working capital management and its impact on firm’s performance: An analysis of Mauritian small manufacturing firms”. International Review Business Research Papers, 2(1), 45-56.

Prasad, R.S. (2001). “Working capital management in the paper industry”. Finance India, 15(1),185-188.

Shin, H.H. and Soenen, L. (1998). “Impact of working capital and corporate profitability”. Journal of Finance Practice and Education, 8(2)37-45.

Smith, K. (1980). Profitability versus liquidity trade offs in working capital management, in readings on the management of working capital. New York, St. Paul: West Publishing Company.

VanHorne, J.C. (1977). “A risk-return analysi8s of a firm’s working capital position”. Financial Economics, 2(1)71-88.

VanHorne, J.C. and Wachowiez, J.M. (2004). Fundamentals of financial management, 12 ed. New York: Prentice Hall.

HERE IS WHAT OUR HAPPY CLIENTS ARE SAYING