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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study Working
Capital Management refers to a company’s managerial accounting strategy
designed to monitor and utilize working capital components (current assets and
current liabilities) to ensure the most financially efficient operation of the
firm (Investopedia. 2018). Working capital management involves planning and
controlling current assets and current liabilities in a manner that eliminates
the risk of inability to meet short term obligations when due and to avoid
excessive investment on current assets which leads to idle cash (Eljelly,
2004). Working capital management involves decisions on the amount which
constituted the composition of net current assets and the financing of these
assets (Samson, et al, 2012). Working Capital Management can also be defined as
the controlled process of current assets less current liabilities (Lukarris
& Eero, 2011). Weston & Bringham (2015), defined working capital
management as investment in short term assets. We have observed that most
researchers see working capital management through the prism of working capital
and they try to define working capital as follows: Cheng, Frank and Wu (2009)
and Guthman & Dougall (1948) defined working Capital as receivables plus
inventory minus payables. Working Capital are short term balance sheet items
which are attributable to current assets on the assets side and current liabilities
on the liabilities side of the balance sheet (Brealey, Meyers & Allen,
2011, p.856). The main elements of working capital should include cash,
marketable securities, receivables and inventories which are important for the
management of the company (Ali & Ali, 2012). Working Capital Management is
important as it has direct impact on the profitability of firms (Ray, 2012). To
maintain liquidity and profitability of an organization, its working capital
should be managed efficiently (Nazir & Afza, 2009). This entails planning
and controlling current assets and current liabilities of firms with the view
to reduce the risk of inadequate and non-availability of cash (Adeniji, 2008).
Deloof (2003) posited that working capital management directly affects the
liquidity and profitability of firms, the study argues that firms in a given
large sample must vary in terms of size, age and Technology among others; that
liquidity settings will also vary greatly depending on the risk appetite of the
firm. Also, that firms will have different credit ratings that determines the
way in which these firms make their purchases. According to Raheman and Nasr
(2007) “Excessive level of current assets account can easily result in a firm
realizing a substandard return on investment”, hence the need to manage working
capital. The working capital management variables considered by this study are;
account receivables, inventories turnover, account payable and cash conversion
cycle (Lukkaris & Eero, 2011). Working capital management involves planning
and controlling current assets and current liabilities in a manner that
eliminates the risk of inability to meet short term obligations when due and to
avoid excessive investment on current assets which leads to idle cash (Eljelly,
2004) and looking at the nature of working capital and its components which are
short lived, there is the need to manage working capital in order to attain
profitability. “Current assets are short-lived investments that are continually
being converted into other asset types” (Rao, 1989). When a firm maintain
excessive current asset, it ends up tying down firm resources and that can
affect 3 profitability (Rahem & Nasir, 2011). Also, large inventory and a
generous trade credit policy may lead to high sales, but that does not
translate in to profitability (Rahem & Nasir, 2011). Efficient working
capital management is necessary for achieving both liquidity and profitability
of a company (Nazir & Afza, 2009). A poor and inefficient working capital
management leads to tying up funds in idle assets and reduces the liquidity and
profitability of a company (Reddy & Kameswari, 2004). Working capital
management became important and necessary during the financial crisis up to
2008 because the cost of long term debt increases and the new cost levels
become difficult to attain, hence the need to manage working capital,
especially when it can influence firm profitability and risk (Smith, 2018).
Keeping larger inventory by a firm reduces the likely risk of a stock-out
(Rahem & Nasr, 2007), even at that, inventories are not to be kept at an
arbitrary level, there is the need for deliberate planning and continuous check
on the inventory. Given that Inventories can save the firm from the risk of
losing an important customer by meeting up with their unexpected demand;
however, keeping too much idle stock may create unnecessary liquidity shock to
a firm thereby affecting firm profitability, hence the need for tradeoff
between liquidity and profitability which is ultimately working capital
management (Shin & Soenen, 1998). Firms sometimes bought goods on credit
from its suppliers meant to be payable in the near future, delaying payment to
suppliers allows a firm to assess the quality of products bought, and can be an
inexpensive and flexible source of working capital for the firm (Perri, 2008).
This in essence allows firms to utilize the available cash that ought to be
used for paying for supplies to another profitable investment opportunity.
However, late payment of invoices can be very costly 4 if the firm is offered a
discount for early payment (Rahem & Nasr, 2007).This decision process need
to be taken by top management and is considered as payables management and as a
component of working capital, it can be seen as working capital management
(Cannon, 2008). Cash conversion circle is a fundamental tool applied in the
assessment of the efficiency of working capital management (Richard &
Laughlin, 1980). The common measure of working capital management (WCM) is the
cash conversion cycle (CCC), this is the time between making payment for the
raw materials purchased and the receipts of proceeds of sales of finished goods
(Deloof, 2003). The more days a company‟s money is tied up in inventory, the
longer the cash conversion cycle and the longer the number of days creditors
must wait for their money (Jason & Kasozi, 2017). It is usually recommended
that firms should have shorter cash conversion cycle for them to be profitable
and remain credit worthy (Bibi & Ajmad, 2017). A longer CCC may translate
into poor profit as inventories are either not converted into goods on time or
they are converted, sold and yet the debtors have delayed payment or we have
delayed paying our creditors (Billie, 2014). Hence, when CCC is shortened, it
is expected to improve firm‟s profitability. Longer CCC results to a greater
need for expensive external financing as cash are tied down on inventories or
because we have lost our credit worthiness as such we have to look elsewhere to
finance that which ordinarily would have been made available to us by our
creditors (Nordmeyer, 2015). Longer CCC ultimately suggest that the firm is
less likely to obtain credit when needed and less likely to continue in
business as it is cash trapped (Jason & Kasozi, 2017). When there is a
reduction in the time cash are tied up in working capital, it tends to improve
on the efficient operations of the firm. The CCC is a useful way of assessing
the firm‟s 5 cash flow as it is the measure of time that the funds were
invested in working capital (Pratap, Kumar & Colombage, 2017). CCC is often
regarded as the powerful and more comprehensive measure of WCM than using the
current ratio and the quick ratio which focus on statistical balance sheet
values (Quang, 2017). The CCC includes the time dimension of liquidity which
measures the overall ability of firms to manage cash (Pratap, Kumar &
Colombage, 2017). There are two major measurement of firm‟s performance
commonly put to use, these are return on asset (ROA) and return on equity (ROE)
(Meena & Reddy, 2016). The impact of working capital management on the
financial performance of industrial goods firms is often measured using the
return on asset (ROA) and not return on equity (ROE) because of timing and
value issues against ROE (Falope & Ajilore, 2010). Often, net operating
income and gross operating income are also used as the measure of financial
performance. Also, the use of operating income to sales and operating cash flow
to sales is beginning to gaining currency as a measure of firm‟s performance
(Enow & Brijlal, 2014). The operating income is often used as a measure of
firm‟s earnings power from ongoing operation and it is regarded as the
difference between revenues and operating expenses. However, for the purpose of
this work, return on assets (ROA) will be adopted as the proxy of firm
profitability because in manufacturing companies, the firm is being financed
mostly by the proceeds from the assets of the company (Falope & Ajilore,
2010).
1.2 Statement of the Problem
Empirical study on the relationship
between Working Capital Management and profitability dwelling on Industrial
Goods Firms in Nigeria must be ubiquitous to enable industrialist have
information at the snap of their finger. These should be the material that will
drive their firms forward by sustaining firm’s operation so that Nigeria will
be positioned in the community of industrialized nations. Nigeria has in its
Vision of becoming one of the 20th Industrialized Economy in the World by year
2020 and a leading Economy in Africa; Nigerian Industrialist need to know the
importance of managing their Working Capital and the relationship that exist
thereto with profitability for Nigeria to sustain the tide. Adequate knowledge
on Working Capital Management in the Industrial Goods Firms will help in
solving the Country‟s developmental challenges such as unemployment, poverty
and other related problems; as its industries will flourish as they become
profitable. Many Industries earlier established have either folded or are
performing very low due to their improper management of working capital which
results in lack of appropriate financing and access to trade credit (Masocha
& Dzamonda, 2016, Enow & Brijlal, 2014). It has been found that there
are a lot of research work on working capital management and profitability but
there is none that dwell on the Industrial Goods Firms in Nigeria. This has
created a gab in the body of knowledge in the Industrial Goods Firms in
Nigeria. With this research, material will be made available that dwells on the
Industrial Goods Firms in Nigeria.
The research shall make materials
available which inevitably bridge the gap that exits from the paucity of
materials dwelling on Working Capital Management and Profitability in the
Industrial 8 Goods Firms in Nigeria. With this material, there is no need for
extrapolation of information that will suffice for knowledge in the Industrial
Goods Firms in Nigeria. This gab in knowledge is to be filled by conducting a
study on the Impact of Working Capital Management on the Profitability of
Industrial Goods Firms in Nigeria. The Variables to be deployed for the study
consist of Account Receivable Days, Inventory Turnover Days, Accounts Payable
Days and Cash Conversion Circle as Proxies for the Independent Variable and
Return on Assets as Proxy for the Dependent Variable. This work will look at
the impact of managing Account receivable days (ARD), Inventory turnover days
(ITO), Account payable days (APD) and cash conversion cycle (CCC) on
profitability of industrial goods firms in Nigeria. Failure to investigate this
relationship will be an issue for concern because there is no specific study
that cover the Industrial Goods Firms in Nigeria as far as the Impact of
Working Capital Management on Profitability is. This work will serve as
material that will cover the knowledge gab that exist as a result of deficit of
research materials on the Industrial Goods Firms in Nigeria.
Format: MS Word
Chapters: 1 - 5, Preliminary Pages, Abstract, References
Delivery: Email
Delivery: Email
No. of Pages: 100
NB: The Complete Thesis is well written and ready to use.
NB: The Complete Thesis is well written and ready to use.
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Masters Project Topics in Accounting and Finance
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