The Effect of Working Capital Management on the Profitability of an Organization
Chapter One
Objective of the Study
This study’s main objective is to determine whether working capital management can impact manufacturing companies’ profitability. Especially to determine the following:
- The relationship between the account receivable period and profitability.
- The relationship between account payable period and profitability.
- Relationship between inventory period and profitability.
- Relationship between cash conversation cycle and profitability.
CHAPTER TWO
REVIEW OF RELATED LITERATURE
Introduction
Evidence-based studies that investigated the association between profitability and working capital management practices of manufacturing firms from emerging market perspective are rare. This may be due to the relatively greater attention that is given to firms by developed markets since it is perceived as the main driver of those economies. Thus, most of the empirical studies that abound in working capital management in the profitability of firms are drawn from developed markets. Chatterjee (2010) studied the relationship between working capital management practices and the profitability of listed firms on the Nigerian Stock Exchange. Management of working capital which aims at maintaining an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables is a fundamental part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses (Deloof, 2003). In practice, it has become one of the most important issues in organizations with many financial executives struggling to identify the basic working capital drivers and the appropriate level of working capital to hold so as to minimize risk, effectively prepare for uncertainty and improve the overall performance of their businesses (Lamberson, 1995). The existence of efficient working capital management practices can make a substantial difference between the success and failure of an enterprise and it is of particular importance to the managers of small scale enterprises, because it is they who strive for finances and the opportunity cost of finances, for them is usually on the higher side (Kwame, 2007). As established by Padachi (2006), efficient management of working capital is vital for the success and survival of the SSEs which needs to be embraced to enhance performance and contribution to economic growth. However, as observed by Atrill (2006), there is evidence that many small scale enterprises are not very good at managing their working capital despite their high investments in current assets in proportion to their total assets and this has been a major cause of their high failure rates as compared to large businesses. According to him, majority of the small scale enterprises operate without credit control department implying that both the expertise and the information required to make sound judgments concerning terms of sales may not be available. They also lack proper debt collection procedures, hence, they tend to experience increased risks of late payment and default by debtors who tend to increase where there is an exclusive concern for growth; in this case, small scale enterprises may not be too willing to extend credit to customers who have poor credit risks. Also, in a recent study by Bowen et al. (2009) debt collection was identified by 55% to be among the top five major challenges facing micro and small businesses. Working capital management is a very important component of corporate finance because it directly affects the liquidity, profitability and growth of a business and is important to the financial health of businesses of all sizes as the amounts invested in working capital are often high in proportion to the total assets employed (Atrill, 2006). It involves the planning and controlling of current assets and liabilities in a manner that eliminates the risk of inability to meet short-term obligations and avoid excessive investments in these assets (Lamberson, 1995). This management of short-term assets is as important as the management of long-term financial assets, since it directly contributes to the maximization of a business’s profitability, liquidity and total performance.
CHAPTER THREE
RESEARCH METHODOLOGY
Research design
The researcher used descriptive research survey design in building up this project work the choice of this research design was considered appropriate because of its advantages of identifying attributes of a large population from a group of individuals. The design was suitable for the study as the study sought to examine the influence of working capital management on profitability of companies
Sources of data collection
Data were collected from two main sources namely:
(i)Primary source and
(ii)Secondary source
Primary source:
These are materials of statistical investigation which were collected by the research for a particular purpose. They can be obtained through a survey, observation questionnaire or as experiment; the researcher has adopted the questionnaire method for this study.
Secondary source:
These are data from textbook Journal handset etc. they arise as byproducts of the same other purposes. Example administration, various other unpublished works and write ups were also used.
Population of the study
Population of a study is a group of persons or aggregate items, things the researcher is interested in getting information for the study the influence of working capital management on profitability of companies 200 staff of selected manufacturing firms was randomly selected as the population of the study.
CHAPTER FOUR
PRESENTATION ANALYSIS INTERPRETATION OF DATA
Introduction
Efforts will be made at this stage to present, analyze and interpret the data collected during the field survey. This presentation will be based on the responses from the completed questionnaires. The result of this exercise will be summarized in tabular forms for easy references and analysis. It will also show answers to questions relating to the research questions for this research study. The researcher employed simple percentage in the analysis.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATION
Introduction
It is important to ascertain that the objective of this study was to ascertain the influence of working capital management on profitability of companies
In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of working capital management on the profitability of companies.
Summary
Working capital management plays a vital role in companies’ financial decisions. The purpose of the study was to investigate working capital management efficiency and profitability. In general, the sustained profitability of companies can be ensured with the ability to manage working capital components efficiently. In practical, impact of the working capital management is varying from company to company. In fact, the impact of working capital cannot be generalized, it can be better understood considering the nature of the business and product. According to the result of the present study, researchers are able to conclude that there is no significant impact of working capital management on profitability.
Conclusion
When the working capital requirements are not properly managed and are allocated more than required, it renders the management inefficient and reduces the benefits of short-term investments. On the other hand, if the working capital is too low, the company may miss a lot of profitable investment opportunities or suffer shortterm liquidity crisis, leading to the degradation of company credit, as it cannot respond effectively to temporary capital requirements. Without working capital every aspect of the enterprise will cease to exist that is there will be no money for the day-to-day running of the business which is the aim of every business establishment. Wellmanaged working capital will produce an increased profitability to meet the financial needs of the company at all times. Findings of the study indicate that indicate that efficient working capital management increases profitability, and hence a negative relationship exists between the measure of working capital management (cash conversion cycle, sales growth, debt ratio and credit ratio) and profitability variable. The study thus concludes that if efficient working capital management increases profitability, one should expect a negative relationship between the measures of working capital management and profitability variable.
Recommendations
The study recommends that there should be proper inventory management system in manufacturing firms to avoid over stock of inventory resulting efficient outcome of investment. Management of manufacturing firms should also make sure certain standards and levels which will stop piling up of inventory. The study further recommends that companies should engage in relationship with those suppliers who allow long credit time period and those customers who allow short payment period. There is also still need in the future to identify the sector wise relationship between working capital management and firms ‘financial performance among manufacturing firms in Nigeria.
Reference
- Afza T., & Nazir, M.S. (2007). Is it better to be aggressive or conservative in managing working capital?, Paper presented at Singapore Economic Review Conference (SERC) on August 02-04, Singapore.
- Agarwal, N. K. (1977). Management of working capital. PhD Dissertation. Delhi School of Economics.
- Al-Sakran, S.A. (2001). Leverage determinants in the absence of corporate tax system: the case of non-financial publicly traded corporations in Saudi Arabia, Managerial Finance, Vol. 27 No.10/11, pp.58-86. Arnold, G. (2008). Corporate Financial Management, 4th edition, Pearson education limited.
- Arthur, J. (1992). Basic financial management (p. 649). New Jersey: Prentice Hall Publishers.
- Banos-Caballero S. Garcia-Teruel, P. & Martinez-Solano, P. (2010). Accounting and Finance, Vol 50, pp. 511- 527, September.
