Impact of Working Capital Management on Corporate Solvency of Listed Companies in the Nigerian Oil and Gas Industry
Chapter One
Objectives of the study
The study’s main objective is to examine the impact of working capital management on the profitability of listed oil and gas firms in Nigeria. Other specific objectives are:
- To investigate the impact of receivables collection management on the profitability of listed oil and gas firms in Nigeria
- To examine the impact of inventory management on the profitability of listed oil and gas firms in Nigeria
- To determine the effect of accounts payable management on the profitability of the listed oil and gas firms in Nigeria
- To identify the impact of cash conversion circle on the profitability of listed oil and gas firms in Nigeria
CHAPTER TWO
LITERATURE REVIEW
Introduction
This chapter reviews and presents relevant literature on working capital management and firm profitability. It discusses the concept of working capital, working capital management and the concept of profitability. The chapter also presents the objectives of working capital management, working capital management policies and working capital management in developing economies. Empirical studies on working capital management and the theoretical framework of working capital management are also discussed and presented.
Conceptual Issues
In this section, conceptual issues relating to working capital, working capital management, objectives of working capital management, working capital management policies, working capital management in developing economies and profitability are discussed and presented.
Concept of Working Capital
Khan and Jain (2005) defined working capital as the funds locked up in materials, work in progress, finished goods, receivables, and cash and cash equivalent. Thus, they defined working capital as capital invested in current assets, which are those assets that can be converted into cash within a short period of time and the cash received is again invested into the assets. In the words of Van Horne and Wachowicz (2004) Working Capital represents the amount of current assets that have not been supplied by current, short term creditors. In the same vein Chandra (2006) sees Working Capital as the excess of current assets that has been supplied by the long-term creditors and the stockholders.
However, working capital is divided into Gross and net; Gross working capital refers to the amount of funds invested in current assets that are employed in the business process while, Net Working Capital refers to the difference between current assets and current liabilities (Khan & Jain, 2005). Moreover, Current assets and liabilities, that is, assets and liabilities with maturities of less than one year, need to be carefully managed. Net working capital is the term given to the difference between current assets and current liabilities: current assets may include inventories of raw materials, work-in-progress and finished goods, trade receivables, short-term investments and cash, while current liabilities may include trade payables, overdrafts and short-term loans. The level of current assets is a key factor in a company’s liquidity position (Pass and Pike 1984). Working capital can be viewed dynamically as equilibrium between the income-generating and resource-purchasing activities of a company (Pass and Pike 1984), in which case it is closely linked to the cash conversion cycle.
According to Pass and Pike (1984) Gross working capital (Total Current Assets) refers to the firm’s investment in current assets. Current assets are the assets, which can be converted into cash within an accounting year or operating cycle. Thus, Gross working capital, is the total of all current assets. Net working capital according to them refers to 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. Net working capital may be positive or negative. A positive net working capital will arise when current assets exceed current liabilities and a negative net working capital will arise when current liabilities exceed current assets i.e. there is no working capital, but there is a working capital deficit. It includes Therefore, the two concepts of working capital, gross working capital and net working capital are exclusive; both are equally important for the efficient management of working capital (Van Horne, 1995). The gross working capital focuses attention on two aspects how to optimize investment in current assets? And how should current assets is financed? While, net working capital concept is qualitative. It indicates the Liquidity position of the firm and suggests the extent to which working capital needs may be financed by permanent sources of funds (Van Horne, 1995). In this the concept of working capital refers to both gross and net working capital, as the study covers accounts receivables and payables, inventory and cash.
Working Capital Components
According to Van Horne and Wachowicz (2004) the necessary components of an organization’s working capital, basically, depend on the type of business and industry. They further narrate that Cash, debtors, receivables, inventories, marketable securities, and redeemable futures can be recognized as the common components of organization’s working capital. However, the question is to recognize the factors that determine the adequacy of working capital based on growth, size, operating cash flow, etc. The inability to understand the determining factors and measurement of adequate amounts of working capital will lead an organization to bankruptcy.
Van Horne, (1995) provides the analysis of the components of gross working capital, which is the current assets, which can be converted into cash within an accounting year or operating cycle. Thus, Gross working capital, is the total of all current assets and includes; Inventories (Raw materials and Components, Work-in-Progress, Finished Goods, Others); Trade Debtors; Loans and Advance; Cash and Bank Balances; Bills Receivables; and Short-term Investment. On the other hand, Net Working Capital refers to the difference between current assets and current liabilities; where current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year (Deloof, 2003). According to him, Net working capital may be positive or negative. A positive net working capital will arise when current assets exceed current liabilities and a negative net working capital will arise when current liabilities exceed current assets i.e. there is no working capital, but there is a working capital deficit. It includes; Trade Creditors; Bills Payable; Accrued or Outstanding Expenses; Trade Advances; Short Term Borrowings (Commercial Banks and Others); Provisions; and Bank Overdraft.
CHAPTER THREE
RESEARCH METHODOLOGY
Introduction
This chapter centres on the methodology adopted in carrying out this study. It could be described as the road map that guides the direction to find answers to the stated research questions. The main issues discussed include research design, population and sample selection technique, data collection technique, data analysis technique as well as justification of the methods adopted.
Research Design
This research adopts correlational and ex-post facto designs. This ex-post facto research aims to study the impact of working capital management empirically on the profitability of oil and gas firms, while the correlational design is to explore the degree of association between all the variables under consideration. The choice of correlational research design in this study is informed by the fact that, the aim of the design is to investigate the relationships between variables and to estimate the impact of one the variable (independent variable) on another (dependent variable), so as to establish a causal relationship or otherwise among the variables. This is therefore consistent with the objective of the study.
Population and Sample of the Study
The population of this study is all the nine oil and gas firms listed on the floor of Nigerian Stock Exchange. In selecting the sample size, the following criteria are adopted;
- Their business activity is not of investment type (non-holding company).
- The company is not suspended from the stock exchange during the period between 2002 and Based on the aforementioned criteria, only 5 oil and gas firms qualified to be members of the sample of this study.
CHAPTER FOUR
RESULTS AND DISCUSSION
Introduction
The analyses and interpretations of the tests conducted on the data collected for the study are presented in this chapter. The chapter begins with the presentation and analysis of the descriptive statistics of the data for the study. This is followed the analysis and discussion of results of the inferential statistics, from which relevant inferences are drawn and the test of hypotheses formulated for the study is conducted. The chapter ends with the discussions of the major findings from the analysis as well as policy implications of the findings.
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
Summary
This study investigates the impact of working capital management on the profitabilty of listed phamaceutical firms in Nigeria, using a sample of five companies. The study covers a period of 10 years (2002–2011) and employed correlation research design and OLS regression analysis. Based on the tests conducted on the data collected and the analyses of the results, this study found a significant relationship between the working capital management components (account receivables, account payables, inventory, cash conversion cycle, operating cash flows to sales, and cash ratio) and the profitability of listed oil and gas firms in Nigeria. In essence, working capital management explained 37.23% of the variations in the profitability (gross operating profit) of the listed oil and gas firms in Nigeria, during the period under review.
In particular, the study found that account receivables (ACR) days has a statistically significant negative impact on the profitability of listed oil and gas firms in Nigeria. The study also found that account payables (ACP) days has significant positive effects on the profitability of listed oil and gas firms in Nigeria. Moreover, the results provide evidence that the sales days in inventory (INV) has a significant negative impact on the profitability of listed oil and gas firms in Nigeria. The study, on the other hand found that cash conversion cycle (CCC) has a significant positive impact on the profitability of listed oil and gas firms in Nigeria. Moreover, it is also found that operating cash flows to sales ratio (CTS) has a significant negative impact on the profitability of listed oil and gas firms in Nigeria, while the cash ratio CTS has a negative impact on the profitability of listed oil and gas firms in Nigeria.
Conclusion
Based on the key findings of this research, the study concludes that a significant relationship exists between the management of working capital components (account receivables, account payables, inventory, cash conversion cycle, operating cash flows to sales, and cash ratio) and the profitability of listed oil and gas firms in Nigeria. Specifically, the study concludes that, account receivables management has a statistical significant negative impact on the profitability of listed oil and gas firms in Nigeria. The study also concludes that account payables management has significant positive effects on the profitability of listed oil and gas firms in Nigeria. Moreover, the study concludes that the sales days in inventory has a significant negative impact on the profitability of listed oil and gas firms in Nigeria.
The study on the other hand, concludes that cash conversion cycle has a significant positive impact on the profitability of listed oil and gas firms in Nigeria. Moreover, the study concludes that operating cash flows to sales ratio has a significant negative impact on the profitability of listed oil and gas firms in Nigeria, while the cash ratio has a negative impact on the profitability of listed oil and gas firms in Nigeria.
Recommendations
In line with the findings and conclusions from this study, the study makes the following recommendations:
The managers of oil and gas firms in Nigeria should give due importance to working capital management, and emphasize an optimal working capital levels in their respective firms. This is because of the positive impact of CCC and accounts payables on the profitability.
The managers of oil and gas firms should decrease their days’ inventory and days’ accounts receivables cycle, by instituting adequate control and flexible credit policy.
The managements of oil and gas firms should employ experts in accounting and finance to help establish and monitor their required liquidity position through efficient working capital.
The result suggest that oil and gas firms should keep optimum level of accounts receivable and cash conversion cycle to increase profitability. This could only be possible when oil and gas firms give due regard to every component of cash conversion cycle.
The managements of oil and gas firms should involve in credit terms bargaining with their suppliers in order to optimize their account payables efficiency which could improve profitability and liquidity positions.
Similarly, the managements of oil and gas firms should adopt the daily stock control policy in order to have an optimal inventory level, which would reduces the cost of holding and ordering and, as a result maximizes profitability in turn.
Limitations
This study is limited to the listed oil and gas firms in Nigeria, therefore the findings is not applicable to other oil and gas firms that are not listed in the Nigerian Stock Exchange market. That is, the findings of this study could only be generalized to listed oil and gas firms covered.
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