Effect Of Working Capital Management On The Profitability Of An Organization

Project and Seminar Material for Accountancy / Accounting

Effect Of Working Capital Management On The Profitability Of An Organization


Abstract


This study titled ‘influence of working capital management on profitability of companies; issues, challenges and strategies examined the various ways by which working capital can be managed to enhance profitability, evaluate the need for the management of working capital, and also identified the hindrances to proper management of account receivables in seeking for information needed for the study , primary and secondary means of data collections were adopted such as oral interview, questionnaires and simple size observation, ESUT library and internet played a great role in data collection. The Taro Yamane’s formula was use in determining the chi-square statistic was adopted in presentation and analysis of data. Findings showed that proper management of account receivable aids efficient and effective operations in CADBURY NIGERIA PLC and that Mis-management of account payable decreases the profitability of firms to a high extent. It was concluded that the primary responsibility of preventing deficiencies and bringing new idea is with the management but financial manager play a very vital role on property management of working capital in an organization


Chapter One


Introduction

1.1 Background of the Study

The Working capital is a financial metric which represents the operating liquidity available to a business concern. As regarding fixed assets such as plants and equipment working capital is considered as a part of a company’s operating capital, referring to current assets such as cash at hand, cash on bank account raw materials working progress, finished goods, account receivable etc. To measures the efficiency of company’s working capitals, net working capital is often used which is defined as the difference between current assets and current liabilities if current assets are higher than current liabilities, the company has working capital efficiency explaining the company’s ability to continue its operations and to have sufficient funds to satisfy both maturing short term debt and upcoming operational expenses.

Working capital management involves planning and controlling current assets and current liabilities in a manner that dominates the risk of liability to meet due short-term obligations on one hand and avoid excessive investment in these assets on the other hand. According to (Elijelly, 2004) there is a combination of policies and techniques for the management of a company’s working capital. These policies involves inventory management debtor’s management etc. a popular measures of working capital management is the cash conversion cycle, which tells how cash is moving through a company in terms of duration.

According to Brigham and Daves (2002) working capital management involves both setting working capital policy and carrying out that policy in day to day operation. It also involves making appropriate investments in cash, marketable securities, receivable and inventories as well as the level and mix of short-term financing (Emery Finnety and Stowe 2004).

In essence, the research tried to examine working capital management issues, specially how a company manages its working capital by shortening or lengthening its cash conversation cycle in order to contribute for a superior operating profitability. Management seeks to contain an optimum balance of cash working capital component thereby ensuring that firm operates with sufficient fund (cash flow) that will service their long-term debt and satisfy both maturing short-term obligation and upcoming operational expenses. Therefore, makes it more glaring that working capital has a pivotal role to play in a company’s drive to achieve great or high profitability.

One can then say that decision relating to working capital must not be taken for granted. To this end, Arnold (2005) assets that if there is too little working capital or lack of working capital can account for inefficiencies in a company’s operation when it is not able to play-off. Its due obligations. On the other hand, without sufficient working capital, the company will not either be able to provide goods or service required to customers due to lack of money to buy materials for producing goods. The company’s profitability can be jeopardized as a result. Therefore the ultimate goal of working capital management is to ensure that firm’s are able to continue their operations with sufficient cash-flow that will service their long-term debts and satisfy both maturing short-term obligation (debts) and upcoming operational expenses. Hence, organization should try as much as possible to meet up with this goal so as to avoid being caught up in the trap of ineffective management of working capital components.


1.2 Statement of the Problem

This study will try to provide solution to the problem listed below.

  1. Hindrances of improper working capital management lead to bankneptey and close down of companies.
  2. Inefficient management of working capital effect the profitability of a company.
  3. With the high rate of corruption in our country can working capital management be wholly implemented?

1.3 Objective of the Study

The main objective of this study is to find out whether working capital management can impact on manufacturing companies profitability. Specially to determine:

  1. The relationship between account receivable period and profitability.
  2. The relationship between account payable period and profitability.
  3. Relationship between inventory period and profitability.
  4. Relationship between cash conversation cycle and profitability.

1.4 Research Questions

The following research questions of this study are:

  1. To what extent do proper management of account receivable impact positively on profitability of firms?
  2. To what extent do proper management of account payable period increase positively on profitability of firms
  3. Can management increase in inventory period and profitability of a firm?
  4. Can proper management increase positively in cash conversation cycle and profitability of firms?

1.5 Research Hypothesis

Hypothesis is a kind of questing thoughts formulated by the researcher in line with the research question. It is classified as follows.

Positive and negative hypothesis positive hypothesis (Alternative) while negative hypothesis means no (null).

Hypothesis one
  • Ho: Proper management of account receivable does not enhance profitability of firms.
  • Hi: Proper management of account receivable enhance profitability of firms.
Hypothesis two
  • Ho: Mismanagement of account payable does not decrease the profitability of firm’s
  • Hi: Mismanagement of account payable decrease the profitability of firm’s.
Hypothesis three
  • Ho: Management of cash and cash equivalents does not enhance profitability of firm’s.
  • Hi: Management of cash and cash equivalents enhance profitability of firm’s.

1.6 Significance of the Study

This study is of importance to the researcher as it equips her with the knowledge of the problems of working capital management to the cabric Nigeria Ltd companies. It will also be importance to various people in the society such as the government and owners of industries. It will reveal the problems of working capital management on profitability companies of working capital management on profitability companies and this knowledge will be vital to the general public and private sectors. It will also provide a model for an efficient and effective management of working capital. It will be significant to other researcher and studies who may want to use it as a reference.


1.9 Scope and Limitations of the Study

A good research to be delimited to a manageable scope delimitation of research refers to the definition of the scope (extent or boundary) covered by the research in other words, the research respondents are going to be concerned with making decisions in the companies.

The researcher faced the following challenges/limitation during the process of data collection.

Due to the economic situation of Nigeria and other academic issue like (buying of textbooks, paying of school fees), that requires financial attention, the researcher encountered financial challenges.

Secondary, due to inability to reach all the members of the sample owing to some circumstance, the resulting sample was not quite of cooperation from some respondents, somehow limited this exercise.

Finally, due to the limited time induced to complete and present the research work, the researcher curtailed her efforts to the most sensitive aspects of the topic. Notwithstanding; the above constraints, the research did her best to present worthwhile and comprehensive work.


1.10 Definition of Terms

Working capital:

Working capital is the total amount of cash tied up in current assets and current liabilities and is calculated by deducting the total amount of current liabilities from the total current assets.

Account payable:

Is money by a business to its supplier shown as a liability on a company’s balance sheet.

Collection policy:

Is the steps that a company follows in ensuring timely payment of its account receivable or procedures a firm follows in attempting to collect account receivable.

Account receivable:

Are money which his owed to a company by a customer for product and service provided. It is been shown as current liabilities.

Management:

This is the decision making body of an organization it is a group of people who manage the company affairs.

Cash conversation cycle:

Is a company that measure how long a firm will be deprived of cash if it increases its investment in resources, in order to expand customer sale

Operating cash flow Ratio:

Is use to measure how well current liabilities are covered by the cash flow generated from a company operation.

Credit policy:

Is a clear, written guidelines that set the term and condition for supplying goods on credit.


Chapter Five


Summary, Conclusion and Recommendation

5.1 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.


5.2 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.


5.3 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.


5.4 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.


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