Impact Of Cash Conversion Cycle On Capital Structure

Project and Seminar Material for Accountancy / Accounting

Project and Seminar Material for Accountancy / Accounting


Abstract


This study aims to investigate the impact of cash conversion cycle on capital structure and financial characteristics. The main aim of the study was to ascertain the impact of cash conversion cycle on capital structure of an organization. A sample of 133 staff of Omatek venture were used for the study. Cash conversion cycle is an important measure for companies in measuring the operating cycle where the work cycle of raw materials for the purposes of service provision and profitability. Data collected were adequately analyzed and conclusion was arrived at. And some recommendations were made.


Chapter One


Introduction

1.1 Background of the study

Effective working capital management is vital for the business survival and their ultimate growth. Scholar in accounting and finance devout their times in finding the effectiveness of the management of inventories, account payables, Account receivables and cash in order to link the effectiveness of their management in relation to policy of achieving the firms growth and development. Cash management appears to be crucial especially in this time when the country is facing serious financing problems, hence financing is likely to be challenges for many business enterprises. Almost all the decisions on the part of the finance managers pertaining to this valuable resource have much bearing upon the performance, risk and the market value of the firms. The financial management decisions of companies are basically concerned with three major areas: capital structure, capital budgeting, and working capital management. Among these major areas, the working capital management (WCM) is an area of great significance for every company as it virtually affects its overall profitability and liquidity (Appuhami, 2008). Companies in the Nigerian information and telecommunication sector play a vital role in proving a lot of job opportunities for the teeming unemployed youth in the country. Today, the sector provides a lot of direct and indirect employment opportunities and as a result, improved income opportunities to people. The services of the sector are of paramount importance in moving virtually entire economic activities in the country. In terms of growth, Nigerian information and telecommunication sector is ranked as the fastest and most robust sector in Africa and among the ten fastest in the world according to US ambassador to Nigeria (Thisday, 2011). According to Nigeria economic fact sheet 2011, the ICT sector contributes to the GDP more than manufacturing sector of the economy (cited in (Schwab, K., & Sala-i-Martin, X. 2011). For instance, ICT sector contributes 25% which is higher when compare to 20% for finance and insurance, 15% from transport and 10% for real estate and business service. Owing to the importance of the sector, it is of paramount importance to study all variables that may enhance the profitability and general performance of the sector. A firm’s performance mainly depends on the way the firm is able to manage its resources at all times. The importance of working capital management is being underestimated by many which results in failure to optimize the potentials of many businesses.

A firm must managed effectively and efficiently its working capital because the inability to manage the working capital well may result in not only reduction in profitability but may also lead to severe result like financial crisis for the firm. However, it’s a matter of greater concern and importance that firms manage their working capital in a way that will lead to ultimate prosperity of the firms. In order to manage working capital efficiently, a firm has to be aware of how long it takes them, on average, to convert their goods and services into cash. This length of time is formally known as the Cash Conversion Cycle. In order to measure how well a firm manages its working capital, a financial performance metric called cash to cash cycle (abbreviated as CCC) which was developed by Richards and Laughlin (1980). This metric which basically indicates length of the period between paying suppliers and being paid by customers, has three determinants: days payable outstanding, days of inventory and days of receivable outstanding. The concept of cash conversion cycle is a basic financial concept. It is a composite metric that has been described as “the average days required to turn a dollar invested in raw material into a dollar collected from a customer” (Stewart, 1995).


1.2 Statement Of Problem

The concept of cash conversion cycle as it may look is a very cumbersome task ,this is because the capital of every organization is the life wire of that organization. When an organization has not been able to manage its account receivable and account payable effectively, the liquidity of that organization is at risk. It is on this backdrop that the researcher embark on the study to ascertain the impact of cash conversion cycle on capital structure and profitability of an organization.


1.3 Objective Of The Study

The main objective of this study is to ascertain the impact of cash conversion cycle on the capital structure of an organization. However, for the successful completion of the study, the researcher set out the following sub-objectives to be achieved:

  1. To ascertain the impact of cash conversion cycle on capital structure
  2. To ascertain the relationship between cash conversion cycle and profitability
  3. To ascertain the role of cash conversion cycle on the liquidity of an organization
  4. To ascertain the relationship between cash conversion cycle and capital structure.

1.4 Research Question

For the successful completion of the study, the following research questions were formulated:

  1. What is the impact of cash conversion cycle on capital structure?
  2. What is the relationship between cash conversion cycle and profitability?
  3. Does cash conversion cycle plays any role in organizations liquidity?
  4. What is the relationship between cash conversion cycle and capital structure?

1.5 Research Hypotheses

For the successful completion of the study, the following hypotheses were formulated:

  1. H0: there is no significant impact of cash conversion cycle on capital structure
    H1: there is significant impact of cash conversion cycle on capital structure
  2. H0: there is no significant relationship between cash conversion cycle and profitability
    H2: there is a significant relationship between cash conversion cycle and profitability of the organization.

1.6 Significance Of The Study

It is perceived that at the completion of the study, the findings will be of importance to management of the organization in planning their capital structure. The study will also be useful to the accountant of diverse organization in management of account receivables and account payable to ensure liquidity. The study will also be of great importance to the academia’s as it will contribute to the pool of knowledge, and finally the study will also be of importance to the researchers who intend to carry out investigation on similar subject matter as it will serve as a source of information.


1.7 Scope And Limitation Of The Study

The scope of the study covers the impact of cash conversion cycle on capital structure. However, the researcher encounters some limitation in the cause of the study.

a) Availability of Research Material:

The research material available to the researcher is insufficient, thereby limiting the study

b) Time:

The time frame allocated to the study does not enhance wider coverage as the researcher have to combine other academic activities and examinations with the study.

c) Finance:

Finance is a major constrain to the scope of these research work, this is because the researcher has to combine academic work and the research work which limit the amount of fund allocated to the studies


1.8 Definition Of Terms

Capital

In economics, capital goods, real capital, or capital assets are already-produced durable goods or any non-financial asset that is used in production of goods or services.

Adam Smith defines capital as “That part of a man’s stock which he expects to afford him revenue”. The term “stock” is derived from the Old English word for stump or tree trunk. It has been used to refer to all the moveable property of a farm since at least 1510. In Middle Ages France contracted leases and loans bearing interest specified payment.

How a capital good is maintained or returned to its pre-production state varies with the type of capital involved. In most cases capital is replaced after a depreciation period as newer forms of capital make continued use of current capital non profitable. It is also possible that advances make an obsolete form of capital practical again. Capital is distinct from land (or non-renewable resources) in that capital can be increased by human labor. At any given moment in time, total physical capital may be referred to as the capital stock (which is not to be confused with the capital stock of a business entity).

Cash conversion cycle

The cash conversion cycle is a metric used to gauge the effectiveness of a company’s management and, consequently, the overall health of that company. The calculation measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash

Account receivable

Accounts receivable is a legally enforceable claim for payment held by a business for goods supplied and/or services rendered that customers/clients have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes

Account payable

Accounts payable is money owed by a business to its suppliers shown as a liability on a company’s balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents. An accounts payable is recorded in the Account Payable sub-ledger at the time an invoice is vouched for payment. Vouchered, or vouched, means that an invoice is approved for payment and has been recorded in the General Ledger or AP subledger as an outstanding, or open, liability because it has not been paid. Payables are often categorized as Trade Payables, payables for the purchase of physical goods that are recorded in Inventory, and Expense Payables, payables for the purchase of goods or services that are expensed. Common examples of Expense Payables are advertising, travel, entertainment, office supplies and utilities


Impact Of Cash Conversion Cycle On Capital Structure


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