The Impact Of Working Capital Management Of The Productivity Of A Manufacturing Company

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The Impact Of Working Capital Management Of The Productivity Of A Manufacturing Company

Abstract

The management of current assets and short term funds is as important as that of fixed assets and long term funds. Therefore, the need for effective working capital management cannot be overemphasized in manufacturing companies for realization of their objectives. The effectiveness of that working capital management depends largely on proper financing of working capital. It was therefore considered appropriate in this research to evaluate the impact of working capital financing management policieson productivity of manufacturing firms in Nigeria. The main objective of the study was to come up with evidences that establish the relationship between working capital management policy and productivity of a firm, and identify the working capital management policy that contributes most to the productivity of a firm under different conditions. To achieve this objective, six (6) manufacturing companies that are quoted in the Nigerian Stock Exchange were selected as a case study, and a sample of one hundred and fifty (150) respondents who were employees of the companies was used in the study. Thus, data from primary sources were analyzed using simple descriptive research design. In addition, three (3) hypotheses were formulated and tested for significance using the t- test statistic technique. The secondary data were collected from the published financial statements of the companies under study and analyzed using correlation coefficient and financial ratios for the period 1999 to 2003. The research revealed that companies using different working capital management policies had different profitability, which concluded that there is significant relationship between working capital management policy and productivity of manufacturing company, and such relationship depends on the operating performance of the firm. It was also discovered that manufacturing companies that adopt conservative working capital management policy are more profitable especially when the demand for company’s product is high. Finally, the researcher recommended that manufacturing companies should employ qualified financial managers so as to effectively control cost of production and balance the trade off between cost of sales and quality of products manufactured in order to boost sales. It was also recommended that factors affecting working capital needs should be critically studied, so that investment in working capital would be appropriate to avoid high risk of uncertainties.

Chapter One

Introduction

Background of the Study

The management of current assets and short term funds is as important as that of fixed assets and long term funds. This is because in both cases, a firm analyses their effects on its return and risk. In managing current assets, firm’s liquidity position is a very important factor; consequently, large holding of current assets, especially cash, strengthens the firm’s liquidity (and reduces risks), but also reduces the overall profitability. Thus, a risk-return trade off is involved in holding current assets. Current assets are the capital available for running the day to day operations of an organization and it is termed as working capital, (Olowe,1997:452).

The need for working capital and its management which involves financing and controlling the current assets of a firm cannot be overemphasized especially in manufacturing companies. Manufacturing companies due to their function possess largest investments in working capital assets, and therefore, the success of these companies depend largely on proper financing and management of working capital. The productivity of these companies contribute immensely to the development and growth of every economy. It has also been noted by Block and Hirt (2000), that the economic environment within which manufacturing companies operate possesses serious challenges; success does not come by chance, it is a payoff for good business management which begins with appropriate use of efficient and effective management policies. Working capital management policy is defined by Brigham and Houston (2001), as the manner in which the permanent and temporary current assets of a firm are being financed. Pandey (1999) sees it as the relative mix of short and long term funds in financing working capital.
In view of the above discussion, it is considered important to carry out this study in order to evaluate the working capital management policies and their impact on productivity of firms, come up with evidences that established the relationship that exists between working capital management policy and productivity of a firm under different conditions and generate information that would be used for better control and management of working capital in Nigerian manufacturing companies.

Statement of the Problem

The profit maximization objective of manufacturing companies depends largely on the management of their corporate investment in assets (fixed and current). For a business to function effectively, it must invest in assets having fairly long life in productive use, importantly, it must also provide for assets that are used in day to day running of the business. For operational purposes, both sets of capital (fixed or working) must be maintained in proportions that would enhance optimum level of operations.

The challenges in business environment are making decisions to become more complex, particularly in developing countries like Nigeria due to uncertainties about the future. Manufacturing companies are finding it difficult to design better ways of coping with the economic trends in managing their working capital. Their survival or growth in this trend is all about the trade-off between their productivity and liquidity position. And this is a reflection of appropriate working capital management.

The consideration of the level of investment in current assets should avoid two danger points; excessive and inadequate investment in current assets. Investment in current assets should just be adequate, not more, not less, to the needs of the business firm. Excessive investment in current assets should be avoided because it impairs the firm’s profitability, as idle investment earns nothing. On the other hand, inadequate amount of working capital can threaten solvency of the firm because of its inability to meet its current obligations. It should be realized that the working capital needs of the firm may be fluctuating with changing business activity. Management should therefore be prompt to initiate action and correct imbalances especially working capital to their mode of financing working capital.

Managers are also facing problems in selecting appropriate means of financing their working capital. According to Olowe (1997), working capital may be financed by one of the following; long term finance, short term finance, or the mix between short and long term finance. Short term finance is a cheap and flexible source of financing usually used in financing short term working capital needs. The sources of short term financing include borrowing from friends and relatives, trade credits, accruals, bank overdraft, bank loans, etc, while long term finance is a fund raised by a company for which interest is paid usually at a fixed rate whether it makes profit or not. Sources of long term finance include loan stock or debentures, preference shares, ordinary shares, etc. Therefore, the choice of selecting one of these alternatives or mixing them relatively to finance working capital would have to involve careful evaluation of their impact.

This study is therefore to address the problems stated above by coming out with the appropriate working capital management policy that considers effectively the trade-off point between productivity and liquidity position of a firm.

Objectives of the Study

The objectives of this study are as follows:

  1. To evaluate working capital management policies and their impact on the productivity of firms.
  2. To come up with evidences that established the relationship between working capital management policy and productivity of a firm.
  3. To identify the working capital management policy that contributes most to the productivity of a firm under different conditions.
  4. To also identify the limitations associated with each working capital policy.
  5. To examine the extent to which working capital polices have contributed to the profit maximization of Nigerian manufacturing companies.
  6. To make appropriate recommendations based on the research findings on the proper mix of short term and long term financing for current assets.

Scope of the Study

This research is specifically focused on issues of working capital management policies having to do with profit maximization in Nigerian manufacturing companies. It will not consider other factors that affect profit maximization in such companies, rather it assumes that such factors are constant. Neither will it delve into issues of working capital management policies or management in other industries of the Nigerian economy.
The research study will only examine manufacturing companies that are quoted on the Nigerian Stock Exchange. Only six (6) companies would be selected, and these are Benue Cement Company Plc, Cement Company of Northern Nig. Plc, Jos International Breweries Plc, Paterson Zochonis (PZ) Industries Plc, Unilever Nigeria Plc, and Vitafoam Nig. Plc. The study aims to cover period from 1999 to 2003.

Research Hypotheses

In line with the already stated central problems of this research, the study addresses the following hypotheses in form of tentative statements as the research assumptions to be tested.

Hypothesis 1
  • H01- There is no significant difference in the productivity of manufacturing companies that adopt aggressive working capital management policy and those that adopt conservative working capitalpolicy.
  • H11- There is significant difference in the productivity of manufacturing companies that adopt aggressive working capital management policy and those that
    adopt conservative working capital policy.
Hypothesis 2
  • H02- There is no significant difference in the productivity of manufacturing companies that adopt aggressive working capital management policy and those that adopt moderate working capital policy.
  • H12- There is significant difference in the productivity of manufacturing companies that adopt aggressive working capital management policy and those that
    adopt moderate working capital policy.
Hypothesis 3
  • H03- There is no significant difference in the productivity of manufacturing companies that adopt conservative working capital management policy and those that adopt moderate working capital policy.
  • H13- There is significant difference in the productivity of manufacturing companies that adopt conservative working capital management policy and those that adopt moderate working capital policy.

Significance of the Study

The outcome of this study could be of tremendous importance to specifically the managers of manufacturing companies in Nigeria. This is because it will open new doors for improvement, growth and excellence in operations through the understanding of the proper mix of short term and long term financing for current assets. It will also be of immense benefit to both potential and existing investors of manufacturing companies, their employees and competitors in the same industry, students and other management policy makers on the field of working capital management.

Besides contributing meaningfully to academic development, this study would also serve as a basis for further research.

1.7 Limitations of the Study

In conducting this research work, some unavoidable constraints were encountered. The major ones include:
Lack of Adequate Knowledge on Working Capital management policies by Respondents:

The respondents selected who are employees of the companies under study for the administration of questionnaires were not very much conversant with the main issue this research was addressing, that is working capital policies.
Inaccuracy from Secondary Source of Data:

The data gathered for this research was mostly obtained through documentation. The degree of correctness and reliability of the study would, to a large extent, depend on the reliability and accuracy of the results published and documented in companies’ financial statements. The reliability of the research would be at stake if the published financial statements used were not showing true financial positions.

Nevertheless, the study was conducted in the most intellectual and academic standard possible under the circumstances

Chapter Five

Summary, Conclusion and Recommendation

Summary of Findings

The findings of the researcher were summarised as follows:

  1. There is significant relationship between financing mix (working capital policy) and productivity of manufacturing companies.
  2. The relationship that exists between the financing mix (working capital policy) and productivity depends on the company’s performance or management efficiency to be positive or negative.
  3. The research revealed that manufacturing companies that use conservative working capital management policy are more profitable than those that use moderate or aggressive working capital policy.
  4. Excessive use of short term funds in financing long term assets results to low productivity and poor management of current assets.
  5. The operating performance and management efficiency in manufacturing, administering and selling products in manufacturing companies are much more important in determination of productivity than working capital policy.
  6. Manufacturing companies that use aggressive working capital management policy are faced with high risk, even though they enjoyed cost and flexibility advantage.
  7. Manufacturing companies that use conservative working capital management policy are always very liquid, and face lesser risks but meet higher cost of capital.
  8. It was also discovered that conservative working capital management policy is appropriate in period of high demand for companies’ products, since there is large sales, and with efficient management of cost of production, profit can be able to cover high cost of capital at a lower risk. And when there is no much demand for the manufactured products, aggressive working capital management policy should be employed so as to minimize the cost of capital.

Conclusion

In line with the findings of this research, the following conclusions are drawn.

It was generally acknowledged that financing mix plays a crucial role in the attainment of the objective of profit maximization of the manufacturing companies. Managers in such companies should ensure operating efficiency and appropriate combination of short and long term funds based on the conditions at a particular point in time. Most of the problems of manufacturing companies using excessive short term funds in financing is due to lack of good control of cost of production and inefficient management of current assets. It was also concluded that excessive use of either short or long term funds in financing assets of manufacturing companies is not good for healthy and vibrant operation of such companies.

The consideration for factors that determine the working capital needs of a firm, such as nature of business, sales and demand conditions, technology and manufacturing policy, credit policy, operating efficiency and price-level changes, is also very important in determining appropriate financing mix that can maximize profit of manufacturing companies in Nigeria. Managers should also be trained on how to manage the trade off between risk and return at a lower cost for the overall benefit of their firms. Experts in assets management should be employed to ensure efficient management of current assets, which affects tremendously the turnover and productivity of manufacturing companies.

It was also acknowledged that there is room for improving the performance of Nigerian manufacturing companies through training managers on how they can effectively use funds from different sources at their disposal for profit maximization. A strategy can also be set to identify at a glance the working capital management policy a company is using in a particular time and its direct impact on profitability. This would allow managers to avoid the combination of short and long term funds that would minimize their profit.

It was also concluded that those companies that adopt conservative working capital management policy are using considerable amount of long term capital in their financing, as such they are more efficient in Assets/Investment management which will yield more profit compared to those that use mostly aggressive working capital policy.

Limitations of the Study

In conducting this research work, some unavoidable constraints were encountered. The major ones include:

1. Lack of Adequate Knowledge on Working Capital management policies by Respondents:

The respondents selected who are employees of the companies under study for the administration of questionnaires were not very much conversant with the main issue this research was addressing, that is working capital policies.

2. Inaccuracy from Secondary Source of Data:

The data gathered for this research was mostly obtained through documentation. The degree of correctness and reliability of the study would, to a large extent, depend on the reliability and accuracy of the results published and documented in companies’ financial statements. The reliability of the research would be at stake if the published financial statements used were not showing true financial positions.

3. Limitations of Ratio Analysis:

Another constraint was from the computation of financial ratios to arrive at the conclusion of the study. The ratios calculated at a point of time could be less reliable than expected as they suffer from short term changes. The price level changes make the interpretations of ratios fairly difficult. They are also generally calculated from past financial statements which are based on historical cost convention, and thus, are a bit less dependable than desired.
Nevertheless, the study was conducted in the most intellectual and academic standard possible under the circumstances

Recommendations

Based on the findings of this study, the following recommendations are made:

  1. Factors affecting working capital needs should be critically studied, so that investment in working capital would be appropriate to avoid high risk of uncertainties.
  2. Manufacturing companies should employ qualified financial managers so as to effectively control cost of production and balance the trade off between cost of sales and quality of products manufactured so as to maintain reasonable level of sales.
  3. Financial managers in manufacturing companies should set a strategy to create more awareness on how financing mix affects productivity and how to identify the working capital management policy in use at a particular point in time.
  4. Manufacturing companies are advised to consider investment in current assets as important as investment in fixed or long term assets.

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