Working Capital Management And Firms Performance (A Study Of Manufacturing Companies In Nigeria)

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Working Capital Management And Firms Performance (A Study Of Manufacturing Companies In Nigeria)


Abstract


This study investigated the relationship between working capital management measured by account receivable period (ACRP), inventory period (INVP), cash conversion cycle (CCC) and sales Growth (SG) and profitability performance measured by returns on assets (ROA). The study utilized secondary data obtained from the annual financial statements of Nigerian Manufacturing companies listed on the Nigerian Stock Exchange (NSE) for period 2008 – 2012. Multiple regression model were adopted for testing all the hypotheses and the study result reveals that there was a negative significant relationship between the account receivable period and profitability of the Nigerian Manufacturing companies. It also reveals that the profit is significantly influenced by the number of days inventory were held (INVP) and that the profitability performance negatively and significantly related to the cash conversion cycle (CCC). These results suggest that effective policies must be formulated for the individual components of working capital. Furthermore, efficient management and financing of working capital (current assets and liabilities) can increase the operating profitability of manufacturing firms.


Chapter One


Introduction

1.1 Background to the Study

Working capital management of a firm, which deals with the management of current assets and current liabilities, has been recognized as an important area in financial management. Working capital (WC) refers to the firm’s investment in short-term assets. Pandey, (2005) classified working capital into gross and net concepts. He defined gross working capital as the firm’s investment in current assets. Current assets are the assets which can be converted into cash within an accounting year and these include; cash, short-term securities, debtors, bills receivables and stocks. He described net working capital as 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. These include trade creditors, bills payable, bank overdraft and short- term loan. Home van, (2000) described working capital management as involving the administration of these assets namely cash, marketable securities, receivables and inventories and the administration of current liabilities.

Management of these short-term assets and liabilities is important to the financial health of business of all sizes. This importance is hinged on the fact that the amounts invested in working capital are often high in proportion to the total assets employed and therefore warrants a careful investigation (Smith, 1980). Working Capital therefore, should neither be more nor less, but just adequate for the smooth running of a firm. While excess amount of working capital results in the reduction of firm’s profitability, holding of inadequate amount of it leads to lower levels of the firm’s liquidity and stock outs resulting in difficulties in maintaining smooth operation (Krueger, 2002).

Business success, therefore, heavily depends on the ability of the financial managers to effectively manage accounts receivable, inventory and account payable (which are component of working capital) (Filbeck and Krueger, 2005). Firm can reduce their financing costs and or increase the funds available for expansion of project by minimizing the amount of investment tied up in current assets (Home Van Wachowicz, 2004). For this reasons, most of the financial manager’s time and efforts are spent in identifying the non-optimal levels of current assets and liabilities and bringing them to optimal levels (Lamberson, 1995). An optimal level of working capital is the one in which a balance is achieved between risk and efficiency. To maintain the optimal level of various components of working capital, continuous monitoring is required (Afza and Nazir, 2009).

A poor or inefficient working capital management leads to tie up funds in idle assets and reduces the liquidity and profitability of a company (Reddy & Kameswar, 2004). Siddart & Das (1993), states that the major reason for slow progress of an undertaking is shortage or wrong management of working capital. Deloot (2003: 573), states that “there is a significant relationship between gross operating income and number of days of account receivable, inventories and accounts payables”. The relationship between accounts payable and profitability is consistent with the view that less profitable firms wait longer to pay their bills.

Considering the importance of Working capital management therefore, the researcher focused on evaluating the Working Capital Management and profitability relationship like other similar works such as Uyar, 2009; Samiloglu and Demirgune 2008; Vishnani and Shah, 2007; Tervel and Solano, 2007; Lazaridis and Tryfonidis, 2006; Padachi, 2006; Shin and Soenen, 1998; Smith et al, 1997 and Jose et al, 1996. However, there are a few studies with reference to Nigeria in respect of the subject. Like Akinsulire, 2005, Falope,, 2009, Ajilore,, 2009 etc.

Most of these studies focused on the Working Capital Management financing policies. Shah and Sana (2006) concentrated on the oil and gas sector and estimated the relationship using small sample of 7 firms. Raheman and Masr (2007) analyzed profitability and Working Capital Management performance of 94 firms listed on Karachi Stock Exchange for the period 1999-2004 by using ordinary least square and generalized least square. However, this study ignored the fixed effect of each firm as each firm has its unique characteristics and also ignores sector-wise analysis of Working Capital Management performance of manufacturing firms. Insufficient evidences on the firm’s performance and Working Capital management with reference to Nigeria therefore, provide a strong motivation for evaluating the relationship between working capital management and firm’s performance in detail. This study therefore, explores the various way of measuring Working Capital components and relates them to the performance of the Nigerian manufacturing sector.


1.2 Statement of the Problem

There has been a growing number of studies that examined the relationship between working capital and corporate profitability in the recent time (Shin and Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; .Jinadu, 2010). Justification for this common efforts centered on the relationship between efficiency in working capital management and firms profitability and its implications on shareholder’s value. Most of these studies were however, centered on large firms operating within well developed money and capital market of developed economies and did not consider the fact that the amount of working capital required varies across industries and indeed firms depending on the nature of business, scale of operation, production cycle, credit policy, availability of raw materials etc (Ghosh and Maji; 2004).

It is regrettable to note that in spite of these huge literatures in this area, many firms had crashed, more especially manufacturing sector of the Nigerian economy in which application of working capital is more pronounced (Jinadu, 2009). In addition, some promising investments with high rate of return are failing and being frustrated out of business because of inadequacy of working capital. Many factories had been either temporarily or completely shot down because they could not meet their financial obligations as at when due because they were not liquid. Many Nigerian workers had been forcefully thrown into unemployment market and frustratingly became dependent on relations as a result of the aborted mission of their organization caused by poor attention given to the management of working capital . Unfortunately, Nigeria capital and money markets are not really helping to ameliorate the problem, instead, more often than not; they compound the problem by creating bottleneck with harsh conditions that could not be easily met by the companies that are at the verge of collapse.

The problem then arises as to how managers of these manufacturing organizationcould be encouraged to pay more attention to the management of their working capital. In other words, how could working capital be managed in order to impact positively on firms performance.


1.3 Objectives of the Study

The main objective of this study is to investigate the relationship between working capital management and the corporate performance (profitability) of the Nigerian manufacturing companies. While the specific objectives of the study are to: –

  1. Investigate the relationship between the accounts receivable period (as a measure of WCM) and profitability of manufacturing companies in Nigeria.
  2. Investigate the relationship between inventory period (as a measure of WCM) and profitability of manufacturing companies in Nigerian.
  3. Investigate the relationship between cash conversion cycle period (as a comprehensive measure of checking the efficiency of WCM) and profitability of manufacturing companies in Nigeria.

1.4 Research Questions

In a bid to actualize the research objectives, the following research questions have been formulated which serve as a guide in the researcher’s quest for answers. These questions are;

  1. What is the significant relationship between the accounts receivable period (ACRP) and profitability of Nigerian manufacturing companies?
  2. What is the significant relationship between the inventory period (INVP) and profitability of Nigerian manufacturing companies?
  3. To what extent is the relationship between cash conversion cycle (CCC) and profitability of manufacturing companies in Nigeria?
  4. To what extent does the effective management of working capital affect the profitability of the Nigerian manufacturing companies?
  5. What level of working capital is optimal and desirable?
  6. To what extent has the inadequacy of working capital affect the profitability of the Nigerian manufacturing companies.

1.5 Research Hypotheses

A hypothesis is a conjecture or a prediction of what can be seen in the world of reality and this prediction is made from the world of theory. It is a tentative statement about the relationships that exist between two or among many variables (Asika, 2005).

HO1: There is no significant relationship between the accounts receivable period (ACRP) and profitability of Nigerian Manufacturing Companies

HO2: To provide an empirical support to the relationship between working capital management and profitability of the Nigerian manufacturing companies, three hypotheses have been formulated and stated in their null forms as follows:

HO3: There is no significant relationship between the inventory period (INVP) and profitability of Nigerian Manufacturing Companies There is no significant relationship between the cash conventions cycle (CCC) and profitability of Nigerian Manufacturing Companies


1.6 Scope of Study

The scope of the study enables the researcher to circumscribe his/her research within a manageable limit (Asika, 2005).

In this research work, an attempt is made to explore the relationship between working capital management and firm’s performance for twenty (20) manufacturing firms out of the 134 manufacturing firms listed on the Nigerian stock exchange for the period 2008-2012. The twenty (20) manufacturing firms were selected based on the following criteria:

Companies must remain listed on the Nigerian Stock Exchange (NSE) during the 2008 – 2012 periods.

Companies must have complete financial statements for the period under review.

Companies must be operational within the period under investigation. Manufacturing organizations were so taken into consideration since they play a very important role in the Nigerian economy.


1.7 Significance of the Study

This study is very crucial as it will give the financial managers of these manufacturing organizations, better insights on the need to pay particular attention to the effective and efficient management of their working capital. They will be in a better position to be able to design and implement strategies and policies that are aim at stabilizing and managing the various components of working capital especially as it significantly impact on the main aim of business which is creating shareholders’ value.

The study would further, enable the management to know at what extend they should increase their liquidity in order to make their performance up to the mark.

This is very important in improving the good will of their firms, since firms that pay creditors as at when due are considered credit worthy and gains a good reputation.

And for the academic purposes, the research work will contribute to the existing body of knowledge on working capital management and firm’s performance. Finally, it is expected that the study will serve as a source of information to students undergoing research work of this nature in the future.


Chapter Five


Summary, Conclusions and Recommendations

5.1. Introduction

This chapter presents: summary of the study findings, conclusions and possible policy implications of the results, recommendations of the study as well as areas of further research.


5.2. Summary

This study examined the Impact of Working Capital Management on the Profitability of Nigerian manufacturing companies quoted on the Nigerian Stock Exchange (NSE) for the period of five years spanning from 2008-2012. The specific objectives of the study were to examine the relationship between the various measures of WCM, which includes the Account Receivable Period (ACRP), the Inventory Period (INVP) and the Cash Conversion Cycle (CCC) on the profitability of the Nigerian manufacturing concern. To achieve these objectives, Ex-post Facto research design was adopted for the study after the previous relevant empirical literatures on the Impact of Working Capital Management on Profitability of manufacturing firms were reviewed. The choice of Ex-post Facto research design was because the explanatory factors (independent variables) have existed in the data without being manipulated or controlled and the study is out to see their effects on the dependent variable.

The data collected for the study were obtained through the secondary source. The study used five (5) variables with their choice being primarily guided by previous empirical studies. For the dependent variable, firm’s profitability was measured by using the returns on assets (ROA) and with regards to the independents variables, Working Capital Management was measured by using ACRP, INVP and CCC while Sales Growth was used as a control variable in the model.

The data presentation was facilitated by the use of tables and regression results to analyze the relevant data that were extracted from the annual financial report of the sampled manufacturing companies, for the period 2008 to 2012. This data analysis was done with a view to ascertaining the relationship between the measures of WCM and profitability of manufacturing firms in Nigeria. The student t-test was used to test the study hypotheses at 5% level of significance. The regression results table reveals that by using any of the independent variables and holding others constant, ACRP, INVP, CCC will affect ROA negatively by 0.3%, 0.1% and 0.2% respectively while the sales growth used as a control variable has a positive coefficient of 2.1%. The result for VIF reveals that there is no problem of multi-collinearity among the independent variables. The result also reveals an R2 of 77.5% indicating that 77.5% of variations of ROA is accountable by ACRP, INVP, CCC and SG while only 22.5% is attributable to other factors outside this study. The Durbin Watson statistics of 1.708 indicates the absence of auto correlation for all the variables. The sig. F. change of 0.028 indicates the fitness of the model.

A summary of the findings from the study analysis and test are:

  1. The profitability of Nigerian manufacturing companies is significantly influenced by the number of days account receivable are outstanding (Account Receivable Period).
  2. The profitability of Nigerian manufacturing companies is significantly influenced by the number of days inventory is held in store (Inventory Period) (INVP).
  3. The profitability of Nigerian manufacturing companies is significantly influenced by the Cash Conversion Cycle (CCC).
  4. The profitability of Nigerian manufacturing companies is significantly influenced by Sales Growth (SG).

The above results are consistent with the empirical findings of Petersen and Rajan (1997), Deloof (2003), Shin and Soenen (1998), Padachi (2006), Rahaman and Nasr (2007), and Falope and Ajilore, (2009).

The findings therefore, confirm that there is a significant relationship between measures of working capital management and Profitability of the Nigerian manufacturing companies in line with the previous studies. This means that Nigerian firms should ensure adequate management of working capital management measures especially the CCC, INVP and ACRP as efficient working capital management is expected to contribute positively to firm’s performance.


5.3. Conclusions

The contribution of manufacturing sector to the economic growth of Nigerian cannot be overemphasized. To this end, the main objectives of the study are to empirically analyze the Impact of Working Capital Management on Profitability Performance of manufacturing firms quoted on the Nigerian Stock Exchange (NSE). The results show that for overall manufacturing sector, working capital management has a significant impact on profitability of the firms and plays a key role in value creation for shareholders. Longer cash conversion cycle have negative impact on net operation profitability of a firm. The Cash Conversion Cycle offer easy and useful way to check working capital management efficiency. For value creation of shareholders, firms must therefore, try to keep these numbers of days to minimum level. There also exists negative association between the number of days inventory are held (Inventory Period) and profitability for manufacturing firms under study which implies that keeping lesser inventories will increase profitability, while Sale Growth which serves as an indicator of firm’s business opportunities was found to have a positive association with profitability. The Sales Growth is a very important factor which allows firm to enjoy more profit.

Form the foregoing; it is therefore imperative for managers of Nigerian manufacturing firms to design and implement strategies and policies that will aim at stabilizing and managing the various components of working capital.

5.3.1 Policy Implication

Several policy implications can be drawn from the above findings of the study which include that working capital management should be the concern of all the manufacturing sector firms and need to be given due importance. In addition, the collection and payment policies of the firms in manufacturing sectors in general need to be thoroughly reviewed. It is generally argued that firms need to accelerate their cash collections and slow down their payments. This can however, only be possible with some professional advice and supervision.


5.4. Recommendations

The results of this study suggests that by reducing the number of days inventory are held (inventory period) as well as the cash conversion cycle to a reasonable minimum, Managers of Manufacturing firms in Nigeria can enhance profit performance of their firms. The study therefore recommends that managers should pay more attention to the proper inventory management. This may be achieved by setting certain standard that will help to maintain inventory at optimal level. Findings from the study further suggested that efficient management and financing of Working Capital (Current assets and current Liabilities) will not only increase the operating profitability of the manufacturing firms in Nigeria but also maximize returns to shareholders’ investment. It is therefore recommended that specialized person in the field of finance should be hired by these firms for expert advice.

Finally, the study recommends that the account payable which is regarded as a major source of working capital financing for firms should be repositioned in order to reduce the Cash Conversion Cycle further. This will improve their liquidity position and also reduce their over-dependence on high interest loans for financing of the day-to-day operations. Managers of these companies can achieve this by re-negotiating with their regular and important suppliers for further increase in the number of days account payable are due for payment (Pandey, 2005).


5.5. Suggestions for Further Research

This study examined the Impact of Working Capital Management on Profitability Performance of Nigeria manufacturing Companies quoted on the Nigerian Stock Exchange (NSE) for the period 2008 – 2012. Further research could be conducted to include companies not quoted on the Nigerian Stock Exchange in order to have an in-depth assessment of the impact of WCM on the Profitability of manufacturing companies in Nigeria. In addition, an exploratory study could also be carried out on how global best practices in working capital management can be implemented in Nigerian manufacturing firms.


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Frequently Asked Questions


How can managers improve the performance of working capital?

Product in stock less time, are all associated with an increase in the firms performance. Managers, therefore, can increase firms‟ profitability by improving the performance of management of working capital components.

What are the measures of Working Capital Management Profitability?

These Firms financial performance on the profitability measurements (i.e. return on asset and return on investment capital) as a measure of working capital management. 2.4.1. RETURN ON ASSETS Return on assets means how much a firm generates profits and effectiveness with given resources. It is also called return on investment (ROI).

What is the best book on Working Capital Management?

Kieschnick, R., LaPlante, M., Moussawi, R., 2008.Working capital management, agency costs, and Company value, University of North Texas University Press, AustinLuo, M. et al., 2009. Cash Conversion Cycle, Firm Performance and Stock Value Koperunthevi, K (2010), Working Capital Management and Firms‟ Performance Lantz, B. (2008).

Does Working Capital Management affect organizational performance in Pakistan?

Raheman et al (2010) selected some firms in Pakistan during 1998 to 2007 in order to seek the impact of working capital management on the organizational performance. They argued that cash conversion cycle and inventory turnover

What are the benefits of efficient working capital management?

Efficient working capital management helps maintain smooth operations and can also help to improve the company’s earnings and profitability. Management of working capital includes inventory management and management of accounts receivables and accounts payables.

How do you improve working capital?

Ways to Improve Working Capital 1. Improve Accounts Receivables Collections. Are accounts receivable being collected in a timely manner? Encourage… 2. Improve Accounts Payable. Negotiate better payment terms with materials suppliers and distributors (or replace them… 3. Negotiate Better Pricing …

What is included in Working Capital Management?

Management of working capital includes inventory management and management of accounts receivables and accounts payables.

What are the key performance ratios of a working capital management system?

An efficient working capital management system often uses key performance ratios, such as the working capital ratio, the inventory turnover ratio and the collection ratio, to help identify areas that require focus in order to maintain liquidity and profitability.

What is the relationship between Working Capital Management and profitability?

It same apply for Ganesan (2007), analysis on the WCM efficiency in telecommunication equipment industry, found that there is negative relationship between working capital and profitability. It can be said that management of working capital have significant impact on profitability and liquidity in different countries and industries.

What is working Capital Management (WCM)?

Working capital management (WCM) refers to management of a firm’s current assets and current liabilities, which is also a primary function that support firm daily operation such as used to funds its stock, credit sales, and credit purchases.

Why is it important to manage working capital requirements?

Therefore, he highlights the importance of managing working capital requirements to ensure an improvement in firm’s market value and profitability and must consider the working capital when making company’s strategic.

Does working capital liquidity affect risk and return on investment?

By referring to the risk and return theory (Pettengill et al, 1995), higher risk investments will result in higher returns and vice versa. Hence, firms with low liquidity of working capital may have higher risk then high profitability. Conversely, high liquidity of working capital may face low risk then low profitability.

Is it necessary to manage working capital?

The financial management today, because of various complexi­ties in the market and competitive business environment, finds it nec­essary to deal with working capital in two parts — overall manage­ment and management of each item separately.

What is your review of the book’ Working Capital Management’?

The book provides multidirectional and multidimensional investigation of various aspects of working capital management. The book discusses all the important aspects in a systematic manner. Apart from its extensive coverage and lucid presentation, the strength of the book lies in its Indian background.

What are the three working capital management strategies?

Key Takeaways 1 Working Capital Management requires monitoring a company’s assets and liabilities to maintain sufficient cash flow. 2 The strategy involves tracking three ratios: the working capital ratio, the collection ratio, and the inventory ratio. 3 Keeping those three ratios at optimal levels ensures efficient working capital management.

Where can I download the Working Capital Management Notes?

Working Capital Management Notes can be downloaded in working capital management pdf from the below article. A detailed working capital management syllabus as prescribed by various Universities and colleges in India are as under.

Does Working Capital Management affect firms’ financial performance?

Results suggest that Working Capital management has a significant impact on firms’ financial performance in terms of profitability, as well as growth. As far as component wise results are concerned, inventory management does influence the firms’ growth and Payable management significantly, hence affecting the firms’ profitability. 

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