ABSTRACT
The study examined the effect of working capital management on the profitability of listed manufacturing companies in Nigeria. The main objective of the study is to evaluate the effect of working capital management on the profitability of listed manufacturing companies in Nigeria. The study specifically investigated the effect of current ratio, quick ratio, inventory days and trade receivable days on the profitability of listed manufacturing firms in Nigeria. To achieve the stated objectives, an ex-post facto research design was used through the published annual reports of the companies. The hypotheses were tested using multiple regression analysis. The findings revealed that there is a significant relationship between the working capital variables and the profitability of the companies. However, while some of the companies recorded a positive relationship, others recorded a negative relationship. The study recommends that poor performing firms should adequately plan and control their operations, adjust all the short falls as noted from the financial ratios calculated and bring them to standard in order to ensure the management of working capital variables.
TABLE OF CONTENTS
Title i
Certification ii
Approval
iii
Dedication
iv
Acknowledgements iv
Table
of Contents v
Abstract vi
1.1 Background to the study 1
1.2 Statement of the Problem 3
1.3 Objectives of the
study 4
1.4 Research Questions 5
1.5 Research Hypotheses 5
1.6
Significance of the Study 6
1.7
Scope of the study 7
1.8
Limitation of the study 7
2.1 Conceptual Framework 8
2.1.1 Composition of Working Capital 9
2.1.2 Working Capital Management 11
2.1.3 Working
Capital Policy 12
2.1.4 Working
Capital Cycle 13
2.1.4
Element of Working Capital Inventory 14
2.1.5
Management of Trade Debtors or Accounts Receivable 15
2.1.6 Management of Cash 15
2.1.8 Management
of Creditors or Accounts Payable 17
2.1.9 Management of Marketable Securities 19
2.1.10
Working Capital Financing 20
2.2 Theoretical Framework 21
2.2.1 The Cash Conversion Cycle Model (CCC
model) 21
2.3 Review of Related Empirical Literature 24
3.1 Research Design 30
3.2 Area of the Study 30
3.3 Method of data collection 30
3.4
Method of Data Analysis 30
3.5
Model Specification 30
3.6 Description of Research
Variables 32
3.7 Decision Rule 32
4.1 Presentation of Data 33
4.2 Data analysis 38
4.3 Hypothesis Testing 42
4.4
Discussion of Result 44
5.1 Summary of Findings 46
5.2 Conclusion 46
5.3 Recommendations
47
References 48
Appendix 50
CHAPTER ONE
INTRODUCTION
1.1
Background to the study
Working
capital is the money needed to finance the daily revenue generating activities
of the firm. Working Capital is the flow of ready funds necessary for the
working of a concern. It comprises funds invested in current assets, which in
the ordinary course of business can be turned into cash within a short period
without undergoing diminishing in value and without disruption of the
organization (Mohanty, 2013). Working capital is a vital element in any
organizational setting that requires cogent attention, proper planning and
management (Owolabi and Alu, 2012). The essence of working capital is on its
ability to enhance organizational performance in terms of profitability and
other performance indices. Working capital does not on its own create any
impact on the performance of any organization until the forces of management is
being applied on it. Working capital management refers to investment in current
assets and current liabilities which are liquidated within one year or less and
is therefore crucial for firm’s day-to-day operations (Adeniji, 2008). It is
concerned with short-term investment and financing decision of an entity and is
a major business requirement and a significant part of corporate finance
(Sajjad and Bukhari, 2012). It covers the planning and controlling activities
of companies regarding their current assets and current liabilities in a manner
that guarantees their ability to meet their current obligations satisfactorily
as well as a maximum return on their precious investment in these floating
assets. The ultimate goal of working capital management is to ensure that firms
are able to continue their operations with sufficient cash flow that will
service their long-term debts and satisfy both maturing short-term obligations
and upcoming operational expenses (Owolabi and Alu, 2012). Working capital
management is used as an optimization tool to make the most profitable use of
liquid funds while maintaining a minimum level of liquidity to cover possible
unexpected short-term expenditures (Kunze and Peri, 2015). A positive working
capital indicates the ability of the business to pay off its short term
obligations at most when request comes from suppliers but a negative working
capital indicates the inability of the business organization to pay short term
obligations. As such, excessive working capital indicates an accumulation of
idle current assets, which do not contribute in generating income for the firm
during the operating period. Inadequate working capital on the other hand harms
the credit worthiness and the day-to-day activities of firms, which may lead to
insolvency (Singh and Asress, 2010). According to Alfred (2007) working capital
management plays a significant role in determining success or failure of firm
in business performance due to its effect on firm’s profitability as well on
liquidity. Business success depends heavily on the ability of financial
managers to effectively manage the components of working capital (Filbeck &
Krueger, 2005). A firm may adopt an aggressive or a conservative working
capital management policy to achieve this goal. Irrespective of the method
adopted, the aim will be to minimize the cost of working capital whilst
maximizing value to the organization.
Working capital management
is considered to be a crucial element in determining the financial performance
of an organization. Working capital management is a simple and straight forward
concept of ensuring the ability of the firm to fund the difference between
short-term assets and short-term liabilities (Egbedi, 2009). The essential part
in management of working capital lies in maintaining adequate liquidity in
day-to-day operations to ensure smooth functioning of the business. Therefore,
a firm is required to invest more in current assets rather than fixed assets to
maintain adequate liquidity. However, the firm’s decision about the level of
investment in current assets involves a trade-off between risk and return. When
the firm invests more in current assets it reduces the risk of illiquidity, but
loses in terms of profitability since the opportunity of earning from the
excess investment in current assets is lost. The firm therefore is required to
strike a right balance.
Working capital management
efficiency is vital especially for manufacturing firms, where a major part of
assets is composed of current assets (Falope, and Ajilore, 2009). Every
organization whether, profit oriented or not, irrespective of size and nature
of business requires necessary amount of working capital. Therefore, it is
possible to say that working capital can be regarded as life blood of the firm
and its efficient management can ensure the success and the sustainability of
the firm while its inefficient management may lead the firm into a pitfall.
1.2
Statement of the Problem
An
ideal business needs sufficient resources to keep it going and ensures that
such resources are maximally utilized to enhance its profitability and overall
performance. It has however been discovered that some methods that managers use
in practice to make working capital decisions do not rely on the principles of
finance, rather they use imprecise rules of thumb or poorly constructed models
(Emery, Finnerty and Stowe 2004). This, however, makes the managers not to
effectively manage the various mix of working capital component which is
available to them, and as such, the organization may either be overcapitalized
or undercapitalized or worst still, liquidate. Most financial managers place
much emphasis on other long-term financial decisions, particularly investments
and capital structure decisions. In the pursuit of running the day to day
business of a firm, Madhou, (2011) opined that CEOs and managing directors fail
to pay attention to the management of working capital. As a result of this,
most of the working capital decisions are delegated to junior employees of the
firm and are rarely factored in when major decisions are undertaken by the
CEOs.
Smith (1993) in Egbide (2009) discovered that large
number of business failures in the past has been blamed on the inability of the
financial manager to plan and control the working capital of their respective
firms. These reported inadequacies among financial managers are still practiced
today in many organizations in the form of high bad debts, high inventory costs
etc., which adversely affect their operating performance (Egbide 2009).
Also, the fact that an organization makes profits is
not necessarily an indication of effective management of its working capital because
a company can be endowed with assets and profitability but short of liquidity
if its assets cannot readily be converted into cash. As such, there will be shortage of cash
available for the firm’s utilization as at when due. Such an organization may
run into debts that could affect its performance in the long run because the
smooth running of operations of the organization comes to a sudden halt and it
will not be able to finance its obligations as at when due.
Again, some managers do neglect the organization’s
operating cycle thereby having longer debtors’ collection period and shorter
creditors’ payment period. All these constitute the problem of the
investigation, hence, the need to study the effects of working capital
management on the profitability of manufacturing industries in Nigeria.
1.3 Objectives of the study
The main objective of the study is to evaluate the
effect of working capital management on the profitability of listed
manufacturing companies in Nigeria.
The specific objectives of the study are
(i)
To determine the effect of current ratio on the profitability
of listed manufacturing firms in Nigeria
(ii)
To ascertain the effect of quick ratio on the profitability
of listed manufacturing firms in Nigeria.
(iii)
To determine the effect of inventory days on the profitability
of listed manufacturing firms in Nigeria
(iv)
To examine the effect of trade receivable days on the profitability
of listed manufacturing companies in Nigeria.
1.4 Research Questions
(i)
What is the extent of the effect of current ratio on the profitability
of manufacturing firms in Nigeria?
(ii)
To what effect is quick ratio on the profitability of
manufacturing firms in Nigeria?
(iii)
To what effect are inventory days on the profitability of
manufacturing firms in Nigeria?
(iv)
To what extent is the effect of trade receivable days on the profitability
of manufacturing firms in Nigeria?
1.5 Research Hypotheses
For the purpose of the
study, the following hypotheses was tested in null form
H01: Current ratio has no
significant effect on the profitability of manufacturing firms in Nigeria.
H02: Quick Acid Test ratio has no significant effect on the
profitability of manufacturing firms in Nigeria.
H03: Inventory
days has no significant effect on the profitability of manufacturing firms in
Nigeria.
Ho4: Trade
receivable days have no significant effect on the profitability of
manufacturing firms in Nigeria.
1.6 Significance of the
Study
The
purpose of this study is to identify whether the performance of organizations
are affected by working capital management in some selected companies quoted on
Nigerian Stock Exchange (NSE). Based on the fact that working capital is the
life wire of any organization, the importance of its effective and efficient
management and control cannot be over emphasized. This research work will lead
to a deeper understanding of its importance and its satisfactory provision can
lead not only to material savings in the economical use of capital but can also
assist in furthering the ultimate aim of a business, namely that of maximization
of financial returns.
Regarding
profit as cash is a fallacy that has lead to the dissolution of many companies.
This is because liquidity problems probably break more companies than lack of
order, strike, late deliveries or poor workmanship. Bad management is a simple
cause of business failure. In the light of the above, this study will therefore
be of great significant to the following:
i.
Manufacturing companies
in Nigeria: It will help companies in the manufacturing sector to improve their
technique of cash flow management. A “good cash flow management” means a lot
more money coming in than going out, and it can be used to finance expansion.
It will also aid their variance analysis with respect to working capital so
that if it is favorable, they will intensify effort to maintain it or adjust
their working capital policy if adverse effect is envisaged.
ii.
The study will serve as
an addition to the existing literature on working capital management, thereby
standing as a reference point to prospective researchers.
iii.
The study will also be of
great important to financial analyst and finance consultants.
1.7 Scope of the study
The
study deals with the evaluation of working capital management on the
performance of manufacturing companies in Nigeria. The study was carried out
using Nigeria Breweries, Guinness Plc, Aba Textile Mile, PZ Cussons and
Unilever Plc for data generation.
The study focused more on the effect of current ratio
on the profitability of manufacturing firms in Nigeria, effect of quick ratio
on the profitability of manufacturing firms in Nigeria, the effect of inventory
days on the profitability of manufacturing firms in Nigeria and the effect of
trade receivable days on the profitability of manufacturing firms in Nigeria.
There are many yardstick used to measure the profitability of companies whether
in manufacturing or non-manufacturing sector. This study covers only return on
asset (ROA) with respect to profitability.
1.8 Limitation of the
study
The
limitations of this study include some of unavoidable constraints and problems
encountered in the process. They are as follows:
Finance: The problem of finance is not left
out in the course of research to this study. This type of study required
adequate money and time to enable the researcher visit the necessary places for
collection of data. Insufficient fund will hinder an in-depth study of this
research since it is finance from pocket money of the researcher. Although the
researcher, as a student, is not financially dependent, he is poised to making
the best use of the available monetary resources to get the job properly done
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