EFFECTS OF WORKING CAPITAL MANAGEMENT ON BUSINESS OPERATIONS (A STUDY OF PZ CUSSONS PLC)

TABLE OF CONTENTS

Title page                                                                                                                    i

Declaration                                                                                                                 ii

Certification                                                                                                                iii

Dedication                                                                                                                   iv

Acknowledgements                                                                                                     v

List of Tables                                                                                                              viii

Abstract     

CHAPTER ONE: INTRODUCTION

1.1 Background to the Study                                                                                                      1

1.2 Statement of the Problem                                                                                         2

1.3 Objective of the Study                                                                                             4

1.4 Research Questions                                                                                                  4

1.5 Hypotheses                                                                                                               4

1.6 Scope of the Study                                                                                                   5

1.7 Significance of the Study                                                                                         5

1.9 Operational Definition of Terms                                                                              6

CHAPTER TWO: REVIEW OF LITERATURE

2.1  Conceptual Model                                                                                                  8

2.1.1 Working Capital                                                                                                    8

2.1.1.1 Working Capital Management                                                                           13

2.1.1.2 Working Capital Components                                                                            15

2.1.1.3 Objectives of Working Capital Management                                                    15

2.1.1.4 Management of Working Capital Components                                                16

2.1.1.5 Working Capital Management Policies                                                             20

2.1.1.6 Working Capital Management in Developing Economies                                            21

2.1.1.7 Average Collection Period (ACP)                                                                     22

2.1.1.8 Inventory Turnover in Days (ITID)                                                                               23

2.1.1.9 Average payment period (APP)                                                                         24

2.1.1.10 Cash Conversion Cycle (CCC)                                                                        25

2.1.2 Organizational Performance                                                                                 25

2.1.2.1 Return on Assets                                                                                                26

2.1.2.2 Return on Equity                                                                                                27

2.1.3.3 Return on Investment                                                                                         28

2.1.2.4  Return on Sales                                                                                                 29

2.2 Theoretical Review                                                                                                  30

2.2.1 Agency Theory                                                                                                                  31

2.2.2 The Modern Portfolio Theory                                                                                           33

2.2.3 Operating Cycle Theory                                                                                        35

2.2.4 Cash Conversion Cycle Theory                                                                            38

2.2.5 Resource Based Theory                                                                                        39

2.3 Empirical Review                                                                                                     40

2.4 Summary and Gaps in Literature                                                                             43

CHAPTER THREE:METHODOLOGY

3.1 Research Design                                                                                                                   45

3.2 Sources of Data Collection                                                                                       45

3.3 Population                                                                                                                           45         

    3.5 Method of Data Collection                                                                                    46

3.6 Validity and Reliability of Data                                                                                           46

3.7 Method of Data Analysis                                                                                         46 

APPENDIX

LIST OF TABLES

4.1: Preliminary Analysis for Working Capital Management and

Organizational Performance                                                      49

4.2: Variance Inflation Factor for Multicollinearity                            50 

4.3 Hausman Tests                                        50

4.4 Dependent Variable: ROA; Panel Regression result based on Return on Asset.                  51

4.5: Dependent Variable: ROE; Panel Regression Result based on Return on Equity               53

4.6: Dependent Variable: ROI; Panel Regression Result based   on Return on Investment      55

4.7: Dependent Variable: Return on Sales; Panel Regression Result  based on ROS               57

4.8: Summary Table of Hypotheses Tested                            60

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The Nigeria Economy is faced with several challenges which could impede the speed of having a huge return on the resources employed by the firm. As a result, however, proper initiative and capital management is required. It is worthy to note that out of every resource that a firm has, working capital is the most important.

Working Capital refers to the capital available for running day-to-day operations of an organization. Working Capital is a financial metric which represents the operating liquidity available to a business. Along with 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 at bank, raw materials, work-in-progress, finished goods, accounts receivable, and etc. To measure the efficiency of a company's working capital, people often use net working capital which is defined as the difference between current assets and current liabilities. If current assets are higher than current liabilities, this 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 eliminates the risk of inability to meet due short-term obligations on one hand and avoid excessive investment in these assets on the other hand (Eljelly,2004).

There is a combination of policies and techniques for the management of a company's working capital. These policies involve inventory management, debtors' management (credit policy) and short-term financing management, and etc. A popular measure of working capital management is the cash conversion cycle, which tells us how cash is moving through a company in terms of duration.

Given the definitions, this research shall examine working capital management issues, specifically on how a company manages its working capital by shortening or lengthening its cash conversion cycle in order to contribute for a superior operating profitability. Current assets may be financed either by long term finance or short term finance (current liabilities) which is a cheap source of finance. Net current assets required will depend on the nature of the company's business. As a company expands or grows and its output increase, the volume of its working capital will also increase. The volume of net assets will depend on policies adopted by a company. Company with no stock, no debtors and no creditors will have little or no investment in working capital. This will result in few sales and therefore little profit.

Cash is an important ingredient of any thriving business. It is essential that investment in working capital is effectively and sufficiently managed to maintain control of business cash flows. Thus, investment in working capital must consider the tradeoff between risk and profitability. Overcapitalization is an inefficient working capital management that results in excessive stocks, debtors and cash and very few creditors. This implies that working capital will be excessive. The return on capital employed would be lowered than it should be as long term funds would be unnecessarily tied up. Overtrading occurs if a business is trying to support large volume of trading with little long term capital as its disposal.

According to Sen and Oruc (2009), defines working capital management as consequential to a firm and this is usually explained by the relationship between working capital management and profitability. Working capital has a lot to do with how risky a business is and therefore managing it properly can improve the operation of a firm.

According to Farounbi (2005), working capital as to the amount of capital, which is readily available to a firm, that is, the difference between resources in cash or readily convertible into cash (current assets) and the firm commitments for which cash will soon be required (current liabilities).

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 operation. 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. 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 firm may either be overcapitalized or undercapitalized.

Smith (1973) 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 firms in the form of high bad debts, high inventory cost etc, which adversely affect their operating performance.

Current assets may be financed either by long term finance (current liabilities). Short-term financing is a cheap source of finance. For instance, trade creditors do not carry interest cost. However short term financing is risky. They create the danger of insolvency through insufficient liquidity. The effectiveness of working capital management can have a significant impact on both the liquidity and profitability of a company (Shin & Soenen, 1998). For the liquidity, lacking working capital can account for inefficiencies in a company's operation when it is not able to pay off its due obligations. On the other hand, without sufficient working capital, the company will not either be able to provide goods or services required to customers due to lack of money to buy materials for producing goods. The company's profitability can be jeopardized as a result.

In addition, Lamberson (1995) showed that working capital management is of importance in managing financial aspect of a company. Many financial managers are finding it difficult to identify the important drivers of working capital management that can enhance their company profitability. Most of researchers finds strong negative cause-and-effeet relationship between number of days inventories, number of days accounts receivable and cash conversion cycle with, and the corporate profitability (Shin and Soenen, 1998; Deloof, 2003; Raheman & Nars 2007); and a positive relationship between number of days accounts payable with the corporate profitability (Lazaridis & Tryfonidis, 2006).

In contrast, there are few researchers who have provided different results. For example, Nobanee (2009), concludes that there is a positive relationship between cash conversion cycle, number of days accounts receivable and number of days inventory with the firm's operating income to sales whereas number of days accounts payable has significant negative impact on the firm's performance. 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 business operations of PZ Nigeria PLC.

1.3 Objective of the Study

The main objective of this study is to examine the effect of working capital management on business PZ Cusson PLC.

The specific objectives are to:

i.               determine the effect of average collection period on return on assets of PZ Cusson PLC;

ii.              examine the influence of inventory turnover in days on return on equity of PZ Cusson PLC;

iii.            evaluate the effect of average payment period on the return on investment of PZ Cusson PLC and

iv.            assess the effect of cash conversion cycle on the return on sales of PZ Cusson PLC.

1.4 Research Questions

The following statements would serve as research questions for this study.

i.               How does average collection period affects return on assets of PZ Cusson PLC?

ii.              Does inventory turnover in days influence return on equity of PZ Cusson PLC?

iii.            What is the effect of average payment period on return on investment of PZ Cusson PLC?

iv.            What is the effect of cash conversion cycle on return on sales of PZ Cusson PLC? 

1.5 Research Hypotheses

H₀₁: Average collection period has no significant effect on the return on assets of PZ Cusson PLC.

H₀₂:   Inventory turnover in days does not influence return on equity of PZ Cusson PLC.

H₀₃:   There is no significant effect of average payment period on return on investment of PZ Cusson PLC.

H₀₄:   There is no significant effect of cash conversion cycle on return on sales of PZ Cusson PLC.

1.6 Scope of the Study

This study examined the relationship between working capital management and organizational performance manufacturing firms in Lagos State. The study employ ex-post-facto research design to explore factors that affect relationship between working capital management and organizational performance. This study covers all food and beverage firms in Lagos State which are listed on the Nigerian Stock Exchange. This study made use of secondary data and sample period range from 2007 to 2018. The data would be sourced from CBN statistical bulletin as well as from Annual reports of PZ Cusson PLC. 

1.7 Significance of the Study

The relevance or actual significance of this study would be discussed under different functional headings below:

Management Practice

Findings from this study would enhance the management practice of different organizations, in that it may help manufacturing firms in Nigeria and other companies in general improve on their financial decision making so as to optimize the value of the shareholders and maintain a favourable trade-off between liquidity and profitability. The findings are also expected to be useful to shareholders (as owners), creditors, and managers.

Industry

For every organization to survive there is need to have a reliable workforce as well as work process. As such the findings of this study are expected to help create a reminder for managers and owners on various manufacturing firms the importance of managing their working capital properly to attain their desired goals and objectives. Also findings from this study would keep key players of the manufacturing industry informed about the potentials working capital management has on improving profitability and the overall firm value in general. More so, key players like shareholders as the business owners could be the primary beneficiaries of the findings from this research, as anything affecting the value of their investments is of great importance to them. On the other hand, the findings would enable businesses to measure the level of safety in being able to discharge obligations in order to attain profitability and to be prepared for unforeseen events by providing cushion for such occurrences.

Government

At the end of this study, government agencies like Manufacturing Association of Nigeria would see this study as an added material that is specifically targeted at helping manufacturing firms in Nigeria improve their organizational performance. More so, the need for the government to ensure that policies that are favourable to these business owners should be considered and to ensure the provision of enabling business environment is given to the manufacturing firms in Nigeria.

Society

The study would make an exposition on the issue of working capital management, its implication on the performance of manufacturing organizations in Lagos State, in Nigerian and how to ensure that their business is sustained by enhancing their profitability level. 

The researcher would expose the nature of manufacturing companies’ working capital management through the review of several related literatures and the use of data gathered in the course of the analysis about the variables of working capital management as it influences the performance of manufacturing firms in Nigeria, Nigerian. However, the researcher would make recommendations based on the study findings to ensure that societal interest are well considered for future businesses in this field to be well informed on the role working capital on the success or failure of such businesses as discussed.

1.9 Operational Definition of Terms

Working capital: The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.

Working capital management: A company's managerial accounting strategy designed to monitor and utilize the two components of working capital, current assets and current liabilities, to ensure the most financially efficient operation of the company.

Organizational Performance: The actual output or results of an organization as measured against its intended outputs (or goals and objectives).

Foods and Beverages Industry: Is all companies involved in the processing raw food materials, packaging and distributing them. They include fresh, prepared foods as well as packaged foods and alcoholic and non- alcoholic beverages.

Manufacturing: The process of converting raw materials, components, or parts into finished goods that meet a customer's expectations or specifications.

Industry: A classification that refers to groups of companies that are related based on their primary business activities.

Average collection period: It is the average number of days it takes a company to collect its accounts receivable

Inventory turnover in days: How fast a business sells its products within a specific period of time.

Average payment period: Refers to the time taken to pay firm’s creditors.

Cash conversion cycle: Represents the current sales and the amount of time it takes to collect the cash from these sales.

Return on assets: A financial ratio that shows the percentage of profit a company earns in relation to its overall resources.

Return on equity: Refers to how efficiently a firm can use the money from shareholders to generate profits and grow the company.

Return on investment: The amount of additional profits produced due to a certain investment.

Return on sales: A financial ratio that calculates how efficiently a company is at generating profits from its revenue.

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