IMPACT OF WORKING CAPITAL MANAGEMENT ON FIRMS EFFICIENCY AND PROFITABILITY (A STUDY OF SELECTED COMPANIES IN PORT HARCOURT)

ABSTRACT

Working capital has been found to be an essential ingredient for the survival of a typical business organization.   The way this is carried out could affect the profitability or effectiveness of the firm.  This study was undertaken to investigate the ways company adopt to manage their working capital and the possible effect on the firm’s efficiency and profitability.   Three (3) companies based in Port Harcourt were used as a study.  Questionnaire copies were issued to management staff of these companies.  Responses from these questionnaire provided the data for our analysis; Annual reports of these firms also provided the secondary data. To give the study a scientific focus, four (4) hypotheses were formulated and tested in the core areas of investigation.  It was discovered in the study that most firms depend on the use of cash budget to determine the optimal cash to hold.  Inability to use the cash models to determine the level of cash to shift to marketable securities and the possible balance to maintain at any particular period had rendered the working capital management ineffective in these firms.  Based on the findings of this  study,  we recommended among others, that, firms in Nigeria should employ managers who are skilled on the use of financial models so as to be able to apply the necessary tools in the management of their working capital for effective result.

CHAPTER ONE

1.1      Background of the Study

Working capital is an essential ingredient for the survival of a typical business organization (Ola 1982:89).  Traditionally, working capital means a  firm  investment  in  net  currents  assets,  that  is,  inventories,  cash, marketable securities and accounts receivable.

Decision relating to working capital and short term financing are referred to as working capital management.  These involve managing the relationship between firm’s short term assets and its short term liabilities. The goal of working capital management as to ensure that the firm is able to continue its operations and that, it has sufficient cash flow to satisfy both maturing short-term debt and up coming operational expenses.

Working capital management entails short term decision generally, relating  to  the  next  one  year  periods  which  are  “reversible”.    These decisions are therefore, not taken on the same basis as capital instrument decisions (NPV, or related as above).  Rather, they will be based on cash flow and/or profitability.   In this context, the most useful measure of profitability is Return on Capital (ROC).   The result is shown as a percentage determines by dividing relevant income for the 12 months by capital employed.  Return on Equity (ROE) shows that the result for the firm’s shareholders value is enhanced when and if the return on capital which results from working capital exceeds the cost of capital which results from capital investment decisions as above.  (ROC) measures are therefore, useful as a management tool in that they like short-term policy with long- term decision making.

Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital.   These require managing the currents assets, generally cash and cash equivalents

inventors and debtors.   These are also a variety of short term financing options which are considered.

Cash Management: Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.

Inventory Management: Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials and hence increase cash flow.

Debtor’s Management:   Identify the appropriate credit policy i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be off set by increases revenue and hence, return on capital (or vice versa).

Short term Financing:  Inventory is wealth financed by credit granted by the supplier depending on the cash conversion cycle.  It may be necessary to utilize a bank loan (overdraft) or to convert debtors to cash through “factoring”

The management hopes to achieve the following:

(a)       Management of the monies of the firm in order to attain maximum cash availability and minimum interest income on any idle funds

(b)      Obtain satisfactory credit from suppliers

(c)       To enjoy extension of credit during periods of cash shortage (Obara and Eyo, 2000)

(d)       The  need  for  cash  management  is  to  balance  liquidity  with profitability (Aborode, 2005:225).

(e)       Managing inventory, in order to have optimal stock available at a point in time (Aborode, 2005:225).

1.1.1  The Selected Company’s History

A.       Chapal Technical Company Limited

Chapal Tech Company was established in Lagos in 1978 as a privately owned company.   Initially, it specialized in heavy duty injector pump calibration and overhauling. Soon after, services were extended to include maintenance, repair and overhaul of company owned workshops.  Chapal Technical Company Ltd was converted in 1988 to a Limited Liability Company, incorporating new shareholders, and  diversifying its  services.    Thus,  in  addition to mechanical  services,  chapel  extended  its  scope  of  work  to  oil services and fabrication.

In 1992, former member of Society General, De Surveillance S.A., joined chapel as a foreign partner.  As a result, chapel has been in a projection to employ foreign experts as required, and this expands its activities to the areas of technical inspection.

Services Provided by CHAPAL

(1)      Consultancy and Inspection

      Chapal’s  expatriate  and  Nigerian  experts  inspect  and supervise various oil companies’ projects.

      Chapal carries out technical surveys and feasibility studies of construction and mechanical ventures.

(2)      Direct field project execution mechanical

      Complete  or  partial  installation  of  heavy  plants  and generating sets.

      Maintenance  and  repair  of  Oil  Plants  and  equipment already in operation.

(3)      Supply Services

Supply  of  mechanical,  construction  and  chemical materials following client’s requirement and specifications.

Location of Offices

Chapal operates for both offices and a number of field offices, depending on projects currently being executed.

B.       Simplex Packages and Allied Limited

Simplex packages and Allied Resources Limited is an offshoot of Garden City Yoghurt Nigeria Enterprise.   The later was founded in 1999 by a team of young dynamic and highly   resourceful   Nigerian’s,   committed   to   absolute economic independence through the pursuance of legitimate prosperous business.    Garden  City  Yoghurt  Nig Ent.  was registered under the laws of the Federal Republic of Nigeria in Port Harcourt, Rivers State; to carryout the business of production and sale of dairy products and other related beverages.   It further sought for and obtained NAFDAC certification to commence the business of yoghurt production in February 2000.  Then, the company has been in that line of business,  providing nutritious  food  drinks  to  the  Nigerian market.

From the beginning in 2000, through the provision of qualitative refreshing and hygienic food items, Garden City has distinguished itself as a potential force to reckon within its chosen line of business; this was obviously sequel to the visionary  stewardship  and  inflicting  commitment  of  the sundry   members.      The   products   were   quick   to   gain acceptance into most of the major outlets such as the supermarkets, fast food shops and other retailers, as it was soon becoming a consumer’s delight within Port Harcourt and Aba metropolis.

Due to phenomenal growth in the volume of activities and  the  earnest desire  to  meet the  ever-increasing market demand, a group of highly professional technocrats were consulted with a view to repositioning the business for further diversification and other related challenges ahead.   This informed the incorporation of  Simplex Packages & Allied Resources Ltd. in July 2001, taken on Garden City Enterprise as a business subsidiary.

C.       Air Liquide Nigeria PLC

Present in 65 countries, Air Liquide is the world leader in industrial and medical gases and related services.   The group offers innovative solutions based on constant and entranced technologies.   These solutions, which are in line with Air Liquide’s commitment to sustainable development, help to protect life and enable our customers to manufacture many dispensable everyday products.

Founded in 1902, Air Liquide has more than 30,000 employees. The group has successfully developed a long-term relationship   with   its   shareholder   built   on   trust   and transparency and guided by the principles of corporate governance.   Since the publication of its first consolidated financial statements in 1971, Air Liquide has posted strong and steady earnings growth.

Sales in 2003 totaled 8.394 billion euros of which sales outside trance accounted almost 80%.  Air Liquide is listed on the Euronet pairs stock exchange and is a component of the CAL  40  and  Eurostoxx  50  index  (ISIN  Code  FR  000 120073).

1.2      Statement of the Problem

The   importance   of   a   well-managed   working   capital   to   the profitability and for the survival of the firm cannot be waved aside.  This importance is also borne out of the fact that every firm needs working capital  to  finance  daily  operation.    According to  Baranele  (1969:107), profitability is determined in part by the way in which a company manages its working capital.  Lack of good management leads some companies to have ineffective working capitals and some of the problems arising from that are:

Over  trading:    Where  the  expansion  in  the  scale  of  the  firm’s business outstrips its working capital.   Unable to secure long-term loans, such firms often use bank overdraft facilities to buy fixed assets.  The firm will be unable to pay off the overdraft facilities on maturity because the funds have been sinking into fixed assets.  This may result in selling stocks at low prices to pay pressing creditors, which will also result in loss of profit.  The major cause of this overtrading is that, as we discussed earlier, is improper management of working capital.  A situation where a company could not manage it well, it may result to divert current liabilities which is overdraft to financed fixed assets.  These two items are not compatible and it can automatically result in the management of the working capital problems, which is overtrading.

1.3      Objectives of the Study

Working Capital Management cut across various aspects in an organization.    It has different meaning to different organization. Additionally, each company has different view in terms of objectives and aims.  However, the objectives of this study are:

(1)       To investigate problems confronting firms in designing strategies for optimal cash holding in companies.

(2)       To   investigate  the   impact   of   inadequate   working  capital   on profitability of firms.

(3)       To investigate the extent to which financial models are adopted to determine optimal cash holding in the firm.

(4)      To examine working capital management practices in the companies.

1.4      Research Questions

Given  the  above  objectives,  the  following  research  questions  shall  be addressed in this study:

(1)      Why should a company hold adequate cash for its operations?

(2)       What  is  the  relationship  between  working  capital  and  a  firm’s profitability?

(3)       Why is it necessary for a company to adopt a particular system or model of management in their working capital?

(4)       Why is it necessary for a company to maintain adequate working capital?

1.5      Research Hypotheses

In order to provide answers to the above research questions, the following null hypotheses shall be tested in this study.

1.6      Significance of the Study

It is hoped that this study shall be of great significance to the following people:

People in finance and accounting environment, because they are the people who are maintaining, controlling and managing working capital in an organization.

These people are financial managers, account officers, budget and control officers and managers of the companies.

Apart from enabling finance mangers to understand possible techniques, for the management of working capital, this study is significant because it promotes research endeavours, thus, adding to the knowledge.

Findings from this study will form the foundation and bedrock for further research effort in the improvement of financial management as an academic subject.

1.7      Scope of the Study

The study is limited to working capital management in oil industries. The companies involved in this research are:

(1)      Chapal Tech. Co. Ltd.

(2)      Simplex Packages & Allied Resources Ltd

(3)      Air Liquide Nigeria Ltd.

We are therefore concerned primarily in this research to find out: Whether current assets and current liabilities are being analyzed and identified by selected companies.  This is a very “tall” objective although achievable.

1.8      Limitations of the Study

However, the limitation of the study is likely to be the sample size, where some respondents are likely to refuse to answer questionnaire or provide the necessary information for the study.  Others are financial and logistics  constraints,  such  as  transportation,  long  distance  and  other variables beyond the control of the researcher.

Because of the importance attached to the topic, it is the desire of the researcher  to  reach  out  to  as  many  companies  as  possible  in  the investigation through out the country. This may not be possible due to time and financial constraints.  For these reasons, the study is limited to firms located in Port Harcourt.  Even at that, it may not be possible to go round all the firms located in Prot Harcourt.  This underscores our choice of three companies to be used as a case study.

1.9      Definitions of Terms

Since the research topic is a financial/accounting topic, it has some accounting terminologies, in which it can be only understood by the people in accounting environments.   This is the reason why certain terms are defined to offer more clarity.

Working Capital:    Working Capital is the management of the firm’s short term  assets   and   liabilities,   individually   and   in aggregation with all the functional areas of business (Bhalla, 2005:401).

Short Term Assets: These are assets which can easily be converted to cash within one year and they are cash, debtors etc.

Short Term Liabilities:      These are liabilities which is maintainable under 3 months e.g creditors and overdraft, but not exceeding one year.

Management:           This is the  process of controlling and  directing the business of the firm.

Overtrading:             Is  where  the  expansion  in  the  size  of  the  firm’s business outstrips its working capital.

Undertrading:          Is a surplus of working capital where the business is not earning sufficient return on capital employed.

Short Term Investment:    Are   generally   liquid   and   very   marketable financial       securities   which   can   be   held   by   an organization in lieu of cash holding e.g. treasury bills.

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