ABSTRACT
Recently, the issue of many business failures in Nigeria had been linked to mismanagement of working capital in the form of high bad debts, high inventory costs and deterioration of firms’ credit standings. In view of the above, this study aims at examining the effect of mismanagement of working capital on corporate profitability and liquidity, the relationship between liquidity and profitability and the effect of use of debts in Nigerian firms. In carrying out this study, the ex-post facto research design was adopted. The population was one hundred and seventy four companies listed in the Nigerian Stock Exchange. The sample was sixty five companies which were made up of twenty six manufacturing sector and thirty nine service sector companies. The sample size was randomly selected through stratified sampling technique. Secondary data were collected from past financial annual published accounts of the firms for the period 2007 to 2012. Data collected were analyzed using both descriptive and quantitative methods. Hypotheses were tested using Regression and student T-test. Results obtained showed that inefficient management of working capital has a negative impact on corporate profitability, a negative relationship between liquidity and profitability, an inverse relationship between liquidity and profitability and also, negative effect on profitability due to increase in debts. This study concludes that for a corporate profitability and growth to be achieved, there is need for efficient management of working capital. It also recommends that management should ensure proper and efficient use of working capital to achieve corporate growth and survival.
CHAPTER ONE INTRODUCTION
1.1 BACKGROUND TO THE STUDY:
Working capital refers to the organisation’s investment in short term assets and it is important to the financial health of businesses of all sizes (Padachi, 2006). This importance is hinged on many reasons, first, the amounts invested in working capital are often so high in proportion to the total assets employed and it is vital that these amounts are used in an efficient way. Second, the management of working capital directly affects the liquidity and profitability of the corporate organization and consequently its net worth. Working capital management therefore, aims at maintaining a balance between liquidity and profitability while conducting the day-to- day operations of a business concern (Smith, 1980).
Working capital is of utmost importance in any organization. Management of working capital is one of the most important functions of corporate management. Every organisation whether profit oriented or not, irrespective of its size and nature of business, needs requisite amount of working capital to be maintained at any point in time. The capital to keep an entity moving on day-to-day operation of the business is working capital. The efficient working capital management is the most crucial factor ensuring survival, liquidity, solvency and profitability of the concerned business organisation (Jose, Lancaster and Stevens,1996). An organisation needs sufficient cash to carry out purchase of raw materials, payment of day-to-day operational expenses including salaries, wages, repairs and maintenance expenses and others. Funds to meet these expenses are collectively known as working capital.
In simplicity, working capital refers to that portion of total fund, which finances the day-today working expenses during the operating cycle of a business. Working capital is necessary in the day to day running of the business and this includes inventories, debtors, short term marketable securities, cash at bank, cash on hand, short term loans and advances, payment of advance tax and all current assets and current liabilities. A business organisation should determine the exact requirement of working capital and maintain the same evenly throughout the operating cycle. It is worth mentioning that a firm should have neither excess nor inadequate working capital as both phenomena of over capitalisation and under capitalisation of working capital generates adverse effects on the profitability and liquidity of the concerned companies. The effective working capital necessitates careful handling of current assets as to ensure liquidity and solvency of the business (Harris, 2005).
The ultimate objective of any firm is to maximize the profit (Deloof, 2003). However, preserving liquidity of the company to a minimal level is also an important objective for organisational survival (Smith, 1980). Thus, the problem is that increasing profits at the cost of liquidity can bring serious problems to the company. Therefore, there must be a trade off between these two objectives of the company (Eljelly, 2004). The debtors collection period should be reduced while the creditors payment period should be increased. One objective should not be at the cost of the other because both have their importance for corporate survival. If organisations do not care about profit, they cannot survive for a longer period. On the other hand, if they do not care about liquidity, they may face the problem of insolvency or bankruptcy which may finally lead to liquidation. Thus, to achieve the above corporate objectives, there is need for proper consideration of working capital management and ultimately its effect on corporate profitability (Egbide, Enyi and Uremadu, 2012). Hence, this study examines working capital management and corporate profitability, analysis of Nigerian firms.
1.2 STATEMENT OF RESEARCH PROBLEM
One of the serious problems faced by a good number of companies is poor working capital management (Smith, 1980). A large number of business failures in the past had been blamed on the inability of financial managers to plan and control the working capital of their respective organizations (Egbide et al, 2012). These reported inadequacies among financial managers are still manifesting today in many organizations in the form of high bad debts, high inventory cost, etc. which adversely affect their operating performance. Also, increasing of profits at the cost of liquidity might cause serious trouble to the firm and this might lead to financial insolvency. Moreover, insufficient liquidity might damage the firm’s goodwill, deteriorate firm’s credit standings and might lead to forced liquidation of company’s assets (Charterjee, 2012). In view of the above problems, this study will consider working capital management and corporate profitability, analysis of Nigerian firms.
1.3 OBJECTIVES OF THE STUDY
The main objective of the study is
(a) To assess the impact of working capital management on corporate profitability in Nigerian companies.
The specific objectives are,
(b) To examine the impact of working capital management on liquidity in Nigerian companies.
(c) To establish the effects of liquidity on corporate profitability of firms in Nigeria.
(d) To ascertain a relationship between corporate profitability and debt of firms in Nigeria.
1.4 RESEARCH QUESTIONS
(a) To what extent does working capital management affect corporate profitability? (b) To what extent does working capital management affect liquidity of business
organizations?
(c) What is the relationship between liquidity and corporate profitability? (d) How is profitability related to debt?
1.5 HYPOTHESES OF THE STUDY
To solve the problems stated above, the following hypotheses were formulated: (H1) Efficient management of working capital has a positive impact on corporate profitability.
(H2) Liquidity is affected by poor management of working capital in corporate organisations.
(H3) There is a relationship between liquidity and corporate profitability.
(H4) Efficient management of debt by organization has a positive effect on corporate profitability.
1.6 SIGNIFICANCE OF THE STUDY
This study will be of relevance to;
A. Corporate Organizations and their Management:
To corporate organizations in general, it will expose the relationship existing between our relevant variables (Inventory Conversion Period, Debtors Collection Period, Creditors Payment Period, Cash Conversion Cycle, Current Ratio, Quick Ratio, Debt Ratio and Fixed Assets on Total Assets) which will be of interest to them in their respective organizations.
Specifically, to the different companies under study, it will expose to a large extent the goings-on in the different companies with regard to our relevant variables (Inventory Conversion Period, Debtors Collection Period, Creditors Payment Period, Cash Conversion Cycle, Current Ratio, Quick Ratio, Debt Ratio and Fixed Assets on Total Assets). The results of this study would provide organizational managers better insights on how to create efficient working capital management that have the ability to maximize organizational value. As a result, it will build up confidence in investors to invest in that firm.
B. Academic Significance:
In the academic arena, this study will prove to be significant in the following ways:
It will serve as a secondary source of data and also contribute to the enrichment of literature on the issue through provision of additional insights.
It will expand the knowledge on the relationship between working capital management and other variables (Inventory Conversion Period, Debtors Collection Period Creditors Payment Period, Cash Conversion Cycle, Current Ratio, Quick Ratio, Debt Ratio and Fixed Assets on Total Assets) apart from profitability.
1.7 SCOPE AND DELIMITATIONS OF THE STUDY
This study covered issues bordering on the impact of working capital management and corporate profitability of the Nigerian companies for a six year period of 2007 to 2012. The choice of the years is due to data availability, and the need to expand on the length of time adopted by previous researchers on the same topic. It also covered areas such as effects of working capital on liquidity, relationship between liquidity and profitability, relationship between profitability and debt, causes of corporate failures and dangers of inadequate and excessive working capital. Return on Assets (R.O.A.) is to be adopted as a measure of profitability.
On the other hand, the delimitation of the study is that this study did not cover issues bordering on other forms of financing such as long term debt financing in organizations.
1.7 OPERATIONAL DEFINITION OF TERMS
The importance of definition of terms is to ensure that essential terms in the research are not lost through mis-interpretation.
Working Capital = The amount of cash and cash convertibles within a short period of time or all current assets that includes cash and cash equivalent.
CPP = Creditors Payment Period: This is the period it takes to pay the creditors. Given by: Average Creditors x 365 days
Credit Purchases
DCP = Debtors Collection Period: The period it takes for a business to receive payments owed from its customers. Given by:
Average Debtors x 365 days
Credit Sales per Annum
ICP = Inventory Conversion Period: The period during which a company must invest cash while it converts materials into sale. Given by:
Average Stock purchased x 365
Cost of Sales per Annum
ROA = Return on Assets: This is the earnings that are generated from invested capital
(assets). It indicates how profitable a company is relative to its total assets.
Given by: Net Income
Total Assets
CCC = Cash Conversion Cycle: This is the number of days for which working capital has been invested in the business.
Given by: DCP + ICP – CPP
CR = Current Ratio: It is the company’s ability to pay its short term debts.
Given by: Current Assets
Current Liabilities
QR = Quick Ratio: It is the company’s ability to pay its short term debts. It is a more stringent test of liquidity if compared with CR.
Given by: Current Assets – Inventories
Current Liabilities
DR = Debt Ratio: This is the portion of the total assets that is financed by debt.
Given by: Total Long Term Debts
Total Assets
FATA = Fixed Assets on Total Assets: This means the company’s ability to generate much revenue from the use of their assets.
Given by: Fixed Assets
Total Asset
This material content is developed to serve as a GUIDE for students to conduct academic research
WORKING CAPITAL MANAGEMENT AND CORPORATE PROFITABILITY(ANALYSIS OF NIGERIAN FIRMS, 2007 – 2012.)
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