WORKING CAPITAL MANAGEMENT AND PROFITABILITY IN NIGERIA PETROLEUM MARKET SECTOR (2000-2013)

ABSTRACT

The aim of this study is to investigate the working capital management and profitability in  Nigeria  petroleum  marketing  sector.  The  statistical   significance   between  the individual component of working capital management and profitability is examined in this  study.  In the  light  of this  objective  the  study adopted  quantitative  method  of research  approaches  to  test  a number  of  research  hypothesis.  The  study selected  a sample of six (6) major oil marketers in Nigeria that have the complete annual report and accounts on Nigeria Stock Exchange for the period of fourteen years (2000-2013) with the total of 84 observations. Data was then analyzed on quantitative basis using fixed  effect  regression  model  (FEM)  and  OLS  regression  analysis  to  define  the association between firm’s profitability and working capital management components. The results  showed  that  Average  Collection  Period  (ACP)  has  a  positive  and  non significant impact on profitability. It means that, a firm with generous credit terms can increase sales as it allows more time for customer to make payment.  It was also found that Inventory Period (IP) has a positive  and  non significant  impact on profitability which means that keeping high inventory saves firm from stock out and also result in more sales which leads to increase in profit. Moreover the study finds that there is no positive relationship  and  significant  impact between Average Payment Period (APP) and profitability, it means that the shorter the account payable days, the more profitable the companies are. And finally the researcher found that Cash Conversion Cycle (CCC) has a positive and non significant impact on profitability which implies that if a firm takes more time to collect cash against credits, it will increase its profit. But despite that individual  variable  does  not  have  a  significant  impact  on dependent  variables  but collectively,  the F- statistics shows that all the independent  variables  taken together have a significant impact on the dependent variable. ( that is F- Statistic = 0.02, P-value

= 0.7 in ACP, F-Statistic = 0.02, P-value = 0.26 for IP and F- Statistic = 0.01, P-value =

0.09 for CCC).

Keywords:  working  capital  management,   firm  size,  Average  Collection   Period, Inventory Period, Account payable period, cash conversion cycle, and profitability.

1.1      Background of the study

CHAPTER ONE

INTRODUCTION

Corporate  finance  literature  has  traditionally  focused  on  the  study  of  long-term financial  decisions  such  as  the  capital  structures,  investments,  dividends  and  firm valuations. However, finance theories are discussed under three main threads as capital budgeting, capital structure and working capital management. As a result, the first two are  mostly  related  to  financing  and  managing  long  term  investments.  Meanwhile, financial decisions about working capital are mostly related to financing and managing short term investments and habilitate, classified under both current assets and current liabilities  simultaneously (Mueller,  1953;  Pinches,  1992;  Brealey and Myers,  1996; Damodaran,  2002). Hence, management of working capital refers to management  of current assets and current liabilities (Ross et al., 2003, Raheman and Nasr, 2007).

Working  capital  consists  of current  assets  and  current  liabilities  and  the  first  one includes capital tied up in cash, short-term financial investments, inventories, account receivables and other current assets (Brealey, Myers & Allen, 2006, p. 813). Current liabilities include short-term loans, the debts to suppliers as account payables, accrued income taxes, and interest payments on long-term  debts,  dividend  and other current liabilities (Pass & Pike, 2007). The concept of working capital management addresses companies’ managing of their short-term capital and the goal with the management of working capital is to promote a satisfying liquidity, profitability and shareholders value (Jeng-Ren,  Li  &  Han-Wen,  2006).  Meanwhile,  financial  decisions  about  working capital  are  mostly  related  to  financing  and  managing  short  term  investments  and habilitate  classified  under  both  current  assets  and  current  liabilities  simultaneously (Mueller, 1953; Pinches, 1992; Brealey and Myers, 1996; Damodaran, 2002).

The three concepts, solvency, liquidity and financial flexibility, are all affected by the choices that companies  make regarding their working capital policies.  Simplified,  a solvent company has more assets than liabilities and to find out a companies solvency, the  current  ratio  and  net  working  capital  can  be  used.  Liquidity,  a  measure  of companies’  ability to pay their short-term  obligations  without unnecessary  costs,  is evaluated  using  the  measurements;   cash  flow   from  operations,   cash  conversion efficiency and cash conversion cycle. The  third concept,  the financial  flexibility,  is

measured by sustainable growth rate. A firm’s financial flexibility reflects a company’s ability  to  deal  with  unforeseen  opportunities  and  adversities  with  regards  to  the company’s financial policies and structure (Maness & Zietlow, 2005, p. 25-45). These measurements,  all evaluate  working  capital  management  in  some  way and  for our study, we have chosen to use the cash conversion cycle as a measurement for working capital management.

The cash conversion cycle evaluates how fast companies’ activities of resources can be converted  into  cash  and  this  measurement  is used  to  evaluate  a company’s  liquid situation  and  how  effective  the  working  capital  management  is (Deloof,  2003).  A shorter cash conversion cycle indicates a more effective managed working capital and it has lately become more common that companies has their goal set to achieve a zeroed working capital (Maness & Zietlow, 2005, p. 15). However, a goal of having a zeroed working capital is not the optimum for all companies as a liquidity level close to zero may result in a shortage of cash which could lead to difficulty in operations and in the ability of managing their financial short-term debts. With this in mind, each company should find the level between current assets and liabilities that will serve them most value (Maness & Zietlow, 2005, p. 5-9). As the effectiveness of the working capital management relies on the cash conversion cycle, companies should put their efforts in making their cash  management  more effective by reducing number of day accounts receivable,  number of days inventories and raising number of days accounts payable (Theodore Farris II & Hutchison, 2003).

Management  of  working  capital  is  an  important  component  of  corporate  financial management because it directly affects the profitability of firms. Nwude (2004) states that management of working capital has a significant effect on firms profitability and liquidity, irrespective of the nature and size of the business.  Smith (1980) concluded that  working  capital  management   is  important   because   of  its  effect  on  firm’s profitability and risk, and consequently its  value. Similarly, Deloof (2003) indicated that the way working capital is  managed  has a significant  impact on profitability of firms.  The above  studies  point out  that  there  is a certain  level of working  capital requirement,  which  potentially maximizes firm’s returns. On the other hand, Kargar and Bluementhal (1994) mentioned  that bankruptcy may be likely for firms that put inaccurate  working capital management  procedures  into  practice,  even though their

profitability is constantly positive. Therefore, firms must avoid receding from optimal working capital level by bringing the aim of profit maximization in the foreground.

The ultimate  objective  of any firm  is to  maximize  its profit.  However,  preserving liquidity of the firm is an important objective as well. The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm. Therefore, there must be a tradeoff between these two objectives (liquidity and profitability) of firms. One objective  should  not be at the cost of the other  because  both have their own importance. If firms do not care about profit, they cannot survive for a longer period. In other  round,  if  firms  do  not  care  about  liquidity,  they  may  face  the  problem  of insolvency  or bankruptcy.  For these  reasons  managers  of firms should  give proper consideration   for  working   capital   management   as  it  does  ultimately  affect  the profitability of firms. Indeed firms may have an optimal level of working capital that maximizes their  value. Large inventory and generous trade credit policy may lead to high sales.  Large  inventory also  reduces  the risk of a stock-out.  Trade  credit  may stimulate sales because it allows a firm to access product quality before paying (Long,

1993 and Raheman and Nasr, 2007). Another component of working capital is accounts payables.  Raheman  and  Nasr  (2007)  indicated  that  delaying  payment  of  accounts payable to suppliers allows firms to access the quality of obtaining products and can be inexpensive  and  flexible  source  of financing.  On the other  hand, delaying  of such payables can be expensive if a firm is offered a discount for the early payment. By the same token, uncollected accounts receivables can lead to cash inflow problems for the firm.

A popular measure of working capital management is the cash conversion cycle, that is, the time span between  the  expenditure  for the purchases  of raw materials  and  the collection of sales of finished goods. Deloof (2003) found that the longer the time lags, the larger the investment  in working capital, and also a long cash  conversion cycle might  increase  profitability  because  it  leads  to  higher  sales.  However,  corporate profitability  might  decrease  with  the  cash  conversion  cycle,  if the  costs  of  higher investment in working capital rise faster than the benefits of holding more inventories or granting more trade credit to customers.

In general, working capital management is not only improving financial performance in today’s cash-strapped and uncertain economy, but it is the question of meeting firm’s

day to day operation. Hence, it may have both negative and positive impact on firm’s profitability,  which  in  turn,  has  negative  and  positive  impact  on  the  shareholders wealth.

Therefore, it is a critical issue to know and understand the impacts of working capital management and its influence on Petroleum marketing company’s profitability. Indeed, a lot of research has been conducted on this topic in other countries by using panel data (that is a data set in which the behavior of entities are observed across time) through multiple regressions to show the impacts of working capital components on petroleum marketing company’s profitability. However, to knowledge of the researcher, the cost of petroleum marketing companies has not been addressed. This limited evidence in the context of Nigeria along with the importance of working capital management calls for research on the impacts on Petroleum marketing company’s profitability. In light of the above points, the general objective of the study will be to examine or assess the impacts of working capital management on the profitability of Petroleum marketing sector firms in Nigeria.

1.2 Statement of the Problem

Working capital management is an important issue in any organization. This is because without a proper management of working capital components, it is difficult for the firm to run its operations smoothly.   That is why Brigham and Houston (2003) mentioned that about 60 percent of a typical financial manager’s time is devoted to working capital management. Hence, the crucial part of managing working capital is maintaining the required liquidity in day-to-day operation to ensure firms smooth running and to meet its obligation (Eljelly, 2004). The existence and maintenance of working capital is the lifeblood of a corporation. Regardless of the size of the company, the management of working capital accounts should influence its financial health (Lifland 2011, p. 57).

In addition,  Sankar  2011  states  that  Working  capital  can  also  be  regarded  as  that portion of the firm’s total capital, which is employed in current operations. It refers to all aspects of current assets and current liabilities. Current assets are those assets, which in the ordinary course of business can be or will be converted into cash within one year without undergoing a diminution in value and without disrupting the operations of the firm.  Working  capital  is essential  to  maintain  the  smooth  running  of business.  No

business can run successfully without an adequate amount of working capital. Working capital refers to a firm’s investment in short term assets (Thappa, 2014).

The fundamental subject of working capital is to provide optimal balance between each element forming working capital. Most of the efforts of finance directors in a firm are the efforts they make to carry the balance between current assets not at optimal level and responsibilities to an optimal level (Lamberson, 1995). The most important of all, it is  the  determination  of  investment  volume  and  to  which  asset  it  will  be  invested (Appuhami, 2008:11). One reason for this is the decisive influence of current assets on others, one another reason is the obligation of  fulfillment of current responsibilities. Working capital necessity influences  liquidity level and profitability of a firm. As a result, it affects  investment  and  financing decisions,  too. Despite the compounds of working capital that a company must have, basically depends on the company type and the sector in which it operates. Company size, growth rate and cash flow are the other important factors. If the determination factors are not explained fully and adequacy of working   capital   is   undetermined,   companies   would   be   routed   to   bankruptcy (Appuhami,  2008:11,  Ramachandran,  Kanakiraman,  2009:64).  Amount  of  current assets to be calculated at a level where total cost is of a  minimum degree means an optimum working capital level. The optimum working capital level is the case in which balance between risk and efficiency is provided.  A quest for such balance requires a constant monitoring of the elements forming working capital.

Poor management of working capital results to liquidity problems which might lead to bankruptcy   in   every   severe   case   (Nwude,   2004:628).   When   organization   has insufficient working capital, it will be difficult for them to survive in a  competitive environment because they cannot be able to meet the needs of their customers and also their short term creditors and it also makes difficult the  implementation of operating plans and achievement of profit target.

Further,  working capital management  has been major issue especially in  developed countries.  As a result,  in order to explain the relationship  between  working capital management  and profitability different researches  have been  carried out in different parts of the world  especially  in developed  countries.  However,  despite  the obvious importance this issue failed to attract the attention of researchers in Nigeria petroleum marketing sector. Thus, while browsing on internet, searching through the books and

journals the researcher did not find any research directly related to Nigeria petroleum marketing  sector.  Therefore,  the  researcher  believed  that,  the  problem  is  almost untouched and there is a knowledge gap on the area.

The traditional view of working capital management is to shorten the cash conversion cycle to

Increase profitability. However, if firm has higher level of account receivable due to the generous trade credit policy, it would result to longer cash conversion cycle.  In this case, the longer cash conversion cycle may lead to increase  in  profitability but this cannot be applied to all circumstances. Hence, lack of proper research study in the area gives a chance  for  Nigeria  petroleum  market  managers  to  have limited  knowledge concerning working capital management relative to profitability. Therefore, by keeping the above problem in mind, the study tried to find out the impacts of working capital management and profitability on Nigerian petroleum market sector.

1.3 Objectives of the Study

The study aims to examine the impacts of working capital management on profitability of Petroleum marketing sector in Nigeria.

The Specific objectives are to assess the impact of

1.    Inventory  period  on  the  profitability  of  Petroleum  Marketing  sector  firms  in

Nigeria.

2.    Average Collection Period on the profitability of Petroleum Marketing sector firms in Nigeria.

3.    Average payment Period on the profitability of Petroleum Marketing sector firms in Nigeria.

4.   Cash Conversion cycle on the profitability of Petroleum Marketing sector firms in

Nigeria.

1.4. Research Questions

To address these objectives, the following research questions have been formulated:

1.   How far does Inventory period impact on the profitability of petroleum marketing sector firms in Nigeria?

2.   To what extent  does Average  Collection  Period  impact on the profitability  of petroleum marketing sector firms in Nigeria?

3.   To  what  extent  does  Average  payment  period  impact  on  the  profitability  of petroleum marketing sector firms in Nigeria?

4.   How far does Cash  conversion  cycle  impact  on the  profitability  of  petroleum marketing sector firms in Nigeria?

1.5. Research Hypotheses

To examine the questions raised above, the following are the research hypotheses:

1.   Average Collection Period does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.

2.   Inventory  Period  does  not  have  a  positive   and  significant   impact  on   the profitability of petroleum marketing sector firms in Nigeria.

3.   Average payment Period does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.

4.   Cash conversion  cycle does not have a positive and significant  impact on  the profitability of petroleum marketing sector firms in Nigeria.

1.6 Scope of the Study

The research covers the six major oil marketers  out of the total of nine  petroleum marketers that were quoted on Nigeria Stock exchange. These firms include Fort Oil plc, MRS plc, Mobil plc, CONOIL plc, Total plc, Oando plc. The sample was chosen because three of the quoted firms were acquired by the two major marketers and this made the remaining six marketers to be the only petroleum marketers that have the complete annual report and accounts with Nigeria Stock Exchange.  It is the availability of these annual reports that guided the researcher’s choice of companies in this study. The sample covered fourteen fiscal years, 2000-2013.

1.7 Significance of the Study

Much has been written and studied about working capital management and profitability of the firm in different country, but this research add some insight about this issue as related to Nigeria as a country and petroleum marketing company in particular. The significance  of this study can be  viewed  in two  ways,  the  practical  and  academic significant.

(a)  Practical significance

      It  benefits  the  top  managers  and  policy  makers  of  those  selected  companies regarding decision on optimum level of working capital, ways of managing it and overall policies on working capital management.

      It  gives  clear  understanding  about  the  relationship   between  working  capital components and corporate profitability.

      It gives brief information for the shareholders, prospective customers and creditors of a firm regarding profitability in relation to efficient working capital management and policy.

(b) Academic significance

      In academic area, the study helps as a guideline for those who will conduct their study on the topic similar but in different sectors.             Finally, the study benefits researchers to obtain new knowledge from the added literature based on petroleum marketing companies.

₦5,000.00 – DOWNLOAD FULL PROJECT DOWNLOAD FULL PROJECT Added to cart

---

---

---

---

Related Project Topics :