COMPLETE SCHOOL PROJECT TOPICS & MATERIALS :
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CHAPTER ONE
INTRODUCTION
1.1 BackgroundtotheStudy
The resources of a firm that are used to conduct the day-to-day activities of any business are referred to as the working capital. Its proper management is one of the most important areas in determining the success of a firm. It is generally believed that the working capital is the amount of capital which is readily available to an organization; that is, the difference between resources in cash or readily convertible into cash (current assets) and the organizational commitments for which cash would soon be required (current liabilities). Looking at this, it can be said that working capital simply means the resources which a firm has at hand to run its daily operations.
Working capital connotes the funds locked up in materials, work in progress, finished goods (inventory), account receivables (debtors) and cash. In this regard, Khan and Jain (2005) state that current assets are those assets, which can be converted into cash within a short period of time, and the cash received is again invested into these assets; hence, it is constantly revolving or circulating. Therefore, working capital is one of the most important measurements of the financial position, which according to Guthmann (2008) is the lifeblood and nerve centre of any business entity. For the reasons and more, the proper and efficient management of the working capital of every business becomes a necessity if not obligatory.
Working capital management is concerned with managing the different components of current assets (inventories, debtors/receivables, cash/bank, short-term investments, prepaid expenses) and current liabilities (creditors/payables, provision for tax, other provisions against the liabilities payable within a period of 1 year) in such a way and manner that optimum level of working capital is attained and maintained. All this is very crucial in order to promote a satisfactory profitability and thus achieve the goal of the business which is the maximization of shareholder’s wealth (Ojeani, 2014). It is therefore of importance to state at this juncture, as posited by Ojeani (2014) that optimal efficient working capital is usually achieved through the management of inventory, receivables, payables, cash conversion cycle and the operating cycle as a whole. In essence, managing working capital is necessary owing to its direct impact on the profitability and liquidity of a corporate entity.
Osisioma (1997) reveals that working capital management ensures a sound liquidity and attainment of profit generating process, and also ensures acceptable relationship between the components of firms’ working capital for efficient mix which guarantees capital adequacy. Inventory management, according to Stephen (2012), consists of three components: raw material, work-in-progress and finished goods. He further explains that the holding of excessive stocks will lead to tying up capital in stocks while the holding of inadequate stock may lead to stock out cost such as lost profitability and goodwill from customers. Therefore, a firm needs to set an optimal level of stock. Van Horne (1995), in his view on receivables, says that account receivables management involves achieving an optimal average time taken by credit customers to settle their accounts. Moreover, since the purpose of giving out credit is to maximize profitability, the cost of debt collection should not be allowed to exceed the amounts recovered. Cash conversion cycle, according to Wang (2002), is used to measure cash management, and it represents the interaction between the components of working capital and the flow of cash within a company. Similarly, it can also be used to determine the amount of cash needed for any sales level; it is therefore a period of time between the cash outlay on raw materials and the inflow of cash from sales of finished goods.
It is believed that the management of working capital will go a long way in the achievement of profitability and overall performance of businesses since there is a great relationship between level of a company’s liquidity and its profitability Ojeani (2014). This implies that a firm’s liquidity does, to a large extent, determine its profitability. However, liquidity and profitability are not the same but are the core objectives of a firm. Any attempt to increase profitability by reducing the liquidity can bring some problems as goals cannot be ignored at any cost. If the goal of maximizing profit is ignored, survival is not possible for a longer time and if liquidity objective is ignored, insolvency or bankruptcy could be faced (Qazi, Syed, Zaheer and Nadeem, 2011). Managers must therefore endeavor to monitor and appropriately manage the in-balances.
The foregoing discussions have gone a long way to demonstrate the need to balance working capital position of the business enterprise in order to maintain adequate liquidity, minimize risks and raise profitability at all times. Although several researches have been conducted in various industry, like the manufacturing industry, banking industry, building industry and so on, but no attention has been given to the Nigerian conglomerate industry. It is on the above that the research aims at evaluating the impact of working capital on the profitability of firms in the Nigerian conglomerate industry.
Therefore, this study focuses on conglomerate companies in Nigeria; the conglomerate
industry manufactures and distributes variety of goods mostly of household use.
1.2 Statement of the Problem
One of the major objectives of working capital management is to ensure that corporate entities have sufficient, regular and consistent cash flow to fund their activities. Therefore, efficient working capital management could enable firms in sustaining growth which, in turn leads to strong liquidity and profitability for ensuring effective and efficient customer services. As such efficient management of working capital is very vital for a business survival. A company, whose working capital is poorly managed, for instance, is prone to financial crisis when faced with unforeseen circumstances such as unforeseen expenditure. Thus, an investor who invests in
such a company tends to get disappointed at the end of the day because it (the company) is bond to fold up at the initial stage. Stephen (2012) says that evidence that most business organizations do not hold the right amount of stocks, debtors and cash; as a result of which the firms are unable to meet their maturing short term obligations and its upcoming operational needs.
Similarly, insufficient working capital means that a firm is unable to undertake expansion projects and increase its sales, therefore limiting the growth and profitability of the business. Empirical efforts have been made by researchers to proffer solutions to these problems of working capital management faced by some firms; most of the researches still have some lapses due to approaches and methodologies adopted. For instance, some of these works were carried out trying to study the impact of an optimal inventory management on profitability; many others only focused on the optimal way of managing receivables to attain desired level of profitability: Rahmen and Nasr (2007) studied effect of working capital management on the profitability of a sample of 94 Pakistani companies listed on Karachi Stock Exchange for a period of six years; Lazaridis and Tryfonidis (2006) studied the relationship between working capital management and corporate profitability of listed companies on the Athens Stock Exchange. They used a sample of 131 listed companies for the period 2001-2004. The results from the regression analysis suggest that there is a statistically significant positive relationship between profitability, measured through gross operating profit, and the cash conversion cycle; Ganesan, (2007) analyzed working capital management efficiency and profitability and liquidity of firms in Telecommunication equipment industry in USA, using a sample of 349 companies for a period of 7 years (2001-2007). Using correlation and regression analysis, the results indicated that there is a significant negative relationship between cash conversion cycle which was used as a measure of working capital management and firm’s profitability.
Uremadu, Egbide and Enyi (2012) also tried to determine the effect of working capital management and liquidity on profitability of listed firms in the Nigerian productive sector for a period of 2 years (2005-2006). The micro-data were analyzed using descriptive statistics and ordinary least square (OLS) methodology. They discovered a negative relationship between cash conversion cycle, creditors’ payment period and profitability but a positive relationship between inventory conversion period, debtor’s collection period and profitability. It was also discovered that cash conversion cycle is the most significant precision variables in influencing profits and leads corporate profitability in Nigeria.
Despite the existence of all these studies, a careful look at all of them, one will quickly discover that little or none exists on the relationship between working capital management and profitability using combined variables (debtor turnover, inventory turnover and cash conversion cycle as proxies for working capital management) and Return on Asset-ROA ( as proxy for profitability).
Furthermore, another problem associated with these studies is that most of them used just one dependent variable to proxy profitability. Also, worthy to note is the fact that none of the studies is being carried out on conglomerate companies in Nigeria. Though Nwidobie (2012) chose conglomerate as one of the sectors when he studied the effect of working capital management on profitability of some selected manufacturing companies. The problem with Nwidobie’s study is the use of cross-sessional data. This study used panel data.
In view of the above therefore, the researcher is being motivated to carry out this study in order to fill this gap.
1.3 Objectives of the Study
The main objective of this study is to examine the impact of working capital management on the profitability of manufacturing firms in Nigeria. The specific objectives are to:
(i) investigate the impact of debtor’s turnover ratio on profitability of listed conglomerate companies in Nigeria.
- determine the impact of inventory turnover ratio on profitability of listed conglomerate companies in Nigeria.
- examine the impact of cash conversion cycle on profitability of listed conglomerate companies in Nigeria.
1.4 Hypotheses of the Study
In view of the above stated objectives, the following null hypotheses are formulated:
Ho1 Debtor’s turnover has no significant impact on the profitability of listed
conglomerate companies in Nigeria.
Ho2 Inventory turnover has no significant impact on the profitability of listed conglomerate companies in Nigeria.
Ho3 Cash Conversion Cycle has no significant impact on the profitability of listed conglomerate companies in Nigeria.
1.5 Scope of the Study
The study focuses on the issues of working capital management and profitability within the boundary of manufacturing firms in Nigeria. It is also of importance to mention that the whole population, the six listed conglomerate companies on the Nigeria Stock Exchange as at 31st December, 2015 forms the sample size. Ten year (2006-2015) financial reports of the said companies were studied. The variables in use are Return on Assets, Return on Equity,
Debtor turnover, inventory turnover and cash conversion circle.