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THE EFFECT OF WORKING CAPITAL ON THE OPERATIONAL EFFICIENCY OF AN ORGANIZATION

CHAPTER ONE

INTRODUCTION

1.1   Background to the Study

The current scarcity of cash and credit is threatening the survival of many businesses in all over the world primarily in Nigeria as its considered the sources of company’s working assets and liabilities referred to as working capital. it is a fact that corporations could not exist without working capital and this is undeniable. Eventually, the management of working capital (WCM) necessitates short term decisions in working capital (WC) and financing of all aspects of both firms short term assets and liabilities. This explains the fact that firms with inadequate working capital are in financial strait jacket. As the name implies, working capital refers to the funds that are required for the day to day running of the activities of a firm. it is the excess of current assets over current liabilities. Working capital management involves the relationship between a firms short term assets and its short term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short term debt and upcoming operational expenses. In view of that, working capital management has become one of the most important issues in the organizations where many financial executives strive to identify the basic working capital drivers and the appropriate level of working capital (Lamberson 1995).

The management of working capital involves managing inventories, account payables, account receivables and cash. Large numbers of business failure has been attributed to the inability of financial managers to plan and control the current assets and current liabilities of their respective organizations. This explains why working capital management is vital to firms with limited access to the long term capital market. The working capital measures both a company’s efficiencies and its short term financial health. It also gives investors an idea of the companies underlying operational efficiency. The working capital shows a company’s efficiency, financial strength and cash flow health which also helps in determining the profitability and risk as well as its value (Smith 1980).

The significant of working capital had been highlighted in most of the literature of WCM i.e. Eljelly (2004) described that the efficient WCM are engaged with planning and controlling current assets and liabilities in such a way that eliminates the risk of inability to meet short term obligations in hands with the avoidance of excessive investments in these assets. Siddiquee and khan (2009) indicate that the inefficient management of WC not only reduces profitability but ultimately may also lead a concern to financial crisis thus every organization irrespective of its profit orientation, size and nature of business needs requisite amount of WC. Consequently, the efficient WCM is the most crucial factor in maintaining survival, liquidity, solvency and profitability of the concerned business organization. Thus, we could say that approach in managing working capital has enormous influence to the firm’s performance.

The importance of working capital in the day to day running of the business activities of a firm are stated in the books. Having said that working capital is the live wire of a business, it is expected that effective provision of it will ensure greater success of a company while in — effective management of it will lead to ultimate downfall of what otherwise might be considered as a prosperous concern. Working capital is important to the operations of a firm but the maintenance of a working capital is more crucial. This is because excessive working capital means holding costs and idle funds which earns no profits for the firms is dangerous while inadequate working capital which means not having sufficient funds only limits the firm’s profitability but also results in production interruptions and inefficiencies and sales disruptions.

1.2    Statement of the Problem

Working capital management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities in respect to each other. Generally speaking, the immediate problem facing most financial managers always centers on the best way to ensure suitable survival of the business as well as its expansion in terms of working capital management. A firm or company should be in a sound working capital position. It should have adequate working capital to run its business operations. One should note that both excessive as well as inadequate working capital position are dangerous to any business, therefore a company is required to maintain a balance between liquidity and profitability which are sometimes conflicting objectives while conducting its day to day activities.

However, financial managers are faced with the major problem of obtaining an optimum level of working capital which is a situation whereby working capital managers are able to avoid the problem of holding idle funds which earns no profit for the firm and inadequate working capital which reduces the firm’s profitability as well as production interruptions and inefficiencies. The credit policy of a firm is another bottleneck confronting working capital management. A flexible credit policy adopted by the management in most cases results in writing off a high proportion of bad debts while a rigid credit policy reduces the level of sales and also scares away customers. Therefore, financial managers are faced with the problem of determining an effective and efficient credit policy which should be in line with their company’s goals and objectives.

Fraud is almost in every organization and this is also a big problem to working capital managers since working capital management requires a substantial part of the capital held in liquid cash so as to run the day to day activities of a firm. Financial managers are faced with the task of providing adequate security in order to prevent embezzle of money meant for the organization. Working capital management is mostly important to firms in developing economics because they are faced with many problems such as; low investment, low sales, lack of resources, low level of product and process technology, small market, lack of access to capital, lack of physical infrastructure, production capacity to satisfy demand (because they are small), thereby, making inventory management more crucial. Most of the Nigerian firms do not have access to capital and lack the opportunity of getting the benefit of financial market.

Working capital policy is one of the minimizing committed finance whereas working capital management is an optimizing process aimed at filling the minimization policy to operational requirement. This implies that inefficient and ineffective management of working capital will hinder the growth and survival of the organization. A survey of empirical literature on the determinants of working capital and its effect on profitability showed that few studies have been conducted on these issues in both developed and developing countries. Many of these studies identified such factors as size, leverage, operating cash flow among others as major determinants of working capital while few found negative effect of working capital management on profitability. However, it was observed that most of the existing studies focused only on developed economies. Not many studies have focused on firms’ in developing countries. In addition, none of the existing studies has addressed the issue of long run relationship between working capital and profitability and the direction of causation between the two phenomena. These are the main gaps that this study intends to fill. Firstly, this study is focused on firms’ in Nigeria. Secondly, it does not only examine the determinants of working capital and its effect on profitability but also investigates the relationship between working capital management and profitability.

1.3       Objectives of the Study

The broad objective of this study is to examine the effect of working capital management on the profitability of manufacturing firm. The specific objective is to:

(i)  Investigate the various components of working capital in Cadbury Nigeria PLC.

(ii) Examine  the level of working capital management in Cadbury Nigeria PLC and

(iii) Evaluate the impact of working capital management on the profitability of Cadbury Nigeria PLC.

1.4  Research Questions

This study intends to provide answers to the following questions;

(i)  What are the components of working capital management in Cadbury Nigeria PLC?

(ii) How effective does the working capital management of Cadbury Nigeria PLC enhances its profitability?

(iii) Has Cadbury Nigeria PLC been able to manage its trade debtors, stock and trade creditors effectively?

1.5  Research Hypotheses

The main purpose of this study is to examine the effect of working capital management on profitability, This will form the basis for formulating the hypotheses which will be tested and validated with a view to making some recommendations.

Ho: Working Capital Management of Cadbury Nigeria PLC does not enhance its profitability

Hi: Working Capital Management of Cadbury Nigeria PLC enhances its profitability

Ho: Cadbury Nigeria PLC does not have an optimum level of working capital management

Hi: Cadbury Nigeria PLC has an optimum level of working capital management.

1.6  Significance of the Study

This study is generally designed for the benefits of all investors and owners of manufacturing companies who have not adopted any policy on working capital management. To investors and owners of firms, a good working capital management indicates sound liquidity position of the company meaning that the company is well managed, financed and sound. From the research, the firm ability to finance long and short term liabilities is determined. Since investors wish to invest therefore, proper study of the firm’s working capital position must not be overlooked.

Apart from the above, the study will also highlight certain problems associated with the management of working capital and equally give useful information on the possible means of improvements in the university’s library and for other students who may wish to embark on the research of working capital management in future. Finally, the general public may find this work useful in areas where they wish to broaden their knowledge on working capital management in business organization.

1.7  Scope of the Study

This project is meant to cover the working capital management in manufacturing companies with particular reference to Cadbury Nigeria PLC. However, it is restricted to the general management of current assets and current liabilities. The study shall cover a period of 5 years from 2009- 2014 .Because of the importance of working capital management as a tool for cost reduction and improvement in profitability, the study is been conducted in other to evaluate the effect of working capital management on firm’s profitability.