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1.1 Background of the study
Management of working capital which aims at maintaining an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables is a fundamental part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses (Deloof, 2003).Firms have been praised for playing a crucial role in their contribution to developing economies such as Nigeria. They comprise a large portion of manufacturing firms in the economy hence believed to provide an impulse to the economic progress of developing countries. However, business failure rate is of particular interest to those who believe that the major source of job growth in the economy is through the startup and growth of manufacturing firms. Effective management of working capital is very important because it affects the profitability of firms hence the need to understand the impact of working capital management on the profitability of manufacturing firms.
Management of working capital thus involves the decisions about the amount and composition of current assets and financing of these assets. The decision making process on the level of different working capital components has become a key concern as it affects the profitability of the manufacturing firm. Thus the main objective of working capital management is to maintain an optimal balance between each of the working capital components. Lack of understanding about the impact of working capital management on profitability, lack of clarity about its determinants and the lack of management’s ability to plan and control its components may lead to insolvency and bankruptcy.
Working capital management involves the relationship between a manufacturing firms short – term assets and its short term liabilities. Working capital is recognized as an important concern for financial managers due to many reasons. For example, maintenance of excessive levels of current assets can easily result in a substandard return on a firm’s investment. Manufacturing Firms with inadequate levels of current assets may incur shortages and have difficulties in smoothly maintaining day-to-day operations (Van Horne and Wachowics, 2000). Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on one hand and avoids excessive investment in these assets on the other hand (Eljelly, 2004). In analyzing working capital management an important aspect is that managers should make sure that the desirable quantities of each component of their working capital are available for management. It thus, involves the decisions about the amount and composition to stimulate growth, improve performance and reduced risk in today’s challenging economic climate. If done right, working capital management can generate cash for growth together with streamlined processes along the value chain and lower costs. Efficient working capital management may enable a manufacturing firm to react quickly and appropriately to unanticipated changes in the market variables, such as interest rates and raw material prices, and gain comparative advantages over its rivals. Too often, however, this is an area that many organizations have ignored. Many businesses still under estimate the importance of working capital management as a lever for freeing up cash from inventory accounts receivable and accounts payable. By effectively managing these components, firms can sharply reduce their dependence on outside funding and can use the realized cash for further investment and growth. The inability to understand the determining factors and measurement of adequate amount of working capital will lead an organization to bankruptcy.
Cash is the life – blood of any business, no matter how large or small a business is. If a business has no cash and no way of getting any cash, it will have to close down (Ayiro, 2012). Following on from this we can say that if a business has no idea of its working capital position it could easily be in a serious trouble. This calls for the need for small and medium scale enterprise to have insight and knowledge on working capital management, its components and how they influence their profitability. Porter (1985) ascribed firm’s business performance on how well it manages the influence from external and internal factors. In his view success or failure of a business enterprise is influenced by external factors such as technology and environmental factors. However, skills of work force, accounting systems and financial management practice particularly working capital management also influence the profitability of small and medium scale enterprise. This study is on the impact of working capital management on profitability of manufacturing firms in Nigeria and will investigate Nestle Nigeria Plc.
1.2 Statement of the Problem
Many research have found out that managers spend a considerable time on day-to-day working of capital decisions since current assets are short-lived investment that require continually being converted into other assets (Rao, 1989 ). In the case of current liabilities, the firm is responsible for paying obligations on a timely basis. As a result, working capital management of any business is a very sensitive area in the field of financial management. This ensures that an organization with a positive working capital is able to meet its short term obligations whenever they fall due. However, working capital management appears to have been neglected in spite of the fact that a high proportion of business failure is due to poor decisions concerning the working capital management structure of organizations. There are also policies of working capital management that are not adhered to thus leading to the poor performance of SMEs in Nigeria. Working capital management is important because of its effects on the manufacturing firm’s profitability and risk and consequently its value. Failure to meet current obligations is often a source of business failure.
An understanding of wrking capital management is of particular importance especially in developing countries like Nigeria where majority of SMEs have their major investment in current assets and use short term loans as a source of finance. Working capital management is thus a basic requirement for all business organizations as it is what keeps the business running smoothly. Having sufficient funds invested in working capital reduces the chances of the manufacturing firm running into liquidity problems besides ensuring uninterrupted operations of the business. It is within this context that the researcher seeks to investigate the impact of working capital management on profitability of manufacturing firms in Nigeria and whether owners and managers of Nigerian manufacturing firms employed working capital management policies in running their businesses.
1.3 Objective of the study
The main objective of the study is to examine the impact of working capital management the profitability manufacturing firms in Nigeria other specific objectives are:
1. To investigate impact of receivable collection on profitability of manufacturing firms in Nigeria
2. To determine the effect of account payable management on the profitability of the manufacturing firms in Nigeria.
3. To identify the impact of cash conversion circle on the profitability of the manufactory firm in Nigeria.
4. To examine the impact of inventory management on the profitability of manufacturing firms in Nigeria.
1.4 Research Hypothesis
In line with the objective of the study, the following hypotheses have been formulated.
H01: Receivable collection management has no significant impact on profitability of manufacturing firms in Nigeria.
H02: Account payable management has no significant impact on the profitability of manufacturing firms in Nigeria.
H03: Inventory management has no significant impact on the profitability of manufacturing firms in Nigeria.
H04: Cash conversion circle has no significant impact on the profitability of manufacturing firms in Nigeria.
1.5 Scope of study
The scope of this study is to assess the impact of working capital management on
profitability of firms in Nigeria. The research covert the period of five years from 2011 to
2015 as it will provide an insight into the management of working capital and its impact on
Profitability of firms.
1.6 Significance of the study
The critical role of working capital management is playing in the short term liquidity position and the recent crises of credit and liquidity make this studies a necessity.
Therefore this study is significance is revealing the effect of working capital management on the profitability of manufacturing firms on the floor of Nigeria stock exchange. The study findings may help the manufacturing firms in Nigeria and other companies in general improve on their financial decision making so as to optimize the value of the shareholder and manufacturing favourable trade off between liquidity and profitability.
The finding are also great important to them working capital management has the potentials of improving profitability and the overall firm value in general.
This study is design to find out the impact of the individual working capital component on the profitability of manufacturing firm in Nigeria thus the shareholders of the manufacturing firms will benefit from the findings of the study.
Managers of the manufacturing industry in Nigeria are also among the main beneficiaries of the findings of the research. This is because managers are usually interested in understanding the effect of their performance on the profitability and the firm value.
Hence, this study is an attempt toward such direction more over managers will like to know the stability of the firm’s liquidity position, particularly under unfavourable economic conditions.
On the other hand, the finding will enable businesses to measure the hand of safety in being able to discharge obligation in order to attain profitability and to be prepared for unforeseen events by priority cushions for such occurrence.
This study could also be significance importance to creditors because they are interested in the credit worthiness of the firms in meeting their obligation, which only is possible with efficiency management of firm working capital. The study could be of interest to the business community in particular and to the government of Nigeria whose concern is to promote economic growth of the country through creation of an environment that tis conducive for business.
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