1.1 BACKGROUND OF THE STUDY
The sustainability of a firm heavily depends on the ability and success of its financial management function (Karaduman et al 2011). Traditionally, corporate finance involves capital budgeting, capital structure and working capital management, capital budgeting and structure, such as investments in fixed assets are about the management of long-term capital and attract more attention than working capital management in finance literature. However, working capital management is also a very important field of corporate finance, because of its considerable effects on the firms profitability and liquidity (Nazir and Afza, 2009, Chiou, et al 2006, and Alshubiri; 2011) In order to maintain its activity firms typically need two types of assets, fixed assets and current assets. Fixed assets which include, building, plant, machinery, furniture, fixture and fitting among others are not only purchased for the purpose of resale, but also for operational purposes (Singh and Pandey, 2008). On the other hand, current assets are seen as key components of the firm`s total assets. A firm may be able to reduce its investment on fixed assets by leasing, but this becomes practically difficult for current assets. (Afza and Nazir 2008).
A firm’s investment in current assets such as cash, bank deposits, short term securities, accounts receivables and inventories are called working capital. To put it differently, net working capital is the surplus of current assets over the short term liabilities and represents the liquidity margin available to meet the cash demands in order to maintain the daily operations and benefit from the profitable investment opportunities (Yaday, Kamtt and Manjrekar, 2009, Padachi, 2006). Therefore it is possible to say that working capital can be regarded as lifewire of the firm and its efficient management can ensure the success and the sustainability of the firm while its inefficient management may lead the firm to bankruptcy (Padachi, 2006).
In this framework, working capital management represents the decision about the manipulation of ratios which involves managing the relationship between a firm’s current assets and current liabilities. One of the main purposes of working capital management is to provide sufficient liquidity to sustain firm’s operations and to have to meet its obligations (Ejelly, 2004).
All firms, regardless of their size and industry need to acquire positive cash flow and liquidity (Stewart, 1995). The way that working capital is managed has also noted unworthy effects on the firm’s profitability (Deloof, 2003). For a firm’s trading activities, working capital can be considered as a spontaneous fund, and the amount of funds tied up to current assets can exceed that of fixed assets in many firms (Sathyamoorithi and Wally-Drima, 2008). In this context, funds committed to working capital can be seen as hidden sources that can be used for improving firm’s profitability (Alshubiri, 2011). Hence it is the fact that working capital management involves a trade – off between profitability and risk. According to the theory of risk and return, investments with higher risk may create higher returns. Thus a firm with high liquidity of working capital
will have low risk to meet its obligation and low profitability at the same time (Garciateruel and Martine Solano, 2007, Zariyawati et all 2009). Therefore, efficient working capital management, plays a significant role in overall corporate strategy in order to increase shareholder value (Dong and Su 2010) by determining the composition and level of investments on current assets, the leve,l sources and mix of short-term debt (Nwankwo and Osho, 2010). Especially an efficient working capital management can enable a firm to react quickly and genuinely to unexpected changes in economic environment and gain competitive advantages over its rivals (Alshubiri, 2011). An efficient working capital management primarily aims to ensure an optimum balance between profitability and risk (Ricci and Viho, 2000). This objective can be achieved by continuous monitoring of working capital components such as accounts payable, accounts receivable and inventories. Receivables for instance are directly affected by the credit collection policy of the firm and the frequency of converting these receivables into cash matters in the working capital management. However, the operating cycle theory tends to be deceptive in that it suggests that current liabilities are not important in the course of firms operation. Payables are understood to be sources of financing the firm’s activities given this inadequacy of the operating cycle theory it is essential to infuse current liabilities in the picture to enhance the analysis and understanding. Cash conversion theory integrates both sides of working capital that is current assets and current liabilities. In their published seminar paper, Richard and Laughlin (1980 devised this method of working capital as part of a framework of analysis known as working capital cycle. It claims that the method is superior to other forms of working capital analysis. In this study, Nigeria is used as the case study because of the problems she is experiencing like other countries of the world. This area of working capital management of firms has been neglected in spite of its importance.To the best of the Researchers knowledge, only few Nigerians had studied on this topic. It is on this note that the researcher has deemed it necessary to carry out a study on this area to fill the gap. Using a population sample of all the Nigerian manufacturing companies quoted on the Nigerian stock exchange (NSE for the period 2000-2011.The study is aimed at examining the impact of working capital management as a measure to profitability.
1.2 STATEMENT OF RESEARCH PROBLEM
Some promising investments with high rate of return had turned out to be failures and were frustrated out of business (Salandeen, 2001). Many factories had been either temporarily or completely shot down Example, Nigeria paper mills ltd, jebba, Nigeria sugar company Bacita, Kastina steel rolling mill Co.Ltd, among others. Many Nigerian workers had been thrown into unemployment market and frustratingly became dependent on relations and friends, example, Ajaokuta steel complex reduced its staff from 5000 to 1000 in 2007. Some Nigerian manufacturing firms that are still in business cannot pay dividend to shareholders in their companies, Example, Champion Breweries has not paid dividend since 1988, Golden Guinea Breweries has not paid since 1997 etc. (Salandeen, 2001) Some of these companies are still shaking inspite
of their being quoted on the NSE. Some manufacturing firms were acquired by another because they could not stand alone, example Savannah. Sugar Company limited was acquired by Dangote industries limited in 2002. It is in the light of this crisis that the researcher had deemed it necessary to examine the impact of working capital management on the profitability of Nigerian manufacturing firms quoted on the NSE from 2000-2011. Working capital is the lifewire of any business enterprise. It therefore requires that the way it is managed will to a large extent determine whether such enterprise can survive or not.The management decides the best proportion of its investment in both fixed and current assets and finally her liability level to enable improvement and correction of imbalances in the liquidity position of the firm. However, the inability to make payments as at when due may definitely have serious consequences on the organizations financial growth (profitability). Therefore, it seems important to look into the above problem to know how to encourage managers so that their companies can stand the test of time, however, (Van Home and Wachobvics, 2004) pointed out that excessive level of current assets may have a negative effect on a firm’s profitability whereas a low level of current assets may lead to lowers of liquidity and stock-out, resulting in difficulties in maintaining smooth operations.
1.3 Objectives of the Study
The general objective of this study is to examine the impact of working capital management on the profitability of Nigerian manufacturing firms. Thus the objectives of this study shall specifically be:
- To determine the impact of accounts payable ratio on corporate profitability.
- To ascertain the impact of accounts receivable ratio on corporate profitability.
- To ascertain the impact of cash conversion cycle (CCC) ratio on profitability.
- To investigate the relationship between stock turnover ratio and firm profitability.
- To determine the impact of liquidity ratios on the profitability of Nigeria quoted Manufacturing firms.
1.4 Research Questions
The following research questions will be considered in the study.
- To what extent does accounts payable ratio influence profitability?
- To what extent does accounts receivable ratio influence profitability?
- How far has cash conversion circle ratio affected the profitability of the companies under study?
- To what extent does stock turnover ratio influence firm profitability?
- To what extent does liquidity ratio influence the profitability of Nigeria quoted manufacturing firms under study?
1.5 Research Hypotheses
In order to address the issue raised above, the following hypotheses shall be proved
- Accounts payable ratio has no significant and positive impact on corporate profitability.
- Accounts receivable ratio has no significant and positive impact on corporate profitability.
- There is no significant and positive impact of cash conversion cycle ratio on profitability of the Nigeria quoted manufacturing firms.
- There is no relationship between stock turnover ratio and firm profitability.
1.6 Scope of the Study
The study is on the impact of working capital management as a measure for profitability following previous studies on this area, the study focuses on five independent variables, Accounts receivable, Accounts payable, inventory , cash conversion cycle and liquidity. The study also focuses on Dependent variable[Profitability],five independent variables[Accounts Payable,Accounts Receivable,Cash Conversion Cycle, Stocks,Liquidity, and other control variables that affect profitability such as sales growth and debt. The study is for the period: 2000-2011, and it will include all the publicly listed manufacturing firms in Nigeria.
1.7 Significance of the study.
It was mentioned earlier in this study that working capital is the life wire of organization. It is assumed that what blood is to human existence is what working capital is to business. Therefore a well designed and implemented working capital management is expected to contribute positively to a firm value (Padachi, 2006). It is expected that this study will:
- Help to create awareness on the impact of working capital management and how it can enhance corporate profitability.
- Help managers of the firms under study to have better insights on how to maximize their firms value.
- Help investors to invest in the manufacturing companies under study that are managing their working capital well. These investors will have more confidence in the company they want to invest in. Their investing in Nigeria will influence the growth of the economy.
- It will also assist policy makers to implement new set of policies regarding working capital management in Nigeria to ensure continuous economic growth.
- Meet the need of management accountants, academia, and students who will be interested in this study. Other researchers on corporate governance will find useful information from this study, it will also add to the existing literature on the topic.
1.8 Limitation of the study
The study was conducted on only manufacturing firms in Nigeria Accordingly the result could not be generalized for all the manufacturing firms operating in Nigeria due to unavailability of data for some of these firms.
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