Effects of Working Capital Management on the Profitability of Manufacturing Company

Abstract of Effects of Working Capital Management on the Profitability of Manufacturing Company

The study investigated the Effects of Working Capital Management on the profitability of manufacturing Company, A Case study of Cadbury Nigeria Plc. The specific objectives of the study are to identify the various components of working capital in Cadbury Nigeria PLC; identify the level of working capital management in Cadbury Nigeria PLC; and to evaluate the impact of working capital management on the profitability of Cadbury Nigeria PLC. Total of questionnaires was distributed to staff in Cadbury Nigeria Plc drawn from the study population was used for the analysis. Three hypotheses were formulated for the study, simple percentage and ratio analysis. Under the simple percentage and ratio analysis was analyzed by the use of tables which involved the use of simple percentages. Contrarily, the reason for using this method is to enable the researcher compare and group information and data accordingly. The computation of ratios was limited to those that have to do with working capital of the company. At the end of the study, the researcher found out that, Working Capital Management of Cadbury Nigeria PLC does not enhance its profitability and Cadbury Nigeria PLC does not have an optimum level of Working Capital Management. Based on the findings the following recommendations were made that the company should reduce the period between the time cash is paid out for raw material and the time cash is recorded from sales of the company’s product. This will provide funds for regeneration and increasing working capital of the firm there after, the company should pay more attention to its liquidity position and improve on it. This is because a company that has no favorable liquidity position may likely face insolvency problems, the poor working capital can also be remedied through provision of additional fund by the shareholders and loans from banks and cadbury as international company should carry out more research to develop new product with the view of diversifying into new areas or lines of business.

Chapter One of Effects of Working Capital Management on the Profitability of Manufacturing Company

INTRODUCTION

Background to the Study

The working capital of a company has a major role in making it profitable or non-profitable. Most of the potential investors and other sanalyze position statement to evaluate the management of working capital. Net Working capital consists of current assets less Short term obligations. Positive working capital explain that the corporation is in a fine condition to reimburse it’s short-term debt whereas negative working capital explain that the most liquid assets of the corporation are not sufficient to fulfill its current monetary commitments. Any finance manager must sustain a most favorable point of investment in the most liquid assets of the company. Working capital for any business is the amount of capital to carry out its daily basis operations. In manufacturing concerns, it is the investment required for the conversion of raw material into ready to sell products for the company. The most important items inside determination of working capital are inventories of the corporation, its accounts receivables and payables. The management of working capital frequently considered a tool to maintaining competence of the business inside their operations. Working capital is often assessed by lenders to judge the financial short term paying back ability in difficult financial periods.

One of the key determinants of survival and sustainable business growth of modern organisations is the effectiveness of accounting and finance department or function (Eljielly, 2004). One area of accounting and finance that affects the efficient operations of business organisations in general is working capital management (WCM), among other things (Eljielly, 2004; Shin & Soenen, 1998; Tauringana & Afrifa, 2013). WCM has been described as the management of current assets and current liabilities (Agyei & Yeboah, 2011; Tauringana & Afrifa, 2013). The concept of WCM addresses companies’ management of their short-term capital, which is an important component of corporate financial management, directly affects the profitability and liquidity of both small and large firms (Agyei & Yeboah, 2011; Tauringana & Afrifa, 2013). It has been well noted that small scale industries contribute immensely to providing job opportunities, nurturing a society of entrepreneurs and opening up new business avenues for the development of a country.

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. EljeUy (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 firms 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.

Over the last five to ten years, the world brewery market has become increasingly concentrated with a wave of business combinations among brewery giants as well as diversification of investments outside their geographical location. All these are in the quest to dominate the market as well as the maximization of shareholders wealth. Increasing market domination that will enhance the maximization of shareholders wealth depends largely on certain firm specific factors such as persistent profitability. Profit maximization for any firm depends on efficient management of cost

and process of production as well as increases in sales resulting from firm’s market domination. One factor that is deduced to influence firm profitability grossly is the firm’s working capital.

Working capital is the stock stored that has a conversion or resale value in order to gain profit. It represents the largest cost of a firm especially the manufacturing firms. In normal circumstances, working capital consists of about 30% – 40% of a firm’s total investment. Investment in working capital to a large extent determines the returns earned by a firm. Nevertheless, excessive levels of current assets can easily result in a firm realizing a substandard return on investment while firms with too few current assets may incur shortages and difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2000). As a result,working capital management is a very important component of corporate finance as it directly affects the liquidity and profitability of a firm. It centers on current assets and current liabilities of a firm. For one thing, the current assets of a typical manufacturing firm accounts for over half of its total assets (Abdul and Mohamed, 2007).

One reason why managers spend considerable time on day-to-day management of working capital is that current assets are short-lived investments that are continually being converted into other asset types (Rao, 1989). Liquidity for the on-going firm is not reliant on the liquidation value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 1993). Working Capital Management is therefore a sensitive area in the field of financial management (Joshi, 1994). It involves the decision of the amount and composition of current assets and the financing of these assets.

Efficient working capital management involves planning and control of current assets and current liabilities in a manner to strike a balance between liquidity and profitability. Harris (2005) pointed out that working capital management is a simple and straightforward concept of ensuring the ability of the firm to fund the difference between the short term assets and short term liabilities. The ultimate objective of any firm is to maximize shareholders wealth and maximizing shareholders wealth can be achieved by a firm maximizing its profit. A firm that wishes to maximize profit must strike a balance between current assets and current liabilities and hence keeping abreast of the liquidity and profitability trade-off. Preserving liquidity and profitability of the firm is an important objective as increasing profit at the expense of liquidity can bring serious problems to the firm and vice-versa. Working capital management is considered to be a very important element to analyze the firm’s performance while conducting day to day operations. There are chances of imbalance of current assets and current liability during the life cycle of a firm and profitability will be affected if this occurs. This is why the study of influence of working capital on firm’s profitability is drawing scholars’ attention in recent times.

Numerous studies on the drivers and financial impact of working capital management for different manufacturing firms for different countries of the world have been published in recent times. However, inter-country studies of world leading firms in a given industry are spare. Attempting to

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.

 Aim and Objective 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:

1.                  identify the various components of working capital in Cadbury Nigeria PLC;

2.                  identify the level of working capital management in Cadbury Nigeria PLC; and

3.                  evaluate the impact of working capital management on the profitability of Cadbury Nigeria PLC.

Relevant Research Questions

This study intends to provide answers to the following questions;

1.                  What are the components of working capital management in Cadbury Nigeria PLC?

2.                  How effective does the working capital management of Cadbury Nigeria PLC enhances its profitability?

3.                  Has Cadbury Nigeria PLC been able to manage its trade debtors, stock and trade creditors effectively?

Relevant 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.

H0:       Working Capital Management of Cadbury Nigeria PLC have no significant influence on working capital profitability

H1:       Working Capital Management of Cadbury Nigeria PLC have significant influence on working capital profitability.

H0:       Cadbury Nigeria PLC does not have significant influence on optimum level of working capital management

H1:       Cadbury Nigeria PLC have significant influence on optimum level of working capital management.

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.

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 2004- 2008.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.

Operational Definition of Terms

For the purpose of this research, the following terms are defined as they were use in the study

i.Working capital: This is the capital or fund available for carrying on the day to day operations of an Organization.

ii.Working Capital Management: It refers to the efficient management of current assets and current liabilities

iii.Current assets: These are resources that are held or consumed within a short period of time usually one year. They include stock, cash, debtors, prepayments etc.

iv.Current liabilities: These are the amounts failing due to creditors within a year. It includes trade creditors, bank overdraft, accruals etc

v. Loan Port Folio: A mixture of shares and bonds held by a firm.

vi. Fixed Asset: Assets, which are not readily convertible into cash and are acquired for long term usage in the firm, e.g. building, plant, machine etc.

vii. Inventories: Inventories are stocks of raw materials, works in-progress and finished goods of a company engaged in manufacturing operations.

viii.Bankruptcy: Where the firm is unable to meet the payment of its debts. The company could not pay its debts and therefore officially declare bankrupt or insolvent.

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