THE IMPACT OF EFFECTIVE WORKING CAPITAL MANAGEMENT OF COMPANY’S PERFORMANCE IN A DEPRESSED ECONOMY

CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

Working capital usually referred to as the life wire of a company is made up of those resources which are capable of being converted into cash.  The efficient management of working capital is pre-requisites for overall operational efficiency of a company.

“Working capital is not current asset”.  It is the difference between current assets and current liabilities.  Any transaction that increases the amount of working capital is source of working capital.

The various components of working capital management cannot be separated from fundamental decision of investment and financing, the takes of the financing manager in managing working capital effectively, to ensure sufficient liquidity in the operations of the company.

A company’s liquidity is measured by the ability to satisfy short-term financial obligations as they are done.  The net working capital is one of the measures of a company’s liquidity other measures include the current ratio and acid test ratio.

“The net working capital has been commonly defined as  excess of current asset over current liabilities”.   Effective working capital management requires that a company should operate with some net working capital, though the exact amount varies from one company to another.

The theoretical justification for the use of net working capital to measure a company’s liquidity is based on the assumption that the greater margin by which the current assets cover the short-term obligation when they fall due payment.  The net working capital is quite useful in internal control, though not quite for company comparison of performances.  The greater the net working capital, the more liquid the company is and the less it is to become insolvent.

Most profitable companies have failed because of improper management of working capital, especially cash and accounts receivable.  The management of these resources is a balancing problem and this problem stems from the fact that the relationship between cash flow and profitability is not fully understood.  The privilege economic condition in Nigeria today calls for a more serious attention in the effective management of working capital in companies.  The unprecedented oil boom of the early seventies in Nigerian economy has come and gone.  The sudden down-turn in the price of oil the backbone of out natural economy culminated in our present economic woes.  This is manifest by the rapid rise in unemployment, price and interest rates, coupled with fluctuations in the exchange value of our currency at the foreign exchange market. 

Profitability and liquidity of companies has been effected by this development. Therefore, effective management of working capital has necessarily become a test that should be given such importance, more ever than before in any company.  It should be noted that companies would do better by tying down less funds in receivables.  However, economic considerations and circumstance often makes it difficult to keep these items down as far as most companies would wish.  Frequent examination of the size, competition and significant change in not working capital would assist financial managers to achieve the much desired balance between profitability and liquidity.

1.2     STATEMENT OF PROBLEM

The management of inter-relationship existence between assets and liabilities has been the primary problem of working capital management.  Effective working capital management involves sourcing of funds for the management daily operations of companies.   Every company need to maintain a satisfactorily level of working capital or it would go into banking and finally wound up.  However profitability liquidity and other related risks have been a major problem facing companies in our depressed economy.  This is an important characteristics of working capital management maintaining a large size of current asset would improve the liquidity positive of the company but profitability would be adversely affected as funds remain ideal.

Conversely, if a company’s holding asset are relatively small the overall profitability will no doubt increase, but this will have an adverse effect on the company’s overall performance.  Including its liquidity position and thus making the company more risky. Working capital management should therefore aim at striking a balance between the liquidity and profitability positions of the company by ensuring that right combinations of current assets and liabilities are held at each point in time for a better performance.  

1.3     PURPOSE OF THE STUDY

As mentioned earlier, effective working capital management plays effective role on the financial decision making of any company, which is however, the backbone of success in any viable company.  As  earlier observed, the objective of financial decision-making is to maximum share wealth.

       However, company’s profit usually depends on the rate of their turnover.  There is a deficit and curtained day-to-day operation of the company.   

       Primarily the purpose of this study is to examine how Paul – B Nigeria Plc:

1.          Identify and discuss the basic determination of working capital, because the individual need of companies as influenced by many factors and fluctuates over time.

2.          Identify and highlight areas of short-term investment of the company with a view of making recommendation on better utilization of funds to generate higher earning and to offer suggestions for improving cash balances, to meet current obligations.

3.          Discuss the place of receivable in the liquidity of a company with a view to proving solutions.  Through lightening of collection policies where receivable appears excessive.

4.          Highlight the importance of net working capital as a measure of liquidity as this is as important consideration of any contemplating granting to the company. 

1.4      SIGNIFICANCE OF THE STUDY         

Virtually continuous growth and development of every business or company depends on its source and proper application of fund generated, which acts as its measure of profitability.  This topic is therefore significant as it provides a panacea to the profitability problem of companies through product cash management.

Inadequacy of cash receivable, which are the vital forms of working capital impairs the growth of any business.  However, the present degree of uncertainty prevailing in the economy makes it important to maintain better cash or its equivalent for contingency expenditure.  This is the crux of the need for effective working capital management.

Nevertheless, determination of the current ratio of companies has been a determinant of credit grant to companies.  The working capital ratio is particularly significant in this regard as it is indicative of the degree of shrinking in current asset that will not discourage the interest of the current creditors.  Therefore working capital is significant and crucial in this context.

1.5     SCOPE OF THE STUDY

This research work will only cover the management of cash account receivable which is the foundation of working capital since working capital is naturally wide in scope, this is the management of current assets and liabilities.

1.6     RESEARCH HYPOTHESIS

HYPOTHESIS I:  

Ho:  Effective working capital management does not have

significant impact on profitability of companies.

H1:  Effective working capital management have significant impact on profitability of companies impact on the working capital management.

HYPOTHESIS II:  

H0:  Credit management policies of companies does not have significant impact on the working capital management.

H1:  Credit management policies of companies have significant impact on the working capital management.

HYPOTHESIS III

Ho:  Liquidity is not the best single measure of quality adopted by companies in working capital management.

H1:  Liquidity index is the best single measure of quality adopted by companies in working capital management.

1.7     RESEARCH QUESTION

What is the impact of effective working capital management on company performance in a depressed economy.