IMPACT OF WORKING CAPITAL MANAGEMENT ON THE PROFITABILITY OF SELECTED FOOD AND BEVERAGES MANUFACTURING COMPANIES IN NIGERIA

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

Management of working capital which aims at gaining  an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables is a major part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses today  (Deloof, 2012). In essence , it has become one of the most valuable issues in organizations with many financial executives struggling to show  the basic working capital drivers and the appropriate level of working capital to hold so as to reduce  or decrease risk, properly  prepare for uncertainty and increase the overall working performance of their companies (Lamberson, 2017).Working capital management is a very essential component of corporate finance because it directly has an effect on  the liquidity and profitability of a  company. It centers mainly with current assets and current liabilities. Working capital management is essential due to several reasons. For a single thing, the current assets of a manufacturing firm accounts for over half of its total assets. For a distribution company, they account for even more of it. High levels of current assets can easily result in a firm's realizing a low return on investment. However firms with too few current assets may incur shortages and difficulties in maintaining good operations (Horne and Wachowicz, 2010). Many researchers have shown that managers spend considerable time on day -to-day problems that involve working capital decisions. One reason for this is that current assets are short- lived investments that are continually being converted into other asset types (Rao, 2014). With regard to current liabilities; the company is responsible for paying these obligations on a timely basis. Liquidity for the ongoing company is not reliant on the liquidation value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 2011). A good working capital management includes planning and controlling current assets and current liabilities in a manner that reduces the risk of inability to meet due brief term obligations on the one hand and avoid excessive investment in these assets on the other hand (Eljelly, 2014). The manufacturing sector is one of the Nigerian most notable contributors to economy of the country. A firm’s aim is maximization of profits and shareholders wealth. The study shall therefore focus on the various working capital management practices and their impact on the profitability of manufacturing food and beverages companies in Nigeria. Working capital management is considered to be a very essential element to analyze the organizations’ performance while conducting day to day operations, by which balance can be maintained between liquidity and profitability. Maintaining liquidity on daily base operation to make sure it is running and meets its commitment is a crucial part required in managing working capital. It is a hard task for mangers to make sure that the business function running in well-organized and advantageous manner. There are lapses of inequality of current assets and current liability during this procedure Firm’s growth and profitability will be affected if this occurs and company’s manager would not be able to manage it efficiently. Literature relating to corporate funds and finance has settled mostly on long-term financial decisions, mainly on investment decisions, company valuations, capital structure and dividends (Afza & Nazir, 2017). The short-term assets and liabilities are important components of total assets and therefore needs to be carefully analyzed (Afza & Nazir, 2017). In view of their importance, there is the need for reasonable and systematic investigation of these short term assets and liabilities, since they play a vital role for firm`s profitability, risk, as well as its value (Smith, 1980). Efficient and effective management of working capital is an important component of overall corporate strategy to create the shareholder`s value. Firms try to keep an optimal level of working capital that maximizes the value (Deloof, 2012; Howorth & Westhead, 2012; and Afza & Nazir, 2017). In line with this, working capital management has become one of the most important issues in the organizations (Lamberson, 2017).Therefore, working capital and its importance is unquestionable (Fillbeck & Krueger, 2015). It directly influences the liquidity and profitability of a company (Raheman & Nasr, 2017). Good management of working capital decreases the dependence on external financing due to increased cash flow, thus lowering the chances of default for an organization (Deloof, 2012). Over the last ten years, the world food manufacturing sector has become increasingly concentrated with a wave of business combinations among food and beverages 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 company specific factors such as persistent profitability. Profit maximization for most firms 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 biggest 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, 2010). 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. Profitability is generally depending on working capital management, thus working capital indicators such as inventory conversion period (ICP), current ratio (CUR), cash conversion cycle (CCC) should have relationship with profitability indicators. There are two components of firm performance: one of them is profitability and the other is firm value. A lot of gaps exist in the literature regarding the extent of relationship between component of working capital and profitability of firms. The study is aimed at examining the impact of Working Capital Management on the Profitability of food and beverages manufacturing Companies in Nigeria.

1.2 STATEMENT OF THE PROBLEM

Maintaining a proper liquidity indicates that funds are confined to liquid assets thereby making them unavailable for operational use or for investment purposes for higher returns. Thus, there is an opportunity cost associated with the maintenance of those liquid assets and this might affect the overall profitability of the firm. In other words, increasing profitability would tend to reduce firms liquidity and too much attention on liquidity would tend to affect the profitability (Smith 1980). So, Raheman and Nasr (2017) think that, the final goal for any firm is to maximize the profitability of the firm by preserving the liquidity. However, increasing profits at the cost of liquidity might cause serious trouble to the firm and this issue might lead to financial insolvency as well. Thus an effective WCM would be needed to strike a balance between the two core objectives of the firm. The firm’s liquidity should not be too high or too low. Excessive liquidity on one hand indicates the accumulation of idle funds that don’t fetch any profits for the firm (Smith 1980). On the other hand, insufficient liquidity might damage the firm’s goodwill, deteriorate firm’s credit standings and that might lead to forced liquidation of firm’s assets. Afterwards problems like bankruptcy and insolvency might happen. To add up, a company unable to make profits might be seen as a sick company but, a company having no liquidity might cease to exist.

1.3 OBJECTIVE OF THE STUDY

The general objective of this work is to examine the impact of working capital management on the profitability of selected food and beverage manufacturing companies in Nigeria. The specific objectives of the study are;

1) To examine how firm’s characteristics affect the relationship between working capital management and profitability.

2) To examine the effect of cash conversion cycle on profitability of food and beverages companies in Nigeria.

3) To examine the level of Working capital management on profitability of food and beverages companies.

4) To examine the impact of management policies on the relationship between working capital management and profitability.

5) To examine the effect of current ratio on the food and beverages companies in Nigeria. 

1.4 RESEARCH QUESTIONS

1) How do firm’s characteristics affect the relationship between working capital management and profitability?

2) What is the effect of cash conversion cycle on profitability of food and beverages companies in Nigeria?

3) What is the level of Working capital management on profitability of food and beverages companies?

4) What is the impact of management policies on the relationship between working capital management and profitability?

5) What is the effect of current ratio on the food and beverages companies in Nigeria?

1.6 RESEARCH HYPOTHESES

Hypothesis 1

Ho: There is no significant relationship between cash conversion cycle and profitability of food and beverages manufacturing companies in Nigeria

H1: There is a significant relationship between cash conversion cycle and profitability of food and beverages manufacturing companies in Nigeria

Hypothesis 2

Ho: There is no significant relationship between current ratio and profitability of food and beverages companies in Nigeria

H1: There is a significant a significant relationship between current ratio and profitability of food and beverages companies in Nigeria.

Hypothesis 3

Ho: There is no significant impact of firm characteristics on profitability of food and beverages companies in Nigeria

H1: There is a significant a significant impact of firm characteristics on profitability of food and beverages companies in Nigeria

1.6 SIGNIFICANCE OF THE STUDY

The study would have contribution to enlighten the society on the impact of working capital management on the profitability of selected food and beverages manufacturing companies in Nigeria. It would also prepare ground for interested researcher who might wish to conduct further research in related areas and could contribute to the existing literature.

1. SCOPE OF THE STUDY

The study is restricted to the impact of working capital management of selected food and beverages manufacturing companies in Nigeria.

1.8 LIMITATION OF THE STUDY

Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview)

Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work

1.9 OPERATIONAL DEFINITION OF TERMS

Working Capital Management: Working capital management is a business strategy designed to ensure that a company operates efficiently by monitoring and using its current assets and liabilities to the best effect. A company's working capital is made up of its current assets minus its current liabilities.

Profitability: Is the ability of a business to earn a profit. A profit is what is left of the revenue a business generates after it pays all expenses directly related to the generation of the revenue, such as producing a product, and other expenses related to the conduct of the business activities.

Food and Beverages Companies: The food and beverages industry is all companies involved in processing raw food materials, packaging, and distributing them. This includes fresh, prepared foods as well as packaged foods, and alcoholic and nonalcoholic beverages.