ABSTRACT
Working capital management involves the management of the most liquid resources of the firm which includes cash and cash equivalents, inventories, trade debtors and other receivables. Most firms do not ensure optimal level of working capital and this has been a major obstacle to their overall profitability. The study examined the impact of working capital management and control in the Financial Institutions. Correlation and ex-post facto research designs were used in a sample of 10 manufacturing firms. Secondary data for a period of 6 years (2014-2021) was used, general Least Squares (GLS) multiple regression was employed in data analysis. The study found that working capital management (account receivables collection management, accounts payables management, cash conversion cycle management) has a significant impact on the Central Bank of Nigeria. It is therefore recommended among others that managers should focus on collecting receivable as soon as possible because it is better to receive inflows sooner than later, and delay payment of creditors in order to invest the money in short-term securities which are profitable. Also, the cash conversion cycle should be elongated to the extent that it maximizes profit.
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The sustainability of a firm heavily depends on the ability and success of its financial management function (Karaduman, H. A., Akbas, H. E., Caliskan, A. O., & Durer, S. 2014). Traditionally, corporate finance involves capital budgeting, capital structure and working capital management. 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 and Alshubiri; 2014) 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.
The economic theory of firm requires that firm resources should be utilized efficiently in order to achieve economic successes. Moreover, the competitive modern business environment makes financial managers irrespective of the nature of their business to ensure efficient utilization of firm resources. Firm resources are broadly classified into two, long-term assets (non-current assets) and short-term assets (current assets). Therefore, there are two major decisions in the theory of corporate financial management, that is, the long-term or capital budgeting decision and the short-term or working capital management decision (Pandey, 2009). Although long-term capital decisions are of critical importance to the going-concern of a firm, workings capital management has direct consequences on the liquidity position and the ultimate profitability of a firm (Burt and Abbate, 2009).
Working capital connotes the funds locked up in materials, work in progress, finished goods, receivables and cash. Therefore, working capital is one of the most important measurements of the financial position, which according to Guthmann (2008) is the life-blood and nerve centre of any business entity. This necessitated the need for the careful management of working capital in every business organization with the value maximization objective.
Therefore, working capital management involves the application of strategies and policies in the use of firm’s current assets and liabilities in such a way that an optimum level of working capital is maintained. In essence, the goal of working capital management is to promote a satisfying profitability and maximizes shareholders’ value (Li and Han-Wen, 2006). In essence, managing working capital is necessary because of its’ directs effects on the profitability and liquidity of a corporate entity. Rehn (2012) asserts that working capital usually refer to net working capital, the difference between current assets and current liabilities. Thus, it involves minimizing the timing of collecting receivables, deferring the period of payables, cash management and keeping the minimal inventory.
However, optimal efficient working capital management is usually achieved through the management of receivables, payables, inventory, cash conversion cycle and the operating cycle as a whole. A firm therefore needs to set an optimal level of stock to hold. Working capital management is considered as a very sensitive area in the field of financial management (Joshi, 1994); because it involves the decision of the amount and composition of current assets and the financing of these assets. However, most firms do not hold the correct amount of working capital and this has been a major obstacle to their overall profitability (Stephen, 2012). This together with the current liquidity crisis has highlighted the significance of working capital management.
1.2 Statement of the problem
A firm is required to maintain a balance between liquidity and profitability while conducting its day to day operations. Liquidity is a precondition to ensure that firms are able to meet its short-term obligations and its continued flow can be guaranteed from a profitable venture.
Firms can maximize their value by having an optimal level of working capital (Deloof, 2003). On the balance sheet; firms have large inventory and generous trade credit policy which leads to higher sales. Larger inventory reduce the risk of stock-outs. Account receivables, which is a part of trade credit, stimulates sales because it allows customers to assess product quality before paying (Long, Malitz and Ravid, 1993; and Deloof and Jeger, 1996).The negative side of granting trade credit and keeping inventories in that money is locked up in working capital (Deloof, 2003).
Another component of working capital is account payable, which keeps the trade credit not to extend but receiving it from the supplier. Receiving trade credit from a supplier allows a firm to assess the quality of the product bought ,and can be an inexpensive and flexible source of financing for the firm(Deloof,2003;Raheman and Nasr,2007).The flipside is that receiving such a trade credit can be expensive when firms offered a discount for the early payment. This is also the case with uncollected and extended trade credit, which can lead cash inflow problems for the firm. (Gill et al., 2010).
Researchers have studied working capital management in many different ways. while some authors studied the impact of an optimal inventory management, others have studied the optimal way of managing account receivables that leads to profit maximization (Lazaridis and Tryfonidis, 2006; and Besley and Meyer, 1987). Other studies have focused on how reduction of working capital improves a firm’s profitability (Jose et al., 1996; Shin and Deirgunes, 2008; Sharma and Kumar, 2014).
Much of the currently available empirical literature on working capital management is focused on its impact on firms in developed countries. But, there are studies with reference to Nigeria on working capital management and firm profitability; Tewodros (2010) studied its impact on profitability by taking 11 private limited manufacturing firms. He took ROA, OPM and ROE as a measure of profitability. The results show that longer accounts receivable and inventory holding periods are associated with lower profitability. There is also negative relationship between accounts payable period and profitability measures; however, except for operating profit margin this relationship is not statistically significant. The results also show that there exists significant negative relationship between cash conversion cycle and profitability measures of the Central Bank of Nigeria.
On the other hand, Tiringo (2013) examined the impact of WCM on profitability of micro and small enterprises in Nigeria for the case of Bahirdar city administration. The result showed that there is a strong positive relationship between number of day’s account payable and enterprise profitability. However, number of days account receivable, number of day’s inventory and cash conversion cycle have a significant negative impact on profitability.
Also, Wubshet (2014) examined the impact of working capital management on performance by using the CBN for the period of 2014 to 2021.The performance was measured in terms of profitability by return on total assets, and return on investment capital as dependent financial performance (profitability) variables. The results shows that there is no significant relationship between cash conversion cycle, account receivable period, inventory conversion period and account payable period with return on investment. On the other hand, findings show that a highly significant negative relationship between account receivable period, inventory conversion period and account payable period with return on asset.
According to the knowledge of the researcher, the recent study wubshet (2014) have been done with a sample of Central Bank of Nigeria, Nigeria for the period of 2014 to 2021, So this study was conducted with larger sample size, including all manufacturing company type, used unstructured period for each company and to identify that the presence of inconsistent results might be found. Hence, the study will conducted to fill the gap on impact of working capital management on performance of Central Bank of Nigeria.
1.3 Objective of the Study
1.3.1 General Objective
The general objective of the study is to examine the effect of working capital management on profitability of Central Bank of Nigeria.
1.3.2 Specific Objective
1. To analyze the effect of accounts receivable period on performance of Central Bank of Nigeria.
2. To evaluate the effect of inventory holding period on financial institutions performance in Nigeria.
3. To ascertain the effect between average payment period and profitability of the Central Bank of Nigeria.
4. To examine the effect between cash conversion cycle and profitability of the Central Bank of Nigeria.
1.4. Research Hypothesis
H1: Account receivable period have significant negatively related to a firm’s profitability.
H2: Inventory holding period of a firm is significant negatively related to a firm’s profitability.
1.5 Scope of the Study
The study is delimited to the effect of working capital management on the profitability of large tax payers of Central Bank of Nigeria. The total sample size of the study have 25 large tax payers financial institutions according to Inland Revenue Service (IRS) large tax payer’s registration data as of Dec-16. The study took five years data from year 2014-2021 based on the company’s interest to provide their financial statement as there were companies who do not permit to provide their data. The reason for restricting to this period was that the latest data for investigation was available for these periods. This was necessary to obtain an accurate measure of the impact of the practices in terms of liquidity and profitability as we recover less number of year’s data company with more number of years’ data company.
1.6 Significance of the Study
The findings of this study may have implications for other companies who are trying to make decisions regarding working capital management reform model. This finding would help to develop an understanding of the advantages and disadvantages of financial practices and techniques of managing Working Capital Components in manufacturing companies. The study would reveal how essential Working Capital Management Strategies such as policies, practice and techniques is for the Central Bank of Nigeria in terms of performance. The study would suggest various financial management techniques manufacturing companies can use to measure their performance in terms of profitability. For example, Current Ratio to assess the firm’s liquidity status, Leverage ratios, Cash Conversion Cycle (CCC), and Return on Equity (ROE).
This study would greatly benefit financial managers and chief executive officers of Central Bank of Nigeria. By understanding the relationship between working capital management policies and profitability, finance managers would be able to plan their working capital strategies based on working capital management policies that enhance profitability. The study has an important resource document for academicians and future researchers who may wish to investigate the performance of firms in relation to working capital management and profitability.
1.7 Limitations of the Study
The sample size for this study may not be large enough to study the issue and to represent the study population, for the very reason that, the problem of getting complete financial information for the study period. Moreover, the financial managers of the manufacturing private limited company were not interested to give Secondary data about the issue under consideration. The most difficult problem was shortage of time for the study to collect the necessary data, organize and analyze to finalize the study.
1.8 Organization of the Research Report
The paper is organized in five chapters. Chapter one provides an introductory overview of the full study comprising the statement of the problem, objective of the study, research hypothesis, relevance of the study, delimitation and limitation of the study, and how the study was organized also captured in this chapter.
The second chapter, literature review gives an extensive literature study on working capital and the management of its different parts.
Chapter three presents the methodology used for the study and gives a detailed overview of the population, sampling technique, the research design, data source and collection procedures and data analysis procedures. It also provides the description of the relevant variables that was included in the model, model selection criteria and diagnostic test analysis on the model specification used for the study. Model selection criteria and diagnostic test analysis on the model specification summarizes, concludes and offer recommendations for the study.
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