The Effect of Working Capital Management on Financial Performance of Manufacturing Firms

The Effect of Working Capital Management on Financial Performance of Manufacturing Firms

ABSTRACT

In this research work titled “Effect of working capital management on financial performance of manufacturing firms focusing on Nigeria beer sector” the researcher examined the relationship between stock turnover and return on equity. Examined the relationship between the current ratio and return on equity. The researcher also ascertained the extent of association between the debt collection period and return on equity. The researcher made use of only secondary data from six years annual report and accounts of the two quoted (Guinness Nigeria Plc and Nigeria Brewery Plc) listed on the Nigeria stock exchange were collected and regression analysis was utilized in the data analysis. At end of the research work, the researcher found out that there is a significant relationship between stock turnover and return on equity. This research work shows that there is a significant relationship between the current ratio and return on equity. It was also discovered that there is a significant association between debt collection period and return on equity. Based on the above findings the researcher recommends that poor-performing firms should adequately plan and control their operations, adjust all the shortfalls as noted from the financial ratios calculated and bring them to standard to enhance management of each working capital component and thus improve the organizations’ profitability. Since the world is fast growing towards scientific management where problems are solved even before decisions are made, instead of using poorly constructed models in decision making as the case may be, managers of firms should adopt (solely rely on) the principles of finance. By so doing, management of working capital is guaranteed, even liquidity and profitability of the firm is assured.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Working capital management refers to investment in current assets and current liabilities which are liquidated within one year or less and is therefore crucial for a firm’s day to day operation (Eljelly 2008:67) working capital is the money needed to finance the daily revenue-generating activities of the firm.

According to Afza (2008:54), working capital management plays a significant role in determining the success or failure of a firm in business performance due to its effect on the firm’s profitability as well as on liquidity. Business success depends heavily on the ability of financial managers to effectively manage the components of working capital. A firm may adopt an aggressive or a conservative working capital management policy to achieve this goal.

Working capital management efficiency is vital especially for manufacturing firm where a major part of assets is composed to current assets (Emekekwue, 2009:574). It directly affects the profitability and liquidity of firms. The profitability liquidity trade-off is important because if working capital management is not given due consideration then the firms are liable to fail and face bankruptcy (Philbeck and krwyen 2010:119) the significance of working capital management efficiency is irrefutable. Working capital is known as a life-giving force for any economic unit and its management is considered among the most important function of corporate management. Every organization whether profit-oriented or not, irrespective of size and nature of business, requires a necessary amount of working capital.

Maintaining liquidity, survival, solvency and profitability of the business. Working capital management is one of the most important areas while making the liquidity and profitability comparisons among firms involving the decision of the amount and composition of current assets and the financing of these assets (Elyelly 2009:34).

The greater the relative proportion of liquid assets the lesser the risk of running out of cash, all other things being equal. All individual components of working capital including cash, marketable securities, account receivables and inventory management play a vital role in the performance of any firm.

Filbeck, G and T.M. Krueyer, (2010) argued that efficient working capital management is very important to create value for the shareholders. They also affirmed that profitability and liquidity are the silent goals of working capital management necessitating the essence of this study on the impact of working capital management on the financial performance of manufacturing firms.

1.2 Statement Of The Problem

The management of a firm’s liquidity is necessary for all businesses, small, medium or large.  When a business does not manage its liquidity well, it will have cash shortages and as a result experience problems paying its obligations when they fall due. Indeed, working capital starvation has generally been credited as a major cause of not the main cause of failure of the manufacturing sector in Nigeria. This directly affects the return on equity which is the amount of net income returned as a percentage of shareholders equity.

Working capital management is therefore important because of its effect on the firm’s profitability and risk and consequently its value.

Investments in current assets represent a very significant position of total assets. Working capital management is critical to all firms but particularly to the manufacturing sector based on the premise that irregularities in working capital management are known to have a direct effect on such ratios as stock turnover ratio and current ratio as well as debt collection period. This is because the liquidity of a manufacturing firm that experiences is affected as well.

1.3 Objectives Of The Study

The broad objective of this study is to appraise the impact of working capital management on the financial performance of manufacturing firms focusing on the Nigerian beer sector.

The specific objectives include the following

1.  To examine the relationship between stock turnover and return on equity.

2.  To examine the relationship between the current ratio and return on equity.

3.  To ascertain the extent of association between debt collection period and return on equity.

1.4 Research Questions

The following research questions are stated for this study:

1.  Does a significant relationship exist between stock turnover and return on equity?

2.  Does a significant relationship exist between the current ratio and return on equity?

3.  What is the extent of the association between the debt collection period and return on equity?

1.5 Research Hypotheses

The following hypotheses are formulated for this study.

Hypothesis one

H0: A significant relationship does not exist between stock turnover and return on equity.

H1: A significant relationship exists between stock turnover and return on equity.

Hypothesis two

H0: A significant relationship does not exist between the current ratio and returns on equity.

H1: A significant relationship exists between the current ratio and returns on equity.

Hypothesis three

H0: The extent of association between debt collection period and return on equity is not significant.

H0: The extent of association between debt collection period and return on equity is significant.

1.6 Significance Of The Study

This study will be of immense significance to the Nigerian beer sector in that it will go to a great extent in enlightening them on the concepts of working capital management as well as how it affects financial performance of organizations.

The recommendation will suggest for them the strategies adopted in effectively managing their capital for improved financial performance.

Students and other researchers will as well widen their scope from the information contained in this study.

1.7 Scope And Limitations Of The Study

This study on the impact of working capital management is focused on Guinness and Nigerian Breweries.

The researcher encountered diverse constraints in the process of carrying out this research study.

Difficulty in gathering research material: there was difficulty in gathering the necessary information or materials necessary for their successful completion of this research study. This is because most of the staff of Nigeria brewery Plc, 9th-mile corner, Enugu were either not on sit or were uncooperative in providing the necessary information as regards their reward management practices.