Academic journal article Journal of Business Economics and Management

The Effects of Working Capital Management on the Profitability of Nigerian Manufacturing Firms

Academic journal article Journal of Business Economics and Management

The Effects of Working Capital Management on the Profitability of Nigerian Manufacturing Firms

Article excerpt

1. Introduction

A significant (and positive) development in corporate financial management over the recent years has been an increased emphasis on WCM decisions. According to Appuhami (2008) WCM is a very important component of corporate finance for two main reasons. The first is that a typical firm's current assets account for a substantial proportion of total assets. The second being that the maintenance of adequate levels of current assets is required to optimize returns on investment. Indeed, firms with inadequate levels of current assets may incur shortages and have difficulties in smoothly maintaining day-to-day operations (Van Horne and Wachowicz 2000, 2004). However, funds tied up in working capital (WC) are hidden reserves that can be used to fund growth strategies, such as capital expansion. Firms that have earned profits and grown have underscored efficient WCM in reacting quickly and appropriately to unanticipated changes in market variables and gain competitive advantages over rivals.

Consequently, there have been several studies on the effects of WCM on the profitability of firms across countries. This study also examined the relationship between efficiency of WCM and profitability of manufacturing firms in Nigeria. The motivation is that a previous study by Falope and Ajilore (2009) bears a number of significant weaknesses. First, the sample lumped together purely manufacturing firms and service rendering firms (e.g. hospitals, aviation firms, trading companies) without taking due cognizance of the fact that WCM requirements and practices differ across broad categories of firms. The second is the single use of ROA as measure profitability. The literature identified alternative measures Exploring these alternatives, I believe would provide more insightful results. The last but fundamental is that while the study reportedly covered the period 1996-2005 for 50 firms, the reported results was for 694 firm year observations instead of 500 for which the sample and year of study suggest. This makes the reported results very questionable and doubtful.

This study has attempted to fix these weaknesses by focusing only on manufacturing firms and explored alternative measures of profitability. The study therefore, aims to expand and contribute new findings to the existing literature particularly on Nigeria and at large.

The rest of the paper is organized as follows. Section two reviews the literature on the imperatives of efficient WCM and the empirical evidences on WCM and firm profitability. The study sample and data collection as well as the method of analysis are indicated in section three. Section four presents and discusses the results obtained, while section five gives the summary and conclusion of the study.

2. Literature review

2.1. Theoretical insights

Smith (1973) noted that the failure of a large number of firms can be attributed to inefficient WCM due to the inability of financial managers to properly plan and control WC. WC is commonly understood as the fund needed to meet the day-to-day expenses of an enterprise. Technically, it is defined as the difference between a firm's current assets and liabilities (Guthman and Dougall 1948; Park and Gladson, 1963; Bhattacharya 2009). In Deloof (2003), Planware (2010) and Lukkari (2011), the major measures of WC indicated include: number of days inventories are turnover, account receivable and payable; current ratio (CR); quick ratio; WC ratio; net liquidity balance; WC requirement; and the CCC, first introduced by Gitman (1974) and later refined by Gitman and Sachdeva (1984).

The CCC captures the time lag between the expenditure for the purchase of raw materials and the collection from the sale of finished goods (Shin and Soenen 1998). Longer cash cycle means more investment in WC while shorter cycle implies otherwise. Reducing the CCC to a reasonable minimum generally leads to improved profitability, but in some cases longer cash cycle might increase profitability because it leads to higher sales (Deloof 2003). …

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