IMPACT OF WORKING CAPITAL MANAGEMENT ON FINANCIAL PERFORMANCE OF MANUFACTURING FIRMS IN NIGERIA
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CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Working capital management is the practice of striking a balance between liquidity and profitability, typically from two distinct perspectives: cash (or liquidity) management and inventory (or stock) management. The goal is to guarantee the business enterprise’s survival. Interest is not paid on cash. Every asset in the same risk class is priced to provide the same expected marginal benefit when everything is in equilibrium. For example, the benefit of storing Treasury bills is the income you receive; the benefit of holding cash is that it provides you with a handy place to store value and liquidity. According to Brealey and Myers (2016), in an equilibrium, the marginal value of this liquidity is equal to the marginal value of the interest on an equivalent investment in Treasury bills.
Additionally, as you store more cash, the marginal value of liquidity decreases. A little more cash can be quite helpful if you have a tiny percentage of your assets in cash; however, if you have a large holding, any additional liquidity is not very valuable. In light of this, you should retain cash balances as a financial manager until the interest’s marginal value equals the interest that is not received. When it comes to managing their raw material stocks, production managers also have to make a similar trade-off.
They are not required to do so; instead, they could just purchase the materials on a daily basis as needed. However, placing a small-quantity order would result in greater costs, and if the materials were delayed in delivery, there would be a chance that production would be delayed (Brealey and Myers, 2016).
But keeping inventory comes with a price. Money connected to inventories loses interest, storage costs must be covered, and spoiling and deterioration are commonplace. In order to avoid incurring excessive expenditures, production managers attempt to maintain a reasonable balance between the costs of maintaining too little and too much inventory (Brealey and Myers, 2016).
READ ALSO: THE ROLE OF WORKING CAPITAL MANAGEMENT AS A TOOL EFFECTIVENESS
According to Uremadu (2012) and Brockington (2009), “stock levels should be ideal, that is, neither too large nor too small…and that, generally speaking, we ought to be conscious of the consequences associated with a business deviating from the ideal. Therefore, one crucial aspect of cash management is weighing the costs and benefits of liquidity.
They go on to add that choosing the right capital structure for a business depends in large part on its liquidity position. The year-round capacity of a business to raise capital to pay off debt is of interest to creditors and investors. It is crucial to be able to pay off debt in both good and bad situations. Debt holders are more concerned about how well the business can continue to make payments on its debts even in difficult circumstances.
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