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WORKING CAPITAL MANAGEMENT AND PROFITABILITY OF LISTED PHARMACEUTICAL FIRMS IN NIGERIA

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Abstract

Working capital managemt 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 profitabilty. The study examined the impact of working capital management and profitability of listed pharmaceutical firms in Nigeria. The study found that working capital management (account receivables collection management, accounts payables management, inventory management, cash conversion cycle management, operating cash flow management) has a significant impact on the profitability of listed pharmaceutical firms in Nigeria. It is therefore recommended among others that managers should focus on reducing inventory days, collect receivable as soon as possible because it is better to recieve inflows sooner than later, and delay payment of creditors inorder 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 of the Study

The term working capital has several meanings in business and economic development finance. In accounting and financial statement analysis, working capital is defined as the firm’s short-term or current assets and current liabilities. Net working capital represents the excess of current assets over current liabilities and is an indicator of the firm’s ability to meet its short term financial obligations (Brealey & Myers, 2002). Effective working capital management consists of applying the methods which remove the risk and lack of ability in paying short term commitments in one side and prevent over investment in these assets in the other side by planning and controlling current assets and liabilities (Lazaridis & Tryfonidis, 2006).

Working Capital Management is the administration of current assets and current liabilities. It deals with the management of current assets and current liabilities, directly affects the liquidity and profitability of the company (Deloof, 2003; Eljelly, 2004; Raheman and Nasri, 2007; Appuhami, 2008; Christopher and Kamalavalli, 2009; Dash and Ravipati, 2009). Current liquidity crisis has highlighted the significance of working capital management. Management of working capital has profitability and liquidity implications and proposes a familiar front for profitability and liquidity of the company. To reach optimal working capital management firm manager should control the tradeoff between profitability maximization and liquidity accurately (Raheman & Mohamed, 2007). An optimal working capital management is expected to contribute positively to the creation of firm value (Howorth & Weshead, 2003; Deloof, 2003; Afza &Nazir, 2007). Working capital management is important due to many reasons. For one thing, the current assets of a typical manufacturing firm accounts for over half of its total assets. For a distribution company, they account for even more. Excessive levels of current assets can easily result in a firm’s realizing a substandard return on investment. However firms with too few current assets may incur shortages and difficulties in maintaining smooth operations Horne and Wachowicz, (2000). Efficient working capital management involves planning and controlling.

There must be a balance between current assets and current liabilities so as to eliminate the risk of inability to meet short term obligations on one hand and avoid excessive investment in these assets on the other hand (Eljelly, 2004). Many surveys have indicated 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, 1989). With regard to current liabilities, the firm is responsible for paying these obligations on a timely basis. Liquidity for the ongoing firm is not reliant on the liquidation value of its assets, but rather on the operating cash flows generated by those assets (Soenen, 1993). Taken together, decisions on the level of different working capital components become frequent, repetitive, and time consuming.

Working Capital Management is a very sensitive area in the field of financial management (Joshi, 1994). It involves the decision of the amount and composition of current assets and the financing of these assets. Current assets include all those assets that in the normal course of business return to the form of cash within a short period of time, ordinarily within a year and such temporary investment as may be readily converted into cash upon need.

The Working Capital Management of a firm in part affects its profitability. The ultimate objective of any firm is to maximize the profit. But, preserving liquidity of the firm is an important objective too. The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm (Shin and Soenen, 1998). Therefore, there must be a trade- off between these two objectives of the firms. One objective should not be at cost of the other because both have their importance. If we do not care about profit, we cannot survive for a longer period. On the other hand, if we do not care about liquidity, we may face the problem of insolvency or bankruptcy. For these reasons working capital management should be given proper consideration and will ultimately affect the profitability of the firm. Firms may have an optimal level of working capital that maximizes their value (Afza and Nazir, 2009).

Working Capital Management has its effect on liquidity as well as on profitability of the firm. The study analyzed the relationship between different variables of working capital management including the Average collection period, Inventory turnover in days, Average payment period, Cash conversion cycle and Current ratio and the gross operating profit. Debt ratio, size of the firm (measured in terms of natural logarithm of sales) and financial assets to total assets ratio were used as control variables.

Consequently, the extent to which working capital management affect cooperate performance is the thrust of this study.

  1. Statement of the Problem

Working capital is the live wire of any enterprise which means that its management is quite crucial to the business. Cooperate societies of whatever type survive with efficient working capital management. The capital of the cooperate enterprise has to be effectively managed for the benefit of the cooperate business so that stated objectives can be achieved. Given every stage and level of cooperate activities, finance tends to play a significant role in the efficiency of the enterprise.

Many cooperate businesses may have adequate finance but could lack proper efficient working capital management. It is disheartening to discover that several cooperate societies seem not be performing up to expectation even in the light of apparent effective and efficient working capital management on cooperate efficiency so that informed measures could be taken to facilitate efficient working capital management in cooperates in such a way that the cooperate business can effectively achieve stated objectives for the benefit of the shareholders. Consequently, how working capital management affects cooperate efficiency and the modalities that could ensure effective working capital management to promote cooperate business is the thrust of the study.

  1. Objectives of the Study

The objectives of this study are to:

  1. Find out how working capital management affects cooperate performance.
  2. Determine the extent of member’s participation in working capital management in cooperates.
  3. Find out the modalities in ensuring effective working capital management by cooperate organizations.
  4. To identify the problems affecting efficient working capital management in cooperates.

1.4     Research Questions

          The research questions of this study are:

  1. What are the effects of working capital management on cooperate efficiency?
  2.  What is the extent of member’s participation in working capital management in cooperates?
  3. What are the modalities in ensuring effective working capital management by  cooperate organizations?
  4. What are the problems affecting working capital management in cooperate?

1.5     Significance of the Study

This study examines the effects of working capital management on cooperate efficiency. No doubt, this study is significant to government cooperate departments, cooperate societies and of course incoming students.

It is hoped that at the end of this research work, the findings will reveal which pattern of working capital management will be ideal for any cooperate society. The society will be able to appreciate what is capital composition will be for effective and efficient running of the society towards attaining her aims and objectives. Hence, the significance of this study can be said to be enormous.

To the government cooperate department, the result of this study will be a pointer for evaluating problems hindering the development of cooperate societies in the country with reference to working capital management. Besides, the government cooperate department can also use the research findings to protect cooperate from exploitative by some individual, groups, private business and other cooperate organization and other researchers may use this study as a reference material for their own study by referring to the research methodology, data presentation modalities and the pattern of statistical analysis.

  1. Scope and Delimitations of  the study

This study finds out the effects of working capital management on the efficiency of cooperates, an examination of the extent of member’s participation in working capital management by cooperate organizations fall within the ambit of the study. Included in the scope is a critical assessment of the problems affecting working capital management by cooperates so that possible solutions could be proffered.

1.7     Definition of Terms

          The following terms are contextually defined:

  • Account Payment: This is the receipt of inventories and payment for it.
  • Account Receivable: These are all payments made to an organization for the sale of its inventories and collection or receivable.
  • Accruals: These are liabilities not paid for but postponed to the following financial years.
  • Bankruptcy: The inability to pay debt in full and the asst of the business confiscated and distributed to the business creditors.
  • Business: Any legal activities which individual, group cooperate bodies etc. engage themselves in doing to provide satisfying goods and services with the ultimate aim of making profit.
  • Current Liabilities: These are liabilities that can be payable within the next accounting year and operational circle and which can be incurred in the ordinary course of business. These will consist of money owned to suppliers, tax and all other current expenses that will be incurred by the cooperate enterprises.
  • Inventories: Inventories are stocked goods which include raw materials, spare part, tools, component, assembles, semi finished goods, finished goods.
  • Management: The effective and efficient utilization of human and material to achieve organizational goal and objective i.e ability to get things done through other people.
  • Working capital: This is simply current asset minus current liability. Current assets are the assets that will be turned over in the normal course of the  business. They include stock of goods, debtors and cash at hand etc.

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