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ACC00059 - THE EFFECT OF WORKING CAPITAL ON THE PERFORMANCE OF ENTREPRENEURIAL FIRMS IN KWARA STATE,


CHAPTER ONE

INTRODUCTION

  • Background to the study

Working capital is the capital available for conducting day to day operation of the business and consists of current asset and current liabilities, Working capital can be viewed as a whole but interest is usually focused on the individual components such as inventories and trade receivables. Working capital is effectively the net current asset of a business and every entrepreneurial operation is affected by working Capital Performance (WCP).

Working capital performance is the administration of current asset and current liabilities. Effective management of working capital ensures that the organization is maximizing the benefits from net current asset by having and optimal level to meet working capital demands. Working capital performance is considered to be a very important element in entrepreneurial day to day operations. According to Harris (2005) Working capital performance is a simple and straight forward concept of ensuring the ability of the firm to fund the difference between the short term assets and short term liabilities.

There is much evidence in the financial literature that present the important of WCP. Results of empirical analysis show that there is statistical evidence for a strong relationship between the entrepreneurial operations and its WCP efficiency. The study also gives significant evidence that issues of WCP are different for different industries and firms from different industry sectors adopt different approaches to working capital performance. Firms follow an appropriate working capital performance approach that is favorable to their industry. Firms in an industry that has less competition would focus on minimizing the receivable to increase the cash flow. For firms in industry where there are large numbers of suppliers of materials, the focus would be on maximizing the payable. The working capital meets the short-term financial requirements of a business enterprise. It is investment required for running day-to-day business. It is the result of the time lack between the expenditure for the purchase of raw materials and the collection for the sales of finished products. The components of working capital are inventories, accounts to be paid to suppliers, and payments to be received from customers after sales. Financing is needed for receivables and inventories net of payables. The proportions of these components in the working capital change from time to time during trade cycle. The working capital requirements decide the liquidity and profitability of entrepreneurial activities and hence affect the financing and investing decisions. Lesser requirement of working capital leads to less need for financing and less cost of capital and hence availability of more cash for shareholders. However the lesser working capital may lead to lose sales and thus may affect the profitability. In the past working capital strategies has been the responsibility designated to those managers in accounting and finance departments. However, today’s economy is changing those roles and many managers who traditionally were not part of this process are being called upon to take pro-active steps in reducing the risk associated with working capital.

Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapsed without (i) adequate supply of raw materials for processing; (ii) cash to pay for wages, power and other cost; (iii) creating a stock of finished goods to feed the market demand regularly; and, (iv) the ability to grant credit to its customers. Working capital performance (WCP) is the performance of short-term financing requirements of a firm. This includes maintaining optimum balance of working capital components- receivables, inventory and payables- and using the cash efficiently for day-to-day operations. Optimization of working capital balance means minimizing the working capital requirements and realizing maximum possible revenues.

All these require working capital hence Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital. The effective working capital performance is very important because it affects the management and liquidity of the firms (Taleb et al., 2010). The main objective of working capital performance is to reach optimal balance between working capital performances components (Gill, 2011). “The efficient management of working is a fundamental part of the overall corporate strategy to create shareholders value (Nazir and Afza, 2008)”. Therefore firms try to keep an optimal level of working capital that maximizes their value (Deloof, 2003).

This study empirically investigates the effect of working capital performance on the entrepreneurial firms. There is limited research which considers effects of working capital performance on firm performance for manufacturing firms. The purpose of this study is to investigate the impact of working Capital Management on firms’ performance.

Working capital performance is considered to be a very important element to analyze the organizations’ performance while conducting day to day activities, by which balance can be maintained between liquidity and profitability. Maintaining liquidity on daily base operation to make sure it’s running and meets its commitment is a crucial part required in managing working capital, it is a difficult task for mangers to make sure that the business function running in well- organized and advantageous manner. There are chances of inequality of current assets and current liability during this procedure Firm’s growth and profitability will be affected if this occurs and firm manger wouldn’t be able to manger it efficiently.

According to Harris (2005) Working capital performance is a simple and straightforward concept of ensuring the ability of the firm to fund the difference between the short term assets and short term liabilities. Nevertheless, complete mean and approach preferred to cover all its company’s activities related to vendors, customer and product (Hall, 2002). Now a day working capital performance has considered as the main central issues in the firms and financial managers are trying to identify the basic drivers and level of working capital performance (Lamberson, 1995).

Working capital cycle involves conversions and rotation of various constituents/components of the working capital. Initially ‘cash’ is converted into raw materials. Subsequently, with the usage of fixed assets resulting in value additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus ‘cash’ assumes its original form again at the end of the one such working capital cycle but in the course it passes through various others forms of current assets too.

This paper investigates the relationship between working capital performance and entrepreneurial firms in Ilorin Kwara state. Working capital performance decisions are very important and strategic because they affect the firm profitability and firm value. Working capital performance involves managing current assets and current liabilities of firms. The purpose of this study is to identify whether the performance of firms affected by working capital performance in some selected businesses who engage in entrepreneurial firms especially just international Multi-venture Limited opposite UMCA along Ajase – Offa road in Ilorin Kwara state which deals with furniture for offices, schools, homes etc.

At one given time both the current assets and current liabilities exist in the business. The current assets and current liabilities are flowing round in a business like an electric current

However, “The working capital plays the same role in the business as the role of heart in human body. Working capital funds are generated and these funds are circulated in the business.As and when this circulation stops, the businessbecomes lifeless. It is because of this reason that he working capital is known as the circulating capital as the business just like blood in the human body.

  • Statement of the problem.

An ideal business needs sufficient resources to keep it going and ensures that such resources are maximally utilized to enhance its profitability and overall performance. Working Capital Performance and its effects on entrepreneurial firms has been studied significantly by different researchers (Padachi, K. (2006); F.Finau, (2011); Anand And Gupta (2002); Mohamad and Noriza (2010); Deloof (2003); Luo et al. (2009); Vishmani at el, (2007) Koperunthevi (2010); Fathi and Tavakkoli (2009); V. Ganesan, (2007). Most of the these and other researchers identify significant association between  working capital management and firms’ performance. It has however been discovered that some methods that managers use in practice to make working capital do not rely on the principles of finance. Rather they use vague rules of thumb or poorly constructed models (Emery and Stowe 2004). This , however, make the manager not to effectivelyutilize the various mix of working capital  component which is available to them, and as such, the organization may either be  over capitalized or undercapitalized or worst still,liquidate.

Egbide (2009) found that large number of business failures in the past has been blamed on the inability of the financial manager to plan and control the working capital of their respective firms. These reported inadequacies among financial managers are still practiced today in many organization  in the form of high bad, debts, high bad debts, high inventory costs etc., which adversely affect their operating performance (Egbide 2009:45).

Also, the fact that an organization makes profits is not necessarily an indication of effective management of its working capital because a company can be endowed with asset and profitability but liquidity if its assets cannot readily be converted into cash, there will be shortage available for the firm’s utilization as at when due. Such an organization may run into debts that could affect its performance in the long run because the smooth running of operations of the organization comes to a sudden halt and it will not be able to finance its obligation as at when due. (Eljelly, 2004). Again, some managers do neglect the organization’s operating cycle thereby having longer debtors’ collection period and shorter creditors’ payment period.

However, despite the above consequence this issue raises to attract the attention of researchers in Kwara state. Thus, while searching on internet, browsing through the books and journals the researcher didn’t find directly related to research topics carried out in Ilorin as well as in Kwara state. Therefore, the researcher believed that, the problem is almost untouched and there is a knowledge gap on the area. In its effect Kwara state company’s managers thought regarding working capital performance is, traditionally views to shorten the cash conversion cycle to increase firm’s profitability. Hence, lack of proper research study on the area gives a chance for Kwara state company’s managers to have limited awareness in relation to working capital performance to increase firms’ performance. All these constitute the investigation, hence, the need to study the effect of working capital performance and entrepreneurial operation in Ilorin Kwara state.

One of the problems faced by entrepreneurs is the availability of capital to run the business and another problem is about their debtors who fail to pay at the promised date. The challenge of transportation can’t be left out because the means of transporting their goods.

  • Research Question:

The study was guided by the following specific research questions:-

  1. What is the effect of cash conversion cycle on entrepreneurial firms in Ilorin Kwara State?
  2. To what extent does inventory holding period influences entrepreneurial firms in Ilorin Kwara State?
  • What are effects of the approaches of working capital performance on operational activities of SMEs in kwara State?
  1. Is there any significant relationship between working capital management and Entrepreneurs operational and Efficiency?
    • Objective of the study

The main objective of this study is to examine the effects of working capital on the performance of entrepreneurial firms in Kwara state.

Other Specific Objectives are:

  • To examine the impact of cash management on entrepreneurial operations.
  • To evaluate the effect of inventory management on entrepreneurial operations.
  • To determine the relationship between working capital performance and Entrepreneurial operation activities in Kwara state.
    • Research Hypothesis.

H1: Working capital performance has No significant effect on entrepreneurial operations.

H2: There is No significant relationship between Working Capital Performance and Entrepreneurial operation activities in Kwara State.

H3: There is significant effect of inventory management on entrepreneurial operation.

1.6.      Significance of the Study

The purpose of this research was to study how working capital performance practices affect entrepreneurial firms in Ilorin state. This research would help owner of SMEs in understanding the proper working capital performance practices and its effects on their entrepreneurial firms and how they can use them to increase profitability of their enterprises.

The research would also be useful to company managers in understanding funds maintenance and setting standards for efficient capital levels. Prospective researcher would also gain useful information from the findings of this research in that it would provide relevant data that can be used in further studies in the area. The research if done as a whole entirely, would give overall view of the organization and it is useful in further expansion decision to be taken by management. The outcome of this research would also be resourceful to the government agents and policy makers within Small and Medium Enterprises in Nigeria, which would assist in better resource allocation in the SME sector. The research would also add knowledge to the existing literature on Working Capital Performance in small and Medium Enterprises in Nigeria and form basis for future research.

1.7.      Scope of the Study

This study focuses on working capital performance in Kwara state, its effects on entrepreneurial operation and how to manage working capital to produce a desired result. Ilorin was chosen since it’s the capital of Kwara state and the economic city of Kwara state where most of the Kwarans have headquarters. The study area was good enough to give ground for generalization of the finding on all entrepreneurial business in Kwara state.

1.8.      Limitation of the Study.

The research work fell short of my expectations due to the following constraints: the study is limited to the study of working capital performance on entrepreneurial firms in Kwara state.

Lack of adequate financial, material and time resources, And not all entrepreneurs are ready to give full information about their working capital.

1.9.      Definition of Terms.

  • Working Capital:

Working capital is the capital available for conducting day-to-day operation of the business and consist of current and current liability.

  • Entrepreneur:

It is an individual who organizes or operates a business or business. It is also defined as an individual who undertakes the risk of setting up business for profit.

  • Working Capital Performance:

            Working capital performance is one of those related aspects related to finance management which is concerned with all management areas regarding finance not only sources and uses of finance in the company but also the financial implication of investment, marketing or personnel decision.

  • Inventory period

This is the average number of days of held by the firm.

  • Accounts Receivable period

Is the average number of days that a firm takes to collect payments from its customers.

  • Accounts Payment Period

This is the average time it takes firms to pay supplier.