1

AZEEZ, Nurudeen Oyebamiji

PG/M.SC/09/54079

WORKING CAPITAL MANAGEMENT AND

FIRMS PERFORMANCE: A STUDY OF

MANUFACTURING COMPANIES IN NIGERIA

FACULTY OF BUSINESS ADMINISTRATION

DEPARTMENT OF ACCOUNTANCY

Azuka Ijomah

Digitally Signed by: Content manager’s Name

DN : CN = Webmaster’s name

O= University of Nigeria, Nsukka

OU = Innovation Centre

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WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE: A

STUDY OF MANUFACTURING COMPANIES IN NIGERIA

BY

AZEEZ, Nurudeen Oyebamiji

PG/M.SC/09/54079

3

DEPARTMENT OF ACCOUNTANCY,

FACULTY OF BUSINESS ADMINISTRATION,

UNIVERSITY OF NIGERIA, ENUGU CAMPUS

AUGUST, 2015

WORKING CAPITAL MANAGEMENT AND FIRMS PERFORMANCE.

A STUDY OF MANUFACTURING COMPANIES IN NIGERIA.

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AZEEZ, Nurudeen Oyebamiji

PG/M.SC/09/54079

BEING A DISSERTATION PRESENTED TO THE DEPARTMENT OF

ACCOUNTANCY, FACULTY OF BUSINESS ADMINISTRATION

UNIVERSITY OF NIGERIA, ENUGU CAMPUS.

IN PARTIAL FULFILMENT OF THE AWARD OF MASTERS OF SCIENCE IN

ACCOUNTANCY

SUPERVISOR: PROFESSOR (MRS.) UCHE MODUM

AUGUST, 2015

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DECLARATION

This is to certify that this dissertation is an original work written by AZEEZ

NURUDEEN OYEBAMIJI Registration number: PG/MSc/09/54079. The

dissertation was submitted in partial fulfillment for the award of MSc in

Accounting in the department of Accountancy, University of Nigeria, Enugu

Campus and has not been submitted in part or full for any other diploma or degree

of this or any other University.

-------------------------------------------------------------------

AZEEZ, Nurudeen Oyebamiyi

PG/M.Sc/09/54079

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APPROVAL PAGE

This is to certify that AZEEZ, Nurudeen Oyebamiji , a post graduate student in the

department of accountancy, faculty of Business administration, university of

Nigeria Enugu Campus (UNEC) with Registration Number PG/M.SC/09/54079,

has satisfactorily completed the requirements of Dissertation research in partial

fulfillment of the award of M.sc in accountancy of the University of Nigeria.

---------------------------- ---------------------------

Prof (Mrs.) Uche Modum Date

Supervisor

--------------------------- ---------------------------

Osita Aguolu (Reader) Date

(Head of Department)

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DEDICATION

This work is dedicated to Allah (SWT) for His infinite mercies and grace.

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ACKNOWLEDGEMENTS

I wish to express my profound gratitude to God almighty for His providence,

guidance and divine provision in making this educational sojourn a reality. To Him

be the glory.

I sincerely acknowledge the efforts of my supervisor, Prof (Mrs) Uche Modum for

her patience, advice, suggestions and constructive criticism which has not only led

to the completion of this work but has also improved my knowledge in research.

My appreciation goes to my uncle; engineer T.A Shittu for his immense

contribution towards my educational career. To my elder sister Mrs Kazeem Seidat

I. for her encouragement. To my friends and colleagues Mr Iorpev Luper of Benue

State University, Makurdi, Benjamin Yio and others for their support, I say many

thanks to you all.

Finally, I wish to acknowledge my dearest wife Hajia Azeez Dolapo Omowumi for

her steadfastness, support and prayers in making this struggle a success.

May God bless you all (Amen).

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ABSTRACT

This study investigated the relationship between working capital management

measured by account receivable period (ACRP), inventory period (INVP), cash

conversion cycle (CCC) and sales Growth (SG) and profitability performance

measured by returns on assets (ROA). The study utilized secondary data obtained

from the annual financial statements of Nigerian Manufacturing companies listed

on the Nigerian Stock Exchange (NSE) for period 2008 – 2012. Multiple

regression model were adopted for testing all the hypotheses and the study result

reveals that there was a negative significant relationship between the account

receivable period and profitability of the Nigerian Manufacturing companies. It

also reveals that the profit is significantly influenced by the number of days

inventory were held (INVP) and that the profitability performance negatively and

significantly related to the cash conversion cycle (CCC). These results suggest that

effective policies must be formulated for the individual components of working

capital. Furthermore, efficient management and financing of working capital

(current assets and liabilities) can increase the operating profitability of

manufacturing firms

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TABLE OF CONTENTS

Content Page

Title page - - - - - - - - - - i

Declaration - - - - - - - - - - ii

Approval - - - - - - - - - - iii

Dedication - - - - - - - - - - iv

Acknowledgements - - - - - - - - - v

Abstract - - - - - - - - - - vi

List of tables - - - - - - - - - xi

List of figure - - - - - - - - - xi

CHAPTER ONE : INTRODUCTION

1.1 Background to the Study - - - - - - 1

1.2 Statement of the Problem - - - - - - - 3

1.3. Objectives of the Study - - - - - - - 4

1.4 Research Questions - - - - - - - - 5

1.5 Research Hypotheses - - - - - - - 5

1.6 Scope of the Study - - - - - - - 6

1.7 Significance of the Study - - - - - - - 7

References - - - - - - - - - 8

CHAPTER TWO: REVIEW OF LITERATURE

2.0. Introduction - - - - - - - - 10

2.1. Conceptual Review - - - - - - - 10

2.1.0. Concepts of Working Capital Management - - - - 10

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2.1.1. Working Capital - - - - - - - - 10

2.1.2. Working Capital Management - - - - - - 12

2.1.3 Working Capital Management Efficiency - - - - - 13

2.1.4. Policy of Working Capital - - - - - - - 13

2.1.5. Working Capital Cycle - - - - -- - - 16

2.1.6. Components of Working Capital Management (WCM) - - - 18

2.1.7. Cash Management - - - - - - - - 19

2.1.8 Cash Positioning - - - -- - - - - 22

2.1.9 Cash Flow Volatility, Earnings Volatility and Firm Value. - - 23

2.1.10 Cash Budget - - - - - - - - - 25

2.1.11. Management of Cash Receivables - - - - - 26

2.1.12. Credit Standards - - - - - - - - 26

2.1.13. Credit Extension Policy - - - - - - - 27

2.1.14. Credit Collection Policy - - - - - - - 28

2.1.15. Inventory (Inv) Management - - - - - - 29

2.1.16. Need to Hold Inventory - - - - - - - 30

2.1.17 Inventory Control - - - - - - - - 31

2.1.18. The Economic Order Quantity (EOQ) - - - - - 31

2.1.19. Re-Order Point - - - - - - - - 32

2.1.20. Relation to Financial Management - - - - - 32

2.1.20.1. Payables Management - - - - - - - 33

2.1.21. Receivables Management - - - - - - - 33

2.1.22. Cash Conversion Cycle (CCC) Management - - - - 34

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2.1.23. Measures of Profitability - - - - - - - 34

2.1.24. Liquidity - - - - - - - - - 36

2.1.25. Nature of Working Capital - - - -- - - - 37

2.1.26. Trade-Off between Profitability and Risk - - - - 37

2.1.27. The Efficient Management of Firm’s Working Capital - - 38

2.1.29 . The Consequences of Inefficient Management of Working Capital 39

2.1.30. The Costs and Benefits of Firm’s Investments in Working Capital - 44

2.1.31. The Nigerian Economy and Working Capital Management of Quoted

Firms in Nigeria =- - - - - - - - 46

2.20. Theoretical Review - - - - - - - - 47

2.2.1. The Operating Cycle Theory - - - - - - 48

2.2.2. The Cash Conversion Cycle (CCC) Theory - - - - 48

2.2.3. The Pecking Order Theory - - - - - - - 49

2.2.4 Agency Theory - - -- - - - - - 50

2.2.5. The Risk –Return Trade-Off Theory - - - - - 51

2.3.0. Review of Empirical Studies - - - - - - 51

2.3.1. Summary of Literature Review - - - - - 57

References - - - - - - - - - - 58

CHAPTER THREE: METHODOLOGY

3.0 Introduction - - - - - - - - - 60

3.1 Research Design - - - - - - - - 60

3.2 Population of the Study - - - - - - - 61

3.3 Sampling Techniques and Sample Size - - - - - 61

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3.4 Sources of Data Collection - - - - - - - 61

3.5 Variables Used for the Study - - - - - - 62

3.5.1 Dependent Variable - - - - - - - - 62

2.5.2 Independent Variables - - - - - - - 63

3.6 Data Analysis Techniques - - - - - - - 65

3.7 Model Specification - - - - - - - 66

3.8 Limitation of the Study - - - - - - - 66

References - - - - - - - - - 68

CHAPTER FOUR: DATA PRESENTATION, ANALYSIS AND

INTERPRETATION

4.0 Introduction - - - - - - - - 69

4.1. Presentation and Analysis of Multiple Regression Results - - 70

4.2. Data Validity Test - - - - - - - - 71

4.3. Summary of Regression Results - - - - - 72

4.4. Testing of Research Hypotheses - - - - - 73

4.5. Interpretation of results and discussion of findings - - - 75

4.5.1. The Impact of ACRP on Profitability - - - - 75

4.5.2. The Impact of Inventory Period (INVP) on Profitability - - - 75

4.5.3. The Impact of Cash Conversion Cycle (CCC) on Profitability - 76

4.5.4. The Impact of Sales Growth (SG) on Profitability - - - 76

CHAPTER FIVE: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.1. Introduction - - - - - - - - 78

5.2. Summary - - - - - - - - - 78

5.3. Conclusions - - - - - - - - - 80

5.3.1 Policy Implication - - - - - - - - 81

5.4. Recommendations - - - - - - - - 81

5.5. Suggestions for Further Research - - - - - - 82

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Bibliography - - - - - - - - - 83

Appendices - - - - - - - - 86

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LIST OF TABLES

3.1.1.1 Table 1: Measurement of variables and Abbreviation - - 65

Table 1: Regression results showing Data Estimate effects of WCM on ROA 70

Table 2: Summary of Regression Results for the Study Model - - 72

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LIST OF FIGURES

Fig. 2.1 Working Capital Cycle: Source from JPMorgan (2003)

Fleming International Cash Management Survey in

conjunction with the ACT - - - - - - 17

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CHAPTER ONE

INTRODUCTION

1.1 Background To The Study

Working Capital management of a firm, which deals with the management of

current assets and current liabilities, has been recognized as an important area in

financial management. Working capital (WC) refers to the firm’s investment in

short-term assets. Pandey, (2005) classified working capital into gross and net

concepts. He defined gross working capital as the firm’s investment in current

assets. Current assets are the assets which can be converted into cash within an

accounting year and these include; cash, short-term securities, debtors, bills

receivables and stocks. He described net working capital as the difference between

current assets and current liabilities. Current liabilities are those claims of

outsiders, which are expected to mature for payment within an accounting year.

These include trade creditors, bills payable, bank overdraft and short- term loan.

Home van, (2000) described working capital management as involving the

administration of these assets namely cash, marketable securities, receivables and

inventories and the administration of current liabilities.

Management of these short-term assets and liabilities is important to the financial

health of business of all sizes. This importance is hinged on the fact that the

amounts invested in working capital are often high in proportion to the total assets

employed and therefore warrants a careful investigation (Smith, 1980). Working

Capital therefore, should neither be more nor less, but just adequate for the smooth

running of a firm. While excess amount of working capital results in the reduction

of firm’s profitability, holding of inadequate amount of it leads to lower levels of

the firm’s liquidity and stock outs resulting in difficulties in maintaining smooth

operation (Krueger, 2002).

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Business success, therefore, heavily depends on the ability of the financial

managers to effectively manage accounts receivable, inventory and account

payable (which are component of working capital) (Filbeck and Krueger, 2005).

Firm can reduce their financing costs and or increase the funds available for

expansion of project by minimizing the amount of investment tied up in current

assets (Home Van Wachowicz, 2004). For this reasons, most of the financial

manager’s time and efforts are spent in identifying the non-optimal levels of

current assets and liabilities and bringing them to optimal levels (Lamberson,

1995). An optimal level of working capital is the one in which a balance is

achieved between risk and efficiency. To maintain the optimal level of various

components of working capital, continuous monitoring is required (Afza and

Nazir, 2009).

A poor or inefficient working capital management leads to tie up funds in idle

assets and reduces the liquidity and profitability of a company (Reddy &

Kameswar, 2004). Siddart & Das (1993), states that the major reason for slow

progress of an undertaking is shortage or wrong management of working capital.

Deloot (2003: 573), states that “there is a significant relationship between gross

operating income and number of days of account receivable, inventories and

accounts payables”. The relationship between accounts payable and profitability is

consistent with the view that less profitable firms wait longer to pay their bills.

Considering the importance of Working Capital Management therefore, the

researcher focused on evaluating the Working Capital Management and

profitability relationship like other similar works such as Uyar, 2009; Samiloglu

and Demirgune 2008; Vishnani and Shah, 2007; Tervel and Solano, 2007;

Lazaridis and Tryfonidis, 2006; Padachi, 2006; Shin and Soenen, 1998; Smith et

al, 1997 and Jose et al, 1996. However, there are a few studies with reference to

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Nigeria in respect of the subject. Like Akinsulire, 2005, Falope,, 2009, Ajilore,,

2009 etc.

Most of these studies focused on the Working Capital Management financing

policies. Shah and Sana (2006) concentrated on the oil and gas sector and

estimated the relationship using small sample of 7 firms. Raheman and Masr

(2007) analyzed profitability and Working Capital Management performance of

94 firms listed on Karachi Stock Exchange for the period 1999-2004 by using

ordinary least square and generalized least square. However, this study ignored the

fixed effect of each firm as each firm has its unique characteristics and also

ignores sector-wise analysis of Working Capital Management performance of

manufacturing firms. Insufficient evidences on the firm’s performance and

Working Capital management with reference to Nigeria therefore, provide a strong

motivation for evaluating the relationship between working capital management

and firm’s performance in detail. This study therefore, explores the various way of

measuring Working Capital components and relates them to the performance of

the Nigerian manufacturing sector.

1.2 Statement Of The Problem

There has been a growing number of studies that examined the relationship

between working capital and corporate profitability in the recent time (Shin and

Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; .Jinadu,

2010). Justification for this common efforts centered on the relationship between

efficiency in working capital management and firms profitability and its

implications on shareholder’s value. Most of these studies were however, centered

on large firms operating within well developed money and capital market of

developed economies and did not consider the fact that the amount of working

capital required varies across industries and indeed firms depending on the nature

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of business, scale of operation, production cycle, credit policy, availability of raw

materials etc (Ghosh and Maji; 2004).

It is regrettable to note that in spite of these huge literatures in this area, many

firms had crashed, more especially manufacturing sector of the Nigerian economy

in which application of working capital is more pronounced (Jinadu, 2009). In

addition, some promising investments with high rate of return are failing and

being frustrated out of business because of inadequacy of working capital. Many

factories had been either temporarily or completely shot down because they could

not meet their financial obligations as at when due because they were not liquid.

Many Nigerian workers had been forcefully thrown into unemployment market

and frustratingly became dependent on relations as a result of the aborted mission

of their organization caused by poor attention given to the management of working

capital . Unfortunately, Nigeria capital and money markets are not really helping

to ameliorate the problem, instead, more often than not; they compound the

problem by creating bottleneck with harsh conditions that could not be easily met

by the companies that are at the verge of collapse.

The problem then arises as to how managers of these manufacturing organization

could be encouraged to pay more attention to the management of their working

capital. In other words, how could working capital be managed in order to impact

positively on firms performance.

1.3 Objectives Of The Study

The main objective of this study is to investigate the relationship between working

capital management and the corporate performance (profitability) of the Nigerian

manufacturing companies. While the specific objectives of the study are to: -

i. investigate the relationship between the accounts receivable period (as a measure

of WCM) and profitability of manufacturing companies in Nigeria.

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ii. investigate the relationship between inventory period (as a measure of WCM) and

profitability of manufacturing companies in Nigerian.

iii. investigate the relationship between cash conversion cycle period (as a

comprehensive measure of checking the efficiency of WCM) and profitability of

manufacturing companies in Nigeria.

1.4 Research Questions

In a bid to actualize the research objectives, the following research questions have

been formulated which serve as a guide in the researcher’s quest for answers.

These questions are;

i. What is the significant relationship between the accounts receivable period

(ACRP) and profitability of Nigerian manufacturing companies?

ii. What is the significant relationship between the inventory period (INVP)

and profitability of Nigerian manufacturing companies?

iii. To what extent is the relationship between cash conversion cycle (CCC)

and profitability of manufacturing companies in Nigeria?

iv. To what extent does the effective management of working capital affect the

profitability of the Nigerian manufacturing companies?

v. What level of working capital is optimal and desirable?

vi. To what extent has the inadequacy of working capital affect the profitability

of the Nigerian manufacturing companies

1.5 Research Hypotheses

A hypothesis is a conjecture or a prediction of what can be seen in the world of

reality and this prediction is made from the world of theory. It is a tentative

statement about the relationships that exist between two or among many variables

(Asika, 2005).

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To provide an empirical support to the relationship between working capital

management and profitability of the Nigerian manufacturing companies, three

hypotheses have been formulated and stated in their null forms as follows:

HO1: There is no significant relationship between the accounts receivable

period (ACRP) and profitability of Nigerian Manufacturing

Companies

HO2: There is no significant relationship between the inventory period

(INVP) and profitability of Nigerian Manufacturing Companies

HO3: There is no significant relationship between the cash conventions

cycle (CCC) and profitability of Nigerian Manufacturing Companies

1.6 Scope Of Study

The scope of the study enables the researcher to circumscribe his/her research

within a manageable limit (Asika, 2005).

In this research work, an attempt is made to explore the relationship between

working capital management and firm’s performance for twenty (20)

manufacturing firms out of the 134 manufacturing firms listed on the Nigerian

stock exchange for the period 2008-2012. The twenty (20) manufacturing firms

were selected based on the following criteria:

Companies must remain listed on the Nigerian Stock Exchange (NSE)

during the 2008 – 2012 periods.

Companies must have complete financial statements for the period under

review.

Companies must be operational within the period under investigation.

Manufacturing organizations were so taken into consideration since they play a

very important role in the Nigerian economy.

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1.7 Significance Of The Study

This study is very crucial as it will give the financial managers of these

manufacturing organizations, better insights on the need to pay particular attention

to the effective and efficient management of their working capital. They will be in

a better position to be able to design and implement strategies and policies that

are aim at stabilizing and managing the various components of working capital

especially as it significantly impact on the main aim of business which is creating

shareholders’ value.

The study would further, enable the management to know at what extend they

should increase their liquidity in order to make their performance up to the mark.

This is very important in improving the good will of their firms, since firms that

pay creditors as at when due are considered credit worthy and gains a good

reputation.

And for the academic purposes, the research work will contribute to the existing

body of knowledge on working capital management and firm’s performance.

Finally, it is expected that the study will serve as a source of information to

students undergoing research work of this nature in the future.

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REFERENCES

Afza, T. and Nazir, M. (2009). “Impact of aggressive working capital management policy

on firm’s profitability”. The IUP Journal of Applied Finance, 15 (8), 20 – 30.

Akinsulire, O. (2005). Financial management. Lagos: El-Toda Ventures.

Deloof, M. (2003). “Does working capital management affect profitability of Belgium

firms”? Journal of Business Finance and Accounting, 30 (3), 573-588.

Falope, O.I. and Ajilore, O.T. (2009). “Working capital management and corporate

profitability: Evidence from Panel Data Analysis of selected quoted companies in

Nigeria”. Research Journal of Business Management, 3(3)73-84.

Filbeck, G. and Krueger, T. (2005). “Industry related differences in working capital

management”. Mid-American of Business, 20(2), 11-18.

Filbeck, G., Krueger, T. and Preece, D. (2007). “CFO magazine’s working capital

surveys: Do selected firms work for shareholders”? Quarterly Journal of Business

and Economics, 46(2)3-22.

Krueger, T. (2002). “An analysis of working capital management results across

industries”. Mid-American Journal of Business, 20(2), 11 – 18.

Lamberson, M. (1995). “Changes in working capital of small firms in relation to changes

in economic activity”. Journal of Business, 10(2), 45-50.

Lazaridis, I. and Tryfonidis, D. (2006). “Relationship between working capital

management and profitability of listed companies in the Athens Stock Exchange”.

Journal of Financial Management and Analysis, 19(1)26-35.

Ohikhena, P. (2006). Research methodology in the social and management sciences.

Lagos, Nigeria: Bunmico Publishers.

Oxford (2005). A dictionary of accounting, 3 ed. Oxford University Press.

Pandey, I.M. (2005). Financial management, 9 ed. New Delhi Vikas Publishing House

PVT Ltd.

Padachi, K. (2006). “Trends in working capital management and its impact on firm’s

performance: An analysis of Mauritian small manufacturing firms”. International

Review Business Research Papers, 2(1), 45-56.

25

Prasad, R.S. (2001). “Working capital management in the paper industry”. Finance India,

15(1),185-188.

Shin, H.H. and Soenen, L. (1998). “Impact of working capital and corporate

profitability”. Journal of Finance Practice and Education, 8(2)37-45.

Smith, K. (1980). Profitability versus liquidity trade offs in working capital management,

in readings on the management of working capital. New York, St. Paul: West

Publishing Company.

VanHorne, J.C. (1977). “A risk-return analysi8s of a firm’s working capital position”.

Financial Economics, 2(1)71-88.

VanHorne, J.C. and Wachowiez, J.M. (2004). Fundamentals of financial management, 12

ed. New York: Prentice Hall.

26

CHAPTER TWO

REVIEW OF RELATED LITERATURE

2.0. Introduction

The aim of this research work is to examine the impact of Working Capital

Management on the performance of Nigerian manufacturing companies listed on

the Nigerian Stock Exchange (MSE). This chapter reviews the related literature in

respect of the subject matter under investigation and it is divided into five (5)

sections as shown below:

2.0. Introduction

2.1. Conceptual Review

2.2. Theoretical Review

2.3. Empirical Review

2.4. Summary

2.1. Conceptual Review

2.1.0. Concepts of Working Capital Management

2.1.1. Working Capital

Many authors have different perceptions about the concept “Working Capital”.

Falope and Ajilore (2009) regard working capital as the firm’s investment in short

term assets. To Akinsulire (2005), working capital is viewed as the items that are

required for the day to day production of goods to be sold by a company.

An understanding of the concept of working capital cycle will give appreciation

for the study of relationship between capital and firm’s performance. Weston

(1998) described working capital or cash operating cycle as the total length of time

required to complete the following sequence of events:

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Conversion of cash into raw materials

Conversion of raw materials into work in progress

Conversion of work in progress into finished goods

Conversion of finished goods into debtors through sales and

Conversion of debtors into cash

Pandey (2005), however argues that working capital is a tow faced concept- gross

and net WC. He defined gross WC as the firm’s investment in current assets while

the net WC is the difference between current assets and current liabilities. Net WC

can be positive or negative. It will be positive if current assets are more than

current liabilities and negative when current assets are less than current liabilities.

Efficient management of working capital is very essential in the overall corporate

strategy in creating shareholders value (Afza & Nazir, 2009). Agreeing with the

view of Afza and Nazir, Eljelly (2004) states that working capital management

involves planning and controlling current assets and current liabilities in a manner

that eliminates the risk of inability to meet due short term obligations on one hand

and avoid excessive investment in current assets on the other hand.

Padachi (2006) opines that the management of working capital is important to the

financial health of businesses of all sizes. This is because, first, the amounts

invested in working capital are often high in proportion to the total assets

employed and so it is vital that these amounts are used efficiently. Secondary, the

management of working capital directly affects the liquidity and the profitability

of firms and consequently their net worth (Smith, 1980).

Agreeing with the view of Padachi (2006), Raheman and Nasir (2007) consider

working capital management as striking a balance between the two objectives of a

firm, that is, profitability and liquidity. They posited that firms must strive to

28

maximize profits and enhance shareholders wealth but at the same time not

sacrifice their liquidity which is necessary for smooth operations and most

importantly, corporate survival. To achieve this dual objective of working capital

management, most of the financial manager’s time and efforts are consumed in

identifying the non-optimal levels of the various components of working capital

and bringing them to optimal levels (Lamberson, 1995). The optimal level of

working capital components, which is a balance between risk and efficiency, is

maintained by continuous monitoring of the various components of working

capital (Afza & Nazir, 2009).

The basic objective of working capital management therefore is to ensure that a

firm’s current assets and current liabilities are maintained at a satisfactory level.

That is, to avoid neither more nor less working capital but to ensure that is just

adequate (Dong & Su, 2010). Agreeing with the view of Dong and Su, VanHorne

and Wachomicz (2004) observed that excessive level of current assets may have a

negative effect on a firm’s profitability; where as a low level of current assets may

lead to low level of liquidity and stock-outs thereby resulting in difficulties in

maintaining smooth operations.

For this work, suffice it to state that working capital management is all managerial

decisions taken by financial managers in maintaining a balance between liquidity

and profitability while conducting the day to day operations of a business concern.

The task of maintaining this balance, however, requires continuous monitoring of

the optimal levels of the various components of working capital.

2.1.2. Working Capital Management

Working capital management is the functional area of finance that covers all the

current accounts of the firm. It is concerned with the management of the levels of

29

the individual components of the working capital (Loneux, 2004). The basic

objective of working capital management is to manage firms’ current assets and

current liabilities in such a way that working capital is maintained at a satisfactory

level (Dong & Su, 2010).

Therefore, in this study, working capital management can be referred to as actions

taken by managers in maintaining a balance between liquidity and profitability

while conducting the day-to-day operations of a business concern.

2.1.3 Working Capital Management Efficiency

Efficient management of working capital has been defined by Ghosh and Maji

(2004) as the management of various components of working capital in such a

way that an adequate amount of working capital is maintained for the smooth

running of a firm and for fulfillment of twin objectives of liquidity and

profitability.

Modern financial management aims at reducing the level of current assets without

ignoring the risk of stock outs, to an optimal level (Bhattacharya, 1997).

2.1.4. Policy of Working Capital

The policy of working capital in accordance to Weston et al position is concerned

with two sets of relationship among balance sheet items. Firstly, the policy

question about the degree of total current assets to be held. Though current assets

vary with sales, it should be noted that the ratio of current assets to sales becomes

a policy issue. A company may hold relatively little proportion of stocks of current

assets if it elects to operate aggressively. Such move is to lower the required level

of investment and enhance the expected rate of return on investment. Thus, due to

excessive tough credit policy, such aggressive policy may as well enlarge the

possibility of running out of inventories and cash or sales loss.

30

The connection/relationship between types of assets and means such assets are

financed is the second policy question. One policy requests for harmonizing asset

and liability maturities: financing short term assets with short term debt, and long

term assets with long term debt or equity. If such policy is implemented, the

maturity formation of debt is resolved by considering fixed versus current assets.

Meanwhile, short-term debt is often less expensive to long term debt. This implies

that the expected rate of return may be more if short term debt is employed.

By offsetting the return advantage shows that huge proportion of short term credit

amplifies the risks as follows:

First, having to renew this debt at much higher interest rates

Second, not being able to renew the debt at all whenever the company goes

through tough times.

Both areas of working capital policies entail risk/return tradeoffs. Therefore, the

need to work-out a modality to establish the best possible levels of each type of

current assets to hold, and the substitute methods to finance them is necessary. The

procedure of accomplishing these optimal conditions is what may be termed as

working capital management.

As pointed out by Shin and Soenen (1998) that Wal-Mart and K-Mart had

comparable capital formations in 1994, but K-Mart’s poor management of

working capital contributed to its going bankrupt. This is because K-Mart had a

cash conversion cycle of about 61 days whereas Wal-Mart had a shorter

conversion cycle of 40 days instead. K-Mart was with faced an extra $193.3

million per year financing costs arising from long-term conversion cycle.

31

As pointed out in their 2005 U.S. survey report, there is a high positive correlation

between the efficiency of a corporation’s working capital policies and its return on

invested capital.

Hence, Nunn (1981) employs the PIMS database to study the reason for some

product lines having small working capital requirements, whereas some product

lines are having large working capital requirements. Moreover, Nunn has much

interest in permanent rather than temporary working capital investment since he

employed data averaged over four years. By employing factor analysis, he’s able

to identify factors connected with the production, sales, competitive position and

industry.

While highlighting the function of industry practices on firm practices, Hawawini,

Viallet, and Vora (1986) observe the influence of a company’s industry on its

working capital management. They resolved that there is a greater industry

consequence on company working capital management practices which is stable

over time; having used data on 1,181 U.S companies over the period 1960 to 1979.

Their studies arrived at the conclusion that sales growth and industry practices are

essential issues that influence company’s investment in working capital.

The review above depicts that there are models to illustrate the way working

capital refers to a company’s investment in short term assets-cash, short-term

securities, accounts receivable, and inventories. Though, these assets are financed

by short- term liabilities. Thus, net working capital is current assets less current

liabilities.

Van Horne (1986) submitted that working capital management is a misnomer; if

the working capital of the company is not managed. The term he stressed describes

a set of management decisions that affect specific types of current assets and

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current liabilities. In turn, those decisions should be rooted in the overall valuation

of the company.

This submission does not disagree with the substance of the postulations of

Weston et al. Thus, it strengthens their arguments that the idea of working capital

management must do with those management decisions which border on balancing

of risk/return tradeoffs for current asset holdings and the liabilities that create

those assets.

Weston et al then advised that working capital should be considered as an

investment no less important that equipment and materials. They both argued that

current assets embody more than half the total assets of a business, and since the

investment is relatively volatile, it is worthy of careful consideration.

They argued that it is even more so for the small business. The small business may

lower its investment in fixed assets by renting or leasing plant and equipment, but

there is no way it can avoid an investment in cash, inventories and receivables.

Further, since small and medium companies have relatively limited access to the

long-term capital markets, it must necessarily rely heavily on trade credit and

short- term bank loans, both of which affect net working capital by increasing

current liabilities

2.1.5. Working Capital Cycle

In a business cycle, cash flows into, around and out of the business. Cash is life

blood of a business, and a manager's key mission is to assist in keeping it to flow

and to take the advantage of the cash-flow in making profits. A business that is

operating profitably, in theory is generating cash surpluses. If it does not generate

surpluses, then the business ultimately will run out of cash and expire.

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The more speedily the business gets bigger the further cash it will need for

working capital and investment. The cheapest and best sources of cash exist as

working capital right within business. Better management of working capital

generates cash, and will assist in improving profits and lessen risks. Hence, it is

imperative to note that the cost of offering credit to customers and holding stocks

may signify a significant percentage of a company's total profits.

There are two elements in a business cycle that absorb cash, these are - receivables

(debtors that owe you money) and inventory (stocks and work-in-progress). Major

sources of cash are Payables (payment from your creditors), and Equity and Loans

Fig. 2.1 Working Capital Cycle: Source from JPMorgan (2003) Fleming

International Cash Management Survey in conjunction with the ACT

Every component of working capital, such as inventory, receivables and payables

has two dimensions, which are TIME and MONEY. To manage working capital

entails both time and money. A business will spawn more cash or will need to

borrow less money to finance working capital if possible to get money to move

faster around the cycle, i.e. getting monies due from debtors as fast as possible or

lowering the sum of monies tied-up by lowering inventory levels relative to sales.

As a consequence, one can lower bank interest cost or one will have extra free

34

money that will be available to enhance more sales growth or investment. In the

same way, negotiating improved terms with suppliers such as getting longer credit

or an increased credit limit will effectively create free finance to assist funding

future sales.

Working capital is referred to as the fuel powering global business activities, but

often a greater percentage of this fuel is constantly stuck in the pump; tied up in

aging invoices and lengthy Days Sales Outstanding (DSO) cycles. Those firms

that are looking to enhance cash flow have primarily focused on collections.

Whereas traditionally, collections have always been a reactive process i.e. picking

up on aging invoices after they are already late in payment, and then resolving the

underlying issues in an effort to collect. Since it is not easy to go up-stream and

systematically uncover and resolve the root causes of issues that actually drive the

delayed payments. Hence, most of the collections efforts normally end up squarely

emphasizing on dealing with symptoms, rather than addressing the real issues.

As a result of process automation built around innovative dispute prevention

technologies, it is now possible to take a more proactive approach to collections

that are proving to yield enormous dividends that include the unlocking of millions

in working capital, elimination of revenue leakage, and radical improvements in

overall customer satisfaction. Many companies have already seen significant

returns from their work in this area. As submitted by JP Morgan (2005); to

optimise working capital globally, payment and information components of a

transaction must be integrated.

2.1.6. Components of Working Capital Management (WCM)

Working capital management processes involve crucial decisions on multiple

aspects, including the investment of available cash, maintaining a certain level of

inventories, managing accounts receivable and accounts payable (Hadley, 2006).

35

However, WCM is not limited to these tasks, but is implicated in multiple levels of

interactions both internally and between external parties (supplier, customers,

distributors, bankers and retailers). For example, credit officers are required to

investigate credit history of their clients in order to understand their financial

worthiness.

For this study, WCM components can be narrowed to four important components,

namely; cash, receivables, inventory and payables management which are

explained as follows:

2.1.7. Cash Management

The purpose of cash management is to determine the optimal level of cash needed

for operations and investments in marketable securities, which is suitable for the

nature of business operations cycle (Hadley, 2006).

The challenge of cash management is to balance the appropriate level of cash and

marketable securities that will reduce the risk of insufficient funds for operations

and opportunity cost of holding excessively high level of these resources (Filbeck,

et al, 2007). Thus, a company’s competency to synchronize cash inflows with cash

out flows, by using cash budgeting and forecasting in formulating a cash

management strategy is important.

A consideration as to how organizations manage its current asset is quite

important. Though this did not cover marketable securities such as shares,

debentures etc rather, such current assets could be receivable (debtors) and

inventories (stock). Cash is known to be the most liquid of all current assets

needed to keep the business running while at the same time it is the ultimate

output expected to be selling services or products manufactured by the firm. Cash

is (legal tender) which the firm can disburse immediately without any restrictions.

36

The term “cash” include coins, currency notes and cheque held by the firm and

balance in its bank account. Sometimes near cash items such as marketable

securities are also included in cash. This is because near cash can readily be

converted into cash.

Generally, when a firm has excess cash, it invests it in marketable securities or

other investments. This kind of investment contributes some profit to the firm.

Cash management is concerned with management of the following;

i. Cash flow in and out of the firm.

ii. Cash flow within the firm

Cash management is assumed more important than most significant and

least productive assets that a firm holds. It is significant because it is used to pay

the firm obligations.

Therefore, the main aim of cash management is to maintain adequate cash position

to keep the firm sufficiently liquid, and to use excess cash in some profitable way.

It is also important because it is difficult to predict cash flow accurately and there

is no perfect coincidence between the inflows and outflow of cash. Thus during

some period, cash outflows will exceed cash inflows because of payment for taxes,

dividend, seasonal inventory buildup. Sometime because they may be large sums

promptly.

In order to resolve the uncertainty about cash flow prediction and lack of

synchronization between cash receipts and payments, some strategies for cash

management are developed. They include:

i. Cash Planning: This is planning of cash inflow and outflow to project cash

surplus or deficit for each period of the planning period. Cash budget is

prepare for this purpose

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ii. Managing the Cash Inflow: The inflow and outflow of cash is properly

managed so as to delay the outflow of cash and for proper calculation of

cash flows.

iii. Optimal Cash Level: The firm decides about appointment level of cash

balance.

iv. Investing Idle Cash: Idle cash can be invested in marketable securities or

inform of bank deposit.

Reasons for Holding Cash

There are three major reasons for holding cash

i. Transaction Motive: Firm need cash to pay accounts payable, wages,

taxes, operating expenses, and other maturity current obligations. The

desire to hold cash to meet operating requirement is called the transaction

motive for holding cash. The amount of cash for transaction purpose is a

function of the viability of the firm’s cash flows. This cash flow is

principally affected by fluctuations in sale, the credit policies of raw

materials and the characteristics of the industry.

ii. Precautionary Motive: Cash is held under precautionary motive as a

buffer or cushion to meet unforeseen and unexpected cash requirements or

contingency. Firms with highly variable cash flow would generally have

cash reserves in excesses the need for transactions. Excess cash reserves

held to meet exceptional cash outflow requirements satisfies the

precautionary motive for holding cash reserves and thus allows the firm to

cope adequately with unexpected cash outflows. The need may however,

diminish whenever the cash flows of a business can be fairly predicted with

accuracy or where the business has the ready power to borrow to meet

contingency.

iii. Speculative Motive: This is relating to holding of cash in order to take

advantage of expected changes in security price. When interest rates are

38

expected to rise and security price to fall. The speculative motive would

suggest that the firm should wait until the rise in interest rate cease. When

interest rates are expected to fall, cash may be invested in securities; the

firm will benefit by any subsequent fall in interest rates and rise in security

prices.

There are some strategies for cash management, these include:

i. Cash disbursement should be based on plan and should be slow to avoid

shortage and production interruption.

ii. Loan negotiation and rescheduling of loan where appropriate.

iii. Accelerating collection from customers without adversely reducing future

sales and profit by requesting customers to pay promptly or through cash

discount or through a provided collection system.

iv. Idle or excess cash should be properly invested in short-term marketable

securities.

v. Prepayment should be avoided except in cases of insurance premium or

when necessary.

vi. Sound forecast for cash or short-term and long-term bases.

vii. There should be sound dividend policy

2.1.8 Cash Positioning

Whichever form of business and however volatile the cash flows, treasurers can

maximize the value of their cash holdings by more accurately identifying and

predicting positions throughout the day to enhance investment or borrowing

opportunities and therefore overall return.

Working capital expresses the liquidity of a business. A business with poor

liquidity will have difficulty in paying its everyday expenses, such as salaries and

wages, rent and telephone bills. If management refuses to constantly monitor,

39

control and manage a business's liquidity (its amount of working capital), then the

business may likely end up in a difficult situation with its creditors.

The following key points are important to working capital:

The current assets (cash, inventories/stock and accounts receivable/debtors)

in the business need to be monitored and kept at realistic levels.

Current liabilities constitute all the short-term payments that need to be met

by the business (obligations that need to be paid within one year). Short-

term loans and accounts payable are examples.

Most successful businesses keep the working capital ratio as low as

possible, and keep cash circulating, so as to maximize profit.

The size of the working capital ratio depends on the type of industry the

business operates in, and on financial arrangements such as overdrafts and

creditor policy. Ratios between 1.5:1 and 2:1 are acceptable for most

businesses.

2.1.9. Cash Flow Volatility, Earnings Volatility and Firm Value.

The theory of corporate risk management argues that shareholders are better off if

a firm maintains smooth cash flows. For instance, Froot, Scharfstein, and Stein

(1993) argued that smooth cash flows can add value by reducing a firm's reliance

on costly external finance. Empirically, Minton and Schrand (1999) showed that

cash flow volatility is costly as it affects a firm's investment policy by increasing

both the likelihood and the costs of raising external capital. One recurring theme in

this literature is that, all things being equal, firms with smoother financial

statements should be more highly valued. While previous research finds that cash

flow volatility is costly, no direct evidence exists linking financial statement

volatility to firm value. Such a link is important because, in order for risk

management to matter, smooth financials must be valued at a premium to more

40

volatile ones. Investors value firms with smooth cash flows at a premium relative

to firms with more volatile cash flows. Consistent with risk management theory,

strong evidence shows that cash flow volatility is negatively related to proxies for

firm value.

There are a number of reasons why earnings volatility may matter to the firm,

independent of cash flow volatility. For instance, prior empirical work suggests

that analysts tend to avoid covering firms with volatile earnings, as it increases the

likelihood of forecast errors Similarly, it is imperative that institutional investors

avoid companies that experience large variations in earnings. High earnings

volatility also increases the likelihood of negative earnings surprises; in response,

managers have engaged in extensive earnings smoothing. It should be noted that

earnings smoothing may likely reduce a company's perceived probability of

default and therefore a firm's borrowing costs. Goel and Thakor (2003) suggest

that a firm may smooth earnings so as to reduce the informational advantage of

informed investors over uninformed investors, and therefore protect these

investors who may need to trade for liquidity reasons. Last but not the least,

Francis, Lafond, Olsen, and Schipper (2004) find firms with greater earnings

smoothing have a lower cost of capital even after accounting for cash flow

volatility.

In fact, under certain specifications the market appears to punish firms for

undertaking smoothing behavior preferring earnings volatility mirror cash flow

volatility. These results are important and suggest Managers focus their actions on

smoothing cash flows rather than necessarily utilizing accruals to smooth earnings.

Of course, there are a number of other ways in which financial uncertainty

interacts with firm value. According to the CAPM, systematic risk should be

41

negatively related to value, since higher discount rates yield a lower value, all

things being equal.

Further, recent empirical work suggests that not only does systematic risk affect

value, but also idiosyncratic risk may be priced (Shin and Stulz, 2000). Empirical

evidence suggests that there is a negative relation between systematic risk and firm

value, as well as a negative and significant association between unsystematic risk

and firm value.

The two alternative types of risk, namely, cash flow and earnings volatility are of

primary importance since unlike financial market variables they reflect the actual

stability of the firms' financial statements and are directly affected by managerial

decisions and the firms' risk management policies.

2.1.10 Cash Budget

Cash budget is the most significant device to plan for control of cash receipt and

payment. Cash is summary statement of the firm expected cash inflows and

outflows over projected cash time period. It gives information on the timing and

magnitude of expected cash flows and cash balances over the projected period.

This information is helpful to the financial manager to determine the future cash

need of the firm, plan for financing for those need and exercise control over cash

and liquidity of the firm. In preparing a cash budget, the financial manger has to

forecast receipts and payments.

The most important source of cash receipts is sales. Developing forecast is the first

step in preparing the cash budget. All precautions are taken to forecast sales as

accurately as possible, sales can be for cash or on credit.

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Once the cash budget has been prepared and appropriate net cash flow is

established, the financial manger ensures that there does not exists a significant

deviation between projected cash flows and actual cash flows. To achieve this,

through collections and cash disbursement, this forms the objective of managing

the cash flow. One of the techniques used by companies to accelerate their cash

collections is concentration banking.

2.1.11. Management of Cash Receivables

Trade credit is known to be the most prominent force of the modern business. It is

considered as essential marketing tools, acting as a bridge for the movement of

goods through production and distribution stages to consumers. A firm grants

trade credit to protect its sales from the competitors and to attract potential

customers to buy its product at favorable terms. When a firm sells its product or

services and does not receive cash from it immediately, the firm is said to have

granted trade credit to customer. Trade credit, thus create receivables or book debt

and receivable arising from the credit had three characteristics which include

involvement of an element of risk which should be carefully analyzed.

Cash sales are totally risk less, but not credit sale, as the cash payments are yet to

be received.

2.1.12. Credit Standards

Credit standards are criteria that determine which customer will be granted credit

and to what event. First attempting to implement ideal credit standard may result

in a too stringent or too light policy that may eliminate the risk non-payment, but

also eliminate potential sales to those rejected customers who would have paid

their bill. At the other extreme, an excessively liberal policy may lead to higher

sales, but greater bad debt losses and collection cost would follow. Therefore, the

tradeoff between managerial benefit and cost dictate the balance between two

extremes.

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Nevertheless, credit standards often revolve round five C’S of credit analysis.

i. Character: Has to do with the probability that a customer will try to honor

his/her obligation. This factor is of considerable importance between every

credit transaction which implies a promise to pay. Experience credit

managers frequently insist that character, is the most important issue in a

credit evaluation.

ii. Capital: This is measured by the general financial position of the firm as

indicated by a financial ratio analysis with a special emphasis on the

tangible net worth of the enterprises.

iii. Collateral: This is represented by assets the customers offer as a pledge for

security of the credit extends.

iv. Condition: This have to do with impact of general economic trends on the

firm or special development in certain area of the economy that affect the

customers’ ability to meet the obligation.

v. Capacity: This describes a subjective judgment of the customers’ ability to

pay. It is gauged by the customers past business performance record

supplemented by physical observation of the plant.

2.1.13. Credit Extension Policy

Credit extension policies provide guide lines for granting credit, the terms of

payment and amount of credit to extend to a customer. The cost of a credit

extension policy can be grouped into the following categories:

i. Cash Discount: A percentage of sales deducted as an incentive to

encourage early payment. Early payment not only reduces capital

requirement but also saves administrative cost of pursuing outstanding

debtors and may reduce the overall risk of bad debts as well. Cash discount

are a relative expensive way of improving the inflow of cash and most

companies would prefer to avoid them by raising extra working capital at a

44

more advantageous market rate. There may sometime be an element of

price reduction in the cash discount. It is a concealed way of offering lower

price to a sector of the market, which might otherwise go to competitions

(Brockingtion; 1287:273).

ii. Bad Debt Losses: These are usually accounts that are uncollectible and

written off as a charge against sales.

iii. Credit and Collection Expenses: Administrative cost for conducting in-

house credit operations are also charge against sales.

iv. Financing Cost: The opportunity cost of capital of funds tied up in a

receivable investment.

2.1.14. Credit Collection Policy

The overall debt collection policy of the firm should be that, the administrative

cost and other cost incurred in debt collection should not exceed the benefit

received from incurring those cost. The following are some of the best method to

be adopted in a debt collection department.

i. Polite reminder: This is done when a bad debt matured but the debtor has

done nothing about it.

ii. Strongly Worded Reminder: This is usually send when the debtor is

presumed to have received the polite reminder but still remains adamant.

iii. Tele-phone Call: This is a person to person contact employed as a step on

the debtor’s collection policy when the debtor does not need polite and

strongly worded reminder.

iv. Personal Call: When all the steps enumerated above fail to produce result,

staff of the credit company should be dispatched to the debtor to personally

persuade him/her to pay.

v. Collection Agencies: Collection agencies employ almost unlimited means

of collecting their customer’s funds, so businesses do not employ it readily

for fear of losing customers goodwill.

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vi. Legal Action: This is last resort because it is costly both in terms of time

and money.

vii. Withdrawal of credit facilities: This is a situation whereby such credit

facilities are been withdrawn from the debtor’s form or possession for

default in payment.

2.1.15. Inventory (Inv) Management

Inventories are the product a company is manufacturing for sale and the

components that make up the product (Pandey, 2005). He classified the various

forms in which inventories exist in a manufacturing company as: raw materials,

work-in-progress facilitate production, while stock of finished goods is required

for smooth marketing operations (Hadley, 2006). Similarly the Oxford Dictionary

of Accounting (2005) defined inventory (stock) as the products or supplies of an

organization on hand or in transit at any point in time.

In the context of inventory management, Pandey (2005) opined that a firm is faced

with the problem of meeting two conflicting needs. First, to maintain a large size

of inventories of raw materials and work-in-progress for efficient and smooth

production and of finished goods for uninterrupted sales operations. Secondary, to

maintain a minimum investment in inventories to maximize profitability. The

objective of inventory management should be to determine and maintain optimum

level of inventory investment which should normally lie between the two danger

points of excessive and inadequate inventories.

According to Pandey (2005), the major dangers of over-investment are: the

unnecessary tie-up of the firm’s funds and loss of profit; the excessive carrying

costs (such as the costs of storage, handling, insurance, recording and inspection),

and the risk of liquidity. While the consequences of under-investment in

46

inventories are: the production hold-ups and the failure to meet delivery

commitments.

Inventory, therefore, plays an important role to determine the activities in

producing, marketing and purchasing. Since inventory determines the level of

activities in a company, managing it strategically contributes to profitability

(Filbeck, Krueger & Preece, 2007). A company’s ability to respond to demand is

largely dependent on how efficient the company manages inventories and how

committed its suppliers are to support a company’s production lines (Rafuse,

1996).

The number of days inventory are held (DINV) is used as a proxy for the

inventory policy and is calculated as (INV×365)/cost of goods sold (Dong & Su,

2010). DINV reflects the average number of days stock are held by the firm.

Longer storage days represent a greater investment in inventory for a particular

level of operations.

2.1.16. Need to Hold Inventory

There are three general reasons why inventory is held in manufacturing firms.

i. To maintain inventories to facilitate smooth sale operations.

ii. To guide against risk of unpredictable change in demand and supply forces

and factors.

iii. To take advantage of price fluctuation, which influence the decisions to

increase or reduce inventory level. Supply of raw materials may be delayed

due to such factors as transport disruption, short supply etc. Therefore, it is

necessary for a firm to maintain sufficient stock of raw materials at a given

streamline production.

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2.1.17. Inventory Control

For a given level of inventory, the affectability of inventory control affects the

flexibility of the firm, inefficient inventory control result to unbalance inventory

and rigidity. The firm may sometimes be out of stock and sometimes pile up

unnecessary stock. This makes the firm unprofitable.

Better management of inventory has the following:

i. How much of the inventory should be order

ii. When should it be ordered?

The first problem relates to the problem of determining the economy order

quantity (EOQ) and is explain with analysis of the cost of maintaining certain

level inventories. On the other hand, when to order because of uncertainties and is

a problem of determining the re-order point.

2.1.18. The Economic Order Quantity (EOQ)

The problem of how much inventory should be added when inventory is

replenished or in case of raw materials, the lot which it has to purchase on each

replenishment are called “order quantity problem” and the task of the firm is to

determine optimum or economic order quantity and to determining the optimum

carrying cost.

Carrying costs are cost incurred for holding a given level of inventory they include

opportunity cost of funds invested in inventories, Insurance, Taxes, storage cost

and cost of deterioration. The carrying cost move in direct proportion to inventory

size. The optimum inventory size is commonly referred to as economic order

quantity (EOQ). It is that order size at which annual total cost of ordering and

holding are at minimum.

Economic order quantity is calculated by using the formulae below:

EOQ = √2𝐴𝑄

𝐶

48

Where: EOQ = Economic Order Quantity

A = Total Annual Requirement

O = Ordering cost per order

C = Carrying Cost per order

2 = Constant

2.1.19. Re-Order Point

This is the inventory level at which an order should be place to replenish the

inventory. To determine the re-order point under certainty, we should know the

lead time, the average usage and the economic order quantity. The lead time is the

time normally taken in receiving delivery of inventory after the order had been

placed.

Re-order Point = Lead Time + Average Usage

It is difficult to predict usage and the lead time accurately. Demand for materials

may be different from the normal lead time. These might lead to stock-out. To

guard against stock-out safety may be maintained. There are some minimum or

buffer inventories as cushion against expected increase usage and or delay in

delivery time.

When all uncertainties are taken into consideration, it means re-order point is

determined under uncertainty which thus give the following formulae.

Re-order Point (when safety is maintained) = Lead Time x Average usage + Safety

stock.

2.1.20. Relation to Financial Management

Techniques of inventory management are very useful in determining the optimum

level of inventory and finding solution to the problem of the economic order

quantity, the re-order point and the safety stock.

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The investment of fund in an inventory is a very important aspect of financial

management therefore; the financial manager must be familiar with way to control

inventories effectively so that the allocation of capital will be done effectively.

When demand or usage of inventory is uncertain, the financial manager may try

lead time when an order is placed. The lower the average lead time, the lower the

safety stock needed and the lower the total investment.

In the case of purchases, the purchases department may look for a new vendor that

promise quicker delivery or put pressure in the case of finished goods. The

production runs may be scheduled by the production by producing smaller runs or

fast delivery. The greater the efficiency with which the firm manages its inventory,

the lower the inventory in it.

2.1.21. Payables Management

Falope and Ajilore (2009) view accounts payable (AP) as supplies whose invoices

for goods or services have been processed but have not yet been paid. While the

Oxford Dictionary of Accounting (2005) defined accounts payable, which is also

called trade creditors, as the amount owed by a business to suppliers. Accounts

payable are classed as current liabilities on the balance sheet but distinguished

from accruals and other non-trade creditors. Organizations often regard the

amount owing to creditors as a source of free credit because it has no identifiable

interest charges. It is in view of this that accounts payable are always regarded as a

major source of working capital financing for firms (Pandey, 2005). Therefore,

strong alliance between company and its suppliers will strategically improve

production lines and strengthen credit record for future expansion.

The number of days accounts payable (DAP) is used as a proxy for payment

policy. It reflects the average days it takes firms to pay their suppliers. DAP is

calculated as (AP×365)/cost of goods sold (Dong & Su, 2010).

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2.1.22. Receivables Management

Refuse (1996) view accounts receivable (AR) as customers who have not yet made

payment for goods or services, which the firm has provided. While the Oxford

Dictionary of Accounting (2005) defined accounts receivable, which is also called

trade debtors, as the amounts owing to a business from customers for invoiced

amounts. AR are classed as current assets on the balance sheet, but distinguished

from prepayments and other non trade debtors.

The objective of debtors (receivables) management is to minimize the time-lapse

between completion of sales and receipt of payments (Hadley, 2006). Profits may

be called real profits after the receivables are turned into cash (Srivastarva, 2004)

refuse (1996) posited that the management of accounts receivable is largely

influence by the credit policy and collection procedure.

He maintained that a credit policy specifies requirements to value the worthiness

of customers and a collection procedure provides guidelines to collect unpaid

invoices that will reduce delays in outstanding receivables.

The number of days accounts receivable (DAR) is used as a proxy for the

collection policy. DAR is calculated as (AR×365)/sales (Dong Su, 2010), which

represents the average number of day that the firm takes to collect payments from

its customers. The shorter the DAR, the better the quality of debtors, since a short

DAR implies prompt payments by debtors. The DAR should be compared against

the firm’s credit terms and policy to ascertain its credit and collection efficiency

(Pandey, 2005).

2.1.23. Cash Conversion Cycle (CCC) Management

Working capital are the funds which are used to operate in the short term. If

receivables are postponed, there can be delays in payments and these could be

51

suspended causing a situation of illiquidity for the firm. Therefore, aligning the

receivables management between cash, inventory and payable management is

relatively challenging and important (Richards & Langhhin, 1980). In this context,

CCC is an important tool of analysis that enables us to establish more easily why

and how the business needs more cash to operate and when and how it will be in a

position to refund the negotiated resources (Elizalde, 2003). For Dong and Su

(2010), CCC is considered as a comprehensive measure of checking the efficiency

of working capital management. In their seminar paper, Richards and Laughhin

(1980) devised this method of working capital cycle which is considered as the

period between the payments of cash to creditors (cash out-flow) and the receipt of

cash from debtors (cash in-flow). They claimed that the method is superior to

other forms of working capital analysis that rely on ratio analysis.

A business can generate losses during a number of different periods, but it cannot

go on indefinitely with poor CCC Management. The activities that are directly

related to CCC management are:

i. The determination of the effective number of days to collect receivables.

ii. Determining the inventory needs and

iii. Determining the future growth of sales.

These activities must be integrated in such a way that the period of time in which

the cash is not being used to fund the working capital is minimized (Deloof, 2003).

The three activities are carried out through the implementation of credit policy,

inventory policy and cash management policy.

The CCC is calculated by subtracting the number of days accounts payable

(accounts payable×365/cost of goods sold) from the sum of the number of days

accounts receivable (accounts receivable×365/sales) and the number of days

inventory are held (inventories ×365/cost of goods sold). CCC has been

52

interpreted as a time interval between the cash outlays that arise during the

production of output and the cash inflows that result from the sale of the output

and the collection of accounts receivable (Falope & Ajilore, 2009). Padachi (2006)

posited that CCC is either negative or positive. A positive result indicates that a

company must borrow while awaiting payments from cutomers, if it must meet up

with its due obligations. A negative result indicates the number of days a company

has to receive cash from sales before it must pay its suppliers (Harris, 2005).

However, the ultimate goal is having low CCC, if possible negative, because the

shorter the CCC, the more efficient the company in managing its cash flows and

the better a firm profitability (Padachi, 2006).

2.1.24. Measures of Profitability

According to Eljelly (2004), profitability is the ability to create an excess of

revenue over expenses in order to attract and hold investment capital.

Four useful measures of firm’s profitability are the rate of return on firm’s assets

(ROA), the rate of return on firm’s equity (ROE), operating profit margin and net

firm income. The ROA measures the return to all firm’s assets and is often used as

an overall index of profitability, and the higher the value, the more profitable the

firm. ROA is an indicator of managerial efficiency and also shows how the firm’s

management converted the institution’s assets under its control into earnings

(Falope & Ajilore, 2009).

The ROE measures the rate of return on the owners equity employed in the firm

(Pandey, 2005). ROE indicates how well the firm has used the resources of

owners.

The operating profit margin measures the returns to capital per naira of gross firm

revenue. It focuses on the per unit produced component or earned profit and the

asset turnover ratio.

53

The net income comes directly on the income statement and it is calculated by

matching firm revenue with expenses incurred to create revenue, plus the gain or

loss on the sale of firm capital assets (Gitman, 2006).

2.1.25. Liquidity

Liquidity has been defined by Eljelly (2004) as the ability to convert an asset to

cash with relative speed and without significant loss in value. Liquidity measures

the ability of the firm to meet financial obligations as they fall due, without

disrupting the normal, ongoing operations of the business (Smith, 1980).

A frequent cause of liquidity problems occurs when debt maturities are not

matched with the rate at which the business assets are converted to cash (Eljelly,

2004).

Liquidity ratios measures the firm’s ability to meet current obligations, and are,

calculated by establishing relationships between current assets and current

liabilities (Pandey, 2005).

2.1.26. Nature of Working Capital

Working capital management is centred on problems arising in attempting to

manage the current assets, the current liabilities and the interrelationship that

exists between them. As explained earlier, the term current assets refer to those

assets which business will be converting into cash within one year without

experiencing a dwindling in value and upsetting the operations of the company.

Most major current assets are cash, marketable securities, accounts receivable and

inventory.

Current liabilities are referred to those liabilities that are intended at the beginning,

payable in the ordinary course of business, within a year, out of the current assets

54

or earnings of the concern. Among the essential current liabilities are accounts

payable, bills payable, bank overdraft, and outstanding expenses. The Principal

objective of working capital management is to manage the company’s current

assets and liabilities in such a way that a satisfactory level of working capital is

maintained. It is so due to the fact that if the company cannot sustain an acceptable

level of working capital, it is certainly may lead into what is termed insolvency

and may end up into bankruptcy.

Current assets must be large as much as necessary to be able to cover its current

liabilities to guarantee a reasonable margin of safety. All of the current assets are

to be managed efficiently so as to maintain the liquidity of the company; while not

keeping too high a level of any one of them. Every of the short-term bases of

financing must be managed continuously to guarantee the possible best way usage.

Hence, the interaction between current assets and current liabilities is the main

premise of the theory of working management.

The central elements of the theory of working capital management includes its

definition, need, optimum level of current assets, the trade-off between

profitability and risk which is associated with the level of current assets and

liabilities. In addition to financing mix strategies and so on.

2.1.27. Trade-Off between Profitability and Risk

While carrying out the evaluation of a company NWC position, one important

consideration is the trade-off between profitability and risk. This is to say that the

level of NWC has a bearing on profitability and also on risk. The term profitability

employed in this framework is a measure of profits after expense. Risk is the

probability that a company will develop into technically insolvent so as not be able

to meet its obligations whenever they are due for payment The risk of becoming

technically insolvent is measured using NWC. It is assumed that the greater the

amount of NWC, the less risk prone the company is. Or, the greater the NWC, the

55

more liquid is the company and, therefore, the less likely it is to become

technically insolvent. On the contrary, lower of NWC and liquidity are connected

with rising levels of risk. The correspondence between liquidity, NWC and risk is

such that if either NWC or liquidity increases, the Company’s risk decreases

If a company is to increase its profitability, it risk must also be increased.

Similarly, if it is to decrease risk, it must decrease profitability. The tradeoff

between these variables is that in spite of how the company increases its

profitability in the course of the manipulation of working capital, the effect is a

corresponding increase of a related increase in risk as determined by the level of

NWC. The consequences of changing current assets and current liabilities on

profitability-risk trade-off are discussed first and afterwards they have been

integrated into an overall theory of working capital management.

While evaluating the profitability-risk trade-off related to the level of NWC, three

basic assumptions, which are generally true, are:

that we are dealing with a manufacturing company

that current assets are less profitable than fixed assets; and

that short-term funds are less expensive than long-term funds

2.1.28. The Efficient Management of Firm’s Working Capital

Decisions relating to working capital and short-term financing are referred to as

working capital management. It involves managing relationships between a firm’s

short-term assets and its short-term liabilities. Its goal is to ensure that a firm is

able to continue its operations and that it has sufficient cash flow to satisfy both

maturing and short-term debts, and upcoming operational expenses (Nwankwo &

Osho, 2010). Working capital decisions are reversible and based on cash flows and

profitability. Measurement of a firm’s cash flow is by the cash conversion cycle,

56

the net of days from the outlay of cash for raw materials, to receiving payments

from customers. This metric makes explicit the inter-relatedness of decisions

relating to inventories, accounts receivables and payable, and cash. This

effectively corresponds to the time the firm’s cash is tied up in operations and

unavailable for other activities (Vedavinayagan, 2007).

The profitability measure of a firm’s working capital compares the returns on

capital (ROC) which results from working capital management, with the cost of

capital, resulting from investment decisions (Barine, 2012). Firm value is

enhanced when ROC exceeds cost of capital. In combination of these criteria,

firm’s management combines policies and techniques for managing of working

capital. These policies aim to mange current assets, cash and its equivalents,

inventories, debtors, and short-term financing such that cash flows and returns are

acceptable (Akinlo, 2011). Cash management identifies the cash balance which

allows for the business to meet day-to-day expenses while reducing cash holding

costs. Inventory management identifies the level of inventory which allows for

uninterrupted production while reducing investments in raw materials and

minimizing re-ordering costs, and hence increasing cash flow (Teruel & Solano,

2007).

Debtor’s management identifies appropriate credit policy i.e. credit terms which

will attract customers, such that any impact on cash flows and the conversion

cycle will be offset by increased revenue and hence return on capital. Short-term

financing management identifies the appropriate sources of financing given the

cash conversion cycle. Though it is agreed in financial theory that inventory is

ideally financed by credit granted by the supplier, firms may need to utilize

overdraft or convert debtors to cash through factoring (Pandey, 2005).

57

Investments in customers credit in the form of accounts receivables and

inventories of goods or materials are long-term resource commitments.

Minimization of these investments relative to the level and pattern of a firm’s

operation is crucial in the total management of operating funds. The key to a

successful management of customer’s credit and inventories according to Helfert

(2003), is a clear understanding of the economies of trade-off involved in it. Credit

terms are a function of the competitive environment as well as of a careful

assessment of the nature and credit worthiness of the customers.

Involved in this is the decision on whether extended credit terms, and the resulting

rise in receivables outstanding are compensated for by the contribution from any

incremental sales gained (Mathuva, 2009). Similarly, extending normal credit to

marginal customers need to be carefully assessed in terms of risk of delayed

payments or default, compared with contribution from sales gained (Wang, 2002).

To forestall adverse effects of credit on firms operations, working capital

efficiency require constant updating of credit performance, and developing sound

criteria for credit extension. Efficiency in credit management ensures that a firm’s

is able to pay its bills on time and carry sufficient stocks (Elizalde, 2003).

Inventory management in successful firms, according to Hadley (2006), evolved

into a rigorous process of maximizing assets. This he added is made possible by

advances in information technology, leading to reduction inventory levels. Efforts

to reduce investments in inventory yielded the just-in time deliveries by suppliers

to customers and carefully rescheduled restocking triggered by instantaneous

purchase data from supplies available in the press and the internet (Barine, 2012).

In effect, these techniques have created a close relationship between major

suppliers and customers usually with electronic linkages of inventories, order,

processing and production scheduling. This allows for timely co-ordination of

58

schedules and minimization of firm’s inventories and associated investments costs

(Samiloglu & Derimirgunes, 2008).

Efficiency in working capital management requires a firm to make use of credit

terms extended to it, balancing such with favourable trade-offs for early payments

from customers with discounts. Accounts payable, a form of working capital

finance to this end should be maximally used by firms (Kulter & Dermirgunes,

2007).

Pandey (2005) suggested the exceeding of normal credit terms deliberately, as

such making the interest pay-off more favourable; cautioning of the risk of

affecting the company’s credit standing if delays beyond the credit terms granted,

become habitual. Sound management of supplier’s credit, thus requires current up-

to-date information on accounts and aging of payables to ensure proper payments

(Mona, 2012).

Firms are going concerns requiring working capital for its day-to-day operations.

Though current, their investments should be considered a long-term commitment

to ensure proper planning and commitment of resources, unless the firm is

characterized by significant seasonal or cyclical fluctuations. This central

importance of working capital to the operational efficiency has co-opted firm’s to

put much emphasis on adequate planning, co-ordination and control of its working

capital to reduce associated costs and increase revenue and profitability

(Appuhami, 2008).

Management of working capital in financing theory is possible using ratios. The

ratios used to analyze components of working capital; attempts to express the

relative effectiveness with which inventories and receivables are managed. They

aid in detecting signs of deterioration in value, or excessive accumulation of

inventories and receivables. Inventories are related to sales and cost of sales to

59

determine changes in relationship overtime. Accounts receivables are also related

to sales to determine changes overtime (Gitman, 2006). The debtors-to-credit

sales; and creditors-to-purchases ratio to establish the length of time it takes a firm

to pay its suppliers (Uyar, 2009).

The liquidity ratios, of current and acid-test, are used to determine the

responsiveness of a firm to pay for its liabilities. According to Pandey (2005), the

ideal levels of these ratios are 2:1 for current ratio, and 1:1 for acid-test ratio.

Working capital turnover ratio focuses on working capital items only, relating

sales revenue to working capital. The cash conversion cycle determines the length

of time for cash to complete the operating cycle, from time of purchase of

materials with cash to time of sales and recovery of cash. This cycle which is a

measure of firm’s liquidity, according to Richards and Laughlin (1980), indicates

the time interval for which additional short term financing might be needed to

support sales. These measures of turnover, gives an indication of how well a firm

managers particular subsets of its assets, and regular analysis ensures early

detection of signs of deterioration in value or excessive accumulation of

inventories and receivables (Barine, 2012).

2.1.29 . The Consequences of Inefficient Management of Working Capital

Firms acquire fixed assets with which it intends carrying on its business. These are

long-term and capital in nature. They require consumable inputs to yield the

desired purpose for their acquisition. The consumables are necessary for the

operation of fixed capital assets of the firm. These consumables are raw materials,

finance, labour and overheads. The combination of these for production and

service delivery, outputs finished products and services to meet customer needs

and firm sales and profit objectives. These consumable their absence causes

embarrassment to the firm (Block & Hirt, 2005).

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Illiquidity makes a firm unable to meet its cash requirements: payment for raw

materials, salaries, overheads and debts. Non-availability of raw materials will

result in a firm being unable to meet production runs, with resultant production

shut down; and inability to meet customer demand. This is more pronounced in

period of expanding sales (Barine, 2012). Insufficient cash results in delay in

payment to suppliers, lenders, labour and payment for overheads; resulting in

withdrawal of input supplies by suppliers. These affect production, cause labour

strike and turnover, absence of necessary overheads for production and operation’

and finished goods supply shortage. Insufficient finished goods to meet customer

demands cause customer disappointment, loss of their goodwill and patronage, lost

sales and profit. The non-availability of these consumables-components of

working capital results in disruption of production and disappointment of

customers (Akinlo, 2011).

Carrying out the day-to-day business of a firm is essential for achieving the

operational, sales and profit objectives of the firm. Prompt execution of production

and sales schedules is a function of prompt delivery of raw materials inputs,

provision of overheads, payment for labour services and availability of finished

goods (Pandey, 2005). The profit level of a firm is a measure of efficiency in the

use of firm resources in operation, measured as the difference between cost of

operation and sales (Howorth, 2003).

The lower the cost expended on operations in a firm, the higher will be the profit

of the firm, a measure of operational efficiency. Input materials, overheads, labour

and finished goods quality should be high and cheap to achieve production

efficiency, high patronage and profit (Singh & Pandey, 2008).

2.1.30. The Costs and Benefits of Firm’s Investments in Working Capital

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Working capital component are controllable y firms management. Empirical

studies reveal that investments in firm’s working capital have attendant costs and

benefits. Firms reduce investments in inventories of raw materials to accumulate

cash, with the risk of running out of inventories and production halt.

Reduction in money tied up in receivables, by reducing credit to customers result

in their patronizing the firm’s competitors. Cost of firm’s investment in

receivables is the interest that would have been earned if customers had paid up

quickly or interest paid on finance borrowed to acquire the current assets (Pandey,

2005). The firm also forgoes interest of investing such in marketable securities.

The cost of holding inventory is the storage cost, insurance costs, and risks of

spoilage, obsolescence and the opportunity of cost of capital (Barine, 2012). These

costs encourage firms to hold current assets to a minimum. Carrying costs

discourages large investments in inventories; and low level of inventories make it

more likely that the firm will face shortage costs. Running out of inventory will

result in inability of the firm fulfilling orders (Eljelly, 2004).

Holding little cash will require the firm selling securities to meet up its cash, and

incurring capital market trading costs. Minimization of accounts receivables,

restrict credit sales and loss of customers. These according to Brealey, Myers and

Allen (2008), suggest the need for striking a balance between the cost and benefits

of current assets thereby findings the level of current assets that minimizes the

sum of carrying costs and shortage costs.

Firms are going concerns requiring working capital for its day-to-day operation.

Though current, their investment should be considered a long-term commitment to

ensure proper planning and commitment of resources, unless the firm is

characterized by significant seasonal or cyclical fluctuations. This central

importance of working capital to the operational efficiency thus require firm’s to

62

put much emphasis on adequate planning, co-ordination and control of its working

capital to reduce associated costs and increase revenues.

2.1.31. The Nigerian Economy and Working Capital Management of Quoted

Firms in Nigeria

Nigerian firms as others the world over, utilize working capital for smooth

operation. They plan for and manage their inventories, cash, receivables and

payables, to ensure that requirements in these items are met (Barine, 2012). Raw

materials are needed for production; finished goods inventory to meet customers

demand, sales and profit objectives of firms. Cash is necessary to meet the

liquidity of Nigerian firms. Considering the low per-capital income and disposable

income of Nigerian consumers, Nigerian firms offer trade credit to customers,

creating accounts receivables (Akinlo, 2011). These firms also take advantage of

trade credit from other firms, creating accounts payables. The little working

capital available to Nigerian firms is managed by them to avoid operational

embarrassments (Akinlo, 2011).

The Nigerian economy characterized by low capacity utilization of firms,

infrastructural breakdown, unstable monetary policies, lack of local raw materials

inputs, unstable foreign exchange market, multiple taxation, low level of

disposable income and purchasing power of citizens, and high cost of finance, has

negatively impacted on the working capital situation of Nigerian firms (Barine,

2012). He stated further that liquidity situations of these firms are negative due to

the high interest charged on bank loans obtained by them to meet short-term

financial obligations, also necessitated by failed trade credit policies to customers.

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Multiple taxes by the three tiers of governments have worsened the financial

situations of Nigerian firms.

Raw materials inputs, mostly imported, are affected by unstable foreign exchange

market and monetary policies of the government. Raw materials inventory are thus

affected by inadequate foreign exchange for importation, delays in clearing at the

Nigerian port, and poor transportation network. These affect the production runs

of Nigerian firms and delivery of finished goods to customers (Jinadu, 201).

Retailers importing finished goods are also affected by these factors. Local

delivery of raw materials to firms and delivery of finished goods to customers, are

hampered by poor transport infrastructures in the country. Low level of disposable

income and purchasing power of citizens affect patronage of firm’s products. This

does not favour holding of large inventories with attendant costs. Thus firms opt

for the just-in-time system which is negatively affected by poor infrastructure.

High cost of debts ad overdraft in Nigeria limits the short-term finance of Nigerian

firms to collections on sales, hampering growth in net working capital (Nwankwo

& Osho, 2010).

These factors have negatively affected the working capital positions, planning,

management, and the operational efficiencies of Nigerian firms, exposing them to

operational embarrassments, though improvements in working capital positions of

quoted firms have been recorded since increase in capital base of bank to N25

billion (Barine, 2012).

2.20. Theoretical Framework

There have been various opinions on working capital management which has

generated some theories that are used in explaining the relationship that exist

between some guiding concepts in working capital management (Ramachandran

& Janakiramank, 2007). Beaumont & Begemann (1997), for instance, emphasized

64

that the major concepts of the working capital management are profitability and

liquidity. They pointed out that there exist a trade-off between profitability and

liquidity. Thus, the relationship between profitability and working capital helps to

understand the relationship between profitability and liquidity, the dual goals of

the working capital management (Ghosh and Maji, 2004). Although, it is viewed

by many that, the scholars who have written on this relationship have not

completely synthesized their various hunches into a theory. However, there is a

noticeable consistency in the use of few guiding concepts in working capital

management literature (Falope & Ajilore, 2009). These concepts constitutes what

is here labeled the theoretical framework, after all, a theory is a supposedly tenable

explanation about a relationship.

The relevant working capital theories identified in the literature and used for this

study are: the operating cycle theory, the cash conversion cycle theory, the

pecking order theory, agency theory and the risk-return trade off theory and are

explained as follows:

2.2.1. The Operating Cycle Theory

This theory looks explicitly at one side of working capital (that of current asset

accounts) and therefore gives income statement measures of firm’s operating

activities, that is, about production, distribution and collection (Falope & Ajilore,

2009). Receivables, for instance, are directly affected by the credit collection

policy of the firm and the frequency of converting these receivables into cash

matters in the working capital management. By granting the customers more

liberal credit policy, the profitability will be increased but at the same time

liquidly will be scarified (Smith 1980). The same analysis goes for other

components of current assets account. However, the operating cycle theory tends o

be deceptive in that it suggests that current liabilities are not important in the

course of firm’s operation (Falopre & Ajilore 2009) Our understanding of

65

accounts payable as the source of financing the firm’s activities can be assailed as

a result. The operating cycle theory therefore has a shortcoming of not including

current liabilities in its analysis.

2.2.2. The Cash Conversion Cycle (CCC) Theory

This theory integrates both sides of working capital. It infuses current liabilities in

the working capital in order to enhance analysis and to overcome the inadequacies

of the operating cycle theory. In their seminar paper, Richards & Laughlin (1980)

devised this method of working capital as part of a broader framework of analysis

known as the working capital cycle. They claimed that the method is superior to

other forms of working capital analysis that rely on ratio analysis or a

decomposition of working capital as claimed in the operating cycle theory.

Therefore CCC is the length of time between actual cash expenditures on

productive resources and actual cash receipts from the sale of products or services

(Elijelly, 2004). The cash conversation cycle has been interpreted as a time

interval between the cash outlays that arises during the production of output and

the collection of accounts receivable (Dong & Su, 2010). The cash conversion

cycle is calculated by subtracting the accounts payable deferral period from the

sum of the inventory conversation period and the accounts receivable conversion

period (Falope & Ajilore, 2009). CCC is likely to be negative as well as positive

(Padachi, 2006).

A positive result indicates the number of days a company must borrow or tie up

capital while awaiting payments. A negative result indicates the number of days a

company has received cash from sales before it must pay its suppliers. (Haris,

2005). However, the ultimate goals is having low CCC, if possible negative,

because the shorter the CCC, the more efficient the company in managing its cash

flows and the better a firm’s profitability (Padachi, 2006). This means that the firm

uses less of external financing and less of time for cash tied up in current assets.

66

2.2.3. The Pecking Order Theory

The pecking order theory takes into consideration the information asymmetry

which indicates that managers know more about the firm’s value than potential

investors (Myers & Majluf, 1984).

Jensen (1994) opined that the order is based on the consideration that resources

generated internally do not have transaction costs and the fact that issuing new

bonds tend to send positive information about the company while issues of new

stock signal negative information about the issuing company. This explainS why

more profitable companies usually prefer to hold less debts and why the less

profitable companies issue bonds to finance investment decisions in fact, the less

profitable companies also prefer issuing debts before the decision to issue new

stocks.

In support of the pecking order theory, Brealey, Myers and Allen (2008) posited

that not only managers of less profitable companies but also managers of more

profitable companies would choose a more aggressive working capital policy,

pressuring for lower level of current assets and higher level of financing through

suppliers, in order to source internally the needed funds to finance their companies

and to avoid issuing debts and equity.

2.2.4 Agency Theory

Jensen and Meckling (1976) asserts that a firm can be seen as a nexus of a set of

contracting relationships among individuals by means of which shareholders

(principal) delegate every day decisions about the firm to managers (agent) who

should use their specific knowledge and the firm’s resources to maximize

principal agent’s return. However, the interest and decisions of mangers do not

always align to the shareholders interest, resulting in agency costs or problem

(Jensen, 1994). Jensen and Meckling 91976) defined agency cost as the sum of the

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expenses in monitoring by the principal, the bonding expenditures by the agent

and the inevitable residual loss derived from the separation of ownership and

control. The cause of agency problems is the separation of ownership and control

(Jensen, 1994).

Shareholders must therefore encourage management to utilize internal funds to

their benefit. Easterbrook (1984) suggest that when managers have a substantial

part of their human capital allocated in company’s share, they tend to take

decisions to enhance the profitability of company’s survival. These decisions can

be reflected n a conservative management of working capital, reducing the risk

involved in the business operation, such as: to keep high level of inventories

beyond the process cycle needs, to offer credit terms above the product turnover,

to accept low payment terms not aligned to the market practices, and so on. These

investment decisions would be translated in excess of working capital (Jensen,

1994).

2.2.5. The Risk –Return Trade-Off Theory

This theory is concerned with how firms avoid taking additional risk unless

compensated with additional returns. Working capital decisions provide a classic

example of the risk-return nature of financial decision making. Increasing a firm’s

net working capital, current assets less current liabilities, reduces the risk of a firm

not being able to pay its bills on time. This at the same time reduces the overall

profitability of the firm. Working capital management involves the risk-return

trade-off: not taking additional risk unless compensated with additional returns

(Akinlo, 2011).

The existence of a firms according to Barine (2012), depend on the ability of its

management to manage the firm’s working capital. He stated further that working

capital management involves the process of converting investment in inventories

and accounts receivable and finally into cash for the firm to use in paying its

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operational bills. As such, working capital management he added, is thus at the

very heart of the firm’s day-to-day operating environment, and improving

corporate profitability.

2.30. Review of Empirical Studies

The study on the relationship between working capital management efficiency and

profitability has attracted great attention from both academic and financial

practitioner for many years and is still ongoing. This is evident in the number of

studies conducted in this area over the years. In fact, many previous studies have

indicated the relationship between working capital management efficiency and

profitability of firms in different firms across industries as well as in different

environments. Shin & Soenen (1998) used a sample of 58,985 firms listed in the

Unite State Stock Exchange during the period spanning from 1975-1994 in order

to investigate the relationship between CCC and the profitability of the firms.

They found a significant negative relationship between the lengths of the firm’s

CCC and its profitability. The result suggests that WCM has an important impact

on the profitability of the firms.

Deloof, (2003) in turn investigated the relationship between working capital

management and corporate profitability for a sample of 1,009 large Belgian non-

financial firms for the period 1992-1996. The result from his analysis showed that

there was a significant negative relationship between profitability that was

measure by gross operation income and cash conversion cycle as well as the

number of days accounts receivable, accounts payable and inventories. The results

suggest that managers can increase corporate profitability by reducing the number

of days account receivables and inventories while less profitable firms waited

longer to pay their bills. These results show that there is a certain level of WC that

maximizes the value of the firms.

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In the Mauritian context, Padachi (2006) analyzed the trends in working capital

management and its impact on firm’s performance using 16 manufacturing firms

in Mauritian for the period of five years spanning from 2000-2004. His study

revealed that inventory and accounts receivable periods were negatively correlated

with the profitability, indicating that managers of firms can create value by

reducing the firm’s outstanding periods of accounts receivable and inventories.

Contrary to results of similar works which shows negative relationship between

CCC and profitability, his results from CCC shows positive relationship between

CC C and profitability measured by ROA. This result indicates that resources are

blocked at different stages of supply chain, thus prolonging the operating cycle

which could lead to increase in sales and higher profits. However, this is possible

only if the benefit of keeping more inventories is greater than the cost of tied up

capital.

Lazaridis & Tryfonidis, (2006) investigated the relationship between working

capital management and corporate profitability listed companies in the Athens

Stock Exchange. A sample of 131 listed companies for the period of 2001-2004

was used to examine this relationship. The result from regression analysis

indicated that there was a statistical significant negative relationship between

profitability, measured through gross operating profit, and the cash conversion

cycle. From those results, they claimed that the managers could create value for

shareholders by handling correctly the cash conversion cycle and keeping each

difference component to an optimum level.

Raheman & Nasr, (2007) used a sample of 94 Pakistani firms listed on Karachi

Stock Exchange (KSE) for a period 6 years from 1999-2004 to study the effect of

different components of working capital management on the net operating profits.

From the result of the study, they showed that there was negative relationship

between variables of working capital management including the average collection

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period, inventory turnover in days, average payment period, cash conversion cycle

and profitability. Besides, they also indicated that size of the firm measured by

natural logarithm of sales and profitability had a positive relationship.

Ramachandran & Habjurabnab (2007) investigated the relationship between

working capital management efficiency and earnings before interest and taxes of

the paper industry in India listed on BSE. A sample of 30 listed companies for the

period of 1997-1998 to 2005-2006 was used to examine this relationship. The

result revealed that the paper industry has managed working capital satisfactorily.

The accounts payable days has a significant negative relationship with earnings

before interest and taxes (EBIT), which indicates that by deploying payment to

suppliers they improve the EBIT. They concluded that even though the paper

industry in India performs remarkably well during the period, les profitable firms,

however, wait longer to pay their bills, and pursue a decrease in cash conversion

cycle.

Singh & Pandey, (2008) had examined the working capital components and the

impact of working capital management on profitability of Hindalco Industry

Limited for the period of 1900-2007. Results of their study showed that current

ratio, liquidity ratio, receivables turnover ratio and working capital to total assets

ratio had statistically significant impact on the profitability of Hindalco Industries

Limited.

Gill, Bigger and Mathur (2010) investigated the relationship between working

capital management and profitability of 88 American manufacturing firms listed

on New York Stock Exchange for a period of 3 years (2005 to 2007). Using

weighted least square (WLS) regression analysis for data analysis, the study

revealed that cash conversion cycle and number of days inventory were positively

related to profitability whole number of days accounts receivable and number of

days accounts payable had a negative relationship with profitability.

71

Hayajneh and Yassine (2011) investiaged the relationship between working capital

management efficiency and the profitability of 53 Jordanian manufacturing firms

listed on Amman Stock Exchange for the period (2000 to 2006). The data for the

study was analyzed using simple regression analysis. The study revealed that

profitability had a significant negative relationship with number of days inventory

and number of days accounts payable while number of days accounts receivable

had a significant positive relationship with profitability.

Afza & Nazir (2009) investigated the traditional relationship between working

capital management policies and a firm’s profitability for a sample of 204 non-

financial firms listed on Karachi Stock Exchange (KSE) for the period 1998-2005.

Study found significant differences among their working capital requirements and

financing policies across different industries. Moreover, regression result found a

negative relationship between the profitability of firms and degree of

aggressiveness of working capital investment and financing policies. They

suggested that managers could create value if they adopt a conservative approach

towards working capital investment and working capital financing policies.

In Nigeria, Falope & Ajilore (2009) investigated the effect of working capital

management on profitability performance for a panel made up of a sample of 55

Nigerian quoted non-financial firms for the period of 1996-2005. They found a

negative relationship between net operating profitability and the average collection

period, inventory turnover in days, average payment period and cash conversion

cycle. They concluded that managers can create value for their shareholders if they

can manage their working capital in more efficient ways by reducing the number

of days account receivable and inventories to a reasonable minimum.

Akinlo (2011) investigated the effect of working capital on profitability of 66

firms in Nigeria for the period 1999 to 2007. Using the dynamic panel general

method of moments in analyzing the data, the study revealed that sales growth,

72

cash conversion cycle, number of days accounts receivable and number of days

inventory period had positive relationship with profitability while leverage and

number of days accounts payable had negative relationship with profitability.

Finally, Dong & Su (2010) investigated the relationship between working capital

management and profitability for a sample of 130 firms listed on Vietnam Stock

Market for the period of three years spanning from 2006-2008. Their study shows

that there is a strong negative relationship between profitability measured through

gross operating profit, and the cash conversion cycle. This means that as the cash

conversion cycle is increases, it will lead to declining of profitability of firm. They

concluded that managers can create a positive value for the shareholders by

handling adequate cash conversion cycle and keeping each different component to

an optimal level.

A survey of the empirical review presented above shows different opinions on the

Impacts of Working Capital Management on the profitability of firms in different

environments. It can also be observed from the review of empirical studies that

the few studies from Nigeria on the subject have all focused on the aggregate

study of non-financial firms across industries in Nigeria.

They did not present a sectorial approach to the study that may allow for sectorial

comparism. Lack of empirical evidence on the impact of working capital

management on the profitability of firms within a specific industry in Nigeria

coupled with lack of consensus among researchers on which of the explanatory

variables of WCM that will impact, either positively or negatively on the

profitability of firms, as shown in the empirical studies have therefore, made this

study imperative. The researcher also extends his study by making use of recent

data to permit the analysis of trend in working capital management need of firms

in Nigeria.

73

It is in view of this lack of empirical studies on the impact of WCM on the

profitability of firms in specific industry in Nigeria that the present study examine

the impact of WCM on the profitability of Nigerian manufacturing companies in

order to identify those measures of WCM that have significant impact on the

profitability of manufacturing companies in Nigeria and thereby narrowing the

existing gap in the literature on the study.

2.31. Summary of Literature Review

Management of Working Capital is important to the financial health of business of

all sizes. This is so, because the amount invested in WC is often high in proportion

to the total assets employed and it is vital that these amounts are used in an

efficient and effective way (Padachi, 2006).

This chapter therefore, presents the review of work previously done by researchers

or scholars in different industries and firms on the subject matter with study design

and research methods similar to this researcher’s work.

Most of the empirical studies support the traditional belief that there is

statistically, a significant relationship between profitability and measures of

Working Capital. They explained that a well designed and implemented WCM is

expected to contribute positively to the creation of firm’s value. Managers can

create profit by correctly handling the individual components of working capital to

an optimal level. However, divergent to traditional belief, other researchers are of

the view that more investments in WC (conservative policy) might also increase

profitability. When high inventory is maintained, it reduces the cost of

interruptions in the production process, decrease in supply cost, protection against

price fluctuation and loss of business due to scarcity of products. (Blinders and

Maccini, 1991)

74

Measures of WC such as the cash conversion cycle, inventory period, cash

management, receivables e.t.c. are as well extensively analysed in the chapter.

REFERENCES

Afza, T. and Nazir, M. (2009). “Impact of aggressive working capital management policy

on firm’s profitability”. The IUP Journal of Applied Finance, 15 (8), 20 – 30.

Akinsulire, O. (2005). Financial management. Lagos: El-Toda Ventures.

Deloof, M. (2003). “Does working capital management affect profitability of Belgium

firms”? journal of Business Finance and Accounting, 30 (3), 573-588.

Dong, H.P. and Su, J. (2010). “The relationship between working capital management

and profitability: A Vietnam Case”. International Research Journal of finance and

Economics, 49(3),62-70.

Ejelly, A.M. (2004). “Liquidity-profitability trade off: An Empirical Investigation in an

emerging market”. International Journal of Commerce and Management, 14 (2)

48-61.

Falope, O.I. and Ajilore, O.T. (2009). “Working capital management and corporate

profitability: Evidence from Panel Data Analysis of selected quoted companies in

Nigeria”. Research Journal of Business Management, 3(3)73-84.

Filbeck, G. and Krueger, T. (2005). “Industry related differences in working capital

management”. Mid-American of Business, 20(2), 11-18.

Filbeck, G., Krueger, T. and Preece, D. (2007). “CFO magazine’s working capital

surveys: Do selected firms work for shareholders”? Quarterly Journal of Business

and Economics, 46(2)3-22.

Hadley, L. (2006). “International working capital management”. The Business Review

Cambridge, 5 (1)233-239.

75

KPMG, (2005). Working capital management survey: How do European companies

manage their working capital? KPMG LLP.

Krueger, T. (2002). “An analysis of working capital management results across

industries”. Mid-American Journal of Business, 20(2), 11 – 18.

Lamberson, M. (1995). “Changes in working capital of small firms in relation to changes

in economic activity”. Journal of Business, 10(2), 45-50.

Lazaridis, I. and Tryfonidis, D. (2006). “Relationship between working capital

management and profitability of listed companies in the Athens Stock Exchange”.

Journal of Financial Management and Analysis, 19(1)26-35.

Ohikhena, P. (2006). Research methodology in the social and management sciences.

Lagos, Nigeria: Bunmico Publishers.

Oxford (2005). A dictionary of accounting, 3 ed. Oxford University Press.

Pandey, I.M. (2005). Financial management, 9 ed. New Delhi Vikas Publishing House

PVT Ltd.

Padachi, K. (2006). “Trends in working capital management and its impact on firm’s

performance: An analysis of Mauritian small manufacturing firms”. International

Review Business Research Papers, 2(1), 45-56.

Prasad, R.S. (2001). “Working capital management in the paper industry”. Finance India,

15(1),185-188.

Rahaman, A. and Nasr, M. (2007). “Working capital management and profitability: Case

of Pakistani firms”. International Review of Business Research, 3 (2)275-296.

Ramachandran, A. and Janakirma, M. (2007). “The relationship between working capital

management efficiency and earnings before interest and taxes (EBIT)”. Journal of

Managing Global Transitions, 7 (1), 61-74.

Shin, H.H. and Soenen, L. (1998). “Impact of working capital and corporate

profitability”. Journal of Finance Practice and Education, 8(2)37-45.

Smith, K. (1980). Profitability versus liquidity trade offs in working capital management,

in readings on the management of working capital. New York, St. Paul: West

Publishing Company.

76

VanHorne, J.C. (1977). “A risk-return analysi8s of a firm’s working capital position”.

Financial Economics, 2(1)71-88.

VanHorne, J.C. and Wachowiez, J.M. (2004). Fundamentals of financial management, 12

ed. New York: Prentice Hall.

77

CHAPTER THREE

METHODOLOGY

4.0 Introduction

The main objectives of this study is to ascertain the relationship between working

capital management and the corporate performance of Nigerian manufacturing

companies listed on the Nigerian stock exchange (NSE). This chapter focuses on

the following key areas; research design, population of the study, sampling

technique and sample size, sources of data collection, variables of study, data

analysis techniques, model specification an limitation of the study.

4.1 Research Design

The concept of research design refers to the specification of relevant procedures

for collecting and analyzing data, which would help solve the problem under study

(Prasad, 2001).

This study adopts an ex-post facto design and uses only secondary data from the

financial statement of manufacturing companies listed on the Nigerian stock

exchange (NSE) from 2008 to 2012. The ex-post facto design is adopted because

the variables used in this study are readily available and obtained in the audited

financial statements of the sampled manufacturing companies without being

manipulated or controlled and the variable cannot be studied experimentally but

the effect of relationship between the independent variables and the dependent

variable can be established. Similarly, the availability of these data underlines the

choice of time period to the study. Therefore, the data used for the analysis relate

to the ten sampled manufacturing companies listed on the Nigerian stock exchange

for the period of five years spanning from 2008 to 2012.

78

4.2 Population Of The Study

The population of this study is made-up of the 134 manufacturing companies

listed on the Nigerian stock exchange during the period of study and the reason for

the choice of this market is primarily due to the reliability of the financial

statements. Audited financial statements are reliable as auditors certify them.

4.3 Sampling Techniques And Sample Size

The study uses judgmental sampling techniques to select the sample based on the

following criteria:

Companies must remain listed on the Nigerian Stock Exchange (NSE)

during the 2008 – 2012 periods.

Companies must have complete financial statements for the period under

review.

Companies must be operational within the period under investigation.

Twenty (20) manufacturing firms met the criteria set out and they cut across all

sectors. Please Appendix I.

4.4 Sources of Data Collection

In obtaining the necessary information for this study, compiled data (secondary

data) were used which (Miller, 1999) described as data which has received some

forms of selection. The choice of documentary secondary data which (Imonitie,

2004) termed as archival research was informed by the nature and objectives of

the study to establish relationship that subsists between working capital

management and corporate performance of manufacturing firms in Nigeria.

Therefore, relevant documents and records which are used for the study are from

the annual audited accounts of the 20 sampled companies and are obtained from

the NSE library. Various libraries such as the University of Nigeria library are all

visited for proper information and understanding of the study.

79

Finally, relevant academic research journals for the study were accessed on the

internet, downloaded and used with due care as per the requirement of the study.

4.5 Variables Used For The Study

The choice of the variables used for the study was primarily guided by previous

empirical studies and availability of data. Thus, the variables are defined to be

consistent with those of Falope and Ajilore (2009) and Dong and Su, 2010) as well

as other empirical literature cited in section 2.3 of this study.

Therefore, the variables used in this study based on previous researches, about the

relationship between WCM and firm’s performances are as follows:

4.5.1 Dependent Variable

The dependent variable is the variable that is been predicted or projected. In this

study, the dependent variable is the firm’s performance (profitability) measured by

the return on the assets (ROA). In order to investigate the relationship between

WCM and performance of the Nigerian manufacturing companies, Return on

Assets (ROA) is used as the dependent variable.

Return on assets (ROA) is an indicator of managerial efficiency and it shows how

the firm’s management converted the institution’s assets under their control into

earnings (Pandey, 2005). ROA is defined in this study as earnings before interest

and taxes (EBIT) divided by total book value of assets (TA) (Falope and Ajilore,

2009).

80

4.5.2 Independent Variables

Independent variable also known as the predictor or explanatory is the variable

that causes the change to happen anytime it is concomitantly manipulated with the

dependent variable. This study used three independent variables namely; accounts

receivable period, inventory period and cash conversion cycle, while sales growth

is used as control variable. Accounts payable was also used as an independent

variable but was excluded because it did not fit in the model. However, it is

defined in the study to explain the calculation of cash conversion cycle. The

variables are defined as follows:

a) Accounts Receivable Period (ACRP): This is the time between sales of

inventory and collection of receivables. It measures how long an

organization collects accounts receivable after sales. It is measured in days.

It can be expressed as Accounts receivables (AR) multiply by 365, divided

by sales.

b) Inventory period (INVP): Inventory period otherwise known as day’s sales

in inventory gives us a rough idea of how long stocks or inventory remain

in the store on average, before being sold. Closely related to the inventory

period is the inventory turnover which measures physical turnover of

trading stock during the period. The higher the turnover, the higher will be

the reported profits or vice versa, Cateris paribus but the higher or longer

the INVP, the lower the reported profits or vice versa. INVP is measured in

days while inventory turnover is given in times.

The INVP is the inverse of inventory turnover ratio. It is expressed as

inventories divided by cost of sales multiplied by 365. Inventory turnover

can be expressed as cost of sales divided by inventories (Igben, 2000 and

Ross, waster field and Jordan, 2003)

81

c) Cash conversion cycle (CCC): cash conversion cycle also known as cash

cycle is a measure of the time between cash disbursement and cash

collection. It is simply the number of days that passes before collection of

cash from sales, measured from when organizations actually pay for

inventories. It can be expressed as accounts receivable period plus

inventory period less accounts payable, multiplied by 365 then divided by

cost of sales i.e

(𝐴𝐶𝑅𝑃 + 𝐼𝑁𝑉𝑃 − 𝐴𝑃)X365

𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠

This expression can be represented simply as Operating cycle less accounts

payable period. Operating cycle is the time period from inventory purchase

until the receipt of cash (i.e. inventory period plus accounts receivable period).

d) Accounts payable: accounts payable according to the Oxford Dictionary

according, the amount owed by a business to suppliers (e.g. for raw materials).

The accounts payable period (ACP) used as a proxy for the payment policy is

the time between receipt of inventory and payment for its (i.e. accounts

payables multiplied by 365, divided by cost of sales)

e) Sales growth (SG)

Sales growth may influence the WCM because managers can decide to prepare

the company to meet demand level, such as building up inventories in anticipation

of future growth (deloof, 2003). Sales growth variable is measured by (this year’s

sales (st) – previous year’s sales/previous year’s sales (Lazarids and Tryfonidis,

2006).

82

4.5.3 Table 1: Measurement of variables and Abbreviation

Variables How to measure Abbreviation Types of

variables

Return on Assets Net income/total assets ROA Dependent

Net operating cycle Average collection period

(ACP) + inventory/net sales ×

365)–accounts

payable/purchases × 365

NOC Independent

Average collection

period

Account receivable/net sales ×

365

ACP Independent

Inventory turnover

in days

Inventory/cost of goods sold ×

365

ITD Independent

Cash conversion

cycle

ACP+ITD-APP CCC Independent

Sales growth (current year N sales – last year

N. sales/last year’s N. sales

SG Control

(independent

4.6 Data Analysis Techniques

This study uses descriptive statistics which highlights measures of central

tendency and dispersion such as the mean and standard deviation. The choice of

descriptive statistic of the analysis of data in this study is as a result of its great

advantage, as it makes a mass of research material easier to read, by reducing a

large set of data into a few statistics. Andy, (2005) argues that the descriptive

statistics is a useful summary of the data. Multiple regression model was also used

as a statistical technique to analysis the relationship which subsists between

working capital management and the corporate performance of the selected

manufacturing companies

83

4.7 Model Specification

The study adopts the multiple regression model used by Falope and Ajilore,

(2009) and Dong &Su, (2010) with little modifications to suit the requirements of

the study.

The model used for the study is therefore, stated as follows;

ROA = β0+ β1(ACRPi) + β2(INVPi)+ β3(CCC)+ β4(SG)+ei

Where:

ROA = Return on Assets Calculated as EBIT/TA

EBIT = Earnings before interest and taxes

TA= Total Assets

ACRP = Account Receivable Period

INVP =Inventory Period

CCC = Cash Conversion Cycle

SG = Sales growth

ei = random error term which takes care of the effects of other factors which are

not fixed in the model, on dependent variable

β0 = Regression Constant

i = i…N refers to the number of companies

t = t… Ti refers to time period

β1, β2, β3, β4 are the regression co-efficient associated with independent variables.

WC = F (∏).

4.8 Limitation of The Study

The following limitations are inherent in the study;

i. The study is confined to five years data spanning from 2008 to 2012.

Detailed analysis covering a lengthier period which may give slightly

different results has not been made due to non-availability of data.

84

ii. This study is confined to only manufacturing companies listed on the NSE,

the accuracy of the result is therefore, purely based on the data obtained

from these companies. If more samples are taken, and manufacturing

companies not listed on the NSE were included in the sample, the results

would have been slightly different.

iii. The study is based on secondary data collected from the NSE, the study

therefore, depends purely upon the accuracy, reliability and quality of the

secondary data source. Besides, approximations and relative measures with

respect to the data source might impact the results.

iv. The multiple repression models used for this study may not have captured

all the predictors of financial performance. In other words, there may be

unmeasured variables that are affecting the relationship between working

capital management policies and the financial performance of the

manufacturing companies.

85

REFERENCES

Berenson, I. and Levine, M. (1999). Basic business statistics: Concepts and applications.

7 ed. Prentice Hall, Inc.

Dong, H.P. and Su, J. (2010). “The relationship between working capital management

and profitability: A Vietnam Case”. International Research Journal of finance and

economics, 49(3)62-70.

Falope, O.I. and Ajilore, O.T. (2009). “Working capital management and corporate

profitability: Evidence from Panel Data Analysis of selected quoted companies in

Nigeria”. Research Journal of Business Management, 3(3)73-84.

Krueger, T. (2002). “An analysis of working capital management results across

industries”. Mid-American Journal of Business, 20(2), 11 – 18.

Lazaridis, I. and Tryfonidis, D. (2006). “Relationship between working capital

management and profitability of listed companies in the Athens Stock Exchange”.

Journal of Financial Management and Analysis, 19(1)26-35.

Martin, J.D. (1991). Basic financial management, 2nd ed. New Jersey: Prentice Hall.

Ohikhena, P. (2006). Research methodology in the social and management sciences.

Lagos, Nigeria: Bunmico Publishers.

Oxford (2005). A dictionary of accounting, 3 ed. Oxford University Press.

Padachi, K. (2006). “Trends in working capital management and its impact on firm’s

performance: An analysis of Mauritian small manufacturing firms”. International

Review Business Research Papers, 2(1), 45-56.

Pandey, I.M. (2005). Financial management, 9 ed. New Delhi Vikas Publishing House

PVT Ltd.

Prasad, R.S. (2001). “Working capital management in the paper industry”. Finance India,

15(1),185-188.

86

CHAPTER FOUR

DATA PRESENTATION, ANALYSIS AND INTERPRETATION

4.0 Introduction

The main objective of this study is to examine the relationship between Working

Capital Management and the Corporate Performance of Nigerian Manufacturing

Companies quoted on the Nigerian Stock Exchange (NSE). In order to achieve this

objective, this chapter focused on data presentation, analysis and interpretation of

results based on the analytical technique (multiple regressions) adopted for the

study.

Test of research hypotheses is also carried out in this chapter in an attempt to

provide answers to the research questions stated in chapter one.

The dependent variable for the study is the firm’s profitability (measured by

Return on Assets-ROA) while the independent variables are the Accounts

Receivable period (ACRP), Inventory period (INVP) and the Cash Conversion

Cycle (CCC) while Sales Growth (SG) is used as control variable.

The data for this study has been presented with the use of tables and the

presentations made possible with the aid of statistical packages for social sciences

(SPSS) version 1.5 which uses the summarized data in appendix 2 that was

calculated using the data in appendix1.

87

4.1. Presentation and Analysis of Multiple Regression Results

Table 1: Regression results showing Data Estimate effects of WCM on ROA

Variable Coefficient T-values Sig Collinearity Statistics

(B) Stad error Tolerance VIF

Constant 0.588 0.212 2.771 0.007

ACRP -0.003 0.001 -6.995 0.000 0.775 1.291

INVP -0.001 0.000 -22.945 0.126 0.759 1.318

CCC -0.002 0.001 -1.973 0.052 0.640 1.862

SG 0.020 0.008 2.489 0.015 0.889 1.128

SOURCE: Regression Output based on the data generated from Appendix i.

a. Dependent Variable: ROA

b. Predictors: (constant), SG, ACRP, INVP and CCC

R2 = 0.775

R2 = 0.767

Sig f change = 0.020

Duration Watson = 1.708

The table above presents the results of the regression analysis on the impact of the

measures of working capital management viz: Account Receivable Period

(ACRP), Inventory Period (INVP) and Cash Conversion Cycle (CCC) respectively

on profitability of Nigerian Manufacturing Companies listed on the Nigerian Stock

Exchange (NSE). (See appendixes 1 to 2 for data used).

The estimation result shows that ACRP has a negative coefficient of -0.003,

indicating that firm’s profitability is reduced by 0.30% point by a day lengthening

of the numbers of days it takes debtor to settle their accounts. This result is

consistent with several previous empirical studies such as Deloof (2003) and

88

Falope & Ajilore (2009). This finding however, contradicts conventional

conjecture that lengthening of deadlines for clients to make their payments

provides incentives for increase sales and thus profitability (Falope & Ajilore,

2009). Thus, a more restrictive credit policy potentiality improves firm’s

profitability performance.

The estimation results also reveal a negative coefficient of -0.001 in respect of the

Inventory Period, indicating that firm’s profitability performance is decreased by

0.10% point by a day lengthening of the number of days it takes firms to sell their

inventories.

The coefficient of the CCC from the table is -0.002. This negative coefficient of

the Cash Conversion Cycle is an indication that firms that can reduce Cash

Conversion Cycle by one day will see their profitability increase with 0.20%.

This is consistent with the traditional view on Working Capital Management that

Ceteris Paribus, firms with shorter Cash Conversion Cycle have more efficient

working capital management and save costs.

Table 1 again shows that Sales Growth (SG) as a control variable has a positive

coefficient of 0.020 indicating that an increase in SG by one will increase ROA by

2.1%.

4.2. Data Validity Test

In order to ensure that the results are robust, some diagnostic tests were performed

on the data. In an attempt to detect Multicollinearity, Variance Inflation Factor

Statistics (VIF) and Tolerance Level statistics (TOL) were computed as shown in

table (1) above and are used in this study to explain the absence or otherwise of

Multicollinearity problem. (Multicollinearity refers to a situation in which two or

more explanatory variables in a multiple regression model are highly linearly

89

related). Usually, a tolerance level (TOL) of less than 0.20 or 0.10 and or a

variance inflation factor (VIF) of 5 or 10 and above indicate a strong linear

relationship of an independent variable. With other independent variables used in

the regression analysis thereby introducing the problem of multicollinearity

(Gujarati and Sangeetha, 2007). The VIF of all the independent variables as shown

in table (1) above consistently fall below 10 (rule of thumb), indicating complete

absence of Multicollinearity among the variables. This shows the fitting of the

study model with the four independent variables. Table 1 also reveal tolerance

coefficients that are greater than 0.4 for all the variables. This further substantiates

the absence of mulitcollinearity among the independent variables included in the

study model (Gill, Biger & Mathur, 2010). Therefore, the two diagnostic measures

for testing multicollinearity indicates absence of multicollinearity problem among

the independent variables used in this study.

4.3. Summary of Regression Results

Table 2: Summary of Regression Results for the Study Model

R R2 Adjusted

R2

Stad error

of the

estimate

Change statistics Durbin

Watson

R2

change

F.

change

Df Df2 Sig. f.

change

0.8411 0.775 0.767 0.0822 0.775 14.766 4 27 0.020 1.708

a. Predictors: (constant), SG, ACRP, INVP and CCC

b. Dependent Variables: ROA

SOURCE: Regression Output based on data generated from Appendix ii.

90

The summary of regression results is shown in table 2 above for the study model.

In the table, ROA was regressed against three independent variables; Account

Receivable Period (ACRP), Inventory Period (INVP), Cash Conversion Cycle

(CCC) and one control variable; Sales Growth (SG). The regression result shows a

significant F. change of 0.020 indicating the fitness of the model. (The F. test is

used for testing the overall significance of the regression and is normally

compared with the theoretical F (table). The results also produced a coefficient of

determination (R2) of 77.5% which was sufficiently high indicating that the

independent variables in the model account for 77.5% in the variability of

profitability (measured by ROA) of the sampled manufacturing companies in

Nigeria for the study period. The remaining 22.5% of the variation in profitability

of the Nigerian manufacturing firms is explained by factors not captured in the

study model. (The coefficient of determination denoted usually by R2 indicates

how well data points fit a statistical model, it is a statistic that will give some

information about the goodness of fit of a model. It is usually between 0 and 1

with 0 denoting that the model does not explain any variation and 1 denoting that

it perfectly explained the observed variation. Similarly, Durbin Watson statistics

(DW) of 1.708 also indicates the absence of auto correlation for all the variables.

(Durbin Watson test is a popular test to detect autocorrelation, named after the

developers, statisticians Durbin and Watson (1951). It has been established that

once DW = 2, then there is no problem of autocorrelation). Therefore, with the

results of the regression coefficients revealed in table 2, an ideal model values for

the relationship between WCM and Profitability of the Nigerian manufacturing

companies can be states thus:

𝑅𝑂𝐴 = 0.583 + (−0.003𝐴𝐶𝑅𝑅) + (−0.001𝐼𝑁𝑉𝑃) + (−0.002𝐶𝐶𝐶) + (0.20𝑆𝐺) + 𝑒

4.4. Testing of Research Hypothesis

To test the hypothesis as formulated in section 1.5 of this study, calculated t-

values shown in Table 1 of the study are compared with critical-value using the

91

student t-statistics. The level of significance for the study is 5% for a two-tailed

test and the critical value is t±1.96.

The Decision Rule:

i. If the calculated t-value, (as shown in table 1) is greater than the critical

value, reject null hypothesis.

ii. If the calculated t-value (as shown in table 1), is less than the critical value,

then accept the null hypothesis

The tests are carried out as follows:

HO1: There is no significant relationship between the accounts receivable

periods (ACRP) and profitability of the Nigerian manufacturing companies.

Since the calculated t-values (-6.996) associated with the (ACRP) as shown in

table 1 is greater than the critical value of 1.96, the null hypothesis is rejected

leading to the conclusion that there is a significant relationship between the

Accounts Receivable Period and Profitability (measured by ROA) of the Nigerian

manufacturing companies.

HO2: There is no significant relationship between the Inventory Period (INVP)

and Profitability of the Nigerian manufacturing companies.

By comparing the calculated t-value of (-22.945) as shown in table 1 with the

critical t-value of ±1.96, it can be seen that the calculated t-value (22.945) is

greater than ±1.96 which leads to the rejection of the null hypothesis and the

conclusion that there is significant relationship between the inventory period

(INVP) and profitability using ROA of the Nigerian manufacturing industry.

HO3: There is no significant relationship between Cash Conversion Cycle and

Profitability of the Nigerian manufacturing companies.

92

The calculated t-value of (-1.973) associated with CCC as shown in table 1 is

greater than critical t-value of ±1.96, on the basis of this, the null hypothesis is

rejected leading to the conclusion that there is indeed a significant relationship

between Cash Conversion Cycle and Profitability (measured by ROA) of the

Nigerian manufacturing companies listed on the Nigerian Stock Exchange.

4.5. Interpretation of Results

4.5.1. The Impact of ACRP on Profitability

The result of the regression analysis indicates that Accounts Receivable Period

(ACRP) has a significant negative relationship with the Profitability (measured by

ROA) of the sampled Nigerian manufacturing companies for the study period. A

negative relation is consistent with the traditional view and implies that more

profitable firms have a shorter accounts receivable cycle. Firms with lower

accounts receivable have more efficient credit management enabling them to

collect sales faster, free up cash and increase profitability.

Furthermore, the negative relation between ACRP and the profitability of these

sampled companies also implies that their profitability will be impacted negatively

if the number of days it takes debtors to settle their accounts is increased and vice-

versa. The negative relationship for the present study is consistent with the

previous empirical studies such as Petersen and Rajan, (1997) who also found a

significant negative relationship between Profitability and ACRP.

4.5.2. The Impact of Inventory Period (INVP) on Profitability

The result of regression analysis revealed that INVP has a significant negative

relationship with the profitability (proxy by ROA) of the sampled Nigerian

manufacturing companies during the study period. This implies that when

inventors stay longer in stores before they are sold, it leads to tie down of cash and

increase in costs of storage, insurance, spoilage and obsolescence. These costs

93

impacts negatively on the profitability of manufacturing companies in Nigeria.

The negative relationship between profitability and INVP is consistent with the

previous empirical findings of Shin and Soenen (1998), Deloof (2003), Padachi

(2006), Shah and Sana (2006), Rahaman and Nasr (2007), Falope and Ajijore

(2009), Dong and Su (2010) and Hayajneh and Yassine (2011) who also found a

negative relationship between INVP and profitability. The present finding

however, contradicts the findings of Gill, Biger and Mathur (2010), and Akinlo

(2011) who found INVP to be positively related to profitability.

4.5.3. The Impact of Cash Conversion Cycle (CCC) on Profitability

The result of the regression analysis indicates that the Cash Conversion Cycle

(CCC) has a significant negative relationship with profitability (measured by

ROA) (a comprehensive measure of working capital management). This is

consistent with the view that decreasing the CCC will generate more profits for the

company.

It also implies that manufacturing companies can create value for their

shareholders by keeping the CCC minimum. The finding from this study is

consistent with the previous empirical findings of Shin and Soenen (1998), Deloof

(2003), Lazaridis and Tryfornidis (2006), Rahaman and Nasr (2007), Falope and

Ajilore (2009), and Dong and Su (2010) who fund a negative relationship between

CCC and Profitability. This negative relation between CCC and Profitability

however contradicts the findings of Padachi (2006), Ramaehandran and

Janakiramen (2007), Gill, Biger and Mathur (2010), and Akinlo (2011) who found

significant positive relation between CCC and Profitability of firms.

4.5.4. The Impact of Sales Growth (SG) on Profitability

The result of the regression analysis indicates a significant positive relationship

between Profitability (measured by ROA) and the control variable, Sales Growth

94

(SG). Sales Growth is included in the model to see the impact of growth on the

performance of Nigerian manufacturing firms. It indicates a firm’s business

opportunities. The findings imply that the growth in sales of Nigerian

manufacturing firms increased their performances. The positive association

between sales growth and ROA is consistent with the findings of Shin and Soenen

(1998) and Deloof (2003) who concluded that sales growth had a positive relation

to changes in accounting measure of Profitability.

95

CHAPTER FIVE

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS

5.1. Introduction

This chapter presents: summary of the study findings, conclusions and possible

policy implications of the results, recommendations of the study as well as areas of

further research.

5.2. Summary

This study examined the Impact of Working Capital Management on the

Profitability of Nigerian manufacturing companies quoted on the Nigerian Stock

Exchange (NSE) for the period of five years spanning from 2008-2012. The

specific objectives of the study were to examine the relationship between the

various measures of WCM, which includes the Account Receivable Period

(ACRP), the Inventory Period (INVP) and the Cash Conversion Cycle (CCC) on

the profitability of the Nigerian manufacturing concern. To achieve these

objectives, Ex-post Facto research design was adopted for the study after the

previous relevant empirical literatures on the Impact of Working Capital

Management on Profitability of manufacturing firms were reviewed. The choice of

Ex-post Facto research design was because the explanatory factors (independent

variables) have existed in the data without being manipulated or controlled and the

study is out to see their effects on the dependent variable.

The data collected for the study were obtained through the secondary source. The

study used five (5) variables with their choice being primarily guided by previous

empirical studies. For the dependent variable, firm’s profitability was measured by

using the returns on assets (ROA) and with regards to the independents variables,

Working Capital Management was measured by using ACRP, INVP and CCC

while Sales Growth was used as a control variable in the model.

96

The data presentation was facilitated by the use of tables and regression results to

analyze the relevant data that were extracted from the annual financial report of

the sampled manufacturing companies, for the period 2008 to 2012. This data

analysis was done with a view to ascertaining the relationship between the

measures of WCM and profitability of manufacturing firms in Nigeria. The

student t-test was used to test the study hypotheses at 5% level of significance.

The regression results table reveals that by using any of the independent variables

and holding others constant, ACRP, INVP, CCC will affect ROA negatively by

0.3%, 0.1% and 0.2% respectively while the sales growth used as a control

variable has a positive coefficient of 2.1%. The result for VIF reveals that there is

no problem of multi-collinearity among the independent variables. The result also

reveals an R2 of 77.5% indicating that 77.5% of variations of ROA is accountable

by ACRP, INVP, CCC and SG while only 22.5% is attributable to other factors

outside this study. The Durbin Watson statistics of 1.708 indicates the absence of

auto correlation for all the variables. The sig. F. change of 0.028 indicates the

fitness of the model.

A summary of the findings from the study analysis and test are:

a. The profitability of Nigerian manufacturing companies is significantly

influenced by the number of days account receivable are outstanding

(Account Receivable Period).

b. The profitability of Nigerian manufacturing companies is significantly

influenced by the number of days inventory is held in store (Inventory

Period) (INVP).

c. The profitability of Nigerian manufacturing companies is significantly

influenced by the Cash Conversion Cycle (CCC).

d. The profitability of Nigerian manufacturing companies is significantly

influenced by Sales Growth (SG).

97

The above results are consistent with the empirical findings of Petersen and Rajan

(1997), Deloof (2003), Shin and Soenen (1998), Padachi (2006), Rahaman and

Nasr (2007), and Falope and Ajilore, (2009).

The findings therefore, confirm that there is a significant relationship between

measures of working capital management and Profitability of the Nigerian

manufacturing companies in line with the previous studies. This means that

Nigerian firms should ensure adequate management of working capital

management measures especially the CCC, INVP and ACRP as efficient working

capital management is expected to contribute positively to firm’s performance.

5.3. Conclusions

The contribution of manufacturing sector to the economic growth of Nigerian

cannot be overemphasized. To this end, the main objectives of the study are to

empirically analyze the Impact of Working Capital Management on Profitability

Performance of manufacturing firms quoted on the Nigerian Stock Exchange

(NSE). The results show that for overall manufacturing sector, working capital

management has a significant impact on profitability of the firms and plays a key

role in value creation for shareholders. Longer cash conversion cycle have

negative impact on net operation profitability of a firm. The Cash Conversion

Cycle offer easy and useful way to check working capital management efficiency.

For value creation of shareholders, firms must therefore, try to keep these numbers

of days to minimum level. There also exists negative association between the

number of days inventory are held (Inventory Period) and profitability for

manufacturing firms under study which implies that keeping lesser inventories will

increase profitability, while Sale Growth which serves as an indicator of firm’s

business opportunities was found to have a positive association with profitability.

The Sales Growth is a very important factor which allows firm to enjoy more

profit.

98

Form the foregoing; it is therefore imperative for managers of Nigerian

manufacturing firms to design and implement strategies and policies that will aim

at stabilizing and managing the various components of working capital.

5.3.1 Policy Implication

Several policy implications can be drawn from the above findings of the study

which include that working capital management should be the concern of all the

manufacturing sector firms and need to be given due importance. In addition, the

collection and payment policies of the firms in manufacturing sectors in general

need to be thoroughly reviewed. It is generally argued that firms need to accelerate

their cash collections and slow down their payments. This can however, only be

possible with some professional advice and supervision.

5.4. Recommendations

The results of this study suggests that by reducing the number of days inventory

are held (inventory period) as well as the cash conversion cycle to a reasonable

minimum, Managers of Manufacturing firms in Nigeria can enhance profit

performance of their firms. The study therefore recommends that managers should

pay more attention to the proper inventory management. This may be achieved by

setting certain standard that will help to maintain inventory at optimal level.

Findings from the study further suggested that efficient management and financing

of Working Capital (Current assets and current Liabilities) will not only increase

the operating profitability of the manufacturing firms in Nigeria but also maximize

returns to shareholders’ investment. It is therefore recommended that specialized

person in the field of finance should be hired by these firms for expert advice.

Finally, the study recommends that the account payable which is regarded as a

major source of working capital financing for firms should be repositioned in

order to reduce the Cash Conversion Cycle further. This will improve their

99

liquidity position and also reduce their over-dependence on high interest loans for

financing of the day-to-day operations. Managers of these companies can achieve

this by re-negotiating with their regular and important suppliers for further

increase in the number of days account payable are due for payment (Pandey,

2005).

5.5. Suggestions for Further Research

This study examined the Impact of Working Capital Management on Profitability

Performance of Nigeria manufacturing Companies quoted on the Nigerian Stock

Exchange (NSE) for the period 2008 – 2012. Further research could be conducted

to include companies not quoted on the Nigerian Stock Exchange in order to have

an in-depth assessment of the impact of WCM on the Profitability of

manufacturing companies in Nigeria. In addition, an exploratory study could also

be carried out on how global best practices in working capital management can be

implemented in Nigerian manufacturing firms.

100

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103

APPENDIX I

DATA FROM THE ANNUAL FINANCIAL REPORTS OF THE SAMPLED

MANUFACTURING COMPANIES IN NIGRIA FOR ANALYSIS

Manufacturin

g

Company

Study

year

Inventory

(INV)

N,000

Cost of

Sales

(COGS)

N,000

Sales

N,000

Trade

Debtors

(AR)

N,000

Trade

Creditors

(AP)

N,000

Ebit

N,000

Net Assets

(NA) N,000

Short

term loan

(STL)

N,000

Long-term

loan (LTL)

N,000

BERGER

PAINT (NIG)

PLC

2008 416679 1267949 2139252 307330 19695 313967 1214395 5720 162365

2009 307504 1396432 2379786 206332 164786 322896 2281236 8000 203256

2010 543321 1532123 2756565 2070615 150223 519895 2605441 3788 137443

2011 575221 1605223 2574443 107333 249456 369256 2675000 6455 207785

2012 537899 1536566 2513675 110887 313110 284456 2906561 6678 237676

CADBURY

NIG PLC

2008 3512456 1897002 2467656 1207546 14127651 1278961 22016782 199876 207785

2009 3027786 19159891 25585561 1407455 1702676 -2379342 25246891 261444 3669673

2011 26767722 221951443 34110457 3470457 2111443 50825666 33711111 1500000 3192000

2012 3576133 22453000 33550000 3780543 1923129 55105677 36466771 176573 54331132

104

WAPCO NIG

PLC

2008 8571757 23323115 38664793 17179657 157488127 11665291 34847805 4712880 221332134

2009 10083280 26606616 43273809 18587114 18099375 12708896 43669041 7112544 32324200

2010 12517380 32089034 45589698 185277 2521613 9237328 87163067 2331677 24793394

2011 9728455 30535332 43841256 569566 2113675 8464354 100715789 14114577 12230066

2012 10315896 42898332 62502255 688455 5330675 10219222 127904677 5551100 49707679

CEMENT

COMPANY

OF

NORTHERN

NIG. PLC

2008 3015829 5759223 8042946 645045 2182673 559986 9118564 533175 478812

2009 2913756 5923443 9123736 683013 232298113 311465 93274566 600245 633333

2010 3158565 6704378 11868787 712673 2567899 2317265 9804232 670875 506667

2011 4723467 7629098 13915005 589154 2217197 3294043 11323086 401898 223450

AFRICAN

PAINTS NIG.

PLC

2007 7.7 234.0 50.9 1.5 35.1 -31.1 377.7 117.6 113555

2009 6.0 43.0 52.0 3.76 34.0 -14.0 357.0 116.0 345421

2010 4.0 54.0 59.0 5.0 34.0 -50.0 348.0 154.0 89665

2011 65.11 34.0 23.0 3234.09 12.07 28.0 545.05 22131 1132556

2012 32477.9 119035.9 298454.1 3407.5 26502.9 135647.6 673666.2 1777.2 112462.5

NIGERIAN

GERMANY

CHEMICALS

PLC

2008 851150 1477785 263089 418711 129672 194044 336767 615651 464223

2009 942224 1456000 2845010 461801 155255 411500 4901560 1686782 622342

2010 879825 1523632 2765020 396821 146534 400324 5817175 182301 2543206

2011 784880 1779610 2967210 293000 336781 -360788 7460015 1580311 539150

2012 721331 1962001 324000 534455 466782 383455 8375630 257000 43210

ASHAKA

CEMENT

PLC.

2008 4220235 10867691 16473955 385826 1151489 2514625 22259692 16907 16907

2009 4706692 14039116 21376197 139355 1920957 3430941 24995945 17705 17705

2010 4707390 11770820 171940 876188 2296110 2365181 256185 256513 282816

2011 5330.0 11916 19153.0 35200 1786000 4388000 28124101 200123 1019210

2012 4930898 87937880 16771564 152259 8886843 4951464 18474436 15996 31992

DANGOTE 2008 2041932 3016814 3473439 995121 3826877 1870302 9607188 11081692 341006

105

CEMENT

PLC.

2009 1219265 8252101 16453711 209333 5014473 4733990 137513395 6088178 41006

2010 13374.1 105872.4 189621.0 6825.7 4715.0 63775.9 291779.3 3759.3 49619.8

2011 14404.0 8138.0 202565.7 11378.2 3834.4 100051.5 398699.6 528.9 98251.14

2012 14350.5 98026.4 241406.0 7242.7 17529.2 113719.6 526483.4 5034.9 116766.4

DANGOTE

FLOUR

MILLS PLC.

2008 8703565 32734114 45823222 6934121 4008178 2670455 59687355 19020145

5

876500

2009 9910456 38288111 47927334 7410143 4387380 3167566 61897278 20111551 2110056

2010 8248897 48561000 61388115 9402898 6408275 5374118 6388244713 868258 2050065

2011 8257456 54398332 67601005 11643789 10875567 4911995 696107 1449045

5

1980022

2012 12021879 56582444 66281332 8597457 4701566 396677 83453.6 2968647

7

21840755

FLOUR

MILLS

INDUSTRIAL

PLC.

2008 2073960

0

156993.0 180068.2 5347.6 1002.21 3595444 137520.4 18396.6 27240.3

2009 31310.2 160541.6 206608.0 6355.3 8637.8 24439.5 143520.2 17613.9 28220.8

2010 46634.4 198611.6 238796.9 8623.7 7637.4 16445.4 163261.9 9855.6 45919.2

2011 50565.4 218702.4 258268.3 8173.5 8668.2 12048.8 232857.4 33643.1 62562.9

2012 32477.9 119035.9 298454.1 3407.5 26502.9 135647.6 673666.2 1777.2 112462.5

NESTLE NIG.

PLC.

2008 5225829 27805162 44027325 777722 2394634 8463788 21252320 8236796 66779003

2009 6415165 31300680 51742302 3118863 3001440 11862213 29159522 11093617 9034695

2010 10697567 39956771 68317303 1951039 3123137 13783244 44250372 1901096

0

14695469

2011 8494039 43877896 80108730 8410169 4085379 18244454 60347062 3398377 7904762

2012 9902238 57168571 97961260 8585072 7543859 185396669 76945793 6780417 8372414

VITAL

FOAM PLC.

2008 1585119 4473236 6149520 275151 542530 652284 1401588 552293 64911

2009 2088337 5774289 8172005 350262 583686 1013719 1895134 400716 278599

2010 2280.2 6853.2 9758.5 335.2 808.8 780.9 5436.0 859.3 132.9

106

2011 2182.5 7460.6 10624.5 755.4 798.6 823.3 6109.5 1162.3 22.8

2012 4341.3 10166.5 14520.8 290.9 1772.9 823.6 9292.8 2888.4 300.0

HONEYWEL

L FLOUR

MILLS PLC.

2008 2876.9 25935.1 2967.0 987.4 799.8 568.4 23896.0 2978.0 3721.1

2009 3925.8 27353.0 2838.0 1298.0 899.1 687.2 24533.0 3219.0 2466.2

2010 3847.6 26084.8 33528.0 659.8 808.2 2330.3 30007.7 8072.9 2377.1

2011 3808.9 26933.4 34057.6 684.8 953.7 3515.8 29137.6 5942.9 1358.6

2012 5013.6 31502.0 38071.5 603.2 1021.9 3663.1 44940.1 15511.4 6243.8

NIG

BREWERIES

2008 16156788 111748 52558213 7585753 14648032 27876336 43183042 32229181 17946249

2009 20741461 145462 74561945 3849950 21893752 3751914 32229181 14109681 25862961

2010 22064847 164207 62858805 3589438 21153415 23204399 46570094 18099291 42318498

2011 21231097 185863 98694860 6445450 21353133 44880248 50172162 5435600 32983271

2012 24056210 226229 117161711 10977150 26650728 57118042 78436237 300000

00

9000000

GLAXOSMI

TH

CONSUMER

PLC

2008 2541814 5852019 9915400 788670 3361510 1174290 4029992 7660021 3849950

2009 2538985 6959647 12545129 1885545 2905457 1852250 4764841 3434320 3589438

2010 3465440 8278264 14952445 1616061 3863623 2471096 5772938 52260116 6445450

2011 4361915 9270835 16863533 1838385 4576644 2935285 7385195 2904522 1272898

2012 4657354 12314048 21525803 2488055 6610469 3501119 8911598 2320487 185863

DANGOTE

SUGAR

2008 4097643 48184147 80649442 5435011 6541013 30660730 25956151 117167110 4473236

2009 9257767 49789909 80671383 5402003 8999918 30151378 32627198 7563588 652284

2010 14094044 61635551 82395712 5946265 14003672 19586932 41612797 3400132 6934121

2011 15960357 71946668 89980499 5958702 9794006 16146930 40895037 9766501 652284

2012 23934307 92777191 106510507 6989416 16724256 10553872 39491515 8909291 17490412

GUINESS 2008 1272898 34144021 62265413 6662196 15745338 14884450 31638842 802465 3500000

107

NIG. PLC. 2009 12867442 35611016 69172852 6528920 15368671 17092950 36862557 3705076 7886414

2010 16847699 46509596 89148207 9104844 17957642 18991762 31524701 6897234 8093952

2011 16152706 61672051 109366975 16152706 23628073 19988735 47748499 2675541 765990

2012 17433924 68619520 123663125 17433924 26342948 26176966 55639184 2114564 511005

UNILEVER

NIG. PLC.

2008 5083483 22557945 33990848 5066930 8215777 2013148 5030844 4035570 747248

2009 4632184 24360549 37377492 7097871 10177373 4144849 6681553 2615000 3013504

2010 4927265 27092437 44481277 6798481 9135337 5661052 3202734 1500000 3074336

2011 6286744 29361666 46807860 5231304 11678176 6151855 8335227 730809 3204941

2012 7706348 34723123 54724749 5611356 16068411 7983312 9664678 5445631 9767564

PZ

CUSSIONS

PLC.

2008 17490412 45710321 54216824 5811728 772752 2976585 28098218 963210 196836

2009 16618499 54266049 65945174 6928488 721453 4553426 29036715 1540678 2454067

2010 15079505 6824644 80974071 6489272 503852 4375703 30073307 7739 2770216

2011 11925600 50139515 62667910 8091245 1194677 6599905 13073027 1278003 3776581

2012 11978715 54129454 65877984 8865618 176592 4766551 17224610 4556730 6575540

108

APPENDIX II

SUMMARY OF COMPUTED ACRP, INVP, AP, CCC, SG AND ROA

Year ACRP=AR×365

SALES

INVP=INVP×365

COGS

AP=AP×365

COGS

CCC=( ACRP+

INVP)-DAP

SG=(Cur.Yr.S-

Lst.Yr.S)

Last.Yr.Sales

ROA=EBIT

NA

BERGER NIG. PLC.

2008 52.44 119.95 5.67 166.72 0.74 0.26

2009 31.65 80.38 43.07 91.23 0.83 0.14

2010 74.17 129.44 35.79 267 0.14 0.20

2011 15.22 130.80 56.72 98.48 0.03 0.14

2012 16.10 127.77 74.38 79.74 0.09 0.10

CADBURY NIG. PLC

2008 78.61 175.83 218.29 181.0 -0.11 0.06

2009 20.08 57.68 32.44 52.06 0.15 -0.09

2010 37.14 44.02 3.47 46.25 10.44 1.51

2011 37.14 58.13 31.26 88.33 0.38 1.51

2012 36.04 60.98 69.07 152.00 0.08 -0.05

WAPCO NIG. PLC.

2008 162.18 134.15 264.64 -261.64 -0.15 0.33

2009 156.78 138.33 248.29 145.02 0.25 0.29

2010 1.48 142.38 28.68 115.81 1 0.11

2011 4.74 116.29 25.27 97.83 -0.16 0.08

2012 4.02 87.77 45.36 48.27 0.27 0.08

109

7UP BOTTLING CO. PLC.

2008 2.40 191.13 138.33 93.68 -0.24 0.06

2009 2.35 179.54 214.11 -292.48 0.1 0.00

2010 0.21 171.96 139.80 70.96 0.05 0.24

2011 15.45 225.99 106.08 148.09 0.2 0.29

2012 4.17 99.59 8.27 28.77 0.1 1.00

CCNN PLC.

2008 10.76 12.01 54.75 -40.40 -0.12 -0.08

2009 26.39 50.93 288.60 -205.76 0.12 -0.04

2010 30.93 27.04 229.81 -168.98 -0.99 -0.14

2011 3.31 98.98 129.58 188.31 -108.78 0.05

2012 4.17 99.59 81.27 28.77 -0.34 0.20

AFRICAN PAINTS NIG. PLC

2008 280.90 210.23 32.03 181.62 -0.14 0.58

2009 59.25 136.20 38.92 113.05 0.22 0.08

2010 52.38 210.77 35.10 170.73 -1 0.07

2011 36.04 160.98 69.07 152.00 0.37 -0.05

2012 62.09 134.19 86.84 146.78 0.32 0.05

CGN PLC.

2008 8.55 141.74 38.67 116.02 -0.28 0.11

2009 2.38 122.37 49.94 76.05 0.74 0.14

2010 260.00 145.97 71.20 101.94 -0.88 9.23

2011 270.81 63.6 207.12 165.64 -0.14 0.16

2012 3.31 20.47 36.89 -15.79 -0.03 0.27

ASHAKA CEMENT PLC.

2008 104.57 247.05 263.01 -95.56 -0.09 0.19

2009 4.64 53.93 221.80 -158.61 0.11 0.03

110

2010 13.14 46.11 16.26 53.38 -0.15 0.22

2011 20.50 246.04 171.98 284.39 10.44 0.25

2012 10.95 53.43 65.27 15.13 -0.88 0.22

DANGOTE CEMENT PLC.

2008 55.23 97.05 44.69 129.67 -0.08 0.04

2009 56.43 94.48 41.82 123.29 0.15 0.05

2010 55.91 62.00 48.17 84.51 0.25 0.00

2011 62.87 55.41 72.97 60.56 1 7.06

2012 47.34 77.55 30.33 102.68 -0.16 4.75

DANGOTE FLOURMILLS PLC.

2008 10.84 218.42 2.33 228.52 -0.27 26.14

2009 11.23 71.19 19.64 66.00 0.24 0.17

2010 13.18 85.70 14.04 87.52 0.1 0.10

2011 11.55 84.39 14.47 83.56 0.05 0.05

2012 4.17 99.59 81.27 28.77 0.2 0.20

FLOURMILLS INDUSTRIAL PLC.

2008 6.45 68.60 31.43 47.37 -0.1 0.40

2009 22.00 74.81 35.00 76.18 0.12 0.41

2010 10.42 97.72 28.53 87.01 0.12 0.31

2011 38.32 70.66 33.98 106.63 -0.99 0.30

2012 31.99 63.22 48.16 69.87 108.78 2.41

NESTLE NIG. PLC.

2008 16.33 129.34 44.27 107.52 -0.34 0.47

2009 15.64 132.01 36.90 117.25 0.14 0.53

111

2010 12.54 121.44 43.08 96.22 0.22 0.14

2011 25.95 106.78 39.07 104.66 -1 0.13

2012 7.31 155.86 63.65 102.66 0.37 0.09

VITAL FOAM PLC.

2008 121.47 40.49 11.26 43.13 -0.32 0.02

2009 166.94 52.39 12.00 57.71 -0.28 0.03

2010 7.18 53.84 11.31 51.76 -0.23 0.08

2011 7.34 51.62 12.92 47.97 0.04 0.12

2012 5.78 58.09 11.84 53.24 102.21 0.08

NIG. BREWERIES

2008 29.03 158.54 209.66 -1.94 -1 0.29

2009 54.86 133.16 152.38 79.67 -0.88 0.39

2010 39.45 152.80 170.35 53.70 0.21 0.43

2011 39.79 171.73 180.19 63.92 0.04 0.40

2012 42.19 138.05 195.94 15.86 0.14 0.39

GLAXOSMITH CONSUMER PLC.

2008 24.60 31.04 49.55 22.66 -0.43 1.18

2009 24.44 67.87 65.98 41.49 0.00 0.92

2010 26.34 83.46 82.93 35.75 0.37 0.47

2011 24.17 80.97 49.69 61.51 0.52 0.39

2012 23.95 94.16 65.80 55.86 0.36 0.27

112

DANGOTE SUGAR

2008 39.05 13.61 168.32 -83.49 -0.28 0.47

2009 34.45 131.89 157.52 41.28 0.3 0.46

2010 37.28 132.22 140.93 62.74 0.35 0.60

2011 53.91 95.60 139.84 51.36 0.18 0.42

2012 51.46 92.73 140.12 45.35 0.12 0.47

UNILEVER NIG. PLC

2008 54.41 82.25 132.94 31.30 - 0.40

2009 69.31 69.41 152.49 23.26 0.09 0.62

2010 55.79 66.38 123.07 34.90 0.16 1.77

2011 40.79 78.15 145.17 -1.99 0.05 0.74

2012 37.43 81.01 168.91 -28.91 0.14 0.83

PZ CUSSIONS

2008 39.13 139.66 6.17 179.90 -0.15 0.11

2009 38.35 111.78 4.85 153.53 0.18 0.16

2010 29.25 106.49 26.95 126.61 0.19 0.15

2011 47.13 86.81 8.70 137.02 -0.29 0.50

2012 49.12 80.77 1.19 139.36 0.05 0.28

Source: Extracts from Appendix II