THE IMPORTANCE OF WORKING CAPITAL MANAGEMENT IN MANUFACTURING COMPANY (A CASE STUDY OF NESTLE NIGERIA PLC)
Abstract
This study examined the impact of working capital management on firm performance using Nestle Food Nigeria plc as a case study. The study was anchored on Behavioural Finance Theory, Economic Order Quantity (EOQ) Model and Theory of Capital Movement. Secondary data was used for the study and it was obtained from the financial statement of Nestle Nigeria Plc for the period of 2004-2013. The study made use of Ordinary Least Squares (OLS) regression after the data was subjected to unit root test and found to be stationary at levels and are integrated of order zero [I(0)] . The findings revealed that a positive relationship exist between Current Ratio (CUR), Quick Ratio (QUR) and Return on Asset (ROA) and the relationship is statistically significant (p<0.05) and in line with a priori expectation. The coefficient of determination (R2) for the study is 85.23%. This indicates that 85.23% of the variations in the model can be explained by the explanatory variables of the model. The result shows that the management of working capital is important to business organization performance. It was recommended among others that the management of the Nestle Food Nig Plc should pay more attention on the management of quick ratio as its management indicates the best way of measuring the amount of the most liquid current assets there are to cover current liabilities. Management should therefore aim at higher values of quick ratio as a higher ratio means a more liquid current position of the company which is a good indicator of firm performance.
Introduction
In the current recessionary environment, where traditional sources of financing have been constricted, strict attention to working capital management is of paramount importance to organizations of all sizes and financial condition . Indeed, in a world where “cash is king,” it is important that a working capital management program be properly aligned with an organization’s overall business strategy and goals. This requires an organization to implement processes and related tools to measure, and thereby monitor the components of working capital.
The principle goal of Working Capital Management is to ensure that an organization generates sufficient positive working capital (specifically in the form of Cash) from ongoing business activities to continually fund both debt payments and operating expenses Effective management of working capital involves managing discrete, but highly inter-related processes (cycles). Since these processes are interrelated, decisions made within each one of the disciplines can impact the other processes, and ultimately affect an organization’s overall financial performance. Working Capital is the perception within much organization’s that you cannot effectively predict when cash will be collected or when it will need to be disbursed. In reality, analyzing statistics (i.e., metrics) for individual components of working capital often yield patterns or trends that enable managers to reasonably forecast sources and uses of cash.
This study presents the perspectives of Nigerian financial executives regarding the importance of working capital management to Nestle Food Nigeria Plc. It explores their views on how companies manage working capital, examines whether their organizations have implemented improvement programs and how their companies have managed various working capital management challenges, solutions and strategies.
The management of working capital is one of the most challenging issues for financial managers as the success or otherwise of the management of the financial ratios affects the company either positively or negatively. The consequences of ineffective management of working capital are the inability of the company to meet its financial obligations.
It is almost impossible to have a business venture that does not encounter cash problem. These problems are aggravated today in Nigeria by the economic crisis and various government policies which directly or indirectly affect the cash that a firm holds at any point in time.
Firms are always faced with the problem of how much cash to hold in a particular period and when to hold small or large amount of cash. This however, is as a result of the fact that holding too much cash makes the organization lose the profit that would have accrued if such excess cash was invested. Similarly, insufficient cash can disrupt the activities of the firm.
In contemporary Nigeria, organizations are faced with liquidity problems. Some of these businesses have either totally collapsed or are experiencing business decline. Many organizations have lost some of their valuable staff while some individuals in some organizations have refused to work cooperatively with other staff, all because of ineffectiveness among departments or units within the organization due to working capital management. As a result of this, coordination of activities become difficult and achievement of the overall organizational goals unattainable. These and many others issues relating to the impact of working capital on the performance of firms in Nigeria is what this current study is set out to explore.
The broad objective of this study is to examine the impact of working capital management on the performance of food and beverage industries in Nigeria. The specific objectives are to: determine the effect of Current Ratio as a working capital management tool on the performance of food and beverage industries in Nigeria, assess the effect of Quick Ratio as a working capital management tool on the performance of food and beverage industries in Nigeria, examine the effect of Cash ratio as a working capital management tool on the performance of food and beverage industries in Nigeria.
Review of Related Literature
Working capital management
Managing the firm’s working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operation, this relates to the firm’s receipt and disbursement of cash [3]. In doing this, the company should:
i. Determine the amount of cash and inventory that are to be kept in hand;
ii. Determine whether to sell on credit or not, the credit terms that are offered to the customer and how much to extend the credit limit;
iii. Determine how and where to raise or borrow short-term funds in order to meet short-term needs.
The amount of working capital available to firm is considerably interest to short -term creditors since it represents assets financed from long-term capital sources that do not require near term repayment. For a firm to qualify for favourable credit terms, and to take advantage of opportunities quickly, ample working capital is a necessary precondition.
Although it is always confronting to short-term creditors to use target working capital balance, their joy is full only after they have, been, satisfied that the working capital is turning over at an acceptable rate and that their obligations could, be paid when due. Rather than being a sign of strength, a large of working capital balance means that stagnant or absolute inventory is building up. To put the working capital figure into proper perspective therefore, it must be supplemented with other analytical work.
Rockley states that working capital is a measure of the extent to which the current assets could lose their value before the amount owing to short-tent) creditors were jeopardized. Therefore, a monthly or an annual trend, in the working capital amounts would be a relevant feature to observe in any study of the adequacy of working capital in companies. A matter of even greater significance for corporate liquidity appraisal liabilities is qualified. The excess of an enterprises total current assets over its total current liabilities at the same point in time may be termed its net current assets or working capital, furthermore, the various sources can be determined without reviewing and classifying every transaction that occurred during the year (period). There is also need to determine the individual effects of a number of similar transactions. In summary, figures are sufficient. In view of the above definitions and explanations the researcher is made to suggest that the Working capital should be those assets which may be rapidly converted into cash and used to acquire labour, materials power and other items needed before the fixed assets can operate and to finance the business sales activities.
Metrics used to assess performance of various components of working capital: The CR is used primarily to determine a company’s ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, accounts receivable). The higher the current ratio, the more capable the company is of paying its obligations.
Quick Ratio (QR): (Total Current Assets-Inventory)/Total Current Liabilities Also known as the “acid test ratio,” the QR predicts your immediate liquidity more accurately than the current ratio because it takes into account the time needed to convert inventory to cash.
Inventory Turnover Ratio (ITR): Cost of Goods Sold/Average Value of Inventory. The ITR indicates how quickly inventory is turning. A low turnover ratio often implies poor sales, and therefore, excess inventory. A high ratio suggests strong sales or ineffective buying. Frequently it is a good idea to evaluate the ITR by inventory class or subgroup to better understand the underlying causes that contribute to the overall ITR results. Working capital management and control is the flow of funds through the cycle back to the original fund from where the cycle is repeated, in the first instance, the original funds invested are used to meet expenses, supplies of raw materials or payment to creditors, goods or services are sold to customers who either settles on cash transaction basis or ultimately convert their debts by means of these sales transactions flow into the business and issued for various purposes including the provision of funds to recommence the cycle.
According to Ramond, in producing an item of output, it requires the use of working capital. It ties up fund’s that could be used elsewhere from the time materials were purchased for its production until payment is collected from its sales. This includes the time raw materials and the finished products are held in inventory, and the time after the sale before the payment is actually received. For a part of this time interval the use of working capital is financed by accounts payable and other accrued payable and other accrued liabilities since payment is not made immediately for purchases and labour.
Firms operate more or less continuously with working capital committed to all stages of production. The generalized sequence from the initial outlay to the receipt of payment is called the short-term operating cycle or cash-to-cash cycle.
Theoretical framework
Miller-Orr cash management model: The approach of Miller-Orr model assumes that the underlying problem facing the manager is to keep enough cash on hand to meet daily transactions demand, while minimizing the opportunity cost of not holding a return yielding asset. Miller and Orr focus their model on maintaining two boundaries: the upper and lower boundaries as depicted in