Analysis Of Effects Of Working Capital Management On Profitability Of Manufacturing Companies

Analysis Of Effects Of Working Capital Management On Profitability Of Manufacturing Companies

Abstract

Working capital operation involves the operation of the most liquid coffers of the establishment which includes cash and cash coequals, supplies and trade and other receivables. utmost enterprises don’t hold the correct quantum of working capital and this has been a major handicap to their overall profitability. The study anatomized the goods of working capital operation on the profitability of manufacturing enterprises listed on the Nairobi Securities Exchange. The study employed a individual exploration design and targeted the 9 listed manufacturing enterprises trading on the Nairobi Securities Exchange. still, the study covered 6 of the targeted manufacturing companies, 3 were moreover not trading or had in complete records at the time of the study. Data was attained from document analysis of consolidated fiscal reports of times ending December 2006, 2007, 2008, 2009 and 2010. Multiple retrogression and correlation analyses were carried out on the data to determine the connections between factors of working capital operation and the gross operating profit of the enterprises. The study established that gross operating profit was appreciatively identified with Average Collection Period and Average Payment Period but negatively identified with Cash Conversion Cycle. The relationship between force Development in Days and gross operating profit was insignificant. Profitability of manufacturing enterprises depends upon effective working capital operation. The study thus recommended that directors should concentrate on reducing cash conversion cycles, collect receivables as soon as possible because it’s better to admit inrushes sooner than latterly and delay payment of creditors in order to invest the plutocrat in short term securities which are profitable.

crucial words Working Capital Management; Profitability; Average Collection Period Average Payment Period; Cash Conversion Cycle, force Development in Days.

Chapter One

Preface

Background of the study

The term working capital has several meanings in business and profitable development finance. In account and fiscal statement analysis, working capital is defined as the establishment’s short- term or current means and current arrears. Net working capital represents the excess of current means over current arrears and is an index of the establishment’s capability to meet its short term fiscal scores( Brealey & Myers, 2002). Effective working capital operation consists of applying the styles which remove the threat and lack of capability in paying short term commitments in one side and help over investment in these means in the other side by planning and controlling current means and arrears( Lazaridis & Tryfonidis, 2006).

Working Capital Management is the administration of current means and current arrears. It deals with the operation of current means and current arrears, directly affects the liquidity and profitability of the company( Deloof, 2003; Eljelly, 2004; Raheman and Nasri, 2007; Appuhami, 2008; Christopher and Kamalavalli, 2009; gusto and Ravipati, 2009). Current liquidity extremity has stressed the significance of working capital operation. operation of working capital has profitability and liquidity counteraccusations and proposes a familiar front for profitability and liquidity of the company. To reach optimal working capital operation establishment director should control the dicker between profitability maximization and liquidity directly( Raheman & Mohamed, 2007). An optimal working capital operation is anticipated to contribute appreciatively to the creation of firm value( Howorth & Weshead, 2003; Deloof, 2003; Afza & Nazir, 2007). Working capital operation is important due to numerous reasons. For one thing, the current means of a typical manufacturing establishment accounts for over half of its total means. For a distribution company, they regard for indeed more. inordinate situations of current means can fluently affect in a establishment’s realizing a unacceptable return on investment. still enterprises with too many current means may dodge dearths and difficulties in maintaining smooth operations Horne and Wachowicz,( 2000). Effective working capital operation involves planning and controlling.

There must be a balance between current means and current arrears so as to exclude the threat of incapability to meet short term scores on one hand and avoid inordinate investment in these means on the other hand( Eljelly, 2004). numerous checks have indicated that directors spend considerable time on day- to- day problems that involve working capital opinions. One reason for this is that current means are short- lived investments that are continually being converted into other asset types( Rao, 1989). With regard to current arrears, the establishment is responsible for paying these scores on a timely base. Liquidity for the ongoing establishment isn’t reliant on the liquidation value of its means, but rather on the operating cash flows generated by those means( Soenen, 1993). Taken together, opinions on the position of different working capital factors come frequent, repetitious, and time consuming.

Working Capital Management is a veritably sensitive area in the field of fiscal operation( Joshi, 1994). It involves the decision of the quantum and composition of current means and the backing of these means. Current means include all those means that in the normal course of business return to the form of cash within a short period of time, naturally within a time and similar temporary investment as may be readily converted into cash upon need.

The Working Capital Management of a establishment in part affects its profitability. The ultimate ideal of any establishment is to maximize the profit. But, conserving liquidity of the establishment is an important ideal too. The problem is that adding gains at the cost of liquidity can bring serious problems to the establishment( Shin and Soenen, 1998). thus, there must be a trade- off between these two objects of the enterprises. One ideal shouldn’t be at cost of the other because both have theirimportance.However, we can not survive for a longer period, If we don’t watch about profit. On the other hand, if we don’t watch about liquidity, we may face the problem of bankruptcy or ruin. For these reasons working capital operation should be given proper consideration and will eventually affect the profitability of the establishment. enterprises may have an optimal position of working capital that maximizes their value( Afza and Nazir, 2009).

Working Capital Management has its effect on liquidity as well as on profitability of the establishment. The study anatomized the relationship between different variables of working capital operation including the Average collection period, force development in days, Average payment period, Cash conversion cycle and Current rate and the gross operating profit. Debt rate, size of the establishment( measured in terms of natural logarithm of deals) and fiscal means to total means rate were used as control variables.

Problem statement

The effective operation of working capital is veritably vital for a business survival. This is presumed on the fact that having too important capital signifies inefficiency where as too little cash in hand signifies that the survival of the business is shaky. utmost business associations don’t hold the right quantum of stocks, debtors and cash. Due to this reason the establishment is unfit to meet its growing short term scores and its forthcoming functional requirements. Lack of acceptable working capital also means that a establishment is unfit to take over expansion systems and increase its deals, thus limiting the growth and profitability of the business. maturity of listed manufacturing enterprises have displayed abating returns as well as poor stock performance in the last five times. still, the extent to which working capital operation affects profitability of these enterprises isn’t well known. It’s on this premise that this study anatomized the relationship between working capital operation and the establishment’s gross operating profit.

Purpose of the study

The purpose of the study was to dissect the goods of working capital operation on profitability of listed manufacturing enterprises trading on the Nairobi Securities Exchange.

Objects of the study

General objective

The general ideal of the study was to determine the relationship between working capital operation and the profitability of listed manufacturing enterprises in Nairobi Securities Exchange.

Specific objects

The study was guided by the following specific objects

1. To dissect the relationship between average collection period and profitability of listed manufacturing enterprises.

2. To assess the relationship between supplies development in days and profitability of listed manufacturing enterprises.

3. To establish the relationship between average payment period and profitability of listed manufacturing enterprises.

4. To estimate the relationship between cash conversion cycle and profitability of listed manufacturing enterprises.

Exploration Hypotheses

The following suppositions were tested at a = 0.05.

H01 There’s no statistically significant relationship between average collection period and profitability of listed manufacturing enterprises.

H02 There’s no statistically significant relationship between force development in days and profitability of listed manufacturing enterprises.

H03 There’s no statistically significant relationship between average payment period and profitability of listed manufacturing enterprises.

H04 There’s no statistically significant relationship between cash conversion cycle and profitability of listed manufacturing enterprises.

Significance of the Study

The study’s findings may help the manufacturing enterprises and other companies in general ameliorate on their fiscal decision making so as to optimize the value of the shareholders and maintain a favorable trade- off between liquidity and profitability. The findings may also be of great benefit to unborn experimenters in the field of working capital operation in furnishing applicable literature in erecting up the course of study. It may profit other scholars and scholars of finance who may use the findings for academic purposes.

With the working capital operation playing a major part in fiscal stability of different enterprises its effective application is necessary in achieving the pretensions of fiscal stability. The study recommended ways through which working capital can be effectively employed in fiscal decision timber. This effective application in the long run will increase wealth of the shareholders.

Compass of the Study

The study concentrated on the factors of WCM, videlicet average collection period; average payment period; force development in days and cash conversion cycle and their goods on gross operating profit. The study was limited to the 9 manufacturing companies trading on the Nairobi Securities Exchange and the consolidated fiscal records from the time 2006 to 2010.

Limitations and Delimitations of the Study

The first limitation of the study was that three out of the nine companies targeted by the study were moreover not trading or had in complete records at the time of the study. It was thus not possible to gain their consolidated fiscal reports for the period covered by the study, therefore the findings of the study may not be generalized to these companies. Secondly, the fiscal directors of some of the companies studied weren’t willing to give all the fiscal records that formed the main data sources for the study. This limitation was overcome by sourcing the missing information from the libraries of the Nairobi Stock Exchange where the companies were listed, since the enterprises are public realities whose deals are records must be made available to the public.

Description of Significant Terms Used in the Study

The following terms assumed the stated meanings in the environment of the study

Average collection period( ACP) refers to the average time needed for changing the company’s receivables into cash. It’s calculated as

Receivable accounts x 365

Average payment period( APP) refers to the average number of days a company takes to pay off credit purchases. Average Payment Period is calculated as

Outstanding accounts x 365

App = ,-,

Cost of goods vended

Cash conversion cycle( CCC) The sum of days of deals outstanding( average collection period) and days of deals in force less days of payables outstanding( Keown etal., 2003). It’s calculated as

Cash Days of Deals Days of Deals Days of

Conversion outstanding force Payables

Cycle outstanding

force development in days( ITID) is the normal needed time to change the accoutrements into the product and also vend the goods. It’s calculated as

force x 365 ITID = —————————–

Cost of goods vended

Working capital Working capital, also known as net working capital or NWC, is calculated as current means minus current arrears. The major factors of working capital are accounts delinquent, supplies, cash and cash coequals and accounts outstanding.