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CHAPTER ONE

INTRODUCTION

1.1   Background to the Study

The current scarcity of cash and credit is threatening the survival of many businesses in all over the world primarily in Nigeria as its considered the sources of company’s working assets and liabilities referred to as working capital. it is a fact that corporations could not exist without working capital and this is undeniable. Eventually, the management of working capital (WCM) necessitates short term decisions in working capital (WC) and financing of all aspects of both firms short term assets and liabilities. This explains the fact that firms with inadequate working capital are in financial strait jacket. As the name implies, working capital refers to the funds that are required for the day to day running of the activities of a firm. it is the excess of current assets over current liabilities. Working capital management involves the relationship between a firms short term assets and its short term liabilities. The goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short term debt and upcoming operational expenses. In view of that, working capital management has become one of the most important issues in the organizations where many financial executives strive to identify the basic working capital drivers and the appropriate level of working capital (Lamberson 1995).

The management of working capital involves managing inventories, account payables, account receivables and cash. Large numbers of business failure has been attributed to the inability of financial managers to plan and control the current assets and current liabilities of their respective organizations. This explains why working capital management is vital to firms with limited access to the long term capital market. The working capital measures both a company’s efficiencies and its short term financial health. It also gives investors an idea of the companies underlying operational efficiency. The working capital shows a company’s efficiency, financial strength and cash flow health which also helps in determining the profitability and risk as well as its value (Smith 1980).

The significant of working capital had been highlighted in most of the literature of WCM i.e. Eljelly (2004) described that the efficient WCM are engaged with planning and controlling current assets and liabilities in such a way that eliminates the risk of inability to meet short term obligations in hands with the avoidance of excessive investments in these assets. Siddiquee and khan (2009) indicate that the inefficient management of WC not only reduces profitability but ultimately may also lead a concern to financial crisis thus every organization irrespective of its profit orientation, size and nature of business needs requisite amount of WC. Consequently, the efficient WCM is the most crucial factor in maintaining survival, liquidity, solvency and profitability of the concerned business organization. Thus, we could say that approach in managing working capital has enormous influence to the firm’s performance.

The importance of working capital in the day to day running of the business activities of a firm are stated in the books. Having said that working capital is the live wire of a business, it is expected that effective provision of it will ensure greater success of a company while in — effective management of it will lead to ultimate downfall of what otherwise might be considered as a prosperous concern. Working capital is important to the operations of a firm but the maintenance of a working capital is more crucial. This is because excessive working capital means holding costs and idle funds which earns no profits for the firms is dangerous while inadequate working capital which means not having sufficient funds only limits the firm’s profitability but also results in production interruptions and inefficiencies and sales disruptions.

1.2    Statement of the Problem

Working capital management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities in respect to each other. Generally speaking, the immediate problem facing most financial managers always centers on the best way to ensure suitable survival of the business as well as its expansion in terms of working capital management. A firm or company should be in a sound working capital position. It should have adequate working capital to run its business operations. One should note that both excessive as well as inadequate working capital position are dangerous to any business, therefore a company is required to maintain a balance between liquidity and profitability which are sometimes conflicting objectives while conducting its day to day activities.

However, financial managers are faced with the major problem of obtaining an optimum level of working capital which is a situation whereby working capital managers are able to avoid the problem of holding idle funds which earns no profit for the firm and inadequate working capital which reduces the firm’s profitability as well as production interruptions and inefficiencies. The credit policy of a firm is another bottleneck confronting working capital management. A flexible credit policy adopted by the management in most cases results in writing off a high proportion of bad debts while a rigid credit policy reduces the level of sales and also scares away customers. Therefore, financial managers are faced with the problem of determining an effective and efficient credit policy which should be in line with their company’s goals and objectives.