CHAPTER ONE INTRODUCTION 1.1 BACKGROUND OF THE STUDY
The resources of a firm that are used to conduct the day-to-day activities of any business are referred to as the working capital. Its proper management is one of the most important areas in determining the success of a firm. It is generally believed that the working capital is the amount of capital which is readily available to an organization; that is, the difference between resources in cash that can be readily convertible into cash (current assets) and the organizational commitments for which cash would soon be required (current liabilities). Looking at this, it can be said that working capital simply means the resources which a firm has at hand to run its daily operations.
Working capital connotes the funds locked up in materials, work in progress, finished goods (inventory), account receivables (debtors) and cash. In this regard, Khan and Jain (2005) state that current assets are those assets, which can be converted into cash within a short period of time, and the cash received is again invested into these assets; hence, it is constantly revolving or circulating. Therefore, working capital is one of the most important measurements of the financial position, which according to Guthmann (2008) is the lifeblood and nerve centre of any business entity. For the reasons and more, the proper and efficient management of the working capital of every business becomes a necessity if not obligatory.
Working capital management is concerned with managing the different components of current assets (inventories, debtors/receivables, cash/bank, short-term investments, prepaid expenses) and current liabilities (creditors/payables, provision for tax, other provisions against the liabilities payable within a period of 1 year) in such a way and manner that optimum level of working capital is attained and maintained. All this is very crucial in order to promote a satisfactory profitability and thus achieve the goal of the business which is the maximization of shareholder’s wealth (Ojeani, 2014). It is therefore of importance to state at this juncture, as posited by Ojeani (2014) that optimal efficient working capital is usually achieved through the management of inventory, receivables, payables, cash conversion cycle and the operating cycle as a whole. In essence, managing working capital is necessary owing to its direct impact on the profitability and liquidity of a corporate entity.
Osisioma (1997) reveals that working capital management ensures a sound liquidity and attainment of profit generating process, and also ensures acceptable relationship between the components of firms’ working capital for efficient mix which guarantees capital adequacy. Inventory management, according to Stephen (2012), consists of three components: raw material, work-in-progress and finished goods. He further explains that the holding of excessive stocks will lead to tying up capital in stocks while the holding of inadequate stock may lead to stock out cost such as lost profitability and goodwill from customers. Therefore a firm needs to set an optimal level of stock. Van Horne (1995), in his view on receivables, says that account receivables management involves achieving an optimal average time taken by credit customers to settle their accounts. Moreover, since the purpose of giving out credit is to maximize profitability, the cost of debt collection should not be allowed to exceed the amounts recovered. Cash conversion cycle, according to Wang (2002), is used to measure cash management, and it represents the interaction between the components of working capital and the flow of cash within a company. Similarly it can also be used to determine the amount of cash needed for any sales level; it is therefore a period of time between the cash outlay on raw materials and the inflow of cash from sales of finished goods.
The foregoing discussions have gone a long way to demonstrate the need to balance working capital position of the business enterprise in order to maintain adequate liquidity, minimize risks and raise profitability at all times. Although several researches have been conducted in various industry, like the manufacturing industry, banking industry, building industry and so on, but no attention has been given. to the Nigerian telecommunication firm. It is on the above that the research aims at evaluating the impact of working capital on the profitability of listed telecommunication firms in Nigeria.
1.2 STATEMENT OF THE PROBLEM
1.3 OBJECTIVES OF THE STUDY
The main objective of this study is to examine the impact of working capital management on the profitability of listed telecommunication firms in Nigeria. The specific objectives are to:
1.4 RESEARCH QUESTIONS
1.5 HYPOTHESES OF THE STUDY
In view of the above stated objectives, the following null hypotheses are formulated:
Ho1: there is no significant relationship between poor management of working capital andfirm profitability.
Ho2: there is no significant association between working capitalandfirm profitability.
Ho3:Economic and political crisis does not significant affect the profitability of telecommunication firms in Nigeria.
1.6 SCOPE OF THE STUDY
The study focuses on the issues of working capital management and profitability within the boundary of listed telecommunication firms in Nigeria. It is also of importance to mention that the whole population, the six listed telecommunication firms on the Nigeria Stock Exchange as at 31st December, 2015 forms the sample size. Ten year (2006-2015) financial reports of the said companies were studied. The variables in use are Return on Assets, Return on Equity, Debtor turnover, inventory turnover and cash conversion circle.
1.7 SIGNIFICANCE OF THE STUDY
This study is very significant in the sense that it centers on the working capital management which plays a critical role in the short-term liquidity position of companies. The study’s findings may help the telecommunication firms in Nigeria and other companies in general to improve on their financial decision making so as to optimize the value of the shareholders and maintain a favourable trade-off between liquidity and profitability.
This study could broaden the knowledge of managers in choosing accurate working capital strategies that would improve their efficiency. This is because understanding the firm’s liquidity position, as being discovered by this study, helps managers to be more efficient and productive bearing in mind the information at their disposal. The findings may be helpful to financial managers to be able to measure the level of safety for them to discharge obligations towards attaining profitability and to get prepared against eventualities. By this singular fact, awareness is being created for the financial managers that there is the need to pay serious attention to financing current assets. Managers of finance are therefore, expected to derive a lot of benefits from this work as it gives details and comprehensive analysis on the importance of working capital which is the main tool they use in achieving the desired goal of profit maximization.
Helping students of accounting and finance and researchers in the field on practical approach to knowledge. It is hoped that this piece is going to be of great use to the students of accounting and finance who may also have interest in researching further on this topic. This is because the work is expected to serve as one of the sources knowledge can be derived for students as well as researchers who may be interested in carrying out further study on similar topic.
Creditors/prospective creditors who may be interested in ascertaining the credit worthiness of the firms could also benefit from the study. This is because the credit worthiness of a firm is about meeting financial obligations as and when due. This can only be established through efficient management of firms’ working capital.
This study is also going to add to the existing literature for the fact that it has employed two different dependent variables (Return on Assets and Return on Equity) to proxy profitability which has not been found in any of the early work.
Lastly, this study is significant in the sense that it can be of beneficial source of information to government of Nigeria who is always interested in promoting economic activities through establishing of an enabling environment.
1.8 DEFINITION OF OPERATIONAL TERMS
Working Capital: The capital of a business which is used in its day-to-day trading operations, calculated as the current assets minus the current liabilities.
Cash Conversion Cycle: Is a metric used to gauge the effectiveness of a company’s management and, consequently, the overall health of that company. The calculation measures how fast a company can convert cash on hand into inventory and accounts payable, through sales and accounts receivable, and then back into cash.
Telecommunication is the transmission of signs, signals, messages, words, writings, images and sounds or information of any nature by wire, radio, optical or other electromagnetic systems. Telecommunication occurs when the exchange of information between communication participants includes the use of technology.
Return on Assets – ROA’
Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets. ROA gives a manager, investor, or analyst an idea as to how efficient a company’s management is at using its assets to generate earnings. Return on assets is displayed as a percentage and its calculated as:
Is the ability for a business to earn a profit. A profit is simply the revenue left over after you have paid all the costs and expenses related to your business activities. Profitability ratios are a series of metrics that you can use to measure the relative profitability of a business.
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