The Relevance of Working Capital Management in a Firm

The Relevance of Working Capital Management in a Firm

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Chapter one on The Relevance of Working Capital Management in a Firm

INTRODUCTION

BACKGROUND OF THE STUDY

Working capital management involves not only the management of current assets but also the management of current liabilities and the relationship between the two. Time is the feature of all items making up working capital. Working capital describes the assets and liabilities of a business that are related directly to its trading activities. Some of them are held to enable the business to function, such as debtors and creditors. They are the items in the balance sheet whole vale and nature change continuously, since they are turned over regularly in the course of normal trading. Working capital liabilities are those for which the business is most immediately at risk, hence, they are normally termed current liabilities. Working capital assets are those on which the business can call most easily: hence, they tend to be referred to as current assets. Many businessmen control their working capital very carefully, they are aware that however high national profit is, survival and real success depend on whether profit materializes into cash and whether that cash is available when the business needs it. Controlling the working capital will be limited value unless it is exercised within a framework, which takes into account: 
1. The assets required to achieve the objective of the business. 
2. The way in which such assets are used. 
3. The way in which the business chooses to finance its activities. Without adequate cash, a business cannot exist. For this simple reason cash is often described as the “Lifeblood of a business and its control the means of maintaining commercial health”. Liquidity is a pre-requisite for commercial life and cash management is as natural as staying alive: It is the Naira amount of a firm’s current assets including cash and short term investments, account receivable and inventories. These assets are regarded as liquid because they can be converted to cash within one year. Considering the diversity of the scope of operations among our millions, of business firms, the many varieties of their seasonal patterns, the varied influences of secular growth and decline, the diverse effects of cyclical developments in general business activities, the wide differences in the degrees of competition among firms and industries, and variations among firms in their access to new sources of cash, it is patently impossible to formular a set of asset management rules or policies that would be good for all businesses at all times. Indeed a most reasonable conclusion is that asset management policies that are good for a given firm at a given time may be quite bad for another at that time, as well as for the firm itself at other times when surrounding circumstances have changed. Managing the firm’s net working capital position (that is, its liquidity) has been shown to involve simultaneous and interrelated decisions regarding investment in current assets and use of current liabilities. Fortunately, a guiding principle exists that can be used as a benchmark for the firm’s working capital policies: The hedging principles, of principle of self-liquidating debt. This principle provides a guide to the maintenance of a level of liquidity sufficient for the firm to meet its maturing obligations on time.

STATEMENT OF PROBLEM 

The management of the working capital of any organization is sensitive area of that organization and its growth and strength depends on it. In this country, much is not being said about the working capital management of firms and because of this much is not known about the importance of the management of working capital of firms. The problem of inadequate information about the working capital management shall be addressed in this work. 

 OBJECTIVE OF THE STUDY

The aim of this work “Relevance of working capital management” is to: 
1. Study the methods adopted by firms in the management of their working capital. 
2. To verify whether there is conformity in the management of working capital from one firm to another (firms in the same line of production or business). 
3. Determine the factors that have aided the firm in the course of having an efficient working capital management. 
4. Arrive at a conclusion and make recommendation where necessary. 

SCOPE OF THE STUDY

The study will cover the appraisal of the working capital management in an organization. The standard requirement of working capital management shall be study. The method applied by the firm in the management of its working capital shall also be looked into as well. The main focus of this work will be to verify the approach of a firm in the management of their working capital. In the course of this research work, the researcher carried out the study with limits imposed by practical considerations of the financial involvement and time constraints. The non-availability of enough data also passed a hindrance to the researcher. These constraints limited the researcher’s ability to have a more comprehensive research work. Nevertheless the researcher had to rely on interviews and review of past work on certain areas. 

RESEARCH QUESTIONS

In order to achieve the objective of this work, the researcher uses the following questions for this project topic: “The Relevance of Working Capital Management in a Firm”. 
1. How important is it to invest fund in current assets? 
2. What amount should be invested in the different types of current assets?
3. Which appropriate sources of fund should be used to finance current assets? 
4. How liquid should a firm be at any particular tie? 
5. What should be the level of stock a firm should keep in order to continue in business? 

RESEARCH HYPOTHESIS

The hypothesis upon, which the study is based are: 
H0 : A firm’s working capital does not influence its prospects in business. 
H1 : A firm’s working capital influence’s its prospects in business. 
H0 : Inadequate funding by finance houses does not affect working capital. 
H1 : Inadequate funding by finance houses affects working capital. 
H0 : Excess level of stock does not tie down working capital. 
H1 : Excess level of stock ties down working capital. 
H0 : Stringent credit policy does not affect working capital. 
H1 : Stringent credit policy affects working capital. 

SIGNIFICANCE OF THE STUDY

This research work is significance for the fact that it tries to high-light the importance of working capital management in firms. It is paramount to study working capital management, which had in the past been neglected and to know the extent of its impact on the firm’s services. It is also important to study steps taken by the firm to see that they maintain a balance between liquidity and profitability in order to remain in business. 

DEFINITION OF TERMS 

The definitions that will be made here may not necessarily mean the general one used, the ones made here are relevant for this work. 
Net Working Capital: This is the different between current assets and current liabilities. 
Permanent Working Capital: It is the Naira amount of working capital that persists over time regardless of fluctuations in sales. 
Temporary Working Capital: It is the additional assets required to meet variations in sales above the permanent level.
Working Capital Loan: It is the temporary accommodation required by a firm in excess of sanctioned credit limit to meet information contingencies. 
Gross Working Capital: This means the firm’s investment in current assets to convert sales into cash. 
Hedging Principle: In involves matching the cash flow – generating characteristics of an asset with the maturity of the source of financing used to finance its acquisition. 
Perfect Hedge: It is the financing of temporary current stock with short-term sources of funds and fixed assets and permanent current asserts with long-term sources of funds. 
Conservative Hedge: It is the financing of some temporary current assets with short-term sources of funds and financing the remaining assets are financial with long-term source of funds. 
Aggressive Hedge: The financing of temporary current assets and some permanent assets with short-term sources of funds. Working Capital Policy: It is the decisions regarding:
(i) Target levels for each current asset account. 
(ii) How current assets will be financed 
Cash Conversion Cycle: It is the length of time from the payment for the purchase of raw materials to manufacture a product until the collection of the accounts receivable associated with the sale of the product. 
Inventory Conversion Period: It is the average length of time required to convert materials into finished goods and then sell those goods, it is the amount of time the product remains in inventory in various stages of completion. 
Near-Cash Assets: They are such assets like marketable securities, which essentially serve the same purposes as cash; such assets are extremely liquid. 
Cash: The funds a firm holds that can be use for immediate cash disbursement needs.

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