CHAPTER ONE
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.
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.
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.
1.2
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.
The problem of inadequate information about the working capital
management shall be addressed in this work.
1.3
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.
1.4
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.
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.
1.5
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.
1.6
HYPOTHESIS
The hypothesis upon, which the study is based are:
A firm’s working
capital does not influence its prospects in business.
A firm’s working
capital influence’s its prospects in business.
Inadequate
funding by finance houses does not affect working capital.
Inadequate
funding by finance houses affects working capital.
Excess level of
stock does not tie down working capital.
Excess level of
stock ties down working capital.
Stringent credit
policy does not affect working capital.
Stringent credit
policy affects working capital.
1.7
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 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.
1.8
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.