ABSTRACT
The aim of this study is to investigate the working capital management and profitability in Nigeria petroleum marketing sector. The statistical significance between the individual component of working capital management and profitability is examined in this study. In the light of this objective the study adopted quantitative method of research approaches to test a number of research hypothesis. The study selected a sample of six (6) major oil marketers in Nigeria that have the complete annual report and accounts on Nigeria Stock Exchange for the period of fourteen years (2000-2013) with the total of 84 observations. Data was then analyzed on quantitative basis using fixed effect regression model (FEM) and OLS regression analysis to define the association between firm’s profitability and working capital management components. The results showed that Average Collection Period (ACP) has a positive and non significant impact on profitability. It means that, a firm with generous credit terms can increase sales as it allows more time for customer to make payment. It was also found that Inventory Period (IP) has a positive and non significant impact on profitability which means that keeping high inventory saves firm from stock out and also result in more sales which leads to increase in profit. Moreover the study finds that there is no positive relationship and significant impact between Average Payment Period (APP) and profitability, it means that the shorter the account payable days, the more profitable the companies are. And finally the researcher found that Cash Conversion Cycle (CCC) has a positive and non significant impact on profitability which implies that if a firm takes more time to collect cash against credits, it will increase its profit. But despite that individual variable does not have a significant impact on dependent variables but collectively, the F- statistics shows that all the independent variables taken together have a significant impact on the dependent variable. ( that is F- Statistic = 0.02, P-value
= 0.7 in ACP, F-Statistic = 0.02, P-value = 0.26 for IP and F- Statistic = 0.01, P-value =
0.09 for CCC).
Keywords: working capital management, firm size, Average Collection Period, Inventory Period, Account payable period, cash conversion cycle, and profitability.
1.1 Background of the study
CHAPTER ONE
INTRODUCTION
Corporate finance literature has traditionally focused on the study of long-term financial decisions such as the capital structures, investments, dividends and firm valuations. However, finance theories are discussed under three main threads as capital budgeting, capital structure and working capital management. As a result, the first two are mostly related to financing and managing long term investments. Meanwhile, financial decisions about working capital are mostly related to financing and managing short term investments and habilitate, classified under both current assets and current liabilities simultaneously (Mueller, 1953; Pinches, 1992; Brealey and Myers, 1996; Damodaran, 2002). Hence, management of working capital refers to management of current assets and current liabilities (Ross et al., 2003, Raheman and Nasr, 2007).
Working capital consists of current assets and current liabilities and the first one includes capital tied up in cash, short-term financial investments, inventories, account receivables and other current assets (Brealey, Myers & Allen, 2006, p. 813). Current liabilities include short-term loans, the debts to suppliers as account payables, accrued income taxes, and interest payments on long-term debts, dividend and other current liabilities (Pass & Pike, 2007). The concept of working capital management addresses companies’ managing of their short-term capital and the goal with the management of working capital is to promote a satisfying liquidity, profitability and shareholders value (Jeng-Ren, Li & Han-Wen, 2006). Meanwhile, financial decisions about working capital are mostly related to financing and managing short term investments and habilitate classified under both current assets and current liabilities simultaneously (Mueller, 1953; Pinches, 1992; Brealey and Myers, 1996; Damodaran, 2002).
The three concepts, solvency, liquidity and financial flexibility, are all affected by the choices that companies make regarding their working capital policies. Simplified, a solvent company has more assets than liabilities and to find out a companies solvency, the current ratio and net working capital can be used. Liquidity, a measure of companies’ ability to pay their short-term obligations without unnecessary costs, is evaluated using the measurements; cash flow from operations, cash conversion efficiency and cash conversion cycle. The third concept, the financial flexibility, is
measured by sustainable growth rate. A firm’s financial flexibility reflects a company’s ability to deal with unforeseen opportunities and adversities with regards to the company’s financial policies and structure (Maness & Zietlow, 2005, p. 25-45). These measurements, all evaluate working capital management in some way and for our study, we have chosen to use the cash conversion cycle as a measurement for working capital management.
The cash conversion cycle evaluates how fast companies’ activities of resources can be converted into cash and this measurement is used to evaluate a company’s liquid situation and how effective the working capital management is (Deloof, 2003). A shorter cash conversion cycle indicates a more effective managed working capital and it has lately become more common that companies has their goal set to achieve a zeroed working capital (Maness & Zietlow, 2005, p. 15). However, a goal of having a zeroed working capital is not the optimum for all companies as a liquidity level close to zero may result in a shortage of cash which could lead to difficulty in operations and in the ability of managing their financial short-term debts. With this in mind, each company should find the level between current assets and liabilities that will serve them most value (Maness & Zietlow, 2005, p. 5-9). As the effectiveness of the working capital management relies on the cash conversion cycle, companies should put their efforts in making their cash management more effective by reducing number of day accounts receivable, number of days inventories and raising number of days accounts payable (Theodore Farris II & Hutchison, 2003).
Management of working capital is an important component of corporate financial management because it directly affects the profitability of firms. Nwude (2004) states that management of working capital has a significant effect on firms profitability and liquidity, irrespective of the nature and size of the business. Smith (1980) concluded that working capital management is important because of its effect on firm’s profitability and risk, and consequently its value. Similarly, Deloof (2003) indicated that the way working capital is managed has a significant impact on profitability of firms. The above studies point out that there is a certain level of working capital requirement, which potentially maximizes firm’s returns. On the other hand, Kargar and Bluementhal (1994) mentioned that bankruptcy may be likely for firms that put inaccurate working capital management procedures into practice, even though their
profitability is constantly positive. Therefore, firms must avoid receding from optimal working capital level by bringing the aim of profit maximization in the foreground.
The ultimate objective of any firm is to maximize its profit. However, preserving liquidity of the firm is an important objective as well. The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm. Therefore, there must be a tradeoff between these two objectives (liquidity and profitability) of firms. One objective should not be at the cost of the other because both have their own importance. If firms do not care about profit, they cannot survive for a longer period. In other round, if firms do not care about liquidity, they may face the problem of insolvency or bankruptcy. For these reasons managers of firms should give proper consideration for working capital management as it does ultimately affect the profitability of firms. Indeed firms may have an optimal level of working capital that maximizes their value. Large inventory and generous trade credit policy may lead to high sales. Large inventory also reduces the risk of a stock-out. Trade credit may stimulate sales because it allows a firm to access product quality before paying (Long,
1993 and Raheman and Nasr, 2007). Another component of working capital is accounts payables. Raheman and Nasr (2007) indicated that delaying payment of accounts payable to suppliers allows firms to access the quality of obtaining products and can be inexpensive and flexible source of financing. On the other hand, delaying of such payables can be expensive if a firm is offered a discount for the early payment. By the same token, uncollected accounts receivables can lead to cash inflow problems for the firm.
A popular measure of working capital management is the cash conversion cycle, that is, the time span between the expenditure for the purchases of raw materials and the collection of sales of finished goods. Deloof (2003) found that the longer the time lags, the larger the investment in working capital, and also a long cash conversion cycle might increase profitability because it leads to higher sales. However, corporate profitability might decrease with the cash conversion cycle, if the costs of higher investment in working capital rise faster than the benefits of holding more inventories or granting more trade credit to customers.
In general, working capital management is not only improving financial performance in today’s cash-strapped and uncertain economy, but it is the question of meeting firm’s
day to day operation. Hence, it may have both negative and positive impact on firm’s profitability, which in turn, has negative and positive impact on the shareholders wealth.
Therefore, it is a critical issue to know and understand the impacts of working capital management and its influence on Petroleum marketing company’s profitability. Indeed, a lot of research has been conducted on this topic in other countries by using panel data (that is a data set in which the behavior of entities are observed across time) through multiple regressions to show the impacts of working capital components on petroleum marketing company’s profitability. However, to knowledge of the researcher, the cost of petroleum marketing companies has not been addressed. This limited evidence in the context of Nigeria along with the importance of working capital management calls for research on the impacts on Petroleum marketing company’s profitability. In light of the above points, the general objective of the study will be to examine or assess the impacts of working capital management on the profitability of Petroleum marketing sector firms in Nigeria.
1.2 Statement of the Problem
Working capital management is an important issue in any organization. This is because without a proper management of working capital components, it is difficult for the firm to run its operations smoothly. That is why Brigham and Houston (2003) mentioned that about 60 percent of a typical financial manager’s time is devoted to working capital management. Hence, the crucial part of managing working capital is maintaining the required liquidity in day-to-day operation to ensure firms smooth running and to meet its obligation (Eljelly, 2004). The existence and maintenance of working capital is the lifeblood of a corporation. Regardless of the size of the company, the management of working capital accounts should influence its financial health (Lifland 2011, p. 57).
In addition, Sankar 2011 states that Working capital can also be regarded as that portion of the firm’s total capital, which is employed in current operations. It refers to all aspects of current assets and current liabilities. Current assets are those assets, which in the ordinary course of business can be or will be converted into cash within one year without undergoing a diminution in value and without disrupting the operations of the firm. Working capital is essential to maintain the smooth running of business. No
business can run successfully without an adequate amount of working capital. Working capital refers to a firm’s investment in short term assets (Thappa, 2014).
The fundamental subject of working capital is to provide optimal balance between each element forming working capital. Most of the efforts of finance directors in a firm are the efforts they make to carry the balance between current assets not at optimal level and responsibilities to an optimal level (Lamberson, 1995). The most important of all, it is the determination of investment volume and to which asset it will be invested (Appuhami, 2008:11). One reason for this is the decisive influence of current assets on others, one another reason is the obligation of fulfillment of current responsibilities. Working capital necessity influences liquidity level and profitability of a firm. As a result, it affects investment and financing decisions, too. Despite the compounds of working capital that a company must have, basically depends on the company type and the sector in which it operates. Company size, growth rate and cash flow are the other important factors. If the determination factors are not explained fully and adequacy of working capital is undetermined, companies would be routed to bankruptcy (Appuhami, 2008:11, Ramachandran, Kanakiraman, 2009:64). Amount of current assets to be calculated at a level where total cost is of a minimum degree means an optimum working capital level. The optimum working capital level is the case in which balance between risk and efficiency is provided. A quest for such balance requires a constant monitoring of the elements forming working capital.
Poor management of working capital results to liquidity problems which might lead to bankruptcy in every severe case (Nwude, 2004:628). When organization has insufficient working capital, it will be difficult for them to survive in a competitive environment because they cannot be able to meet the needs of their customers and also their short term creditors and it also makes difficult the implementation of operating plans and achievement of profit target.
Further, working capital management has been major issue especially in developed countries. As a result, in order to explain the relationship between working capital management and profitability different researches have been carried out in different parts of the world especially in developed countries. However, despite the obvious importance this issue failed to attract the attention of researchers in Nigeria petroleum marketing sector. Thus, while browsing on internet, searching through the books and
journals the researcher did not find any research directly related to Nigeria petroleum marketing sector. Therefore, the researcher believed that, the problem is almost untouched and there is a knowledge gap on the area.
The traditional view of working capital management is to shorten the cash conversion cycle to
Increase profitability. However, if firm has higher level of account receivable due to the generous trade credit policy, it would result to longer cash conversion cycle. In this case, the longer cash conversion cycle may lead to increase in profitability but this cannot be applied to all circumstances. Hence, lack of proper research study in the area gives a chance for Nigeria petroleum market managers to have limited knowledge concerning working capital management relative to profitability. Therefore, by keeping the above problem in mind, the study tried to find out the impacts of working capital management and profitability on Nigerian petroleum market sector.
1.3 Objectives of the Study
The study aims to examine the impacts of working capital management on profitability of Petroleum marketing sector in Nigeria.
The Specific objectives are to assess the impact of
1. Inventory period on the profitability of Petroleum Marketing sector firms in
Nigeria.
2. Average Collection Period on the profitability of Petroleum Marketing sector firms in Nigeria.
3. Average payment Period on the profitability of Petroleum Marketing sector firms in Nigeria.
4. Cash Conversion cycle on the profitability of Petroleum Marketing sector firms in
Nigeria.
1.4. Research Questions
To address these objectives, the following research questions have been formulated:
1. How far does Inventory period impact on the profitability of petroleum marketing sector firms in Nigeria?
2. To what extent does Average Collection Period impact on the profitability of petroleum marketing sector firms in Nigeria?
3. To what extent does Average payment period impact on the profitability of petroleum marketing sector firms in Nigeria?
4. How far does Cash conversion cycle impact on the profitability of petroleum marketing sector firms in Nigeria?
1.5. Research Hypotheses
To examine the questions raised above, the following are the research hypotheses:
1. Average Collection Period does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.
2. Inventory Period does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.
3. Average payment Period does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.
4. Cash conversion cycle does not have a positive and significant impact on the profitability of petroleum marketing sector firms in Nigeria.
1.6 Scope of the Study
The research covers the six major oil marketers out of the total of nine petroleum marketers that were quoted on Nigeria Stock exchange. These firms include Fort Oil plc, MRS plc, Mobil plc, CONOIL plc, Total plc, Oando plc. The sample was chosen because three of the quoted firms were acquired by the two major marketers and this made the remaining six marketers to be the only petroleum marketers that have the complete annual report and accounts with Nigeria Stock Exchange. It is the availability of these annual reports that guided the researcher’s choice of companies in this study. The sample covered fourteen fiscal years, 2000-2013.
1.7 Significance of the Study
Much has been written and studied about working capital management and profitability of the firm in different country, but this research add some insight about this issue as related to Nigeria as a country and petroleum marketing company in particular. The significance of this study can be viewed in two ways, the practical and academic significant.
(a) Practical significance
It benefits the top managers and policy makers of those selected companies regarding decision on optimum level of working capital, ways of managing it and overall policies on working capital management.
It gives clear understanding about the relationship between working capital components and corporate profitability.
It gives brief information for the shareholders, prospective customers and creditors of a firm regarding profitability in relation to efficient working capital management and policy.
(b) Academic significance
In academic area, the study helps as a guideline for those who will conduct their study on the topic similar but in different sectors. Finally, the study benefits researchers to obtain new knowledge from the added literature based on petroleum marketing companies.
This material content is developed to serve as a GUIDE for students to conduct academic research
WORKING CAPITAL MANAGEMENT AND PROFITABILITY IN NIGERIA PETROLEUM MARKET SECTOR (2000-2013)>
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