Introduction
1.1 Background to the Study
The sustainability of a firm heavily depends on the ability and success of its financial management function (Karaduman, H. A., Akbas, H. E., Caliskan, A. O., & Durer, S. 2011). Traditionally, corporate finance involves capital budgeting, capital structure and working capital management. However, working capital management is also a very important field of corporate finance, because of its considerable effects on the firms profitability and liquidity (Nazir and Afza, 2009 and Alshubiri; 2011) In order to maintain its activity, firms typically need two types of assets: fixed assets and current assets. Fixed assets which include, building, plant, machinery, furniture, fixture and fitting among others are not only purchased for the purpose of resale, but also for operational purposes (Singh and Pandey, 2008). On the other hand, current assets are seen as key components of the firm’s total assets.
The economic theory of firm requires that firm resources should be utilized efficiently in order to achieve economic successes. Moreover, the competitive modern business environment makes financial managers irrespective of the nature of their business to ensure efficient utilization of firm resources. Firm resources are broadly classified into two, long-term assets (non-current assets) and short-term assets (current assets). Therefore, there are two major decisions in theory of corporate financial management, that is, the long-term or capital budgeting decision and the short-term or working capital management decision (Pandey, 2009). Although long-term capital decisions are of critical importance to the going-concern of a firm, workings capital management has direct consequences on the liquidity position and the ultimate profitability of a firm (Burt and Abbate, 2009).
Working capital connotes the funds locked up in materials, work in progress, finished goods, receivables and cash. Therefore, working capital is one of the most important measurements of the financial position, which according to Guthmann (2008) is the life-blood and nerve centre of any business entity. This necessitated the need for the careful management of working capital in every business organization with the value maximization objective.
Therefore, working capital management involves the application of strategies and policies in the use of firm’s current assets and liabilities in such a way that an optimum level of working capital is maintained. In essence, the goal of working capital management is to promote a satisfying profitability and maximizes shareholders’ value (Li and Han-Wen, 2006). In essence, managing working capital is necessary because of its’ directs effects on the profitability and liquidity of a corporate entity. Rehn (2012) asserts that working capital usually refer to net working capital, the difference between current assets and current liabilities. Thus, it involves minimizing the timing of collecting receivables, deferring the period of payables, cash management and keeping the minimal inventory.
However, optimal efficient working capital management is usually achieved through the management of receivables, payables, inventory, cash conversion cycle and the operating cycle as a whole. A firm therefore needs to set an optimal level of stock to hold. Working capital management is considered as a very sensitive area in the field of financial management (Joshi, 1994); because it involves the decision of the amount and composition of current assets and the financing of these assets. However, most firms do not hold the correct amount of working capital and this has been a major obstacle to their overall profitability (Stephen, 2012). This together with the current liquidity crisis has highlighted the significance of working capital management.
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