CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Working capital usually referred to as the life wire of a company is made up of those resources which are capable of being converted into cash. The efficient management of working capital is pre-requisites for overall operational efficiency of a company. “Working capital is not current asset”. It is the difference between current assets and current liabilities. Any transaction that increases the amount of working capital is source of working capital. The various components of working capital management cannot be separated from fundamental decision of investment and financing, the takes of the financing manager in managing working capital effectively, to ensure sufficient liquidity in the operations of the company. A company’s liquidity is measured by the ability to satisfy short-term financial obligations as they are done. The net working capital is one of the measures of a company’s liquidity other measures include the current ratio and acid test ratio. “The net working capital has been commonly defined as excess of current asset over current liabilities”.
Effective working capital management requires that a company should operate with some net working capital, though the exact amount varies from one company to another. The theoretical justification for the use of net working capital to measure a company’s liquidity is based on the assumption that the greater margin by which the current assets cover the short-term obligation when they fall due payment. The net working capital is quite useful in internal control, though not quite for company comparison of performances. The greater the net working capital, the more liquid the company is and the less it is to become insolvent.
Most profitable companies have failed because of improper management of working capital, especially cash and accounts receivable. The management of these resources is a balancing problem and this problem stems from the fact that the relationship between cash flow and profitability is not fully understood. The privilege economic condition in Nigeria today calls for a more serious attention in the effective management of working capital in companies. The unprecedented oil boom of the early seventies in Nigerian economy has come and gone. The sudden down-turn in the price of oil the backbone of out natural economy culminated in our present economic woes. This is manifest by the rapid rise in unemployment, price and interest rates, coupled with fluctuations in the exchange value of our currency at the foreign exchange market. Profitability and liquidity of companies has been effected by this development.
Therefore, effective management of working capital has necessarily become a test that should be given such importance, more ever than before in any company. It should be noted that companies would do better by tying down less funds in receivables. However, economic considerations and circumstance often makes it difficult to keep these items down as far as most companies would wish. Frequent examination of the size, competition and significant change in not working capital would assist financial managers to achieve the much desired balance between profitability and liquidity.
1.2 STATEMENT OF PROBLEM
The management of inter-relationship existence between assets and liabilities has been the primary problem of working capital management. Effective working capital management involves sourcing of funds for the management daily operations of companies. Every company need to maintain a satisfactorily level of working capital or it would go into banking and finally wound up. However profitability liquidity and other related risks have been a major problem facing companies in our depressed economy. This is an important characteristics of working capital management maintaining a large size of current asset would improve the liquidity positive of the company but profitability would be adversely affected as funds remain ideal. Conversely, if a company’s holding asset are relatively small the overall profitability will no doubt increase, but this will have an adverse effect on the company’s overall performance. Including its liquidity position and thus making the company more risky. Working capital management should therefore aim at striking a balance between the liquidity and profitability positions of the company by ensuring that right combinations of current assets and liabilities are held at each point in time for a better performance.
