Working Capital Management
Background information
Working capital refers to the funds that are used to meet short-term responsibilities or the funds used to carry out the day-to-day activities of an organization. The management of these resources is equivalently important as the management of the long term finance funds. The management of the working capital is fundamental in making sure that the operations of the organization are smooth. This is mainly because the management of these funds ensures that there is effective use of resources (Lazaridis & Tryfonidis, 2006).
In every business, working capital is an important and critical part of an investment because it is impossible for an organization to run without these funds. Organizations requires adequate raw materials, finances to pay for labor, funds to create a stock to meet the demands of the consumers and the ability to provide goods on credit for its customers. All these are financed by working capital. Subsequently, working capital can be defined as the major determinant of the organizations survival or it can also be defined as the lifeblood of an organization’s operations (Juan García-Teruel & Martínez-Solano, 2007). Businesses are unable to operate without adequate working capital. This necessitates the research on the management of these funds in an organization.
Working capital has been an area of interest to many researchers, particularly because of the effect of the funds on the operations of an organization. During the times of recession organizations seek strategies that can be helpful in the improving the chances survival of the organization. External market factors play a role in the organization operations and the organization has minimal or no control of these factors.
This makes it important and critical to manage the working capital to facilitate and allow the organization to survive and increase their performance in these conditions. This is particularly important in large organizations where the management of working capital prevents liquidity problems and improves the capacity of the organization to manage in severe financial problems or any other unexpected change (Padachi, 2006).
Working capital is important because it allows the organization to maintain a production schedule and maintain sales, which are the major concerns of an organization. These are also the major determinants of an organization’s survival. The lack of a proper working capital interrupts the production process andincapacitates the organization, which may lead to the foreclosure of the business. The capacity to provide credit sales to the market is important in sales promotion, without adequate working capital, the organization is unable to provide credit sales since it is dependent on the available funds for the production process (Nazir& Afza, 2009).
This limits the number of sales that the organization can make and collectively this reduces the chances for the organization’s survival or demise. Poor management of the working capital impairs the operations of an organization and affects the profitability and the survival of the organization. This necessitates the research on proper mechanisms to manage these funds to ensure that the management of the organization pays the issue enough emphasis.
Working capital is important in maintaining sound profitability and liquidity levels. The current economy has made an increase the cost of capital and subsequently, this has necessitated more emphasis to be placed on working capital management. Increase in the working capital allows the organization to run with minimal external funding. This use of working capital in the day-to-day operations is efficient and affordable as compared to external funding.
This has made the management of working capital important to the management to ensure that the organization is profitable and maintains a high level of liquidity (Samiloglu & Demirgunes, 2008).The management main role is to ensure that a business is profitable and is in a capacity to meet its obligations. This makes the study and research on working capital management important to facilitate the achievement of the goals.
Investors play a vital part in financing the operations of an organization. The rate at which investors find an organization or investment to be attractive is determined by the risk and the profitability of the organization. The working capital is major determinant of the risk of an organization or an investment. An increase in the working capital of an organization indicates that investing in the organization is not risky because the organization has a greater chance of survival as compared to a similar investing operating on a lower working capital. The working capital of an organization is also a major determinant of the profitability of the organization (Boisjoly,2009) Consequently, the determination of strategies to manage the working capital effectively is very important to ensure that the organization attracts investors by increasing its profitability and reducing its risk.
According to Boisjoly (2009), working capital management refers to the ability of the management of an organization to manage the short-term capital available to operate the day-to-day activities effectively. Proper management of the organization’s working capital allows the organization to gain a higher market share and maintain good liquidity levels. The author describes the major components of working capital as cash received, receivables, and inventory. The management of the three components ensures that the organization is operating on a favorable working capital.
Growth of a business is a major concern for the stakeholders of the organization. The growth of an organization is characterized by its profitability and ability to survive and gain more market share. The study and evaluation of working capital management is very important because these funds play an important role in determining the profitability, survival, and ability of the organization to gain more market share. It is also vital in the declaration of dividend, evaluation of the employees’ remuneration and the development of a new product line. Collectively, working capital affects all the stakeholders in an organization. This makes the management of these funds important to ensure that every need of the stakeholders is met sufficiently.
Problem Statement
Working capital is established as an important part of an organization. It is a major determinant of the organization’s profitability and liquidity levels. Research indicates that a high number of the US startup Companies with an increased capital had dropped 744 in the 1990’s to 526 in 2001-2011(Mulcahy, Jobs, Zuckerberg, &Brin, 2013). Many businesses are finding it hard to manage their working capital, which is a major influence in the foreclosure of businesses. This is as reported by Security exchange commission, which published a report indicating that fifty percent of the businesses fail due to lack of proper and effective working capital management strategies (United State Securities and Exchange Commission, 2013). The overall problem is the lack of profitability and growth among organizations because of poor management of the working capital of organizations, which results to customer dissatisfaction, and the decreased sales of the company.
Purpose Statement
The study seeks to evaluate the importance of working capital in the profitability of an organization. It also identifies the various components that make up the working capital. The study seeks to identify strategies that may be adopted to manage the working capital. To establish the study adopts a qualitative and research methodology. This allows the study to develop concepts that can be utilized to manage capital. The variables that are studied in the research include working capital management techniques and profitability.
The study seek to identify the working capital management techniques that will improve the management of these funds and lead to increased performance in terms of profitability and the growth of the organization. The study will use two companies in the service and manufacturing industries. This will provide a wide perspective on ways to manage capital and raise funds in the two types of industries. The study will help improve the performance of organization facing working capital management problems. The study seeks to identify the mechanism that can be adopted by the managers in these businesses, which will contribute the survival and performance of organizations subsequently leading to an improved economy.
Research questions
1. What is the role of working capital in the operations of an organization?
2. What are the effects of poor working capital management strategies?
3. What are the strategies adopted in the management of the working capital in an organization or business?
4. What is the relationship between the performances of an organization to the implementation of effective working capital management strategies?
Theoretical and conceptual framework
Working capital management can be classified into four the management of the inventory, receivables, and cash received and accounts payable in an organization. Inventory is the stocks available in an organization. Working capital management requires that the inventory‘s ordering and holding cost are minimized. Subsequently this will reduce the stock out cost(Deloof, 2003).Cash received is a major factor in the working capital. This is very important in the daily operations of the business. The proportions of assets that are in cash in most cases are very small however, it is very important to manage this asset for the solvency of the business(Jeng-Ren & Han-Wen, 2006).
Receivables management is very important in maintain an effective working capital. Organizations sell their products and services on credit basis to increase the sales of the organization. Investment in this type of current assets requires that the proper and effective management of the costs that may arise. The management of the resource requires that the management maintain a level of credit that will generate more income than the cost and risk of issuing this credit. This also ensures that the gap between the cost of the products and the sale are high to ensure that there are increased profits (Eljelly, 2004).
The objective of working capital management is to create a balance between the current assets and liabilities of an organization. This balance should be favorable to the company and ensure that the company will gain the most value. This balance should ensure that the company increases its profitability and the liquidity is desirable (Uyar, 2009).Finally, there is the management of accounts payables. The payables are major determinants of the working capital in an organization. An increase in the accounts payable leads to the depletion of the working capital. The management of working capital entails the management of the timing of payments.
Significance of the study
The study defines working capital and elaborates on the importance of these funds in the performance of an organization. It elaborates on the way in which the management of working capital influences the performance and profitability of the organization. It emphasizes on the review and analysis of tan organizations working capital. This allows the management of an organization to identify the relationship between working capital and the profitability and overall performance of an organization. Subsequently motivating the managers to invest time into the field, this would later lead to improved performance.
The study will play a vital role in businesses. This is because it offers strategies that will be adopted in the management of the working capital of an organization. Working capital is established to influence the profitability and growth of an organization, which are the major objectives of the organization. Subsequently the study provides mechanisms that will be adopted to improve the profitability and overall performance of the organization.
The study contributes to the theoretical framework and acts as a reference points for future studies in the field. Working capital is a broad area that affects the performance of an organization. Consequently, it attracts many researchers to identify various problems in the field and develop possible solutions. The study will act as a reference point to various studies and contributes to the theories available in the field.
References
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Deloof, M. (2003). Does working capital management affect profitability of Belgian firms? Journal of Business Finance & Accounting, 30(3/4), 573-587.
Eljelly, A.M.A. (2004). Liquidity – profitability tradeoff: An empirical investigation in an emerging market. International Journal of Commerce & Management, 14(2), 48- 60.
Jeng-Ren, C., Li, C., & Han-Wen, W. (2006). The determinants of working capital management. Journal of American Academy of Business, Cambridge, 10(1), 149- 155.
Juan García-Teruel, P., & Martínez-Solano, P. (2007). Effects of working capital management on SME profitability. International Journal of Managerial Finance, 3(2), 164-177.
Lazaridis, I., & Tryfonidis, D. (2006). Relationship between working capital management and profitability of listed companies in the Athens stock exchange. Journal of financial management and analysis, 19(1).
Lazaridis, I., & Tryfonidis, D. (2006). Relationship between working capital management and profitability of listed companies in the Athens stock exchange. Journal of Financial Management and Analysis, 19(1), 26-35.
Mulcahy, D., Jobs, S., Zuckerberg, M., & Brin, S. (2013). Six myths about venture capitalists. Harvard Business Review.
Nazir, M. S., & Afza, T. (2009). Impact of aggressive working capital management policy on firms’ profitability.
Padachi, K. (2006). Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms.International Review of business research papers, 2(2), 45-58.
Samiloglu, F., & Demirgunes, K. (2008). The effect of working capital management on firm profitability: Evidence from Turkey.
Untied State Securities and Exchange Commission (2013) The Investor’s Advocate: How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation. Retrieved from Unites State Securities and Exchange commission: http://www.sec.gov/about/whatwedo.shtml#.VMWdrf7F9dQ.
Uyar, A. (2009). The relationship of Cash Conversion Cycle with Firm Size and Profitability: An Empirical Investigation in Turkey, International Research Journal of Finance and Economics, 24, 186-192.
