the effects of working capital management on the performance of an agro-based corporation: the Cameroon Development Corporation

CHAPTER ONE

INTRODUCTION

• Background of the Study

Some enterprises succeed and others fail. The success or failure of these enterprises is caused by different economic factors. These factors are linked to managerial, human capital, material and financial aspects. In order for business sustainability and the attainment of business mission statement by an entity, it is but fundamental that effective planning and financial management is required of its working capital. This implies that, the success or failure of any business significantly depends on how well it manages its working capital. An adequate management of working capital is most likely to lead to the success of a business on the one hand mean while on the other hand, if working capital is not well managed, it could probably cause a business failure. Working capital is usually referred to as a managerial tool which is used to shape the functioning of a business and if adequately managed, it will of course improve on the profitability as well as the liquidity of a business. According to Harris (2014), working capital management is a simple and straight forward concept of ensuring the ability of the firm to fund the difference between the short term assets and short term liabilities.

In order to monitor and better analyze the performance of a firm as it carries on its day to day activities, working capital management is a very important tool used by management to conduct such an analysis. This monitoring and analysis strives to strikes a balance between the liquidity and profitability of the business as these are the two main aspects of performance taking into consideration as regards to performance in the management of working capital. Nowadays, working capital management is a central issue in the management of firms and managers are trying by the day to identify the basic drivers and an adequate level of working capital to maintain in a business in other to guarantee firms performance (Lamberson, 2013).

Furthermore, working capital management refers to all management decisions and actions that ordinarily influence the size and effectiveness of the working capital (Kaur, 2010). It is a managerial accounting strategy which focuses on maintaining efficient levels of current assets and liabilities to ensure that a firm has sufficient cash flows in other to meet its short term obligations. WCM is an essential part of financial management and it contributes significantly to a firm’s wealth creation as it influences the profitability of the firm as well as its liquidity (Raheman and Nasr, 2010; Naser et al, 2013). The most important issue of WCM is liquidity in the day-to-day operations of the firm. This is crucial as it prevent creditors and suppliers whose claims are due in short-term from exerting unwarranted pressure on management and thus ensure the smooth running of the firm. This suggests that the main objective of WCM is to ensure the maintenance of a satisfactory level of working capital in a way that will prevent excessive or inadequate availability of working capital (Filbeck and Krueger, 2015). It is important for us to note that, insufficient WCM may not only reduce profitability but lead to financial crisis and its associated effects. As stipulated by Padachi (2015), the management of WC is important for the financial health of all businesses regardless the size or nature of the business. Specifically, in the manufacturing sector where our case study is suited, large amounts of money is often invested in inventory and work in progress which are key components of working capital and thus adequate management  of these resources is paramount if the firm must succeed financially.

Among other things, sound WCM ensures that organizations have the ability to meet their short term liabilities adequately and on time. This further makes it possible to curb the situations where firms have accumulated idle resources which may not generate any income or as indicated earlier prevent unavailability of sufficient financial resources needed for meeting short-term financial obligations. Thus this therefore explains why it is often argued that efficient WCM is very crucial in achieving the over-arching goal of the firm, which is shareholders value maximization. It should be noted that, an excessive level of current assets may have a negative effect on the firm’s profitability whereas a low level of current assets may lead to a low level of liquidity and stock outs resulting in the difficulties in maintaining smooth operations (Van Horne and  Wachowicz, 2010).

Given the fact that securing other sources of income in our country today to finance company activities is becoming difficult by the day, it has become imperative therefore for businesses in Cameroon to efficiently manage their working capital in other to become profitable. The importance of WCM by manufacturing firms cannot be over emphasized as this is extremely needed to boost profitability and boost expansion, which are prerequisites in solving the country’s unemployment issues and ensuring economic stability. Supporting this point, the World Bank Annual Report (2014) holds that, developing counties can considerably resolve their socio-economic challenges when they take significant step in reviving and developing their manufacturing base.

This field of working capital management comprises decisions about the amounts and combination of current assets and how they are financed.  WCM is a process which takes into consideration different aspects of cash investment, the maintenance of a certain level of inventories to carter for customers as well as production and the management of receivables and payable accounts. One of the goals of working capital management is to reach and keep an optimized balance between components of working capital (Gitmen, 2011). Therefore, business success heavily depends on the ability of financial executives to effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2015)

• Problem Statement and Justification of Study

The primary objective of a firm is to increase by any means possible the wealth of its shareholders. One of the measure determinants of the value of a firm is its profitability. The working capital management of a firm affects its profitability, risk and consequently its value (smith, 2012). Working capital is focal in maintaining liquidity, survival, solvency and profitability of a firm (Mukhopadhyay, 2014).

In the studies conducted by Deloof (2013), Raheman and Nasr (2010) and Teruel and Solano (2014), it was concluded that a negative relationship exist between profitability of a firm and its Cash Conversion Cycle (CCC). Thus it is possible to increase a firm’s profitability through more efficient working capital management. According to Soenen (2013), the negative relationship between working capital components and profitability of a firm is different for different industries. Most studies conducted on the relationship between working capital management and profitability predominantly identify return on asset (ROA) as the appropriate measure of profitability but according to Deloof (2013), profitability should be measured by gross operating income divided by total assets less financial assets. He argues that for a number of firms, financial assets which are mainly shares in other firms are a significant part of total assets. For that reason, ROA should not be used as a measure for profitability for such firms since their operating activities will contribute little to the overall ROA.

Working capital management is used to ensure that companies are able to fund the difference between short term assets and short term liabilities. Many financial managers have a problem of recognizing the core drivers of working capital as well as difficulties in measuring the adequate level of working capital. The consequence of this inability is that companies are limited in their ability to minimize risk, effectively prepare for uncertainty and improve overall performance. To accomplish these perspectives, companies need to understand the role and drivers of working capital, alongside taking appropriate measures in ensuring that adequate levels of working capital is reached (Harris, 2014).

The purpose of working capital management is to keep an optimum level of both working
capital components (current assets and current liabilities). An optimum level refers to a
balance between risk and efficiency (Filbeck and Krueger, 2015). According to others (Shin
and Soenen, 2013) efficient and effective working capital management refers to keeping a
balance between liquidity and profitability, because decisions that tend to maximize
profitability tend not to maximize the challenges of adequate liquidity. On the other hand,
focusing almost entirely on liquidity will tend to reduce the potential profitability of a
company. When companies focus on liquidity, they increase the level of investment in current
assets, meaning that there will also be an increase in total assets. If return on investment (net
profit/total assets) is used as a measure of profitability, than it becomes clear that when total
assets increase as a result of the investment in current assets, the profitability of a company
will decrease.

In times of financial uncertainty it is most likely that companies will shift their focus from
maximizing profit to entirely focusing on liquidity to continue their day-to-day operations.
This could have consequences for the profitability of companies. It is important that
companies give WCM proper consideration, because it can make the difference in times of
financial uncertainty.

Working capital management is very important to the smooth running and functioning of a company. It assures success and guarantees continuity of the business’ livelihood. All companies aim at exploiting their full capacity so as to optimize profit and ensure continuity. In other for this to happen, it is prerequisite that companies sufficiently manage their working capital. The proper management of working capital ensures an uninterrupted production level which failure to have this might lead to customer loss, failure in the timely delivery of orders, breaks in the production chain to name a few.  This study therefore is expected to establish a framework that incorporates various components of working capital in a manner that optimizes and stabilizes profitability and liquidity in order to ensure the maximization of shareholders wealth. In order to set up such a framework, the following research questions guides the study.

• What is the relationship between the set of determinants of working capital management and CDC’s performance (ROA)?
• What is the effect of Working capital management determinants on the performance of CDC?
• How does current ratio affect the financial performance of the Cameroon Development Corporation?
• What trend pattern has CDC’s working capital determinants taken over the years?
• What are the challenges CDC faces in the proper management of its working capital?

1.3 Objectives of the study

The main objective of the study is to critically examine the effects of working capital management on the performance of an agro based corporation like the Cameroon Development Corporation using data from the corporation for a period of 24 years (1990 – 2014). In order to achieve this; the following specific objectives are relevant.

• To assess whether there is a significant relationship between the set of determinants of working capital management and CDC’s Performance (ROA).
• To examine the effects of working capital management on CDC’s performance.
• To evaluate the effects of CDC’s current ratio on its financial performance
• To analyze the trends of CDC’s working capital determinants
• To determine the challenges which CDC faces in the proper management of its working capital.
• To make recommendations based on the findings on how to ameliorate working capital management in CDC.