1.1 Background To The Study

Working Capital management of a firm, which deals with the management of current assets and current liabilities, has been recognized as an important area in financial management. Working capital (WC) refers to the firm’s investment in short-term assets. Pandey, (2005) classified working capital into gross and net concepts. He defined gross working capital as the firm’s investment in current assets. Current assets are the assets which can be converted into cash within an accounting year and these include; cash, short-term securities, debtors, bills receivables and stocks. He described net working capital as the difference between current assets and current liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year. These include trade creditors, bills payable, bank overdraft and short- term loan. Home van, (2000) described working capital management as involving the administration of these assets namely cash, marketable securities, receivables and inventories and the administration of current liabilities.

Management of these short-term assets and liabilities is important to the financial health of business of all sizes. This importance is hinged on the fact that the amounts invested in working capital are often high in proportion to the total assets employed and therefore warrants a careful investigation (Smith, 1980). Working Capital therefore, should neither be more nor less, but just adequate for the smooth running of a firm. While excess amount of working capital results in the reduction of firm’s profitability, holding of inadequate amount of it leads to lower levels of the firm’s liquidity and stock outs resulting in difficulties in maintaining smooth operation (Krueger, 2002).

Business success, therefore, heavily depends on the ability of the financial managers to effectively manage accounts receivable, inventory and account payable (which are component of working capital) (Filbeck and Krueger, 2005). Firm can reduce their financing costs and or increase the funds available for expansion of project by minimizing the amount of investment tied up in current assets (Home Van Wachowicz, 2004). For this reasons, most of the financial manager’s time and efforts are spent in identifying the non-optimal levels of current assets and liabilities and bringing them to optimal levels (Lamberson, 1995). An optimal level of working capital is the one in which a balance is achieved between risk and efficiency. To maintain the optimal level of various components of working capital, continuous monitoring is required (Afza and Nazir, 2009).

A poor or inefficient working capital management leads to tie up funds in idle assets and reduces the liquidity and profitability of a company (Reddy & Kameswar, 2004). Siddart & Das (1993), states that the major reason for slow progress of an undertaking is shortage or wrong management of working capital. Deloot (2003: 573), states that “there is a significant relationship between gross operating income and number of days of account receivable, inventories and accounts payables”. The relationship between accounts payable and profitability is consistent with the view that less profitable firms wait longer to pay their bills.

Considering the importance of Working Capital Management therefore, the researcher focused on evaluating the Working Capital Management and profitability relationship like other similar works such as Uyar, 2009; Samiloglu and Demirgune 2008; Vishnani and Shah, 2007; Tervel and Solano, 2007; Lazaridis and Tryfonidis, 2006; Padachi, 2006; Shin and Soenen, 1998; Smith et al, 1997 and Jose et al, 1996. However, there are a few studies with reference to Nigeria in respect of the subject. Like Akinsulire, 2005, Falope,, 2009, Ajilore,, 2009 etc.

Most of these studies focused on the Working Capital Management financing policies. Shah and Sana (2006) concentrated on the oil and gas sector and estimated the relationship using small sample of 7 firms. Raheman and Masr (2007) analyzed profitability and Working Capital Management performance of  94 firms listed on Karachi Stock Exchange for the period 1999-2004 by using ordinary least square and generalized least square. However, this study ignored the fixed effect of each firm as each firm has its unique characteristics and also ignores sector-wise analysis of Working Capital Management performance of manufacturing firms. Insufficient evidences on the firm’s performance and Working Capital management with reference to Nigeria therefore, provide a strong motivation for evaluating the relationship between working capital management and firm’s performance in detail. This study therefore, explores the various way of measuring Working Capital components and relates them to the performance of the Nigerian manufacturing sector.

1.2 Statement Of The Problem

There has been a growing number of studies that examined the relationship between working capital and corporate profitability in the recent time (Shin and Soenen, 1998; Deloof, 2003; Fildbeck and Krueger, 2005; Falope, 2009; .Jinadu, 2010). Justification for this common efforts centered on the relationship between efficiency in working capital management and firms profitability and its implications on shareholder’s value. Most of these studies were however, centered on large firms operating within well developed money and capital market of developed economies and did not consider the fact that the amount of working capital required varies across industries and indeed firms depending on the nature of business, scale of operation, production cycle, credit policy, availability of raw materials etc (Ghosh and Maji; 2004).

It is regrettable to note that in spite of these huge literatures in this area, many firms had crashed, more especially manufacturing sector of the Nigerian economy in which application of working capital is more pronounced (Jinadu, 2009). In addition, some promising investments with high rate of return are failing and  being frustrated out of business because of inadequacy of working capital. Many factories had been either temporarily or completely shot down because they could not meet their financial obligations as at when due because they were not liquid. Many Nigerian workers had been forcefully thrown into unemployment market and frustratingly became dependent on relations as a result of the aborted mission of their organization caused by poor attention given to the management of working capital . Unfortunately, Nigeria capital and money markets are not really helping to ameliorate the problem, instead, more often than not; they compound the problem by creating bottleneck with harsh conditions that could not be easily met by the companies that are at the verge of collapse.

The problem then arises as to how managers of these manufacturing organization could be encouraged to pay more attention to the management of their working capital. In other words, how could working capital be managed in order to impact positively on firms performance.