Role Of Working Capital Management In Financial Performance Growth Of Organization
Corporate finance traditionally focuses on the role that long-term financing decisions play in the functioning of a business. In fact, researchers have particularly offered empirical findings analyzing capital investments, capital structure, dividend policies or company value, among other topics. Yet, a significant portion of a firm’s capital structure is represented by short-term assets and other resources that mature in less than a year (Garcia-Teruel & Martinez-Solano, 2007). This implies that the financial management of a business hinges on the management of its short-term operations which then drive to the long-term goals.
The management of working capital and the role it plays in advancing financial performance continues to steer debate among scholars and practitioners alike. Several authors agree that this process manages the firm’s short-term assets and liabilities in a manner that creates an asset-liability imbalance, which inherently increases profitability, at the risk of possible insolvency (Dalayeen, 2017; Ngwenya, 2010; Padachi, 2006). Others believe that it is the optimal mix of the firm’s current-to-total assets which determines the firm’s willingness towards risk (Sharma & Kumar, 2011; Nazir & Afza, 2009). In both instances, the firm has to manage the amount of liquidity since the latter impairs its chances of sustained profitability and growth (Beaumont-Smith & Fletcher, 2009).
The current thrust of empirical study on the relationship between working capital management (WCM) and financial performance is directed towards informing policy on the appropriate current asset-liability mix which maximizes a firm’s profitability while minimizing its risk (Jajongo & Makori, 2013). Yet, no general consensus currently exists on this issue because firms exist in unique economic environments that influence their working capital management decisions differently. Further, it is notable that a significant portion of the existing research concentrates on developed rather than on developing economies (Qurashi & Zahoor, 2017; Samiloglu & Akgun, 2016; Garcia-Teruel & Martinez-Solano, 2007; Deloof, 2003). It is then debatable whether the working capital methodologies used on firms in the developed economies apply to firms within the developing economies whose contrasting economic conditions affect them in distinct ways.
In Africa, recent literature on working capital focuses on West and East African countries with scanty studies on Southern Africa (Ayako, Kungu, & Githui, 2015; Akoto et al., 2013; Mathuva, 2010). South Africa is one of the emerging economies on the continent and boasts a high growth trend among medium to small business enterprises. Yet, most of its studies on working capital management appear to be either out dated or focused on an aspect of working capital that does not directly relate to financial performance.
Notable works in this regard include studies by Enow and Brijlal (2014), Ngwenya (2010), Erasmus (2010), Beaumont-Smith and Fletcher (2009). While the contributions made by these authors cannot be ignored, an investigation into the current working capital management (WCM) practices is necessary to capture the latest developments in this vital aspect of business operations. Such knowledge will help to inform current policies, practices and future literature on working capital management within the context of South Africa.
Working capital management is part of the financing considerations that a finance manager of a corporation needs to determine, besides capital structure and capital budgeting (Ross, Westerfield and Jordan, 2010). In view that each company emphasized on maximizing profitability that can be generated from their business operation, many studies had been conducted on the effect of capital structure and working capital management in determining the profitability, which the results varies based on the study undertaken. In this study, working capital management components and working capital management policy are analysed on their effect towards the firm’s profitability.
Meanwhile, in determining the firm’s profitability, the finance manager also need to take into account the firm’s working capital management, which basically means managing the firm’s current assets and current liabilities at satisfactory level (Dong and Su, 2010; Gill, Biger and Mathur, 2010). Generally, in a balance sheet, current assets consist of raw materials, work in progress, finished goods or inventories, account receivables, cash and bank balances which are short term in nature that are used for production and sales; which are able to be converted to cash within the year. On the other hand, current liabilities refer to obligations that need to be paid within the year or not beyond the business operating cycle, whichever is earlier (Ross, Westerfield and Jaffe, 2005).
Generally, current liabilities comprise of accounts payable, accrued wages, taxes and other expenses payable and short-term debt. Hence, it is vital in managing the working capital efficiently as it is able to increase the firm’s profitability and shareholder value (Smith, 1980; Deloof, 2003, Dong and Su, 2010). Furthermore, the benefits of having an efficient working capital management are the firms able to meet its short-term obligations and maintain adequate liquidity position in order to continue the operation of the firms (Eljelly, 2004).
In view that working capital management decision is important factor as it determines the firm values maximisation and shareholders wealth; many researches had conducted various studies to examine on the relationship between working capital management and firm’s performance over the last decades. However, the findings are inconsistent for different studies carried out by numerous researchers and are performed separately.
Cite this Essay
To export a reference to this article please select a referencing style below