CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Working capital management of a firm has been recognized as an important area in financial management. The main goal of working capital management is to teach and keep an optimized balance between each component of working capital (Gitmen, 2009). Traditional concept of working capital is the difference between current assets and current liabilities, which does not provide an accurate concept of corporate liquidity. Every organization whether profit oriented or not and irrespective of size and nature of the business requires necessary amount of working capital. Working capital is the most crucial factor for maintaining liquidity, survival, solvency and profitability of business (Mukhopadhyay, 2004). All individual components of working capital include cash, marketable securities, account receivables and inventory management play a vital role in the performance of any firm. In the management of working capital, the firm is faced with two key questions.
First, given the level of sales and the relevant cost considerations, what are the optimal amounts of cash assets, account receivable, and inventories that a firm should choose to maintain? Second, given these optimal amounts, what is the most economical way to finance these working capital investments? To produce the best possible returns, firms should keep no unproductive assets and should finance with the cheapest available sources of funds. Corporate performance is a composite assessment of how well an organization executes on its most important parameters, typically financial, market and shareholder performance. It is a subset of business analytics /business intelligence that is concerned with the health of the organization, which is traditionally measured in terms of financial performance.
However, in recent years, the concept of corporate health has become broader. Liquidity and profitability are two important and major aspects of corporate business life (Dr K.S.Vataliya, 2009). The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm. Therefore, there must be a trade-off between the liquidity and profitability of firms. One of these should not be at the cost of the other because both have their own importance. If firms do not care about profit, they cannot survive for a longer period. Also, if firms do not care about liquidity, they may face the problem of insolvency or bankruptcy. For these reasons, managers of firms should give utmost consideration for working capital management as it does ultimately affect the profitability of firms. As a result, companies can achieve maximum profitability and can maintain adequate liquidity with the help of efficient and effective management of working capital. In addition, the effective working capital management is very important because it affects the performance and liquidity of the firms (Taleb et al., 2010). The main objective of working capital management is to reach optimal balance between working capital management components (Gill, 2011).
1.2 Statement of The Problem
An ideal business requires sufficient resources to keep it going and ensures that such resources are maximally utilized to enhance its profitability and overall performance. Working capital and its effect on firms’Performance has been studied by different researchers (Padachi, K. (2006); F.Finau, (2011); Fathi and Tavakkoli (2009). Existing researchers among whom are; Filbeck and Kruger(2005), Nyabwanga, Ojera, Lumumba,Odondo, Otieno (2012) to mention a few, have stated that most successful organisation do not have problem with management of working capital components, but this is actually misleading, because this research work has identified a gap in this findings, by establishing that successful organisation still have problems with management of working capital components which is in agreement with the study of mathuva,(2010), Rahman et al.,(2010). Most of these and other researchers identify significant association between working capital and corporate performance. It has however been discovered that some methods that managers use in practice to make working capital decisions do not rely on the principles of finance, rather vague rules of thumb or poorly constructed models are used (Emery, Finnerty and Stowe, 2004).