CHAPTER ONE
INTRODUCTION
1.1
BACKGROUND OF THE STUDY
Capital can be
classified into two broad categories based on tenure viz. long term and short
term capital. The long term capital of firms is committed to investment in
fixed assets. It includes shareholders. On the other hand, short term capital
is applied for investment in current assets such as cash, marketable securities
and short- term credits. Current assets are usually acquired very often in
varying quantities depending on the demand structure for the firm’s product
Pondy, M.I. (2004). Each time a decision to acquire current assets is taken,
finance becomes inevitable.
However, it does not
necessarily mean that cash has to be paid each time an order for recurrent
production input is placed, rather it implies that just like in the case of
fixed assets, every decision on current assets has financial implications. For
instance, a firm has to decide how much of the material used
for production of goods and services are to be on credit or on cash and carry
basis. It also has to determine what
proportion of its sale has to be on credit Retort, J.V (2003). Also both the
optimum and minimum stock levels for raw materials and work-in-progress (WIP)
have to be determined and maintained at a given point in time.
Orjih (2001) refers to
working capital as a firm’s short –term assets cash, marketable securities,
trade debtors and stock, less current liabilities used to finance the current
assets. He stated that working capital management therefore means the planning
and controlling of both current asset and current liabilities. It involves the
administration of cash receivables, inventories, marketable securities and the
current liabilities. He also discussed
the two aspects of working capital: This means that the firm’s investment
assets. Current assets are those which can be converted in to cash within an
accounting year and they include cash, short term securities, and stock. Net
working capital- this refers to the difference between current
assets and current liabilities.
Current liabilities are those of outside is which
are expected to mature for payment within an accounting year. Net working capital can be positive or
negative. It is positive when current assets exceed current liabilities and
negative when current liabilities exceed current assets Davidson, S. (2002).
Weston &Brigham (2002)
defined working capital management as “management decision on invested in
various current assets and how this investment is to be financed”. It is fundamental and it enables the
organization conduct its activities from free financial embarrassment.
Working capital
management also aids the management to avoid the losses consequent upon
incurring commitments below or above its capacity in ordinary course of
business.
Retrof (2000) said that
a firm should always maintain a sound working capital position for it to have
enough to run its business activities. Both excessive as
well as inadequate working capital position are dangerous from firm.
Excessive working
capital means idle fund which means no profit for the firm, while inadequate
working capital renders the firm unable to avail attractive credit
opportunities and drastic reduction in the rate of return on total investment.
The firm losses its reputation and capital base could be eroded, there by
affecting the organizations credit worthiness Breadley, R. And Myers S.C (2004).
Just as blood is life
wire of any human being, the working capital of any company is the pivot around
which its day-to-day operations revolve. It cuts across all departments and functions
of an organization to the extent that all the organizational activities would
ground to a halt if the working capital were not properly managed. Therefore,
the need for a sound and realistic working capital policy for a Company becomes
imperative.
1.2
STATEMENT OF THE PROBLEM
The present world economic
hazard coupled with economic policies being operated in the nation has led to a
situation where many business organizations have to fold up. Others barely survive by thriving on very lean
financial and material resources. This is due to the mere fact that procurement
of capital to finance their daily operations is increasingly becoming
difficult. However, the efficient management and control of working capital can
generate a considerable amount of internal financing.
“The study seeks to investigate
working capital management as a tool
for cost minimization and profit maximization”.
It topic will equally
determine the extent to which the profitability of a company is dependent on
the level of its working capital management.
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