CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Working capital management plays a vital role in the success of the business because of its effects on liquidity and profitability. Capital is what makes or breaks a business, and no business can run successfully without enough capital to cover both short and long-term needs.

Maintaining sufficient levels of short-term capital is a constantly ongoing challenge, and in today’s turbulent financial markets and uncertain business climate external financing has become both harder and costlier and companies are therefore increasingly shifting away from traditional sources of external financing and turning their eye towards their own organizations for ways of improving liquidity.

One efficient but often overlooked way of doing so is to reduce the amount of capital tied up in operations, that is, to improve the working capital management of the company. A positive working capital position is required for the continuous running of a company’s operations that is to pay short-term debt obligations and to cover operational expenses. A company with a negative working capital balance is unable to cover its short-term liabilities with its current assets.

Working capital management (WCM) 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 that focuses on maintaining efficient levels of current assets and current liabilities to ensure that a firm has sufficient cash flow to meet its short-term obligations.

Working capital management is an essential part of financial management and contributes significantly to a firm’s wealth creation as it directly influences organizational profitability and liquidity (Raheman and Nasi, 2007; Nase et al 2013).

The most important issue in working capital management is the maintaining of liquidity in the day-to-day operations of the firm. This is crucial to prevent creditors and suppliers whose claims are due in the short-term from exerting unwarranted pressure on management and thus, ensure the smooth running of the firm. This suggests that the main objective of working capital management is to ensure the maintenance of the satisfactory level of working capital in a way that prevents excessive or inadequate availability of working capital (Fil back and Krueger, 2005).

It is important for us to note that inefficient working capital management may not only reduce profitability but also lead to financial crises and their associated effects. According to Padechi (2006), the management of working capital is important for the financial health of all businesses, irrespective of type and size.

Specifically, in manufactured firms, a large amount 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 working capital management ensures that organizations could meet their short-term liabilities adequately and on time.

This further makes it possible in 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 working capital management is very crucial in achieving the over-arching goal of the firm, which is shareholders value maximization.

In Cameroon, working capital management is very important as most providers of credit prefer the short-term credit market to the long-term market. This behavior may be attributed to the relatively higher inflation rates in Cameroon compared to other developed or emerging countries which have the tendency of reducing the purchasing power of future cash flows.

Given the above circumstances coupled with the fact that other sources of financing the firm are scarce, it has become imperative therefore for businesses in Cameroon and Douala community to efficiently manage their working capital to become profitable.

Furthermore, the importance of efficient working capital management by manufacturing firms in Cameroon cannot be overemphasized as this is extremely needed to boost profitability and increase expansion, which are pre-requisites in solving the countries unemployment issues and ensuring economic stability.

Buttressing this point, the WorldBank Annual report (2007) observes that developing countries can considerably resolve their socio-economic challenges when they take significant steps to revive and develop their manufacturing base. Resulting from the above several interventions were undertaken by Cameroon Government aimed at revamping the country’s manufacturing sectors to create employment and also boost Gross Domestic Product (GDP).

However, given those developments, it is intriguing to note that there are no known evidence-based studies that have investigated how profitable manufacturing firms manage their working capital in Cameroon. This study, therefore, attempts to fill the gap and contribute to the extant literature by investigating the effects of working capital management on corporate performance – short-term liquidity. The case study of this research involves Small and Medium Size enterprises of Douala Community.

1.2 Statement of the Problem

All business needs cash to survive; cash is needed to invest in fixed assets; pay suppliers and employees; fund overheads and other fixed costs and pay the tax due to the government. Nearly all businesses use much of their cash resources to finance investment in “Working Capital”.

Managing working capital effectively is, therefore, a vital part of making sure the business has enough cash to continue. It has been discovered that some methods that managers use in practice to make working capital decisions, do not rely on the principles of finance, rather they use imprecise rules of Thumb or poorly constructed models (Emery, Finnerty, and Stowe 2004).

This, however, makes the managers not to effectively manage the various mix of the working capital component, which is available to them, and as such, the organization may either be overcapitalized or undercapitalized or worst still liquidate. (Egbide 2009) discovered that many business failures in the past have been blamed on the inability of the financial manager to plan and control the working capital of their respective firms.

These reported inadequacies among financial managers are still practiced today in many organizations in the form of high bad debts, high inventory cost, etc. which adversely affect their operating performance (Egbide 2009).

Also, the fact that an organization makes a profit is not necessarily an indication of effective management of its working capital because a company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. As such there will be a shortage of cash available for the firm’s utilization as at when due. Such an organization may run into debts that could affect its performance in the long run because the smooth running of operations of the organization comes to a sudden halt and it will not be able to finance its obligations as at when due.

Again, some managers do neglect the organizations operating cycle thereby having a large debtor’s collection period and a shorter creditor’s payment period. All these constitute the problem of the investigation, hence the need to study the effects of working capital management on the short-term liquidity of SMEs in Douala community.

Specific research studies exclusively on the effect of working capital management on SMEs performance are scanty, especially in the case of Cameroon. Keeping this in view and the wide recognition of the potential contribution of SMEs business organizations as a key player in the real sector of the economy of developing countries. The performance of these organizations is key to a country’s economic growth and working capital management significant to accelerate their performance.

1.3. Research Questions

Looking at the huge efforts made so far on this issue and the response on SMEs short-term liquidity efficiencies which has been below expectations, the possibility is that either the problem has not been properly diagnosed or the right solutions have not been proposed and fully implemented.

Thus, the need for this study is to close this gap by providing more concrete solutions to this problem of working capital management on short-term constant liquidity as well as profitability of SMEs in Douala community using CAMAS Group Ltd, Goodwill Group of Companies et al as the case study. It is against this background that this research is of importance and is therefore designed to provide answers to the following general and specific research questions:

1.3.1 General Research Question:

What is the existing working capital management process in SMEs and how does it affect their short-term liquidity?

1.3.2 Specific Research Questions:

1. How will Cash management affect the short-term liquidity of SMEs in Douala community?
2. How will Inventory management improve the short-term liquidity and efficiency of SMEs in the Douala community?
3. How will Account Receivable management improve the short-term liquidity and efficiency of SMEs in the Douala community?
4. How will Account Payable management improve the short-term liquidity and efficiency of SMEs in the Douala community?

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