CHAPTER ONE

INTRODUCTION

1.1. Background of Study

Working capital management deals with the management of all aspects of both currents assets and current liabilities to minimize the risk of going bankrupt and at the same time increasing returns on assets (FTC Foulks Lynch, 2005). It involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet short term obligations as they fall due and avoiding excessive investment in the current assets (Eljelly, 2004). This requires a combination of techniques which include cash management, inventory management, payables management and receivables management.

Working capital management involves the management of both current assets and current liabilities to minimize the risk of going bankrupt and at the same time increasing returns on assets (ROA). It involves planning and controlling the gross current assets as against the net working capital which deals with the cash of the company (Mathur, 2002). Aspects of working capital management include short-term loans, merchandise purchased on credit, goods and services provided on credit and merchandise, goods and services paid for upon delivery. Managing working capital essentially entails managing the cash flow of a business on a daily, weekly and monthly basis in such a way that satisfies all debts while reserving enough capital to continue operations and the generation of profits. The objective of working capital management is to make sure that a firm can continue operating and to ensure that it has made enough money from operations to take care of short-term debt and upcoming expenses (Bose, 2012). This means that the company must maintain the right ratio of assets, liabilities and working capital otherwise it would have become very difficult for them to stay in the market. With most pasted literatures carried out in the business world it had traditionally been concentrating on the study of financial decisions, which were long-term and had also focused on the firm’s performance. This had allowed scholars to concentrate on looking deep into analysing the capital structure, dividend, investments and company valuations. But, as of late there has been recent surveys that had been carried out and shown indications that managers spent a good amount of time in coming up with a solution to their everyday problems which involves working capital decisions for their firm (Raheman & Nasr, 2007).

Small and medium enterprises would face bankruptcy when insufficient capital resources prevent them from paying their debts. Successful working capital management allows small and medium enterprises to pay all debts as they mature, or come due, while continuing profitable business operations, which concludes a positive impact to them standing and relationship with their competitors. At the very least, successful working capital management allows small and medium enterprises to break even when calculating their profits either at the end of the day or month depending on how the firm looks at it (Teruel and Solano 2007). Therefore, working capital management is directly responsible for the avoidance of bankruptcy of small and medium enterprises. Unsuccessful working capital management can lead directly to bankruptcy by preventing a business from paying off liabilities or by preventing the generation of new capital with which to pay future debts, therefore keeping working capital at a good stand allows small and medium enterprises to prosper and prevent themselves from bankruptcy.

Working capital is important to small and medium enterprises as it is key in the financial health of a company whereby, it deals with the efficiency of the small and medium enterprise and their turnovers of their inventory, accounts receivables and payables. The efficiency pillar is amongst the 4 pillar of the financial health of a company, other being the profitability pillar, leverage pillar and liquidity pillar. These pillars are important for a company since it helps keep companies from falling and allows the analysis of the ratios used in the financial health to see which areas of the firm should be focused on (Santosuosso, 2014). According to Eljelly, working capital management of corporate entities is one of the most crucial aspects in attaining optimal liquidity position and in ensuring that corporate going concern. It is important in making decisions for companies when making a trade-off between liquidity and profitability, in a way that optimizes the amount and composition of their current assets and how they are financed, allowing better management of their assets (Eljelly, 2004).

Management of working capital aims at maintaining an optimal balance between each of the working capital components, that is, cash, receivables, inventory and payables. This is a fundamental part of the overall corporate strategy to create value and is an important source of competitive advantage in businesses (Deloof, 2003). The existence of efficient working capital management practices can make a substantial difference between the success and failure of an enterprise and it is of particular importance to the managers of SMEs as they strive for finances. The existence of efficient working capital management practices can make a substantial difference between the success and failure of an enterprise and it is of particular importance to the managers of small scale enterprises, because it is they who strive for finances and the opportunity cost of finances, for them is usually on the higher side (Kwame, 2007). As observed by Padachi (2006), efficient management of working capital is important for the success and survival of the SMEs. According to Atrill (2006), there is evidence that many small and medium enterprises are not very good at managing their working capital despite their high investments in current assets in proportion to their total assets and this has been a major cause of their high failure rates as compared to large businesses. According to him, majority of the small scale enterprises operate without credit control department implying that both the expertise and the information required to make sound judgments concerning terms of sales may not be available. They also lack proper debt collection procedures, hence, they tend to experience increased risks of late payment and default by debtors who tend to increase where there is an exclusive concern for growth; in this case, small scale enterprises may not be too willing to extend credit to customers who have poor credit risks. In a recent study by Bowen $ al. (2009), debt collection was identified by 55% to be among the top five major challenges facing micro and small businesses. In this study, we will be looking at the small and medium-sized enterprises in the Cameron context. Small and medium-sized enterprises have played a huge role in the Cameroon economy as it has led to many positive impacts to the people of Cameroon.

1.2 Statement of Problem

It is hard for the SMEs to access finances from the financial institutions since they lack proper working capital management skills Atrill (2006). The major problem that arises is on how working capital management practices affect the profitability of SMEs. Most of the Small and Medium Enterprises face challenges in balancing between surplus and shortage of working capital. As a result, these firms have been experiencing slow growth because of inability to pay daily expenses of their operations and difficulty to exploit new markets and undertake profitable projects due to shortage of working capital mainly because of poor working capital management. There is, therefore, a need for firms to have efficient working capital management practices. This study sought to find out the effect of working capital management practices on profitability of SMEs in Bamenda II.

In Westerfield, Ross, Jordon and Jaffe (2010), it was accounted for that there exist a crisscross between money inflow and money outflow during operating activities in small enterprises. To control the flow of cash and in this way lessen the potential negative impacts on profitability and risk, it is imperative that working capital management instruments and strategies are embraced. This in the process will enhance their quality settling on choices on working capital suggests making a trade-off among profitability and risk (Ross, Westerfield , Jaffe, & Jordan, 2010). Despite the importance of working capital management on SMEs, there is still a lack of understanding about different working capital management practices affect the way in which SMEs operate.

1.3. Research questions

1.3.1. Main Research Question

1. What is the effect of working capital management on the profitability of small and medium size enterprises in Bamenda II

1.3.2. Specific Research Question

1. To what extend does account receivables effect the profitability of small and medium size enterprises in Bamenda II
2. How does cash convention cycle effect the profitability of small and medium size enterprises in Bamenda II

• How does account payable effect the profitability of small and medium size enterprises in Bamenda II

1.4. Research objective

1.4.1. Main objective

1. To determine the effect of working capital management on profitability of small and medium size enterprises in Bamenda II.

1.4.2. Specific objective

1. To assess the effect of account receivable on the profitability of small and medium size enterprises in Bamenda II
2. To explore the effect of cash convention cycle on the profitability of small and medium size enterprises in Bamenda II

• To examine the effect of account payable on the profitability of small and medium size enterprises in Bamenda II