CHAPTER ONE

              INTRODUCTION

• Background of the study

Due to globalization, technological advances and increasing competition, managing business entities entails a number of complexities which warrant a diverse skillset and knowledge base of top managers. One area where such skills have proven vital is in the management of working capital. Mann (1918) defines working capital as the amount of money equivalent required to finance a company’s operations. In this early definition, the author elaborates further, describing working capital as the amount of capital required keeping a company in operation or ensure it stays liquid. Otherwise called Net Working Capital (NWC), working capital is a reflection of a firm’s operating cycle, financing alternatives and liability obligations.

Though not a new field of research, working capital management has gone through several distinct phases as a management concept or area. Despite its early definition and recognition in academia, limited research was carried out on working capital between 1900 and the 1940s. This was the awareness era. A search of ABI Inform Database found only 23 studies related to working capital published in various journals in this period and there appeared to be an inconsistent interpretation of what was concluded within the term working capital (Medwell, 2015).

In 1920, the pre and post-World-War II (WWII) era (l 920-l 950s) had a significant influence on the development of working capital studies. The overlapping period between awareness stage and this era was due to similar operating environments and the evidence appeared in both periods. The main arguments in this period are revolved around appropriate levels and financing of working capital (Benjamin, 1939) stated that companies were better off having positive networking capital (NWC) as it would improve liquidity. Positive NWC is achieved when companies keep higher ratios of current assets to current liabilities and depend less on bank loans or suppliers’ credit to finance working capital requirements. Conversely, a low current ratio means having low current assets and high current liability which increases dependency on bank loans and other sources of credit to finance working capital.

In 1947, the Committee on Accounting Procedure of American Institute of Accountants issued an Accounting Research Bulletin (ARB), No. 30 which defined working capital and classified the operating cycle. In its definition, it stated that working capital, sometimes called net working capital is represented by the excess of current assets over current liabilities and identifies the relatively liquid portion of total enterprise capital which constitutes a margin for meeting obligations to be incurred and liquidated within the ordinary operating cycle of the business (CAP/ATA, 1947).

The industrialization era between 1950 and 1980s resulted in a change of direction in working capital studies. Advanced technologies and machinery transformed manufacturing sectors, enabling companies to gain benefits of economies of scale hence lowering operational cost (Kaplan, 1994). Chandler (1994) identified that after the 1950s, American companies grew in size and created multiple divisions to focus on many different business activities. He explained that senior managers lacked the necessary training and experience to evaluate the performance of different business activities and a range of mathematical models were used to support their decision-making processes. Consequently, working capital studies in this period developed various mathematical and simulation models to help managers.

As Abuzayed (2012) argues, there is limited research and scholarly studies about working capital management in Small and Medium Enterprises (SMEs) in many developing countries. This is equally the case in Cameroon, a country which aspires to achieve her optimum goal of becoming an emerging nation by the year 2035. SMEs are key in reaching that destination since they contribute to the economy as well as help to decline unemployment. To meet up with these high aspirations, SMEs must be profitable. Profitability refers to the ability of a given investment to earn a return from its use. The term “Profitability” is composed of two words; “Profit” and “Ability”. The word profit can be defined as the sum arrived at by deducting total cost incurred from total revenue earned. The term ability refers to the power of an enterprise to earn profits. This ability is also known as earning power, earning capacity or the operating performance of a concerned investment (3^rd ICRISME-2016). The management of working capital is essential for SMEs to remain liquid enough to meet their short term obligations (Atrill 2006). An effective working capital management helps firms maintain their liquidity and enables them to have sufficient cash flows to repay mature short-term liabilities and to acquire lower cost of capital (Barine 2012). To increase profitability in SMEs, proper working capital management practices must be employed by SME managers in developing nations like Cameroon

• Statement of the problem

Working Capital (WC) comprises mainly of cash and its equivalent, accounts receivable (AR), inventory and accounts payable (AP). Working capital management practice involves the full range of business processes, such that the decisions made regarding working capital components should be synchronized in order to maximize organizational performance (Crum et al., 1983). As such, WC and working capital management (WCM) are a vital necessity for SMEs to remain liquid, profitable and continue to grow. 

Based on past studies, little has been done on working capital management in Cameroon, on SMEs. Few or different variables have been used in the past studies. Egbide (2009) discovered that large number of business failures in the past has been blamed on the inability of the financial manager to plan and control the working capital of their respective firms. This reported inadequacy among financial managers is still evident today in SMEs in Cameroon in the form of high bad debts, high cost of Inventory, and more, which adversely affect the operating performance. Also, the fact that SMEs in Cameroon still make profit is not necessarily an indication of effective management of WC because although they are endowed with the assets and the profitability they still run short of liquidity. This is due to the fact that their assets cannot easily be converted to cash. As such there is shortage of cash available for utilization as at when due. This causes the company to run into debts that will affect its performance in the long-run as it will not be able to finance its obligations as at when due.

Again some managers of SMEs, neglect the organization of the operating cycle, thereby having large debtors’ collection periods and shorter creditors’ payment periods. All these constitute the problem of the investigation. Hence the need to study the effects of working capital management on the profitability of SMEs in Cameroon precisely Buea, the South West Region of Cameroon. However, several interventions have been undertaken by the Cameroon government aimed at revamping the country’s manufacturing sector in order to create employment and also boost the country’s Gross Domestic Product (GDP). Despite this development, it is important to note that there is no known evidence based studies that have investigated how profitable manufacturing firms manage their WC in Cameroon. This study therefore attempts to fill the gap and contribute to the extant literature by assessing the impact of working capital management on corporate performance.

1.3. Research Questions

This research seeks to answer the following questions, classified as main and specific research questions.

• Main research question

The main research question to be answered in this study is:

• What is the effect of working capital management on the profitability of SMEs?

               Specific research questions

To answer the main research question above, the following specific questions are to be answered:

• What is the effect of Cash Conversion Cycle (CCC) on the profitability of SMEs?
• What is the effect of Inventory Conversion Period (ICP) on the profitability of SMEs?
• What is the effect of Debtor Collection Period (DCP) on the profitability of SMEs?
• What is the effect of the Creditor Payment Period (CPP) on the profitability of SMEs?

• Objective of the study
  • Main objective

   The main objective of this study is to assess the effect of working capital management on the profitability of SMEs.

                  Specific objectives

In order to achieve the main objective, the following specific objectives will be pursued:

• To assess the effect of the cash conversion cycle on the profitability of SMEs.
• To assess the impact of the Inventory Conversion Period on the profitability of SMEs.
• To assess the effect of Debtor Collection Period on the profitability of SMEs.
• To assess the effect of the Creditor Payment Period on the profitability of SMEs.