CHAPTER ONE

INTRODUCTION

1.1 Background of Study.

Over the past years, corporate finance research has centered on long-term financial decisions, with particular emphases on investments, dividend policies, capital structure, and firm valuation. Current assets and current liabilities on the other hand have demonstrated to be critical components of total assets and must thus be thoroughly studied. Current assets and current liabilities are those elements used by entities to carry out their day-to-day operations and it is very necessary for all businesses to take management of these components seriously in order to effectively and efficiently run their business, hence working capital management. Financial institutions especially micro finance institutions have for the past years always have problems managing their working capital, which has brought numerous negative consequences including the inability to meet up with financial obligations as well as conflicts in profitability and liquidity not excluding stock-outs (Howarth and Westhead, 2003).

Working capital or gross working capital refers to a firm’s investment in short term assets, that is, cash, accounts receivables, short-term or marketable securities and inventories. In other words, it is the collection of all current assets. There is also what we call networking capital which is defined as current assets fewer current liabilities. Current liabilities are those claims of outsiders, which are expected to mature for payment within one accounting period or year, and include bills, payable, creditors and outstanding expenses. Meanwhile current assets are those claims of the enterprise or what firms owns and includes cash, inventories, marketable securities and account receivables (Harris, 2005).

According to Falope and Ajilore (2009), a lack of unity and confusion about the understanding of working capital led in the past to the fact that many authors have either completely neglected the concept and subject of working capital, or dealt with a low priority.

John S.M defines working capital as, the sum of the current assets. According to the definition of Weston and Brigham, working capital refers to a firm’s investment in short-term assets, cash, account receivable, inventories. Working capital is a main source of funding, especially small firms (Ebben & Johnson, 2011). Working capital significantly affects shareholder wealth and firm value (Aktas et al., 2015; Kieschnick et al., 2013; Le, 2019). Before, firms manufacturing companies, public sector entities focused more on the first two major decisions of corporate finance: capital budgeting and capital structure decisions which deals with managing long-term financing and investments and looked down on working capital management, which this brought a lot of challenges as companies were unable to meet up with financial obligation due to limited cash, a fall in profitability and poor management of inventory leading to stock-outs. Due to these challenges and difficulties, firms began to see the need of also taking working capital management seriously.

Working capital management ensures a company has sufficient cash flow in order to meet its short-term debts obligations and operating expenses. Many firms operating in different economic sectors may have an optimal level of working capital that maximizes their wealth (Ramthirance 2017). Ramesh, Hamad and Tammam (2017) argue that working capital management is one of the prominent financial functions and it represents the amount of money invested by an organization to meet the day-to-day operations.

Management of working capital necessitates short term decisions in working capital and financing of all aspects of both firm’s short-term assets and liabilities (Nyabuti & Mokeira 2014). They further indicate that the main objective is to ascertain that the firm has the ability to continue operating with sufficient cash flow for payment of both maturing short term debt and impending operational expenses. Its thus involves multiple crucial decisions which involves managing account payables and account receivables.

Managing of working capital is an essential task of the financial manager. He has to ensure that the amount of working capital available is neither too large nor too small for its requirements. A large amount of working capital should mean that the company has idle funds. Since funds have a cost, the company has to pay huge amount as interest on such funds. If a firm has adequate working capital, such firm stands the chance of being solvent. Paucity of working capital may lead to a situation where the firm may not be able to meet its liabilities. When businesses make investment decisions they must not only consider financial outlay involved with acquiring the new machine or the new building but also take account of the additional current assets that are usually required with any expansion of activity (Horne and Lachowicz, 2002).

The objective of working capital is to manage the firm’s current assets and liabilities in such a way that satisfactory level of working capital is maintained. The mismanagement of working capital may lead to liquidity crisis and a reduction in profitability (Raza & Ul Haq, 2020). Haq et al. (2011) indicates that working capital management directly affects the profitability of a firm. Deloof (2003) also emphasised that the way working capital is managed has a significant impact on the profitability of firms. This implies that working capital management is one of the key decisions that a financial manager makes. Moreover, working capital is known as life-giving force for any economic unit and its management is considered among the most important function of corporate management. Working capital management is one of the most important areas while making the liquidity and profitability comparisons among firms (Eljelly, 2004).

In Cameroon, Micro Finance institutions have also embraced working capital management and it has actually improved financial performance. The management of working capital has made most MFIs in Cameroon to be able to be solvent; they have been able to meet up with customer demand for cash at the same time achieving the objective of profitability. Notwithstanding the important contribution of working capital management to the growth of the national economy, the microfinance sector in Cameroon faces many challenges; this is according to a study by Djatang (2020), the most significant of which is the closing of some MFIs. The best known in the society and most publicized cases are: the Goldy Businessmen fund (GBF) in 2018; the Compaignie Financiere de l’Estuaire (CONFINEST) in 2011. And problems recently encountered by the Compagnie Equatoriale pour l’Epargne et la Credit d’investtissement (COMECI), affected in 2016 by a cash crisis, revealing the financial instability of these failures, including: the existence of over-indebted clients, practices of high overall effective costs, loss of the confidence of clients who have seen their savings disappear without any guarantee of repayment. It is believed that these organizations had to close down because they had not adequately or effectively used working capital management to measure performance. Financial performance is a measure of how much a company’s ability to create profit or revenue from the assets it uses.

According to Kento (2020) Financial Performance is a subjective measure of how well a firm can use its primary mode of business and make measure of a firms overall financial well- being over a given period. SMES performance is not only important for its shareholders but also for the scholars as it is important to understand the factors affecting financial performance of firms. In order to measure the financial performance of an organization, we use financial ratios such as; the profitability ratio, the liquidity ratios, the solvency ratios, the efficiency ratios and the Leverage. When companies do not adequately use this working capital management to measure its performance, the end result will always below profitability which they might cause the organization to go bankrupt and consequently crumble.

1.2 Statement of Problem

In the past years, companies in Cameroon have taken various measures and procedures to improve efficiency and effectiveness in business operations. SMES have also taken several measures to improve efficiency. Among the measures embraced by SMES was the introduction of capital budgeting and capital structure. These capital budgeting and capital structure was intended to manage long term assets such as ATM machines, office equipments such as computers and printers and buildings. Though with capital budgeting and capital structure, most SMES in Cameroon still experienced poor financial performance. As a result, they understood that capital budgeting was not enough and saw the need for managing short term assets and liabilities as they make up most of the business total assets. With the introduction of working capital management, it has increased the profitability and solved the problem of insolvency in most SMES in Cameroon (Smith,J., and Johnson, A.2023).

Despite the fact that working capital management is of utmost priority, there still exist many SMES especially in Bamenda Town that still experience incidences of insolvency which has been the other of the day, low profitability and inability to meet up with their short term obligations. These scenarios occur as a result of mismanagement of working capital. Working capital management acts as a major tool in performance appraisal of SMES as it increases stakeholder’s confidence in the microfinance and encourage them to invest more in the institution (Owusu, 2008; Arko, 2012)

The researcher noticed that most SMES in Bamenda do not effectively manage their working capital and as such, they end up having a very low turnover and profitability in their organizations. The researcher also noticed that so many customers in many microfinance institutions have ran away from saving their cash in the institutions because of fear of not receiving back their money. There have always been this cases were customers had issues with SMES because there was limited liquidity available to satisfy their demand due to ineffective cash management by the institution. As a result, the researcher seeks to examine how the performance of SMES in Bamenda will look like if they effectively manage their working capital, whether it will solve the conflict between profitability and liquidity, and enhance higher turnover.

1.3 Research questions

1.3.1 Main Research Question

What is the effect of Working Capital Management on the financial performance of SMES in Bamenda Town?

1.3.2 Specific Research Question

1. What is the effect of Cash Management on the Financial Performance of SMES in Bamenda?
2. To what extend does Account Receivable Management affects financial performance of SMES in Bamenda?

• How does Account Payable Management affect Financial Performance of SMES in Bamenda?

1.4 Objective of Study

1.4.1 Main Objective

The primary objective of this study is to examine the effect of Working Capital Management on the Financial Performance of SMES in Bamenda

1.4.2 Specific Objectives

1. To assess the effect of Cash Management on the Financial Performance of SMES in Bamenda.
2. To evaluate the effect of Account Receivable Management on the financial performance of SMES Bamenda.

• To examine the effect of Account Payable Management on the Financial Performance of SMES in Bamenda.