THE EFFECTS OF WORKING CAPITAL MANAGEMENT ON THE FINANCIAL PERFORMANCE OF MICROFINANCE INSTITUTIONS IN THE MUNICIPALITY OF BUEA. LOBE COOPERATIVE CREDIT UNION'S CASE
No of pages
|Descriptive statistics and regression|
|MS Word & PDF|
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The purpose of this research is to determine the effect of working capital management on the financial performance of microfinance institutions in Buea Municipality, with a particular emphasis on Lobe cooperative credit union. This was done to gain a better understanding of the working capital management variables that affect financial performance (return on equity) at Lobe cooperative credit union. These variables include cash management, inventory management, account receivables management, and account payable management.
These variables assist illustrate the impact of working capital management on the credit union’s financial performance (return on equity). Secondary data were gathered from the annual report for 16 years, beginning in 2003 and ending in 2018.
Additionally, the regression analysis software Stata 12 was used to determine the pair-wise correlation between variables and determine the presence of heteroscedasticity, autocorrelation, serial correlation, and multicollinearity. Our results indicate that cash management, inventory management, accounts receivable management, and accounts payable management are statistically significant at the 5% level of significance.
As a result, it was recommended that Lobe cooperative credit union Cameroon, including the Buea branch, have a thorough understanding of the independent variables that affect financial performance as measured by net income and return on assets.
Additionally, they should forecast a country’s economic status and examine credit regulations to strike a balance between liquidity and profitability for members. However, the corrected R-squared coefficient and the overall model are statistically significant since the likelihood of the F-ratio is statistically significant at 10%, indicating that the results are reliable.
INTRODUCTION IN GENERAL
1.1 The Study’s Context
For a lengthy period, corporate finance research has centred on long-term financial decisions, with a particular emphasis on investments, dividend policies, capital structure, and firm valuation. Current assets and current liabilities, on the other hand, have been demonstrated to be critical components of total assets and must thus be thoroughly studied.
Working capital management requires close examination since it is critical to the entire corporate strategy of creating shareholder value (Howarth and Westhead, 2003) The three primary components of working capital are inventory, accounts payable, and payments due from clients post-sale.
The success of a corporation is highly dependent on the managers’ ability to manage receivables, inventories, and payables successfully (Filbeck and Krueger, 2005). Working capital requirements influence a business’s liquidity and profitability, which in turn affects its financing and investment decisions.
Working capital management encompasses all aspects of current assets and liabilities, including cash, inventories, marketable securities, and debtors. Working capital management is a simple and easy notion that refers to a company’s ability to fund the difference between its short-term assets and short-term liabilities (Harris, 2005).
Working capital is the most critical component of a business’s liquidity, survival, solvency, and profitability (Mukhopadhyay, 2004). Every firm, regardless of its size or style of operation, requires a certain level of working capital.
Working capital management is critical for comparing organizations’ liquidity and profitability (Eljely, 2004), as it serves as a foundation for financing decisions and the composition of current assets.
Working capital management enables businesses to strike an ideal balance between the various components of working capital (Gill, 2011). Efficient working capital management is critical for firms because it plays a critical role in creating shareholder value (Nazir and Afza, 2008). As a result, the majority of firms strive to maintain an ideal amount of working capital that boosts their worth (Deloof, 2003).
The amount of working capital and the efficiency with which it is managed have a direct effect on a firm’s growth. While having a high level of current assets may result in low returns on investment, enterprises with a low level of current assets run the danger of experiencing shortages and having difficulty maintaining smooth operations (Horne and Lachowicz, 2000). When addressing working capital management, it is critical to understand two key terms: gross working capital and net working capital.
Gross working capital is defined as total investment in current assets. Short-term financing is used to fund a portion of the working capital investment (current liabilities). Networking capital is defined as the difference between current assets and current liabilities.
In a word, working capital management is critical to a firm’s financial management decisions. Inventory is a critical current asset that accounts for a sizable portion of working capital. Inventories can be comprised of a variety of items, including raw materials, work-in-progress, and finished commodities. A business must seek to achieve the optimal balance between revenue and invested capital.
Increased inventory minimizes the danger of stock-outs and may also result in increased sales. Low inventory levels may result in a business loss in the event of increased demand. When a business sells items on credit, it accrues accounts receivable. Depending on the payment agreement, the company may get cash for goods sold in weeks or months.
Thus, the corporation must adopt sound credit management policies governing credit analysis, debt collection, and terms of sale. While an efficient collection approach can greatly enhance a business’s working capital situation, an aggressive collection policy can sour relations with debtors, thereby affecting sales. Accounts payable is another component of working capital.
Businesses withhold payment to suppliers to assess the quality of their purchases. This approach can be considered a cost-effective and flexible method of funding for businesses. However, when suppliers provide incentives for early payment of invoices, the practice can become quite costly for the business.
Cash, like inventories, accounts for a sizable portion of working capital. Businesses maintain a reasonable level of idle cash to strengthen their liquidity position. Having an excessive amount of cash on hand, on the other hand, affects the cost of capital required to finance maturing commitments.
The firm must maintain an optimal balance between cash on hand and the amount to be invested in marketable securities, as cash shortages would almost always result in transaction expenses. The cash conversion cycle is a critical indicator of the working capital management system’s success.
The cash conversion cycle quantifies the time gap between raw material purchases and cash collection from credit sales. The longer the time gap, the greater the working capital investment. A longer cash conversion cycle will almost certainly boost profitability as a result of increased sales, but it may also have a detrimental effect on business profitability if the cost of investing in huge inventories outweighs the benefits of retaining more inventory (Deloof, 2003).
In recent decades, the concept of organizational performance has acquired significant traction, becoming prevalent in practically all domains of human endeavour. Performance is a subjective impression of reality, which explains the concept’s and its measurement tools’ plethora of critical reflections.
The proliferation of studies at the international level in the field of performance is also a result of the global financial crisis, which has resulted in an ongoing demand for improvement in the area of entity performance. Although the term “business performance” is frequently used in academic literature, it is rarely defined.
Due to the vast number of ideas used to define performance, the possibility of conceptual confusion is becoming increasingly questioned. Thus, organizational performance is perplexed by concepts such as productivity, efficiency, effectiveness, economy, earning capacity, profitability, and competitiveness, to name a few.
As a result, increased emphasis is being placed on a precise and unambiguous definition of the concept of performance. The term “performance” initially appeared in the mid-nineteenth century to refer to the outcome of a sporting encounter. The concept grew and established a series of meanings over the twentieth century, intending to encompass the broadest sense of what is seen through performance.
At the moment, no performance is unrelated to the targeted objectives. Attaining the objectives equates to doing the task. Because an organization’s objectives cannot be exactly defined and are growing in number, performance becomes increasingly difficult to quantify, as it is a relative measure.
Additionally, management teams and scholars have always been interested in estimating an organization’s performance. In this context, some studies concentrated on defining organizational performance and identifying ways to assess it. The primary purpose of this study is to provide an overview of the formulation and assessment of organizational performance indices.
Performance history is split into six distinct subcategories. Numerous perspectives and viewpoints are expressed on each of the performance subcategories. This review study is intended to assist researchers and students in gaining a better understanding of how performance is defined and modelled in organizational studies.
1.2. Problem Statement
Working capital is a critical component of any business. It is a critical factor in determining an organization’s profitability and liquidity levels. According to a study, the number of US startup companies with increasing capital decreased from 744 in the 1990s to 526 between 2001 and 2011. (Mulcahy, Jobs, Zuckerberg and Brin, 2013).
Many firms are having difficulty managing their working capital, which is a significant factor in business foreclosures. This is according to the securities and exchange commission, which produced a report stating that 50% of businesses fail due to a lack of adequate working capital management practices (United States Securities and Exchange Commission, 2013).
The underlying issue is a lack of profitability and growth among businesses, which results in consumer unhappiness and a decline in firm sales.
Working cash is the lifeblood of any firm, which implies that its management is critical. Effective working capital management is critical for the survival of cooperative organizations of all types. The corporate enterprise’s capital must be handled properly for the benefit of the cooperative business to accomplish stated objectives. Finance, at every stage and degree of cooperative activity, tends to play a key influence on the enterprise’s efficiency. Amy Drury and Alicia Tuovila
While the lobe cooperative credit union Ltd may have sufficient financing, it may lack effective working capital management. It is disheartening to discover that this cooperative credit union is not performing up to expectations, despite apparent effective and efficient working capital management, so that informed measures can be taken to facilitate efficient working capital management in this cooperative for the cooperative to effectively achieve stated objectives for the benefit of its members.
To this end, this research will examine how working capital management influences the efficiency or performance of the Lobe cooperative credit union, as well as the mechanisms that could assure effective working capital management to promote cooperative business in Buea municipality.
Worth noting is that every cooperative credit union receives monthly contributions from members as one of its components of current assets, and places a higher premium on real estate and government security investments. There is an issue with the misalignment of liquidity objectives and profitability. Maintaining a healthy liquidity position receives less attention; various research has been conducted on the influence of working capital. However, little is known about the effect of working capital on organizational performance (financial performance).
Even though working capital is the primary driver of organizational performance in lobe cooperative credit unions, specifically the Buea branch, empirical studies have revealed that working capital is susceptible to a variety of problems, which will ultimately result in a focus on current assets (loans) and current liabilities (deposits or savings). As a result, the overarching research question and four specific research questions were posed.
1.3.1 Theme of the Research
What influence does working capital management have on the financial performance of microfinance institutions in Buea Municipality, namely the Buea branch of lobe cooperative credit union limited (LTD)?
1.3.2 Specific Research Questions
What effect does cash management have on Lobe cooperative union limited’s (LTD at the Buea branch) financial performance?
Is inventory management affecting Lobe cooperative credit union Ltd’s financial performance in the Buea branch?
How do accounts receivable affect the financial performance of the Buea branch of Lobe cooperative credit union limited (LTD)?
What influence do accounts payable have on Lobe cooperative’s financial performance in the Buea branch?