Alfred Mwangi Research Project _ Final Review II.pdf - University of

73 Pages·2013·0.77 MB·English

THE RELATIONSHIP BETWEEN WORKING CAPITAL MANAGEMENT
AND FINANCIAL PERFORMANCE OF MANUFACTURING FIRMS
LISTED AT THE NAIROBI SECURITIES EXCHANGE

BY
MWANGI ALFRED MAINA
D61/62787/2011

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULLFILMENT OF
THE REQUIREMENTS FOR THE AWARD OF DEGREE OF MASTER OF
BUSINESS ADMINISTRATION, UNIVERSITY OF NAIROBI

NOVEMBER, 2013
DECLARATION

This research project is my original work and has never been presented in any other university or
college for an award of degree, diploma or certificate.
Signed……………………………………… Date…………………………………
Alfred M. Mwangi
D61/62787/2011

This research project has been submitted for examination with my approval as the university
supervisor.
Signed……………………………………… Date…………………………………
Mr.Mirie Mwangi
Lecturer, Department of Finance and Accounting
School of Business,
University of Nairobi

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ACKNOWLEDGEMENTS
My appreciation to our Almighty God for his grace through this journey and granting me
courage, good health and inspiration that was essential for the study so demanding as this. I wish
to express my sincere gratitude and appreciation to my supervisor, Mr. Mirie Mwangi, Lecturer
department of finance and accounting, whose guidance, suggestions, and patience was enormous
and inspirational despite his busy schedule. Special thanks to my colleagues and a number of
people who contributed greatly to completion of this research project, May God bless you all.

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DEDICATION
This research project is dedicated to dear parents Mr. and Mrs. Hesbon Mwangi for laying the
strong foundation to my life. My special dedication to my beloved wife Mercy Karanja and my
dear sons, Allan, Ian and Ryan, who always remained my source of joy, inspiration and desire to
excel through academically. I am humbled to have you.

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ABSTRACT

Management of working capital which aims at maintaining an optimal balance between each of
the working capital components, that is, cash, receivables, inventory and payables 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 main objective of the study was to
establish the relationship between working capital management and financial performance of
manufacturing firms listed in NSE.
The research used both descriptive and quantitative research design. The population of interest in
this study constituted all manufacturing companies quoted at the NSE for the period of five years
from 2007 to 2011.The quantitative research approach was employed to arrive at the findings of
the study.
From the regression models, the study found out that inventory turnover in days has negative
relationship with Return on Equity which means that companies‘ financial performance can be
increased by reducing inventory in days. Cash Conversion period and Net payment period shows
significant negative relation with Return on Equities showing that firms‘ financial performance
can be increased with short size of both of them. The study recommends that there should be
proper inventory management system in manufacturing firms to avoid over stocking of inventory
resulting to efficient outcome of investment. Management of manufacturing firms should also
make sure certain standards and levels which will stop piling up of inventory. The study further
recommends that companies should engage in relationship with those suppliers who allow for
long credit period and those customers who accepts short payment period.

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TABLE OF CONTENTS
DECLARATION ............................................................................................................................ ii
ACKNOWLEDGEMENTS ............................................................................................................ ii
DEDICATION .............................................................................................................................. iiv
ABSTRACT .................................................................................................................................... v
TABLE OF CONTENTS ............................................................................................................... vi
LIST OF TABLES ....................................................................................................................... viii
ABBREVIATIONS ....................................................................................................................... ix
CHAPTER ONE ............................................................................................................................. 1
INTRODUCTION .......................................................................................................................... 1
1.1 Background of the Study ...................................................................................................... 1
1.2 Research Problem ................................................................................................................. 9
1.3 Research Objectives ............................................................................................................ 12
1.4 Value of the Study .............................................................................................................. 13
CHAPTER TWO .......................................................................................................................... 14
LITERATURE REVIEW ............................................................................................................. 14
2.1 Introduction ........................................................................................................................ 14
2.2 Review of Theories ............................................................................................................ 14
2.3 Empirical Literature ........................................................................................................... 20
2.4 Conclusion ......................................................................................................................... 27
CHAPTER THREE ...................................................................................................................... 29
RESEARCH METHODOLOGY.................................................................................................. 29
3.1 Introduction ........................................................................................................................ 29
3.2 Research Design................................................................................................................. 29
3.3 Population .......................................................................................................................... 30
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3.4 Sample Design ................................................................................................................... 30
3.5 Data Collection .................................................................................................................. 31
3.6 Data Analysis ..................................................................................................................... 31
3.7 Research Model ................................................................................................................. 32
CHAPTER FOUR ......................................................................................................................... 34
DATA ANALYSIS, RESULTS AND DISCUSSION ................................................................. 34
4.1 Introduction ........................................................................................................................ 34
4.2 Data Analysis and Findings ............................................................................................... 34
4.3 Summary of Findings and Interpretations .......................................................................... 40
CHAPTER FIVE .......................................................................................................................... 42
SUMMARY, CONCLUSION AND RECOMMENDATIONS ................................................... 42
5.1 Introduction ........................................................................................................................ 42
5.2 Conclusions ........................................................................................................................ 42
5.3 Recommendations .............................................................................................................. 43
5.4 Limitations of the study ..................................................................................................... 43
5.5 Suggestions for Further Research ...................................................................................... 44
REFERENCES ............................................................................................................................. 45
APPENDIX I: MANUFACTURING COMPANIES LISTED ON NSE .................................... 56
APPENDIX II:RAW DATA ANALYSIS ................................................................................... 57

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LIST OF TABLES

Table 4.1: Summary Statistics of Financial Perfomance Variables .............................................. 35
Table 4.2: Correlation Analysis .................................................................................................... 36
Table 4.3: Regression Coeefficients ............................................................................................. 36
Table 4.4: Working capital management Vs Firms financial performance ................................. 39

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ABBREVIATIONS

AIP - Aggressive Inventory Policy
CCC - Cash Conversion Cycle
CMA - Capital Markets Authority
CSE - Colombo Stock Exchange
EAC - East Africa Community
EOQ - Economic Order Quantity
GDP - Gross Domestic Product
JIT - Just in Time
KAM - Kenya Association of Manufacturers
KSE - Karachi Stock Exchange
NLB - Net Liquidity Balance
NPV - Net Present Value
NSE - Nairobi Securities Exchange
NTC - Net Trade Cycle
ROA - Return on Assets
ROE - Return on Equity
TCE - Transaction Cost Economics
WCM - Working Capital Management
WCR - Working Capital Requirement
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CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Management of working capital which aims at maintaining an optimal balance between each of
the working capital components, that is, cash, receivables, inventory and payables is a
fundamental part of the overall corporate strategy to create value and is an important source of
competitive advantage in businesses (Deloof, 2003). In practice, it has become one of the most
important issues in organizations with many financial executives struggling to identify the basic
working capital drivers and the appropriate level of working capital to hold so as to minimize
risk, effectively prepare for uncertainty and improve the overall performance of their businesses
(Lamberson, 1995).

Working capital management is a very important component of corporate finance because it
directly affects the liquidity and profitability of the company. It deals with current assets and
current liabilities. Working capital management is important due to many reasons. For one thing,
the current assets of a typical manufacturing firm accounts for over half of its total assets. For a
distribution company, they account for even more. Excessive levels of current assets can easily
result in a firm's realizing a substandard return on investment. However firms with too few
current assets may incur shortages and difficulties in maintaining smooth operations (Horne and
Wachowicz, 2000).

Many surveys have indicated that managers spend considerable time on day -to-day problems
that involve working capital decisions. One reason for this is that current assets are short-lived
1