Working capital management: Tool for internally financing business operations

Just as the human body relies heavily on food and water for its survival, growth and prevention of diseases, so do businesses thrive on financing and the management of same.

The financing could either be from internal or external sources.

Internally, there are a number of ways businesses could finance their operations.

These include cash flow management, retention of earnings, reducing and cutting cost, savings and reserves, tax planning and optimisation, invoice discounting, and asset-based financing.

Others are receivables management, payables management and inventory management and a few others.

Exploring and utilizing these financing options could enable the business to lessen its reliance on external sources of funding and place the firm in charge of its financial operations.

However, this article duels on managing working capital which comprises inventory management, cash management, payables management as well as receivables management.

Working capital management (WCM) has to do with how current assets and current liabilities are controlled and coordinated in daily business activities.

A handful of researches relating to working capital management such as Ansah (2021), Prempeh (2016), Mawutor (2014), Akoto et al. (2013), and Agyeman and Asiedu (2013) have been conducted on Ghanaian listed firms, highlighting the significant role WCM plays in the Ghanaian as well as the developing economies.

A firm that does not have a satisfactory working capital will find it very difficult to undertake its day-to-day business operations regardless of the quantum of fixed assets in its possession.

This is one of the reasons why some firms collapsed as a result of liquidity challenges even though they appeared to be wealthy on the face of their statement of financial positions [balance sheets].

Adverse consequences that a firm could face when working capital is either inadequate or not managed properly include retardation of growth arising from not being able to take up positive Net Present Value (NPV) projects as a result of lack of funds, missing profit targets arising from not being able to implement plans, inefficiencies in operations, loss of attractive credit chances due to low level of working capital, and inability of the firm to settle its maturing debts.

Cash Conversion Cycle

Quite a number of researchers have used cash conversion cycle (CCC) as a proxy measure of working capital management.

It is the difference in time [that is, if expressed in time period] from the purchase of raw materials to the collection of moneys from customers who have purchased the finished goods.

The quantum of investment in working capital, whether large or small, is determined by the length of this time interval.

The CCC could also be expressed in monetary terms. In this case, the lower the value, the better working capital is managed.

Thus, WCM theory suggests that, it is healthy for firms to have a short cycle of WCM as a testament to the efficiency and effectiveness of managing working capital.

A well-managed CCC leads to increased sales which eventually increases profitability.

Thus, working capital provides an assessment of how liquid a firm is.

It ensures that adequate capital is maintained to settle current liabilities and future operating expenditures to ensure uninterrupted business operations.

In a study conducted in 2014, Okreglicka (2014) opines that, insolvency and bankruptcy issues are the resultant effects of the inability on the part of managers to fully regulate working capital.

Some company characteristics

As a result of the key role working capital plays, a host of empirical studies have been conducted over the years to explore factors impacting working capital.

There is ample empirical evidence to show the existence of relationship between working capital management and company characteristics, one of which is profitability, being one of the most salient company characteristics to firms.

A study by Ansah (2021), conducted on the impact of company characteristics on working capital management, sampled non-financial companies listed on Ghana Stock Exchange, using seven company characteristics as independent variables.

These independent variables are sales growth, debt ratio, current ratio, profitability, quick ratio, company size and operating cash flow.

The results indicate that company size, debt ratio and current ratio (CR) are the most significant contributors in predicting WCM. 

Access to free capital

Free capital or free cash [which would have been obtained from external sources at a cost] could be obtained through effective and efficient management of working capital. Reasonably delaying in settling suppliers of raw materials and other goods enables the firm to hold on to that cash and plough it back into the business operations before making any payment afterwards.

Efficient and effective WCM enable firms to boost production, which results in increased revenue.

It is, therefore, expected that firms devise strategic ways of harnessing the nitty-gritty of working capital management in order to lessen their burden of seeking financial support for operational purposes elsewhere other than from within the firm (internal).  

The writer is a member of The Chartered Institute of Tax Law and Forensic Accountants–Ghana (CITLFAG) and an employee of Ghana TVET Service.

Email: ekornunye@gmail.com