WORKING CAPITAL: A TOOL FOR SMALL AND MEDIUM SCALES ENTERPRISE EFFICIENCY

WORKING CAPITAL: A TOOL FOR SMALL AND MEDIUM SCALES ENTERPRISE EFFICIENCY

CHAPTER ONE

INTRODUCTION

• Background of the Study

Working capital is the life blood and nerve Centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital. The purpose of working capital is to ensure the effective and efficient utilization of the business’s investment in assets. Working capital among Small and Medium Scale Enterprises (SMEs) appears to have been relatively neglected despite the fact that a high proportion of failures in businesses, is due to poor decisions concerning the working capital of enterprises (Tewolde, 2002). Management of working capital is an important component of corporate financial management because it directly affects the profitability of the firms.

According to Bhattacharya (2009), the concept of working capital was first evolved by Karl Marx in 1914, though in a somewhat different form, and the term he used was “variable capital”. Working capital is the capital required to finance a firm’s day-to-day operational activities. It can be defined as current (short-term) assets minus current (short-term) liabilities. Adequate working capital is vital in maintaining a firm’s liquidity. On the other hand, working capital management is concerned with the management of a firms short-term assets (stocks, debtors and cash), short-term liabilities (creditors and borrowing), and short-term cash flows (Park and Gladson, 2003). McMenamin (2005) noted that the goal of working capital management is to secure the optimum investment in working capital consistent with the overall financial goal of shareholder wealth maximization. Small and Medium Scale Enterprises may have an optimal level of working capital that maximizes their value. Raheman & Nasr (2007) posited that large inventory and a generous trade credit policy may lead to high sales.

However, important the components of working capital management is to Small and Medium Scale Enterprises, the existence of working capital management practices, begins with the sources of financing working capital which forms the bedrock for its existence and continuous survival.

1.2   Statement of the Problem

Despite the fact that Small and Medium Scale Enterprises are the engine room behind a nation’s development, yet this sector is bedeviled by several constraints amid poor working capital management practices which continues to mar its laudable objectives. It has been widely accepted that the profitability of a business concern vis-à-vis Small and Medium Scale Enterprises (SMEs) in Supermarket largely depends upon the manner in which its working capital is managed(Planware, 2011). Both excessive and inadequate working capital is harmful for a firm. Excessive working capital leads to unremunerative use of scarce funds. On the other hand, inadequate working capital usually interrupts the normal operations of SMEs. Small and Medium Scale Enterprises often encounter several problems in their working capital management like: not knowing the required sources of financing working capital; inappropriate management of cash flows; no laid down collection policies of accounts receivables; frequent inventory stock-out; poor controlling of accounts payables; and non-evaluation of risk on investment (Lyytinen, 2009).