CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
The growing population of small
businesses and startups, and the increasing rate of ‘crashing out’ or
liquidation of such businesses has become an issue of concern in an
already harsh national economy. The small businesses in no small measure
contribute to the development of the nation’s economy as they not only
provide avenues for entrepreneurs to spring up, but they serve as
employers of labor; thus reducing the level of unemployment in the
economy.
Given the aforementioned benefits, it
will thus be important to ensure the sustainability of the small and
medium scale enterprises.
In spite of the fact that SMEs have been
regarded as the bulwark for employment generation and technological
development in Nigeria, the sector nevertheless has had its own fair
share of neglect with concomitant unsavory impacts on the economy. In a
seminar titled “Career Crisis and Financial Distress- The Way Out”, the
General Manager of Enterprise and Financial Support Company Limited, Mr.
Oluseyi Oluboba, identified in his paper the following as the main
problems of SMEs, which are however not insurmountable: low level of
entrepreneurial skills, poor management practices, constrained access to
money and capital markets, low equity participation from the promoters
because of insufficient personal savings due to their level of poverty
and low return on investment, inadequate equity capital, poor
infrastructural facilities, high rate of enterprise mortality, shortages
of skilled manpower, multiplicity of regulatory agencies and
overbearing operating environment, societal and attitudinal problems,
integrity and transparency problems, restricted market access, lack of
skills in international trading bureaucracy, lack of access to
information given that it is costly at times (Basil, 2005)
The Small Scale and Medium Sized
Enterprises (SMEs) have been credited with enormous contribution to the
growth of the developed economies of the world. In the same vein, the
Information and Communications Technologies (ICT), and particularly the
Internet have played their own part in those economies. The SMEs provide
the cornerstones on which any country’s economic growth and stability
rests. The American economy, the largest economy in the world, depends
largely on the success of SMEs for “innovation, productivity, job growth
and stability” (SBA Report, 2000).
Small businesses represent more than 99%
of all employers, employ 51% of private-sector workers, employ 38% of
workers in high-tech occupations, provide about 75% of new jobs of the
private sector output and represent 96% of all goods exporters” (Twist,
2000).
There was a dramatic growth in the
American economy in 1999 when almost 2.8 million new, private-sector
jobs were created. According to the SBA Report (2000), 75 percent of
these new jobs were created by the SMEs with the services sector topping
the list with about 1 million, followed by manufacturing, finance and
insurance. The same story emerges in every other economy. The
differences lie in the magnitude of impact and the indices for measuring
them.
The rapid transformation of the “Asian Tiger” countries of India, Malaysia, Indonesia,
Taiwan and Hong Kong, has also been
hailed as proof that SMEs are major catalysts to economic development.
Their importance to any economy hinges on their ability to stimulate
indigenous entrepreneurship, to provide employment to a greater number
of people; to mobilize and utilize domestic savings and raw materials,
to provide intermediate raw materials or semi-processed products to
large-scale enterprises, and to curtail rural-urban migration. Of equal
strategic importance is also the role of the SMEs in other developing
countries like Nigeria. With a Gross National Product (GNP) of some
$41.2 billion and a World Bank estimated population of 126.9 million,
Nigeria is one of the largest economies in Africa (World Bank Report,
2000). This being the case, the economic success or failure of Nigeria
can affect not only the country but the whole of sub Sahara Africa. This
is why any effort geared towards understanding how the SMEs make use of
emerging technologies in improving their products and services which
ultimately reflect on their growth potential is worthwhile.
A study conducted in Nigeria by the
Federal Office of Statistics shows that over 97% of all businesses in
Nigeria employ less than 100 employees. This therefore means that about
97% of all businesses in Nigeria are SMEs (Ariyo, 2000). The Federal
Government of Nigeria initiated and actualized some policy measures,
like the setting up of Small and Medium Industries Equity Investment
Scheme (SMIEIS), in the expectation that improved funding would
facilitate the achievement of higher economic growth.
Working Capital (abbreviated
WC) in the simplest of terms refers to the financial input a business
or organization requires for its day to day running and maintenance to
ensure sustainability.
Working capital is a financial metric
which represents operating liquidity available to a business,
organization or other entity, including governmental entity. Along with
fixed assets such as plant and equipment, working capital is considered a
part of operating capital. Net working capital is calculated as current
assets minus current liabilities. It is a derivation of working capital
that is commonly used in valuation techniques such as DCFs (Discounted
cash flows). If current assets are less than current liabilities, an
entity has a working capital deficiency, also called a working capital
deficit.
The existence, survival, growth and
stability of any corporate body is highly dependent on the efficiency
and effectiveness of its management. This is measured by the ability of
the organization’s management to combine all the necessary material for
optimal and efficient actualization of their set objectives within the
stipulated time. In any organization, cash forms the life wire, which
determines to a large-extent, its growth, existence and survival among
other competing firms. As a result, it becomes imperative for the
management of any organization to give a close attention to the
management of working capital if they want to stand the test of time.
The management decides the best proportion of its investment on both
fixed and current assets and finally her liability level to enable
improvement and correction of imbalances in the liquidity position of
the firm. Most organizations believe in profitability, but it is
generally accepted that liquidity is more important for survival and
growth. The reason behind this premise is that most organizations make
profit but do not posses enough or adequate, liquid asset to off-set
current obligations. However, this inability to make payment at when due
may definitely have serious consequences on the organization financial
growth. Weak liquidity makes it unsafe and unsound for the survival of
the company but all it takes is efficient and effective management
Nwankwo (2005).
A company can be endowed with assets and
profitability but short of liquidity if its assets cannot readily be
converted into cash. Positive working capital is required to ensure that
a firm is able to continue its operations and that it has sufficient
funds to satisfy both maturing short-term debt and upcoming operational
expenses. The management of working capital involves managing
inventories, accounts receivable and payable, and cash (Wikipedia,
2011).
The working capital meets the short-term
financial requirements of a business enterprise. It is a trading
capital, not retained in the business in a particular form for longer
than a year. The money invested in it changes form and substance during
the normal course of business operations. The need for maintaining an
adequate working capital can hardly be questioned. Just as circulation
of blood is very necessary in the human body to maintain life, the flow
of funds is very necessary to maintain business. If it becomes weak, the
business can hardly prosper and survive. Working capital starvation is
generally credited as a major cause if not the major cause of small
business failure in many developed and developing countries (Rafuse,
1996).
The success of a firm depends
ultimately, on its ability to generate cash receipts in excess of
disbursements. The cash flow problems of many small businesses are
exacerbated by poor financial management and in particular the lack of
planning cash requirements (Jarvis et al, 1996).
Net working capital on
the other hand, is the difference between a business' current assets and
its current liabilities. Working capital policy, then, refers to
decisions related to types and amounts of current assets and the means
of financing them. These decisions will necessarily involve:
• The management of cash and inventories
• Credit policy and collection of accounts receivables
• Short-term borrowing and other financing opportunities such as trade credit
• Inventory financing
• Receivables financing
Working capital management is primarily
concerned with the day-to-day operations rather than long-term business
decisions. For example, plans for introducing new products to the market
and plans for obtaining the facilities and equipment necessary to
produce them are strategic in nature, as are the long-term financing
needs of the firm. On the other hand, working capital management
policies target short-term concerns such as the:
• Availability of raw material and inventories
• Continuous operation of the production line
• Granting credit to customers and collecting past-due accounts
• Taking advantage of credit purchases and the discounts for early payments
• The management of the cash account
These factors help promote smooth operation of the business on a day-to-day basis.
Since the average firm has about 40
percent of its capital tied up in current assets, decisions regarding
working capital greatly impact business success. This is especially true
for smaller businesses which often minimize their investment in fixed
assets by leasing rather than buying, but which cannot avoid investing
in inventories, cash and receivables. Further, small businesses tend to
have a limited number of financing opportunities and less access to
capital markets. This requires them to rely heavily on short-term credit
such as accounts payable, bank loans and credit secured by inventories
and/or accounts receivable. The use of any of these financing sources
influences working capital by increasing current liabilities Deloof
(2003).
Decisions relating to working capital
and short term financing are referred to as working capital management.
These involve managing the relationship between a firm's short-term
assets and its short-term liabilities. The goal of working capital
management is to ensure that the firm is able to continue its operations
and that it has sufficient cash flow to satisfy both maturing
short-term debt and upcoming operational expenses Owolabi, (2005).
Working capital management (WCM) is of
particular importance to the small business. With limited access to the
long-term capital markets, these firms tend to rely more heavily on
owner financing, trade credit and short-term bank loans to finance their
needed investment in cash, accounts receivable and inventory
(Chittenden et al, 1998; Saccurato, 1994). However, the failure rate
among small businesses is very high compared to that of large
businesses. Studies in the UK and the US have shown that weak financial
management - particularly poor working capital management and inadequate
long-term financing - is a primary cause of failure among small
businesses (Berryman, 1983; Dunn and Cheatham, 1993). The success
factors or impediments that contribute to success or failure are
categorized as internal and external factors. The factors categorized as
external include financing (such as the availability of attractive
financing), economic conditions, competition, government regulations,
technology and environmental factors. While the internal factors are
managerial skills, workforce, accounting systems and financial
management practices.
Some research studies have been
undertaken on the working capital management practices of both large and
small firms in India, UK, US and Belgium using either a survey based
approach (Burns and Walker, 1991; Peel and Wilson, 1996) to identify the
push factors for firms to adopt good working capital practices or
econometric analysis to investigate the association between WCM and
profitability (Shin and Soenen, 1998; Anand, 2001; Deloof, 2003).
A firm is required to maintain a balance
between liquidity and profitability while conducting its day to day
operations. Liquidity is a precondition to ensure that firms are able to
meet its short-term obligations and its continued flow can be
guaranteed from a profitable venture. The importance of cash as an
indicator of continuing financial health should not be surprising in
view of its crucial role within the business. This requires that
business must be run both efficiently and profitably. In the process, an
asset-liability mismatch may occur which may increase firm’s
profitability in the short run but at a risk of its insolvency. On the
other hand, too much focus on liquidity will be at the expense of
profitability and it is common to find finance textbooks (Gitman, 1984
and Bhattacharya, 2001) begin their working capital sections with a
discussion of the risk and return tradeoffs inherent in alternative
working capital policies. Thus, the manager of a business entity is in a
dilemma of achieving desired tradeoff between liquidity and
profitability in order to maximize the value of a firm.
Managing Working Capital involves the various activities combined to ensure the effective utilization of the available working capital.
While the performance levels of small
businesses have traditionally been attributed to general managerial
factors such as manufacturing, marketing and operations, working capital
management may have a consequent impact on small business survival and
growth (Kargar and Blumenthal, 1994). The management of working capital
is important to the financial health of businesses of all sizes. The
amounts invested in working capital are often high in proportion to the
total assets employed and so it is vital that these amounts are used in
an efficient and effective way. However, there is evidence that small
businesses are not very good at managing their working capital. Given
that many small businesses suffer from under capitalization, the
importance of exerting tight control over working capital investment is
difficult to overstate.
A firm can be very profitable, but if
this is not translated into cash from operations within the same
operating cycle, the firm would need to borrow to support its continued
working capital needs. Thus, the twin objectives of profitability and
liquidity must be synchronized and one should not impinge on the other
for long. Investments in current assets are inevitable to ensure
delivery of goods or services to the ultimate customers and a proper
management of same should give the desired impact on either
profitability or liquidity. If resources are blocked at the different
stage of the supply chain, this will prolong the cash operating cycle.
Although this might increase profitability (due to increase sales), it
may also adversely affect the profitability if the costs tied up in
working capital exceed the benefits of holding more inventory and/or
granting more trade credit to customers Akwaja, (2004).
Another component of working capital is
accounts payable, but it is different in the sense that it does not
consume resources; instead it is often used as a short term source of
finance. Thus it helps firms to reduce its cash operating cycle, but it
has an implicit cost where discount is offered for early settlement of
invoices.
1.2 STATEMENT OF THE PROBLEM
Small and Medium Enterprises (SMEs) in
Nigeria have not performed creditably well and hence have not played the
expected vital and vibrant role in the economic growth and development
of Nigeria. This situation has been of great concern to the government,
citizenry, operators, practitioners and the organized private sector
groups. Year in year out, the governments at federal, state and even
local levels through budgetary allocations, policies and pronouncements
have signified interest and acknowledgement of the crucial role of the
SME sub-sector of the economy and hence made policies for energizing the
same. There have also been fiscal incentives, grants, bilateral and
multilateral agencies support and aids as well as specialized
institutions all geared towards making the SME sub-sector vibrant.
Just as it has been a great concern to
all and sundry to promote the welfare of SMEs, it has also been a great
cause of concern to all, the fact that the vital sub-sector has fallen
short of expectation. The situation is more disturbing and worrying when
compared with what other developing and developed countries have been
able to achieve with their SMEs. It has been shown that there is a high
correlation between the degree of poverty hunger, unemployment, economic
well being (standard of living) of the citizens of countries and the
degree of vibrancy of the respective country’s SMEs.
Most SMEs die within their first five
years of existence. Another smaller percentage goes into extinction
between the sixth and tenth year thus only about five to ten percent of
young companies survive, thrive and grow to maturity.
Many factors have been identified as to
the possible causes or contributing factors to the premature death. Key
among this include insufficient capital, lack of focus, inadequate
market research, over-concentration on one or two markets for finished
products, lack of succession plan, inexperience, lack of proper book
keeping, lack of proper records or lack of any records at all, inability
to separate business and family or personal finances, lack of business
strategy, inability to distinguish between revenue and profit, inability
to procure the right plant and machinery, inability to engage or employ
the right caliber staff, lack of good plan, cut-throat competition,
lack of official patronage of locally produced goods and services,
dumping of foreign goods and overconcentration of decision making on one
(key) person, usually the owner. Other challenges which SMEs face in
Nigeria include irregular power supply and other infrastructural
inadequacies (water, roads etc) unfavorable fiscal policies, multiple
taxes, levies and rates, fuel crises or shortages, policy
inconsistencies, reversals and shocks, uneasy access to funding, poor
policy implementation, restricted market access, raw materials sourcing
problems, competition with cheaper imported products, problems of
inter-sectoral linkages given that most large scale firms source some of
their raw material outside instead of sub contracting to SMEs,
insecurity of people and property, fragile ownership base, lack of
requisite skill and experience, thin management, unfavorable monetary
policies, lack of preservation, processing and storage technology and
facilities, lack of entrepreneurial spirit, poor capital structuring as
well as poor management of financial, human and other resources.
If Nigeria were to achieve an
appreciable success towards attaining the Millennium Declaration Goals
for 2015, one of the sure ways would be to vigorously pursue the
development of its SMEs. Some of the key Millennium Declaration Goals
like halving the proportion of people living in extreme poverty,
suffering from hunger, without access to safe water, reducing maternal
and infant mortality by three-quarts and two thirds respectively and
enrolment of all children in primary school by 2015 may indeed be a
mirage unless there is a turnaround of our SMEs’ fortunes sooner than
later. The time is now to do something surgical to the situation of our
SMEs given the aggravating level of poverty in Nigeria and the need to
meet up with the Millennium Declaration Goals. The decreasing level of
Nigeria’s per capita income, which declined from $870 in 1981 to $260 in
1998, and $205 in 2004 as well as a low level of agricultural,
industrial and infrastructural development (irrigation, road and railway
networks) all represent disturbing indices, which also contribute to
the dismal performance and contribution of our SMEs. Dr. Ade Oyedijo, a
financial expert in a paper titled “Nigeria’s Economy and its Career
Promise for the Mature Employee” affirmed that the plights of SMEs in
Nigeria have to do with key variables and challenges that characterize
the nation’s economy. These include but are not limited to a very high
unemployment rate, which is expected to increase as a result of the
current ongoing public sector reforms, high unemployment rate, high
poverty level, disease, hunger, etc. Dr. Oyedijo also mentioned a
drastic shift from the production of non-oil traded goods (mostly
agricultural) to traded goods while about 95 million Nigerians are
reported to be living below the poverty line even as 19 of her citizens
are ranked among the 500 wealthiest men in modern capitalist economy as
among the characteristics of our nation’s economy which aggravate the
problems of Nigerian SMEs. He also opined that since independence, the
main thrust of Nigeria’s development strategies and objectives have been
the development of industrialization, education and a self reliant
economy but regretted that the human capital which is expected to
support the industrialization process and propel other sectors to
maturity has not exhibited the right mix of knowledge, attitude and
skills required to achieve this purpose.
1.3 RESEARCH QUESTIONS
The research questions of this study
aims at eliciting information in certain areas that will serve as a
guide or map in data generation and information gathering. The following
questions were asked to serve this purpose:
- Can Working Capital Management influence business survival?
- What are the trends regarding small and medium scale business in Nigeria?
- How can Working Capital Management influence business survival?
- What are the main causes of liquidation of most small and medium scale enterprises in the country?
- What roles do banks and other financial houses play in the sustenance of SME’s?
1.4 AIM AND OBJECTIVES
The research study mainly aims at evaluating the impact of Working capital management as a tool for business survival;
The specific objectives of the study are to:
- Elicit information on the relationship between working capital
management and the survival of small and medium scale enterprises.
- Examine how working capital management can affect business survival
- Examine the inherent benefits in effective working capital
management for the benefit of small and medium scale enterprises in
Nigeria.
- Review the major problems, challenges and constraints, which have
militated against the SMEs from playing the vital role in the Nigerian
economic growth and development.
1.5 JUSTIFICATION FOR THE STUDY
The interest behind this study stems
from the researchers overall look and from personal observations at the
trends of growth and closure patterns of small and medium scale
enterprises in the country. After reviewing some related and relevant
literature work, it became clear that the issue of survival of small and
medium scale enterprises should not sidelined. Small and Medium scale
enterprises are more present in the Nigerian economy than the Large
scale sector and serves as a higher employer of labor.
Though there has been countless research
work carried out in the area of small and medium scale enterprise
survival, only a handful have actually looked into the area of working
capital management as a key factor in their survival in Nigeria.
This study, if successful, will throw
more light to effective working capital management as a viable tool for
the survival of small and medium scale enterprises.
1.6 STUDY AREA
The Ramsgate pharmacetical store is
located just outside the borderlines between Lagos and Ogun state,
Nigeria. The outfit has been popularly known in the area as one of the
foremost pharmaceutical dealers for both wholesale and retail consumers.
Over the years, the pharmacy has witnessed a change in the management;
three times, 1998, 2005 and 2009 respectively. The pharmacy employs
about 120 staff capacity (both confirmed and casual); the confirmed
staff carryout the daily activities in the administrative section of the
business to ensure a smooth flow of responsibilities and results, while
the casual staff are mostly used for the loading and unloading of the
goods.
The Topman Paint Industry on the other
hand, is also located in Abule-egba area Lagos. It was initially a paint
shop at startup, but grew into a popular paint industry especially
valued by wholesale and retailers.
Both case studies were chosen by the
researcher not just for proximity reasons, but for the fact that they
served as good representation of the typical Small and Medium scale
enterprises in the country today.
1.7 LIMITATION OF THE STUDY
Beginning with timing and initial
financial constraints, as the study was financially tasking on the
researchers financial capacity, the study faced some limitations. The
acquisition of journals and materials for the research work took
considerable effort to scout through the pool of sources. Also, the
issue of communication constituted strain as most of the respondents was
unwilling to cooperate. Despite the limitations, adequate information
was gathered by the researcher as the case studies finally chosen had
respondents who were willing to divulge as much details as they could.
1.9 DEFINITION OF TERMS
Small Enterprise: An
enterprise whose total cost including working capital but excluding cost
of land is between ten million naira (N10,000,000) and one hundred
million naira (N100,000,000) and/or a workforce between eleven (11) and
seventy (70) full-time staff and/or with a turnover of not more than ten
million naira (N10,000,000) in a year.
Medium Enterprise: A
company with total cost including working capital but excluding cost of
land of more than one hundred million naira (N100,000,000) but less than
three hundred million naira (N300,000,000) and/or a staff strength of
between seventy-one (71) and two hundred (200) full-time workers and/or
with an annual turnover of not more than twenty million naira (N20, 000,
000) only
Large Enterprise: Any
enterprise whose total cost including working capital but excluding cost
of land is above three hundred million naira (N300,000,000) and/or a
labor force of over two hundred (200) workers and/or an annual turnover
of more than twenty million naira (N20,000,000) only (Basil, 2005).
Assets: A thing of value, especially property, that a person or company owns, which can be used or sold to pay debts.
Exacerbated: An action or condition that happens to make something worse than its previous state.
Inventories: A written list of all objects or goods in a particular place that could be used for reference or planning purposes.
Receivables: Money or assets that has not yet been received, or money that is owed to a business.
Impediments: Anything that delays or stops the progress of something.
Liquidity: The state of owning things of value that can easily be exchanged for cash.