Working Capital Management and Keynesians Theory on Cash Conversion Cycle Theory: Discursive Essay

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Working Capital Management and Keynesians Theory on Cash Conversion Cycle Theory: Discursive Essay

Introduction

This section provides an overview of the study. It includes background of the study, statement of the problem, research objectives, and research questions, scope of the study, significance of the study and justification of the study. Conceptual framework and definition of terms are also included in this section.

Background of Study

The financial institutions like banks are the most important sector in the development of the country’s economy as they serve as an essential tool for administering excess funds from the surplus spending sector to the deficit spending sector of the economy. They act as middleman and this is done through intermediation by collecting funds in form of savings and deposits and afterwards makes the funds available to the deficit spending sector in form of loans and subsidies. The loans granted to their customers it gives a positive impact on a country’s economy as it enables the firms to increase their productive capacity thereby increasing a country’s Gross domestic product. (Olaitan, 2010). This will eventually lead to the increase of average incomes for the residents as their income per capita will be increased and hence a better standard of living.

Banks in developing countries are known to offer services to the general public and to companies. Essentially on granting a permanent post facility to customers. This is largely attributed to the source of funds at their disposal which is usually short tenured. It is known that markets for long term funds are not so developed hence the scenario described above. The above situation implies that banks always put forward to grant short term credits hence the importance of working capital management (Olaitan, 2010).

Working capital management is a process of managing activities and processes related to working capital. Keynesians Theory on Cash Conversion Cycle Theory argues that a company has to ensure an effective working capital management and this is done through establishing an optimal level of working capital. This level of management serves as a counterbalance system to ensure that the amount of cash flowing into the business is enough to sustain the company’s operation. This is an ongoing process that must be evaluated using the current level of asset and liabilities. This is very essential after realization that working capital elements including cash, inventories, accounts receivables, accounts payables are keys to the better performance of the business but on the other hand it’s a cost to the business. Baumol (1952) and Tobin (1956) noted that optimal cash balances, just like inventory models have cost associated with sourcing, maintenance, beside the benefits that companies obtain from optimal cash levels.

Working capital management includes implementing short-term decisions that may or may not extend from one earning period to the next. Working capital management deals with management of current assets and current liabilities with two objectives of minimizing the risk of failure while maximizing return on assets (Sagner, 2014).

Working capital has become an important element in investment decisions since the amount and day to day management has become an important determinant of profitability (Deloof, 2013). However, significant consideration is not often made of working capital when financing decisions are made by firms because it involves investment and financing in the short term. Companies often desire to maintain liquidity and operational efficiency by minimizing their investment in working capital (Brigham & Campsey, 2011).

Implementing an effective working capital management system is an effective way many companies uses to improve their profit. The main aspects of working capital management are cash, inventories, accounts receivables, accounts payable. Financial analysts argue that ineffective working capital management is one of the most significant hindrances to profitability growth of banks and in reaching out to more customers (Lyngstadaas & Berg, 2016). Although, the commercial banks sometimes find it hard to obtain external loans from other corporate financial institutions to expand their working capital requirements. Where the borrowing is convenient and the cost of borrowing from that sources has an unsupportable arising from high interest costs. Also, the government policies such as excessive debt burden, persistent increase in inflation, increase in minimum capital requirement of the central banks and intense competition in the banking industry are indications of the need to undertake a study into working capital management (Brigham & Campsey, 2011).

The main key performance ratios of a working capital management system are the working capital ratio, inventory turnover and the collection ratio. Ratio analysis will lead management to identify areas of focus such as inventory management, cash management, accounts receivable and payable management (Samiloglu & Demirgunes, 2016). The results of fixed and random effects models show a negative relationship between performance and the different working capital components. This reveals that commercial banks and other financial institutions which deal with financial affairs should shorten their cash conversion cycle by reducing the number of days of accounts receivable and payable to increase their performance. As the result, the commercial bank fails to meet its obligations such paying creditors on time, purchasing raw materials for production and so on. All these may be due to mismanagement of the working capital (Samiloglu & Demirgunes, 2016).

The research intends to assess how commercial Banks, especially how Equity manage their working capital and contribution it has on the performance. The working capital management deals with the levels of Working capital to optimum, because if a concern has inadequate opportunities and if the working capital is more than required then the concern will lose money in the form of interest on the blocked funds. Therefore, the Working Capital management plays a very important role in performance of commercial Banks (Iyewumi, Remy, & Omotayo, 2015).

Statement of the Problem

The main objective of working capital management is to manage the company’s current assets and current liabilities in such a way that a satisfactory of working capital is maintained. It is due to the fact that if the company cannot sustain an acceptable level of working capital management certainly may lead into what is termed insolvency and may end up into bankruptcy (Berry, Faulkner, Hughes, & Jarvis, 2013). Current assets must be large as much as necessary to be able to cover its current liabilities to guarantee a reasonable margin of safety. All of the current assets are to be managed efficiently so as to maintain the liquidity of the company; while not keeping too high a level of any one of them. Hence, the interaction between current assets and current liabilities is the main premise of the theory of working capital management.

The problem generally explains that, less attention has been paid to the area of short term finance, in particular that of working capital management. Such as neglect might be acceptable were working capital considerations of relatively little importance to the firm, but effective Working capital management has a crucial role to play in enhancing the performance and growth of the firms indeed, experience shows that inadequate control of working capital is one of the Common causes of business failure (Abosede & Luqman, 2014).

The efficient management of working capital is very vital for a business survival. This is premised that having too much working capital means efficiency, whereas too little cash at hand means that the survival of business is trembling. However, implementing best practices of Working capital management has becomes one of the most exciting and challenging operational areas of business. Therefore, it has always been for any commercial banks to survive with competitive environment, Working Capital Management practices is one of the most important elements of increasing performance of any company and have been done to analyze importance of working capital practices in selected commercial banks in Nandi County.

Research Objective

The main objective of this study is to analyze the effects of working capital management to the financial performance of selected commercial banks in Nandi County.

Specific Objectives

To establish the effect of accounts receivable on the financial performance of selected commercial banks in Nandi County.
To establish the effect of cash conversion cycle on the financial performance of selected commercial banks in Nandi County.

Research Questions

What are the effects of accounts receivable on the financial performance of selected commercial banks in Nandi County?
What are the effects of cash conversion cycle on the financial performance of selected commercial banks in Nandi County?

Research Hypothesis

H0: There is no significant effect of accounts receivables and cash conversion cycle on the financial performance of selected commercial banks in Nandi County.

Conceptual Framework

Figure1: Conceptual Framework

Independent variables Dependent variables

(Accounts Receivables)

(Cash Conversion Cycle)

(Financial Performance)

Source: Researcher’s Compilation 2019

Significance of Study

The study will improve the skills and knowledge of the researchers by learning some skills on the working capital management and its performance on commercial Banks. The study will help Equity to better manage its working capital in order to get much of liquidity/cash, which will help to cover its obligations and It will also enable the management to know with reasons the basic causes of the changes in net working capital through suggestions and recommendations, this study will help the commercial Banks to improve their working capital management and solve problems related to customer’s satisfaction. The result of this study will be useful to the commercial banks and future researchers to understand management of working capital and its effects on their performance.

Scope and Limitations of the Study

This study will be faced with limitations in terms of space and period to be covered. This study will be carried out in Equity and will be aimed at finding the effects of working capital management on the performance of the bank.

[bookmark: _Toc6145368]Operation Definition of Terms

Accounts Receivable: Accounts receivable is the balance of money due to a firm for goods or services delivered or used but not yet paid for by customers (Gaur & Raman, 2015).

Cash conversion cycle: Sometimes referred to as an asset conversion cycle or a net operating cycle, the cash conversion cycle is a simple process that is used to evaluate the current financial stability of a business (Joshi, 2015).

Working Capital: Working capital, also known as net working capital, is the difference between a company’s current assets, like cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, like accounts payable (Shin & Shoenen, 2014).

Performance: Financial performance is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues (Smith, 2010).