Impact of Efficient Working Capital Management for Profitability of a Firm

Introduction

The ultimate objective of any firm across the globe is to maximize the profit and stay strong in global competition. But this objective changes due to the course of time, and for such, preserving the liquidity became another important objective too. In this case, a firm should learn how to balance the two objectives to gain the competitiveness. This means that the firm should monitor the continuous profit gaining of the organization while managing the liquidity on the other side. If the organization did not care to face the objectives, the firm might fall in between insolvency or bankruptcy. These are the reasons for working capital management should be given proper consideration.

Background and Problem Statement

A firm, disregarding the size, type, and scale, should maintain the liquidity and profitability while operating in a daily basis. 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 (Padachi, 2006). Therefore, the working capital of the firm should be set on return trade-offs inherent in alternative working capital policies. However, how can be a working capital management is efficient in a firm?

Research Aim and Objectives

The main aim of the study is to investigate the impact of working capital of the companies with recognizable market shares. In order to facilitate the investigation, there are three objectives that should be considered. First is to describe the companies and their nature of working capital. Second is to determine the management of working capital in the organizations’ success. And third is to discover the other intervention or working capital policies the firms created that can play an important role in their profitability and liquidity.

Literature Review

Working capital management (WCM) 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. Efficient working capital management involves planning and controlling current assets and current liabilities in a manner that eliminates the risk of inability to meet due short term obligations on the one hand and avoid excessive investment in these assets on the other hand (Raheman & Nasr, 2007). Even the small businesses are using the idea of WCM because of their characteristics with limited access in long-term capital markets but with needs on the continuous financial investment. Also, failure among the firms in terms of financing is foreseeable due to the weak financial management - particularly poor working capital management and inadequate long-term financing. Although there are internal and external factors that might contribute to the success or failure of a firm, still the efficient working capital management plays a significant role (Padachi, 2006). In understanding the WCM, the requirements should include the maintenance of the optimum balance of working capital components. Optimization of working capital balance means minimizing the working capital requirements and realizing maximum possible revenues. If there is an efficient WCM, it will definitely increase the growth of the opportunities and return to the shareholders (Ganesan, 2007; Afza & Nazir, 2007).

Methodology

The suggested method in the study is the use of secondary information. The sample that will be used in the method are the materials regarding the three of the telecommunications company as listed in 2009’s top companies of Business Week- MTN (South Africa with International Sales of 63%), America Movil (Mexico with International Sales of 61%), and Telefonica (Spain with International Sales of 39.3%). The information coming from the these companies will give the study the idea on how well the firms use the opportunity on working capital as a good foundation in their success and increase their profitability.

References:

Afza, T., & Nazir, M.S., (2007) Is it Better to be Aggressive or Conservative in Managing Working Capital? [Online] Available at: https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=SERC2007&paper_id=107 [Accessed 16 August 2010].

Ganesan, V., (2007) An Analysis of Working Capital Management Efficiency in Telecommunication Equipment Industry, Rivier Academic Journal, 3(2) [Online] Available at: http://www.rivier.edu/journal/ROAJ-Fall-2007/J119-Ganesan.pdf [Accessed 16 August 2010].

Padachi, K., (2006) Trends in Working Capital Management and its Impact on Firms’ Performance: An Analysis of Mauritian Small Manufacturing Firms, International Review of Business Research Papers, 2 (2) [Online] Available at: http://www.bizresearchpapers.com/Kesseven.pdf [Accessed 16 August 2010].

Raheman, A., & Nasr, M., (2007) Working Capital Management and Profitability – Case Of Pakistani Firms, International Review of Business Research Papers, 3(1) [Online] Available at: http://www.bizresearchpapers.com/Paper%2019.pdf [Accessed 16 August 2010].