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University of Nigeria Research Publications
UKO, Ugonma Chinatu
Aut
hor
PG/MBA/98/20846
Title
Working Capital Management Practices in Selected Nigeria Manufacturing Enterprises (A Case Study of Paterson Zochonis Industries P.
L. C. and Nestle Nigeria )
Facu
lty
Business Administration
D
epar
tmen
t
Banking and Finance
Dat
e
July, 2002
Sign
atur
e
WORKING CAPITAL MANAGEMENT PRACTICES IN SELECTED NIGERIAN MANUFACTURING
ENTERPRICES (CASE STUDY OF PATERSON ZOCHONIS INDUSTRIES P.L.C. AND NESTLE NIGERIA
P.L.C.)
'j7 f' I a 6
UKO UGONMA CHINATU
P= -
PGIM BA198120846
s t p e n , .'-q O-Y; 4 ~ . A-ILZ .p, T c l ,[+
DEPARTMENT OF BANKING AND FINANCE FACULTY OF BUSINESS ADMINISTRATION UNIVERSITY OF NIGERIA, ENUGU CAMPUS
6
CERTIFICATION
This is to certify that this project written by UKO, Ugonma C. with registration number PG/MBA/98/20846 presented to the department of Banking and finance, University of Nigeria Enugu Campus, is original and has not been submitted for the award of any degree or diploma either in this or any other tertiary institution.
is is to certify that this research work by UKO, Ugonma C. with registration -amber PG/MBA/98/20846 presented to the department of Banking and Finance .das submitted in partial fulfillment for the award of Masters of Business -.;dministration (M.B.A.)
Supervisor
Head of D partment LP
Date
DEDICATION
This work is dedicated to my family - Aham, my darling husband and pillar; my children Kennedy, David, Adaugo and Christina for being my pride of motherhood, and Chiefly to the Almighty for the strength and ability He enabled me with to complete this study.
IV.
ACKNOWLEDGEMENT
I humbly acknowledge my Supervisor Dr. A.M.O., Anyafo, for assessing and making the necessary corrections that have helped in putting this project into a proper shape.
ABSTRACT
This research is directed towards the elucidation of fundamental issues regarding working capital management in manufacturing firm, making Paterson Zochonis Industries PIC (PZ) and Nestle Nigeria PIC a Case Study.
The purpose of the study was to find out the methods adopted by the selected companies in determining the level of working capital, different forms in which they are kept as well as the financing methods.
Five most recent published financial statements of both P.Z. PIC and Nestle Nigeria PIC (1997-2001) as well as management reports within the periods were analyzed. Data was also collected through discussions with corporate managers as well as use of questionnaires.
The analytical techniques employed include graphical representation, ratios as well as statistical analysis. Statistical tools employed were t-test, ANOVA, Correlation analysis and Kendall Coefficient of Concordance.
Three hypotheses were tested at different levels of significance. We confirmed that individual working capital do not follow the same trend. Our research confirmed further that closing inventory is not significant in relation to the aggregate cost of sales. We also discovered that working capital items are dependent on total assets.
There is no Concordance among respondents as to the factors that led to the selected companies impressive performances, but rather a blend of factors which include plant maintenance, availability of market, effective distribution system and effective management.
Based on our findings, we recommended measures that when taken will enhance better working capital management in manufacturing firms. These include use of information from other sources, taking interest in other financial statement items, reducing government intervention in working capital management to the minimum as well as search for local substitutes of raw materials.
TABLE OF CONTENTS
TITLE PAGE CERTIFICATION PAGE DEDICATION ACKNOWLDGEMENT ABSTRACT TABLE OF CONTENTS
CHAPTER ONE: INTRODUCTION
OVERVIEW STATEMENT OF THE PROBLEM OBJECTIVES OF THE STUDY RESEARCH QUESTIONS HYPOTHESIS SIGNIFICANCE OF THE STUDY LIMITATIONS OF STUDY DEFINITION OF TERMS SUMMARY
CHAPTER TWO: LITERATURE REVIEW
i i i iii iv V
vi-vii
CONCEPTUAL CONSIDERATIONS 13 WORKING CAPITAL CYCLE 16 WORKING CAPITAL INVESTMENT 20 WORKING CAPITAL MANAGEMENT: RATIO ANALYSIS 33 WORKING CAPITAL MANAGEMENT: THE PIPELINE PRINCIPLE 39 RETURN ON CAPITAL EMPLOYED (ROCE): THE DUPONT ANALYSIS 4 1 PATERSON ZOCHONIS INDUSTRIES PLC (PZ): AN OVERVIEW 42 NESTLE NlGlER PLC: AN OVERVIEW 45 CONCLUSION 49 REFERENCES 51
CHAPTER THREE: METHODOLOGY PAGEE)
3.1 INTRODUCTION 53 3.2 SOURCES OF PRIMARY AND SECONDARY DATA 53 3.3 SCOPE OF THE RESEARCH 53 3.4 SAMPLING METHODS AND SIZE OF SAMPLE 54 3.5 ANALYTICAL TECHNIQUES 55 3.6 SUMMARY 63 3.7 REFERENCES 64
CHAPTER FOUR: DATA ANALYSIS AND INTERPRETATION
INTRODUCTION 65 QUALITATIVE AND QUANTITATIVE ANALYSIS 65 GRAPHICAL REPRESENTATION 65 RATIO ANALYSIS 68 INTER-COMPANY COMPARISON AND TREND ANALYSIS 78 R.O.C.E.: A CRITICAL OVERVIEW 85 STATISTICAL ANALYSIS 88 SUMMARY 109
CHAPTER FIVE: SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION
5.1 INTRODUCTION 5.2 SUMMARY OF FINDINGS 5.3 RECOMMENDATIONS 5.4 SUGGESTIONS FOR FURTHER STUDY
BlBlOGRAPHY APPENDIX
CHAPTER 1
INTRODUCTION
1.1 OVERVIEW
All organizations for the sake of survival need to generate and use
information for sundry purposes in relation to their varied field of operation.
Consequently, an information system must be established and modelled
towards the generation of vital information. The role of accounting as a
formal information system in almost all organizations has made it to be
referred to as the "Language of business" The role of accounting in data
generation for planning, controlling and evaluating the activities of the
business cannot be divorced from the use of tools of financial analysis in
planning and controlling the activities of the firm.
Planning is essential as it is the key to financial success and it determines
the outlook of the firm while enabling the financial manager to know the
company's position in order to estimate its capabilities (Johnson, 1959:69)
~onfioll ing is the process by which a manager determines objectives, draws
up plans to attain those objectives, organizes and supervises the operation
necessary for the implementation of tasks and appraises performance
(Adewunmi, 1982:31).
However, both planning and controlling involve financial analysis. Financial
analysis is the process of identifying the financial strengths and weaknesses
of the firm by properly establishing relationships between items in the
balance sheets and the profit and loss accounts (Pandey, 1985: 500).
Financial analysis is dependent on financial statements which are the
instruments panel of a business enterprises, and constitute a report of
managerial performance, attesting to managerial success or failure and
flashing warning signals of impending difficulties (Meigs and Johnson, 1967:
81 5).
Financial analysis helps in providing an objective analytical review of
corporate performance, acts as an indicator of efficiency, effectiveness or
otherwise in the course of the life an enterprise, and assists in resolving
unexpected difficulties; hence financial analysis keeps the conducts of
management's, enabling external parties to evaluate and appraise the
busiiess.
Working capital consists of cash, stocks of various kinds (raw-materials,
work-in-progress and finished goods) and debtors balances, primarily the
outstanding receivables from customers; in other words, the current assets of
the business. This is otherwise referred to as gross working capital. When
working capital is offset by the current liabilities, net working capital results.
The importance of working capital cannot be overemphasized. These
include inter-alia, the following:
(i) Most financial manager's time is devoted to the day to day internal
operation of the company, which comes under working capital
management.
(ii) Small companies can afford not to invest in fixed assets possibly by
leasing them from bigger establishments. However, investments in
cash, receivables and stocks are unavailable. Also, they are not listed
in the stock market, hence this limits their financing to trade credit and
short term bank loans both of which are included on working capital
management.
(iii) Current assets are directly related to sales which is a function of time.
Managing current assets is a dynamic process and involves sales
close monitoring.
(iv) Sales growth and investment in current assets are close and directly
related. This implies that financial managers should pay particular
attention to sales trend and their resultant effects on the corporate
working capital needs.
Creditors, be they financial or trade creditors, secured or unsecured, are
majorly concerned with firstly the safety of their fund (i.e. the certainty of
repayments and), or the servicing of the loan depending on the
circumstances. In this instance, creditors have to be very prudent in
determining who their potential debtor is going to be. The determination of
credit-worthy debtors can perhaps best be achieved by reviewing past
company's performance and corporate liquidity. Ratios useful in this regards
include that of the current assets to current liabilities, and the rapidity with
which receivables turn into cash in the normal course of business (Johnson,
1959), i.e. monitoring the corporate working capital.
Working capital management is important also in that management's
attention is quickly directed to critical areas that need to be attended to in the
nearest future. It assists management in appraising past performance and
usinb the deducted results as a yard-stick in studying the present and
.forecasting the future. Thus, management takes a corrective action to
reverse unsavouring conditions or consolidate corporate advantages and
how to implement the decided action.
In brevity, working capital management have the technical characteristics of
being versatile in ascertaining corporate health or predicting corporate
failure. It pinpoints the efficiency and effectiveness of management
performance.
This research is directed towards the exposition of basic operational facts
about working capital management in a manufacturing environment. The
demonstration of the operational analysis is undertaken using empirical
survey data obtained from the annual reports and management reports of
Nestle PIC and Paterson Zochonis Industries Plc. Discussion would be
carried out with relevant corporate managers as questionnaires would also
be utilized.
These data are consequently used to test the quantitative and operational
efficiency- and effectiveness of the selected companies' working capital
management. Tests would be performed on these data using graphs,
relevant working capital ratios as well as statistical analysis. Both parametric
and non-parametric tests would be employed in the statistical analysis. T-
test, analysis of variance (anova) and the correlation and analysis forms of
5
parametric tests would be employed. Kendall coefficient of concordance
form of non-.parametric test would also be employed. Return on Capital
Employed (ROCE) would be used in inter company comparisons.
Finally, this research work provides summary, conclusion on the research
conducted and makes practical recommendations on the findings, which
hopefully will help in improving on working capital management in
manufacturing environment in particular and other industries in general.
1.2 STATEMENT OF THE PROBLEM
- Financial managers are faced with three major problems in managing
0
- working capital. A careful analysis of these problems as well as a selected
mix of available possible solutions are pre-requisite for an effective working
capital management. The problems are
1. How much working capital should a business hold?
2. What should be the spread of the working capital in each type of
current assets?
3. How should the working capital be financed?
b
A financial manager has to be well equipped to be able to manage these
problems within the limit of available resources. Any transaction in a
6
company must affect at least one of the working capital components. An
effective working capital management is required for the company's success
as it is the life-wire of any company.
1.3 OBJECTIVES OF THE STUDY
The objectives of the study are as follows:
(i) to analyse the different ways of financing working capital;
(ii) To determine the factors responsible for the performance of the
selected companies in working capital management.
(iii) To find out the techniques used by the selected companies in cash
control;
(iv) To determine the factors that influence the management of debtors;
(v) To find out the methods which the selected companies use in
management of inventory;
(vi) Make suggestions and recommendations in line with research
findings.
1.4 RESEARCH QUESTIONS
The following questions are pertinent to the research:
(i) Do movement in individual working capital follow the same trend?
7
(ii) Is there any relationship between closing inventory and the aggregate
costs of sales?
(iii) Is there any relationship between working capital and total assets?
(iv) Are there any factors responsible for the selected companies
impressive success in its operation?
HYPOTHESES
Ho; 1. Movement in individual working capital items do not
follow the same trend.
2. Closing inventory is not significant in relation to the aggregate
cost of sales.
3. Working capital and total assets are not positively correlated.
1.6 SIGNIFICANCE OF THE STUDY
The significance of the study include:
(i) Revealing the strategies adopted by the selected companies in
making an impressive performance even during this difficult economic
situation in Nigeria.
(ii) ' Pinpointing to financial analysts areas to watch out for when
investigating working capital situation of a company.
(iii) Addressing the effects of government intervention in working capital
management of companies such as P.Z. and Nestle Nigeria Plc. This
may compel policy makers in re-addressing the expected limits of
government involvement.
1.7 LIMITATIONS OF STUDY
The research work is limited to empirical data obtained about the
selected companies working capital management and covers a
period of only five years.
To gain more insight into inter-corporate working capital
management comparison, the researcher suggests that more
samples be collected by interested researchers for analysis and a
longer period of time be covered.
1.8 DEFINITION OF TERMS
Liquiditv: The ability of a firm to meet its financial obligation.
Liquidity is usually measured by examining the organization's
balance sheet and relating some or all of its current assets to some
or all bf its current liabilities.
Secured Creditors A creditor who holds a security which will cover
the amount his debtor owes him.
Window Dressing: Financial tactics aimed at presenting a bad
condition as 'safe1 or 'good'.
Workinq Capital: Refers to a firm's investments in short term
securities, accounts receivable and inventories.
Gross Working Capital: Is defined as a firm's total current assets.
Net Working Capital: Is defined as current assets less current
liabilities.
Trend: A dominant movement in data revealed by statistical
process.
Insolvencv: The inability to meet maturing debts obligations
Ratio: The relationship between two qualities which is
expressed by dividing the magnitude of one by that of the other
1.9 SUMMARY
This chapter introduced financial analysis by emphasizing planning and
controlling as indispensable in corporate management. The purpose of the
study and statement of the problem were buttressed. Crucial research
questions were raised as well as the hypotheses to be tested in the course of
the research. The significance as well as limitations of the study were
identified.
The chapter ends by defining some technical terms that were used in the
course of the study.
- REFERENCE
- Johnson, R.W. (1959), Financial Manaqement, McGraw-Hill Inc., New York
Adewunmi, W. (1982), "Why controls fail to control". Professional Manager. -. Journal of the management students Association (MSA), University of
Lagos
Pandey, I.M. (1985), Financial Manaqement, Vickas Publishing House, PVT Ltd., New Delhi
- Meigz, W.B. and Johnson, C.E. (1967), Accounting: The Basis For Business Decision, McGraw-Hill Inc., New York
CHAPTER 2
LITERATURE REVIEW
2.1 Conceptual Considerations
Various writers have attempted defining working capital in various
ways.
Western and Brigham (1979), defined working capital as a firm's
investment on short term assets, namely cash, short term securities,
trade debtors and creditors.
Van-Horne (1 980), asserted that working capital management
involves the administration of cash, marketable securities, .
receivables and inventory as well as current liabilities .
Hobbs and Moore (1 979), laid emphasis on net current assets which
according to them is either the excess of quick assets over current
liabiiities or excess of current assets over current liabilities. In
whichever way it is defined, working capital is the asset held for
current use within a business, less the amount due to those who
await settlement on the short term in whatever form. It is the
effective blood of any business.
Although profitability may be considered the governing factor of a
business, nevertheless the mismanagement of working capital can
effectively bring to a halt or its ultimate downfall what might
otherwise be a successful and profitable enterprise.
Excess working capital has the following dangers:
(1) it results in unnecessary build up of investments. This in turn
increases the danger of:
- Obsolescence
- Deterioration
- Pilferage
Mishandling and
- High insurance costs, etc..
(2) It is an indication of the defective credit policy and slack collection period.
This leads to high incidence of bad debts and loss of profits.
On the other hand, inadequate working capital is also bad and has the
following defects:
1. It becomes difficult to implement operating plant and achieve the
company's profits target.
2. It stagnates growth. It becomes difficult for the company to undertake
profitable projects for non-availability of the working capital funds.
3. Fixed assets are not effectively utilized for the lack of working capital
funds. Thus, the rate of return on the company's investment slumps.
4. The company would be unable to avail attractive credit opportunities
because of inadequate working capital funds.
5. The company losses its reputation when it is not in a position to its
short term obligations (Pandey, 1985: 329)
The investment of any money in a business, whether in fixed assets or
working capital has to be justified in the light of the overall objectives of the
business; whatever investment decision is under review, there must be
constant reference back to its impact on the business as a whole. Once a
decision has been taken, then adherence to the plan, and the effects of
. changes .in parameter on target-result-areas can be checked by using such
asset management ratios as debtors; sales; creditors; purchases; and the
various relationships between stock holdings and input and output figures. b
Wiriakor and Smith (1965), carried out a research on the various causes of
corporate failure. Their conclusion was that the ratio of net working capital to
15
total assets fits in best in measuring corporate failure. In contrast to this
conclusion, Fitzpatrick (1965), based his own research on thirteen
unsuccessful companies and concluded that the best predictor of corporate
failure was the net profit to networth and the networth to total debt ratio.
Harrigan (1965) maintained that Winakor and Smith's research lacked a
contrasting control group of successful firms while Fitzpatrick's sample was
too small and too selective but both studies were significant in evaluating
corporate performance.
2.2 WORKING CAPITAL CYCLE
The working capital (or operating) cycle is the length of time
between a company's paying for materials entering into stock and,
receiving the inflow of cash from sales.
Pandey (1 985), divided this operating cycle into five stages as
follows:
(1) Conversion of cash into raw materials
(2) Cbnversion of raw materials into work-in-progress
(3) . Conversion of work-in-progress into finished goods
(4) Conversion of finished goods into debtors and bills receivables
through sales; and
(5) Conversion of debtors and bills receivables into cash.
When a new business is commenced, the finance required for working
capital will build up progressively as materials are first procured, then labour
is applied in manufacture and stock of finished goods are accumulated.
Once a steady level of production and sales is achieved, each cycle will
overlap the other giving a constant total of days tie-up.
Richards and Langlin (1980), referred to this approach as the cash
"conversion cycle" as it centers on the conversion of materials and labour to
cash.
The operating cycle of a manufacturing firm as P.Z. Industries PIC or Nestle
PIC is represented diagrammatically below.
Finished Goods
- Debtors
Figure 1 : Operating Cycle of a manufacturing firm
4
,
However, many businesses are seasoned and others are spasmodic. There
variations must be noted in the activity level.
Taking the business accounts (either historic or budgeted) the working capital cycle
Sales
Raw Materials
can be calculated in the following ways.
4
Raw materials Stock Days Raw Materials Holding =
Daily Purchases xx Less
b Creditors xx Credit Taken - - -
Daily Purchases xx Add
, Work-in - Progress
Work-in-Progress Production Period - -
Daily Cost of Sales*
Finished Goods Finished Goods Turnover =
Daily Sales
Debtors Customer's Credit Period =
Daily Sales XX
XXX
* Alternatively, the daily cost of input to work-in-progress.
The essence of working capital cycle analysis are
(a) For Control Purposes: This is to improve on previous
working capital ratios. Creditors and stocks are now related
not to sales value but to purchases.
(b) To indicate the relative significance of its constituent parts in order to
emphasize the total time lag within the operating cycle. This is in an
effort to reduce the working capital tied up by action appropriate to
each element
(c) To provide a series of days equivalents which can be used in
budgeting or forecasting to translate sales and cost budgets of
working capital value.
2.3 WORKING CAPITAL INVESTMENT
Investment in working capital is diversified and its effective management
cannot be over-emphasized if corporate objectives are to be achieved.
This project focuses on the following working capital investment
management.
(1) Cash Management
(2) Credit Management
(3) Stocks Management and
(4) Debt Management
2.3.1 Cash Manaqement: Cash is an idle asset. Therefore, a company should
hold the minimum amount sufficient for its needs. How much a company
holds is a function of the purposes for which it is required. Firms hold cash
for the following reasons:
b
(a) Transaction Motives: This requires a firm to hold cash to conduct its
business in ordinary course. The firm needs cash primarily to make
payments for purchases, wages, operating expenses, etc. There is
need to hold cash for this purpose because there is no perfect
synchronization between cash receipts and disbursements.
(b) Precautionarv Motive: According to Stephen Cooper in its book
titled Financial Manaqement, cash inflows and outflows cannot be
predicted with certainty and therefore a company needs to keep a
certain amount of cash in reserve in case of unanticipated
fluctuations. These fluctuations may be caused by variations in
payments by debtors each month, the breakdown of plant and
machinery, etc. (Cooper, 1983:22)
(c) Speculative Motive: This refers to the holding of cash
for investment in profit-making opportunities as and when
they arise. The essence of keeping cash for speculative
purpose is for the fact that such profit making opportunities
come suddenly and there is need to have cash to undertake
the ventures as soon as they arise. The cost of keeping such
amounts in cash should however be kept below the expected
benefits for such undertakings to be worthwhile.
From the above analysis, it is obvious that the financial manager must be
alert every time to merge the corporate cash needs with the cash
available. In order to achieve this aim, the manager must know in
advance as accurately as possible when cash shortages or cash surplus
are likely to occur, so that action can be planned to deal with these
eventualities. Cash management depends on cash forecasting, the most
convenient type of cash forecasting being the receipt and payment
forecast.
The receipt section of the forecast include the following:
( i ) Cash Sales and
(ii) Debt collections
A major item of cash outflow will be payment to suppliers for control purpose,
all items dealt with through the purchase ledger should be grouped together
though various managers will be involved in forecasting transactions of
different types. The procurement manager will, for instance, be required to
prepare a forecast of purchase orders due to be placed from month to
month.
b
Similarly, ,payment to creditors will be derived by compiling a list of accounts
payable at the commencement of the forecast period. This and purchases
forecast will be converted into a forecast of payments due dates, using the
credit period normally taken but adjusted for any special credit terms agreed
by the procurement manager.
The remaining payment will be forecasted using the most convenient
heading for comparison with source documents, for instance.
(i) Net wages and salaries for comparison with payroll
(ii) Petty cash item (in total) for comparison with petty cash book
(iii) Special cheque payments (analyzed by expenses) for comparison
with the analysis column in the main cash book. n lcq? t , , j , ip~qY' :$
r - ' r n O , t p
Each month, net cash flow inwards and outwards is circulated to give the
new month-end balance. It will then be obvious if excess funds will be
available. If not, excess demand may result. This can be met through
overdraft facilities or forecast review to make plan to modify the timing of
particular cash flow so as to restore an acceptable balance.
!.3.2 Credit Manaqement The number of days credit taken from suppliers is to a
large extent under the control of the business, and may be varied from time
to time. . It is generally important, however to be consistent in ones credit
policy. A company may be a slow payer, but if the supplier knows he will get
23
paid regularly, he may accept this delay. He may nevertheless reimburse
himself by increases in price which will then in effect include the interest
charge which the paying company would have incurred if it had borrowed
money to pay its accounts earlier.
Although the practice of offering cash discounts for prompt settlement has
diminished in recent years, some cash discount may be available. Whether
it is beneficial will depend on:
whether the annual discount rate compensates for the opportunity
costs of early payments; if so,
Business operational disruption which may result from suppliers cut-
off by creditors.
Inability of the firm because of its poor rating in obtaining new sources
of supply.
The need to avoid putting suppliers out of business due to cash
shortage. This however is peculiar to small suppliers and
Cost of administering such as telephone calls, letters and statements
in respect to overdue accounts.
b
2.3.3. Stock Manaqement: Stocks unlike debtors, involve commitment of a
large amount of a firm's resources. Their efficient management is a great
24
concern to financial managers. Stocks include raw materials, bought in
parts, finished goods awaiting sales, work-in-progress which are part of a
firm's investment and operations.
Holding stocks enables the company to be more flexible in
supplying customers. There would also be a smaller chance of
sales being disrupted through interruptions in production.
In either case, the benefits associated with them would have to be
balanced against the storage costs incurred. Stocks control is
however not generally under direct control of the financial manager.
Rather, in manufacturing companies, production people typically
have control over stocks, whereas in retail concerns, their control is
exercised by merchandising people. However, the financial
manager is still vitally concerned with stock levels for he or she has
responsibility for trading factors, which affect the overall profitability
of the firm. Because stocks generally amount to 30 to 40 percent of
total assets, poor stocks control may hurt the firm's profitability.
Ineffective management can result in excessive stocks, which in
turn can lead to a low rate of return on investment. According to
Du-Pont equation, stocks management can also have an effect on
25
cash conversion cycle. (Weston,1989). Organisations
should avoid stock-outs as it is detrimental to business operations.
Determination of the exact quantity of stock to be held at any point
in time is a function of the economic order quantity (EOQ)
EOQ = 2DClCr
Where
D - - Annual demand
C - - Ordering Cost
Cr = Holding Cost (e.g. for storage)
EOQ is arrived at as shown graphically below
Figure 2: EOQ graph
Two important things should be noted about EOQ graph.
11 In practice, there is likely to be a range of order quantities
(indicated by shading on the graph)
21 The key factor in the calculation is usually the cost of capital.
One's conclus!on will be that stockholdings should be kept to the
lowest figure possible having regards to any practical difficulties in
obtaining frequent replacement supplies.
2.3.4 Debt Manasement:The management of debt is equally important
because it forms an integral part of the marketing function and the
granting of credit terms attractive to customers may increase sales.
Effective credit management is more than just chasing up slow
papers. It begins with initial selection of customers to whom credit is
to be allowed.
The following form part of the benefits accruing to any organisation
from granting credits to its customers;
increased contributions which eventually increase shareholder's
wealth.
Possibility of future sale to the same customer
Reduces future default in payments
Avoidance of redundancies, and
Improvement in technological know-how
In effective debt management, three types of decisions must be taken.
These are:
(i) what normal credit period should be allowed to customers
(ii) what credit limit should be allowed for individual customers?
(iii) How to ensure that both credit limit and credit period are not
exceeded.
Deciding the Credit Period: If a firm operates in a monopoly
market or that in which demand exceeds supply, the need to offer
credit term is uncalled for. In other cases, the firm will start
establishing the credit period by reviewing the credit terms offered
by competitors. The firm can then, based on this, decide its credit
term, assuming there is no statutory restraints on prices.
If however, the demand for the product is inelastic, shorter credit
may be impossible so that revenue from sales will not be affected
simply by changes in credit terms.
. Establishinq Credit Limit: Though a company has a credit
policy, it is not enough to conclude that all customers must be
granted credit terms. It is difficult to decide whether a customer is b
'credit worthy' because he has both the ability and inclination to pay
at due dates. Most companies require cash from new customers
until their credit worthiness has been established with time.
Two things are of prime importance in assessing a customer's credit
worthiness.
(i) Facts about his business. The accounts of the business would be
analyzed.
(a) whether it generates enough cash within or has access to
sufficient cash to meet its liabilities, and
(b) whether it has suitable assets to cover unsecured creditors in
case of liquidation.
(ii) Facts about the people running the business: either from personal
contact or from third parties, such as business associates, stocks
exchange (if the company is quoted or even from employees changing
jobs).
If consistent and improved ratios are obtained from analysing published
accounts, it is evident that the corporate financial management is purposeful,
and it can be assumed that such trend may continue.
+ In assessing the credit worthiness of overseas customers reports from
bankers are an important source of information. Political or exchange control
30
restrictions must be considered. This is why companies in the third world
countries are rated low generally in terms of credit worthiness.
Having established a customer's credit worthiness, the company will now
decide the amount of credit that will be given. Several ways of doing this
exist theoretically. These include the following.
1) The Income or Cash Flow Method: This is practicable
where the amount of cash available to the customer is known
and how he proposes spending them. This shows his ability to
settle invoices. This is an approach majorly used by banks
when approached by a customer for an overdraft or loan, but
seldomly used in business life.
2) The Capital Structure Method: Using this method, the credit limit
will be a percentage of the unchanged assets in the customer's
,previous balance sheets. This is important when the proposed value
of the future transactions will involve a major increase in the total
indebtedness, but it is not an indicator of liquidity. This method is not b
relevant to small transactions in the ordinary course of trade.
3) The Requirement Method: This method is used mostly in
practice. It is based on the fact that if a customer is credit-
worthy, then we should extend to him the much credit required in the
ordinary course of business. This amount of credit is based on the
value of business which the customer expects to place with the
supplier each month. The monthly sales forecast are multiplied by a
number of months credit laid down as company policy to arrive at the
customer's credit limit.
Emenua (1 992), identified a lot of risks involved in a company
extending credit to customers. These include:
(i) Default in payment, and
(ii) Loss in value as a result of high rate of inflation.
He gave the following recommendations for effective
management of debts:
(i) Clients should be assessed and credit given to those with high
credit rating.
(ii) Reduce collection period during economic distortion period.
(iii) Arrange for longer credit terms for the firm's supplied and other
trade creditors
(iv) Use of after-trade services, cash discount or trade discount
(v) Discourage cash payment to creditors. All payments should be
made by cheques and
(vi) Arrange for direct credit facilities with company's banks. With
this, the firm is given immediate credit of cheque, money or
postal orders lodged into its accounts before actual clearing.
This facility attracts less charges than overdraft facilities.
Another method of ensuring immediate cash is by using factoring which G
involves raising funds on the security of a firm's debt.
2.4 Workinq Capital Manaqement: Ratio Analysis
Ratio is the relationship between two quantities which is expressed by
dividing the magnitude of one by that of the other.
In other to increase the effectiveness of financial ratio in working capital
management, it is necessary to understand its classification, nature and b
behavioural characteristics.
2.4.1 Classification: Two major approaches may be used in classifying ratios.
These are;
(i) by referring to the nature of accounting statements on which the ratio
can be derived.
(ii) By referring to the nature of the ratio itself
The later classification shall of adopted for the purpose of this research.
Using the nature of the ratios itself in classifying the following groups may be
made:
liquidity ratios
Profitability ratios
Leverage ratios
Activity ratios and
Stocks Exchange ratios
The number of ratios that can be computed is not only a function of the
amount of financial information available but also of the use in which the
ratios are to be put. For the present purpose (working capital management),
liquid,ity and activity ratios shall be computed and analysed.
Liquiditv: Liquidity is the capacity of the firm to meet or liquidity financial
obligations (Hobbs and Moore, 1974:251). In order words, the question
centres on how easily the assets of the firm can be used to settle short term
obligations..
Liquidity can be described as the relationship that exists between current
assets and current liabilities of the firm. Short term creditors, such as trade
creditors generally frowns at allowing credit to a firm which is running into
financial doldrums. Small firms in difficulties perish quickly. Large firms
however bring losses to many around them, not only to short term creditors,
but to financial institutions, which have supported capital expenditure
programme and granted creditors (Glantier and Underdawn, 1 976:641).
Ratios that fall under this category are as follows:
1) Current Ratios
This describes the relationship between total current assets and
current liabilities of the firm, and mathematically can be defined as:
Current Ratio - - Current Assets
Current Liabilities
The generally accepted standard ratio is 2:l. An extremely low
amount indicates that if the firm were pressed to pay some liabilities
quickly, management might be forced to obtain a short-term loan or
implement some other measures to obtain the required cash.
On the other hand, an excessive amount of cash or near cash items
might indicate that these assets should be put to more productive or
profitable use elsewhere in the enterprise.
2) Activity Ratios
Activity ratios measure the firm's efficiency in management of its
assets. This efficiency is defined in terms of rapid turnover of certain
variables, hence they are collectively called activity ratios. These
variables include stocks, fixed assets, debtors and creditors. There
should be a proper balance between sales and these variables.
Relevant activity ratios to working capital management are as follows:
(a) lnventorv Turnover: This ratio is obtained by dividing the cost of
'goods sold by the average stock, i.e.
Inventory Turnover = Cost of Goods Sold
Average Stock
A higher turnover of inventory suggests two things:
that the firm is efficient, and
that the firm is inefficient in that it cannot meet the customers'
demand, hence the firm must have been incurring some costs such as
loss of goodwill and stock-out costs.
Averaqe Receivable Turnover (ART): This is the number of time
within the accounting year that accounts receivable is turned over.
The higher the index of ART, the more effective the firm is managing
its accounts receivable. Mathematically, it can be defined as:
Accounts Receivables Turnover (ART)
- - Annual Credit Sales
Accounts Receivables
In other words, ART is the number of times that the value of
credit sales will cover accounts receivable.
(c) Averase Collection Period (ACP = This reveals information to
analysts on the average time it takes to convert debtors balances into
cash. In other words, it is the length of time that the firm will use to
collect its accounts receivable. Mathematically, it is calculated thus:
Average Collection Period (ACP) =
Number of Davs in a vear (365)
Average Receivable Turnover (ART)
Averaae Receivable x 365
Credit Sales
The shorter the ACP, the better the quality of debtors, as a short
collection period implies the prompt payment by debtors (Pandey, ibid:
51 5)
When the ACP is compared with the credit term and policy of
the firm, the efficiency of the firm's credit and collection can be judged.
Where there is an excessive long collection period, it means that the
firm is too liberal and inefficient with respect to its credit and collection
38
performance. This increases the chance of bad debt losses. It only
means that the firm is restrictive in its credit and collection policy.
(d) Averaqe Pavment Period Ratio:The ratio throws light on how long
the firm takes in settling its bills, i.e. in paying creditors. It is
calculated as:
Average Payment Period Ratio
- - Trade Creditors x 365
Purchase of Raw Materials
The period granted by suppliers and the period actually taken by the
firm should be compared. An interesting ratio means that the firm is in
difficulty in settling bills as they fall due. Cash discounts which is
allowed by creditors would not necessarily indicate efficiency in bills
settlement as it may mean that other funds which should have been
used in operation is diverted to credit settlement.
2.5 Working Capital Manaqement: The Pipeline Principle
Any business activity has its goods and services flow one way while money
flo&s back to the concern the other way. Corporate prosperity is a function
of how efficiently management can manage both flows.
Lockhard (1 982:27), linked business activities to two parallel
pipelines with oil flowing one way and cash the other way. He
treated liquidity into two trends: primary and secondary liquidity
Primary Liquidity is the freely accessible cash and marketable security plus
unsecured short term debt capacity. Lockhard (op.cit), maintains a target for
the primary liquidity level which is prudent enough to meet operating
requirements known liabilities and contingencies. He set the minimum cash
and marketable security levels with the rest expected from debt capacity.
Secondary Liquidity refers to those assets and liabilities which are easily
convertible to cash within a relatively short period. This is to keep the cash
flowing by reducing working capital. There is need to decentralise the
execution while the overall responsibility for corporate liquidity is centralized.
The final pipeline analog is that a pipeline must be based on a well
engineered plan which has a planned destination and through put, with
responsibility assigned to the proper engineer to build and run the system.
There has to be pumping stations and guages to ensure that the cash gets
back tob the corporate tanks as quickly as possible. A proper monitoring
system is needed to spot potential leaks and blockages before they occur
(Brown, 1982: 42)
40
The accuracy and effectiveness of corporate performance measure is a
function of how well management can apply the pipeline principle (among
others) in working capital management.
2.6 Return on Capital Emploved (R0CE)-The Dupont Analysis
The DuPont analysis derives its names from E.I. duPont de nemours and co.
inc. of the united States of America. The DuPont company was first to
breakdown the primary ratio (ROCE) into is core components and use this
breakdown as a tool of corporate analysis.
ROCE is derived from a multiplication of two major ratios; the product margin
ratio and the asset turnover ratio. Therefore an improving asset turnover
ratio with a constant profit margin will lead to an improvement on the ROCE.
This will be an indicator of managerial efficacy in using a constant capital
employed to generate more turnover. It is also possible to increase the
ROCE if the profit margin increases with the turnover remaining constant or
increasing.
However, both the turnover ratio and the profit margin ratios are affected by
many'factors the generation or otherwise of which have serious implications
on the ROCE ratio. These components are shown on the chart below which
is referred to as the DuPont chart.
Figure 3: The Dupont Chart. Culled from A.M. Pandey Financial Management, Vikas Publishing House, PVT Ltd (1 985), p.526
Sales -
2.7 Paterson Zochonis lndustries PIC (PZ): An Overview
lnvestment
-
Paterson Zochonis lndustries PIC is a leading conglomerate with its
head office situated at 45/47 town planning way, llupeju Industrial
Estate, P.M.B. 21 132 Ikeja, Lagos State. Dealing in the manufacture and
sale of Consumer products, it is renowned for its top quality products and
brands.
-
Sales
Working Capital Turnover -
Net Profit
Divided
-
-
-
Cost of Goods Sold -
Divided Profit Margin
A
3CE
-
-+
Administrative
Subtraction
-
PI us lnvestment
Expenses
i
Plus
Sales
Non-Current Assets
Multiplied by
-b
Selling and - Expenses
PZ lndustries PIC began simple trading operations in Nigeria on the 4th
December, 1948 under the name of P.B. Nicholas and Company
Limited. Its name was changed to Alagbon lndustries Limited in
1953 and to Associated lndustries Limited in 1960. The company became a
public company in 1972 and was granted a listing on the Nigerian Stock
Exchange. The name was changed to Paterson Zochonis lndustries Limited
on 24'h November, 1976 and in compliance with the companies and Allied
Matters Act 1990, it adopted its present name Paterson Zochonis lndustries
PIC on 22nd November 1990.
The principal activities of the group are the manufacture and sale of
a wide range of consumer products and home appliances which are
leading brand names though out the country in detergent, soap,
pharmaceuticals, Cosmetics, Confectionery, Refrigerators,
Freezers, Air conditioners, Plastic Containers and components.
The main production units were designed in line with modern
manufacturing methods which ensure efficient production of the
following products among others, Jet detergent, Tempo detergent,
the Thermocool Refrigerators, Freezers and Air-conditioners. b
Under a scheme of arrangement concluded and sanctioned by the
Federal High court on 25th June, 2001, PZ Nigeria Plc, Ekopak
Nigeria PIC and Grove properties Limited were merged with the
company.
2.7.1 Raw Materials Sourcing
The company obtains its requirements from both local and overseas
suppliers. Included in the approximately 150 major local suppliers is its
subsidiary, EKOPAK Nigeria Plc. The Principal overseas suppliers are
associated companies in the Paterson Zochonis PIC group. The company
has 25 distribution depots across the country with over 2,000 distributors.
2.7.2 Research and Development
The company's research and development efforts, supported the licensing
and technical services agreements with overseas associate companies in the
Paterson Zochonis PIC group, are designed to ensure a constant programme
of product improvement and new product introduction.
2.7.3 Ownership and Capital Structure
As at 15 November 2001, the company had an authorised share capital of
2,000,000,000 (2000:1,700,000,000) ordinary shares of 50K each, issued
and fully paid share s came up to 1 ,452,060,1 77 (an increase from
1 , I 16,969,367 in 2000.) The issued share capital of 1,452,060,177 shares of
50 kobo each by the company is held as follows:
44
1 Range I
Above 1,000,000 t-----l
No. of [unit of Holdings / Shareholders 9,873 1 12,565,700 1
Paterson Zochonis PIC Manchester held 859,209,983 shares which is 59.1 7
per cent of the paid up capital at 31'' May, 2001. No other shareholder held
more than 10 per cent of the company's paid up capital as at that date.
2.8 NESTLE NIGERIA PLC: An Overview
Nestle Nigeria PIC is associated with the Nes ;tie Group, the single larges
food company in the world and renowned world-wide for its top quality
products. Nestle Nigeria PIC began simple trading operations in Nigeria in
1961 and has today grown into a leading food manufacturing and marketing 1.
company. It is a publicly quoted company listed since 1978, on the Nigerian
Stock Exchange with about 20,500 Nigerian Shareholders participating in
approyimately 43 per cent of the company's equity. About 57 per cent of the
company's equity is owned by Nestle S.A. of Switzerland.
2.8.1 Manufacturinq: Nestle Nigeria's manufacturing complex, located at
Agbara Industrial Estate, in Ogun State, occupies an area of Sixteen
hectares. The main production units were designed in line with modern
manufacturing methods which ensure efficient production of the following
products; Nestle NUTREND, Nestle CRELAC MAIZE and Nestle CERELAC
CHOCOLATE - Infant Cereals; Nestle GOLDEN MORN - an instant family
cereal, Nestle MILO - beverage drink; CHOCOMILO - Chocolate Sweet,
MAGGl CUBES, MAGGl CHICKEN, MAGGl CRAYFISH, MAGGl SUPER
ONION SPICES. Nestle Nigeria also imports and markets NESCAFE -
beverage drink, NESTLE NlDO - Full cream milk powder, and Nestle
CARNATION - evaporated milk.
2.8.2 Raw material sourcinq and Processinq: Nestle Nigeria obtains most of its
agricultural raw materials (Maize, Soyabean and Sorghum) locally from
contract farmers and outgrowers in a partnering agreement that enables
them benefit from the technical advice and assistance of the company's
agricultural services department and, at the same time, guarantees to the
company continuous supply of raw materials that meet high quality
standards. The company has continuously invested in Nigeria by building
and cdmmissioning in 1991 at Agbara, Ogun State, a fully integrated plant
producing concentrated Sorghum Malt extract from locally grown and malted
Sorghum.
46
In June 1995, Nestle Nigeria commissioned another plant at Agbara
which produces Enzymatic Hydrolised Plant Protein Mix (EHPPM).
The investments represent successful and significant effort at replacing
imported raw materials in the manufacture of Nestle MILO food drink and the
MAGGl range of seasonings.
2.8.3 Distribution Facilities: Nestle Nigeria's distribution system ensures that
the widest possible penetration into the nation's markets at a Pan-Nigerian
price which is the same for every buyer anywhere in Nigeria.
At the heart of the system is the distribution center which occupies an 8-
hectare site at Otta Industrial Estate. It is one of the largest of its kind in
Nigeria. The Distribution Center occupies an area of 23,000 square meters
including the canopies and has a capacity for over 21,000 pallet units or
1,600,000 cartons of finished products stacked to a maximum height of 5
meters.
2.8.4 Research Collaboration: Nestle Nigeria is involved in collaborative
researcH with some Nigerian Universities. The company embarked on an
on-,the-farm adaptive research with the University of Agriculture Abeokuta,
(UNAAB), which brought into being a selection of Soyabean varieties with
47
improved seed colour, seed size and seed yield. Nestle Nigeria is also
involved in a joint venture with the International Institute of Tropical
Agriculture ((IITA), lbadan on propagation and development of improved
cowpea seedlings with high protein content. Nestle Nigeria has also
established a Nutrition Research Library at the University of Agriculture,
Abeokuta targeted at Graduate Research level. In addition to supply of
Nutrition journals, Nestle also ensured that the library environment was made
very conducive and comfortable for long hours of work.
2.8.5 Human Resources and Trainins Policy: Nestle Nigeria employs
a total number of 1,137 people. Continuous attention is given to
training and development of staff at all levels. In addition to internal
courses and seminars within the company, Nestle Nigeria also use
their training facilities all over the world through the co-operation of
their technical advisers, Nestec Limited of Switzerland. Some
managers are currently serving in various capacities in Nestle
companies in Switzerland, Ghana, Cote d'voire and United Arab
Emirates (Dubai) under the company's international Management
Exchange Programme. b
In'line with its progressive employee relations policy, Nestle Nigeria
awards secondary and tertiary Education scholarships to deserving
48
children of its staff. The scope and value of the awards are constantly
reviewed and improved.
2.8.6 Commitment to Protection of the environment: Nestle Nigeria
respects the environment, supports sustainable development and is
committed to environmentally sound business practices. To fulfill its
commitment, Nestle integrates environmental principles,
programmes and practices into its business operation; strives for the
continuous development and improvement of its environmental
performance through application of the Nestle Environmental
Management System (NEMS) and complies with applicable
environmental legislation. In the last one and half decades, Nestle
has invested US$2.5 million in the various systematic measures and
programmes that have been adopted to protect and preserve the
environment in their operation.
.. . 2.9 CONCLUSION
The companies selected have through their activities, aimed at
optimizing their long-term progress and development, thus ensuring
the'ir continuity rather than attempting to maximize short term profits.
, With the physical and skilled human resources available to them, high quality
products, high standard of integrity, efficient management and access to the
49
technical know-how of its technical partners, the companies will continue to
contribute to the progress, prosperity and economic development of the
nation.
N'OOOM
2,400
2000 -
Trend Analysis of Individual working item of NESTLE PIC for the years 1997-2001
Figure (4)
b
a = Stocks b = Debtors and Prepayments c = Bank balance and cash d = Creditors e = Bank Overdraft f = Dividend
& Trend Analysis of Individual working item of PZ PIC for the years 1997-2001
a = Stocks b = Debtors 8( Deposits i = Bank balance and cash d = Creditors e = Other Creditors
N'OOOM A
8000 - 7000 -
6000 -
5000 -
4000 -
3000-
2000 -
1000 - 4- --+-- * 3 - - , , - k g (A
&- - --t-*- +-,, I --,-
+-") I I I I I
9 7 98 99 2000 200 1
REFERENCES
Weston, F.J. and Brigham , E.F. (1979), Manaserial Finance, Holt, Rinehart & Weinston
Van-Horne, J. (1980), Financial Manaqement and Policy, 5'h Edition, Prentice-hall International Inc.
Hobbs, E. And Moore, M.A. (1979), Financial Accountins; Concepts valuation Analysis, South-West Publishing co., Cincinati; Ohio
Pandey, I.M. (1 985), Financial Manaqement, Vickas Publishing House, PVT Ltd., Newq Delhi
Winakor and Smith (1965), "Some Emprical Basis In Financing Rated Analysis". The Accountins Review, American Accounting Association(AAA)
Fitzpatrick (1 965), "Some Emprical Basis In Financing Rated Analysis". The Accountina Review, American Accounting Association (AAA)
Horrigan, J.O. (1 985), "Some Emprirical Basis In Financing Rated Analysis". The Accountina Review, American Accounting Association(AAA)
Richard, V.D. and Langlin, E.J. 1980, "A cash Conversion Cycle Approach To Liquidity Analysis". Financial Management Spring
Cooper, S. (1 983), Financial Manaqement, 2"d Edition McGraw-Hill.
West0n;F.J. (1 989), Essentials of Manaserial Finance, gth ~dition, McGraw-Hill
Emeanua, A.O. (1982), "Managing Distortions In The Economy: The Case of Working Capital. Paper Presented at a Seminar.
Glantier, M.W.E. and Underdown, B. (1976), Accountina Theory and Practice, Pitman.
Lockhard, J.B. (1 982), "International Liquidity Management and Pipeline Principle". The Treasurer
Brown, L.J (1 982), "The Pipeline Principle,", Manaqement Accountinq. Journal of the C.I.M.A.
CHAPTER 3 METHODOLOGY
3.1 Introduction
The purpose of this chapter is to analyse the scope of the research, data
points, data size as well as data collection method and also explain the tools
to be employed in data analysis. This includes graphical representation,
ratio analysis as well as statistical analysis
3.2 Sources Of Primary And Secondarv Data
The underlying consideration in the collection of data for this research is the
knowledge that the validity and reliability of research findings depend largely
on the reliability and accuracy of the underlying data. The primary data was
collected through discussion with the companies' corporate managers,
notably the financial manager, procurement manager, materials manager,
treasury manager and the internal audit manager.
, Secondary data was gathered from the annual reports of the companies,
management reports of the companies during the period under review and
the use of questionnaire.
3.3 Scow of the Research
This research study appraised working capital management in a
manufacturing environment using the selected companies as a point of
focus. The research is designed in a way that projects the general corporate
characteristics of companies in the manufacturing industry in Nigeria.
The population of the companies investigated consists of all quoted
manufacturing companies in Nigeria.
3.4 Samplinq Methods and Size of Sample
Samples are drawn from the population based on the researcher's
initiative. The sample size is made up of four major companies in the
manufacturing industry and are viz:
(i) Paterson Zochonis lndustries PIC
(ii) Nestle Nigeria PIC
(iii) Nigerian bottling company PIC
(iv) National Nigeria Flour Mills PIC
However, Paterson Zochonis lndustries PIC and Nestle Nigeria PIC will be
used as'a case study while the others will be investigated and analysed to
facilitate inter-corporate performance analysis.
3.5 Analvtical Techniques
The analytical tools to be employed in data analysis inclde:
3.5.1 Graphical Representation
This will be applied in analysing the movement in individual working capital
item, i.e. trend analysis.
3.5.2 Ratios: Relevant liquidity and activity ratios will be computed and these
include:
(1) Liquidity Ratio (a) Current Ratio
- - Current Assets Current Liabilities
(b) Quick Ratio - - Current Assets - (Stocks+Prepaid Expenses)
Current Liabilities
(2) Activity Ratios (a) lnventory Turnover
- - Cost of Goods Sold (COGS) Average Stock
(b) Average Receivable Turnover (ART) - - Annual Credit Sales
Accounts Receivables
(c) lnventory Total Assets 4 - - Inventow x 10O0/0
Total Assets
(d) lnventory Average Cost of Sales per day - - lnventorv x 365 davs
Cost of Sales
In highlighting the productive ability of these ratios and addressing the minds
of analysts to the rationality or otherwise, arbitrary ratio benchmarks will be
applied. Some ratios will be compared with the industrial average based on
the assumption that the four companies under investigation form an industry.
For efficient and effective inter-company comparism return on capital
employed (ROCE) shall be applied as follows,
1) For Individual Firm
(i) Return on capital employed (ROCE) will be derived in the form
of a ratio pyramid.
ProfitlCapital Employed (A)
b
Ratio A = Ratio B x Ratio C
(ii) Average ROCE for five years ROCE1/5 + ROCE2/5 + ... + ROCE5/5
(2) For the Industry (i) Average ROCE
(ii) Total Average ROCE
5 5 C = C Y = C ROCE CY Lockhard (1982:30)
1 1 3.5.3 Statistical Analysis
Because of the nature of data to be analysed, both parametric and non-
parametric tests would be carried out.
3.5.4 Parametric Tests: Parametric tests are tests that involve assumptions
concerning the form of the distribution of a variable.
The following assumptions must be satisfied before parametric tests can be
carried out:
(i) The variables must be measured on an interval scale.
(ii) The variance within the group must be homogenous
(iii) Normally distributed population must exist.
b
6ase.d on these assumptions, the following parametric tests shall be
conducted:
(1) T-Test: Is a parametric test which can be used when the sample
is less than thirty (30). Using this approach
Ex, = Total variables in sample 1
X1 = Average variable in sample 1
n 1 - - Number of subjects in sample
C.x2 = Total variables in sample 2
x2 - - average variable in sample 2
n2 = Number of subjects in sample 2
The solution obtained is referred to as t calculated ('cal). This will be
compared with 'critical obtained from statistical tables.
If 'cal < 'critical + Accept
'cal ;hitical + Reject
T-test will be used to test the hypothesis that closing inventory is not
significant in relation to the aggregate cost of sales.
2. Analysis of Variance (ANOVA): The analysis of variance (ANOVA)
is used to determine whether there is a significant difference in the
mean score of one or more factors. It can also be used to ascertain
whether there is a significant difference among samples.
The question answered under ANOVA is whether the difference among the
sample means is wide enough to be statistically significant or is likely that
they occur. The following steps are followed in the use of ANOVA:
(i) Find the total sum of squares (SSTO) SSTO = x - m)2
N
(ii) Find the sum of squared derivations of the group mean
SSb = ( Z X ~ ) ~ + p x d 2 + . .. ... + - n n N
(iii) Find the sum of square within group SSw = zxq2 - mil2 + ~x~~ - ( x x ~ ) ~ +Zx2n - ( ~ x n ) ~
n 1 n2 n n
(iv) Find the average of freedom for between groups d.fb = (G - 1)
Where G = number of groups
Find the degree of freedom for within groups (d.fw)
d.fb + d.fw
(v) Find the between groups mean square (MSb) and the within group mean square (Msw)
MSb = SSb/d.fb MSw = SSw1d.f~
(vi) Find the F-ratio
The F-distribution table will be used to determine whether the
calculated value is statistically significant at specific probability levels.
Several probability levels will be applied as the hypothesis may be
accepted at some probability levels and rejected at others.
The ANOVA will be used to test the hypothesis that movement in
individual working capital items do not follow the same trend. (Hobbs
and Moore, 1974:239)
3. Correlation Analvsis: The following assumptions must exist
before correlation analysis can be carried out:
(i) linear relationship must exist between the dependent and
independent variables.
(ii) Both variables are continuously random
(iii) Error term has zero expected value and constant variance for
all observations
(iv) The joint distribution for both the dependent and independent
variables is a bivariate normal distribution. Correlation analysis
is applied to determine the degree to which two variables relate
linearly.
Where
X = Independent Variable
Y = Dependent Variable
The correlation analysis would be used to show how the working capital
is dependent on total assets
X = Total Assets b
Y = Working Capital
3.5.5 Non-Parametric Test: This test involves no assumption or weaker
assumptions concerning the form of the distribution of a variable. Kendall
co-efficient of concordance will be applied in this analysis.
(i) Kendall Coefficient of Concordance
Designated by W1, Kendall coefficient of concordance measures
the degree of agreement among ordinal variables when ranked
Where:
N = Number of models being judged, i.e. number of columns
K = Number of persons judging the proposed models (number of rows)
Rj = Sum of the ranks for each model
It takes value between o and 1. Kendall coefficient of concordance will
be used in ranking the degree of agreement among respondents as to the
factors that lead to the selected companies successes in operation.
Kendall coefficient of concordance is used based on the following
assumptions b
( i N complete sets of data exists
(ii) Ordinal scale of measure exists
(iii) Unranked observations when collected must be capable of being
ranked.
3.6 SUMMARY
This chapter explains the research methodology, which includes the scope of
the research, sampling method and size of samples as well as data
collection methods.
The analytical technique to be employed in data synchronization and
analysis are also explained. These are graphical method, ratio analysis as
well as statistical analysis. Statistical methods employed are t-test, analysis
of variance (anova), correlation analysis and the Kendall coefficient of
concordance.
Return on Capital employed (ROCE) was used for inter corporate
analysis.
REFERENCES
Lockhard, J.B (1 982), "International Liquidity Management and Pipeline Principle". The Treasurer
Hobbs, E. and Moore, M.A. (1979), Financial Accounting, Concepts, Valuation Analvsis, South-West Publishing Co., Cincinati, Ohio
CHAPTER 4 DATA ANALYSIS AND INTERPRETATION
4.1 INTRODUCTION
In the earlier chapters, a lot was said about working capital management
paying particular attention to the selected companies. We shall however
thoroughly analyze working capital management. This will help to eliminate
any sorts of sub-optimalities and dysfuntionalities in corporate functioning.
Earlier chapters dilated upon the theoretical framework of working capital.
This chapter aims at analyzing and interpreting data obtained concerning the
selected companies. These data were derived from their annual reports,
management reports, discussions with the corporate managers as well as
the use of questionnaire.
4.2 QUALITATIVE AND QUANTITATIVE ANALYSIS
Relevant data obtained from the selected companies published accounts for
the years under consideration are as shown in Appendix I.
These among others will be used for qualitative and quantitative analysis.
4.3 GRAPHICAL REPRESENTATION
The trend analysis of the individual working capital items is as shown in
Figure 4
Hvpothesis 1
Ho = The selected companies individual working capital follow the
same trend
H I = Their individual working capital do not follow the same trend.
From the Figure 4, it can be deduced that there is a continuous increase in
most of the working capital items for Nestle Plc., some reaching its peak,
falling and rising subsequently.
Nestle's stock level increased from about N1.5 billion in 1997 to N1.9 billion
and 442.3 billion in 2000 and 2001 respectively. This is because of the need
to stock spare parts over the years to determine the usage rate. This
accounts for the continuous increase. Effective stock levels (minimum,
maximum and re-order levels) have since been determined for all stock
items. b
.Debtors figures have a relative increasing rate over the years. Looking at
this, one may deduce that there is a slack in the debt collection policies.
66
However, debtors figures are not conclusive on their own. There is need to
compare with credit sales to determine the average collection period. This is
done under ratio analysis below. The debtors figures for P.Z. Plc., from the
graph was relatively constant for the period under review. This, according to
the financial systems manager is influenced by the credit policy of the
company which requires an assessment of a potential customer's soundness
in terms of his financial statements and credit ratings and requisite actions to
be taken in case of late payments.
Cash and Bank balances also increased from N41 million in 1998 to 44485
million in 1999; rose to N940 million and $41.9 billion in 2000 and 2001
respectively for Nestle Plc, while it remained fairly constant from
N247 million to 44290 million in 1997 and 2000 respectively for P.Z. Plc.
Creditors figures remained almost constant for P.Z. PIC (44852 million in
1997, 441 billion in 1998, 441.2 billion in 1999, 44903 million and N786 million
in 2000 and 2001 respectively) while it increased from 4478 million in 1998 to
N356 million and $4527 million in 1999 and 2001 respectively for Nestle Plc.
The use of trade credit has increased in recent years due perhaps to the
credit squeeze induced by the structural adjustment of the economy. To
receive goods and delay payment of the amount is a recognized form of
short term financing; the goods can be used to provide returns or benefits
throughout the period that elapses before the bill has to be settled.
Loans to the tune of over N1 billion was obtained in 1997. This was however
reduced to N472 million and N6.3 million in 1998 and 1999 respectively for
Nestle PIC
4.4 Ratio Analvsis
4.4.1 Liauiditv Ratio: Liquidity ratios can be divided into two:
(i) Current Ratio
(ii) Quick Ratio
These are calculated as shown on Tables I and II
The current ratio for Nestle PIC is mostly higher than the ratio benchmark of
2.1 from 1999 to 2001. This shows that the company is very liquid and
needs to embark on some interestlprofit yielding ventures to reduce such
liquidity. It will be misleading to suggest that P.Z. PIC did not show enough b
liquidity because of the low ratios, ranging from 1.7 in 1997 to 2.43 in 2001.
This may have been as a result of unsecured bank loans and overdrafts,
floating rate redeemable debenture stock 199712004 and the floating rate
68
redeemable loan stock from 199912006. Use of ratio benchmark of 2:1
should be with caution as it is influenced by the nature of company under
consideration. The computation of current ratio for the selected companies
is shown on Table I
Synonymous to the current ratios, quick ratio for both companies was mostly
not up to the ratio benchmark of 1 :l. This equally does not mean that at any
time, the companies are not able to meet all its short term obligations as they
fell due. This is shown in Table II. The ratio benchmarks of 2:1 and 1:1 for
current ratio and quick ratio respectively can be quite analytically misleading,
lack objectivity and based on the mistaken premise that all companies are
the same.
TABLE 1 CALCULATION OF CURRENT RATIO FOR NESTLE PLC & P.Z.
NESTLE PLC
Year - Calculation (81'000) Ratio
1.11
P.Z. PLC Year - Calculation (81'000) Ratio -
1.72
2001 12,150,672 5,008,560
l-; ., J;, f p- ' I\!-' *, r ' k-b k ) \ JW
TABLE ll ?
CALCULATION OF QUICK RATIO FOR THE SELECTED I
COMPANIES
P.Z. PLC
Year - Calculation (81'000) Ratio - 0.45
CALCULATION OF QUICK RATIO FOR NESTLE PLC
Year - Calculation (N'000) Ratio
- . 4.4.2 Activitv Ratios: Otherwise referred to as efficiency ratios, these groups
of ratios are used in appraising the firm's operational effectiveness with
regards to resource utilization.
The following activity ratios would be analysed.
(i) lnventory turnover ratio
(ii) Inventory total Assets
(iii) lnventory Average Cost of Sales per day ratio (ICOSR)
(iv) Average receivable Turnover
These ratios are shown from Tables Ill to VI
TABLE Ill CALCULATION OF INVENTORY TURNOVER FOR THE SELECTED COMPANIES
A. P.Z. PLC
Year - Calculation (81'0001
B. NESTLE PLC Year - Calculation (WOO01
Ratio - 2.91
Ratio
4.09
Inventory Turnover is obtained by dividing the cost of goods sold by the
average stock. The inventory turnover expresses how rapidly the inventory
is turning into receivables through the selling process. Generally, a high
inventory turnover is indicative of good inventory management. A low
inventory turnover implies excessive inventory levels than warranted by
production and sales activities or slow-moving or obsolete inventory.
Nestle's inventory turnover was high throughout the years under
consideration (1997-2001). The last being 3.07 in 1998 and the highest was
4.09 obtained in 1998.
This may imply that Nestle is both efficient and inefficient. Inefficiency since
Nestle may be incurring some stock-out costs. However, the materials b
managers asserted that except in cases of serious emergencies, such as
'shut-down periods, no stock-out cost was incurred. These shut-down
periods rarely occur. One may then ignore these costs and conclude that
effective stocks management exists in Nestle.
On the other hand, the lnventory turnover Ratio (ITR) of PZ PIC can be
considered to be low with the lowest being 1.49 in 1998 and the highest 2.91
in 1997. Consideration should be given to the uniqueness of the company
as cost of stocks in the cased of goods manufactured by the group includes
a proportion of factory overheads.
Inventory as a percentage of total assets indicates the extent to which capital
is committed into inventory, the ratio expectedly varies from industry to
industry. In both companies considered, the ratio was at a 40%-45%
average, which is alright since it is within the industrial average of 42%. This
is shown on Table IV
TABLE IV
CALCULATION OF INVENTORY TOTAL ASSETS FOR THE SELECTED COMPANIES
A. P.Z. PLC
Year Calculation (81'000) Ratio
B. NESTLE PLC
Year - Calculation (81'000) Ratio
The inventory average cost of sales per day ratio shows the number of days
inventory at hand. It signifies the number of days the outstanding inventory
will sustain sales, given the tempo of business. The ratio was high for both
companies, indicating that there was enough stock- to sustain production till
a need arises to re-order. This is shown on Table V
TABLE V
CALCULATION OF INVENTORY AVERAGE COST OF SALES PER DAY IICOSR) FOR THE COMPANIES
A. P.Z. PLC
Year - Calculation (81'000) - Ratio
1997 7,804,166 X 365 250.6 Days 11,365,320
B. NESTLE PLC
Year - Calculation (81'000) Ratio
178.5 Days
Nestle's average receivable turnover rose from 0.53 in 1997 to 2.39 in 1999
(within two years). Subsequently, the index fell gradually to 1.8 in 2001.
This ratio was however relatively stable for the period under consideration
indicating due payment for goods sold by the company.
TABLE Vl
CALCULATION OF AVERAGE RECEIVABLE TURNOVER FOR NESTLE PLC
Year - Calculation (81'000) Ratio
4.5 Inter Company Comparison And Trend Analvsis
No single company among those investigated can be said to have performed
best during the period. This can be inferred from the profit margin ratio, the
turnover ratio and the return on Capital employed (ROCE) of each firm.
Relevant working capital data for the selected firms viz: PZ Plc, Nestle Plc,
' Nigerian Bottling Company PIC and Northern Nigeria Flour Mills PIC are
shown from Tables VII to X and analyses of their Return on Capital
Employed (ROCE) from Table XI to Table XV. 4
TABLE VII
RELEVANT WORKING CAPITAL DATA - P.Z. PLC (N'000)
/ Year I PBT lPAT I Sales I Total Assets /
TABLE Vlll
RELEVANT WORKING CAPITAL DATA - NESTLE PLC [N'OOO)
Year - PAT - PBT - Sales Total Assets
TABLE IX
RELEVANT WORKING CAPITAL DATA - N.N.F.M. PLC
1 Year 1 PBT
RELEVANT WORKING CAPITAL DATA - N.B.C. PLC
Year PBT - - PAT - Sales
Using the ROCE percentage on the basis of before tax profit for analysis, as
shown on Table XV, Northern Nigeria flour Mills PIC led in 1997 with 37.28 b
and 24.681 in 1998. During this period, PZ PIC and Nestle recorded a 4.313
and 3.849 ROCE respectively. Throughout the period under review, the
N.N.F.M. PIC was the best performer, but the other companies performance
was equally impressive.
The Nigerian bottling company had a negative ROCE in 1999 (30:103) due
to a posted loss in profit in the corresponding year. PZ Plc was the second
best performer after the Northern Nigeria Flour Mills PIC with 6.436, followed
by Nestle PIC with 3.761.
TABLE XI
RELEVANT WORKING CAPITAL DATA - P.Z. PLC CN'OOO)
Year
1997
2001
PBTlSales
0.192
0.142
Sa1esIT.A
0.828
0.620
PBT ROCE% 4.313
Average = 5.379
4.366
26.895
- PAT1 Sales 0.131
0.101
SaleslT .A 0.828
PAT ROCE% 6.321
0.620 6.139
TABLE XI1
RELEVANT WORKING CAPITAL DATA - NESTLE PLC (N'000)
PBT/ Sales/ PBT - PATISales Sa1esK.A Sales T.A ROCE%
I Average = 4.22 1 1 I
TABLE Xlll
RELEVANT WORKING CAPITAL DATA - N.N.F.M. PLC (N'oool
Year - PBT ROCEOh
PBTISales PATISales Sa1esK.A Sales/ L A ROCE
TABLE XIV
RELEVANT WORKING CAPITAL DATA - N.B.C. PLC (N'OOO)
TABLE XV
ANALYSIS OF ROCE OF SELECTED COMPANIES
Year
1997
Year NESTLE
PBTlSales
0.152
N.N.F.M. N.B.C I AVERAGE
Total
Sales1 T.A 1 .I51
Five Year Average,
It may be noted that almost all the companies suffered a reduction on their
respective ROCE in 2001. This might have to do with the socio-economic
PBT ROCE% 7.572
PATlSales
0.097
environment being operated in by the respective companies and the major
expansion of Nestle's plant with reduction on production and turnover.
Considering the five year average ROCE of each company, the
companies can be listed in order of performance as below:
(i) N.N.F.M. 41.295
(ii) Paterson Zochonis PIC 5.379
(iii) Nestle Nigeria PIC 4.22
(iv) N.B.C. 0.529
Only the N.N.F.M. PIC maintained an average higher than the industry
average. The negative ROCE of NBC in 1999 forced the industry average to
its least at 1.514 in the same year. Between the trio of P.Z. Plc, Nestle and
N.B.C. Plc, none was second best performers for more than a year, with
N.B.C. moving from second position in 1997 to third the following year.
Nestle moved from fourth position in 1997 to second in 1998. PZ. PIC moved
from second position in 1999 with ROCE of 6.436 to third in 2000 with 6.161.
This implies that there has been a competitive atmosphere within the b
industry during the period under investigation.
At this juncture, a question can be asked whether ROCE is stainless? Are
there no limitations to the application of ROCE in analyzing financial
statement. This question forms the subject matter of the next section when
the perfection of ROCE is tested.
4.6 ROCE: A critical Overview
Since ROCE helps a great deal in analyzing and evaluating performance, its
limitations will be examined. This will be carried out via its components, viz
the turnover ratio and the profit margin ratio.
A limitation of ROCE stems from the fact that it is difficult for analysts to
determine which figure is appropriate as a measure of capital employed
since many figures such as total assets, net tangible assets, equity etc are all
acceptable.
- Secondly, inter firm comparison in term of their efficiency will be difficult. For
. instance, a firm may lease its plant while another firm may have a new plant,
while yet another may work with an old fashioned plant. Any device to reduce
these differences to a common figure will bring in an element of unreality into b
the comparison.
Thirdly, the influence of accounting policies cannot be over-emphasized.
Different accounting policies are employed. For stock valuation, available
methods include the First In First Out (FIFO), Last In First Out (LIFO) and
weighted average to mention a few. Various types of methods such as
Straight line, Digital, and Sinking fund methods can be used to write down
the value of assets. The methods employed by firms will affect the definition
of capital employed. It therefore reduces the importance of ROCE as a
measure of profitability.
Fourthly, capital investment is a long term phenomenon. In most cases, a
low return is earned in the early years of the project. The return on the
project over the life span is needed in order to reach a valid conclusion about
profitability of the firm. Capital employed is based on figures derived from
the annual reports of a concern within an accounting year. There comes in
the problem.
Fifthly, it is difficult to determine whether the capital to be used should be
based on assets at the beginning of the accounting period, or at the end or
the average of both. b
In practice, to overcome this problem, accountants use the year end capital
employed. This convention, however, can lead to an unfair comparison.
86
Sixthly, the proportion of fixed assets to current assets varies from firm to
firm. A firm may have 70 percent fixed assets and 30 percent current assets
while another may have the reverse. These two firms although may have the
same ROCE, cannot be said to have an equal financial standard. The first is
better off in terms of securing loans while the other one will be able to obtain
trade credits.
Furthermore, the value of net profits is also subjective. Firstly, net profit
value is obtained after the application of the matching concepts. This implies
that the components are obtained in accordance with the different policies
applicable to them. These policies vary from company to company and they
cannot easily be reduced to common terms. Net profit is also an accounting
value and it neglects the time value of money.
ROCE does not take the effect of risk into account. A high return does not
" . necessarily guarantee managerial effectiveness. The inherent risk in
individual firm's net profit should be examined using the industry average as
a yardstick. b
.In conclusion, ROCE can be referred to as a 'proxy' measurement. This is
due to the fact that while sales and net profit figures are stated at their
87
current prices, investments (assets) are recorded at historical costs.
Investment value can therefore influence the result of ROCE especially when
depreciation changes are taken into cognizance. To normalize this, there is
need for adjustments for inflation and price level changes to profit as well as
to assets value if a more realistic ROCE is to be derived.
4.7 Statistical Analvsis
Both parametric and non-parametric tests would be carried out.
4.7.1 Parametric Tests
The following parametric tests are conducted.
(i) t-test
(ii) Analysis of variance
(iii) Correlation Analysis
The hypothesis that closing inventory is not significant in relation to
the aggregate cost of sales is tested with the use of t-test.
Hypothesis I I
Let X1 = Closing Inventory (N'm)
X2 = Aggregate cost of Sales (Wm)
Ho = Closing lnventory is not significant in
relation to the average Cost of Sales
H I = Closing lnventory is significant in relation
to the Average Cost of Sales
The computations are shown Table XVI
at.(5 + 5 - 2) degree of freedom
t calculated = -0.2095 at 8 d.f
'critical at 0.005 2 2.36 0.025 I 2.31 0.05 I 1.86
Decision Since 'cal < ' critical, accept H, and reject HI.
TABLE XVI USE OF T - TEST
Closing lnventory is Not significant in Relation to the Aggregate Cost of Sales.
(A) P.Z. NIGERIA PLC.
YEAR
1997
1998
1999
2000
2001
at n + n - 2 degree of freedom
where: . Cxl = Total closing lnventory - XI = Average closing Inventory
n - - Number of years of closing Inventory
Ex2 = Total Aggregate Cost of Sales - X2 = Average Aggregate Cost of Sales
n - - Number of years of Aggregate Cost of
Sales
(B) NESTLE NIG. PLC.
YEAR XI XP
1997 1,582 3,235
1998 1,063 4,060
1999 1,494 4,643
2000 1,919 6,457
2001 2,313 8,452
8,371 26,937
at n + n - 2 degree of freedom
where: - Cxl = Total closing Inventory -
XI = Average closing Inventory
n - - Number of years of closing Inventory
Cx2 = Total Aggregate Cost of Sales
X2 = Average Aggregate Cost of Sales
n = Number of years of Aggregate Cost of Sales - x 1
- - 8,371 c 5 = 1,674.2
B NESTLE NIGERIA PLC
at (5 + 5 - 2) degree of freedom
t calculated = -1.4678 R -1.47
t critical at 0.005 5 3.36 0.025 < 2.31 0.05 5 1.86
Decision
'cal < ' critical, accept H, and reject Hi
The closing stocks of both companies ae not significant in relation to
the aggregate cost of sales.
b
2 Analvsis of Variance (ANOVA)
Analysis of variance will be used to determine where there is a
significant difference among each working capital item. Y
The modus-operandi of Anova has been explained in Chapter
three.
HO = There is no significant difference among each working
capital item
HI = There is a significant difference among each working
capital item
Let XI - - Stocks
- x2 - Debtors
- x3 - Bank balance and cash
- x4 - Creditors
X5 = Other creditors (For PZ PIC) & Bank overdrafts
(for Nestle)
X6 = Dividend (For Nestle Plc) b
YRI - YR 5 - - 1997 - 2001
SSTo =
SSb =
ssw =
d.fb =
MSb =
MSw =
F - -
d.fw =
Total sum of squares
Sum of squared derivations of the group mean
Sum of square within group
Degree of freedom for between groups
Between Group Means Square
Within Group mean square
F - Ratio
Degree of freedom for within groups
The F-distribution table will be employed to determine whether the calculated
'F' value is statistically significant at specific probability levels.
Tables XVll and XVlll show the use of Analysis of Variance (ANOVA) to
determine whether there is a significant difference among each working
capital item.
TABLE XVll ANOVA TABLE FOR WORKING CAPITAL ITEMS OF SELECTED COMPANIES
IA) PZ NIGERIA PLC
NESTLE NIGERIA PLC
TABLE XVlll
A. FOR PZ NIGERIA PLC
STEP 1
STEP 2
SSb = (38.1 9 0 ) ~ +(l5.857) +(l,lO6) +(5.026) +(23,lO2) - (83,280)~ 5 5 5 5 5 30
STEP 3
SSW = SSTO - SSb - - 226,066,951 - 299,426,425.2 - - -73,359,474.2
STEP 4
The degree of freedom for total variance is: d.fb + d.fw = 4 + 20
= 24.
STEP 5 Msb - - SSb - - 299,426,425.2
d.fb 4 - - 74,856,606.3
MSW = SSW - -73,359,474.2 - - - 20 - - -3,667,973.71
STEP 6
Calculation of F-Ratio (F)
~b - - 74,856,606.3 F = MSW -3,667,973.71
The result of the calculation can be presented thus:
Summary of Anova of the Five workincr capital items of P.Z. Nis. Plc.
(B) FOR NESTLE NIG. PLC.
Source of Variation
Between Group
Within Group
STEP 1
SSTO = (14,897,259+690,060 +4,809,240 ) - ( 8,371 + 1,742+ 3,494 )2 (+ 502,467 +2,000,654 + 4,601,816 ) ( + 1.371 + 1,812 + 4.206 )
30 = 12,8O7,O95.47
SS
299,426,425.2
-73,359,474.2
226,066,951
STEP 2
SSb = (8,371)* +(1,742) +(3,494) +(1.371) +(l.812) - (4,206)~ 5 5 5 5 5 30
d. f
4
20
24
STEP 3 b
SSW = SSTO - SSb = 12,807,095.47 - 16,985,537.76 - - -4,178,442.29
ms
74,856,606.3
-3,667,973.71
STEP 4
The degree of freedom for total variance is:
d.fb+d.fw = 5 + 2 4 - - 29.
STEP 5
Msb - - SSb - 16,985,537.76 - d.fb 5
- - 3,397,107.55
MSW = SSW - -4,178,442.29 -
d.fw 24
- - 174,101.76 STEP 6
Calculation of F-Ratio (F)
F = N b = 3,397,107.55 Msw 174,101.76
lnterpretation -
Statistical F-table is applied in interpreting results obtained from ANOVA.
Using the difb and d.fw (degree of freedom between and within,) values of F-
table at different probability levels is compared with the calculated F-ratio
If Fcal < Fcrit 3 accept the null hypothesis
If Fcal > Fcrit * reject the null hypothesis
Decision
With 4 and 20 degrees of freedom for PZ we need an F-ratio of 2.87 and
4.43 to reject the null hypothesis at 0.05 and 0.01 probability levels
respectively. For Nestle PIC at 5 and 24 degrees of freedom, we need an F-
ratio of 2.62 and 3.90 to also reject the null hypothesis at the probability
levels of 0.05 and 0.01 respectively.
Since both calculated F-ratios of -20.41 for PZ Nigeria PIC and -19.51 for
Nestle are less than their corresponding values, the null hypothesis is
accepted. This implies that there is no significant difference among each
working capital item.
31 Correlation Analysis
Correlation analysis is used to determine the degree to which two variables
relate linearly bearing in mind the assumptions as explained in chapter three.
Correlation analysis would be used to determine how the working capital of
the selected companies is dependent on total assets. b
- H, . - Working capital is dependent on total assets
- HI - Working capital is not dependent on total assets. 100
The computation of correlation analysis is shown on Table XIX
TABLE XIX
Correlation Analysis of the Selected Companies Working Capital Terms
where
X - - Independent Variable
Y - - Dependent Variable
Computation
(A) P.Z. NIGERIA PLC
= Total Assets (N'000m)
= Working Capital (N'000m)
Cx . = 83.6
CY = 26.9
Cx2 = 1427.62
zy2 = 149.31
CXY = 459.81
n = .5
(B) NESTLE NIGERIA PLC
Cx
CY
Cx2
zy2 CXY
n
I A)
3) Nestle Nigeria PIC
Interpretation
'r' takes values from -1 to +1 depending on the extent of linearity. It is a
measure of degree of association between the dependent and the
independent variables.
Decision
The coefficients of correlation 8 of 0.86 and 0.91 for PZ and Nestle Nigeria
PIC respectively show that a positive relationship exist between the total
assets and working capital.
This shows that working capital of both companies is dependent on total
assets; i.e. accept Ho and reject HI
4.7.2 Non-Parametric Tests: Kendall coefficient of concordance form of non-
parametric test will be applied in this section of the research.
C Designated by W, Kendall's coefficient of concordance measures the degree
of agreement among many ordinal values where ranked.
b
Fendall coefficient of concordance will be used to judge the degree of
agreement among respondents as to the factors that have led to the
performance of the selected companies. The co-efficient takes value
between o and 1 inclusive depending on the degree of agreement.
Let A - - Plant Maintenance
B - - Staff Training
C = Constant Supply of Raw Materials
D = Availability of Market
E - - Effective Distribution System and
F - - Effective Management
Thirty respondents were judged. The findings are as shown on Table XX
TABLE XX RESPONDENTS RANKINGS TO FACTORS CONTRIBUTING TO SELECTED COMPANIES GROWTH
P.Z. NIGERIA PLC.
Respon dents 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2 1 22 23 24 25 26 27 28 29 30
105
A
1 5 5 4 2 1 3 4 2 2 3 4 4 1 1 1 6 3 2 2 2 3 3 5 4 1 6 - 4 3
. 3 90
- F
4 4 1 5 5 5 6 2 5 4 5 5 6 4 6 6 4 5 1 1 5 6 6 4 6 2 5 5 6 1 130
- B
3 2 6 6 4 3 1 5 3 6 6 3 1 6 2 4 5 4 5 6 4 2 1 1 5 5 1 3 5 6 114
- C
2 1 3 2 3 2 4 1 1 5 2 1 3 2 3 2 3 2 3 4 1 1 2 2 1 6 3 2 1 2 70
- D
6 6 4 3 1 4 2 3 6 3 1 2 5 3 4 3 1 6 4 5 3 4 5 3 2 3 4 1 4 4 105
- E
5 3 2 1 6 6 5 6 4 1 4 6 2 5 5 5 2 1 6 3 6 5 4 6 3 4 2 6 2 5 121
NESTLE NIGERIA PLC.
Respon dents 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 2 1 22 23 24 25 26 27 28 29 30
_A
3 5 5 1 2 1 3 5 1 2 2 3 4 1 6 1 5 3 2 5 2 2 1 5 4 1 6 . 4 3 3 9 1
- B
2 6 3 2 5 3 4 1 3 6 6 1 3 2 5 4 6 4 1 2 4 1 2 1 6 5 1 3 4 6 102
- C
1 3 1 3 6 2 1 4 4 5 4 6 1 6 3 2 2 2 3 6 1 3 3 2 1 2 4 2 1 4 88
- D
6 2 4 6 3 4 2 2 2 3 5 4 2 3 1 3 3 6 4 1 3 5 4 3 2 6 5 1 5 2 1 02
- E
5 4 2 5 1 6 6 3 6 1 3 2 5 5 4 5 4 1 5 4 6 6 5 6 3 4 3 6 2 1 119
- F
4 1 6 4 4 5 5 6 5 4 1 5 6 4 2 6 1 5 6 3 5 4 6 4 5 3 2 5 6 5 128
A - - Plant Maintenance B = Staff Training C - - Constant Supply of Raw Materials D = Availability of Market E = Effective Distribution System and F - - Effective Management
Where: N - - Number of models being judged, i.e. 6 K - - Number of respondents, i.e. 30 Rj = Sum of the ranks for each model, i.e. 90, 114, 70, 105, 121,
and 130 for PZ Nigeria PIC and 91,1 O2,88,lO2,119, and 128 for Nestle Nigeria Plc.
For PZ Plc;
For Nestle Nigeria Plc;
There is very little concordance among the respondents as to the factors that led to
the performances of the selected companies.
107
Testinq the Significance of W
If N(the number of models being judged is equal to or less than 7, the sample is
considered 'small'.
Since the factors considered is equal to 6, then the sample size is small.
H0 = W in the population is equal to zero
HI = W in the population is greater than zero.
We calculate the sum of squared deviation (designated S). This will be compared
with the critical value using relevant statistical tables.
For PZ Plc;
For Nestle Nigeria Plc;
Interpretation If the Scalculated < Scritical ==+ Accept Ho
If the Scalculated Scritical ==+ Reject Ho
Decision
Using W table, the 0.05 level, an N of 6 and a k of 30, the critical value of S =
1039.0. S calculated < S critical.
Therefore, we accept Ho (i.e.) there is no agreement by the
respondents as to the factors that led to the companies pedormance.
4.8 Summary
This chapter analyzed data obtained from the selected companies' working
capital management using graphical approach, ratio analysis as well as
parametric and non-parametric approaches of statistical analysis.
Various statistical tests were used in testing the hypotheses. These include
the t-test, analysis of variance, correlation analysis and Kendall co-efficient of
concordance. b
~ypothesis 1 was analyzed through trend analysis using graphical
representation. The null hypothesis was accepted as individual working 109
capital items do not follow the same trend. Liquidity activity as well as return
on Capital employed (ROCE) ratios were employed to judge the corporate
performance by utilizing financial statements as well as management reports
data. It was however discovered that:
(i) The companies could meet their short term financial obligations at any
time
(ii) The companies are quite efficient and have a high receivable
turnover.
Hypothesis 2 was tested using statistical parametric approach of t-test. The
null hypothesis is accepted. This shows that closing inventory is not
significant in relation to the aggregate cost of sales.
The researcher also tested whether there is significant difference among
each working capital item. The use of ANOVA revealed that there is a
significant difference among each working capital item.
Hypothesis 3 was tested using correlation co-efficient. The test revealed that b
working capital items are dependent on total assets.
In judging the degree of agreement among respondents to the appraisal of
the companies performance, Kendall co-efficient of concordance form of
non-parametric test was employed. Results show that there is no consensus
among respondents as to their ranking. This shows that a blend of these
factors are responsible for the companies impressive performance.
CHAPTER 5
SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 INTRODUCTION
This research aimed at investigating an x-ray of working capital management
in a manufacturing environment using Paterson Zochonis (P.Z.) Nigeria PIC
and Nestle Nigeria PIC as case study. This is to enable financial analysts to
overcome the problems encountered in their day to day management of . working capital, and be able to make rational decisions.
Having gone through a rigorous exercise in investigating the case study, we
present below our major findings and recommendations.
- 5.2 SUMMARY OF FINDINGS
11 Working capital refers to a firm's investments in short term securities,
accounts receivables and inventories. The research reveals that there
are several ways of financing working capital which includes: 6
- overdrafts from the company's bankers which is subject to
certain payment conditions as set by the bank policy.
Through the capital market
The company could increase its shareholding (e.g. rights
issues) and use the proceeds of sales to finance its day-to-day
operations
In the case of receivables management, local purchase orders
(L.P.Os) could be issued, usually for raw materials, after which
the raw materials are processed and sold and the proceeds
used to pay off the creditors.
21 Despite the fact that the business environment in Nigeria threw up
many challenges for the companies under study, with wage rates
increasing significantly following the improved minimum wage set by
the government, crippling national strike actions which largely affected
their abilities to manufacture and distribute their products, law
aggregate demand, decaying infrastructure, inflation and insecurity of
lives and property, P.Z. PIC and Nestle Nigeria PIC had impressive
.outings during the years under review. From the interviews
conducted, the researcher could deduce a number of reasons that
aided in their management of working capital to include:
- a significant distribution extension to widen the retail channel
configuration, supported with strong advertising, thus bringing
consumers in closer touch with their favourite products.
Integration of the West Africa sub-region business with benefits
in economies of scale.
Plant modernization in the continuing drive for high efficiency
and superior quality with a significant level of automation,
- Increasing export business and stanmark turn-around firmly
implemented
- Continuing investment in manpower development, skills
enhancement and leadership capability of staff.
31 Cash control has to do with implementing the cash budget and
consists of comparing the budgeted data with actual results, and
subsequently investigating the factors responsible for the variances
with a view to taking any necessary remedial measure.
Cash as is widely known is the most important current asset for the
operations of the business. The basic input needed to keep the b
business running on a continuous basis, cash is also the ultimate
output expected to be realized by selling the product or service
produced by the enterprise.
I I4
Maintaining a sound cash position by ensuring a balance between a
shortage and excess of cash is an important task confronting the
financial manager. For P.Z. and nestle, they not only undertake to
keep books indicating the sources and application of cash, there is
also the statement of cash flow, the profit and loss account and the
balance sheet, all for a proper account of cash in addition to other
expenses, interests, accruals and cash equivalents. Idle
precautionary cash balances for both companies were invested in
shares in subsidiaries, purchase of property, plant and equipment.
P.Z. PIC has resources arising from consolidation, the sinking fund
reserve of which transfers are made from the profit and loss account
and the general reserve. All these measures boil down to the
techniques used by the selected companies for effective cash control
and management.
41 The objective of trade debt management is to maximize the value of
the firm by achieving a trade off between liquidity and profitability.
Generally, costs associated with trade credits include bad debts, b
losses, credit administrative expenses, cash discounts allowed and
the opportunity costs of funds tied up in receivables. Trade debt
management therefore aims at controlling these costs and keeping
them at a minimum.
For both companies, debtors were stated after deduction of specific
provisions for debts considered bad or doubtful of recovery. The
researcher was able to gather that certain factors are usually
considered in managing the companies debtors. They include;
a comprehensive review of the potential customers financial
statement for soundness;
depending on how regular a customers payment is, his credit
line is set on the basis of his normal buying pattern
the credit worthiness of a customer is analyzed bearing in mind
his character, capacity and the prevailing economic condition,
the need for the customers' bankers to provide information on
the financial standing of the customer.
Sometimes, a new customer is required to provide references from
other companies with whom he has had previous commercial dealings
and who are in a position to provide a confidential assessment of the
customer's credit behaviour.
51 For the selected companies, stocks are valued at the lower of cost
and net realizable value after making provision for obsolete and
damaged items. Costs, in the case of Nestle Plc., includes elements
of factory overhead in respect of locally manufactured stocks, and in
the case of goods manufactured by the group, includes a prmrt ion of
factory overheads for P.Z. Plc.
Due to size of the companies being studied and from interviews with
the materials manager and procurement manager, no one method of
inventory control is used. There is however a hybrid of systems
ranging from the "two-bin" system to periodic review and the optional
replenishment system.
5.3 Recommendations
Based on the findings of the study, the following recommendations are
proffered:
(i) Ratios should be used along with other techniques if incorrect
decisions and conclusions are to be avoided.
(ii) Information from other sources such as the stock exchange, the
business and financial press and other publications should be used
along with those extracted from corporate annual reports and
management reports.
(iii) Interested parties should take interest in other financial statements
items rather than only working capital items since changes in one
affects the other.
5.4 Suqqestions for Further Study ' W U ~ .
This research is limited to four companies and covers a period of five years.
To gain more insight into corporate performance, the researcher suggests
that more companies be analyzed by interested researchers and a longer
period of time covered.
- BIBLIOGRAPHY
TEXTBOOKS C
- ACCA Study Pack: Financial Manaqement, McGraw-Hill Inc., New york, 1979
Anyafo, A.M.O.: Manaqement of Working Capital. Modular Lecture Series #3. Banking 8. Finance Publications, U.N.E.C., 2000
Cooper, S.: Financial Manaqernent, McGraw-Hill Inc., New York, 1983
Glantier, M.W.E. and Underdown, B.: Accountinq Theorv and Practice, Pitman, 1976
Hobbs, E. and Moore, M.A.: Financial Accountinq: Concepts, Valuation Analysis, South-West Publishing Cop., Cincinati, Ohio, 1979.
Johnson, R.: Financial Manaqement, McGraw-Hill Inc., New York, 1959
Meigz, W.B. and Johnson, C.E.: Accounting: The Basis for Business Decision, McGraw-Hill Inc., New York, 1967
- Pandey, I. M.: Financial Manaclement, Vikas Publishing House, PVT Ltd.,
New Delhi, 1985
Richard, V.J. and Langhlin, E.J.: A Cash Conversion Cvcle. Approach To Liquiditv Analysis. Financial Management, Spring, 1980
--
Van-Horne, J.: Financial Manaqement and Policy, 5th Edition, Prentice- Hall International Inc., 1980
Weston, F.J. Essentials of Managerial Finance, McGraw-Hill Inc., New York, 1989
Weston, F.J. and Brigham, E.F.: Manaqerial Finance, Holt, Rinehart and Winston, 1990
-
Publication
Nestle Nigeria PIC Annual Reports and Accounts: 1997-2001
Nestle Nigeria PIC Manaqement Reports: 1997-2001
Paterson Zochonis (P.Z.) lndustries PIC Annual Reports and Accounts: 1997-2001
Paterson Zochonis (P.Z.) lndustries PIC Manaqement Reports: 1997-2001
ARTICLES
Adewumi. W. 'YVhy Controls Fail to Control". Professional Manaqer. Journal of the Management Students Association, University of Lagos, 1982
Brown, L. J.: "The Pipeline Principle". Manaqement Accounting Journal of the C.I.M.A.
Emeanua, A.O. (1 992), "Managing Distortion In the Economy. The case study of Working Capital. Paper Presented at a seminar.
Fitzpatrick. "Some Empirical Basis In Financial Ratio Analysis". The Accounting Review. American Accounting Association (AAA), 1965
John, R. "Short term Liquidity Ratio". Manaqement Accounting.
Lockhard, J.B. "International Liquidity Management and Pipeline Principle". The Treasurer, 1982
Roberts, J. "Working Capital Management". Manaqement Accounting. Journal of the C.I.M.A., 1983
Student Pye. "Notes on Cash Manaqement". Students Pye Limited, Lagos, 1 99 1
b
Winakor and Smith. 'Some Emperical Basis in Financial Ratio Analysis". The Accountinq Review. American Accounting Association (AAA), 1965
School of Graduate Studies University of Nigeria, Enugu Campus Enugu
Dear SirIMadam
Questionnaire On Workinq Capital Manaqement In Your Company
As a pre-requisite to the award of an MBA degree in Finance and Banking of the University of Nigeria Enugu Campus, I am currently studying Working Capital Management Practices in Selected Nigerian Manufacturing Companies. The exercise is strictly for academic purposes. Any information supplied will be treated for the purpose and as such confidential.
I appreciate your response to the questions. Thank you for your assistance.
Yours faithfully
Uko, Ugonma C. (Mrs)
QUESTIONNAIRE - - - -
Companv Identification and Corporate Backqround
Name of Company Address of registered head office Type of business Date of Incorporation Date of commencement of business Authorized Capital N Paid up Capital N Equity Share Capital and number of shares Qualification/Professions of Shareholders
2. What are your company's major raw materials?
3. From where are they obtained? (a) Local (b) Foreign (c) Both
(mark x where applicable).
How many plants does your company have?
Name them:
5. Does these plants attain their production capacity?
6. Please rank these factors according to their contribution to the company's growth [{i.e.} best 1, next 2, next 3, etc]
(a) Plant maintenance R
(b) Staff training (c) Constant supply of raw materials (d) Availability of market (e) Effective distribution system (f) Effective management
How is the profitabilitylcorporate health of your company measured? Kindly mark x as appropriate
(a) By using any of the account ratios e.g. profit-sales ratio, return on Investment, etc
(b) By using a combination of two or more accounting ratios (c) By using the multiple Discriminant Analysis (MDA) model (d) By adopting other approaches (please specify)
8. Do you operate a system of Inventory Control in your company?
9. What inventory control techniques are adopted in your company
(a) The Two bin technique (b) The Tag system (c) The Bincard Technique (d) The ABC Technique (e) All of the above (f) Others (please specify)
W 10. What inventory control levels are maintained by your company?
(a) Maximum Stock level (b) ~ i n i m u m Stock level (c) Re-order level (d) Re-order quantity (e) All of the above (f) Others (please specify)
What factors are considered in setting stock levels?
(a) Rate of demand of finished goods by buyers (b) Estimate delivery time of materials by suppliers (c) Usage of raw materials and other materials (d) Economic order quantities (EOQ) (e) All of the above (f) Others (please specify)
W Who makes inventory decisions (such as setting of stock levels in your company?)
(a) Board of Directors (b) Purchasing Manager (c) Inventories Materials Manager (d) Stores Manager (e) Joint decision of several managers (f) Cost accountant (g) Others (Please specify)
How often are cash budgets prepared
(a) Weekly (b) Monthly (c) Quarterly (d) Annually (e) Others (Specify please)
Does your company permit discounts on purchases?
(a) Yes (b) No El Does your granting of credits by your company involve an application and a reasohable presentation of collateral?
(f) Yes for application as well as collateral (g) Yes for application and no collateral is required (h) Collateral is compulsory before release of credits
(i) Others (Specify please)
1 6. Who approves credits in your company?
(a) Board of Directors (b) Group Manager (c) Finance Manager (d) Credit Committee (e) Others (Specify please)
W 17. What problems are encountered in loan repayments?
(a) Insolvency of the debtors (b) Laxity of credit officer (c) Others (specify please)
18. In times of repayment default, what action is usually taken by your company?
(a) waive the commission for the customer (b) legal action taken to enforce repayment of both principal
and interest (c) lengthen the repayment period (d) Outright write-off of the debt (e) Others (Specify please)
19. Which of the financial ratio analysis methods is acceptable to your company?
(d) Current ratio (e) Quick ratio (f) Debt to Equity ratio (g) Asset Turnover ratio (h) Return to Equity ratio (i) Working Capital Coverage ratio
20. Among these ratios, which does your organization consider most useful. Please rank on a scale of 1-5 (in ascending order(i.e.) 1 is more useful than 2).
(a) Current ratio (b) Quick ratio (c) Asset Turnover ratio (d) Return to Equity ratio (e) Working Capital ratio (f) Others (please specify)
General comments:
APPENDIX 1
A P.Z. PLC's RELEVANT WORKING CAPITAL MANAGEMENT DATA
Current Assets (A) Stocks Debtors & Deposits Bank Balance & Cash
lorking Capital (A-B) 1 4,401,988 1 4,856.1 11 1 4,936,085 1 5,688,010 1 7,142.1 12 - I I I I I
7,804,166 2,506,436
Current Liabilities (B) Creditors (Borrowings) " ther creditors
247,389 lO,557,99l
7,432,571 3,028,501
852,470 5,303,533 6.156.003
I I
102,982 10,564,054
I I
Total Assets Cost of Goods Sold
7,720,517 3,101,190
1,261,808 4,446,135 5.707.943
Others
Annual Credit Sales Purchase of Raw
247,837 1 1,069,544
13,719,570 11,365,320
Materials Average Stock
7,677,466 2,842,306
1,221,969 4,911,490 6.133.459
224,725 11,959,870
7,555,212 4,378,948
290,870 1 0,810,642
14,226,447 11,345,918
3,902,083
21 6,512 12,150,672
903,353 4,219,188 5.122.541
276,279 12,030,410
786,511 4,222,049 5.008.560
17,966,936 11,677,484
7,618,369
1 05,812 12,106,275
17,543,130 12,112,536
7,576,544
20,187,756 12,521,074
109,338 12,193,257
83,053 12,291,651
7,698,992 7,611,339
NESTLE'S RELEVANT WORKING CAPITAL MANAGEMENT DATA /1997-2001)
I I I I I
Current Liabilities (B) I
i Current Assets (A) Stocks Debtors & Deposits Bank Balance & Cash
1997 (NOOO)
Trade Creditors Bank Overdraft nividend
J Jorking Capital (A-6) I
1998(44'00 0)
142,564 1,332,832 422,750 1,898.1 46
-
1 Purchase of Raw 1 3,266,769 1 3,996,964 1 4,980,736 ( 6,451,562 ( 9,087,536 1
1 19,357
: Cost of Goods Sold Annual Credit Sales
1999 (N1O0O)
1,581,770 407,149 108,584 2,097,503
78,147 472,540 507,300 1,057,987
Others Total Assets
1,494,369 246,531 485,172 2,226,072
1 ,063,153 176,852 41,859 1,281,864
223,877
3,234,647 21 7,653
Materials , Average Stock
2000 (N1O0O)
356,526 6,347 634,125 996,998
3,334,413
2001 (N'OOO)
1,918,704 363,294 940,654 3,222,652
1,229,074
4,059,786 365,727
790,885
2,312,720 548,365 1,916,617 4,777702
262,672 - 951 ,I 88 1,216,860
2,895,465
527,483 - 1,691,000 2,218,483
2,005,792
4,643,236 588,763
1,322,462
2,559,219
3,546,710 6,456,725 732,795
1,278,761
4,625,740 8,541,723 987794
6,680,291
1,706,537 2,1 15,712