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Full Project – ASSESSMENT OF WORKING CAPITAL MANAGEMENT (WCM) IN NIGERIA FINANCIAL SECTOR

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CHAPTER ONE

1.1 BACKGROUND OF THE STUDY

Management of working capital is an important component of corporate financial management because it directly affects the profitability and liquidity of all firms, irrespective of their sizes. Working capital management refers to the management of current assets and current liabilities. Researchers have approached working capital management in numerous ways but there appear to be a consensus that working capital management has a significant impact on returns, profitability and firm value Deloof, (2003). Thus, efficient working capital management is known to have many favourable effects: it speeds payment of short-term commitments on firms (Peel et. al, 2000); it facilitates owner financing; it reduces working capital as a cause of failure among small businesses (Berryman, 1983); it ensures a sound liquidity for assurance of long-term economic growth and attainment of profit generating process (Wignaraja and O’Neil,1999); and it ensures acceptable relationship between the components of firms working capital for efficient mix which guarantee capital adequacy, (Osisioma, 1997).

Working Capital management is a prime concern in a banking environment and a working capital deficiency (that is excess of current liabilities over current assets) has often been a trigger for bank failures. Working Capital of a Bank simply represents the operating liquidity available to run the bank.

On the other hand, there is also a general agreement from literature that inefficient working capital management also induces small firms’ failures (Berryman, 1983), overtrading signs (Appuhami, 2008), inability to propel firm liquidity and profitability, (Eljielly, 2004; Peel and Wilson, 1996; and Shin and Soenen, 1998), and loss of business due to scarcity of products, (Blinder and Maccini, 1991).

For all firms, in both developed and developing economies, one of the fundamental objectives of working capital management is to ensure that they have sufficient, regular and consistent cash flow to fund their activities. This objective is particularly heightened for financial institutions like banks. In banking business, being profitable and liquid are not negotiable, at least for two reasons; to meet regulatory requirement and to guarantee enough liquidity to meet customers’ unannounced withdrawals. Consequently, proper working capital management would enable banks in sustaining growth which, in turn leads to strong profitability and sound liquidity for ensuring effective and efficient customer services.

A bank is set to be liquid when there is sufficient cash and cash transferable assets including investment in securities that are easily realizable at a short notice without loss to the bank, together with the ability to raise fund quickly from other sources to enable it to meet its payment obligations and financial commitment in a timely manner.

A Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The Current assets are those assets which will be converted into cash within the current accounting period or within the next year as a result of the ordinary operations of the business. They are cash or near cash resources. For banks, these include: Cash and balances with central bank, Treasury bills, Due from other banks, Prepaid expenses.

On the other hand, the Current liabilities are the debts of the firms that have to be paid during the current accounting period or within a year. These include: Customer deposits, Due to other banks, Current income tax, Short-term borrowings, and Dividends payable.

A key activity of the Central Bank of Nigeria (CBN) is liquidity management. According to the CBN Act of 1958 and its subsequent amendments, the CBN is responsible for implementing restrictive or expansionary monetary policies in order to achieve price stability, influence interest rates, manage the growth in credit to the domestic economy and maintain the international value of the local currency. It manages Banking Sector liquidity by supplying or withdrawing liquidity from the Banking Sector which it deems to be consistent with a desired level of short-term interest rates or reserve money. It relies on the daily assessment of the liquidity conditions in the banking system, so as to determine its liquidity needs and thus, the volume of liquidity to inject or withdraw from the economy.

Basically, banking is a service industry operated by human beings for the benefit of the general public while making returns to the shareholders. As such, it is natural that the services provided thereof by the industry cannot be 100% efficient; however, there is always a room for improvement. It is on this statement that the index of our further discussion on this study is based.

The Banking Sector plays an important role in the Nigerian economy. According to Soludo (2009:23), Nigerian banks account for over 90 percent of financial system assets and dominate

the stock market. As a result, a well funded Banking Sector is essential in order to maintain financial system stability and confidence in the economy.

A significant body of literature exists on working capital management and the determinants of banking liquidity; some of these include Central Banks’ recommendations, financial institutions and risk management textbooks. However, Traditional working capital/liquidity management involves the mapping, estimation and simulation of inflows and outflows within some time horizon, including safety margins and contingency plans to deal with exceptional losses and disbursements. The separation from the investment decision makes it difficult to assess objectively how much cash is too much, hindering bank’s ability to seize profitable opportunities, and how much is too few, making the risk of losses higher than acceptable in exchange for the increased returns on illiquid assets. As a result, there is a gap between theoretical developments in liquidity management and what is actually used in practice by commercial banks, and the decision about the optimal liquidity level relies much more on art and professional experience than on science and well specified decision processes.

The recent global financial crisis and its impact on the Nigerian Banking Sector has shown that CBN’s daily forecasts of Banking Sector liquidity is not sufficient in assessing the liquidity requirements of the sector as several

Banks remain relatively fragile and incapable of withstanding periodic liquidity shocks. According to Alford (2010:6) “Following the special examination and during the period from December 2008 to December 2009, Nigerian banks wrote off loans equivalent to 66% of their total capital; most of these write offs occurred in the eight banks receiving loans from the CBN”. Most of the banks also suffered panic runs and flights to safety during the period.

It is on this argument that this work lies to assess the working capital management of deposit money banks in Nigeria.

1.2 STATEMENT OF THE PROBLEM

Between 1991 and 2011, over 55 Nigeria banks have been liquidated by the NDIC due to their protracted problem of distress. According to Soyinbo and Adekanye (2002) and Adam (2003) nearly 100 out of the 128 banks in Nigeria failed and collapsed as result of inadequate capital base, mismanagement of funds, overtrading, and lack of sound regulation, control and unfair competition from the foreign banks.

How are Nigeria banks strategizing to improve upon their working capital management? What are the existing working capital items of Nigeria banks? What has been the end-result of working capital management in Nigeria banking industry?

These stated problems together with the research questions below are what the researcher tries to encapsulate in the research topic with a view to providing their answers in the course of this research.

1.3 RESEARCH QUESTIONS

In view of the above stated problems, my research questions for this study are as follows:

What is the composition of working capital items in Nigeria banks?

What have been the end-results of working capital management in Nigeria banks?

Have these components of working capital well managed?

1.4 OBJECTIVES OF THE STUDY

In dealing with the above research questions, the study seeks to achieve the following objectives; To examine the composition of working capital items in Nigeria banks.

To examine the adequacy of working capital management in Nigeria banks.

To ascertain if the components of working capital are well managed.

1.5 SCOPE OF THE STUDY

This research attempts to study the working capital management among Nigeria banks. The study covers all the commercial banks in Nigeria from 2000-2010 excluding two expatriate banks whose annual reports and financials are in dollars, viz, Citibank and Standard chattered Bank.

1.6 SIGNIFICANCE OF THE STUDY

Although much have been written about banks’ working capital management and liquidity management, the significant of this study can be viewed from two major standpoints- practical and academic.

Practical significance

The bank directors, corporate bodies and management that want to embark on banks’ working capital management and liquidity management will find useful information in this work.

For bankers in general, it will broaden their scope of knowledge on working capital elements, management, optimization and risk management.

Academic Significance

In the academic arena, this research will prove to be significant in the following ways:

It will serve the purpose of arousing deep thoughts and genuine interest on the subject matter for further research.

It will contribute to the enrichment of the literature on working capital management.

It will suggest ways (of interest to academics) based on empirical evidence of enhancing working capital management

1.7 DEFINITION OF TERMS

WORKING CAPITAL: (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity.

MANAGEMENT: The act or manner of guiding or taking charge, handling, directing or control.

OVERCAPITALIZATION: is a state where earnings are not sufficient to justify the fair return on the amount of share capital which has been issued by the company UNDERCAPITALIZATION: is a state where the capital which is owned by the business is much less than the borrowed capital.

LIQUIDITY – It is the ability of banks to pay cash immediately when called upon to do so for all of its demand liabilities

LIQUIDITY MANAGEMENT – It is the ability of the bank to manage the liquidity position so that neither the liquidity nor the profitability will suffer. It involves the provision for the withdrawal of deposit, short time cash cyclical and secular cash requirement of the specks – financial institutions.

DEPOSIT MONEY BANKS: The resident depository corporations and quasi-corporations who have many liabilities in the form of deposits payable on demand, transferable by cheque or otherwise usable for making payments.

DEPRESSION: The state of being depressed. It is a period when there is little economic activity, and many people are poor or without jobs.

ECONOMY: The relationship between production, trade and the supply of money in a particular country or region. It is the system of trade and industry by which the wealth of a country is made and used.

DEREGULATION: It is a way to free a trade, business activity etc from certain rules and controls.

LIBERALIZATION: This is a way to free somebody or something from political, religious, legal or moral restrictions.

LOAN AND ADVANCE: Loan is a sum of money which is borrowed, often from a bank, and has to be paid back usually together with an additional amount of money known as interest, while Advance is bank lending which may be via term loan, overdraft, or bill discounting.

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