DETERMINE THE EFFECT OF WORKING CAPITAL ON THE PROFITABILITY OF HOSPITALITY INDUSTRIES (A STUDY OF RADISSON BLU ANCHORAGE HOTEL)

CHAPTER ONE

INTRODUCTION

 

1.1                Background to the Study

Every business needs investment to procure fixed assets, which remain in use for a longer period. Money invested in these assets is called ‘Long term Funds’ or ‘Fixed Capital’. Business also needs funds for short-term purposes to finance current operations. Investment in short term assets like cash, inventories, debtors etc., is called ‘Short-term Funds’ or ‘Working Capital’. Working capital refers to that part of the firm's capital which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories. Funds, thus, invested in current assets keep revolving fast and are being constantly converted into cash and this cash flow out in exchange for other current assets. Hence it is also known as circulating capital or revolving capital or short term capital. The ‘Working Capital’ can be categorized, as funds needed for carrying out day-to-day operations of the businesss moothly. The management of the working capital is equally important as the management of long-term financial investment.

 

According to Genestenberg:- "Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables into cash."

 

The working capital is needed for the following purposes:-

  1. For the purchase of raw materials, components and spares.
  2.  To pay wages and salaries.
  3. To incur day-to-day expenses and overhead costs such as fuel, power and office expenses etc.
  4. To meet the selling costs as packing, advertising etc.
  5. To provide credit facility to customers.

 

Working capital policy is an important issue in any organization because without the proper management of working capital components it will be difficult for the organizations to run its operations smoothly. Working capital management is significant due to the fact that it plays a vital role in keeping the wheels of the business running (Lawrence and Charles, 1985). Its effective provision can ensure the success of a business while its inefficient management can lead not only to losses but also to the ultimate downfall of what might otherwise be a promising concern. Business success heavily depends on the ability of financial executives to effectively manage receivables, inventory, and payables (Filbeck and Krueger, 2005).

 

Furthermore working capital policy has been major issue especially in developing countries. Adequate working capital needs to be maintained in order to discharge day-to-day liabilities and to protect the business from adverse effects (Sayaduzzaman, 2006; Siddiquee and Khan, 2009). It aims at protecting the purchasing power of assets and maximise the return on investment.

 

Working capital is basically the portion of asset required by a business in current operations. In its gross form, it is the investment in current assets. However, it can also be described in its net form as the difference between current assets and current liabilities. In most organizations, current assets occupy a significant portion of the total asset structure. This invariably requires efficient management of it. Working capital management is concerned with managing the different components of current assets (inventories, debtors/receivables, cash/bank, short-term investments, prepaid expenses) and current liabilities (creditors/payables, provision for tax, other provisions against the liabilities payable within a period of 1 year).

 

The issues involved in managing working capital of any firm are concerned with the management of the firm’s inventory, cash, marketable securities, receivables and payables etc, In order to achieve a proper balance between risk and return. A well-designed and implemented working capital management must contribute positively to the creation of a firm's value (Zirayawati et al., 2009; Afza and Nazir, 2007). For maximising profits or minimising of working capital cost or to maintain a balance between liquidity and profitability, there is a need to optimise working capital (Padachi et al., 2008). Too little investment in working capital i.e. aggressive working capital policy can lead to disruption in production, increases the risk of not being able to meet the financial obligations and impairs profitability. At the same time a conservative financing policy i.e. too much investment in working capital means idle funds that can earn no profit but involves cost. So, a financial manager has to be vigilant in maintaining appropriate levels of working capital.

 

1.2                Statement of the Problem

The main problem of this study is poor profitability of hospitality companies and this is attributed to ineffective management of working capital.

 

Invariably a company must neither keep excess inventory to avoid unnecessary tying down of fund as well as loss in fund due to pilferage, spoilage and obsolescence nor maintain low inventories so as to meet production and sales demand as at when due.

 

These pose a problem to managers. And can be further discuss in the following ways.

  1. The cause of over and under inventory in an organisation
  2. Decrease in company’s profitability as a result of ineffective inventory management.
  3. The deviation between inventory management and production.

 

1.3                Objectives of the Study

The main objective of this study is to evaluate and determine the effect of working capital on the profitability of hospitality industries. Specifically, this research work stands to achieve the following objectives:

 

  1. To examine how working capital can be effectively managed to enhance high profitability in Nigeria hospitality companies.
  2. To examine the relationship between working capital and the performance of Nigeria manufacturing company.
  3. To determine the cause of poor working capital management as it affect profitability.
  4. To establish the relationship between working capital and profitability of hospitality industries.

 

1.4                Research Questions

  1. How can working capital be effectively managed to enhance high profitability in Nigeria hospitality companies?
  2. What are the relationship between working capital and the performance of Nigeria hospitality companies?
  3. How can poor working capital management as it affect profitability of hospitality companies?
  4. What are the relationship between working capital and profitability of hospitality industries?

 

1.5                Research Hypothesis

Subject to the above stated objectives, the hypotheses developed to be tested in this study was:

H0:  Effective management of working capital does not significantly enhance high profitability in Nigeria hospitality companies.

H0:  There are no relationship between working capital and the performance of Nigeria hospitality companies.

H0:  Poor working capital management does not affect profitability of hospitality companies.

 

1.6                Significant & Justification Of the Study

The study will increase awareness on the effect of working capital on the profitability of hospitality industries and suggest measures in managing working capital effectively. It will also reveal the problems caused by bad management of working capital and be useful to researchers, scholars, and other third parties as it shall open new area of further research work and at same time advance challenges to up-coming researchers.

 

1.7                Scope& Limitation of the Study

The effect of working capital aids management effectiveness in an organization (Chukwu, 2008). The study will focus on the effect of working capital on the profitability of hospitality industries and due to the logical point that not every hospitality companies can be studied as a result of time and resources available, this research is therefore limited to Radisson blu anchorage hotel.

 

1.8                Definition of Terms

  1. WORKING CAPITAL: Working capital refers to that part of the firm's capital which is required for financing short term or current assets such as cash, marketable securities, debtors and inventories.
  2. HOTEL: These are companies that are engaged in hospitality business.
  3. LIQUIDITY:  Ability of a company to meet his financial need as at when due.
  4. PROFITABILITY: Ability of a business entity to make profit. It means excess of revenue over expenses for a certain period usually a year period.