Case Study On Vgc Telecom America

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Doctor of Philosophy in Management

A Thesis on Working Capital Management on VGC Telecom Industry, USA


The term working capital implies a company’s investment in short term assets cash, short term securities, accounts receivables and inventories [6]. Precisely, these assets are financed by short-term liabilities, thus net working capital is current assets less current liabilities.

Working capital management is the decision relating to working capital and short term financing, and this includes managing the relationship between the company’s <href=”#Current_assets” title=”Asset”>short-term assets and its short-term liabilities. This enables the company to continue operations and to have enough cash flow at its disposal to satisfy both maturing short-term debt and upcoming operational expenses, which is the major objective of working capital management.


The policy of working capital in accordance to Weston et al position is concerned with two sets of relationship among balance sheet items. Firstly, the policy question about the degree of total current assets to be held. Though current assets vary with sales, it should be noted that the ratio of current assets to sales becomes a policy issue. A company may hold relatively little proportion of stocks of current assets if it elects to operate aggressively. Such move is to lower the required level of investment and enhance the expected rate of return on investment. Thus, due to excessive tough credit policy, such aggressive policy may as well enlarge the possibility of running out of inventories and cash or sales loss

The connection/relationship between types of assets and means such assets are financed is the second policy question. One policy requests for harmonizing asset and liability maturities: financing short term assets with short term debt, and long term assets with long term debt or equity. If such policy is implemented, the maturity formation of debt is resolved by considering fixed versus current assets. Meanwhile, short-term debt is often less expensive to long term debt. This implies that the expected rate of return may be more if short term debt is employed.

By offsetting the return advantage shows that huge proportion of short term credit amplifies the risks as follows:

First, having to renew this debt at much higher interest rates Second, not being able to renew the debt at all whenever the company goes through tough times.

Both areas of working capital policies entail risk/return tradeoffs. Therefore, the need to work-out a modality to establish the best possible levels of each type of current assets to hold, and the substitute methods to finance them is necessary. The procedure of accomplishing these optimal conditions is what may be termed as working capital management.

As pointed out by Shin and Soenen (1998) that Wal-Mart and K-Mart had comparable capital formations in 1994, but K-Mart’s poor management of working capital contributed to its going bankrupt [3]. This is because K-Mart had a cash conversion cycle of about 61 days whereas Wal-Mart had a shorter conversion cycle of 40 days instead. K-Mart was with faced an extra $193.3 million per year financing costs arising from long-term conversion cycle.

As pointed out in their 2005 U.S. survey report, there is a high positive correlation between the efficiency of a corporation’s working capital policies and its return on invested capital.

Hence, Nunn (1981) employs the PIMS database to study the reason for some product lines having small working capital requirements, whereas some product lines are having large working capital requirements [7]. Moreover, Nunn has much interest in permanent rather than temporary working capital investment since he employed data averaged over four years. By employing factor analysis, he’s able to identify factors connected with the production, sales, competitive position and industry.

While highlighting the function of industry practices on firm practices, Hawawini, Viallet, and Vora (1986) observe the influence of a company’s industry on its working capital management. They resolved that there is a greater industry consequence on company working capital management practices which is stable over time; having used data on 1,181 U.S companies over the period 1960 to 1979. Their studies arrived at the conclusion that sales growth and industry practices are essential issues that influence company’s investment in working capital [8].

The review above depicts that there are models to illustrate the way working capital refers to a company’s investment in short term assets-cash, short-term securities, accounts receivable, and inventories [6]. Though, these assets are financed by short- term liabilities. Thus, net working capital is current assets less current liabilities.

Van Horne (1986) submitted that working capital management is a misnomer; if the working capital of the company is not managed. The term he stressed describes a set of management decisions that affect specific types of current assets and current liabilities [9]. In turn, those decisions should be rooted in the overall valuation of the company.

This submission does not disagree with the substance of the postulations of Weston et al. Thus, it strengthens their arguments that the idea of working capital management must do with those management decisions which border on balancing of risk/return tradeoffs for current asset holdings and the liabilities that create those assets.

Weston et al then advised that working capital should be considered as an investment no less important that equipment and materials. They both argued that current assets embody more than half the total assets of a business, and since the investment is relatively volatile, it is worthy of careful consideration.

They argued that it is even more so for the small business. The small business may lower its investment in fixed assets by renting or leasing plant and equipment, but there is no way it can avoid an investment in cash, inventories and receivables. Further, since small and medium companies have relatively limited access to the long-term capital markets, it must necessarily rely heavily on trade credit and short- term bank loans, both of which affect net working capital by increasing current liabilities


In a business cycle, cash flows into, around and out of the business. Cash is life blood of a business, and a manager’s key mission is to assist in keeping it to flow and to take the advantage of the cash-flow in making profits. A business that is operating profitably, in theory is generating cash surpluses. If it does not generate surpluses, then the business ultimately will run out of cash and expire.

The more speedily the business gets bigger the further cash it will need for working capital and investment. The cheapest and best sources of cash exist as working capital right within business. Better management of working capital generates cash, and will assist in improving profits and lessen risks. Hence, it is imperative to note that the cost of offering credit to customers and holding stocks may signify a significant percentage of a company’s total profits.

There are two elements in a business cycle that absorb cash, these are – receivables (debtors that owe you money) and inventory (stocks and work-in-progress). Major sources of cash are Payables (payment from your creditors), and Equity and Loans

Fig. 2.1 Working Capital Cycle: Source from JPMorgan (2003) Fleming International Cash Management Survey in conjunction with the ACT

Every component of working capital, such as inventory, receivables and payables has two dimensions, which are TIME and MONEY. To manage working capital entails both time and money. A business will spawn more cash or will need to borrow less money to finance working capital if possible to get money to move faster around the cycle, i.e. getting monies due from debtors as fast as possible or lowering the sum of monies tied-up by lowering inventory levels relative to sales. As a consequence, one can lower bank interest cost or one will have extra free money that will be available to enhance more sales growth or investment. In the same way, negotiating improved terms with suppliers such as getting longer credit or an increased credit limit will effectively create free finance to assist funding future sales.

Working capital is referred to as the fuel powering global business activities, but often a greater percentage of this fuel is constantly stuck in the pump; tied up in aging invoices and lengthy Days Sales Outstanding (DSO) cycles. Those firms that are looking to enhance cash flow have primarily focused on collections. Whereas traditionally, collections have always been a reactive process i.e. picking up on aging invoices after they are already late in payment, and then resolving the underlying issues in an effort to collect. Since it is not easy to go up-stream and systematically uncover and resolve the root causes of issues that actually drive the delayed payments. Hence, most of the collections efforts normally end up squarely emphasizing on dealing with symptoms, rather than addressing the real issues [12, 13].

As a result of process automation built around innovative dispute prevention technologies, it is now possible to take a more proactive approach to collections that are proving to yield enormous dividends that include the unlocking of millions in working capital, elimination of revenue leakage, and radical improvements in overall customer satisfaction. Many companies have already seen significant returns from their work in this area. As submitted by JP Morgan (2005); to optimise working capital globally, payment and information components of a transaction must be integrated.


Cash is the oxygen which enhances a business survival and prosperity, and is the basic indicator of business health. As a business can survive for a short time without sales or profits, it cannot survive without cash i.e. it will die. As a result the inflow and outflow of cash need careful monitoring and management.

Cash flow is a function of the time and sums of money that flow into and out of the business weekly and monthly basis. A good cash-flow implies that the method of income and spending a business employs, will enable it to have cash availability to pay bills on time.

Cash balances should not be confused with profit. Profit is known to be the difference between the total amount your business generates and all of its costs that is normally assessed over a year or other trading period. There is possibility of being be able to forecast a good profit for the year, but still face situations when you are strapped for cash[11,14].

For most businesses to make profit, they have to supply goods or services to their respective customers before being paid. But, no matter how profitable the bargain, lack of enough money to pay staff and suppliers before receiving payment, the business will be unable to deliver its own side of the bargain or make profit.

In trading and growing your business effectively, one must build up cash balances by ensuring that the timing of cash movements puts you in an overall positive cash flow position. Meanwhile, having a lot of cash in bank does not make any good business sense. If the cash is not needed to be used immediately, it is advisable to lodge it an account where it will earn high interest, or maybe invest it in short term investment.

Companies of various sizes have fluctuating cash balances. These fluctuations can occur at random or at expected intervals. It may occur on a monthly basis due to variations between payables and receivables, or seasonal basis depending to the nature of the business.

Regardless of the reason for fluctuations in the cash account, a company incurs costs in holding cash balances in excess of their immediate transactional needs.

The costs involved in holding cash are stated in terms of opportunities lost to invest these funds at a positive interest rate. The interest income lost becomes increasingly large as the amount of idle funds and the rate of interest increases. The managing of the funds of a company in order to maximise cash availability and interest income on any idle funds is the concern of cash management [9].

At one end, the role of cash management begins the moment a customer writes a cheque to pay the company on its account receivable. The role ends when a supplier, an employee or the government realizes collected funds from the firm on an account payable or accrual. The activities between these two points fall within the realm of cash management.

A perfectly timed asset conversion cycle is completed when the firm collects cash exactly when its accounts payable and accrued expenses fall due or mature. In reality, hardly ever does a firm have its obligation maturing at the same as it collects cash, thus the need for financing.

As reported by Fortune magazine article of 29th November, 2004 S&P 500 non-financial corporations have amassed $600 billion in excess cash. The Wall Street Journal of 1st December, 2004 cited one consultant who estimated that corporate liquidity now totals $4.7 trillion, up from $3.6 trillion in 1999, with a majority of surveyed U.S. companies viewing themselves as net investors rather than net borrowers. While at the same time GDP growth rates and interest rates are increasing. GDP growth necessitates increased investment to keep production apace with demand, while higher interest rates accentuate the value of cash reserves. Cash is a valuable asset that can spur financial growth, reducing more expensive debt, and working-capital requirements.

According to JPMF International Cash Management Survey, treasurers investing cash for short time periods, often overnight or less than one week may be because cyclical companies often generate volatile cash flows, making treasurers more comfortable to remain liquid so that they can react to unforeseen outflows. Inadequate cash flow forecasting and positioning, which leaves treasurers in the dark as to their true cash position and lacking the confidence to invest or borrow for longer time periods may also be the cause.

Average cash balances of short-term investment portfolio (US$) equivalent

Fig.2.2. Cash Management Survey: Source from JPMorgan (2003) Fleming International Cash Management Survey in conjunction with the ACT

Cash positioning

Whichever form of business and however volatile the cash flows, treasurers can maximise the value of their cash holdings by more accurately identifying and predicting positions throughout the day to enhance investment or borrowing opportunities and therefore overall return.

Working capital expresses the liquidity of a business. A business with poor liquidity will have difficulty in paying its everyday expenses, such as salaries and wages, rent and telephone bills. If management refuses to constantly monitor, control and manage a business’s liquidity (its amount of working capital), then the business may likely end up in a difficult situation with its creditors.

The following key points are important to working capital:

· The current assets (cash, inventories/stock and accounts receivable/debtors) in the business need to be monitored and kept at realistic levels.

· Current liabilities constitute all the short-term payments that need to be met by the business (obligations that need to be paid within one year). Short-term loans and accounts payable are examples.

· Most successful businesses keep the working capital ratio as low as possible, and keep cash circulating, so as to maximize profit.

· The size of the working capital ratio depends on the type of industry the business operates in, and on financial arrangements such as overdrafts and creditor policy. Ratios between 1.5:1 and 2:1 are acceptable for most businesses [15].


It is the goal of inventory management to determine the optimum level of stock on hand under conditions of changing market demand, production requirements, and financial resources (Glos et al 1976). Effective inventory management enables an organization to meet or exceed customer’s expectations of product availability while maximizing net profits or minimizing costs.Inventory of materials, parts, goods and supplies represent a high investment in all businesses. The success of a business could be made or marred by its inventory policies. Before any decision rules can be applied to the management of stock, a proper system of control and recording of stocks must be instituted. If stocks are uncontrolled, costs of production will vary indistinctly and this will mean that information required for other financial management decisions will be inaccurate [10]


Accounts payable or trade creditors as sometimes called form a major part of the outside debt of small businesses which have less access to long-term funds. According to Bates (1971), trade creditors form a heterogeneous group, and sums other than pure trade credit and debt are often included. As an example, hire purchase due, sums due for wages, rents, sums due for purchase tax, and income tax are all included, and loans to associated concerns, if of a fairly short-term nature, are frequently included in debtors. Because long-term credit is frequently unavailable to the small business, short-term credit is especially important.

Accounts Receivable versus Accounts Payable

Credit terms granted seem to depend to some extent on the traditions and customs of the trade in which the business is operating, and some trade association have fairly strict rules about trade credit terms, and discounts; but there is little doubt that on occasion, the extension of trade credit on more favourable terms can be a way of extending sales (Bates, 1971).

Moreover, differences between industries also reflect the relationship between the company and its customer. According to Bates, businesses which work basically on specification orders for regular customer tend to give credit; businesses that make their own products and place them in the market without advance orders tend to receive credit. This suggests that firms working on contract for other firms are very much at their mercy when it comes to receiving payment for work done. Government institutions are frequently mentioned as bad payers of trade debt.

Net trade credit results when there is a difference between creditors and debtors; it represents net funds granted or received by the firm on this account. Part of the difference between the two is as a result of value added to materials in the process of production, and it would be expected that the higher was value added and the lower were material costs as a proportion of total costs, the greater would be the difference.

Batesargued that if creditors exceed debtors, that is, the firm receives net trade credit; it is a sign of over trading, which consists of attempting the expansion of a business without adequate background of liquid capital. The danger of over trading is that the returns from trading lag behind expenditure, and after a time, creditors become restive and may, in time, enforce liquidation. On the other hand, the dangers of giving out net trade credit are fairly obvious; if a firm gives out too much in pursuit of sales, as is not uncommon in the early phases of the company’s life, it is danger of overtrading and also runs the risk of acquiring bad debts.


As submitted by Weston et al (1977), one of the policies of working capital management is that investments with short-term gestation period be matched with funds of similar duration. Hence, it is preferred that investments in current assets be financed by short term liabilities.

Late Payment and Credit Management in the Small Firm Sector:

Peel and Wilson (1996) submitted that in small and growing businesses, efficient working

Capital management is a essential component of success and survival i.e. profitability and liquidity.

Managing cash-flow and the cash conversion cycle, is a critical component of overall financing management for all firms, and particularly small firms who are often more reliant on short-term sources of finance.

In recent times, policy initiatives have directed a large amount interest on one element of cash-flow management, the extension of trade credit and management of trade debts i.e. credit management. Trade credit entails the supply of goods and services on a deferred payment basis by giving the customer time to pay. The huge volumes of inter-company sales are by credit terms.

Trade credit is a key source of funding for smaller firms; since the stocks and flows of trade credit are usually twice the size of those for bank credit.

In the Nigerian corporate sector, more than 75% of daily business to business transactions are on credit terms. Evidently, trade debtors is one of the main assets on most corporate balance sheets, representing up to 30-35% of total assets, on average, for all firms.

The impact of the late payment of debts on the corporate firm, and most particularly small business sector, was a subject of debate for so many of years, which attracted significant media attention and a policy intervention (Late Payment of Commercial Debt Act 1998) that made mandatory a statutory right to interest on late payments, initially to small firms less than 50 employees).

Surveys conducted by several bodies such as the Institute of Directors, the Small Business Research Trust, the Forum for Private Businesses indicated that debt was a persistent problem for businesses during the recession of the early 1990s. It should also be noted that late payment of commercial debt is identified as a factor inhibiting corporate performance in most Government.

There are, of course, considerable variations between EU Member States’ legislation on late payments, for instance, surrounding statutory rights to interest, redress procedures and the costs of pursuing debts. Indeed the recent proposed EU Directive to combat aspect of trade credit, however, is the two-way nature of the transaction; many companies, particularly those at intermediate points in the value chain, both use trade credit as customers and provide it as suppliers. Managing the net trade credit position is critical. For small firms supplying trade credit can be an important strategic or competitive tool that plays a role in capturing new business, in building supplier-customer relationships, in signalling product quality, ‘reputation’ and financial health, and in price competition and price discrimination.

Nevertheless for small firms, supplying and financing trade credit, and managing trade debt, can cause cash-flow/financing incomplete and often established between supplier and buyers with asymmetric bargaining difficulties.

Trade credit contracts are by their nature incomplete and often established between supplier and buyers with asymmetric bargaining positions. Indeed enforcing credit terms can be a problem, particularly for smaller firms.

Indeed, the late payment of commercial debt has often been cited as a factor that precipitates financial distress and/or constrains growth amongst smaller firms. Given the importance of trade credit, credit management and the late payment of commercial debt to the small firm sector, it is perhaps surprising that relatively little research evidence has been published on these issues. Moreover, most policy interventions aimed at tackling the ‘late payment problem’, do not appear to have been informed by much empirical and/or theoretical research (White Paper ‘Competitiveness: Helping Business to Win’(HMSO, 1994) )

Empirical studies of businesses financial structures have shown that, in comparison to large firms, small ones are less liquid, exhibit more volatile cash flows and profits, and rely more heavily on short term debt funding. Moreover, they are more likely to be credit rationed, with financial institutions restricting the flow of funds to sectors when they are unable to fully evaluate the risks involved. Given these characteristics, it is perhaps unsurprising that the efficient management of working capital, and more recently good credit management practice, have been stressed as being pivotal to the health and performance of the small firm sector (Peel and Wilson, 1996).Various aspects of working capital have been repeatedly shown to represent constraints and problems to small firms. Dodge et al (1994) reported that, cash-flow management was one of the most important internal problems experienced by small US firms. Working capital management has been shown to be a major problem both at start up (Moore, 1994) and for growing firms (Dodge et al, 1994). In addition, during the 1990s, managing cash flow was consistently reported as one of the most important problems (Survey of small firms by respondents of the NatWest UK quarterly) (SBRT, 1996).

Overall, research suggests that ‘poor’ or ‘careless’ financial management is a major cause of business failure (Richardson, Nwankwo and Richardson, 1994). The fact that rapid growth often consumes cash, rather than generating it, has often caused financial difficulties for financially unsophisticated small firm owners.

Reasons purported include the lack of time, resources and skills of small business managers who appear to prefer to expend their efforts in satisfying the requirements of external parties.

In EU, there had been serious debate on the late payment of commercial resources and skills of small business managers who appear to prefer to expend their efforts in satisfying the requirements of external parties. Credit management practice was required to alleviate the problems. Various lobbying groups, resources and skills of small business managers who appear to prefer to expend their efforts in satisfying the requirements of external parties.Others stressed the need for a greater awareness of and training in ‘best practice’ credit management. For example, the Institute of Directors (IOD, 1993) argued that the majority of overdue debtors can be reduced by improved credit management. However, the Forum for Private Business (FPB), a representative of small UK businesses, was amongst the most vociferous advocates of government intervention to mitigate the effects of late payment on the smaller firm sector. The policy prescription favoured by the FPB was the statutory imposition of interest on late payment by debtors. It was posited that such a provision would simultaneously bind all firms into paying promptly, create a level playing field in payment behaviour and ease the cash flow problems of small firms, compensated for any overdue payments (HMSO, 1998).Arguments against the statutory imposition of interest for late payment were formulated in terms of ‘contractual freedom’; in that trade credit is often used as a competitive tool and as a means of building trading relationships. Suppliers may wish to retain the flexibility to vary (informally) credit terms for specific customers and customers may value the freedom to negotiate payment periods with their suppliers as financial circumstances dictate (Gray, 1997). A further powerful argument against legislative intervention contended that the imposition of statutory interest may in fact, dwindle key source of short term finance for the small firm sector. Small firms have been shown to value trade credit as a source of finance for its flexibility and freedom from formal restrictions (Cosh and Hughes, 1994). It is also posited that trade credit is used widely by small firms who are unable to obtain sufficient finance from other sources such as financial institutions (Peterson and Rajan, 1997). Keasey and Watson (1992) in their study of small firms in the north of England (Yorkshire), found a negative relationship between bank finance and trade credit (meaning that they are used as substitutes), and a positive relationship between external finance and profits.Wilson, et al (1997) in an empirical study of the demand for trade credit by small UK firms, also found strong evidence of a financing demand for trade credit. They surmised that small firms that pay trade credit liabilities late appear to do so when they reach their limit on short-term bank finance. These ‘credit rationed’ firms were, typically, growing and export oriented. In consequence, if the imposition of statutory interest significantly reduces the trade credit offered to smaller firms, this may lead to severe liquidity problems and increased failure rates unless alternative finance is readily available.A number of other solutions to the problem of late payment have been put forward. For example it has been argued that credit management is a neglected function in many problems and increased failure rates unless alternative finance is readily available. Wilson et al (1995) identified poor credit management practices as one of the underlying causes of late payment.In addition to poor credit management practices, causes were considered to include over reliance on trade credit and short term finance and consequently an increased sensitivity to late payments. The Bank of England report on finance for small firms (BOE, 1996) observed a similar occurrence of ad hoc credit management which was viewed as being inefficient. They concluded that this was due to the inherent lack of administrative resources in the small firm sector. It has been argued that policies that emphasise the provision of financial and credit management training for smaller businesses would have a beneficial impact. This may also raise awareness of the services and potential benefits of credit insurance and factoring, and the returns to investments in information technology.

Cash flow volatility, earnings volatility and firm value.

The theory of corporate risk management argues that shareholders are better off if a firm maintains smooth cash flows. For instance, Froot, Scharfstein, and Stein (1993) argued that smooth cash flows can add value by reducing a firm’s reliance on costly external finance.Empirically, Minton and Schrand (1999) showed that cash flow volatility is costly as it affects a firm’s investment policy by increasing both the likelihood and the costs of raising external capital. One recurring theme in this literature is that, all things being equal, firms with smoother financial statements should be more highly valued. While previous research finds that cash flow volatility is costly, no direct evidence exists linking financial statement volatility to firm value. Such a link is important because, in order for risk management to matter, smooth financials must be valued at a premium to more volatile ones. Investors value firms with smooth cash flows at a premium relative to firms with more volatile cash flows. Consistent with risk management theory, strong evidence shows that cash flow volatility is negatively related to proxies for firm value. There are a number of reasons why earnings volatility may matter to the firm, independent of cash flow volatility. For instance, prior empirical work suggests that analysts tend to avoid covering firms with volatile earnings, as it increases the likelihood of forecast errors Similarly, it is imperative that institutional investors avoid companies that experience large variations in earnings. High earnings volatility also increases the likelihood of negative earnings surprises; in response, managers have engaged in extensive earnings smoothing. It should be noted that earnings smoothing may likely reduce a company’s perceived probability of default and therefore a firm’s borrowing costs. Goel and Thakor (2003) suggest that a firm may smooth earnings so as to reduce the informational advantage of informed investors over uninformed investors, and therefore protect these investors who may need to trade for liquidity reasons. Last but not the least, Francis, Lafond, Olsen, and Schipper (2004) find firms with greater earnings smoothing have a lower cost of capital even after accounting for cash flow volatility. In fact, under certain specifications the market appears to punish firms for undertaking smoothing behavior preferring earnings volatility mirror cash flow volatility. These results are important and suggest Managers focus their actions on smoothing cash flows rather than necessarily utilizing accruals to smooth earnings. Of course, there are a number of other ways in which financial uncertainty interacts with firm value. According to the CAPM, systematic risk should be negatively related to value, since higher discount rates yield a lower value, all things being equal. Further, recent empirical work suggests that not only does systematic risk affect value, but also idiosyncratic risk may be priced (Shin and Stulz, 2000). Empirical evidence suggests that there is a negative relation between systematic risk and firm value, as well as a negative and significant association between unsystematic risk and firm value.

The two alternative types of risk, namely, cash flow and earnings volatility are of primary importance since unlike financial market variables they reflect the actual stability of the firms’ financial statements and are directly affected by managerial decisions and the firms’ risk management policies.


Working capital management is centred on problems arising in attempting to manage the current assets, the current liabilities and the interrelationship that exists between them. As explained earlier, the term current assets refer to those assets which business will be converting into cash within one year without experiencing a dwindling in value and upsetting the operations of the company. Most major current assets are cash, marketable securities, accounts receivable and inventory.

Current liabilities are referred to those liabilities that are intended at the beginning, payable in the ordinary course of business, with in a year, out of the current assets or earnings of the concern. Among the essential current liabilities are accounts payable, bills payable, bank overdraft, and outstanding expenses. The Principal objective of working capital management is to manage the company’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained. It is so due to the fact that if the company cannot sustain an acceptable level of working capital, it is certainly may lead into what is termed insolvency and may end up into bankruptcy.

Current assets must be large as much as necessary to be able to cover its current liabilities to guarantee a reasonable margin of safety. All of the current assets are to be managed efficiently so as to maintain the liquidity of the company; while not keeping too high a level of any one of them. Every of the short-term bases of financing must be managed continuously to guarantee the possible best way usage. Hence, the interaction between current assets and current liabilities is the main premise of the theory of working management

The central elements of the theory of working capital management includes its definition, need, optimum level of current assets, the trade-off between profitability and risk which is associated with the level of current assets and liabilities. In addition to financing mix strategies and so on [33].

Concepts and Definitions of Working Capital

The two concepts of working capital are gross and net. The term gross working capital is also known as working capital, implying the total current assets. The term net working capital can be defined in two ways: The most common definition of net working capital (NWC) is the difference between current assets and current liabilities.

Alternate definition of NWC is that portion of current assets which is financed with long-term funds.

Most task of the financial manager in managing working capital proficiently is to guarantee adequate liquidity in the operation of the company. The liquidity of business enterprise is determined by its ability to satisfy short-term obligations as they become due.

Three basic measures of company’s overall liquidity are:

· the current ratio,

· the acid-test ratio, and

· the net working capital.

The suitability of the first two measures is discussed in detail in chapter 5. Net working capital (NWC) as a measure of liquidity is not very useful for comparing the performance of different companies, but it is quite of liquidity that is not really essential for comparing the performance of various companies, but it is very helpful for internal control. The NWC contributes enormously while comparing the liquidity of the same company over time. For the main reason of working capital management, therefore NWC is expected to measure the liquidity of the company. Meanwhile, the focus of working capital management is to mange the current assets and liabilities in such a way that an acceptable level of NWC is sustained

The common Definition of NWC and its Implications

NWC is commonly defined as the difference between current assets and current liabilities. Efficient working capital management requires that company should operate with some amount of NWC, the exact amount varying from firm to firm and depending, among other things, on the nature of industry. The theoretical justification for the use of NWC to measure liquidity is based on the premise that the greater the margin by which the current assets cover the short-term obligations, the more is the ability to pay obligations when they become due for payment. The NWC is necessary because the cash outflows and inflows do not coincide. In other words, it is the non synchronous nature of cash flows that makes NWC necessary.

In general, the cash outflows resulting from payment of current liabilities are relatively predictable. The cash inflows are however difficult to predict. The more predictable the cash inflows are, the less NWC will be required. A company like electricity generation company, with almost certain and predictable cash inflows can operate with little or no NWC. But where cash inflows are uncertain, it will be necessary to maintain current assets at a level adequate to cover current liabilities that are there must be NWC [33].

Alternative Definition of NWC

NWC can alternatively be defined as that part of the current assets which are financed with long-term funds. Since current represent sources of short-term funds, as long as current assets exceed the current liabilities, the excess must be financed with long-term funds. This alternative definition, as shown subsequently, is more useful for the analysis of the trade-off .between profitability and risk


While carrying out the evaluation of a company NWC position, one important consideration is the trade-off between profitability and risk. This is to say that the level of NWC has a bearing on profitability and also on risk. The term profitability employed in this framework is a measure of profits after expense. Risk is the probability that a company will develop into technically insolvent so as not be able to meet its obligations whenever they are due for payment the risk of becoming technically insolvent is measured using NWC. It is assumed that the greater the amount of NWC, the less risk prone the company is. Or, the greater the NWC, the more liquid is the company and, therefore, the less likely it is to become technically insolvent. On the contrary, lower of NWC and liquidity are connected with rising levels of risk. The correspondence between liquidity, NWC and risk is such that if either NWC or liquidity increases, the Company’s risk decreases

Nature of Trade-off

If a company is to increase its profitability, it risk must also be increased. Similarly, if it is to decrease risk, it must decrease profitability. The trade off between these variables is that in spite of how the company increases its profitability in the course of the manipulation of working capital, the effect is a corresponding increase of a related increase in risk as determined by the level of NWC. The consequences of changing current assets and current liabilities on profitability-risk trade-off are discussed first and afterwards they have been integrated into an overall theory of working capital management [33].

While evaluating the profitability-risk trade-off related to the level of NWC, three basic assumptions, which are generally true, are:

· that we are dealing with a manufacturing company

· that current assets are less profitable than fixed assets; and

· that short-term funds are less expensive than long-term funds

Effect of the level of current assets on the profitability-risk trade-off.

The effect of the level of current assets on profitability-risk and trade-off can be shown, using the ratio of current assets to total assets. This ration indicates the percentage of total assets that are in the form of current assets. A change in the ration will reflect a change in the amount of current assets. It may either increase or decrease [33].

Effect of Increase/Higher Ratio

The increase in the ratio current assets to total assets produces a decline in profitability since the current assets are believed to have lowered profitable compared to fixed assets. One other effect of the increase in the ratio will be that the risk of technical insolvency would also decrease because the increase in current assets, assuming no change in current liabilities, will increase NWC.

Effect of Decrease / Lower Ratio

The decrease in the ratio of current assets to total assets produces an increase in profitability along with risk. Increase in profitability is basically as a result of the consequent increasing in fixed assets that may produce higher returns. Since the current assets decrease without

a resultant decrease in current liabilities, the amount of NWS will decrease, and consequently increasing risk


This chapter looks deeply into various authors and researchers view of the causes of failure in many firms and what constitute an efficient working capital management in those firms doing well. Cash management, Inventory management and Trade management are extensively analyzed as main contributors to efficient working capital management.

Chapter three provides the case study analysis and analyses different concentration measures to assess the efficiency of working capital management in the company



VGC Telecoms Limited was incorporated as a private liability company in April 1995. The company is established to provide communications-related services across Nigeria. The company offers both wireless and wire line services across the country.

The company recognises the importance of high standard of corporate governance. The Board consists of two (2) executive and five (5) non-executive directors chaired by Yaakov Chai. The Board met three times in the year 2008 under review. The board has focused on its responsibilities and has perfected its operational strategies to achieve reasonable performance of the company.

The issued and fully paid up capital is N76,893,006 (£310052.44)divide into N153,786,012 (£62000.05) ordinary shares of 50 kobo (£0.002) each .Of this amount, N76,831,048 (£309802.61) shares equivalent to 49.96% was held by Volker Securities & Investment Limited, while N15,548,188 (£62694.31) shares equivalent to 10.11% was held by the Nigerian Social Insurance Trust Fund(NSITF) as at 31 December 2008



A total of 13 questions were answered by the CFO under cash management, covering the areas of (1) cash forecasting (2) management of cash (3) surplus cash management and (4) control of cash. The data are analysed below:

Please see appendix I (page 65) for the questions indicated in tables 1 – 9. There is only one answer to choose out of the three or two likely possible alternatives available to each question. Alternative (a) is not an acceptable working capital policy, alternative (b) is in-between and alternative (c) is the acceptable working capital policy. Alternative (a) attracts 0 point, alternative (b) attracts 2.5 point and alternative (c) attracts a full point of 5 being the acceptable WCM policy.

Table 1


Questions Total Points Points to Options (a) Points to Options (b) Points to Options (c) Score
Question 1 5 0 2.5 5 2.5
Question 2 5 0 2.5 5 5
Question 3 5 0 2.5 5 2.5
Total 15 10

For cash flow forecasting, the company obtained 10.0 points out of the 15 points reserved for the 3 questions. The company’s cash flow could sometimes be predicted due to the nature of the business. This is in the company’s favour as it will aid cash planning. So it scored the 2.5 points allocated to the (b) optional answer. Also, it can be seen that the company plan its operation by budgeting hence it scored 5 points allocated to the (c) optional answer and by scoring 2.5 in the last question it can be deduced that the company sometimes forecast its cash flow.

Table 2


Questions Total Points Points to Options (a) Points to Options (b) Points to Options (c) Score
Question 4 5 0 2.5 5 2.5
Question 5 5 0 2.5 5 2.5
Question 6 5 0 2.5 5 5
Total 15 10

The company score in the management of cash is 10 points out of 15 points. The company has a provision of sourcing immediately needed short-term funds and the source is reliable. Hence, the company obtained the 5 points reserved to the option(c) answer. The 2.5 scored in each of questions four and five shows that the company has a determined optimal and minimal cash balances.

Table 3


Questions Total Points Points to Options (a) Points to Options (b) Points to Options (c) Score
Question 7 5 0 2.5 5 5
Question 8 5 0 2.5 5 5
Question 9 5 0 2.5 5 0
Total 15 10

The company obtained 10 points in surplus cash management. There are periods when the company experiences surplus cash management. This point is easily determined since it has optimal and minimal cash balance policies.

However, the surplus cash points must be when it has cash in excess of immediate requirements. It is the policy of the company to move part of the surplus cash to savings deposits that yield interest and the other part to finance capital assets. Hence it scored 5 points reserved for option(c) in each of the first two questions. However, the aim of investing in capital assets is high profit only, hence it scores zero (0) point.

Table 4


Questions Total Points Points to options(a) Points to options(b) Points to options (c) Score
Question10 5 0 2.5 5 2.5
Question11 5 0 2.5 5 5
Question12 5 0 2.5 5 2.5
Question13 5 0 2.5 5 2.5
Total 20 12.5

With control of cash, it obtained 12.5 out of the 20 points allocated to the 4 questions. Sometimes, the company use accelerated cheque-clearing system where it pays extra charges to the bank. Some other times, under special arrangements, the banks give value to their cheque before clearing. Because it is not done all the time, the score is 2.5 points. The issue of slowing down disbursements is common in the company. Hence, the whole 5 points that question is awarded. The company takes other forms of credit from time to time, but not often enough. It also scored 2.5 points there. It also scored 2.5 points in the use of float, because, it sometimes ensures there is positive float.

A total of 65 points is allocated to the 13 questions under cash management (5×13). The company scored 42.5 out of the 65 points. This is a percentage performance of 65.4 percent (42.5/65).


Seven questions were answered in this section; all seven bordering on the control of inventory and determination of re-order levels and quantities. The answers are shown in table 5

Table 5

Questions Total points Points to options(a) Points to option(b) Points to option(c) Score
Question14 5 0 2.5 5 5
Question15 5 0 2.5 5 5
Question16 5 0 2.5 5 2.5
Question17 5 0 2.5 5 5
Question18 5 0 2.5 5 5
Question19 5 0 2.5 5 2.5
Question20 5 0 2.5 5 2.5
35 27.5

For inventory management the company obtained 27.5 points against the 35 points reserved for the seven questions. The record keeping system was described as accurate and this attracted 5 points. It has an inventory control policy or an institutionalised system of control.

The system of control employed fit into one of Lin’s model. It is not a traditional system that relies on judgement and experience and thus it scored 5 points.

There are also planned re-order level for the company’s stocks and does not wait until stock is completely exhausted before placing a new order. In both areas (i.e. questions 4 and 5) it obtained 5 points. The order quantities are determined and such are varied from time to time. So it obtained 5 points. The re-order quantities and points are determined not by any definite system as suggested by Lin [16], but by rule of thumb. It scored 2.5 points in each of the last two questions.

The seven questions for inventory management have 35 points allocation. The company scored 27.5 points. This is a percentage performance of 78.6 percent (27.5/35).


Seventeen (17) questions were answered in trade credit management, in the areas of (1) purpose and terms of credit, (2) the price credit (3) determination of credit risk and collection policy, (4) control and financing of credit. The analysis was as follows.


Questions Total points Points to option(a) Points to option(b) Points to option(c) Score
Question21 5 0 2.5 5 2.5
Question22 5 0 2.5 5 2.5
Question23 5 0 2.5 5 2.5
Question24 5 0 2.5 5 2.5
Question25 5 0 2.5 5 2.5
Question26 5 0 2.5 5 2.5
Total 30 15

The company obtained 17.5 out of the 30 points reserved for the 6 questions in credit terms and purpose of credit. Its policy regarding how much credit to extend to buyers (as a proportion of total sales) and how much credit should be extended to any one customer. In both cases, it scored 2.5 points. It has definite credit period stated to be 28 days. Usually the shorter the period, the better (except where the incremental gain of the longer period is higher than the marginal cost of carrying the amount of receivables). It scored 2.5 for the 28 days period. There is a planned discount policy in the company but this policy could sometimes be bent to win new accounts. It scored 2.5 in each respectively. The credit sales for the period covered by the study were about 40 percent of total sales.

Table 7


Questions Total Points Points to options(a) Points to options(b) Points to options (c) Score
Question27 5 0 2.5 5 2.5
Question28 5 0 2.5 5 2.5
Question29 5 0 2.5 5 5
Question30 5 0 2.5 5 0
Total 20 10

The score for pricing of credit is 10 against the total points of 20 allocated to the 4 questions.

From the data, between 6 and 10 percent of the bills is spent on collection expenses. At the end of the 28 days credit period, between 21 and 40 percent of the bills still remain outstanding. This means that about 12 to 20 percent of the bills receivable are spent on collection efforts before all bills are collected. The proportion collected and the proportion spent, each scored 2.5 points. Bad debt incidents are negligible. It scored 5 points there.

In pricing credit, the costs of additional billing and record keeping, high collection expenses (between 12 and 20 percent in this case), the time value of the capital tied up, etc are considered.