CHAPTER ONE INTRODUCTION

             Background to the Study

Since time immemorial the management of working capital has been one topical issue financial analysis and managers consider critical in any firm performance. This is mainly because, the goal of working capital management is to ensure that a firm is able to continue its operations and that it has sufficient ability to satisfy both maturing short-term debt and upcoming operational expenses Essentially, the concept of management of working capital involves managing inventories, accounts  receivable,  accounts  payable  and  cash  and cash equivalent,     In modem financial management, administration of working capital is an important and challenging task due to high proportion of working capital in a business and some of its peculiar characteristics The management of current assets (normally converted into cash within an accounting year) and current liabilities (generally discharged within a year) and the interrelationship that exists between them may be termed as working capital management Excessive levels of current assets may have a negative effect on the firm’s profitability whereas a low level of current assets may lead to lower level of liquidity and stock outs resulting in difficulties in maintaining smooth operations (Van Horne and Wachowicz, 2004) Traditional concept of working capital is the different between assets and current liabilities Thus, working capital management is an attempt to manage and control the current assets and the current liabilities in order to maximize profitability and proper level of liquidity in business

Liquidity and profitability are two important and major aspects of corporate business life (Vataliya, 2009) The problem is that increasing profits at the cost of liquidity can bring serious problems to the firm Therefore, there must be a trade-off between these two objectives (liquidity and profitability) of firms One objective should not be at the cost of the other because both have their own importance If firms do not care about profit, they cannot survive for a longer period In other round, if firms do not care about liquidity, they may face the problem of insolvency or bankruptcy For these reasons managers of firms should give proper consideration for working capital management as it does ultimately affect the profitability of firms As a result company can achieve maximum profitability and can maintain adequate liquidity with the help of efficient and effective management of working capital

Inefficient financial management including working capital management may damage business enterprise’s profitability (Gebrehiwot & Wolday, 2006) The efficient management of working capital is a fundamental part of the overall corporate strategy to create shareholders value (Nazir and Afza, 2008) In addition, efficient working capital management leads to improve the operating performance of the business concern and it helps to meet the short-term liquidity (Paramasivan, Subramanian, 2009) Therefore, firms try to keep an optimal level of working capital that maximizes their value (Deloof, 2003) In addition to that, the effective working capital management is very important because it affects the performance and liquidity of the firms (Taleb et al., 2010) The main objective of working capital management is to reach optimal balance between working capital management components (Gill, 2011) Large inventory and generous trade credit policy may lead to high sales Large inventory also reduces the risk of a stock-out Trade credit may

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