ARBA MINCH UNIVERSITY OF SAWLA CAMPUS

COLLEGE OF BUSINESS AND ECONOMICSDEPARTMENT OF ACCOUNTING

AND FINANCE

WORKING CAPITAL MANAGEMENT (IN CASE OF COMMERCIAL BANK OF

ETHIOPIA IN SAWLA CAMPUS)

A SENIOR ESSAY SUMMITED IN THE PARTIAL FULLFILLEMENT OF THE

REQURIMENT FOR AWARD OF BACHLOR OF ART (BA) IN ACCOUNTING AND
FINANCE

PREPARED BY: ID NO:

ASTER AYKA……………..EVBE/366/13

ADVISOR: Mr. KASSA M.

FEBRUARY, 2017
 SAWLA, ETHIOPI

Abstract

The study was undertaken on assessment of working capital management of Commercial Bank
of Ethiopia in Sawla branch. The overall objective of the study was to evaluate the working
capital management of a bank in case of Sawla branch, Sawla the target population of this study
is judgmental sapling techniques, the sample size of the research was 22 ,the data collected from
the sample is analyzed quantitatively and qualitatively. Both primary and secondary data were
collected. To collect primary data a total of 10 questionnaires were distributed and all of them
were collected successfully. The researcher used descriptive method of data analysis. The
finding of the study showed many strengths and weakness of the branch. Among the weakness
identified in this study include lack of networking system and lack of awareness of employees
about the working capital management policies, procedures and strategies of the bank, and does
not give loan service

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Table of content

Content page

Abstract----------------------------------------------------------------------------------------II
CHAPTER-ONE

1. Introduction-------------------------------------------------------------------------------1
1.1 Background of the Study------------------------------------------------------------------1
1.2 Statement of the problems---------------------------------------------------------------2
1.3 Objective of the study--------------------------------------------------------------------3
1.3.1 General objectives-------------------------------------------------------------3
1.3.2 Specific objectives-------------------------------------------------------------4

1.5. Significance of the study---------------------------------------------------------------4

1.6. Scope of the study----------------------------------------------------------------------4
1.7 . Limitation of the study---------------------------------------------------------------5
1.8. Organization of the paper-----------------------------------------------------------5

CHAPTER TWO
2. LITRATURE REVIEW------------------------------------------------------------------6

2.1. Introduction of working capital management---------------------------------------6

2.2 Definition of working capital management-------------------------------------------6

2.2.1 Current assets---------------------------------------------------------------------------7

2.2.2. Liabilities-------------------------------------------------------------------------------7

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2.2.3. Current liabilities----------------------------------------------------------------------7

2.3. Concept of working capital------------------------------------------------------------7

2.4. Nature of working Capital--------------------------------------------------------------8

2.5. Components of Working Capital Management-------------------------------------8

2.5.1 Cash and Cash Equivalent Management-------------------------------------------8

2.5.2 Management of Receivables---------------------------------------------------------9

2.5.3 Management of Account Payables--------------------------------------------------9

2.6. Liquidity-----------------------------------------------------------------------------------10

2.6.1. Current ratio---------------------------------------------------------------------------10

2.6.2. Quick decisive test ratio--------------------------------------------------------------10

2.7. Gross working capital or current assets---------------------------------------------10

2.8 Net working capital or net current assets--------------------------------------------11

2.9 Factors influencing working capital--------------------------------------------------12

2.10 working capital ratio analysis-------------------------------------------------------13

2.11 Working capital investment and financing policies------------------------------14

2.11.1 Alternative current asset investment policy-------------------------------------14

2.12 Working capital financing approaches---------------------------------------------15

2.12.1 The aggressive approaches--------------------------------------------------------15

2.12.2. The conservation approaches-----------------------------------------------------15

2.12.3. The moderate approach------------------------------------------------------------16

2.13. Advantage and disadvantage of short-term finance-------------------------17

2.14 Empirical literature review……………………………………………………………………………….19

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CHAPTER THREE

3.1 Methodology of the research------------------------------------------------------------20

3..1data type and sources----------------------------------------------------------20

3.1.1 Research design and strategy------------------------------------------------20

3.2.2 Method of data collection-----------------------------------------------------20

3.3 Sample design-----------------------------------------------------------------20

3.4 Data processing and analysis-------------------------------------------------21

Reference-------------------------------------------------------------------------------------22

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 CHAPTER-ONE
Introduction

1.1 Background of the Study

The term working capital originated with the old Yankee peddler who would load up his wagon
with goods and then go off on his rout to peddle his wares. The merchandise was defined as his
working capital because it was what he sold or turnover, to produce his profit. The wagon and
horse were his fixed assets. (EugeneF.Brigham&Joel F. Houston, 1999page- 563).

Working capital has been defined as the firm’s investment in current asset. Current assets
comprise all asset that the firm expects convert into cash with in the year, including cash,
account receivables, marketable securities and inventory managing of the firm’s working capital.
Cash is the most liquid asset of a company. Account receivables are listed as assets on a
company’s balance sheet, but they are not actually assets until they are collected. The
management of a corporation’s sources and use of short-term funds is known as working capital
management. This are of managerial finance contributes to be overall goal of public enterprise
and private organization profit as well as wealth maximization by meeting the liquidity of the
organization. (Khan, Jain, 2001, page 133).

Working capital represent the portion of investment that circulates from one form to another in
the ordinary conduct of business this idea embraces the recurring transition from cash to
inventories to receivables and back to cash. (Lawrence J.Gltman, 2003, page-598).

The important of working capital management is reflected in the fact that financial manager
spend operate deal of time in managing current asset and current liability, Arranging short term
financing negotiation favorable credit term, controlling the movement of cash administration
balancing receivable, and monitoring the investment in inventor consume a great deal of finance
manager (prasanna Chandra 1998 page 182_183)

Working capital has been defined as the firm’s investment in current asset current asset
comprises all asset that the firms expect convert in to Cash with in the years, including Cash,
account receivable, marketable security and inventories managing of the firms working capital
1
cash is the most liquid asset of a company, account receivable are listed as asset on a company's
balance sheets, but they are not actually asset on until they are collected. (Khan,Jain,2001,Page
133)

In today competitive world business organization Managing their business carefully, so the
researcher assets the working capital management on commercial bank of Ethiopia in Sawla
branch, the reason is to change awareness of societies to word the bank listing the problems
relates with working capital management.

Working capital management must be adequately and properly manage cost of financing and
level of relatable cash, poor control over working capital component like current asset and
current liability will lead's to incurring loss day to day activities failure in working capital
management may result in the Bank ruptcy of the organization (Melese, 2004) so the effective
management each component of the working capital is important for the firm to

 To control the cost of holding current asset

 To control technical insolvency.

1.2. Statement of the problems

In every private and public enterprise, the management of working capital is crucial, because
working capital maintain the detail necessary to conduct the day-to-day activities. Failure in
working capital management resulted in ultimately bankruptcy (IMPANDAY1997_page
223_226).

The effective management of each component of working capital is essential for the enterprise
to sustain its regular operation and to maintain satisfactory level of liquidity. The proper working
capital management can help control cost of financing and adequate level of realizable cash.
(IMPANDAY,1997, page- 224-228).Proper working capital management avoid the loss caused
by inadequate working capital management (Eugene F.Brigham, 1997,page 675) within in the
purpose this research is conducted in commercial bank of Ethiopia at Sawla branch, one of the
problem in working capital management is too difficult to have optimum current asset. In
generally the day-to-day activities of working capital management is essential for the
organization to control the cost of holding current asset.

2
To insure the adequate working capital, the study would find the solution of for working capital
and its effect on progress on commercial Bank of Ethiopia in Sawla branch. in this regard the
researcher would been decided to fulfilled the gaps of the previous researcher and undertake the
study to investigates working capital management Sawla branch. According to
hiskiel(2017)studied on the assessment of working capital management in Sawla town in order to
analysis the factor that affected inappropriate working capital management. His found was the
working capital management mechanism used to solve problems related to the working capital
management. The researcher would be fund about the organization segregated duties in order to
develop adequate for working capital management.

Working capital is life blood of any types of business, no business can run successful without
adequate amount of working capital, therefore, managers of any business need to have clear
concept a managerial skill on working capital and its management (IBD).

The main problems are poor control over these asset will result in loss, and insolvency.

The proper capital management ensures adequate level of cash account receivable and
investment; thus, it enable avoids the losses caused by study is would be carried out to answer
the following question:-

1.3Research Question

1. Does the bank effective and efficient in managing working capital?

2. How can the bank improve working capital management?

3. What are the factors that affect working capital of bank negatively?

4. How the banks optimize the level working capital?

1.4. Objective of the study

1.4.1. General objectives

The general objective of the study is assessment of the working capital management practice of
commercial bank of Ethiopia in Sawla branch.

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1.4.2. Specific objective

The specific objective of the research is:-

-to evaluate the efficiency and effectiveness of working capital management.

-to identify the factor that affects working capital management of the bank.

-improve the working capital management of bank.

-to identify the current asset those organization hold at high level.

1.5. Significance of the study

Under this research the researcher investigates the real-world application of on assessment of
working capital management by selecting commercial bank of Ethiopia. The study has the
following significances.

 The study can be stepping stone for other researcher to study on issue and it can
take as secondary data.
 This study is useful in bringing into light the strong and weak point in managing
of working capital. Hence it takes appropriate action in its weak point and makes
associational procedure in managing working capital to commercial bank of
Ethiopia.
 The study is important in paving the way to those who are interested to undertake
further research on the same stream in the future.

1.6 Scope of the study

Time study with limit to the working capital management in commercial bank of
Ethiopia at Sawla branch beside the study cannot visualize over all of management in
the organizing as whole the study asses area of study managnent decision objectives
and quantity of which of management.

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 1.7 Limitation of the study

There are some limitations that were expected to face on this research work:-

1. The planned respondents have not interested to give information.

2. The short span of time for collecting and analyzing of questions of the data for final
report.
3. Lack of sufficient material from the organization because the bank manager is not
voluntary to give their secondary source document.
1.4 Organization of the paper

The study contains three chapters; the first chapter is introduction which includes background of
the study, statement of the problem, and objective of the study, scope and limitation of the study,
significance of the study and research methodology. The second chapter deals with literature
review. The third chapter consists of data analysis and interpretations.

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 CHAPTER TWO

LITRATURE REVIEW

2.1. Introduction of working capital management

Working capital management is the process of planning and collecting the level and mix of
current asset of the firm as well as financing of these assets. It involves the use of certain
prescribed aids such as the risk return tradeoff, credit standards, and inventory models. The
objective of working capital management is to determine the optimal amount of investment in
various current asset accounts. The optimal amount of the investment in various current assets is
the level of the current asset holding that maximized return on investment. The basic objectives
of working capital are to provide various current assets and short-term credit necessary to
support the anticipated sales by minimizing the investment in current assets. The motives power
of a business enterprise is provided by it working capital components cash short term investment
receivable and current liability measurement of this components for balance sheet representation
also involves the recognition of revenue and expenses I the process of measuring periodic net
income.(Lawrence j.Gitman, 2009 page 525)

2.2. Definition of working capital management

One of the most important areas in the day-to-day management of the firm deals with the
management of working capital, which is defined as all the short-term assets used in daily
operation. These consist primarily of cash, marketable securities, accounts receivable and
inventory. The balance in these accounts can be highly volatile as they respond quickly to
changes in firms operating environment. The effective management of working capital requires
both medium-term planning and immediate reactions to change in for cost and conditions.

Net working capital may be defined as the difference between current assets (working capital)
and current liabilities. It is a measure of liquidity, which is defined as the adequacy of near-term
cash to meet the firm’s obligation. A highly liquid firm has sufficient cash to pay its bills when
due. Working capital management is the functional are of finance that covers all the current
account of the firm. It is concerned which the adequacy of current asset as well as the level of
risk posed by current liabilities. It is a discipline that seeks proper policies for managing current
asset and liabilities and practical techniques for maximizing the benefits from managing working
capital (VAN HORNE, 201, page 212)
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2.2.1 Current assets
Current asset relatively “liquid” resources this category includes cash investment in marketable
securities receivable, inventories and prepaid expenses. To quality as current asset, asset must be
capable of being converted in to cash with in a relatively short period of time without interfering
with normal business operation.

2.2.2. Liabilities
Liabilities may be defined as debt or obligation from past transaction or events requiring
settlement of a future date.

2.2.3. Current liabilities

Current liabilities are obligation that must be paid with one year or within the operating cycle,
whichever is longer. The time used in define current liability parallel that used in defining
current asset divided by current liability are valuables indicator or company ability to pay its
debts soon. Among the most common example of current liability are account payable short term
not payable and accrued liabilities. (Robert F merigs and Walter B.meigs 1992, page 463)

2.3. Concept of working capital

These are two concepts of working capital, such as networking capital and gross working capital.
When accountant use the term working capital, they are generally referring to net working
capital which is the dollar difference between current asset and current liabilities. This is one
measure of the extent to which firm. It protected from liquidity problems. From the management
view point, however, it makes a little sense to talk about trying to activity manage a net
difference between current asset and current liabilities, practically when the difference is
continually changing. Financial analysis, on the other hand, means current assets when they
speak of working capital. Therefore, there focus is on gross working capital. Because it does
make sense for the financial manager to be involved with always providing the current amount of
current assets for the firm. We will adopt the concept of gross working capital. As the discussion
of working capital management unfolds. Our concern will be to consider the administration of
the firm’s current assets namely cash and marketable securities, receivable and inventory and the
financing (especially current liabilities) needed to support current assets (James Covenhorne,
2003, page 210.)

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2.4. Nature of working Capital
Working capital management is concerned with the problem that a rose in attempting to manage
the current asset, this current liabilities and inter reaction ship that exist between them. The term
current assets refer to hose assert which in the ordinary course of business can be or will be
turned in to cash within one year with undergoing administering in values and without disrupting
the operation of the firm. The goal of working capital management is to manage the firm’s
current asset and current liability in such a way that a sat is factory level of working capital
maintained. This is so because if the firm cannot maintain in sat factory level of working capital
it likely to become insolvent and may even be forced into bankruptcy. The current asset should
be large enough to cover it current liability to ensure a reasonable may in of the safety each of
the current asset must be managed efficiently in order to maintain the liquidity of the firm which
not keeping too high a level of any one of them.

2.5. Components of Working Capital Management

Often the interrelationships among the working capital components create challenges for the
financial managers. Working capital must be managed because the firm cannot always control
how quickly the customers will buy and once they have made purchases, exactly when they will
pay. The different components of working capital management of any organization are:-

- Cash and cash equivalent

-Inventory

- Debtors/account receivables

-Creditors/account payables

2.5.1 Cash and Cash Equivalent Management

One of the most important working capital components to be managed by all organizations is
cash and cash equivalent. Cash management helps in determining the optimal size of the firm’s
liquid asset balance. It indicates the appropriate types and amounts of short-term investments
along with efficient ways of controlling collection and payout of cash. Good cash management
implies the co-relation between maintaining adequate liquidity with minimum cash in bank. All
companies strongly emphasize on cash management as it is the key to maintain the firm’s credit
rating, minimize interest cost and avoid insolvency.
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2.5.2 Management of Receivables

Receivables contribute to a significant portion of the current assets. For investments into
receivables there are certain costs (opportunity cost and time value) that any company must bear,
along with the risk of bad debts associated to it. it is therefore necessary to have a proper control
and management of receivables which helps in taking sound investment decision in debtors.
Thereby, for effective receivables management one needs to have control of the credits and make
sure clear credit practices are a part of the company policy, which is adopted by all other
associated with the organization. One must be vigilant enough when accepting new accounts,
especially larger ones. Thereby, the principle lies in establishing appropriate credit limits for
every customer and stick to them.

Effectively managing accounts receivables;

- Process and maintain records efficiently by regularly coordinating and communicating

with credit managers and treasury in-charges.
- Prepare performance measurement reports
- Control accuracy and security of accounts receivable records
- Captive finance subsidiary can be used to centralize accounts receivable functions and
provide financing for company’s sales.

2.5.3 Management of Account Payables

Creditors are a vital part of effective cash management and must be managed carefully to
enhance the cash position of the business. One must keep in mind that purchasing initiates cash
outflows and an undefined purchasing function can create liquidity problems for the company.
The trade credit terms are to be defined by companies as they vary across industries and among
companies.

Factors to consider;

- Trade credit and the cost of alternative forms of short-term financing are to be defined.

-The disbursement float which is the amount paid but not credited to the payers account needs to
be controlled.

- Appropriate methods need to be adopted for customer to business payment though e-commerce

9
- Company must centralize the financial function with regards to the number, size and location of
vendors.

2.6. Liquidity

Liquidity describes the degree to which an asset or security can be quickly bought or sold in the
market without affecting the assets price. Liquidity may be emergency savings account or the
cash lying with us that we can access in case of any unforeseen happening or any financial
setback. Liquidity also plays an important role as it allows seizing opportunities. A liquid asset is
therefore one that can be quickly converted to cash without a sustainable price reduction. The
amount of cash a company has on hand or can generate quickly reveals how healthy the company
is financially. High level of available cash indicate that the business can pay off debt easily when
due dates occur. The types of assets a company has and the marketability of those assets are
where a discussion of financial liquidity begins.

The main objective of the uses of liquidity ratios is to gives the external analyst to measure of the
firm’s capacity to meet short term obligation. Financial manager has more refined to work with
such as detailed cash budgets. But liquidity ratios are very useful to firm’s short-term creditors
such as bank and suppliers. Their attention is usually focused on the relationship of the firm’s
liquidity asset to its maturing liability two popular liquid ratios are current ratio and the quick
ratio.

2.6.1. Current ratio

The current ratio is defined as the ratio of current asset to current liability current asset includes
all the firms’ asset which is expected to be converted to cash during the firm operating cycle.
They are usually considered the reserve out of which maturing short term one year or less liable
can be paid it follows that a large current ratio consists assert of safety margin for the firm’s
short-term creditors. This ratio is measure of the formality to meet its mature obligation out
assets.

2.6.2. Quick acid test ratio

The quick ratio or decisive test as some analyst calls it. It calculated the same way as the current
ration but after deducting inventories and prepaid expense. Such as, next year insurance, decisive
test reflects a feeling among analyst that inventory and prepaid expense cannot be relied up on to
meet short term obligation. The proposed measure focuses, therefore, an asset that can easily be

10
converted to cash. The quick ratio is much stricter test of liquidity than the current ratio (Ross
Westerfield Jordan, 2006, page- 59)

2.7. Gross working capital or current assets

Gross working capital represents the aggregate of current assets that are converted in the
ordinary course of business in to cash within one accounting year.

Examples of as follows: - stocks, sundry debtors, bill receivables prep payments, accrued income
and case at bank and in hands.

A mentioned earlier, current asset constantly changes from one form to other. For example in a
manufacturing enterprise cash is used to procure raw materials, pay wages and expense. The raw
materials are put in the process for conversion in to finished goods that are then on sale credit
and become debtors.

Finally, debtors are converted in to cash. Current assets are therefore short-lived and their life
span does not normally exceed one year.

2.8 Net working capital or net current assets

In this case, working capital is represented by the excess of current assets over current liabilities
it is also known as “net current assets: thus

Working capital =current assets-current liabilities

Earlier, we have itemized the components of current assets, current liabilities are those which are
liquidated, in the ordinary courses of business within the accounting year normally out of the
current assets or fund from operations.

The net current assets concepts of working capital are considered superior to the current assets or
gross concepts because, overall, what matter is the surplus of current assets over current
liabilities to show the financial strength or liquidity of the firm according, this concepts are
widely used.

Normally, the aggregate of current assets should exceed the aggregate of current liabilities to
leave a surplus or positive balance in the company. Conventionally, when the current assets are
twice the current liabilities, the position of a firm is considered satisfactory, in practice, however,
the margin maybe dependent on many factors via, the nature of the business, efficiency with

11
which various components of current assets and liabilities are managed, Credit reputation rather
the above conventional approach.

In extreme situation, when current liabilities exceed current assets, then working capital is
negative and gives a danger signal. In such a case firefighting measured need to be taken to
remedy the abnormal situation (Bhabatoshbanerjee, 2008 page- 292)

2.9 Factors influencing working capital

I. nature of the business

Working capital requirement affirms are basically influenced by the nature of business. Trading
and financial firms have very small investment in fixed, bit require large sum of money to be
invested.

II. Sales growth

The working capital needs of firms increase as sales growth. It is difficult to precisely determine
the relationship between volume of sales and working capital needs.

III. Production policy

We just noted that strategy constant production may be maintained in order to resolve the
working capital problem arising due to seasonal charge in demand for the firm’s product. Steady
production policy will cause inventory to accumulated during the off-season periods and the
firm’s will can be exposed to greater inventory cost and risks.

IV. Price level charge

The increasing shift in price level makes function of financial manager difficult. He should
anticipate the effected price level charge working capital requirement of the firm. Generally,
rising level will require firms to maintain higher amounts working capital.

V. Availability of credit

The word credit means the creditors believes that the debtors will return the loan and so decides
to give the loan. Advancing credit or loon essentially decides to give the loon, confidence,
character, capacity, capital or collateral of the debtor. In economics the term credit refers to
promise by one party to pay another for money borrowed or goods or services received. It is

12
medium of exchange to receive money or goods on demand at some future data. R.P Kent
defines credit as the right to receive payment or the obligation to account of the immediate
transfer of goods. (R.R. pay, 1996)

The working capital requirement of a firm also affected the credit terms granted by its creditor.
Firms will need less working capital its liberal credit terms are available to it similarly, the
availability of credit from bank also influence the working capital needs of the firm.
(IMPANDEY: 1997, page 131)

2.10 working capital ratio analysis

The working capital ratio, also called the current ratio, is a liquidity ratio that measures a firm’s
ability to pay off its current liabilities with current assets. The working capital ratio is important
to creditors because it shows the liquidity of the company. Current liabilities are best paid with
current assets like cash, cash equivalent, and marketable securities because these assets can be
converted into cash much quicker than fixed assets. The faster the assets can be converted into
cash, the more likely the company will have the cash in time to pay its debts. The reason this
ratio is called the working capital ratio comes from the working capital calculation. When
current assets exceed current liabilities, the firm has enough capital to run its day-to-day
operations. In other words, it has enough capital to work. The working capital ratio transforms
the working capital calculation into a comparison between current assets and current liabilities.
The value of a corporation’s current ratio is a direct function of its net working capital.

The working capital ratio is calculated by dividing current assets by current liabilities.

Working capital ratio= Current assets/Current liabilities

 If current assets exceed current liabilities net working capital is positive and the current
ratio is greater than one. Therefore, this shows the company can pay all its current
liabilities and still have current assets left over or positive working capital.
 If current assets equal current liabilities networking capital is zero and the current ratio
equal one. A ratio 1 is usually considered the middle ground. It’s not risky, but it is also
not very safe. This means that the firm would have to sell all its current assets to pay off
its current liabilities.
 If current asset are less than current liabilities networking capital is negative and the
current ratio is less than one. The ratio less than 1 is considered risky by creditors and

13
 investors because it shows the company isn’t running efficiently and cannot cover its
current debt properly. (PANDEY; 1979, page 133)

2.11 Working capital investment and financing policies

2.11.1 Alternative current asset investment policy

Figure below shows three alternative regarding the total amount of current assets carried
essentially; these policies different in that amount of current assets fare carried to support any
given level of sales. Figure alternative current assets investment policies (in millions of dollar)

Figure 2.1 alternative current assets investment policies (in minimal of dollars)

Current assets

($)

40

30

20

10 50 100 150 200 sales ($)

Figure alternative current investment polices (in millions of dollars)

Policy current assets to support sales as $100

Relaxed $30

Moderate 23

Rusticated 16

The line with the steepest slope in figure represents a relaxed current asset investment (or “fat
cat”) policy. Where relatively large amount of cash, inventories and marketable securities are
carried and where the use of credit policy that provides stimulates sales. Conversely, with the
restricted current asset investment (or lean- and mean”) policy the holding of cash inventories
and marketable securities are minimized the moderate current asset investment policy is between
the two extremes.
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Under condition of certainty when sales costs lead times payment periods and son are known for
sure all sure an firms would only minimally level of current assets any large amount would
increase the need for external funding without a corresponding increase the need for smaller
holding would involve late payments to labor and suppliers, and lost sales due to inventory
storages and only restrictive credit policy.

However, the picture changes when uncertainty is introduced. Here,, the firm require some
minimum amount of cash and inventories based on payments, expected sales, expected order
lead-time and so on. With restricted current asset investment policy, the firms would hold
minimal levels of safety stack for cash inventories and it would have a tight credit policy even
though this would mean a running the risk of losing sales. A restricted or lean and mean current
asset investment policy generally provides the highest expected return but it entails he greatest
risk while the reverse is true under a relaxed policy. The moderate policies fall in between the
two extremes in terms of expected risk and return (BRIGHAM, 1999, page 578)

2.12 Working capital financing approaches

2.12.1 The aggressive approaches

Short – term interest rates are few lower than long-term interest rates. Borrowing short-term is
riskier than borrowing long-term because the loan must be paid off or refinanced sooner rather
than latter the aggressive working capital financial approach involves the use of short-term debt
to finance at least the firm’s temporary assets some of its long-term fixed assets and the amount
of debt due in short – term.

If the firm managers financial all working capital from short-term debt the current assets would
equal current liabilities and the firm would have zero networking capital no cushion at all.
Managers may go even further and financial a portion of firm’s long-term asset (plant and
equipment) with short-term debt creating a negative networking capital however, such an
approaches if short-term interest rates rose UN expectedly).

Usually, lower interest rates tempt to manager to take the aggressive approaches and use a
relatively large amount of short-term debt for making capital financing managers will take a risk
if the promise of return is highly enough to justify it.

15
2.12.2. The conservation approaches
Borrowing long-term is considered less risky than short-term this is because the borrower has a
longer time to use the loan proceeds before payment is due. Furthermore, if interest rates should
go up during the period of loan, the long-term borrower has another advantage. The long-term
borrower has locked in fixed interest than the short-term borrower who must review the loan
each time it comes due at a new interest rates.

If market rate fall, the long-term borrower has locked in a fixed interest than short-term
borrower, who must renew the loan each time it comes due at a new higher interest rate. If
market rates fall, the long-term borrower can usually refinance. The conservative’s working
capital financing approaches involves the use of long-term debt and equity to finance all long-
term fixed assets and permanent current assets, in addition to some pore of temporary current
assets.

All the firms’ permanent current assets and most of its temporary current assets are being
financed with long-term debt or equity. As a result, current assets exceed current liabilities by a
wide margin and the firm has a large amount of networking capital. Having a large amount of
networking capital is a relatively how risk position because the firm has many assets that could
be liquidated to satisfy short-term debts.

A financial manager who applies an ultra-conservative’s approach would use cash from the
owners to finance all assets financing needs (higher cash balance supported be equity), and incur
no debt by using only liability capital. The firm would also have the maximum amount of
networking capital possible because it could have no current liabilities.

The safety of the conservative’s approach has a cost long term financing is generally more
exposing than short term financing so relying on long-term debt and equity source to finance
working capital consumer’s funds that could otherwise be put to more productive use.

2.12.3. The moderate approach

The accounting concept known as the matching principle states that the cost of an asset should be
recognized over the length of time the asset provides revenue or benefit, to the business. The
concept of matching principle can be applied to define a moderate position between the
aggressive and conservative working capital financing approaches. Accounting to the matching
principle, temporary current assess that are only going to be on the balance sheet for a short time

16
should be financed with short-term debt that is current liabilities. Permanent current asset and
long-term fixed asset that are going to be on the balance sheet for long time should be financed
from long-term debt and equity sources.

Some firms have matched their long-term temporary current asset to their current liabilities. It
has also matched it long term permanent current asset to its long-term financing sources. It calls
for a relatively amount of risk balanced by a relatively moderate amount of expected return.

A table 2.1 summarizes the cost and risk consideration of the aggressive, conservative and
moderate approach to working capital financing.

Aggressive Conservative Moderate

Cost Low High In between
Risk High Low In between

2.13. Advantage of and disadvantage of short-term finance

The three possible financing policies are distinguished by the relative amount of short-term debt
used under such policy. The aggressive policy called for the greatest use of short-term debt.
While fells the conservative policy is called for the least. The moderate policy fells in between
although using short-term credit is generally riskier than using long-term credit, short-term credit
does have some significant advantage.
The pros and cons of short-term financing are considered in this section.
Speed
A short-term loan can be obtained much faster than long-term credit.
Leaders will insist on a more through final examination before extending long-term credit and
the loan agreement will have to be spelled out considerable detail because a lot can happen
during the life of a 10-to-20-year loan. Therefore, if funds are needs in a hurry, the firm should
look to the short-term markets.

Flexibility

If its needs for funds are seasonal or cyclical a firm may not want to commit to long-term debt
for three reasons.

 If a floatation costs are generally high when raising long-term debt but trivial for short-
term credit.

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  Although long-term debt can be repaid early, provided the loan agreement includes a
prepayment provision, prepayment penalties can be expensive. Accordingly, if a firm
thinks its need for funds will diminish soon, I should choose short-term debt for the
flexibility it provides.
 Long-term loan agreement always contains provision or covenants which constrain in the
firm’s future action. Short term credit agreements are generally much less in this regard.
 Cost of long term versus short term debt
They yield curve is normally upwards sloping, indicating that interest rates are generally
lower on short term than long term debt. Thus, under normal conditional, interest costs at
the time the funds are obtained will be lower if the firm borrowers on a short-term rather
than on long term basis.
Risk of long term versus short term debt
The yield curve is normally upwards sloping, indicating that interest rates are generally
lower on short-term than on long term debt. Thus, under normal conditional, interest
costs at the time the funds are obtained will be lower if the firm borrowers on a short-
term rather than on a long-term basis.
Risk of long term versus short term debt
Even though short-term debt is often less expensive than long term debt, short term credit
subjects the firms to more risk than long term financing.
This occurs for two reasons:-
If forms borrow on long term basis, its interest occurs will be relatively stable overtime,
but if it uses short-term credit; its interest expense will fluctuate widely, at times going
quite high. Many firms that had borrowed heavily on a short-term basis simply could not
meet their rising interest costs, and as result, bankruptcies hit record level during that
period.

If a forms borrows heavily on a short-term basis, it may find itself unable to replay this debt it
may be in such a weak financial position that the lender will not extend the loan, this too could
force the firm in to bankruptcy (BRIGHAM&HOUSTON 2004 page 616).

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2.14 .EMPIRICAL LITERATURE REVIEW

G/Hiwot (2004) Studies on the assessment of working capital in order to analysis the factors
that affects the ineffective working capital management systems. His fund was the working
capital management, mechanism used solve problems related to the working capital
management.

The researcher also finds about how the organization segregate duties in order to develop
adequate for working capital management.

The researcher would be recommended in order to make working capital management adequate
must exercises surprise management system.

Dawit (2017) has done a research assessment of working capital management commercial bank
of Ethiopia in Sawla branch.to analysis the factor that affects working capital management the
researcher was raise some problems. Those are inadequate system of cash weekly daily recorded
keeping and reporting lack of daily counting cash receipt cash payment.

2.15. Knowledge Gap

As we seen in the previous several local researcher done the research which is related to my title
(2016)did the contributions of working capital inadequately to the problems and absolutely
changed Dawit(2017)in Sawla branch discuss working capital management problems like in
adequate management systems.

Muluken (2016) worked at Dashen bank in mekelle branch assessment of working capital poor
control over these asset will result in loss and difficulties faced on the time of cash recipient and
payment.

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 CHAPTER THREE

3.1 Methodology of the research

3.1.1data type and sources

The study used quantitative and qualitative type of data. The reason is that, quantitative research
approach emphasis on collecting and analyzing numerical data. Qualitative research approach is
more subjective than quantitative and it involves examining and reflecting on the less tangible
aspects of research subject like values, attitudes and perceptions.

3.2. 1 Research design and strategy

The study is conducted on assessment of working capital management in commercial bank of

Ethiopia at Arba Minch branch. The research is descriptive type of research design. Descriptive
research method is easy to describe what the researcher going to do.

3.2.2 Method of data collection and instrument

The data would been collected from employees of commercial bank of Ethiopia in Sawla branch
from the primary sources of data the researcher would use:-questioner would include both open
ended and close ended question. The open ended they would been distributed to employees of
the organization and questionnaire enables to get below the surface, explore and probe,
encourage respondents to think and offer considered answers and it also encourages respondents
to give honest opinions. The close ended questionnaires are often easier for respondents
particularly those who are busy to answer. It is also easy to collect. Secondary data would been
gathered from different book, internal address and written journal documents of the financial and
economic development bureau.

3.3 Sample design

Using all population for data collection is difficult for one researcher sampling is used as a small
part of the population to make conciliation about the whole population the total population of
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bank is 22.therefore the researcher selected 10 employees from the total population, selected
4,customers services, 3,cashier, 1.Accountant, 1.manager and 1.auditory selected 10 respondent
from the total population of bank, through established judgmental sampling techniques, because
the respondent who have direct relationship with the study.

3.4 data processing and analysis

In this study the data has been analyzed and interpreted using tabulation and percentage.
Tabulation is used to arrange data in a table or other summary format to facilitate the process of
comparison of various data analysis.

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Reference

- Fundamental of financial management, 2nd edition, author EUGENE F.BRIGHAM

- Fundamental of financial management, 7th edition, author, BRIHAM HOUSTON
- Fundamental of financial management , 2008, BRIHATOSH BANERJEE
- Financial management, 5TH edition, author, KHAN JAIN
- Toweled F. 2010
- Fundamentals of corporate finance, 7th edition , author, ROSS WESTERFIELD JORDAN
- Principle of managerial finance, 5th edition, author, LAWRENCE J. GITMAN
- Financial accounting, 7th edition, author, MEIGS
- Fundamentals of financial management, 11th edition, author, JAMES C.VANHORNE
- Accounting principle, 16th edition, author, FRES and WARREN
- Company profile
- Fundamental of financial management 2nd edition Eugene F. Brigham
- Financial management 10th edition PANDAY

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