The Effect of Working Capital Management on Financial Performance of Small and Medium Enterprises in Nairobi City County

Abstract

There is usually a tradeoff amid returns and liquidity in the context of working capital management. Too much investment possession of working capital positively influences liquidity but negatively influences revenue earnings for the organization. Conservatism investment in working capital could yield to low liquidity and higher profitability although it could result in unmet customer demands. WCM, therefore, involves management of this relationship to ensure optimization of financial performance. The aim of this study was to determine the effect of working capital management on financial performance of small and medium enterprises in Kenya. The population for the study was all the 1539 SMEs in Nairobi Central Business District while the sample for the study was 155 SMEs in Nairobi City County. The independent variables for the study was working capital management as measured by inventory conversion period, average collection period, average payment period and cash conversion cycle. The control variable for this study was firm size as measured by natural logarithm of total assets. Financial performance was the dependent variable and was measured by Return on Assets (ROA). Secondary data was collected for a period of 5 years (January 2013 to December 2017) on an annual basis. The study employed a descriptive cross-sectional research design and a multiple linear regression model was used to analyze the relationship between the variables. Data analysis was undertaken using the statistical package for social sciences. The results of the study produced R-square value of 0.435 which means that about 43.5 percent of the variation in financial performance of SMEs in Nairobi County, Kenya can be explained by the five selected independent variables while 56.5 percent in the variation of financial performance was associated with other factors not covered in this research. The study also found that the independent variables had a strong correlation with financial performance (R=0.660). ANOVA results show that the F statistic was significant at 5% level with a p=0.000. Therefore the model was fit to explain the relationship between the selected variables. The results further revealed that inventory conversion period and cash conversion cycle produced negative and statistically significant values for this study. Average payables period produced positive and statistically significant values while average receivables period and firm size were found to be statistically insignificant determinants of financial performance of SMEs in Nairobi County, Kenya. This study recommends adequate measures to be put in place by managers of SMEs to improve and grow their financial performance through working capital management. SMEs and all firms in general should manage their working capital properly and this will lead to an increase in financial performance which in essence translates to improved shareholder wealth which is the main goal of a firm.