LIQUIDITY, FOREIGN EXCHANGE FLUNCTUATION AND FINANCIAL PERFORMANCE IN NIGERIA’S MANUFACTURING INDUSTRY
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LIQUIDITY, FOREIGN EXCHANGE
FLUNCTUATION AND FINANCIAL PERFORMANCE IN NIGERIA’S MANUFACTURING INDUSTRY
ABSTRACT
This study
examines liquidity, foreign exchange flunctuation and financial performance in Nigeria’s manufacturing
industry. This study commences with a brief introduction of the content,
background and scope of the work. The objectives, research questions,
hypotheses, review of relevant literature and applicable theories are fully
discussed. The study adopts the use of secondary data from 10 manufacturing
firms listed on the Nigeria stock exchange for five years (2006-2016). Relevant
data were extracted from the published financial reports, CBN bulletin, and
National bureau of statistics corporate website. The Ex-post facto research
method is adopted for the purpose of achieving the objectives of the study.
Panel data is applied to the study for the purpose of capturing the space and
time dimensions. Descriptive and inferential statistical analyses were adopted.
The
financial performance indicator is (dependent variable) is used alongside the
independent variable (liquidity and foreign exchange fluctuation). The panel
data regression was subjected to Hausman test to make appropriate choice
between fixed effect estimator and random effect estimator.
The result
stated that considering the result of the empirical analysis, there are
different patterns of relationship that were displayed between the dependent
variables and independent variables in our model; there is a significant
relationship between liquidity and foreign exchange fluctuation as proxy by
current asset ratio, acid test ratio, cash and cash equivalent ratio, inflation
rate, interest rate, exchange rate of manufacturing firms, all the independent
variables show a significant relationship with dependent variable.
The study
concludes that there is a significant relationship between liquidity, foreign
exchange fluctuation and performance.
The study
recommended that; Government should ensure that capital expenditure and
recurrent expenditure are properly managed in a manner that it will raise the
nation’s production capacity; Government should direct its expenditure towards
the productive sectors like manufacturing sector as it would reduce the cost of
doing business as well as raise the standard living of poor ones in the
country; There is need for efficient management of exchange, inflation and
liqudity rates in such a way to stimulate the economy to grow; That foreign
exchange rate could be maintained at a low rate if there is a consistent growth
in corporate earnings.
CHAPTER ONE
INTRODUCTION
1.1. BACKGROUND OF THE STUDY
Over the
years, it has been observed that the financial performance of any business can
be assessed using the concept of liquidity. Liquidity is a major concept that
has been a source of worry to the management of firms about the uncertainty of
the future. Talking about the liquidity of an asset, it means how quickly it
can be transformed into cash. It is the ability of the company to convert its
assets into cash.
When
referring to a company’s liquidity one usually means its ability to meet its
current liabilities and is usually measured by different financial ratios
(www.investorwords.com). According to Reider and Heyler (2003), liquidity
refers to having an adequate cash flow that allows the business to make
necessary payments and ensure the continuity of operations. Liquidity relates
to solvency of a firm’s overall financial position.
Also, when
discussing on liquidity, one needs to have in mind the concept of Liquidity
management ; which requires maintaining liquidity in day to day operations to
ensure its smooth running and meet its obligations when they fall due (Eljelly,
2004). With this, it can be said that the objective of business owners and
managers is to conceive a strategy of managing all its day to day operations in
order to meet their obligations as they fall due and increases profitability
and shareholders value. The importance of liquidity management as it affects
corporate profitability in today’s business cannot be over emphasis. Liquidity
ratios are used for liquidity management in every organization. That greatly
have effect on profitability of organization.
Efficient
liquidity management involves planning and controlling current assets and
current liabilities in such a manner that eliminates the risk of the inability
to meet due short-term obligations, on one hand, and avoids excessive
investment in these assets, on the other. This is due in part to the reduction
of the probability of running out of cash in the presence of liquid assets.
Liquidity is having enough money in form of cash, to meet ones financial
obligations.
In terms of
accounting, liquidity can be defined as the ability to satisfy short-term
obligation as they fall due. In terms of investment, it is the ability to
quickly convert an investment portfolio to cash with little or no loss in
value.
A liquid company is one that stores enough
liquid assets and cash together with the ability to raise funds quickly from
other source to enable it meet its payment obligation and financial commitment
in a timely manner. Cash is the most liquid asset of all.
There are
various ratios used to measure liquidity. These include: the current ratio,
which is the simplest measure and is calculated by dividing total current
assets by total current liabilities; and the quick ratio, calculated by
deducting inventories from current assets and then dividing the remainder by
current liabilities (Mudida & Ngene, 2010). Even though the two ratios
seems to be similar, the quick ratio provides a more accurate assessment of a
business’s ability to pay its current liabilities. The quick ratio takes into
account the most liquid of all current assets. Inventory is the least liquid
because it is not speedily convertible to cash. The quick ratio is a reasonable
marker of a business’s short term liquidity. The higher the quick ratio the
better the position of the business.
Other
liquidity ratios include: stock/ inventory turnover or rate of stock turnover;
stock/ inventory holding period; working capital turnover; cash and cash
equivalent ratio; cash flow to debt ratio; debtors turnover ratio; debtors or
average collection period; creditors payment period e.t.c
The
inability of a company to pay its creditors on time and continue not to honor
its obligations to the suppliers of credit, services, and goods can be said to
be a sick company or bankrupt company. A company’s inability to meet the short
term liabilities may affect the company’s operations and in many cases it may
affect its reputation too. Lack of cash or liquid assets on hand may force a
company to miss the incentives given by the suppliers of credit, services, and
goods. Loss of such incentives may result in higher cost of goods which in turn
affect the profitability of the business. So there is always a need for the
company to maintain certain degree of liquidity.
Exchange
rate is the price of one country’s currency expressed in terms of some other
currency. It determines the relative prices of domestic and foreign goods, as
well as the strength of external sector participation in the international
trade. Exchange rate regime and interest rate remain important issues of
discourse in the International finance as well as in developing nations, with
more economies embracing trade liberalization as a requisite for economic
growth (Obansa, Okoroafor, Aluko and Millicent, 2013).
The
performance of the manufacturing sector since 1986 has been poorly attributed
to macroeconomic instability and inconsistence in the exchange rate. The
manufacturing sector is weak and heavily import dependent. It is in the light
of the foregoing that this study seeks to evaluate the effects of exchange rate
fluctuations on the Nigeria manufacturing sector output from the year 2000 to
2015.
While
embarking on a research, Ewa, (2011) agreed that the exchange rate of the naira
was relatively stable between 1973 and 1979 during the oil boom era and
when agricultural products accounted for
more than 70% of the nation’s gross domestic products (GDP). In 1986 when
Federal government adopted Structural Adjustment Policy (SAP) the country moved
from a peg regime to a flexible exchange rate regime where exchange rate is
left completely to be determined by market forces but rather the prevailing
system is the managed float whereby monetary authorities intervene periodically
in the foreign exchange market in order to attain some strategic objectives (Mordi,
2006)
Following
the fluctuation of the Naira in 1986, a policy induced by the Structural
Adjustment Programme (SAP), the subject of exchange rate fluctuations has
become a topical issue in Nigeria. This is because it is the goal of every
economy to have a stable rate of exchange with its trading partners. In
Nigeria, this goal was not realized in spite of the fact that the country
embarked on devaluation to promote export and stabilize the rate of exchange.
The failure to realize this goal subjected the Nigerian manufacturing sector to
the challenge of a constantly fluctuating exchange rate. This was not only
necessitated by the devaluation of the naira but the weak and narrow productive
base of the sector and the rising import bills also strengthened it. In order
to stem this development and ensure a stable exchange rate, the monetary
authority put in place a number of exchange rate policies. However, very little
achievement was made in stabilizing the rate of exchange. As a consequence, the
problem of exchange rate fluctuations persisted throughout the study period.
In an advanced country, the manufacturing
sector is a leading sector in many aspects. It is an avenue for increasing
productivity in relation to import substitution and export expansion, creating
foreign exchange earning capacity, raising employment, promoting the growth of
investment at a faster rate than any other sector of the economy, as well as
wider and more efficient linkage among different sectors (Fakiyesi, 2005). But
the Nigerian economy is under-industrialized and its capacity utilization is
also low. This is in spite of the fact that manufacturing is the fastest
growing sector since 1973/74 (Obadan, 1994). The sector has become increasingly
dependent on the external sector for import of non-labour input (Okigbo, 1993).
Inability to import therefore, can impact negatively on manufacturing
production.
In Nigeria,
exchange rate has changed within the time frame from regulated to deregulated
regimes. The impact of fluctuations in exchange rate on manufacturing output
had not received adequate attention. This paper attempts to give attention to
the issue.
Exchange
rate fluctuations affect operating cash flows and firm value through
translation, transaction, and economic effects of exchange rate risk exposure.
(Choi and Prasad, 1995).Exchange rate movements have been a big concern for
investors, analyst, managers and shareholders since the abolishment of the
fixed exchange rate system of Bretton Woods in 1971. This system was replaced by
a floating rates system in which the price of currencies is determined by
supply and demand of money. Exchange rates may affect a firm through a variety
of business operation models: a firm may produce at home for export sales as
well as domestic sales, a firm may produce with imported as well as domestic
components, a firm may produce the same product or a different product at
plants abroad. The model of the firm must be broad enough to capture all of
these channels. The firm described below is a multinational firm (producing and
selling at home and abroad) that uses both foreign and domestic components.
The
profitability of a company can be described as its ability to generate income
which surpasses its expenses. Profitability is usually measured by different
ratios such as ROA 2 and ROE. The management of liquidity determines to a large
extent the quantity of profit that results as well as the wealth of
stakeholders (Ben, 2008). A company in order to survive must remain liquid as
failure to meet its compulsions in due time results in bad credit rating by the
short term creditors, reduction in the value of reputation in the market and
may ultimately lead to bankruptcy (Bhavet, 2011). Thus a good and firm
financial management policy seeks to maintain adequate liquidity in order to
meet its short-term maturing obligations without diminishing profitability.
However the principal focus of most organizations is profitability maximization
while the concern for efficient management of liquid assets is neglected. This
perspective is justified by the belief that profitability and liquidity are
conflicting objectives. Therefore a company can only pursue one at the expense
of the other, in consonance with the tradeoff theory of liquidity and
profitability. According to Padachi (2006) a firm is required to maintain a
balance between liquidity and profitability while conducting its daily
activities. Profitability is directly affected by both inadequate and surplus
liquidity (Ogundipe, Idowu & Ogundipe, 2012). For instance, when the
“necessary” level of liquid assets is exceeded, their surpluses when the market
risks remain stable become a source of ineffective utilization of resources
which has an adverse effect on profitability. Liquidity-profitability
relationship is linked with the continuance of the appropriate intensity of
working capital. Profitability has to do with making an adequate return on the
capital and assets invested in the business. Liquidity is having an adequate
cash flow that 3 allows the business to make necessary payments and ensure the
continuity of operations. The liquidity is essential for company existence. The
significance of liquidity to a company performance might lead to the conclusion
that it determines the profitability level of a company (Eljelly, 2004).
1.2 STATEMENT OF THE PROBLEM
Duttweiler
(2009) defines liquidity as the capacity to fulfill all payment obligations as
and when they fall due. Since it is done in cash, liquidity relates to flows of
cash only. Not being able to perform leads to a condition of illiquidity. Firms
can use their liquid assets to finance their activities and investments when
external sources of financing are not available as argued by Liargovas and
Skandalis (2008). Higher liquidity can allow a firm to deal with unexpected
contingencies and to cope with its obligations during periods of low earnings
but an abundance of liquidity may do more harm than good.
Most failed
businesses resulted from cash flow problem. This is highly contributed by poor
management which forces companies to go to liquidation. A number of companies
have faced liquidity problems in the last decade. One of the major reasons that
may cause liquidation is illiquidity and inability to make adequate profit.
These are some of the basic ingredient of measuring the “going concern” of an
establishment. For these reasons companies are developing various strategies to
improve their liquidity position. Strategies which can be adapted within the
firm to improve liquidity and cash flows concern the management of working
capital, areas which are usually neglected in times of favorable business
conditions (Pass and Pike, 1984).
Liquidity
management and profitability are very important issues in the growth and
survival of business and the ability to handle the trade-off between the two a
source of concern for financial managers.
The problems
to be addressed by this study are to evaluate the relationship between
liquidity management and financial performances of some listed manufacturing
companies in Nigeria, finding the effect of changes in liquidity levels on
profitability of manufacturing companies in Nigeria and the research work also
examines the effect of exchange rate fluctuations on manufacturing sector
output in Nigeria from 2005 to 2015, a period of 10 years.
The argument
is that fluctuations in exchange rate adversely affect output of the
manufacturing sector. This is because Nigerian manufacturing is highly
dependent on import of inputs and capital goods. These are paid for in foreign
exchange whose rate of exchange is unstable. Thus, this apparent fluctuation is
bound to adversely affect activities in the sector that is dependent on
external sources for its productive inputs.
1.3
OBJECTIVE OF THE STUDY
The main
objective of the study is to find out the impact of liquidity and foreign
exchange flunctuation on the financial performances in manufacturing industries
Nigeria.
Other
objectives may include:
To examine the effect of current assets
ratio on the financial performance of the manufacturing industry in Nigeria.
To examine the effect of Acid Test or Quick
Test Ratio on the financial performance of the manufacturing industry in
Nigeria.
To examine the impact of cash and cash
equivalent ratio on the financial performance of the manufacturing industry in
Nigeria.
To show how exchange rate affects the
financial performances of the manufacturing industry in Nigeria.
To examine the impact of inflation rate on
the financial performances of the manufacturing industry in Nigeria.
1.4 RESERCH QUESTION
The study is
aimed at finding solution to the following questions:
What is the relationship between current
assets ratio and the financial performances of the manufacturing industry in
Nigeria?
What is the relationship between the Acid
test ratio on the financial performances of the manufacturing industry in Nigeria?
What is the effect of cash and cash
equivalent ratio on the financial performance of the manufacturing industry in
Nigeria?
What is the relationship between exchange
rate and financial performances of the manufacturing industry in Nigeria?
What is the impact of inflation rate on the
financial performances of the manufacturing industry in Nigeria?
1.5 RESEARCH HYPOTHESIS
In order to
find solutions to the above mentioned problems, the following hypothesis need
to be formulated:
Hypothesis 1
H0: Current
Assets Ratio does not have any significant relationship with the financial
performances of the manufacturing industry in Nigeria.
H1: Current
Assets Ratio does have significant relationship with the financial performances
of the manufacturing industry in Nigeria.
Hypothesis 2
H0: Acid
test ratio does not have any significant relationship with the financial
performances of the manufacturing industry in Nigeria.
H1: Acid
test ratio have significant relationship with the financial performances of the
manufacturing industry in Nigeria.
Hypothesis 3
H0: cash and
cash equivalent ratio does not have any significant relationship with the
financial performances of the manufacturing industry in Nigeria.
H1: cash and
cash equivalent ratio have significant relationship with the financial
performances of the manufacturing industry in Nigeria.
Hypothesis 4
H0: exchange
rate ratio does not have any significant relationship with the financial
performances of the manufacturing industry in Nigeria.
H1: exchange
rate ratio have significant relationship with the financial performances of the
manufacturing industry in Nigeria.
Hypothesis 5
H0:
inflation rate does not have any significant relationship with the financial
performances of the manufacturing industry in Nigeria.
H1:
inflation rate have significant relationship with the financial performances of
the manufacturing industry in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
CORPORATE
MANAGERS: The study will help corporate managers to reduce non-cash flows risk
because of local currency devaluation, The study incorporates the effect of
different currency exchange rates to the world hard currencies namely the
United States Dollar, the Euro, the Sterling Pound, the Japanese Yen and others
like the South African Rand. Foreign exchange risk for such firms affect not
only the values of foreign operating cash flows, but also the foreign asset and
liability values reported in consolidated financial statements.
FINANCIAL
INVESTORS: Understanding of the effect of liquidity and foreign exchange rates
on firms financial performance is equally important for the financial investors
for computing the amount of risk associated with such variation and
consequently the risk involved in their investment decisions. The result of the
study will therefore offer investors a foundation upon which to make strategic
decisions and choose investment strategy.
SHAREHOLDERS:
The study will help shareholders understand and learn the effects of foreign
exchange on the firm’s profits. Since this study assesses the existing capacity
in the country for foreign currency risk management, its findings generate more
knowledge in this area.
RESERCHERS:
The findings of the study are of great importance to help researchers, it adds
to the body of empirical literature on the effect of liquidity and exchange
rate to firms financial performance; Among the areas of importance are: The
study will enhance export and import terms to help businesses remain
competitive.
1.7 SCOPE OF THE STUDY
The scope of
this research work is limited to 10 manufacturing firms in Nigeria and they
include; 7-Up Bottling Company, Cadbury Nigeria Plc, Flour Mills Of Nigeria
Plc, Guinness Nigeria Plc, National Salt Company Of Nigeria Plc, Nestle Nigeria
Plc, Nigerian Breweries Plc, Northern Nigeria Flour Mill Plc, Union Dicon Salt
Plc and U T C Nigeria Plc.
The ten
manufacturing firms were chosen because of their easy accessibility of annual
financial statement reports and for data computation. The geographical area of
the study is Nigeria and the secondary data for the study will cover the time
frame of 2005 to 2015. This study intends to concentrate on the effect of
liquidity and foreign exchange fluctuation on the financial performances of
listed manufacturing firms in Nigeria.
1.8 LIMITATION OF THE STUDY
This project
work is limited to only the manufacturing industries in Nigeria due to
population size, logistics and financial constraint. The project work should
have incorporated all the manufacturing companies in Nigeria, but they are too
confidential and this has made the researcher to limit his scope to examine
only 10 manufacturing industries in Nigeria.
1.9 OPERATIONALISATION OF VARIABLES
The
variables for this research will therefore be operationalized here.
Y=f(X)
Y =
Financial Performance (FP)
X =
Liquidity (L); Foreign Exchange Fluctuation (FEF)
Where Y =
Dependent variable
X = Independent variable
X= x1, x2,
x3, x4, x5
x1 =Current
Assets Ratio (CAR)
x2 = Acid
Test Ratio (ATR)
x3 = Cash
and Cash Equivalent Ratio (CCER)
x4= Exchange
Rate (ER)
x5=
Inflation Rate (IR)
Y=
f(x1)…………………………………………………………….. (1)
Y=f(x2)
…………………………………………………………….. (2)
Y=
f(x3)…………………………………………………………….. (3)
Y=
f(x4)…………………………………………………………….. (4)
Y=
f(x5)…………………………………………………………….. (5)
1.10 DEFINITION OF KEY TERMS.
INFLATION
RATE
Inflation is
the rate at which the general level of prices for goods and services is rising
and subsequently, purchasing power is falling. High inflation rates can have
adverse consequences on the financial performance of a company.
CURRENT
ASSETS RATIO
The current
ratio is mainly used to give an idea of a company's ability to pay back its
liabilities (debt and accounts payable) with its assets (cash, marketable
securities, inventory, accounts receivable). As such, current ratio can be used
to make a rough estimate of a company's financial health.
ACID TEST
RATIO
In finance,
the acid-test or quick ratio or liquidity ratio measures the ability of a
company to use its near cash or quick assets to extinguish or retire its
current liabilities immediately. Quick assets include those current assets that
presumably can be quickly converted to cash at close to their book values.
CASH AND
CASH EQUIVALENT RATIO
The cash
ratio is the ratio of a company's total cash and cash equivalents to its
current liabilities. A cash equivalent is a highly liquid investment having a
maturity of three months or less. It should be at minimal risk of a change in
value. Examples of cash equivalents are: Certificates of deposit. Commercial
paper.
EXCHANGE
RATE
In finance,
an exchange rate is the rate at which one currency will be exchanged for
another. It is also regarded as the value of one country’s currency in relation
to another currency.
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