ABSTRACT
The
purpose of this study was to establish liquidity management measures of cement
producing firms listed on the Nigeria Securities Exchange (NSE). The study
sought to establish the measures of corporate liquidity management, the factors
that affect liquidity requirements and establish the relationship between
liquidity and profitability in manufacturing cement firms.
This
study showed that liquidity is measured by Current Ratio, Quick Ratio and Cash
Ratio. The research findings revealed that the mean values of current ratio were
1.71 which is below the standard conventional rule of 2:1. This indicated that
on average the listed cement companies might find difficult to meet their short
term maturing obligations. However, with the maximum of 2.22 for the current
ratio showed that some of the companies were doing very well liquid wise, as
they were not likely to encounter any difficulty in meeting their short term
obligations. On an average the quick ratio was 1.09 which was satisfactory
compared to the standard conventional rule of 1:1.
The
findings of this study further showed that liquidity measured by current ratio
is influenced by cash conversion cycle measured by inventory turnover,
receivables collection period and payables payment period. Regression analysis
was carried out to examine the relationship between liquidity and cash
conversion cycle. The results revealed that variation in current ratio was
explained by the number of days of cash conversion cycle. The findings showed
that a satisfactory cash conversion cycle had a positive impact on current
ratio while unsatisfactory cash conversion cycle had a negative impact on
liquidity measured by current ratio.
There exists a relationship between liquidity
and profitability indicators. The investigation using both correlation and
regression analysis revealed that liquidity ratios measured by Current Ratio,
Quick ratio and cash conversion cycle have a relationship with profitability
measured by return on capital employed. The findings revealed that Current
Ratio and Quick Ratio were positively associated with return on capital
employed while cash conversion cycle was negatively associated with Return on
Capital Employed.
This
study recommends that to ensure better liquidity management, that is shorter
cash conversion cycle, which would invariably lead to better profitability in
the cement industry, the duration of time that goods are held in inventory
should be reduced. This can be accomplished by improving the inventory control
process. Also accounts receivables should be collected more quickly by
improving the efficiency of the collection process as debt should be collected
in line with the agreed credit terms. Managers should try to delay payables
because it will provide them opportunities to invest in different profitable
areas thus increasing the firm’s profitability.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The
financial performance of companies has attracted a lot of attention in recent
times, comments and interests from both financial experts, researchers, the
general public and the management of corporate establishments/entities. The
Financial performance of an organization can be analysed in terms of
profitability, dividend growth, sales turnover, return on investments, and
return on assets amongst others. However, there is still debate among several
school of thoughts regarding the yardstick for measuring the performance of
firms and the factors that influence corporate liquidity and the performance of
companies/organizations (Liargovas & Skandalis, 2008). According to Iswatia
& Anshoria (2007) performance is the ability of an organization/firm to
gain and manage the available resources in several ways to develop competitive
advantage among other things.
Liquidity
can be said to be an investment in current assets and current liabilities which
are liquidated within one year or less and is therefore important for firm’s
day to day operations (Kesimli & Gunay, 2011). Liquidity is closely related
to working capital which is the money needed to finance the daily revenue
generating activities of the firm. According to Vahid, Mohsen and Mohammadreza
(2012) Liquidity management plays a crucial role in determining the success or
failure of firm in business performance due to its eect on firm’s
profitability. Business success depends heavily on the ability of financial
managers to eectively manage the components of liquidity (Filbeck &
Krueger, 2005).
A
firm may adopt an aggressive or a conservative working capital management
policy to achieve this objective. Liquidity management is a concept that is
receiving serious attention the world over in recent years especially with the
current financial situations and the state of the world economy. The concern of
business owners and managers all over the world is to devise a strategy of
managing their day to day business operations in order to meet their
obligations as they fall due and increase profitability and shareholder’s
wealth.
The
importance of liquidity management as it concerns corporate profitability in
today’s business cannot be over emphasized. The crucial part in managing
working capital is required maintaining its liquidity in day-to-day operation
to ensure its smooth running and meets its obligation (Eljelly, 2004).
Liquidity plays a significant role in the successful managing of a business
firm. A firm should ensure that it does not suer from lack-of or excess
liquidity so as to meet its short-term goals.
A
study of liquidity is of major importance to both the internal and the external
analysts because of its close relationship with day-to-day operations of an
organisation (Bhunia, 2010). Dilemma in liquidity management is to achieve
desired trade o between liquidity and profitability (Raheman et all, 2007).
Liquidity requirement of an organization depends on the peculiar nature of the
firm and there is no specific rule on determining the optimal level of
liquidity that a firm can maintain in order to ensure positive impact on its
profitability.
Liquidity
points out to the ability of firms in paying back their short term liabilities.
It plays an important role in smoothening all operations of a firm. Studying
liquidity is very helpful for both external and internal analysts due to its
impact on firms’ day to day operations (Elangkumaran & Karthika, 2013). The
importance of liquidity to the performance of a company might determine the level
of profitability of a company (Zygmunt, 2013). Liquidity is a prerequisite for
a firm as it shows its ability for meeting its short-term obligations. Quick
ratio and current ratio are considered to be the common measures of liquidity
position of a company. Current ratio sets the association between short term
assets and short term liabilities. Generally, when current ratio is high it can
be said that the firm’s ability to pay back its short term obligations is good,
whereas quick ratio sets the correlation between current liabilities and
current assets.
When
assets are liquid it means that they can be converted into cash quickly without
loss. Low current ratio means that a company cannot pay its obligations on time
to creditors, services and goods suppliers (Owolabi, Obiakor, & Okwu,
2011). Wang (2002) found that aggressive liquidity management boosts the
operating performance of a firm and usually results in higher values for a
firm. Managing liquidity efficiently results in eliminating the risk of inability
of meeting short-term liabilities when it’s due, on one hand. On the other
hand, it helps in avoiding excessive investment in these assets (Priya &
Nimalathasan, 2013).
Profitability’s
information is crucial for decision making and it is used by many people in the
company such as managers, investors, and financial analysts as guide for
dividends payment, management efficiency tool measurement and instrument for
decision making evaluation (Nassirzadeh & Rostami, 2010). Profitability and
liquidity are of substantial issue that all commercial units should keep
studying and thinking about, as one of the most crucial duties. Some authors
believe that there is a great importance for liquidity because companies that
achieve low profitability or zero can serve the economy, whereas firms without
liquidity cannot serve the economy well (as cited in (Nassirzadeh &
Rostami, 2010). Therefore, management of profitability and liquidity are
substantial issues for the growth and survival as well (Priya & Nimalathasan,
2013).
Corporate
financing decision, one of the four major corporate finance decisions (others
include investment, dividend and liquidity decisions), are quite complex
processes. Theories in corporate finance may only have explained certain facets
of the diversity and complexity of financing choices. Researches over the years
have given no accepted conclusion on the exact determinants and relationship
between capital structure and firm performance in either developed or emerging
economies. Graham and Harvey (2001) argued that, although a lot of studies have
been done in investigating capital structure of the firms, the results obtained
are still unclear.
This,
according to them, might be due to wrong measurement of key variables,
investigation on wrong models or issues, misspecification of managerial
decision process or unresponsiveness of owner-managers. Capital structure is
very important for firms because it has an impact on long-term corporate
profits, firm’s valuation and capital budgeting decisions (Aurangzeb and Hag,
2012). It represents the firm’s financial framework which consists of the debt
and equity used to finance the firm. Decisions regarding types of capital
structure of a firm should play a critical role since capital impacts on
profitability and solvency. An optimum capital structure which gives maximum
returns to shareholders plays an important role in the growth and progress of
any company.
As
in Singh and Singh (2016), Solomon and Weston (1973) posit that the proper and
right combination of debt and equity will always lead to a market value
enhancement. In making capital structure decisions managers should consider the
significant difference between the industry and the individual companies within
an industry. Two similar companies can have different capital structures as per
the different judgement of decision makers with the significance of various
factors. Capital structure is the combination of debt and equity that finance
the firm’s strategic plan.
Gitman
(2009) emphases that capital structure policy is a policy concerning the
optimal combination of the use of external and internal sources of funds to
finance an investment and also to support the company’s operations in an effort
to increase its profits and achieve a higher value. It is important to have
optimal combination of funds from internal and external sources in the firm’s
capital structure to avoid a highly leveraged firm, with maximum debt source of
finance in its capital structure which results in the firm finding its freedom
of action restricted by its creditors and may have its profitability affected
with the payment of higher interest costs.
The
problem that financial managers are faced with in capital structure decisions
is that there is yet no clear cut guideline that can be consulted when taking
decisions regarding optimal capital structure. An optimal capital structure
enhances the competency of the firm and impacts higher returns to shareholders
compared to the return provided by an all equity firm. Akinsurile (2008) argues
that most financial managers make capital structure decisions not necessarily
out of empirically verified evidence. Myers (2001) asserts that large number of
business failures in the past have been due to the inability of the financial
managers to correctly identify and take advantage of the economical sources of
financing for their firms based on empirically verified information.
1.2 Statement of the
Problem
Over
the years, the manufacturing sector has been a victim of high production costs
which invariably reduces profitability. As argued by Akinbuli (2006), poor
management is the main reason for business failure as many corporate
organizations went into liquidation because of poor management. Peavler (2009)
observed that most failed businesses were due to cash flow problems. The
importance of cash flow is particularly pertinent when access to cash is
difficult and expensive. According to Basno and Dardac (2004 the required
liquidity for each company depends on the balance sheet situation of the
company. To assess the liquidity state, special importance is held by the way
in which there are classified organizational liabilities and assets (Basno and
Dardac, 2004).
Studies
were made in order to observe the interaction between these two variables, such
as Lazaridis and Tryfonidis (2005) who found a relationship between liquidity
management efficiency and profitability. Companies enjoy better pricing when
they hold enough cash to purchase from suppliers and thus they may enhance
their profit. So having enough liquidity also affects the profitability of the
firm. Siddiquee and Khan (2008) observed that firms which are better at
managing liquidity are found to be able to make cyclical moves to build
competitive advantage. They are also better at generating fund internally and
also face lesser trouble while seeking external sources of financing. The
problem to be addressed by this study is to evaluate liquidity measures and the
relationship between liquidity and profitability of cement manufacturing
companies listed on the Nigeria Securities Exchange (NSE).
1.3 Objective of the
Study
The
purpose of the study was to establish liquidity management measures of cement
producing companies listed on the Nigeria Securities Exchange (NSE).
i.
to establish the measures for corporate liquidity management
ii.
to highlight the factors that affect liquidity
iii.
to identify the relationship between liquidity and profitability.
1.4 Research Questions
The
study was guided by three key research questions namely:
i. What are the measures of corporate liquidity
management relevant for cement manufacturing firms?
ii.
What are the factors that affect liquidity requirement of cement manufacturing
firms?
iii.
Is there any relationship between liquidity and profitability in cement
manufacturing firms?
1.5 Scope of the Study
The
study focused on cement manufacturing companies located in Nigeria. The cement
industry comprises six cement companies of which only three are quoted on
Nigeria Securities Exchange. These three listed cement companies were selected
for a period of 2008 to 2012 on the basis of availability of data. This is in
consideration of time and cost constraints as the research was intended to take
place within four months after the approval of the proposal.
The
research was focused on management of liquidity and liquidity profitability trade-off.
The study used secondary data which was obtained through annual reports of the
three listed cement companies. The use of secondary data enabled the researcher
to collect reliable information from the target population. The annual reports
enabled the researcher to save time in data collection, they were cost
effective and contained the required information.
1.6 Definition of the
terms
Liquidity:
liquidity is the ability to meet expected and unexpected demands for cash
through ongoing cash flow or the sale of an asset at fair market value (Barad,
2010).
Liquidity Management:
Liquidity management has been defined as to involve managing the money of the
firm in order to attain maximum interest income on idle funds (Johnson and
Aggarwal, 2008).
Manufacturing Firms:
Manufacturing industry refers to any business that transforms raw materials
into finished or semi-finished goods using machines, tools and labour.
Manufacturing sectors include production of food, chemicals, textiles, machines
and equipment (Laura, 2009).
Stock Exchange:
Organized and regulated financial market where securities (bonds, notes,
shares) are bought and sold at prices governed by the forces of demand and
supply (Hans and Alissa ,2008).
Profitability:
Profitability is the capacity to make benefit from all the business operations
of an organization, company, firm, or an enterprise. It shows how efficiently
the management can make profit by using all the resources available in the
market (Sandhar, 2013).
Cash Conversion Cycle:
Cash conversion cycle measures the time lag between cash outflow for purchase
of inventories and collection of receivables from debtors (Padachi, 2006).