1.0 Introduction
1.1 Background of Study
The background of the study on liquidity, foreign exchange fluctuation, and financial performance in Nigeria’s manufacturing industry provides context to understand the economic challenges and opportunities within this sector. Nigeria, as Africa's largest economy, relies significantly on its manufacturing sector to drive economic growth and industrialization (Ajayi & Ojo, 2020). However, the manufacturing industry in Nigeria faces various challenges, including inadequate infrastructure, policy uncertainties, and external economic shocks such as fluctuations in global commodity prices and foreign exchange rates (Adegbie et al., 2018). These factors impact the cost structure of manufacturing firms, affecting their profitability and overall financial health.
The history of studying liquidity, foreign exchange fluctuation, and financial performance in Nigeria’s manufacturing industry reflects a growing recognition of the sector's pivotal role in the country's economic development. Over the years, Nigeria has experienced fluctuations in global commodity prices and foreign exchange rates, which have significantly impacted its manufacturing sector (Ajayi & Ojo, 2020). Studies have shown that liquidity management is critical for the survival and growth of manufacturing firms in Nigeria, particularly in mitigating the effects of foreign exchange rate volatility (Oke, 2019). Effective management of liquidity helps firms navigate cash flow challenges and maintain operational stability amidst fluctuating economic conditions.
Historically, studies have highlighted the vulnerability of Nigerian manufacturing firms to liquidity constraints exacerbated by foreign exchange rate volatility. These challenges have underscored the need for robust liquidity management strategies to enhance financial resilience and sustain growth (Adegbie et al., 2018). Research efforts have also explored how fluctuations in exchange rates affect the cost structures of manufacturing firms, influencing their profitability and competitiveness in both domestic and international markets (Oke, 2019). This historical context has informed policy discussions and interventions aimed at improving the regulatory environment, infrastructure, and financial mechanisms supporting Nigeria's manufacturing sector.
The manufacturing sector plays a pivotal role in Nigeria's economic landscape, contributing to employment, GDP, and export earnings. However, the sector is vulnerable to liquidity constraints and foreign exchange rate volatility, which can impact operational efficiency and profitability (Adegbie et al., 2018). Fluctuations in exchange rates affect the cost of imported raw materials, machinery, and equipment, influencing production costs and ultimately financial performance (Oke, 2019).
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 allow 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).
Therefore, in Nigeria where the research was carried out, the activities that was conducted is to know the impact of liquidity and foreign exchange flunctuation on the financial performances in manufacturing industries.
1.2 Statement of Problems
Investigation revealed that the study of liquidity, foreign exchange fluctuation, and financial performance in Nigeria’s manufacturing industry identifies several critical issues. Nigerian manufacturing firms often face significant challenges due to fluctuations in global foreign exchange rates, which directly impact the cost of imported raw materials, machinery, and equipment (Ajayi & Ojo, 2020). These fluctuations can lead to increased production costs, reduced profitability margins, and overall financial instability within the sector.
Moreover, inadequate liquidity management practices exacerbate these challenges, making it difficult for firms to maintain stable cash flow amidst economic uncertainties (Adegbie et al., 2018). This situation hampers their ability to invest in technology upgrades, expand operations, or effectively compete in international markets.
Furthermore, the regulatory environment and policy frameworks governing foreign exchange transactions in Nigeria often lack consistency and transparency, contributing to uncertainty and risk for manufacturing firms (Oke, 2019). These issues collectively undermine the sector's growth potential and its ability to contribute effectively to Nigeria's economic development goals. Addressing these problems requires targeted interventions aimed at enhancing liquidity management capabilities, improving regulatory frameworks, and developing strategies to mitigate the impact of foreign exchange fluctuations on the financial performance of manufacturing firms in Nigeria.
1.3 Aim and Objectives of Study
The aim of the study is to find out the impact of liquidity and foreign exchange fluctuation on the financial performances in Nigeria’s manufacturing industry. In achieving this aim, the following specific objectives were laid out as follows:
- To examine the impact of cash and cash equivalent ratio on the financial performance of the manufacturing industry in Nigeria;
- To assess the impact of foreign exchange rate fluctuations on the financial performance of manufacturing firms in Nigeria;
- To identify the challenges faced by manufacturing firms in managing liquidity amidst foreign exchange rate volatility;
- To analyze the effectiveness of liquidity management practices adopted by Nigerian manufacturing firms; and
- To recommend strategies for enhancing liquidity management and mitigating the effects of foreign exchange fluctuations on financial performance in Nigeria’s manufacturing sector.
1.4 Research Questions
The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:
- Is there relationship between current assets ratio and 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?
- How do fluctuations in foreign exchange rates impact the financial performance of manufacturing firms in Nigeria?
- What are the current liquidity management practices adopted by manufacturing firms in Nigeria and how effective are they in mitigating financial risks?
- What are the major challenges faced by Nigerian manufacturing firms in managing liquidity amidst foreign exchange rate volatility?
- How do regulatory and policy frameworks governing foreign exchange transactions in Nigeria affect liquidity management and financial performance in the manufacturing sector?
1.5 Research Hypothesis
In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.
Hypothesis One
- 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 Two
- 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 Three
- 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 Four
- 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 Five
- 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 Study
The significance of studying liquidity, foreign exchange fluctuation, and financial performance in Nigeria’s manufacturing industry is crucial for various stakeholders:
- Manufacturing Firms: Understanding the impact of foreign exchange fluctuations and effective liquidity management strategies can help manufacturing firms optimize financial performance, reduce risk exposure, and enhance operational efficiency.
- Investors and Financial Institutions: Knowledge about the financial resilience of manufacturing firms in Nigeria amidst currency volatility can guide investment decisions and financial strategies, promoting sustainable economic growth.
- 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 firm’s 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.
- Researchers: 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 Study
The scope of the research is focused on the Impact of Liquidity, Foreign Exchange Fluctuation and Financial Performance in Nigeria’s Manufacturing Industry. This research 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.
1.8 Limitations of the Study
During the course of this study, many things militated against its completion, some of which are:
- Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
- Financial Constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).
Furthermore, this research work is limited to only the manufacturing industries in Nigeria due to population size, and logistics constraint. The research 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 Operationalization 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
Liquidity:
In the context of financial management, liquidity refers to the ability of a firm to meet its short-term financial obligations with readily available cash or assets that can be quickly converted into cash without significant loss (Adegbie et al., 2018).
Foreign Exchange Fluctuation:
This term denotes the variability or changes in the exchange rate of a country's currency relative to other currencies, which can affect the cost of imported goods, equipment, and raw materials for manufacturing firms (Oke, 2019).
Financial Performance:
Financial performance assesses how well a firm uses assets from operations and converts them into revenue. It is typically assessed by various financial ratios, such as profitability margins, return on investment (ROI), and earnings per share (EPS) (Ajayi & Ojo, 2020).
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.
…
