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1.1 Background to the Study
Proper allocation of scarce economic resources is a difficult decision taken by management, as assets and liabilities must be combined in optimum proportions for the survival and profitability of any firm. Moreover, in a competitive modern business environment, financial managers irrespective of the nature of their businesses are made to ensure that the firms’ resources are efficiently utilized. Financial management has been divided into long term financial management and short term financial management. Short term financial management is generally referred to as liquidity management (Amargit, Nahum & Neil, 2010). While long-term capital decisions are of critical importance to the survival of a firm, working capital management has direct consequences on the liquidity position and the subsequent profitability of the firm (Burt & Abbate, 2009).
Profitability is a measure of the amount by which a firm’s revenues exceeds its expenses. Potential investors are interested in dividends and appreciation in market price of stock, so they pay more attention on the profitability ratios. Managers on the other hand are interested in measuring the operating performance in terms of profitability. Hence, a low profit margin would suggest ineffective management and investors would be hesitant to invest in the company. There are two types of profitability ratios, profit margin ratios and return ratios. A profitability ratio commonly includes gross profit margin, net profit margin, net operating profitability and operating profit margin. The Return on Asset, Return on Equity, Return on Capital Employed and Earnings per Share are the most important ratios under the return ratios (Elangkumaran & Karthika, 2013).
A firm is required to strike a balance between profitability and liquidity while steering its day to day operations. Liquidity is a prerequisite to guarantee that firms are able to meet their short-term obligations. The importance of liquidity as a pointer of continuing financial health cannot be over-emphasized in view of its central role within the business cycle, which is the life-blood and nerve center of any business entity (Hoang, 2015). However, too much emphasis on liquidity will be at the expense of profitability. Achieving the desired trade-off between liquidity and profitability in order to maximize the value of the firm has always been a problem for most managers (Padachi, 2006). The main goal of liquidity management is to stimulate a satisfying profitability and maximizes share holders’ wealth through the choices that firms make vis-à-vis their liquidity policies (Jeng-Ren, Li & Han-Wen, 2006).
In liquidity management, the study focuses on the problems that arise in trying to manage current assets, the current liabilities and the inter connection that exists amongst them. The fundamental goal of liquidity management is to manage the firm’s current assets and liabilities to a satisfactory level. If a firm is not able to maintain a satisfactory level of liquidity, it is likely to become insolvent and may be forced into liquidation (Dong & Su, 2010).
Liquidity means the scarce resources lock up in materials, work in progress, finished goods receivables, payables and cash. Liquidity should neither be too high nor low, but just adequate for the firms need. To maintain a good margin of safety, a firm needs its currents assets to adequately cover its current liabilities. This removes the risk of inability to meet outstanding short term obligations and at the same time avoiding excessive investment in these assets that will affect returns. Excessive levels of liquidity can lead to firm realizing a poor return on investment because the firm’s profitability is affected. While low level of liquidity may lead to low liquidity and stock out, resulting in difficulties in maintaining smooth operations. Profit maximization is the main purpose of establishing firm. But sustaining liquidity of the firm is equally an important objective (Priya & Nimalathasan, 2013).
Rehn (2012), Arshad and Gondal (2013), and Afande (2015) asserts that, working capital usually referred to net working capital, is the difference between current assets and current liabilities, which involves minimizing the timing of collecting receivables, deferring the period of payables, and keeping the minimal inventory. Similarly, optimal working capital management is usually achieved through the efficient management of receivables, payables, inventory, cash conversion cycle and the operating cycle as a whole (Ojeani, 2014).
Cash ratio, which is part of the wider task of treasury management, is concerned with optimizing the amount of cash available, maximizing the interest earned by spare funds not required immediately and reducing losses caused by delays in the transmission of funds (Uyar, 2009). Holding cash to meet short-term needs incurs an opportunity cost equal to the return which could have been earned if the cash had been invested or put to productive use. However, reducing this opportunity cost by operating with small cash balances will increase the risk of being unable to meet debts as they fall due, so the most favorable cash balance should be found (Uyar, 2009).
A firm needs to set an optimal level of inventory turnover period to hold stock. Kimeli (2012) & Ojeani (2014), viewed inventory management especially in a manufacturing firm as consisting of three components which include raw materials, work -in- progress and finished goods. The excessive holding of stocks leads to deterioration in the value of stocks due to damage and obsolescence, theft or pilferage by the employees and high stock handling costs. On the contrary, inadequate stocks lead to stock-out and loss of goodwill. To set the optimal amount of stock to hold and to order so as to achieve profit, the Economic Order Quantity (E.O.Q) is usually used (Erlenkotter, 1990 & Bozart, 2016).
Accounts receivable involves the management of firms’ debtors. In the management of working capital, the receivables are a very important component of current assets. Accounts receivable period or debtors’ collection period is the average length of time required to convert the firm’s receivables into cash (Rahema, Qayyum & Afza, 2011; Tsagem Aripin & Ishak, 2014; Leghari, 2015). They opined that, the efficiency of the management in granting and controlling credit could be ascertained on the basis of the period of the accounts receivables because it would indicate the pattern of debtors on the basis of which liquidity of debtors could be ascertained. If the firm takes more time in collecting receivables, the profitability of the firm declines. Similarly, since the purpose of offering credit is to maximize profit, the cost of debt collection should not be allowed to exceed the debt recoverable.
Accounts payable focuses on the average time taken by a company to pay its suppliers its current liabilities and all obligations which mature within a year such as creditors, short-term bank loan, income tax liabilities, bills’ payable, accrued expenses, all of which quickly mature in the current year (Uyar, 2009; Hailu & Venkateswarlu 2016). Accounts payable management shows the credit period received by the firm in terms of payment of credit purchases. However, the effectiveness of the credit time lies in whether the firm is actually benefitting from the credit period promised by the suppliers.
Leverage serve as a moderator variable on the relationship between liquidity management and profitability. It is the ability of a firm to use different sources of borrowed funds to finance its investment in other to generate profit. Financial leverage constitute any technique involving the use of borrowed funds in the purchase of an asset, especially the use of various financial instruments or borrowed capital to increase the potential return of investment, that is total debt to finance assets. Short term financial management is generally referred to as liquidity management (Amargit, Nahum & Neil, 2010).
This study is motivated by the global financial crisis since 2014 which significantly affects the liquidity position and the overall business activities across the world. In Nigeria, due to economy recession, and diversification since 2015 where credit is either unavailable or too expensive to obtain. There exist corporate issues that pertain to liquidity problem and consequently the operating performance of almost all the firms. Currency shortage is also having a seriously adverse impact, pushing up costs and consumer prices (Financial Times, 2016). Financial managers are always expected when there is a liquidity problem, to investigate the current assets and current liabilities in order to make informed decision with regard to the profitability of their entity.
Therefore, this study focuses on the listed conglomerate firms in Nigeria. Nigeria has a population of over 160 million people, with about 63% within the youthful age bracket offers a huge market for diverse products. Due to the large population and its growth rate, the demand for basic goods especially fast moving consumer goods (FMCG), food and housing related items, and transportation which are core areas of conglomerates, investment in Nigeria would continue to grow (Lead Capital Plc, 2016).
It is to this end, the study examine the moderating effect of leverage on the relationship between liquidity management and profitability of listed conglomerate firms in Nigeria.
1.2 Statement of the Problem
There is the need to maintain proper and adequate liquidity in firms because of its importance. Lack of adequate liquidity management accounts for inefficiencies in a company’s operation when it is not able to settle its due obligations. On the other hand, the company profitability can be jeopardized without optimum liquidity, as the company will not be able to meet up its short term financial obligations. Currency shortage is also having a seriously adverse impact, pushing up costs and consumer prices (Financial Times, 2016). Similarly, insufficient liquidity means that a firm is unable to undertake expansion projects and increase its sales, thereby limiting the growth and profitability of the business. These are the signs particularly revealed by the Nigerian conglomerate firms in the recent times, as majority of them have exhibited dwindling profits as well as poor stock management as observed in their annual financial reports.
Previous studies such as Stephen (2012), Bashir, Musa and Shehu (2013), Bala, Garba & Idris (2016), El-Maude & Shuaib, (2016) conducted in Nigeria, only look at the direct relationship between liquidity management and profitability without considering other factors that could also drive or change the liquidity management effect on profitability. Because of the established relationship between leverage and profitability, it is expected that when the liquidity of conglomerate firms increases alongside the increase in the use of debt financing, it will enhance the profitability of the firms positively. Therefore, this study assesses the multiplicative effect of the liquidity management and leverage on profitability of conglomerate firms in Nigeria.
Despite many studies carried out by different researchers on liquidity management and profitability, it was noted that these studies which includes: Ejelly (2004); Raheman and Nasr (2007); Gill, Biger and Mathur (2010); Mathuva (2010); Sharma and Kumar (2011); Stephen (2012); Bashir, Musa and Shehu (2013) Elangkumaran and Karthika (2013); Priya and Nimalathasan (2013); Aileman and Folashade (2014); Hoang (2015); Bala, Garba & Idris, (2016); seems to be at variance as to what appropriate variable should serve as the proxies for liquidity management components. Also worthy of note is the inability of these various studies to give a perfect direction of the relationship between liquidity management and profitability as evidenced in studies such as Gill, Biger and Mathur (2010); Sharma and Kumar (2011); Qazi, Shah, Abbas and Nadeem, (2011); Quayyum (2012); Durrah (2016); and Rafiul & John (2018) found positive relationship between liquidity management and profitability as against the studies of Shin and Soenen (1998); Deloof (2003); Ganesan (2007); Hoang (2015); and Sharif & Islam (2018) that found a negative relationship between liquidity management and profitability.
Again, liquidity management has been empirically examined in many different ways, while some authors studied the impact of an optimal inventory management; others have studied the optimal way of measuring accounts receivables that Leads to profit maximization (Besley & Meyer, 1987; Lazaridis & Tryfonidis, 2006). Other studies have focused on how reduction of liquidity improves a firm’s profitability (Shin and Soenen, 1998; Deloof, 2003; Raheman and Nasr, 2007; Dermirgunes & Samiloglu 2008; Zariyawaiti, 2009; Falope and Ajilore, 2009; Dong and Su, 2010; Sharma & Kumar 2011). In summary, most of these studies concentrated on several different liquidity components and the study are mostly from Asia and developed economy, where the market mechanisms and the business environment significantly differ from Nigeria.
The study covers a period of ten (10) years, 2008-2017. This period was selected due to the recent financial meltdown that engulfed the Nigerian economy since the year 2014 when oil prices started to nose drive, economic recession and to also assess the effect of the recent changes in rate of inflation, scarcity of foreign currency for importation of raw materials and machineries, the recent hike in foreign exchange rate to the naira for all the major currencies in the world making it difficult for managers of firms in this subsector in Nigeria to manage their liquidity during the selected period.
Studies that were conducted on this domain in Nigeria, many of them were conducted using data not extended to 2017, Bala, Garba & Idris (2016) and El-Maude & Shuaib, (2016). These studies might not be very current as at today, because many activities have taken place between that time and now, especially changes in rate of inflation, scarcity of foreign currency for importation of raw materials and machineries and also, the recent hike in foreign exchange rate to naira for all the major currencies in the world making it difficult for managers of conglomerate firms in Nigeria to manage their liquidity.
1.3 Research Questions
The following research questions are raised:
i. What is the effect of cash ratio on the profitability of listed conglomerate firms in Nigeria.
ii. What is the impact of inventory turnover on the profitability of listed conglomerate firms in Nigeria.
iii. What is the effect of accounts receivable period on the profitability of listed conglomerate firms Nigeria.
iv. What is the impact of accounts payable period on the profitability of listed conglomerate firms in Nigeria.
v. Do leverage moderate the relationship between liquidity management and profitability of listed conglomerate firms in Nigeria
1.4 Objectives of the Study
The main objective of the study is to examine the effect of liquidity management on the profitability of listed conglomerate firms in Nigeria, as well as the moderating role of leverage. The specific objectives of the study are:
i. To examine the effect of cash ratio on the profitability of listed conglomerate firms in Nigeria.
ii. To determine the effect of inventory turnover period on the profitability of listed conglomerate firms in Nigeria.
iii. To examine the effect of accounts receivables period on the profitability of listed conglomerate firms in Nigeria.
iv. To determine the effect of accounts payable period on the profitability of the conglomerate firms in Nigeria.
v. To examine the moderating effect of leverage on the relationship between liquidity management and profitability of listed conglomerate firms in Nigeria.
1.5 Research Hypotheses
In line with the objectives of the study, the following hypotheses were formulated in null form:
H01: Cash ratio has no significant impact on the profitability of the listed conglomerate firms in Nigeria.
H02: Inventory turnover period has no significant impact on the profitability of the conglomerate firms in Nigeria.
H03: Accounts receivable period has no significant impact on the profitability of listed conglomerate firms in Nigeria.
H04: Accounts payable period has no significant impact on the profitability of listed conglomerate firms in Nigeria.
Ho5 Leverage does not moderate the relationship between Cash ratio and profitability of listed conglomerate firms in Nigeria.
Ho6 Leverage does not moderate the relationship between Inventory turnover and profitability of listed conglomerate firms in Nigeria.
Ho7 Leverage does not moderate the relationship between Accounts receivable and profitability of listed conglomerate firms in Nigeria.
Ho8 Leverage does not moderate the relationship between Accounts payable and profitability of listed conglomerate firms in Nigeria.
1.6 Significance of the Study
The study adds to existing literature. Though there were a lot of studies on the effect of liquidity management and profitability of firms around the world, there is a dearth of empirical research using data to current year 2017, to assess the relationship between liquidity management and profitability of conglomerate firms in Nigeria. Due to mix findings on the relationship between liquidity management and profitability, this study therefore, examine the moderating effect of leverage on the relationship between liquidity management and profitability of listed conglomerate firms in Nigeria.
This study make available, to a greater extent, impact of liquidity management on the profitability of listed conglomerate firms in Nigeria. Findings of this study have some far reaching implications for users of financial statements such as management, shareholders, potential investors, policy makers, the regulatory bodies and also student. The study is beneficial to investors in making informed decision on where to invest their resources. The study further validates theory as well as the methodology used. The outcome of this study serves as a reference for further research in this area.
1.7 Scope of the Study
The study examines the moderating effect of leverage on the relationship between liquidity management and profitability of listed conglomerate firms in Nigeria. The study covers all the six (6) conglomerate companies listed on the floor of the Nigerian Stock Exchange (NSE) as at 31st December, 2017. The justification for choosing conglomerate to the best of my knowledge is paucity of studies.
The study covers a period of ten (10) years, 2008-2017. This period was selected due to the recent financial meltdown that engulfed the Nigerian economy since the year 2014 when oil prices started to nose drive, economic recession and to also assess the effect of the recent changes in rate of inflation, scarcity of foreign currency for importation of raw materials and machineries, the recent hike in foreign exchange rate to the naira for all the major currencies in the world making it difficult for managers of firms in this subsector in Nigeria to manage their liquidity during the selected period. The dependent variable of the study is return on assets (ROA), which is used to measure profitability of a firm hence; liquidity management is aim at generating profit for the firm. The independent variables are: cash ratio, inventory turnover days, accounts receivable period and accounts payable period. These variables were selected considering the fact that their cycle is completed within one financial year, which are current assets and current liability which will either impact positively or negatively on the returns (profitability) of a firm. The moderating variable is leverage, which is measure as debt ratio divided by total assets. Leverage has relationship to the profitability of a firm.
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