CHAPTER
ONE
1.1
Background of the study
Liquidity management is a concept that
is receiving serious attention all over the world 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 operations in order to meet their obligations as they
fall due and increase profitability and shareholder’s wealth. Liquidity
management, in most cases, are considered from the perspective of working
capital management as most of the indices used for measuring corporate
liquidity are a function of the components of
working capital. The importance of liquidity management as it affects
corporate profitability in today’s business cannot be over emphasis.
The notion of liquidity in the
economic relates to the ability of an economic agent to exchange his or her
existing wealth for goods and services or for other assets. In this definition,
two issues should be noted. First, liquidity can be understood in terms of ‡owes
(as opposed to stocks), in other words, it is a ‡own concept. In this framework,
liquidity refers to the ability of an institution or organization to meet
demands for funds. Liquidity management means ensuring that the institution maintains
sufficient cash and liquid assets to satisfy client demand for goods and services,
and to pay the institution’s expenses. Liquidity management involves a daily
analysis and detailed estimation of the size and timing of cash inflows and
outflows over the coming days and weeks to minimize the risk that savers will
be unable to access their deposits in the moments they demand them. Liquidity
and its management determines to a great extent the growth and profitability of
a firm. This is because either
inadequate liquidity or
excess liquidity may
be injurious to
the smooth operations
of the organization. This
seeming controversy has
attracted a lot
of interest in
the subject of
liquidity management. The primary
aim of this research work is to investigate the relationship between liquidity
and profitability.
Manufacturing sector plays a
crucial role in modern economy and has many dynamic benefits for economic
transformation. In a typical economy, the manufacturing sector is a leading
sector in many respects. It is an avenue for increasing productivity related to
import replacement and export expansion, creating foreign exchange earning
capacity; and raising employment and per capital income which causes unique
consumption patterns. Furthermore, it creates investment capital at a faster
rate than any other sector of the economy while promoting wider and more
effective linkages among different sectors. In terms of contribution to the
Gross Domestic product, the manufacturing sector is dominant but it has been
overtaken by the services sector in a number of Organizations for Economic
Co-operation and Development (OECD) Countries.
Before independence,
agricultural products dominated Nigeria’s economy and accounted for the major
share of its foreign exchange earnings. Initially, inadequate capital
investment permitted only modest expansion of manufacturing activities. Early
efforts in the manufacturing sector were oriented towards the adoption of an
import substitution strategy in which light industry and assembly related
manufacturing ventures were embarked upon by the formal trading companies. Up
to about 1970, the prime mover in manufacturing activities was the private
sector which established some agro-based light manufacturing units such as
vegetable oil extraction plants, turneries tobacco processing, textiles,
beverages and petroleum products. The strategy of light and assemblage
manufacturing shifted somewhat to heavy Industries from the period of the third
National Development plan (1975-1980) when government intervened to establish
care industrial plants to provide basic imports for the downstream industries. The
import dependent industrialization strategy virtually came to a halt in the
Late 1970s and early 1980s when the liberal impart policy expanded the imports
of finished goods to the detriment of domestic production. In this regard,
industrialization constitutes a veritable channel of attaining the lofty and
desirable conception and goals of improved quality of life for the populace.
However, liquidity has an important relationship
with profitability in the manufacturing industry. If companies have enough liquid resources, it
may be able to get benefit of cash discount on purchases and consequently that
will result in increasing profits.
If they cannot
pay the creditors
for goods in
the given period, they have to pay interest on the
amount of purchases. Thus, shortage of liquid resources will result
in low of
cash discount and
payment of interest.
Both the losses will certainly decrease over profits. Secondly,
companies may keep
the stock at
desired manners and
that will benefit them
in circulation of
business activities. Contrary
to this, if
they are not
able to keep sufficient stock
due to shortage
of liquid resources,
then the production
cycle may not continued and that will result in heavy
losses. Liquid resources of a business concern for all over to expand huge
business activities more, and less in financial.
Again, the management of cash
resource is also an important concept in liquidity management. In this context the objectives of a firm can
be unified as bringing about consistency between maximum possible profitability
and liquidity of a firm. Cash
management may be defined as
the ability of a management
in recognizing the problems related with cash which may come across in future
course of action, finding appropriate solution to curb such problems if they
arise, and finally delegating these solutions
to the competent
authority for carrying
them out The
choice between liquidity and profitability creates a state of confusion.
It is cash management that can provide solution to this dilemma. Cash
management may be regarded as an art that assists in establishing equilibrium
between liquidity and profitability to ensure undisturbed functioning of a firm
towards attaining its business objectives. Profitability is a measure of the amount by
which a company's revenues exceeds its relevant expenses. Profitability ratios
are used to evaluate the management's ability to create earnings from
revenue-generating bases within the organization.
1.2
Statement of the problem
Business financing, especially at
the wake of the 2008 financial crisis, which has become a major source of
concern for business managers as bank loans are becoming too expensive to
maintain as a result of tightening of the local financial market and the reluctance
of the public to invest in the share of companies sequel to the crash of the
capital market. These situations compel business managers to device various
strategies of managing internally generated revenue to enhance their chances of
making profit and meeting existing shareholders expectations.
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