ABSTRACT
The study investigated the effect of financial ratios on corporate performance of listed manufacturing firms in Nigeria from 2014-2018. It adopted the ex-post facto research design and extracted data from annual reports of the selected listed firms using the non-probability sampling technique. It employed a log of profit after tax, return on assets and return on equity as corporate performance indicators while current ratio and debt-to-equity ratio were used jointly as proxies for financial ratios. The study engaged panel least squares regression technique of data analysis to ascertain the relationship of the variables. The results established that 87% of the total variation in profit after tax is attributable to the joint financial ratios, 74.3% of the total variation in return on equity is as a result of variations in financial ratios and 52.7% of the total variation on return on assets is as a result of variations in financial ratios. The study also found that current ratio has positive significant relationship with profit after tax whereas debt-to-equity ratio has positive significant relationship with profit after tax, return on equity and return on assets of the sampled slisted firms. The study therefore concludes that financial ratios have significant effect on corporate performance of listed firms in Nigeria and recommend that management of listed firms should have an appropriate level of both current assets and current liabilities to boost performance, management of listed firms should ensure that borrowing be done only when necessary in order not to tie down funds to accumulate interest and principal repayments and that management of listed firms should always monitor the current ratio and debt-to-equity ratio so as not to hamper corporate performance.
TABLE OF CONTENTS
Cover page
Title page i
Declaration ii
Certification iii
Dedication iv
Acknowledgements v
Table of Contents vi
List of Tables ix
Abstract x
CHAPTER ONE: INTRODUCTION
1.1 Background to the study 1
1.2 Statement of the problem 4
1.3 Objectives of the study 5
1.4 Research questions 6
1.5 Research hypotheses 6
1.6 Significance of the study 7
1.7 .Scope of the study 7
1.8 Limitations of the study 8
CHAPTER TWO: LITERATURE REVIEW
2.1 Conceptual Framework 10
2.1.1 Concept of financial ratios 10
2.1.2 Financial ratios 12
2.1.3 Debt to Equity Ratio 14
2.1.4 Current Ratio 16
2.1.5 Profit after Tax 17
2.1.6 Return on Equity 17
2.1.7 Return on Assets 17
2.1.8 Creditors Turnover Ratio 18
2.1.9 Debtors Turnover Ratio 20
2.1.10 Total Assets Turnover Ratio 22
2.1.11 Interest Coverage 23
2.1.12 Concept of Corporate Performance 24
2.1.13 Determinants of Corporate Performance 26
2.1.13.1 Competition 26
2.1.13.2 Ownership 26
2.1.13.3 Profitability 27
2.2 Theoretical Framework 27
2.2.1 Traditional theory of firm 28
2.2.2 Marris’s Approach 29
2.3 Empirical Review 30
CHAPTER THREE: METHODOLOGY
3.1 Research Design 36
3.2 Area of the Study 36
3.3 Population of the Study 36
3.4 Sample Size and Sampling Technique 36
3.5 Method of Data Collection 37
3.6 Method of Data Analysis 37
3.7 Model Specification 38
CHAPTER FOUR: DATA PRESENTATION, ANALYSIS, RESULTS AND DISCUSSION
4.1 Data Presentation 40
4.2 Analysis and Discussion of Panel Unit Root Test 40
4.3 Results and Discussions 41
4.3.1 Effect of financial Ratios on PAT of listed Manufacturing firms 41
4.3.1.1Test of Hypothesis 1 45
4.3.2 Effect of financial ratios on ROE of listed Manufacturing firms 46
4.3.2.1Test of Hypothesis 2 49
4.3.3 Effect of financial ratio on ROA of listed Manufacturing firms 50
4.3.3.1 Test of Hypothesis 3 53
CHAPTER FIVE: SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary of Findings 55
5.2 Conclusion 56
5.3 Recommendations 58
REFERENCES 59
APPENDIX 62
LIST OF TABLES
4.1 Levin, Lin and Chut panel unit root test 41
4.2 Fixed Effect Regression of financial ratios on Profit after tax 42
4.3 Random Effect Regression of financial ratios on Profit after tax 43
4.4 Hausman Test Regression of financial ratios on Profit after tax 44
4.5 Fixed Effect Regression of financial ratios on Return on equity 46
4.6 Random Effect Regression of financial ratios on Return on equity 47
4.7 Hausman Test Regression of financial ratios on Return on equity 48
4.8 Fixed Effect Regression of financial ratios on Return on Assets 50
4.9 Random Effect Regression of financial ratios on Return on Assets 51
4.10 Hausman Test Regression of financial ratios on Return on Assets 52
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND TO THE STUDY
In the accounting world, there has been a growing tendency for firms to evaluate their performance and financial health with the help of financial ratios and it is often necessary to interpret a set of financial statements in order to identify the strengths and weaknesses of a company, highlighting any underlying trends in its operations (Okafor, 2015). It removes some of the mystique surrounding the financial statements and makes it easier to pinpoint items which would be interesting to investigate further. It involves the construction of ratios using specific elements from the financial statements in ways that help identify the strengths and weaknesses of the firm.
The analysis of financial ratios indicate the operating and financial efficiency, and growth of a firm. The financial ratios could be used to determine the ability of the firm to meet its current obligations; the extent to which the firm has used its long-term solvency by borrowing funds; the efficiency with which the firm is utilizing its assets in generating sales revenue and the overall operating efficiency and performance of the firm.
Enekwe (2015) opined that ratios are used as a benchmark for evaluating the financial position and performance of a firm so the relationship between two accounting figures expressed mathematically is known as financial ratio. They are used to assess whether their company is improving or deteriorating. Financial ratios are often divided up into seven main categories which are liquidity, solvency, efficiency, profitability, market prospect, investment leverage and coverage.
There are however a vast group of people interested in the financial statements analysis of an entity, they are the shareholders, management, lenders, customers, suppliers, employees, government agencies and competitors. Yet in many respects, they will be interested in different things and so there is no definite, all-encompassing list of points for analysis for each of the groups. Nevertheless, it is possible to construct a series of ratios that together will provide all these groups with something that they would find relevant (Wood & Sangster, 2002).
The management, having the task of running a business efficiently will be interested in all ratios because they tend to naturally wish to compare their performance over the past years with selected market and profitability objectives and with the performance of competitors (Samuel, 2018). Existing shareholders however, will be interested in investment ratios which indicate the level of return that can be expected on an investment in the business. The investors wish to predict future dividends and changes in the market price of the company’s common stock. Long-term creditors are interested in a company’s long-term solvency which is determined by the relationship between a company’s assets to its liabilities. Generally, a company is considered solvent when its assets exceed its liabilities so that the company has a positive shareholder’s equity. The larger the assets are to the liabilities, the greater the long-term solvency of the company.
Corporate performance on the other hand is the composite assessment of how well an organization executes on its most important parameters, typically financial, market and shareholder performance. It is concerned with the health of the organization which has traditionally been measured in terms of financial performance. It can also be said to be an important concept that relates to the way and manner in which financial, material and human resources available to an organization are judiciously used to achieve the overall corporate objective of an organization (Onubogu, 2016).
Corporate performance keeps the organization in business and creates greater opportunities and financial ratio analysis aids in achieving this. This is due to the fact that financial ratios are being considered as the major tool for assessing the financial health of the business and the accuracy of their financial information.
1.2 STATEMENT OF THE PROBLEM
The continuous demise of most companies in Nigeria is alarming. This is partly due to the inability of these Companies to adequately measure their overall performance and profitability before time using financial ratio analysis. This can also be traced to incompetence of the staff or management who tend to prepare the statements in such a way it would attract investors. Some could be as a result of ignorance while some are due to negligence. This doesn’t only affect the company involved, it affects both the investors and the economy at large.
The choice of ratios to select when making analysis is another problem as we have many parties interested in financial information and the ratios they are interested in vary from one another, therefore there would be different interpretations and different meanings.
Financial accounting statements do not present accurate performance on the level of efficiency of a business at the end of financial period although they show the financial positions of the business at the end. It is observed that the operating profit figure of a company might be higher in the current year than the previous year but this higher profit figure cannot be used to say that the company has performed better in the current year than in the previous year because the cost of asset is being considered at the beginning of that first year which may reduce the profit for that period. If it is judged based on this, it will have adverse or negative impact on the investment or investors.
Due to the above stated problems, the research seeks to empirically examine and investigate the extent to which financial ratios has impacted on the corporate performance of firms.
1.3 OBJECTIVES OF THE STUDY
The overall objective of the study is to examine to effects of financial ratios on the corporate performance of the three listed firms in Nigeria. The specific objectives are to:
1. Ascertain the effect of financial ratios on profit after tax of the listed firms in Nigeria.
2. Evaluate the effect of financial ratios on return on equity of the listed firms in Nigeria.
3. Determine the effect of financial ratios on the return on assets of the listed firms in Nigeria.
1.4 RESEARCH QUESTIONS
This study addresses issues to the following relevant questions forthcoming within the sphere of study problems:
1. To what extent can financial ratios affect the profit after tax of the listed firms?
2. In what ways can financial ratios impact the return on equity of the listed firms?
3. What are the effects of financial ratios on the return on assets of the listed firms?
1.5 RESEARCH HYPOTHESES
The following hypotheses were tested in order to provide useful answers to the research questions and realize the study objectives:
Ho1: Financial ratios have no significant effect on the profit after tax of the listed firms in Nigeria.
Ho2: Financial ratios have no significant effect on the return on equity of the listed firms in Nigeria.
Ho3: There is no effect of financial ratios and return on assets of the listed firms in Nigeria.
1.6 SIGNIFICANCE OF THE STUDY
This study will basically be of great importance to the following group of people:
1.6.1 The Management: It will help them in accessing the strengths and weaknesses of their firm and also help them know and ensure that borrowing should only be done when necessary in order not to tie down funds to accumulate interest and principal repayments.
1.6.2 The educational body: The educational body here refers to academic students, scholars, researchers, etc. It will be of great importance to them as it will increase their knowledge on financial ratios and also serve as a guide to researchers who intend to evaluate financial ratios and corporate performance.
1.6.3 The public: This includes everyone who is interested in understanding how financial ratios impact corporate performance of firms in Nigeria. The government inclusive.
1.7 SCOPE OF THE STUDY
This study focuses on the effect of financial ratios on the corporate performance of listed firms in Nigeria which is a broad sphere of study since it covers a great expanse of time series. However, the researcher will only concentrate on the listed companies in Nigeria and their activities from the periods 2014-2018 from their annual reports. This is because the researcher wants to study the effect of financial ratios on the corporate performance of firms during the Post-International Financial Reporting Standards (IFRS) adoption.
The listed firms are mainly manufacturing companies and they are Cadbury Nigeria Plc, Nestle Nigeria Plc, Unilever Nigeria plc and Guinness Nigerian Plc. This study was carried out in the contest of the Nigerian domestic economy and the independent variables is financial ratio which is proxied by current ratios and debt-to-equity ratios because they are both short and long term liquidity and solvency ratios and debt-to-equity ratios will help companies to be viable. The dependent variables are profit after tax, return on equity and return on assets.
1.8 LIMITATIONS OF THE STUDY
During the course of carrying out this research work, the researcher encountered a lot of challenges which limited this study. The sourcing of relevant materials that will be used for the project was not an easy task, these materials were however not easily accessible, thereby making the work even harder.
Time constraint is another major challenge as the researcher would have to manage time; thereby struggling to ensure that a best result is achieved. The research also had to combine studying for other courses with carrying out this research and time allocated was still not enough.
The non-availability of accurate record is another challenge. This is as a result of the poor record keeping culture and even if the records were available, most of them could face the problem of bureaucracy which would hinder the accessibility of these data and records.
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