Effect of cash flow management activities on financial performance of manufacturing companies in Nairobi

TABLE OF CONTENTS

ABSTRACT

TABLE OF CONTENTS

LIST OF FIGURE AND TABLES

CHAPTER ONE
1.1 Background of the Study
1.2 Statement of the Problem
1.3 Research objective
1.4 Research Questions
1.5 Justification of study
1.6 Scope of the study

CHAPTER TWO
2.1 Introduction
2.2 Theoretical Review
2.3 Empirical Review
2.4 Knowledge Gap
2.5 Conceptual framework
2.6 Operationalisation of Variables

CHAPTER THREE
3.1 Introduction
3.2 Research design
3.3 Target Population
3.4 Sampling and sampling procedure
3.5 Data Collection Instrument
3.6 Data collection procedure
3.7 Data Processing and analysis
3.8 Research Ethics

REFERENCES

ABSTRACT

Cash flow shortfall has proved to be one of the issues facing manufacturing companies in Nairobi. Companies with cash flow problems have witnessed a lot of struggle when it comes to settling their credit commitments whenever they fall due. In some cases, the effect has resulted into extreme losses, low profits, business operation difficulty and high financial costs due to excessive borrowing. The general objective of this study is to determine the effect of cash flow management activities on the financial performance of manufacturing companies in Nairobi. To achieve this objective this study will examine how the three main components of cash flow statement component impact on the financial performance of companies under the scope. Cash flow activities according to Kew e al (2016) are cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. To measure the financial performance of manufacturing companies, the study will apply two key financial ratios which include Return on Equity (ROE) and Return on Assets ROA). Independent variables will be measured using net values of each activity as reported in the cash flow statement. The study will adopt a descriptive research design. The study will target 735 manufacturing companies divided into 14 categories located in Nairobi. A stratified sampling method will be used to determine the population sample guided by Naasiuma (2000) Model to come the sample size. Secondary data will be collected based on the financial statements as well as data from KAM website. Collected data will be prepared and then analyzed by use of STATA software. Diagnostic tests will carried out to ensure that the classical linear modeling assumptions are not violated. Collected data will then be subjected to various analytical tools like Mean, Standard deviation, Correlation and Regression analysis so as to achieve the objective of the study. Finally the analyzed information will be presented in tables, charts and figures to aid in recommendation and future decision making.

Key Words: Cash flow activities, Financial performance, Return on Equity RoE), Return on Asset (RoA)

LIST OF FIGURE AND TABLES

FIGURE1: Effect of Cash Flow Activities on Financial Performance

TABLE 1: Operationalisation of Variables

TABLE 2: Target Population of the study

TABLE 3: The Table of sample size for the study is tabulated….

CHAPTER ONE

1.1 Background of the Study

Cash is a medium of exchange and basis through which measurement of accounting for all financial statement components. Cash must be available to enable organizations settle their obligations in time to avoid contractual obstacles that may lead to incompliance (Ernest & Young LLP, 2018). Cash flow is also referred to as the amount of money that is disbursed and received from different daily activities but excluding solid inventory in store, receivables not yet settled by customers and assets owed or possessed (Kakuru, 2003).

Cash flow management has become an important aspect of the operational strategies and planning of many organizations. Availability of cash plays an important role in the operational as well as financial well being of organizations. Managers of many companies look at cash flow management as the core to the going concern mainly with great emphasis on the financial objectives (Okello and Uwondo, 2013). It is therefore important for organizations to align to cash flow management policies that can properly manage the working capital which include cash sales and debtors collection from stock holdings, to customer account and release of payments to suppliers in order to boost financial performance (Okello and Uwondo, 2013). In accounting and finance perspective, cash flow includes the amount of money in the business at the start of the financial period vis-a-vis cash balances at the closing date of company’s financial period (Faulkender, Flannery, Hankins, & Smith, 2012). According to (Frank and James 2014), cash flow is the net liquid amounts put together with the equivalents of cash that come into and move out of an organization.

Cash flow management activities on the other hand are the determination and evaluation that is used by organizations in monitoring, summarizing and utilizing the net cash payments receipts to achieve fewer cash disbursements and expenditure. Financial performance of a firm is the subjective kind of measure of how well a business entity makes use of its owned or assets in possessions through value addition. Manufacturing companies are deemed to be companies that use parts and components or convert raw materials both useful and recycled to make value added finished products used by end users (Frank and James, 2014)

In line with the above literature, maintaining of optimal cash amount therefore requires good cash flow management activities (Okello and Uwondo, 2013). Organizations with good cash management systems and planning have always stood out to be better placed to make investments decisions which are necessary to achieve better competitive edge (Okello and Uwondo, 2013). Holding of cash kind of management or cash flow in accounting has proven to be more costly to most manufacturing companies. Optimal cash management is critical because keeping idle cash results into diminished yield, increased cost on finances through insurance cover and risk of holding cash as the most volatile asset of an organization. Even though some companies are still involved in carrying out cash flow budgets there still exists effects that can either affect financial performance of an entity in good or adverse way.

Globally, cash flow and cash flow management has attracted attention just like in the local commercial undertakings. In Poland, issues relating to cash flow have in the recent past raised concerns especially cash management which affects the day to day operations of the organization which is important to achieve better financial performance (Darek, 2012). In China, cash flow is looked at from an accounting perspective referring to expenditure and receipts within a firm in relation to its performance (Zhous, 2012). There is an increased need for regulators to come up with cash management controls for all deposits aimed at increasing cash flows hence contribute to better financial performance of organization (Zhous, 2012). For adequate cash management policies in the American economy for instance, financial sector ensures optimal financial performance of organizations because there is desire to achieve economic growth. Essentially, cash is critical resource for the purchase of assets and organization operations which is a priority for market return to cover interests of its stakeholders (Miles, 2010).

In Nigeria, the decrease in cash flow management is based on determining how much an organization is not efficient to rise and this is an indication of its financial performance troubles (Nwanyanwu, 2015). Usually, company financial performance is very important because investing cash flow is valued more than gains in its financial statement. Investors are likely to focus more on risk exposure when making investment decisions, asset solvency and financial performance volatility and mortality or decline is indicated. Cash flow is among standards and parameter that financial statement consumers depend on while making financial and investment decisions rather than accounting standards which are sometimes misused and manipulated by managers (Nwanyanwu, 2015). Closer home, in Tanzania, free cash flow does not necessarily impact on financial performance of firms. However, operating activities of cash involve high cost of raw materials and other items for manufacturing companies, cash paid for salaries and wages paid to human resources related costs, cash paid to suppliers of goods supplied, fees paid out for licenses and government revenue, fines & penalties charged to organizations and tax paid not forgetting interest and other financial costs (Simpasa 2014). Many firms consider operating cash flow as a factor that boosts their financial good standing. This makes them avoid interest costs and avoid credit traps. In addition, in the event that a firm fails to make enough operating cash, it may to be forced into committing in credits to finance its investment plans. High operating cash flow tends to attract a low credit risk (Simpasa, 2014).

In Kenya, the sector of manufacturing is ranked the second largest sector driving the economy of the country contributing approximately 10% of the GDP. The sector serves both local and regional market across east and central Africa region (Mong’o, 2010). Importance of manufacturing sector in Kenya in particular is highlighted by provision of considerable level of employment to the country (KAM ,2018). Manufacturing activities in Nairobi in particular is 80% of the sector due to among other factors ease of accessibility to infrastructure and support services.

1.1.1 Cash Flow Management Activities

Cash flow management activities comprise of the components of cash flow statement. Authors like (Kew, Mettler, Walker & Watson, 2006; Powers and Needles, 2011 and Miles, 2010), have indicated that cash flow involve three main elements or activities. These activities include operating, financing and investment activities. According to (Farshadfar and Monem, 2013), cash flow is classified into three main components namely cash flow emanating from operating activities, investing activities and financing activities. Operating cash flow is said to be amount of money paid for the acquisition of merchandise, tax settlements, payments made to vendors, payments of wages and other operation expenditures (Gordon, Henry, Jorgensen, & Linthicum, 2017). Operating activities provide the management with an idea on how much cash an organization must make available or is generated from its daily undertaking of business activities. Cash inflows comprise of cash received from sales of merchandise and services or rather the normal business activities, cash receipts from the collection from sold goods or services, cash interest and dividends received from investments and other cash receipts not directly recognized with financing of operations or investing activities (Kew at al 2006). Operating activities also involves cash out flow which include cash payments for acquisition of items for trading or processing and conversion or consumptions on the production floor, cash payments to vendors and service providers for services received, payments to employees in terms of salaries and incentives, cash settlement for tax liabilities and interest (Kew et al 2011).

Many researchers have described the various components of cash flow statements and what they entail with a lot of consistence. Taillard (2012) described financing activities as the process of procuring capital to finance start up or expansion or any other engagement the company may need that necessitate additional funding from what would be internal or external sources. Financing activity indicates whether and how much of the operational and investments funds have been procured from outside or within. This can also mean obtaining resources from stockholders and providing them in return with dividends for their investments, and borrowing money from creditors and repaying the amount borrowed according to obligation terms of reference (Powers &Needles, 2011). Kemboi (2010) notes that cash flow from financing activities includes proceed of cash from issued shares and loan borrowings. Cash payment for financing activities includes the following; money spent to repay the principal loan amounts, redemption amount paid for ordinary and preference shares. Wanja (2011) observed that the main intention of accounting information is to provide relevant and satisfactory financial information that help both internal and external consumers to make sound decisions as regards company’s operations and performance. Normally net cash flow from financing activity should be negative in most of well managed businesses because it is an indication that such company has been spending on business growth and expansion.

The third category is investing cash flow activities. It details how much of the monies the business made and used on investments in other entities such as procurement of shares, bonds and securities from other organization in line with viable investment decisions. Acquisition of property and sale of long life assets entails the component of monies from investing events (Keown, Matrin and Titman, 2011). Money received is associated with sale of assets with long life characteristics like buildings and machinery whereas cash outflows occur when long term assets are procured by an organization (Berry, 2011). According to (Power and Needles. 2011) this category may also include the purchase and sale of production assets such as manufacturing equipment whereas cash in flow from investing category comprise collections of principal amounts on loans given out to other entities, cash received through sales of company investments and cash received from the sale of manufacturing assets. In some other cases, assets which have completed their economic life may be removed from organization register by disposing them. However it is important to highlight the fact that assets disposal may also arise with aim of funding the company operations or settlement of credit (Jeter, 2005).

1.1.2 Financial performance

The association between cash flow management activities and financial performance of organizations has not been well established. Most of the studies carried out before focused on the relationship between investing, financing and operating activities in terms of organizational performance. However, it is quite evident that cash flow in a way or other affects an entities’ profitability though there is not enough evidence to support. According to (Miles, 2010) cash flow management activities have to be a result of investment, financing, operating, equity investment, cash collection, plant investment and or debt repayments. This study will focus on manufacturing companies by looking at the cash flow management from investing, operating as well as financing activities.

Efficiency in performances of manufacturing companies and their weaknesses are sometimes a result of failure and lagging of their respective cash flows management identifications. Cash flow management is mainly born out the process of cash accumulation, general business transaction and other events. Cash flow remains the principle of the financial performance of any organization and the circular manifestation as the aim of law that has to be decided by the shareholders. This implies that cash flow management will always be the core of financial performance (Mong’o, 2010).

There are various ways of determining measure of financial performance of a company. Athanase (2015) indicated that the measure of financial performance has been made by applying possible indicators in most businesses by evaluating returns on asset and returns on equity as the appetite of shareholders. The entity’s financial performance can also be measured by applying financial ratios depending on the actual environment and the targeted aim being the most common measures in relation to accounting. These measures include net profit, return on asset, return on equity, current ratio, liquid ratio and credit ratios (Dukes, Davis and Dyckman, 1998; Gullet and Hicks, 1981 and Nwanyanwu, 2013a). Components of cash flow may be measured by adding all the line items that appear under respective cash flow activities component (Collins, Hribar, & Tian, 2014). Therefore, this study will take this dimension to research and evaluate the association and interdependence of variables.

The assumption of this research is grounded stability of monies coming in to any organization and that it is an indicator to the opportunity for financial presence and profitability. The performance of an entity can also be determined by the use of return on equity (ROE) and return on assets (ROA). Cash flow and profits of an organization are much related. A sound cash flow standing is reflected in the cash levels of an organization. When an entry continues in trend of making profits, then it is assumed that has stable cash flow hence has enough cash for investment decisions. It is evident that profit, in turn is always a reflection of the image in its cash flow soundness or bottom line of cash flow statement (Panigrahi, 2013).

1.1.3 Manufacturing Companies in Nairobi

The sector of manufacturing is ranked in line with driving of economic prosperity of the country contributing approximately 10% of the GDP. The sector serves both local and regional market across east and central Africa region (Mong’o, 2010). The importance of manufacturing sector in Nairobi in particular cannot be underestimated because of provision of considerable level of employment opportunity to the county (KAM ,2018). Due to the importance of sector, the government has earmarked the sector as one of its big four-agenda and has set out strategies, targets and regulations to enhance growth and economic prosperity in the country. These plans highlight the government focus that will boost fish processing, agricultural produce processing, leather and textiles sub-sectors among other areas. (KNBS, 2018). The economic survey of 2019 indicates that the sector of manufacturing grew by 4.2 per cent in 2018 compared to statistics of 2017 where growth witnessed was 0.5 per cent lower. The report also indicated that manufacturing output volume expanded by 5.1 per cent in 2018 from a revised contraction of 0.8 per cent in 2017. This is also reflected in employment which shows the impact of manufacturing to the economy (KNBS, 2019).

The sector has many divisions which include transformation and value addition on agricultural products, fruit and meat canning, Cornmeal, wheat and barley milling factories and sugar refineries (economic Survey, 2018). Other sub sectors include Electronics processing, assembly of vehicles and processing of soda ash. Assembly of computers, Textiles, ceramics, cement, shoes, aluminum, steel, glass, wood, cork and plastics are other sub sectors of manufacturing in Kenya, (KAM, 2015). Most manufacturing activities are concentrated within three major urban centers in Kenya. These are Nairobi, Mombasa, and Kisumu with potential location for Industrial Parks to be designed in Nairobi due to its proximity to most important markets and enhanced infrastructure.

The study will exclusively be done on the manufacturing entities dealing with transforming raw materials as well as semi-finished products to forms that are consumable by consumers. According to (KAM, 2015) more than 80% of the manufacturing companies are domiciled in Nairobi. Therefore Nairobi as the scope of study will ensure easy access and collection of data from target population following large number of manufacturing companies operating in the county.

1.2 Statement of the Problem

Management of cash flow of manufacturing companies has proved to be a challenge in against steps by organization to achieve super financial performances. Most of the companies are currently struggling to settle their obligations as a result of cash flow issues. This has made some of manufacturing companies to issue profit warning in pursuant to the provision of fifth schedule of the Capital Markets (Securities) Public offers, listing and Disclosures Regulations, 2002. Elayan and Pukthuanthong (2009) defined profit warning as a prior announcement released by organizations and it indicates that the profits of that particular organization will be lower than expected. Since the enactment of the law, Kenya has witnessed many listed companies issue profit warning. In 2019 for example, manufacturing companies like African Portland Cement, Bamburi Cement, Carbacid, Crown Paints and Sameer Africa issued profit warnings for the 2018 financial reports (sokodirectory.com). Majority of factors that have been attributed to contribute to the reduction in profits are macro-economic environmental factors and other factors that are unique to individual firms (NSE, 2016). The Uchumi Supermarket and Mumias Sugar Ltd in particular issued profit warning announcements stating that working capital and cash flow problems were their main challenges. Economic Survey (2012) showed that growth in sector of manufacturing declined from 3.4% in 2011 to 3.1% in 2012. The survey further highlighted that most of the strong firms have less outstanding debt as compared to companies that experienced cash flow problems. On average 37% percent of the assets of these firms are financed through debt (World Economic Forum, 2013). And therefore decline in growth is attributed to numerous factors including wrong ways of managing the available cash and planning of expected cash.

Studies have confirmed that there is some relationship between cash flow activities and entity’s financial performance. Mbula, Memba, and Njeru (2016) did examine what is the effect of receivable on the firm’s profitability and found out that the two variables positively relate. Akumu (2014) study was on free cash flow and how it affects the financial performances of companies listed on the Nairobi Securities Exchange. Njuguna (2013) focused on cash flows activities and the effects on the financial performance of medium firms in Nyeri. The study purposed to examine how sensitivity of investment, cash balances, account receivables, and company size affects profitability. The study did not use operating cash flows as well as financing cash flows beside the two variables being the main component of cash flows statements activities. Owino (2014) studied the effects of cash flow management on the profitability of manufacturing companies operating in Nairobi County. The main objective of his study was investigating the effect of using current assets on profits of an organization, the relationship between cash receivables and profitability as well as the effect of management of incurred costs on the profitability of the firm. Scope of the study fall short of representativeness of the total population of the Nairobi because it narrowed down to current assets rather than the entire components of cash flow statement

No previous study has specifically focused on evaluating the effect cash flow management on the financial performance of manufacturing companies in Nairobi. This particular study therefore will purpose to fill this gap. In view of the shortcomings raised above and the knowledge gap revealed, this study seeks to establish the effect of cash flow management activities to the financial performance of manufacturing companies in Nairobi.

1.3 Research objective

The study is aimed at establishing the effect of cash flows management activities on the financial performance of manufacturing companies in Nairobi.

1.3.1 Specific objectives

The specific objectives for this study are:

i. To establish the effect of operating cash flow management activities on financial performance of manufacturing companies in Nairobi.
ii. To examine the effect of investing cash flow management activities on the financial performance of manufacturing companies in Nairobi.
iii. To find out the effect of financing cash flow management activities on the financial performance of manufacturing companies in Nairobi.

1.4 Research Questions

i. What is the effect of operating cash flow activities on the financial performance of manufacturing companies in Nairobi?
ii. To what extend does investing cash flow activities affect the financial performance of manufacturing companies in Nairobi?
iii. What is the impact of financing cash flow activities on the financial performance of manufacturing companies in Nairobi?

1.5 Justification of study

This study is important to the management of different manufacturing companies in Nairobi for planning and making financial decision. It is also valuable to the country’s economic profile for better fiscal planning. On completion the results will be beneficial to policymakers when making decision in areas of managing cash and situations relating to handling of cash in manufacturing sectors. Investors who are interested in investing in the manufacturing sector in Nairobi may use the findings of get more information on matters cash flow management activities while making investment decisions as well as other business processes. The national and county governments may also use findings to determine tax performance of the manufacturing sector considering that manufacturing is one of the big four agenda that the government pledge to concentrate on to achieve future economic prosperity. Researcher can use the findings of this study for other studies in future. Other researchers who have interest in this area can also use the findings of the study or use the study in their literature review.

1.6 Scope of the study

The focus of this academic research is on the effect of cash flows management activities on the financial performance of manufacturing companies in Nairobi. The study is based on manufacturing entities in Nairobi. The study will use data from financial statements of entities as published or reported between 2011 to 2016. The respondent are guaranteed that data collected will only be used for research purposes and treated with the highest possible level of confidentiality.

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