Financial Risk Management In Nigeria

Project and Seminar Topics with material for Banking and Finance

Project and Seminar Topics with material for Banking and Finance

Chapter One


1.1 Background Of The Study

“There is risk in everything that one does, and no one knows where he will make his landfall, when his enterprise is at its beginning. One man trying to act effectively fails to foresee something and falls into great and grim ruination, but to another man who is acting ineffectively, a god gives fortunes in everything and escape is folly”

The Great Poet And Stateman Solon In X1TH Century BC.

Life is full of risk that the inability to precisely predict the future still remains the major problem of man on earth. Risk, defined as uncertainty as to loss is universal in that it poses a problem to individuals in nearly all walks of life.

Students, households, business people, employers, travelers, investors and farmers all face risks and develop ways of handling it. Managers, especially those in developing countries like Nigeria, sometimes overlook risk elements when making their investment decisions. This has majorly contributed to collapse of many businesses after some years of their establishment. If a cost or a loss is certain to occur, it may be planned for in advance and treated as a definite problem and known expense. It is when there is uncertainty about the occurrence of a cost or loss that risk becomes important problem.

Risk as earlier pointed out, is universal. It affects everybody, for instance, there is risk of loss of firms earning power through or loss of its plant or other property by fire, windstorm or other events. These perils or events may or may not occur, but the possibility of their occurrence and subsequent effects can not be ignored by the prudent manager in any firm.

Business faces market risks. The manager may misjudge the desire of consumers by manufacturing goods which can be sold only at a loss. Bad debt losses, losses by advertising in inappropriate media, and loss through selection of improper marketing channels may also occur.

Business also faces production risk. Losses may occur by breakdown of machinery, improper quality controls, poor weather, and inefficient use of materials. Business also faces social risk events like strikes, riots, civil commotions, laws hindering business operations, currency inflation and political events which restrict business activity may cause loss.

Business faces financial risk. Sale slowdown may reduce cash flow thereby preventing repayment of debt and resulting in possible bankruptcy. Investment may turn sour; loans needed to keep the business operating may be turned down, causing the firm to use credit sources whose terms or interest rates may be onerous.

Risk as a socio-economics phenomenon means different things to different individuals in different circumstances.

Alhaji M.S.Bellow (1989, p.2) in his article “Risk management in Nigeria oil industry”, “The uncertainty loss”. He further described risk as the possibility of the occurrence of unfavorable event. Risk is the uncertainty or lack of predictability about the future. It is also the potentials for disutility, consequent upon financial loss. Brigham (1979 p.83) defined risk as a hazard or a peril, exposure to harm and in commerce, a chance of loss. While associating risk with the probability of undesirables outcomes, they maintained that the more likely an undesirable outcome, the riskier the decision.

Dickson (1989 p.3) says risk is classified into fundamental and particular or pure and speculative risks. Fundamental risks are impersonal both in origin and consequences and their effects are usually spread to the larger society. It arises out of the nature of the society or from some physical occurrence beyond human control. Particular risks have their origin on individual and their impact is felt locally. A typical example is the road traffic accident.

Speculative risk arise from unexpected charges in the economics productivity of a given capital investment. They arises from market management and political sources and are ambivalent in nature resulting in profit, loss or no loss and they arise from loss of or damage to physical assets and loss of income resulting from damage to property of others.

Speculative risk is apparent in every undertaking. In agriculture, the dynamic or speculative risk present very little threat whereas the prime risk of loss which stems from events that reduce yields poses the major challenge that every investors must contain if he is to achieve the desired objective.

In order to achieve their profit targets, various economic organizations expose themselves to different risks, pure and speculative or entrepreneurial steps have over the years been taken to identify entrepreneurial or speculative risk and devise methods to handle them to the organization best advantage. Since the world war 1939-45, there has been a growth of various management techniques in production, accounting finance, marketing to name but a few, by which corporate planning can be formulated and the risk to profit margin reduced.

In contrast, it is only over the last 10-30years that the real effort has been made to manage or control the pure risk which can equally prevent an organization from achieving its profits goal. When one says he is a risk manager, he has to explain what risk management is all about. Indeed it is the effort in the area of pure risk that has become known as risk management.

Cannon James (1979. p.159) defined risk management as the planning and controlling of hazards. A decision is said to be risky when its precise outcome is unknown when the decisions must be taken. In agriculture, such decisions are pervasive and often inescapable. While their may be some components of decisions which recurs with time, it is generally the case that each decisions to some extent is unique.

Robertson (1990 p.20) Defined risk management as the protection of assets, earnings, liabilities and people of an enterprise with maximum efficiency and at minimum cost.

Willet (1951 p.14) viewed risk management as management technique to preserve the financial and operational integrity of the firm by planning to minimize the impact of unanticipated loss cost. Risk management can be said to be the control and management of pure risk. It is the science concerned with the identifying risk and determining the most satisfying ways of controlling them.

According to William and Hein’s (1976) risk management involves five steps namely:

  1. Risk Identification: This is the scientific approach of analyzing the sources of risk, the type of losses, the immediate and underlying cause and consequences of each risk. The sources of risk could be identified by establishing the full details of the activities of the firm and their dependency on each others and on other outside activities or resources.
  2. Analysis and Measurement: After identification, the next step is the proper analysis and measurement of losses associated with these risks. This includes the determination of probability or chance that the losses will occur, the impact the losses would have upon the financial affairs of the firm if they occur, and the ability to predict the losses that will actually occur.
  3. Evaluation: the various alternative solution of risk management should be considered and decisions with respect to the best combination of tools to be used in solving the problem.
  4. Establish means for effective implementation of decision made
  5. The result of the decision made and implemented must be monitored to evaluate the wisdom of those decisions and to determine if changing conditions suggest different solution

The focal point of this research work is the financial risk management. This type of risk emphasis on the ability of the firm to pay for her debt obligation as it falls due. We know that no standard company can operate effectively without borrowing or having leverages with outsiders. Therefore financial risk management is a management strategy that would be adopted by the firm as to maintain liquidity in the firm’s financial system. Financial risk management is the management of Assets, security, liquidity, working capital, etc. For want of space and time we shall concentrate on one of the components of financial risk management known as liquidity management.

Various institutions have different ways of managing financial risk. Banks, for instance, which trade with other people’s money, the large part of the short term deposit which is withdraw able at depositor’s will and the bank is fully responsible to honour, thus the bank must do everything possible to safeguard its depositor’s interest against any likely vicissitudes.

So a bank can be reduced to naught within a considerable period if it fails to meet up a depositor’s withdrawal request. This will eventually reduced evade the confidence of client in the institution. It is therefore clear that risk is at the heart of banking business but risk taken is one of the way which we justify earning of a profit.

Financial risk can be classified into credit risk and liquidity risk. The former is the risk that credit extended to the customer will not be repaid in accordance with the terms and condition of the loan agreement between the bank and the customer, while the latter is the risk that fund will not be available to meet deposit withdrawals, loan-drawn down, maturities of borrowings or other cash outflows.

This study will also look at the various tools used to manage financial risk available to Nigeria business firms and institution to look in to their various approach to financial risk management vis-à-vis ideal management tools.

Companies manage their risk from the company’s balance sheet which summarizes final books of the accounts of firm in the business world. The other statement is the trading, profit and loss account. The balance sheet portrays the financial health of a business firm at any point in time. The financial health depends on how well and articulate the financial decisions of the firms are being made over a given period.

A firm which takes optimal financial decisions most often would likely produce a balance sheet which shows a healthier financial position than a firm which often takes sub-optimal financial decision. This involves proper employment of available financial resources (source of funds) into assets (uses) so that a delicate balance sheet is maintained between “sources” and “Uses” on one hand, and fixed and current assets on the other hand, to ensure that the value of the firm is maximized.

1.2 Statement Of Problems

The major objective of an enterprise is to maintain adequate liquid asset balance in such a manner that current liabilities as well as the maturing long-term liabilities are settled with ease as they fall due. The ability of a firm to meet the maturing obligation is technically term solvency. The firm that does this effectively may be referred to managing its financial risk well.

In managing risks, the firm has to satisfy many constituencies. One of such is the creditor. A creditor will be ready to supply goods and services to a firm when they are assured of early settlement of debt. Defaulting in settlement of due debts to the creditor discourages them from extending their goods on credit.

Also workers would always be agitating for their entitlement that is always settled in areas. A lot of business opportunities fear to escape the economy as a result of ailing liquidity.

Despite this, the tax authorities complain that tax obligations are not met as they fall due. Infact, various constituencies associated with the company will be complaining due to poor liquidity management.

These matters stimulate interest in exploring the major liquidity, management practice of companies which may have caused the poor state of liquidity. Do they employ so much of capital into fixed assets as to operate with low level of circulation capital? If the circulating in relation to capital employed is adequate, have the been represented in the firm that embraces liquidity? In particular, have the non-cash component (e.g. stock and debtors) been maintained at a high level which allowed cash level to drop too low? It may as well be that these enterprises are regarded by owners as cash cow which they milk for meeting their domestic needs.

1.3 Objectives Of The Study

Financial risk management of an enterprise may be effective or ineffective depending on the effectiveness of management practice adopted. The study seeks to:

  1. Identify the major liquidity management practices of firm.
  2. Evaluate the major practices and hence highlight the strength and weaknesses.
  3. Demonstrate the possible effect of the practices on liquidity and thus bring to focus the item to watch.
  4. Recommend liquidity management practice suitable to be adopted by companies in Nigeria.

1.4 Research Hypothesis

For purposes of advancing the objectives of this study, the following tentative statements have been formulated to serve as effective guide.

  1. HO: Small manufacturing firms always suffer liquidity problem.
    HI: Small manufacturing firms do not always suffer liquidity problem.
  2. HO: Small manufacturing firms do not manage their stock effectively.
    HI: Small manufacturing firms manage their firms effectively.
  3. HO: The length of credit period allowed to debtor do not cause the liquidity position of a firm to deteriorate.
    HI: The length of credit period allowed to debtor causes position of firm to deteriorate

1.5 Scope The Study

The focus of the study is on small manufacturing enterprise located in Lokoja kogi state

Although kogi state has a large contraction of business organizations, especially small manufacturing enterprise, they operate under similar problem. The information can be used to generalize on the financial risk management in Nigeria.

1.6 Significance Of Study

The financial risk managements is significant in view of the impact of the companies in the economy of the country. Ailing liquidity has been noted as a major cause of the insolvency of business enterprise. If these businesses are prone to poor liquidity, it follows that they are vulnerable to business failure if the causes of the problems are not identified and cured.

In separate term, this study will be useful to:

  1. Existing firms to correct the poor liquidity management practices.
  2. Interesting firms to avoid joining the current liquidity management weaknesses.
  3. Government in order to achieve a major thrust of her economic policy.
  4. The society at large in enjoying a recovered economy through the success of firm.

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