An analysis of the relationship between liquidity and micro-economic idicators: An inter-industry comparison
Abstract
Liquidity is cited as a major predictor or determinant of business failure. Financial ratio measures of liquidity have been shown to be suitable predictors of subsequent insolvency of firms. This study attempts to investigate an additional linkage, that is the relationship between the liquidity of firms and the state of a country's economy .The existence of such a linkage may supplement the existing body of knowledge as well as explain additional aspects of financial distress such as its cyclical nature.
A linear model has been used to explain the relationship between computed measures of liquidity and three economic indicators. Four major categories of firms have been used, these categories are currently adopted at the Nairobi Stock Exchange and include the Agricultural, Commercial, Financial and Industrial sectors. Correlation co- efficient were used to measure the strength of the relationships. For each industry
category five separate measures of liquidi..t.y were computed, which covered both short
term and long term aspects of liquidity as well as the static (Balance sheet) and dynamic (Cash flow oriented) aspects of liquidity. A review of literature highlighted problems with the distributions of financial !atios, this problem was tackled by use of natural logarithm transformations on two of the five ratios used in this study. The application of transformations on the ratio data successfully restored normality on some of the ratio categories, although it was unsuccessful in a few instances. The degree of normality was
established using the Lillie fors test at a significance level of 95%.
Results from the analysis conducted indicate that there exists moderate to strong relationships between liquidity and economic conditions. The results also indicate that substantial differences in the relationship described above exist as a result of the nature
of operations undertaken by firms, which are reflected in their industry classification.
,, The results of the analysis also suggest that sectors such as the commercial, industrial
and agricultural sectors have responses that are generally similar to each other, but that the financial sector appears to differ from the other sectors significantly.
Citation
A Management Project Submitted in Partial Fulfillment for the Requirements of the Degree of Master in Business Administration, School of Business, University of Nalrobl.Publisher
Department of Business Administration