Abstract

Many institutions worldwide lack a formal and suitable financial policy on the administration and management of liquidity. For financial institutions experiencing fast paced growth like microfinance banks, the establishment of norms and policies to administer cash and liquidity is nonetheless crucial for the institutional success as much as in the short run as in the long run.

This study was undertaken with the aim of evaluating the impact of liquidity management on the profitability of Microfinance institution in Buea municipality. Secondary data was used in the analysis to study the independent and the dependent variables. Three years’ data was collected from the financial statement gotten from the two microfinance institutions.

The data gotten was presented and analyzed with the use of Microsoft excel and statistical package for social sciences (SPSS). Regression analysis was used to study the relationship between the independent variables and the dependent variable. The significance of the results was tested at 5% significance level. Return on asset and return on equity have been used as measures of microfinance profitability while, current ratio, quick ratio and cash asset ratio represent liquidity management.

The result of this finding showed that cash ratio has a positive and significant impact on profitability while quick ratio and cash ratio have a negative and significant impact on profitability. This study recommends that the microfinance institution and other financial institution should maintain optimal level of liquidity in order to remain profitable.

CHAPTER ONE

INTRODUCTION

1.1 Background To The Study

In recent years, the impact of liquidity on the profitability is most controversial topic in the banking sector particularly and other sectors in general. Acter and Mahmud (2014) point out that the two very crucial issues in organization management which might always evaluate the financial health are liquidity and profitability. Both liquidity and profitability are important decisions for any financial institutions, this is because the shareholder’s return, risk and customer’s satisfaction can be influenced by both liquidity and profitability.

Liquidity management is one of the most important duties in any company and thus it cannot be overlooked. Sound liquidity management is integral for financial institution stability and profitability since deteriorating liquidity management is the most recurrent cause of poor financial performance. Liquid assets to all institution be it for profit making or not for profit have become scarce and liquidity risk has grown.

Companies have adopted complex and very rigorous liquidity management programs to manage their affairs since profitability is significantly influence by liquidity (Adebayo et al… 2011). Liquidity is generally referred to as the ability to generate adequate cash to pay off financial obligation but in banking it mainly refers to the ability to honor maturity deposits (Adalsteinsson,2014). The bank is said to be liquid when it is capable of meeting its own obligations when they become due, repay deposit and to make payments on member order.

According to Choudhry (2011) liquidity management refers is the funding of deficits and investment of surpluses, managing and growing the balance sheet, as well as ensuring that the bank operates within regulatory and stipulated limits. Liquidity management is simply the bank ability to fund assets and meet financial obligations without incurring unacceptable financial costs. The liquidity position of a financial institution greatly affects the financial performance of the institution and due to this liquidity management is therefore a paramount aspect of financial institution performance since it has great impact on the profitability and self-sustainability.

Poor liquidity management has been blame on the inability of financial institution to meet the short term demands of their customers in timely manner. This customer includes depositors (members) and investors. Banks create liabilities through saving from depositors and assets through giving loans to investors. It is imperative that depositors will make small savings in short term and the banks will lend to investors in long term hence exposing the institution to liquidity risk. According to Eljelly, (2004) the conception of liquidity management is getting a thoughtful consideration across the world.

Liquidity management is essential for financial institutions effectiveness and profitability. Profitability is a situation where revenues exceed expenses and which allows banks to generate profits (Bawacha 2018). It is important to determine the relationship between liquidity and profitability. Liquidity and profitability are inversely related to each other, an increase in profitability would tend to reduce the liquidity and too much attention on liquidity would tend to affect the profitability.

Liquidity and profitability are key variables, which provide information concerning the performance and survival of many businesses. In order to obtain a long-term survival and healthy growth of any business venture, both profitability and liquidity should go hand in hand (Ahmad, 2016). The management of a firm’s liquidity and its ability to make profit are very vital issues that contribute to both the growth and survival of a business entity and the capacity of managing a trade-off between these factors are of great concern to the financial managers of an entity (Kimondo, 2014).

Liquidity management is of great important in protecting customer’s deposits during times of bankruptcy and liquidation, which could be resulted by illiquidity. Adequate liquidity are tools for sustainable growth and profitable operation as well as the sustenance of the depositor’s confidence and for the banks in meeting their short term obligations (Ibe, 2013).

Liquidity proves that a bank is able to immediately meet cheques, cash, grant new loan demand and other withdrawals obligations and at the same time abiding by existing reserve requirements (Ibe, 2020). When a bank is not able to settle its obligations as they arise, it is regarded illiquid. In cases of illiquidity, the shareholders and possibly depositors’ losses which are a result of bank default (Odunayo & Oluwafeyisayo, 2015).

Liquidity is a trait that shows the capacity of a firm to obey its financial obligation when required. Therefore, liquidity management entails the amount of investments which should be held as liquid assets so as to obey creditor’s short term maturing obligations that a firm may have entered into (Panigrahi 2019). Liquidity play a vital role in the successful operation of a business entity and it is mostly important to make it known that banks are termed to be liquid when they possess the ability to settle obligations instantly when required (Odunayo & Oluwafeyisayo, 2015).

Profitability is the ability of a business to generate earnings as compared to its expenses and other relevant costs incurred for the period. For a firm to continue existing as a going concern, it will largely depend on its ability to generate profit or even attract equity capital and additional investors (Umobong, 2015). Profitability will mean the ability to generate profit from all the business activities of an enterprise, firm, company or an organizing. In banks, profitability is termed as the ability of generating revenue in excess of costs, in relation to the capital base. For stability of a good financial system, banking sector ought to be sound and profitable so as to be better able to sustain negative shocks that may be experienced in the economy, (Lartey, Antwi & Boadi 2013).

The amount of revenue that exceeds relevant expenses incurred by a firm for the period is known as profit and investors are more concerned with profitability ratio since they are interested in application of market price of stocks and dividends (Niresh, 2012). Included in the major goal of firm is profitability because it is difficult for business that does not make profit to grow and survive. The goal of shareholders of wealth maximization is closely related to profitability, and for an investment in current assets made there should be acceptable returns that are to be obtained (Almad, 2016). Profitably of a bank is driving by its ability to generate sufficient earnings as well as reduce the operational costs.

Liquidity is necessary in obtaining financial performance, maintaining and improving the market share of an entity (Bordeleau & Graham, 2010). By increasing profitability, there is probability of reducing a firm’s liquidity and as concluded by (Panigrahi, 2014), an extensive interest on liquidity would tend to have an effect on the profitability.

A firm will not be able to fulfill its immediate obligation when it is making low profit due to the high liquidity that it gains. This will mean that funds are help in non-liquid assets and could not be used for productive activities, hence lowering the profitability. Eljelly (2004), suggested that practically, profitability and liquidity are effective indicators of the corporate health and performance of not only banks but all profit oriented ventures. These performance indicators are very important to the shareholders and depositors who are the major public of the bank.

As the shareholders are interested in the profitability levels, the depositors are concern with liquidity position which determines a bank’s ability to respond to the withdrawers’ needs which are normally on demand or on a short notice as the case may be. Effective liquidity management helps ensure a microfinance ability to meet cash flow obligation which are uncertain as they are affected be external events and other agents’ behavior. According to Crowe (2009), a bank having good assets quality, strong earning and sufficient capital may still fail if it is not maintaining adequate liquidity. Marozva (2015) posits that a dilemma in liquidity management is finding a balance between liquidity and profitability since these two are inversely associated.

Microfinance over the years witnessed various changes ranging from technological changes and their aim is focus. Microfinance institutions (MFIs) are organization such as credit unions, downscaled commercial banks and financial cooperatives that provides financial services to the (Christen et al 2003). This organization might vary in their legal structure, missing, methodology and sustainability but they all have one thing in common, they provide a broad range of financial services such as deposits, loans, payment services, money transfers and insurance to the poor and low income earners or household and their microenterprises at cheap and affordable interest rate (Robinso). Microfinance is not a new phenomenon as it is widely portrayed to be, it can be traced as far back as the 18th century.

Even though microfinance institutions started earlier in other countries around the world, it started in Cameroon in September 1963 with the St. Anthony,s Discussion Group (Long, 2009). However, it was not until the late 1980s, as a result of the commercial banking sector in Cameroon experiencing a serious of crises, with many major banks becoming illiquid and/or insolvent that microfinance institutions really gain ground. Ever since, the microfinance market and the number of microfinance institutions in Cameroon have been increasing. Today, there are over 850 registered MFIs in Cameroon.

1.2 Problem Statement

The banks and regulatory authorities are becoming increasingly vigilant to the liquidity position held by financial institutions. Liquidity and profitability are very important in the development, survival, sustainability, growth and performance of microfinance. Deposits are a lifeline of banking business and most of banking operations are run through deposits. If depositors start withdrawing their deposit from the bank it will create a liquidity trap for the bank forcing them to borrow funds from the central bank (Plochan, 2007).

Most microfinance institutions in Cameroon try to keep up sufficient funds to meet the unexpected demands from depositors but maintaining the cash is extremely expensive.

This is achieve through maintaining a large cash reserve that may not only lose a number of opportunities in the market but also have to bear the high cost associated with cash. Proper liquidity management will enable financial institution meet their financial obligation and take advantage of profitable investments that are likely to yield higher returns in future.

For a microfinance institution to remain competitive and liquid, it must pay attention to liquidity management and profitability level with regard to how its ability to manage financial performance can contribute to its organizational achievement. Liquidity management is the ability of a business to meet its cash obligation at a stipulated time period. Liquidity plays a big role in determining the success or failure of an institution and its profitability.

For the success operation and survival, microfinance institutions should not compromise efficient and effective liquidity management and both illiquidity and excess liquidity are financial diseases that can easily erode the profit base of microfinance as they affect the attempt to attain high profitability levels. Many studies have been concluded by using different methods of data from develop and developing countries to define the relationship of liquidity management on the profitability of microfinance. These studies have investigated the link between the choice of leverage ratios, performance, the size of bank and other factors.

However, the results of their studies provide contradiction between liquidity management and profitability. In many of this studies conducted, little has been done on the impact of liquidity management on the profitability of microfinance institution in Buea Municipalities. Most of the work done in this area of research has concentrated on commercial banks. Motivated by this gap in literature, this study seeks to determine the impact of liquidity management on the profitability of microfinance institutions in Buea Municipality.

1.3 Research Questions 

1.3.1 Main research question

What is the impact of liquidity management on the profitability of microfinance institutions in Buea municipality?

1.3.2 Specific research questions

1. What impact does current ratio have on the profitability of microfinance institutions in Buea municipality?
2. What impact does quick ratio have on the profitability of microfinance institutions in Buea municipality?
3. What impact does cash asset ratio have on the profitability of microfinance institutions in Buea municipality?

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