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Effect of Current Ratio on the Profitability of Listed Manufacturing Companies in Nigeria

Abstract

Current ratio is an important liquidity indicator that measures a company's ability to meet its short-term financial obligations using its current assets. It is widely used to assess the liquidity position and short-term financial strength of an organization. Profitability, on the other hand, reflects the ability of a company to generate earnings from its available resources and business operations. An appropriate level of liquidity may support profitability by enabling companies to meet short-term obligations, maintain uninterrupted production, take advantage of business opportunities, and avoid excessive financing costs. However, excessively high liquidity may also indicate that substantial resources are tied up in idle cash, inventories, or receivables that could otherwise be invested in productive activities. In Nigeria, listed manufacturing companies operate in an increasingly challenging economic environment characterized by persistent inflation, exchange rate volatility, rising energy and transportation costs, supply chain disruptions, high input prices, and fluctuations in consumer demand. These conditions can significantly affect the liquidity positions, working capital requirements, production costs, and profitability of manufacturing companies. Effective management of current assets and current liabilities is therefore essential for maintaining an appropriate balance between liquidity and profitability. Regulatory institutions such as the Financial Reporting Council of Nigeria (FRCN), the Securities and Exchange Commission (SEC), and the Nigerian Exchange Group (NGX) promote sound financial reporting and corporate governance practices that enable stakeholders to evaluate the financial health of listed companies. Despite these regulatory efforts, manufacturing companies may experience either inadequate liquidity, which can create financial distress and disrupt operations, or excessive liquidity, which may reduce the efficient utilization of resources. Although previous studies have examined liquidity management and financial performance, empirical evidence regarding the effect of current ratio on the profitability of listed manufacturing companies in Nigeria remains limited and inconclusive. Against this background, this study investigates the effect of current ratio on the profitability of listed manufacturing companies in Nigeria. The study is anchored on Working Capital Management Theory, Liquidity Preference Theory, and the Trade-Off Theory. Working Capital Management Theory emphasizes the importance of maintaining an appropriate balance between current assets and current liabilities to achieve both liquidity and profitability. Liquidity Preference Theory suggests that companies require adequate liquid resources to meet short-term obligations and reduce financial uncertainty, although excessive liquidity may involve an opportunity cost. Trade-Off Theory explains that firms must balance the benefits of holding sufficient liquid resources against the costs associated with maintaining excessive current assets. Collectively, these theoretical perspectives provide a comprehensive framework for explaining the relationship between current ratio and profitability of listed manufacturing companies in Nigeria. The study adopts a quantitative research design using a structured questionnaire administered to chief financial officers, finance managers, management accountants, financial controllers, treasury managers, internal auditors, external auditors, and other professionals involved in financial and working capital management within selected listed manufacturing companies in Nigeria. A stratified random sampling technique will be employed to ensure adequate representation of relevant manufacturing subsectors listed on the Nigerian Exchange Group (NGX). Current ratio will be measured using the relationship between current assets and current liabilities, adequacy of current assets, short-term obligation management, working capital adequacy, liquidity monitoring, and management of cash, receivables, and inventories, while profitability will be measured using Return on Assets (ROA), Return on Equity (ROE), net profit margin, operating profit margin, earnings per share, and profit growth. Primary data collected from respondents will be analyzed using descriptive statistics to summarize respondents' demographic characteristics and perceptions regarding current ratio and profitability. Structural Equation Modeling (SEM) will be employed to examine the effect of current ratio on profitability. The measurement model will be evaluated using Cronbach's Alpha, Composite Reliability (CR), Average Variance Extracted (AVE), and Confirmatory Factor Analysis (CFA) to establish the reliability and validity of the research instrument. Additional diagnostic tests, including multicollinearity assessment, common method bias analysis, and model fit indices such as the Comparative Fit Index (CFI), Tucker-Lewis Index (TLI), Root Mean Square Error of Approximation (RMSEA), and Standardized Root Mean Square Residual (SRMR), will be conducted to ensure the adequacy, consistency, reliability, and robustness of the structural model. The study anticipates that current ratio will have a significant effect on the profitability of listed manufacturing companies in Nigeria. An adequate current ratio is expected to improve profitability by enabling manufacturing companies to meet short-term obligations promptly, maintain uninterrupted production, purchase essential raw materials, settle suppliers, and respond effectively to changing business conditions. Adequate liquidity may also reduce dependence on expensive short-term borrowing and minimize the risk of financial distress. However, excessively high current ratios may negatively affect profitability if significant resources remain tied up in low-return current assets such as excess inventory, idle cash, or slow-moving receivables. Conversely, an excessively low current ratio may create liquidity pressures, delay payments to suppliers, disrupt production, and increase short-term financing costs. Therefore, the relationship between current ratio and profitability is expected to depend on the efficiency with which manufacturing companies manage their current assets and short-term obligations. Maintaining an appropriate liquidity position is consequently expected to contribute significantly to sustainable profitability and financial stability among listed manufacturing companies in Nigeria. This study is expected to make significant theoretical and empirical contributions to the literature on working capital management, financial management, accounting, and corporate profitability by providing comprehensive evidence on the relationship between current ratio and profitability of listed manufacturing companies in Nigeria. Unlike previous studies that broadly examined liquidity or working capital management, this research specifically evaluates current ratio as a determinant of profitability using primary data and Structural Equation Modeling (SEM). The findings will provide valuable insights for listed manufacturing companies, financial managers, management accountants, auditors, investors, the Financial Reporting Council of Nigeria (FRCN), the Securities and Exchange Commission (SEC), the Nigerian Exchange Group (NGX), professional accounting bodies, policymakers, regulators, and academic researchers regarding the importance of maintaining an appropriate liquidity position. The study will also provide evidence-based recommendations for improving working capital policies, strengthening liquidity monitoring, optimizing cash and receivables management, controlling inventory levels, improving short-term obligation management, and maintaining an appropriate balance between liquidity and profitability to promote sustainable financial performance among listed manufacturing companies in Nigeria.

Keywords: Current ratio, profitability, listed manufacturing companies, liquidity, working capital management, current assets, current liabilities, financial performance, Structural Equation Modeling (SEM), Nigeria.