An Analysis Of The Techniques Of Determining Solvency In The Nigerian Manufacturing Industry



Nwankwo G.O. 1991 saw liquidity through the banking perspective, he puts it this way in banking this simply means being  able to meet every financial commitment when due.  According to (Hind march 1981).  The concept of solvency is closely related to liquidity.

The view recognized as four back as 1940 by Brown Courtency when he stated that liquidity is essentially synonymous with  liquidity is essentially synonymous with solvency.

In his own view (David E 1981) of the university of Missouri stated that solvency is a condition in which assets exceed abilities.  He went further to say that it is a condition in which a debtor is able to pay his debts as they mature.

Liquidity itself has long been considered a complex and confusing conception are reason for this confusion is the tendency to think of liquidity when applied to asset as subsuming to component.  Firstly, the ability to effect an ability to effect an exchange into money and secondly, the ability to effect an exchange into money at an unwary price in other words market stability and stability many definitions of the liquidity, differing in detail has been given by many writers, however, the majority of them are fundamental different.  There is however a sources of confusion in practice of applying the term “liquidity” both to circulating assets and corporate persons usually without realizing the dichotomy.

The term liquidity when applied to an articles  of wealth or a credit item is denoting the possibility of raising cash upon it by selling or pledging it as a security for a loan (wester field R, 1954) He went further by sating that liquidity in reference to a business concern is measured by the availability of cash whether direct and immediate or indirect and involving the conversion of some assets into cash to meet ordinary or extra-ordinary demands upon it.

Liquidity is a quality inherent in asset or supplied to it by reasonably stable mechanism of society furnishing reasonable assurance that it can be converted into cash within a period of time recognize by the commercial community in which it moves ass reasonably short (Berle Jnr, 1934)

In his definition above wester filed, 1934) made reference to all assets in the first instance and in the second to all business concerns which own assets and owe debts.  From this, two points can be deduced, firstly, liquidity is concerned with possession of availability of cash. Secondary, the cash must be obtainable expeditiously without sacrifice of the value of the previous held assets.  In Berline cases, the time factor becomes some what conspicuous, but the emphasis is still placed on a period recognized by the  commercial community as reasonably short.

From this, it is more valid to conceive of all assets as possessing varying degree of liquidity.  The writer will now make an attempt on liquidity as applied to assets.  The liquidity of persons or corporation and liquidity of assets have been distinguished by several writer.

A person individuals and corporations liquidity statement is measured by the liquidity status of the thing they own, relative to the money amount and maturity schedule of the debts they owe.  Unlike the situation in respect to assets one, here the question of relative value prospects through time enters conspicuously.  A corporation may revise its liquidity as applied to corporative status.  When applied to the status of persons or corporations, liquidity become substantially synonymous with solvency.  It is more precisely with the degree of solvency.

In this case, liquidity refers to the money amount of assets owned by a person corporation) relative to the money amount of debts owed.

It also refers to the maturity schedules of his debts (Brown C.B. 1940).

This identification of liquidity of persons with their degree of solvency is consisted with the use of the term in business parlance.

A brief summary of certain simple accounting terms as they relate to the question of solvency, will serve to focus our attention upon the factors of importance in judging the liquidity of legal or natural persons.

The ability of a person to provide sufficient cash fix its activities is termed its liquidity as postulated by (Hmd March  1981) and other.  They expatiated by starting that liquidity relates to the balance between the demand for and supply of cash resources over a period of time in future. (Van Home 1980) also recognized the time horizon when he stated that liquidity has two dimensions firstly, the time necessary to convert an asset into money and secondary, the degree of certainty associated with the conversion ratio, or price, realized for the asset.

Liquidity however is not synonymous with profit. This can be seen from above. The assertion was recognized by (Richard L, 1981) and others when it was attested that “Given a very profitable company may be forced  into liquidation.  If it is unable to meet it debts.  In view of this most users of accounts are concerned with liquidity of a company which may be conventionally divided into short term liquidity and long term solvency.

There is a big difference between profits and cash”.  It is believed that apart from making profits for substantial growth, new asset than can be financed with retained earnings should be acquired.  This affects the working capital policy (Weston J, 1990).


Solvency is not a precise term.  A commonly used in the business world, solvency means but one things ability to pay debts as they fall due.

According to (Ezejiofor, 1991) of the inner Termple, Barrister Solicitor and Advocate of the supreme count of Nigeria professor of law, university of Nigeria and others a company may be wound up by the count if the company is unable to pay its debts if the court after taking the company’s contingent or prospective liability into account is satisfied to pay its debts.

The company act of 1968- 8.210 also evidenced this as a statutory view.  Where it was stated  that court can dissolved a company unable to pay its debts.

This means that a company can be dissolved owing to an unsatisfied execution or a company unable to pay its debt taking contingent and prospective liabilities into considerations.

Note should also be taken that in the case of a person before a bankruptcy petition can be presented, the court requires prima facie evidence of the debtors insolvency, this evidence is furnished by proof that the debtor had committed an act of bankruptcy.  The Act specifies such act in the following words he files in the court a declaration of his inability to pay his debts or present a bankruptcy petition against himself.

Under the National Bankruptcy Acts instead of referring to a point in time, namely when debts full due.

The legal test of solvency is generally made on the basis of an approval of the fair valuation of debtors property which probabling means the future value of assets relative t the know loan Naira amount of liabilities to others than the owners.  This is a highly significant difference in the treatment of liquidity of assets.

Subsequent judicial interpretation of this definition has elaborated without clarifying its meaning.  When federal courts are called upon in reorganization proceeding, or on the other occasions, to Judge the solvency of an enterprises the test is usually made on the basis of a reasonable appraisal of the total prospective future value of assets relative to the known Naira amount of liabilities to other than the owners.

If at any point in time the company is unable to provide money to meet its maturing obligations or debts, the company is considered insolvent as a going concern, and the court would in all probability be petitioned to take change of its affairs.


Our understanding of the corporate failure or business failure will be of immense help to the continuation of this project as well as to potential users when the work is completed.  The problem involved and the situation facing the firm at any particular time can influence the definition of failure used.  According to (Weston and Bragliben, 1990) failure could be classified mainly into two economic failure and Financial failure.  However, there is no consensus on the definition of failure in an economic sense.

Failure is an economic sense signifies that a firms revenue do not cover its total costs including its costs of capital.  Another school of thought believes that failure in an economic sense is situation where the rate of earnings on a firms instorical lost of investment is less than the firms cost of capital still another  group are of the view that economic failure is a situation where a firms actual returns have fallen below its expected return.  One careful analysis of the above definitions, it would be observed that in actual fact, there is no controversy in the definition of economic failure, except the problem of semantics by the various schools of through as they succeeded in saying the same thing.

Financial failure is another type of failure.  It brings us to the concepts of technical insolvency and insolvency in bankruptcy.

“A firm can be considered technically insolvent if it cannot meet its current obligations as they fall due”.  A firm is insolvent in bankruptcy when its total liabilities exceed the fair valuation of its total assets that is if real net worth of the firm is negative).  However, this is a more serious condition than techniques insolvency and if often leads to liquidation of firm.  From this, we can say that when we are talking of technical insolvency, that we are talking of short term, while insolvency in ,long run.

For the purpose of this paper, failure is used to represent both technical insolvency and insolvency in bankruptcy.



Some Financial /Accounting ration will be used in testing solvency.  According to (Mbachu A.U 1978) in his articles on working capital management working capital is one of the most widely used measures of short term liquidity.  He went on to say that a working capital deficiency exist when current liabilities exceeds  current assets.  A weak liquidity position posses a threat to the solvency of the company and makes it unsafe and unsound (Weston J. and Bragham, 1990) added thus.  If a firm runs out of cash and cannot obtain enough to meet its obligation then it cannot operator and will have to declare bankruptcy.

A ratio is the relationship that one items bears to another, the later know as the base is divided into the formaer.  Accounting ratios provide a means by which various items in the final account are related to an appropriate base, usually the sales or the capital of a business, and there by enables these items to be regarded in their proper perspective.  Because  of the effectiveness of such comparisons as a means of guiding the management efficiency of a business accounting and other ratios provide a bases for inter firm  comparison schemes’.

(Vickey B.G. 1978)

further contribution on the use of ratio as a measure of solvency came from (Berty J. 1975) who was of the opinion that ratio analysis if used properly can be a great boom to assessing important characteristics such as solvency and profitability.

Financial ratios are tools of financial analysis when seeking credit analysis follow a procedure in evaluating the business by first Judging the proposal of feasibility report and then proceed to derive some pertinent ratios by comparing on relating one or more piece of data contained in the Financial statement on the basis at which the business is evaluated”.  (Edionwu J. 1993).

The above mentioned writers used the univeriate approach in the use of ratio.  Under this approach, one particular ratio is examined, comparison are made with the results of previous years or similar companies and tentative conclusions are drawn.

A different approach involves considering several ratios simultaneously by means of multivariate analysis under this approach, several ratios are combined by  means of a formulate to produce an index number and conclusions may be drawn by comparing that index number with similar comparies.  On of the best documented areas in which such approach has been used is in the prediction of business failure.

A number of empirical studies have been under taken that test the prediction power of financial ratios.  Notably among them is (William H.B. 1966) who tested the ability of financial ratios to predict failure based on thirty ratios.   He found out that not only did the financial ratio of failed firm differ significantly from those of non failed firms, but they deteriorated considerably during the five years prior to failure.  In another study, he found out that the best single he predictor of failure was the ratio of cash flow to total debt.

Although the multivariate approach has an empirical study, the most influential work on the predictor of failure has been that of (Altmans E. 1968) of America.  In a work published, he took a sample of 33 failed and 33 non failed American manufacturing companies.

He then examined many ratios to see which ratios taken together best discriminated between comprises in two group in the absence of any well developed theoretical models which would explain why companies fail, he used statistical technique known as the “multiple” discriminant analysis using this technique, he found five rations out of 22 ratios which would be combined to produces what is called a 2 score, the level of which best captured difference between the failed and non failed firms.  In other words, between Bankrupt and non bankrupt comprises as was used by Altman himself.

In an up date of this model, Altman extended the model employing seven variables which includes return on assets ratio the stability of earnings, the interest coverage ratio, the retained earning to total assets ratio, the common equity to total capital ratio, the current ratio and the size of total assets.  The model was  found to be more accurate especially in predicting bankruptcy up to five years in advance.

In another study, discriminate analysis was employed successfully to predict failure.

However, this analysis was on small business as apposed to large corporations thereby lending additions thereby lending additional credence to the technique using a three year average of the following Financial ratios, funds flow to current liabilities, equity to sales, working capital to sales current liabilities to equity, inventory to sales and the trend of the quick ratio relative to the industry average, small business Failure was also predicted successful Robert O.E. 1977)

The use of discriminant analysis in predicting corporate failure was tested an was found satisfactory by Edward B.D. 1972).

The discriminant analysis is also useful in the predict of bond ratings and loan delinquency.  The power of financial ratios to predict corporate bond ratings was also employed.  Using multiple regression analysis with the ratings as the dependent variables on a sample of comprises, we found that the working capital to sales, net worth to total debts, sales to net worth and net operating profit to sales were test for predicting bond ratings.

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