Effects of Financial Risks on Profitability of Sugar Firms in Kenya

Abstract

The sugar industry plays a significant role in socio-economic development of the Kenyan economy and by the nature of its operations, faces a myriad of challenges as a result of financial risk exposure. With the liberalization of trade and free movement of financial assets, risk management through the use of derivatives has become a necessity and despite enormous benefits that can be derived from using derivatives to manage financial risks, Kenyan sugar firms have not embraced their use to full potential and there is lack of a thriving derivative market locally due to limited number of derivative instrument and lack of knowledge of existence of the instrument. This research examined the effects of financial risks on profitability of sugar firms in Kenya. Financial risks examined included credit risks, interest rate risks and liquidity risks. Census research design was used where all the 48 finance officers of the 8 sugar firms registered by the Kenya sugar board were studied. Questionnaires were used to solicit data. Descriptive data was analyzed using frequency counts, percentages, and mean while inferential analysis was done using Pearson correlation analysis. The study established that, a significant, negative correlation existed between firms level of liquidity risk and firms profitability, r = -0.777, P< 0.01. A significant, strong, negative correlation between firms risk rating and profitability r= - 0.689, P<0.01 and a strong, positive correlation also existed between firms efficiency of risk management and profitability r = 0.714, P< 0.01. This indicates that as the firm manages its risks more efficiently, the chances of loss are minimized hence higher profitability is realized. Financial risk management practices are therefore useful to sugar industry that operates in dynamic and competitive environments like Kenya. Liquidity risks have an effect on the profitability of sugar firms in Kenya and therefore the firms should ensure that they are financially stable so that there is smooth running of all operations. Since sugar firms extend credit to farmers in the form of seed cane, fertilizers, and other farm inputs, the firms should ensure constant monitoring of the credit through stringent internal credit control mechanisms. Firms should also try to reduce the sources of funding from loans by diversifying their activities like production of ethanol and being listed in the Nairobi securities exchange to supplement their capital  to minimize the  effects of fluctuations in interest rates on their profitability.

Key Words: Kenya Sugar firms, Financial Risks, Profitability