Exchange Rate Movements and The Reliability of Financial Ratios: A Study of Nigerian Listed Firms

Abstract

This study investigates the impact of exchange rate volatility on the applicability of financial ratios of Nigerian listed companies. Under an unstable macroeconomic environment characterized by recurrent currency devaluations and exchange rate misalignments, financial ratios, which heretofore have been commonly used by investors, creditors, and analysts to analyze firm performance, may be skewed or deceptive. The study uses a conceptual framework drawn from existing literature, theoretical models, and market evidence that is available in Nigeria to explore the influence of movements in exchange rates on the consistency, comparability, and interpretability of financial measures such as return on assets (ROA), current ratio, debt-to-equity ratio, and interest coverage ratio.
Evidence suggests that during periods of high exchange rate volatility, firms with high foreign-denominated exposure or transactions report deflated or inflated figures in naira, which undermines the validity of their ratios. The distortions create challenges for users of financial statements relying on ratios to make decisions. Moreover, the effects are more pronounced in industries with significant import exposure, foreign borrowings, or export receipts, where differences in exchange distort profitability, leverage, and liquidity ratios.
The study underscores the need for higher disclosure, inflation-adjusted reporting, and sophisticated ratio interpretation in the midst of distortions brought about by exchange. It underlines the role played by financial reporting standards, for instance, IAS 21 and IAS 29, in improving the reliability of ratios in foreign exchange-sensitive regimes. Its implications are far-reaching for emerging economies like Nigeria, where there remains exchange rate volatility. The article offers guidance to regulators, financial statement preparers, and users who wish to rely on financial ratios more in macroeconomic distress.