FOREIGN EXCHANGE FLUCTUATIONS AND PROFITABILITY OF EXPORT

COMPANIES, A CASE OF MAIYRE ESTATE LIMITED

TUMWEBAZE DOROTHY MBABAZI

07/U/5338/EXT

SUPERVISOR

MR TIBAINGANA ANTHONY

A RESEARCH REPORT SUBMMITED IN PARTIAL FULFILMENT OF THE

REQUIREMENTS FOR THE AWARD OF THE DEGREE OF BACHELOR OF

COMMERCE, MAKERERE UNIVERSITY

JULY, 2011

DECLARATION

I , Tumwebaze Dorothy Mbabazi, do hereby declare that Foreign exchange fluctuations and

profitability of export companies is entirely my own original work, except where

acknowledged, and that it has not been submitted before to any other University or institution

of higher learning for the award of a degree.

Sign...................................................... Date..........................................................

Tumwebaze Dorothy Mbabazi

07/U/5338/EXT

i

APPROVAL

This research report has been submitted for examination with my approval as the candidate’s

University Supervisor .

Signed.................................................

Mr Tibaingana Anthony Date........................................................

Supervisor

ii

ACKNOWLEDGEMENTS

An undertaking of this nature is virtually impossible to accomplish without external support. It

is under this note that I extend my sincere gratitude to the following

I thank God for the wisdom and strength to write this report without which I would not have

managed.

I am grateful to my supervisor Mr Tibaingana Anthony whose guidence kept me on track

without which this report would not have been possible.

Special thanks to my discussion group (Gods grace group) members especially Tusiime Judith,

Nakaye Sarah, Besigwa Alex, Rwanyaga Godwin and Sebwami Deo who have been a great

help.

I am grateful to the staff of Mairye Estate Limited for their active participation in the survey

I acknowledge the support by my husband Alex Mugabe and my siblings, especially Mwesige

Benjamin and my children who had to bare my absence.

MAY THE ALMIGHTY GOD BLESS YOU ABUNDANTLY

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TABLE OF CONTENTS

DECLARATION...............................................................................................................................i

APPROVAL....................................................................................................................................ii

ACKNOWLEDGEMENT................................................................................................................iii

TABLE OF CONTENTS..................................................................................................................iv

LIST OF TABLES..........................................................................................................................viii

LIST OF FIGURES..........................................................................................................................ix

ABSTRACT.....................................................................................................................................x

CHAPTER ONE..............................................................................................................................1

1.1 Background to the study........................................................................................................1

1.2 Problem statement................................................................................................................2

1.3 Purpose of the study..............................................................................................................3

1.4 Objectives...............................................................................................................................3

1.5 Research questions................................................................................................................3

1. 6 Scope of the study.................................................................................................................3

1.7 Significance of the study........................................................................................................4

CHAPTER TWO.............................................................................................................................5

LITERATURE REVIEW....................................................................................................................5

2.1 Introduction...........................................................................................................................5

2.1.1 Foreign exchange fluctuations............................................................................................5

2.1.2 Brief history of foreign exchange........................................................................................5

iv

2.1.3 Participants of a foreign exchange market.........................................................................6

2.2 Causes of exchange rate fluctuations....................................................................................7

2.2.1 Economic Fundamentals.....................................................................................................8

2.2.2 Flight to Safety....................................................................................................................8

2.2.3 Balance of Payments (BOP)................................................................................................9

2.2.4 Political developments........................................................................................................9

2.2.5 Government policy...........................................................................................................10

2.2.6 Speculation.......................................................................................................................10

2.2.7 Market sentiment.............................................................................................................11

2.2.8 Relative Inflation Rates.....................................................................................................11

2.2.9 Exchange rate policy and intervention.............................................................................11

2.3 Profitability.........................................................................................................................12

2.3.1 Profitability indicators.......................................................................................................12

2.3.2 Gross profit margin percentage........................................................................................13

2.3.3 Net profit margin percentage...........................................................................................13

2.3.4 Return on capital employed (ROCE).................................................................................13

2.3.5 Gross profit margin ratio...................................................................................................13

2.4 Factors affecting profitability of business organizations.....................................................14

2.4.1 Degree of competition of a firm.......................................................................................15

2.4.2 Strength of demand..........................................................................................................15

2.4.3 State of the company........................................................................................................16

2.4.4 Availability of substitutes..................................................................................................16

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2.4.5 Degree of costs.................................................................................................................16

2.4.6 Price discrimination..........................................................................................................17

2.5 The relationship between foreign exchange fluctuations and profitability........................17

2.6 Conclusions..........................................................................................................................18

CHAPTER THREE.........................................................................................................................20

METHODOLGY............................................................................................................................20

Introduction...............................................................................................................................20

3.1 Research design.................................................................................................................20

3.2 Population of study............................................................................................................20

3.3 Sampling designs..................................................................................................................20

3.4 Sample size...........................................................................................................................21

3.5 Data sources.........................................................................................................................21

3.5.1 Primary sources................................................................................................................21

3.5.2 Secondary sources............................................................................................................21

3.6 Data collection methods......................................................................................................21

3.6.1 Observation.......................................................................................................................22

3.6.2 Survey...............................................................................................................................22

3.7 Instruments of data collection.............................................................................................22

3.7.1 Questionnaire...................................................................................................................22

3.7.2 Documentary review.........................................................................................................22

3.8 Data processing, analysis and presentation.......................................................................22

3.8.1 Data processing.................................................................................................................22

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3.8.2 Data analysis.....................................................................................................................23

3.8.3 Data presentation.............................................................................................................23

CHAPTER FOUR..........................................................................................................................24

PRESENTATION, ANALYSIS AND DISCUSSION OF FINDINGS......................................................24

4.1 Introduction.........................................................................................................................24

4.2 Demographic characteristics of respondents......................................................................24

4.3 Foreign exchange rate fluctuations.....................................................................................27

4.4 Level of profitability of Mairye Estate Limited....................................................................30

4.5 Relationship between exchange rate fluctuations and the profitability of Mairye Estate

limited........................................................................................................................................33

CHAPTER FIVE............................................................................................................................40

SUMMARY OF FINDINGS, CONCLUSION, RECOMMENDATIONS AND AREAS FOR FURTHER

STUDY.........................................................................................................................................40

Introduction...............................................................................................................................40

5.1 Summary of study findings..................................................................................................40

5.1.1 Findings on causes of foreign exchange rate fluctuations...............................................40

5.1.2 Findings on determinants of profitability in Mairye Estate Limited.................................41

5.2.3 Findings on the Relationship between foreign exchange fluctuations and profitability of

Mairye Estate Limited................................................................................................................41

5.3 Conclusion............................................................................................................................43

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5.4 Recommendations...............................................................................................................43

5.5 Areas for further research...................................................................................................44

References.................................................................................................................................44

LIST OF TABLES

Table 1: Sex of respondents..............................................................................................24

Table 2: Age of respondents..............................................................................................24

Table 3: Religion of respondents.......................................................................................25

Table 4: Marital status.......................................................................................................25

Table 5: Period of stay with Mairye Estate limited...........................................................26

Table 6: Predictability of Uganda shilling against dollar...................................................27

Table 7: Reasons for unpredictability of Uganda shilling against dollar...........................27

Table 8: Reasons for the shilling fluctuation against a dollar............................................29

Table 9: Causes of exchange rate fluctuations..................................................................29

Table 10: Measuring profitability in Mairye Estate Limited..............................................30

Table 11: Factors that affect the profitability of Mairye Estate Limited...........................31

Table 12: Consistency of profitability in Mairye Estate Limited........................................32

Table 13: Reasons for the inconsistency of profitability in Mairye Estate Limited...........32

Table 14: Currencies accepted during sales in Mairye Estate Limited..............................33

Table 15: Statements showing the relationship between exchange fluctuations and the

profitability of Mairye Estate limited................................................................................36

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Table 16: Effect of Exchange fluctuations and profitability of Mairye Estate Limited......37

Table 17: How Exchange fluctuations affect profitability of Mairye Estate Limited.........37

Table 18: Other Factors that affect the profitability of Mairye Estate Limited.................38

LIST OF FIGURES

Figure 1: Fluctuation of Uganda shilling against the dollar...............................................28

Figure 2: Exchange rate of a dollar since 2000..................................................................34

Figure 3: Relationship between exchange fluctuations and the profitability of Mairye Estate

limited................................................................................................................................35

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ABSTRACT

The purpose of the study was to establish the effect of foreign exchange fluctuations on

profitability of export companies a case study of a flower firm (Mairye Estate Limited) and the

main objectives were to find out the causes of foreign exchange rate fluctuations, establish the

determinants of profitability and establish the relationship between foreign exchange

fluctuations and profitability of Mairye Estate Limited.

The research design that was used in carrying out this research was a cross sectional research

design which involved a descriptive research design. The population of the study included the

employees of Mairye Estate limited. 63 respondents were selected using purposive sampling

design. Data was collected using primary and secondary source.

The findings revealed that differentials in interest rates, terms of trade and high level of

inflation cause exchange rate fluctuations, sales volume determine the profitability levels of

the company and that profitability of the export company is dependent on foreign exchange

fluctuations which implies that unfavorable fluctuations affect profits negatively whereas

favorable fluctuations affect profits positively.

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It is concluded that, exchange fluctuations are related to the profitability of the company and

unfavorable fluctuations affect profits negatively whereas favorable fluctuations affect profits

positively

I recommend that investors should have some understanding of how currency values and

exchange rates play an important role in the rate of return on their investments. More so,

export companies need to adopt and start using a 'Forward Contract' to reduce the effect of

fluctuations on their businesses.

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CHAPTER ONE

1.1 Background to the study

Foreign exchange fluctuation refers to the change in the exchange rates between two or more

currencies by specifying how much one currency is worth in terms of the other. An exchange

rate is simply the price of one currency in terms of another (Eleftherioss, 2007). It is the

value of a foreign nation’s currency in terms of the home nation’s currency (O'Sullivan,

2003). Foreign exchange movement has been a big concern for Mairye Estate managers,

investors and shareholders since the abolition of the fixed exchange rate system in 1971

(Massy, 2007). This system was replaced by the floating rate system in which the price of

currencies is determined by the forces of demand and supply of money. This new system is

responsible for foreign exchange fluctuations (Abor, 2005). These fluctuations expose Mairye

Estate to foreign exchange risk.

Profitability of a company refers to the positive gain from an investment or business

operation after subtracting for all expenses (Black, 2003). It is also a situation where

revenue exceeds the operational costs. It is clear that every business operate in order to earn

profit. In most cases the main goal of a business is making profit. Every business can improve

its profitability and sometimes a single factor can significantly increase the profitability of a

business but, for most businesses increasing profitability is a matter of creating a framework

for implementing a number of small improvements gradually, ideally built into day-to-day

processes and operations (Hirshleifer, 2005).

Increased fluctuation for a currency is due to either an increased transaction demand for

money, or an increased speculative demand for money. This fluctuation is highly correlated to

the country's level of business activity, gross domestic product (GDP), profitability of

1

businesses and employment levels (Sheffrin, 2003). On the importer or exporter side,

companies easily expose themselves to identifiable form of foreign exchange risk known as

'Transactional' exposure. This arises from company’s need to either buy or sell currency

relating to a trade transaction. Movements in exchange rates can work in the company’s favor

and enhance profitability but, equally, they can have the opposite effect and seriously erode

profit margins or lead to making a loss. Therefore, the researcher intends to establish the

effect of foreign exchange fluctuations on the profitability of export companies a case study

of a flower firm (Mairye Estates).

1.2 Problem statement

Despite the fact that Mairye Estate Limited has operated in the export business for over 10

years now, and during the period it has increased its sales volume, controlled its costs and

implemented efficient cash management policies, the company’s profitability levels are still

low. In today's global economy, any company trading in international markets is impacted by

foreign exchange rate fluctuations. The impact of exchange rate fluctuations directly affects

the profitability of the firm (O'Sullivan, 2003). Exchange risk is the effect that unanticipated

exchange rate changes have on the value of the assets, liabilities and operating income of the

firm. This exchange risk determines the foreign exchange exposure of a firm and profitability.

The company faces exposure to foreign-exchange risk and unfavourable foreign exchange

rates. Unfavourable foreign exchange fluctuations eat into a company’s profit margins while

favourable foreign exchange fluctuations boost a company’s profits. It’s against this

background therefore that the researcher intends to find out how the foreign exchange

fluctuations are affecting the profitability levels of Mairye Estate Limited.

2

1.3 Purpose of the study

The purpose of the study was to establish the effect of foreign exchange fluctuations on

profitability of export companies a case study of a flower firm (Mairye Estate Limited).

1.4 Objectives

i. To find out the causes of foreign exchange rate fluctuations.

ii. To establish the determinants of profitability in Mairye Estate Limited.

iii. To establish the relationship between foreign exchange fluctuations and profitability of

Mairye Estate Limited.

1.5 Research questions

i. What are the causes of foreign exchange fluctuation?

ii. What are the determinants of profitability in Mairye Estate Limited?

iii. What is the relationship between foreign exchange fluctuations and profitability of

Mairye Estate Limited?

1. 6 Scope of the study

1.6.1 Subject scope, The study focused on foreign exchange fluctuations as the independent

variable and the level of profitability as the dependent variable.

1.6.2 Geographical scope, The study was carried out in Mairye Estate Limited. Mairye

Estate is located in Wakiso district, Busukuma Sub County off Gayaza Zilobwe road. The

company grows and exports flowers to Europe. Mairye Estates Ltd is a company that has

been growing and exporting cut flowers to Europe specifically the Netherlands and the United

Kingdom since 1994. It has a workforce of over 400 employees.

3

1.6.3 Time scope, The study used literature of the period of 2000 to 2010. This period gave

reference to the situation regarding the fluctuations in foreign exchange and how it affects the

profitability levels of companies.

1.7 Significance of the study

i. The study may help the management of Mairye Estate Limited on the ways of ensuring

that they find a way of reducing or mitigating the effects of foreign price fluctuations in

order to safeguard their profits.

ii. The study may act as a stepping stone for other scholars who intend to do research on

foreign exchange fluctuations and how they affect profitability for it will act as a source

of literature for the subsequent scholars who intend to use it.

iii. The study may also help the researcher to acquire skills and knowledge.

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter presents a review of literature related to the study variable. It entails definitions

of foreign exchange, causes of foreign exchange rate fluctuation, profitability and the

relationship between foreign exchange fluctuations and profitability of business

Organizations.

2.1.1 Foreign exchange fluctuations

Foreign exchange is the process of trading the currency of one country for the currency of

another. This process is necessary for international trade to take place in a world of different

currencies. The value of one currency versus another is determined by the international

exchange rate (Subramania, 2007).

An exchange rate refers to the ratio at which the unit of currency of one country may be, or is,

exchanged for the unit of currency of another country. It is the price of one country’s

currency expressed in terms of another country’s currency (Eleftherioss, 2007). Eiteman

(2008) however defines foreign exchange fluctuation as the upward and downward

interaction of one currency against the other in a foreign exchange market.

2.1.2 Brief history of foreign exchange

For as long as trade between countries with different currencies has taken place, foreign

exchange has been in existence. According to (Julian Walmsley), author of The Foreign

Exchange and Money Markets Guide, although foreign exchange has existed since before

biblical times, a formal global market for foreign exchange did not develop until the 1800s

with cable transfers taking place between London and New York.

5

Historically, governments attempted to set exchange rates themselves to improve a country's

trade position. If a country set its exchange rate low relative to others, it could improve the

country's trade position by making its exports more affordable and imports from other

countries less affordable. Such policies led to trade wars as countries struggled to improve

their trade positions. Since the early 1970s, however, most major currencies have been

allowed to "float," which means allowing exchange rates to be determined by supply and

demand on the currency markets. This system is responsible for foreign exchange fluctuations

(Abor, 2005). Most countries still fine tune exchange rates by keeping a reserve of gold or

foreign currencies, known as foreign exchange reserves, which they buy and sell to stabilize

their own currency when necessary.

2.1.3 Participants of a foreign exchange market

Commercial banks are the main participants in the forex market, but their "market share" is

slowly shrinking. Currently, 43% of all transactions pass through the interbank market, as

opposed to 63% in 1998 and 53% in 2004. In terms of forex trading activity, the main role of

banks is to serve as middlemen for the other market participants. Their objective is to make

profits through "market making", which means that they offer their clients a "buy" price and a

"sell" price.

Institutional investors are the second biggest players. They include investment and insurance

companies, pension funds and hedge funds. They participate in forex trading in order to cover

their stock, bond and currency portfolios and they represent 30% of all foreign exchange

transactions.

6

Central banks participate as they intervene to manage their stocks of currency and state

money. Their transactions represent 5% to 10% of all forex trading volume. They may also

intervene in order to defend their currency and to adjust economic or financial imbalances.

Brokers allow private individuals to access the forex market by transmitting their clients'

orders to commercial banks. They get paid from the spread or by charging a commission on

each transaction. Also, there are many brokers that operate as market makers; like

commercial banks, they also provide their clients with a buy/sell (bid/ask) price to earn the

spread if they are able to find a buyer and seller at the same time. If the market maker doesn't

find a buyer and a seller, it will try to profit by covering its client's position on the interbank

market.

Multinational companies participate in forex trading in order to convert their money during

import or export activities. Their transactions represent approximately 5% of all global forex

transactions. Some companies even have their own trading floors, with traders speculating in

order to make profits and to reduce the risks related to exchange rate fluctuations.

Private investors/individuals have recently been trading the forex market as well, thanks to

the internet, which allows them to have real-time access to currency exchange rates. Today,

their transaction volume adds up to over 5% of all forex transactions. Currency trading is now

suitable for various investor types, who can now profit, just like the bigger players, by

properly applying leverage and money management principles. (Encyclopedia of Business,

2nd ed)

2.2 Causes of exchange rate fluctuations

Exchange rate as earlier defined as the price of one country's currency in terms of another's is

not static but changes depending on several factors. Majorly exchange rates are determined by

7

the supply of and the demand for currencies. The later being dependent factors on several

others as listed below

2.2.1 Economic Fundamentals

Investors choose to buy one currency, because they believe it is going to appreciate in value

against other currencies. For example, if you thought the Euro (EUR) was going to appreciate

against the U.S. dollar (USD), because the European economy will experience significant

growth in the future, you would buy Euros in exchange for your dollars. If many investors

share your sentiment, these purchases would cause the Euro to appreciate and the dollar to

depreciate. When an economy is expected to retract, its currency tends to depreciate. In the

European debt crisis of 2010, as certain countries in the European Union were at risk to

default on their debt, the growth of the European economy was in question. This caused the

Euro to drop to new lows, as investors sought to acquire other currencies (Steve Johnson,

2010).

Dwivedi, (2002) blames the foreign exchange fluctuations on high level of technology among

industrialized nations. He says they produce more than what the nations can consume. As a

result these nations increase their volume of exports, which leads to increase in supply of

foreign currency in the domestic thus currency depreciation; accordingly the situation would

result into expensive exports and a fall in value.

2.2.2 Flight to Safety

Certain currencies are considered riskier than others, especially currencies of developing

countries. When the fundamentals of the global economy are in question, a flight to safety

occurs. A flight to safety is when investors choose not to own riskier investments and only

wish to hold safe investments, or "safe havens." The three major safe havens are: the U.S.

8

dollar, Treasury bills and gold. These investments are considered to be the least risky of all

investments available. Therefore, if uncertainty increases, a flight to safety usually occurs,

and the dollar will appreciate against other currencies. Certain currencies, like the British

Pound sterling (GBP) and the Euro also will take favor with investors over currencies of

developing countries. Uncertainty in various economies can cause the foreign exchange

market to fluctuate (Steve Johnson, 2010)

2.2.3 Balance of Payments (BOP)

This is the systematic recording of all economic transactions, that is, goods and services

including insurance, shipping and earnings from overseas investment (Hsing, 2004). It is

drawn up and published in a similar form to a company’s income and expenditure statements.

With a BOP surplus (that is more goods and services being exported than imported), a

country’s currency will tend to strengthen and with a BOP deficit (that is more goods and

services being imported than exported), the currency will tend to weaken. This is because in

the case of the BOP deficit, there is an outflow of currency to pay for the imports, foreign

currency has to be bought in exchange for the local currency to transact payment, therefore,

there will be more sellers of the domestic currency than buyers and the exchange rate will

tend to drop ( Dwivedi, 2002).

2.2.4 Political developments

In choosing what type of asset to hold, people are also concerned whether the asset will

retain its value in the future. Most people will not be interested in a currency if they think it

will devalue. A currency will tend to lose value, relative to other currencies, if the country’s

level of inflation is relatively higher, if the country’s level of output is expected to decline, or

if a country is troubled by political uncertainty (Dwivedi, 2002).

9

2.2.5 Government policy

Exchange rates can be affected by Central Bank intervention, in line with government policy.

Central Banks can increase or decrease (buys and sell) the supply of their currency in order to

smooth out unfavourable or unrealistic fluctuations in currencies either by flooding the

market with their domestic currency in an attempt to lower the price, or conversely buying in

order to raise the price.. They can also intervene in the domestic market to influence the

exchange rate (Dwivedi, 2002).

2.2.6 Speculation

is the buying, holding and selling of currencies to profit from fluctuations in its price as

opposed to buying it for use or for income. Speculative buying can cause particular currency

fluctuations, as prices rise above their ‘true worth’ simply because the speculative purchasing

is artificially increasing the demand. Speculative selling can also cause prices to fall below

‘true value’ in a similar fashion (Dwivedi, 2002).

Speculation or the anticipation of the market participants many a times is the prime reason for

exchange rate movements. The total foreign exchange turnover worldwide is many times the

actual goods and services related turnover indicating the grip of speculators over the market.

Those speculators anticipate the events even before the actual data is out and position

themselves accordingly in order to take advantage when the actual data confirms the

anticipations. The initial positioning and final profit taking make exchange rates volatile.

These speculators many a times concentrate only on one factor affecting the exchange rate

and as a result the market psychology tends to concentrate only on that factor neglecting all

other factors that have equal bearing on the exchange rate movement. Under these

circumstances even when all other factors may indicate negative impact on the exchange rate

10

of the currency if the one factor that the market is concentrating comes out positive the

currency strengthens (Emmanuel T M, 2001)

2.2.7 Market sentiment

The foreign exchange market is not predictable, nor does it follow a logical pattern. Factors

such as market sentiment consisting of individual and industry views and perceptions,

industry reports, analysis of economic data and events etc, all have a role in influencing

exchange rates (Dwivedi, 2002).

2.2.8 Relative Inflation Rates

Inflation rate is another fundamental factor that affects currency fluctuation. If a nation has

over issued its currency which exceeds the demand in product purchasing, there will be

inflation. Inflation decreases the purchasing power of the people and therefore leads to

currency depreciation. In general sense, the local currency depreciates means the foreign

currencies appreciate. The change in inflation rate changes the demand and supply in

currencies, bonds, and currency value expectation. Inflation leads to higher product price

internally. Under the same currency rate, the nation loses on exports and gain in imports. In

the currency market, the demand of foreign currencies increases, therefore causing the

appreciation of foreign currencies.

Investors will generally move their money where they can earn a higher return (that is the

interest rate). The higher a countries interest rates, the greater the demand for that currency

(Dwivedi, 2002)

2.2.9 Exchange rate policy and intervention

Exchange rates are also influenced in no small measure by expectation of changes in

regulation relating to exchange markets and official intervention. Official intervention can

11

smoothen an otherwise disorderly market but it is also the experience that if the authorities

attempt half-heartedly to counter the market sentiments through intervention in the market,

ultimately more steep and sudden exchange rate swings can occur. In the second quarter of

1985 the movement of exchange rates of major currencies reflected the change in the US

policy in favour of co-ordinated exchange market intervention as a measure to bring down the

value of dollar (Dwivedi, 2002)

Subramaniam, (2007) asserts that currency pegging miracle, foreign investment risk, foreign

loan magic, export import parity and war involvement are the causes of foreign exchange

fluctuations. To him many developing countries like Uganda have their nation curries pegged

to US. So irrespective of the internal production, borrowing, balance of payments among

others their currency rate go up and down in proportion to the dollar has been dipping and as

a “pegged” by product, exchange value of all national curriers tied to it have gone down.

2.3 Profitability

Profitability of a company refers to the positive gain from an investment or business

operation after subtracting for all expenses (Black, 2003). It is also a situation where

revenue exceeds the operational costs.

2.3.1 Profitability indicators

These are ratios which indicate the degree at which various areas of an organization for

example assets profit, liabilities are performing. Ratios therefore are indicators of

performance which are important in showing relationship with and between the various

financial statements (Jennings, 2000).

To be able to know the performance of various areas in an organization there is need to carry

out performance indicators measures as noted bellow.

12

2.3.2 Gross profit margin percentage

Most businesses (with the exception of several service firms), the ratio shows the profit

earning capacity of the business including its ability to pay salaries, interest and dividends.

2.3.3 Net profit margin percentage

This shows what can be paid as dividends and what can be reinvested for business growth.

2.3.4 Return on capital employed (ROCE)

According to (Nkundabanyanga, 2009) return on capital employed measures the percentage

of profits being earned on the total capital employed and related profits to capital invested in

the business. Shareholders require either immediate payment of dividends or the expectation

of higher dividends in the future. It is measured as a ratio of profit on ordinary activities

before interest and tax to the capital employed.

2.3.5 Gross profit margin ratio

According to (Arora 2002), gross profit margin ratio measures the relationship between gross

profit and the sales revenues. If gross profit has not increased with sales revenue, this shows

that there has been increased purchase cost, there are inventory write offs and there are other

increased costs allocated to cost of sales.

The gross profit margin is used to analyze how efficiently a company is using its raw

materials, labor and manufacturing-related fixed assets to generate profits. A higher margin

percentage is a favorable profit indicator (O’Sullivan, 2003).

In the income statement, there are four levels of profit - gross profit, operating profit, pretax

profit and net profit. The term "margin" can apply to the absolute number for a given profit

level and/or the number as a percentage of net sales/revenues. Profit margin analysis uses the

percentage calculation to provide a comprehensive measure of a company's profitability on a

13

historical basis (3-5 years) and in comparison to peer companies and industry benchmarks

(Flyvbjerg, 2008).

Basically, it is the amount of profit (at the gross, operating, pretax or net income level)

generated by the company as a percent of the sales generated. The objective of margin

analysis is to detect consistency or positive/negative trends in a company's earnings. Positive

profit margin analysis translates into positive investment quality. To a large degree, it is the

quality, and growth, of a company's earnings that drive its stock price (Buhl, 2002).

2.4 Factors affecting profitability of business organizations

Profitability is the primary goal of all business ventures. Without profitability the business

will not survive in the long run. Profitability is broadly defined as the rate at which profits are

generated from an investment. Most businesses tend to us the rate of return on assets (ROA)

to measure profitability. Therefore, businesses usually define the rate of return on assets as

the net business income from operations (NFI) plus interest on debt, minus a specific charge

for unpaid management, divided by average total assets. This is a useful measure because,

when uniformly calculated, it is directly comparable between businesses because it is adjusted

for differences in size. In fact any business using this method of profit evaluation can directly

compare their profitability to any others that use the same financial benchmarks. When

national product increases, the output of most firms and the inflationary pressures in the

economy, virtually everyone in the economy has to make the necessary adjustments because

of the lower buying power of money. In actual fact, if the various features of the macro

environment are studied and analyzed thoroughly, it is possible to diagnose and understand

the situations going on within a business and the levels of its profitability (Manasseh, 2000).

14

According to Don Hosfstrand (2006) profitability can be defined in two different ways that is

accounting profitability and economic profitability. Accounting profitability is where positive

results are obtained as a result of deducting business expenses from total income or revenue

(Don Hofstrand 2006) and Economic profitability is where positive results are obtained as a

result of deducting both business expenses and opportunity costs from total revenue or

income. In this case Don (2006) defines opportunity cost as investment returns given up as a

result of not investing your money elsewhere and using it to pay the other related expenses

such as labour.

According to Ariokot (2002); profitability of a firm is affected by the following factors:

2.4.1 Degree of competition of a firm

If a firm has monopoly power then it has little competition, therefore demand will be more

inelastic. This enables the firm to increase profits by increasing the price. If the market is very

competitive then profits will be low. This is because consumers would only buy from the

cheapest firms. Also important is the idea of contestability. Market contestability is how easy

it is for new firms to enter the market. if entry is easy then firms will always face threat of

competition, even if it is just “hit and run competition” this will reduce profits (Sharpp, 1998)

2.4.2 Strength of demand

Turner, (2001) gave an example that demand will be high if the product is fashionable like

mobile phone companies have been very profitable. However in recent months profits for

mobile phone companies have fallen because of the high profit which encouraged over

supply. Products which have falling demand like tinned meat will lead to low profit for the

company (Turner, 2001)

15

2.4.3 State of the company

If there is economic growth then there will be increased demand for most products especially

luxury products which are highly elastic. For example manufactures of luxury sports cars will

benefit from economic growth but will suffer in times of recession.

A successful advertising campaign can increase demand and make the product more inelastic;

however the increased revenue will need to cover the costs of the advertising. Sometimes the

best methods are word of mouth (Yoon, 1998)

2.4.4 Availability of substitutes

If there are many substitutes or the substitutes are expensive the demand for the product will

be higher. Simply complementary goods will be important for the profits of a company

(Yoon, 1998).

2.4.5 Degree of costs

An increase in costs will decrease profits; this could include labour costs, raw material costs

of rent. For example a devaluation of the exchange rate would increase cost of imports

therefore companies who imported raw materials would face an increase in costs (Pacter,

2000). Alternatively if the firm is able to increase productivity by improving technology then

profits should increase. If a firm imports raw materials the exchange rate will be important,

depreciation of a shilling making important more expensive. However depreciation of the

exchange rate is good for exports that will become more competitive.

A firm with high fixed costs will need to produce a lot to benefit from economies of scale and

produce on the minimum efficient scale, otherwise average costs will be too high. For

example in the steel industry we have seen a lot of rationalization where medium sized firms

have lost their competitiveness and had to merger with others (Gorbatova, 2001). If a firm is

16

not dynamically efficient then over time costs will increase. For example state monopolies

often have little incentives to cut costs, like in getting rid of surplus labour. Therefore before

privatization they made little profit, however with the workings of the market they become

more efficient (Millichamp, 2001).

2.4.6 Price discrimination

This involves charging different prices for the same good so the firm can charge higher prices

to those with inelastic demand. This is important for airline firms (Gorbatova, 2001).

2.5 The relationship between foreign exchange fluctuations and profitability

According to Minshkin, (2001) the value of a company’s profitability increases as the stock

prices rises. But (Ajayi and Mougove, 1996) in their investigation found out that stock prices

and exchange rate are positively related. Frequent appreciation of a foreign currency against

local currency makes it difficult to retain local customers because of high prices of imported

input that tend to affect prices of their final products sold locally (Katarikwe and Sebudde,

1999). This therefore implies that a company’s profitability fluctuates because of fluctuations

in currency being translated into fluctuating prices.

Information about financial position and past profitability is frequently used as the basis for

predicting future financial position and profitability among other matters in which users are

directly interested such as dividends and wage payment, security price movements and the

ability of the enterprise to its commitments as they fall due (Nzibonera, 2001). As a result of

the limitations of the traditional profitability performance measures, many researchers have

suggested that a new set of operational profitability measures should be used. The measures

should provide managers, supervisors and operators with on the time information that is

necessary for daily decision-making. These measures should be flexible, primarily non-

17

financial and able to be changed as needed. In response to the new profitability measurement

approaches, many researchers have agreed that time is the new strategic profitability measure

that should be used to drive improvement. Yet, systems based on time-based profitability

measurement have the limitation of over emphasizing the role of time and not considering the

impact of how operational profitability performance measures should be measured, controlled

and improved.

The gain or loss on foreign investments due to changes in the relative value of assets

denominated in a currency other than the principal currency with which a company normally

conducts business. A rising domestic currency means foreign investments will result in lower

returns when converted back to the domestic currency. The opposite is true for a declining

domestic currency.

Investopedia explains that foreign investments are complicated by currency fluctuation and

conversion between countries. A high-quality investment in another country may prove

worthless because of a weak domestic currency. Foreign-denominated debt used to purchase

domestic assets has led to bankruptcy in several cases due to a fast decline in a domestic

currency or a rapid rise in the currency of the foreign-denominated debt.

2.6 Conclusions

From the literature review above it is concluded that foreign exchange which is the process of

trading the currency of one country for the currency of another is very dynamic and will

fluctuate all the time. This is affected by many factors such as economic fundamentals, flight

to safety, balance of payments, political developments, speculation, market sentiment, relative

inflation rates and exchange rate policy. This makes it very unpredictable and one will not

predict which directions the fluctuations will take and with what magnitude.

18

On the other hand Profitability of a company refers to a situation where revenue exceeds the

operational costs. It is also affected by several factors inclusive of the degree of competition

of a firm, the state of the company, availability of substitutes, the degree of costs and price

discrimination.

It can also be concluded that a company’s profitability will fluctuate as the fluctuating foreign

currency is exchanged into the domestic currency. And therefore raising domestic currency

will lead to low profitability when the foreign currency is converted into domestic currency

and the opposite is true for a declining domestic currency.

19

CHAPTER THREE

METHODOLGY

3.0 Introduction

This chapter describes the methods that were followed in conducting the study. It gives

details regarding research design, population of the area of study, sample and sampling

techniques, a description of data collection instruments to be used, as well as the techniques

that were used to analyze data.

3.1 Research design

The research designs that was used in carrying out this research are Cross sectional research

design which takes a snapshot of a population at a certain time, allowing conclusions about

phenomena across a wide population to be drawn, Descriptive research design whose main

goal is to describe the data and characteristics about what is being studied, and studies

frequencies, averages, and other statistical calculations and the Causal approach of research

design which analyzed the problem through cause and effect' line of reasoning.

3.2 Population of study

The population of the study included the employees and management or administrators of

Mairye Estate limited. The company has 75 employees who are administrators.

3.3 Sampling designs

The sampling designs to be used by the researcher to select the sample are, Purposive

sampling design is where the researcher targeted administrators believed to be more

knowledgeable about the effect of foreign exchange fluctuations on the profitability of Mairye

Estate limited as an export company together with Convenience sampling design where

20

researcher considered the administrators of Mairye Estate limited that can be accessed and

available.

3.4 Sample size

The study selected 63 respondents using the above designs who participated in the study.

These represented the rest of the employees in the company to establish the effect of foreign

exchange fluctuations on the profitability of Mairye Estate limited as an export company.

3.5 Data sources

These were the areas where information was acquired for research purposes. This included

Primary sources and secondary sources.

3.5 Primary sources

Primary data is the data which is collected by the researcher directly from his own

observations and experiences or those data which are collected for the first time, Methods of

collecting data here include; Observation, Interview, Questionnaire.

3.5.2 Secondary sources

Secondary data is information gathered for purposes other than the completion of the research

project. In other words   those data, which are already published. It may be useful for many

other persons than the researcher who has published it. This data is got from secondary

sources which are categorised into internal sources including; profitability reports,

Accounting and financial records or external sources like Trade associations, Magazine and

newspaper articles, Library sources and the Internet.

3.6 Data collection methods

The following Data collection methods were used in collecting data

21

3.6.1 Observation

Observation was used to carry out documentary review. The documents under observation

were News papers and financial reports of Mairye Estate limited.

3.6.2 Survey

The researcher used the Survey to get to the respondents to complete the questionnaires.

3.7 Instruments of data collection

The following instruments were used by researcher in collecting data

3.7 Questionnaire

A questionnaire is a research instrument consisting of a series of questions and other prompts

for the purpose of gathering information from respondents. Questionnaires have advantages

over some other types of surveys in that they are cheap, free from bias and do not require as

much effort from the questioner as verbal or telephone surveys, and often have standardized

answers that make it simple to compile data. Some questions were open ended while others

close ended.

3.7.2 Documentary review

The following documents were reviewed in the collection of data. News papers were looked

at to get the exchange rates of the period 2000 to 2010. And financial reports of Mairye Estate

limited were used to get the profitability trend of the same period.

3.8 Data processing, analysis and presentation

3.8.1Data processing

It involves transformation of data into information through classifying, sorting, merging,

recording, retrieving, transmitting, or reporting. Data processing can be manual or computer

based. Data from this research was coded, entered, edited for consistency and easiness

22

3.8.2Data analysis

Data was analyzed using Statistical Package for Social Scientists (SPSS) where correlation

was used to establish the relationship between cost management and profitability.

3.8.3 Data presentation

Data got was presented in form of frequency tables, pie charts and bar graphs to give

meaningful interpretation of the study.

23

CHAPTER FOUR

PRESENTATION, ANALYSIS AND DISCUSSION OF FINDINGS

4.1 Introduction

This chapter presents analysis and discussion of findings and it is arranged according to the

study objectives which include establishing the causes of causes of foreign exchange rate

fluctuations, determinants of profitability in Mairye Estate Limited and the relationship

between foreign exchange fluctuations and profitability of Mairye Estate Limited.

4.2 Demographic characteristics of respondents

Table 1: Sex of respondents

Sex Frequency Percentage

Male 37 58.7

Female 26 41.3

Total 63 100

Source: Primary data

From Table 1 above, 58.7% of respondents were males whereas 41.3% were females and the

findings implied that Mairye Estate employees more males than the females.

Table 2: Age of respondents

Age Frequency Percentage

Below 18 - -

19-25 11 17.5

26-40 32 50.8

Above 40 years 20 31.7

Total 63 100

Source: Primary data

24

From Table 2 above, 50.8% of the participants in the study were aged between 26-40 years,

followed by 31.7% who were aged above 40 years and only 17.5% were aged between 19-25

years. The above findings however implied that the target group of participants in the study

reached was deemed to be mature and provide reliable information about the exchange

fluctuations and how they affect their company’s profit levels.

Table 3: Religion of respondents

Religion Frequency Percentage

Christian 54 85.7

Muslim 9 14.2

Others - -

Total 63 100

Source: Primary data

Table 3 above shows that 85.7% were Christians whereas 14.2% were Muslims and there was

no other religious denomination apart from these two mentioned. The findings therefore

implied that all the religious denominations participated in the study.

Table 4: Marital status

Status Frequency Percentage

Married 41 65.1

Single 22 34.9

Total 63 100

Source: Primary data

From Table1.4 above, 65.1% of the respondents were married whereas 34.9% not married

which means that many married people participated in the study which gave reliable

information about the study.

25

Table 5: Period of stay with Mairye Estate limited

Period Frequency Percentage

Less than 1 year 3 4.8

1-5 years 19 30.2

6-10 years 31 49.2

Above 10 years 10 15.8

Total 63 100

Source: Primary data

From Table 5 above, 49.2% of the respondents revealed that they had worked with the

company for a period between 6-10 years and 30.2% said that they had worked for the

company for a period between 1-5 years. More so, 15.8% noted that they had spent more than

10 years working with Mairye Estate and only 4.8% had only spent less than a year with the

company. The results above therefore imply that respondents who had stayed for long in the

company were the majority to participate in this study. Therefore, they were believed to have

the required information regarding foreign exchange fluctuations than employees who had

worked in the company for few years.

4.3 Foreign exchange rate fluctuations

Table 6: Predictability of Uganda shilling against dollar

Response Frequency Percentage

Yes 11 17.5

26

No 52 82.5

Total 63 100

Source: Primary data

Results from Table 6 show that 82.5% of the respondents revealed that it is not easy to predict

the Uganda shilling against a dollar whereas only 17.5% noted that the dollar can be

predictable. The findings above show that Uganda shillings cannot be predicted against a

dollar an implication that the dollar is always valuable as against the Uganda shillings since

the shilling cannot be predictable against a dollar.

Table 7: Reasons for unpredictability of Uganda shilling against dollar

Reasons Frequency Percentage

Forces of demand and supply for the

dollar in the currency markets

33 52.4

Speculative demand and supply for the

dollar

29 46

Interest rates 1 1.6

Total 63 100

Source: Primary data

From Table 7 above, 52.4% revealed that it was because of the forces of demand and supply

for the dollar in the currency markets whereas 46% said it was because speculative demand

for the dollar and only 1.6% noted that it was because of the interest rates. Regarding the

findings in the table above, the forces of demand and supply for the dollar makes the Uganda

shilling unpredictable against a dollar. Respondents argued that when currency markets

speculate an increase in demand for the dollar, they reduce the dollars on markets such that its

27

selling price increases due to its increased demand which s not the case for the Uganda

shillings

Figure 1: Fluctuation of Uganda shilling against the dollar

Yes; Percentage; 68.3; 68%

No; Percentage; 31.7; 32%

Percentage

YesNo

Source: Primary data

Results in Figure 1 above show that 68.3% revealed that Uganda shillings actually fluctuates

against a dollar but 31.7% disagreed with this view and said that it was instead the dollar

which fluctuates against a shilling. The above findings therefore implied that Uganda shilling

fluctuates against the dollar meaning that as a dollar gains value, Uganda shilling

continuously loses value in monetary terms which in turn affects profitability.

Table 8: Reasons for the shilling fluctuation against a dollar

Reasons Frequency Percentage

Terms of Trade 11 17.5

Level of Inflation 27 42.9

28

Speculation 21 33.3

Differentials in Interest Rates 4 6.3

Total 63 100

Source: Primary data

From Table 8 above, 42.9% and 33.3% revealed that the level of inflation and speculation

were the main reasons why the shilling was fluctuating against a dollar. More so, 17.5% said

that the unfavorable terms of trade with other countries makes the shilling fluctuate against a

dollar but 6.3% noted that it was because of interest rate differentials that the shilling

fluctuates against a dollar. The above findings therefore implied that the main reasons why

the shilling was fluctuating against a dollar was because inflation and speculation

Table 9: Causes of exchange rate fluctuations

Causes Frequency Percentage

Terms of Trade 11 17.5

Differentials in Inflation 21 33.3

Speculation 22 34.9

Differentials in Interest Rates 3 4.8

Political Stability and

Economic Performance

6 9.5

Total 63 100

Source: Primary data

Results in Table 9 above show that 33.3% revealed that it was because of differentials in

inflation because a country with a consistently lower inflation rate exhibits a rising currency

value, as its purchasing power increases relative to other currencies while those countries with

higher inflation typically see depreciation in their currency in relation to the currencies of

29

their trading partners which affects the businesses. More so, differentials in interest rates

cause exchange rate fluctuations. Speculation and Terms of Trade cause exchange rate

fluctuations as shown by 34.9% and 17.5% responses because who noted that if the price of a

country's exports rises by a greater rate than that of its imports, its terms of trade have

favorably improved.

Majority of the respondents (4.8%) noted that interest rates, inflation and exchange rates are

all highly correlated. Political Stability and Economic Performance was also shown to cause

exchange rate fluctuations where 9.5% noted that a country with such positive attributes will

draw investment funds away from other countries perceived to have more political and

economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and

a movement of capital to the currencies of more stable countries. The above findings

therefore implied that speculation and inflationary tendencies are the main causes of exchange

rate fluctuations.

4.4 Level of profitability of Mairye Estate Limited.

Table 10: Measuring profitability in Mairye Estate Limited

Measure Frequency Percentage

Sales volume 34 54

Return on capital employed 13 20.6

Gross profit margin ratio 16 25.4

Total 63 100

Source: Primary data

From Table 10 above, 54% of the respondents revealed that the sales volume gained by the

company determines the profitability levels in the company whereas 20.6% said that it is the

return on capital employed measures the profit levels in the company but 25.4% said that

30

gross profit margin ratio was one of the determinants of profitability in Mairye Estate. The

above findings however implied that the profit margin was the main determinant of

profitability in the company however much there are other moderating determinants of profit

levels in the company.

Table 11: Factors that affect the profitability of Mairye Estate Limited

Factors Frequency Percentage

Costs incurred by the firm 13 20.6

Demand for the product 7 11.1

Competition 9 14.3

Price and exchange rate

fluctuations

31 49.2

Availability of substitutes 3 4.8

Total 63 100

Source: Primary data

Results in Table 11 above show that 49.2% revealed that the prices and exchange rate

fluctuations affect the profitability of the company whereas 20.6% noted that the costs

incurred by the firm determines how much profits the company gets after sale of the products.

Furthermore, 11.1% and 14.3% of the respondents noted that the demand for the product and

competition affect the profit levels of the company but 4.8% also revealed that the availability

of substitutes has an effect on the profitability of Miarye Estate Company. The findings

implied however implied that price and exchange rate fluctuations were the main factors that

affect the profitability of Mairye Estate limited an indication that once the fluctuations are

unfavorable, the profits will go down.

Table 12: Consistency of profitability in Mairye Estate Limited

31

Response Frequency Percentage

Yes 24 38.1

No 39 61.9

Total 63 100

Source: Primary data

Table 12 above shows that 61.9% of the respondents revealed that the level of profitability

was not consistent in the company whereas 38.1% said that the profitability level was

consistent in Mairye estate limited. The findings implied however that the level of profits was

not consistent as revealed by majority of the participants in the study. Several reasons were

however given for the inconsistency of profits in Mairye Estate Limited as discussed in table

below.

Table 13: Reasons for the inconsistency of profitability in Mairye Estate Limited

Reasons Frequency Percentage

Increasing competition 11 17.5

Increased inflationary tendencies 10 15.9

High interest rates 6 9.5

Increased speculation in business 7 11.1

Unfavorable exchange rate

fluctuations

29 46

Total 63 100

Source: Primary data

From Table 13 above, 46% noted that unfavorable exchange rate fluctuations have the

biggest impact on profit level of Mairye Estate whereas 17.5% and 15.9% revealed that

increased competition from similar exporters of flowers and inflation lead to the

32

inconsistency of profitability in the company respectively. Higher interest rates attract foreign

capital and cause the exchange rate to rise and the fact that the company sells its products in

foreign currency, the rise in interest rates reduces their profits as shown by only 9.5%

response. The above findings however still bring out unfavorable exchange fluctuations as the

main cause of inconsistency of profitability in Mairye Estate Limited.

4.5 Relationship between exchange rate fluctuations and the profitability of Mairye

Estate limited

Table 14: Currencies accepted during sales in Mairye Estate Limited

Response Frequency Percentage

Dollar 63 63

Total 63 100

Source: Primary data

Table 14 shows that all the respondents revealed that the dollar is the only currency accepted

during the sale of their flowers and other products for the company. This implied therefore

that the dollar being the only currency accepted, its exchange rate has a direct impact on how

much the company earns, which eventually determines the profit level in the long run.

Figure 2: Exchange rate of a dollar since 2000

33

Rate in Ug Shs

Rate in Ug Shs

Source: Bank of Uganda Estimates as per December 2010

According the estimates given by Bank of Uganda, the US dollar has been increasing steadily

over the previous years and its increase in value implies that the local Ugandan currency loses

value over a dollar. The statistics show that in 2010, one dollar was worth 2308/= Uganda

shillings which is a very high value. This implies that the dollar is valued highly and any

transaction using a dollar affects that transaction negatively.

Figure 3: Relationship between exchange fluctuations and the profitability of Mairye

Estate limited

34

Yes; Percentage; 74.6; 75%

No; Percentage; 25.4; 25%

YesNo

Source: Primary data

From Figure 3 above, 74.6% of the respondents revealed that there is a relationship between

exchange fluctuations and the profitability of Mairye Estate limited but only 25.4% disagreed

saying that exchange fluctuations are not related to the profitability of Mairye Estate limited.

It should be noted however that since the majority are in support of the idea, exchange

fluctuations are related to the profitability of Mairye Estate limited. Furthermore, emphasis

should also be put on whether it is a negative relationship or a positive relationship. The fact

that the relationship exists can be explained to be a negative relationship because it implies

that the increasing unfavorable exchange fluctuations reduce the profits of the company

because if the fluctuations are high, profits have to be low and viceversa

Table 15: Statements showing the relationship between exchange fluctuations and the

profitability of Mairye Estate limited

Statement Frequency Percentage

35

Stock prices and exchange rate are positively

related

3 4.8

Company’s profitability fluctuates because of

fluctuations in currency

6 9.5

Increase in fluctuations reduces profitability of

Mairye estate

28 44.4

There is a relationship between exchange

fluctuations and profitability

18 28.6

Fluctuation affect the capital stock of the

company

8 12.7

Total 63 100

Source: Primary data

From Table 15 above, majority of the respondents (44.4%) revealed that Increase in

fluctuations reduces profitability of Mairye estate whereas 28.6% also noted that there is a

relationship between exchange fluctuations and profitability. More so, 12.7% said that

fluctuation affect the capital stock of the company but 9.5% and 4.8% also noted that stock

prices and exchange rate are positively related and Company’s profitability fluctuates because

of fluctuations in currency respectively. The above findings on the statement however can

prove that respondents were convinced that exchange fluctuations were related to the

profitability of Mairye Estate limited.

Table 16: Effect of Exchange fluctuations and profitability of Mairye Estate Limited

Response Frequency Percentage

Yes 47 74.6

No 16 25.4

36

Total 63 100

Source: Primary data

From Table 1.16 above, 74.6% of the respondents revealed that exchange fluctuations affect

the profitability of Mairye Estate Limited but only 25.4% disagreed with the idea saying that

exchange fluctuations don’t have an effect on profitability of Mairye Estate Limited. This

also implied that exchange fluctuations have an effect on the profitability of Mairye Estate

limited. Therefore, a negative effect affects the company’s profits negatively and positive

effect also affects the profits positively.

Table 17: How Exchange fluctuations affect profitability of Mairye Estate Limited

Reasons Frequency Percentage

Fluctuations reduce operating

income of the firm.

6 9.6

Fluctuations expose the company to

foreign-exchange risk

20 31.7

Lead to reduction in company’s

profit margins

37 58.7

Total 63 100

Source: Primary data

From Table 17 above, there were three main dimensions given by the respondents on how

exchange fluctuations affected the profitability of Mairye Estate Limited. Majority of the

respondents (58.7%) revealed that fluctuations lead to reduction in company’s profit margins

whereas 31.7% noted that fluctuations expose the company to foreign-exchange risk and

9.6% finally revealed that fluctuations reduce operating income of the firm. The above

findings therefore implied that exchange fluctuations affect profitability of Mairye Estate

37

Limited but the majority identified the effect to be on the company’s profit margin which

therefore justifies that exchange fluctuations affect a company’s profitability.

Table 18: Other Factors that affect the profitability of Mairye Estate Limited

Other factors Frequency Percentage

Competition with other

companies

13 20.6

Availability of substitutes 17 27

Low demand for the products 27 42.9

Political instability 6 9.5

Total 63 100

Source: Primary data

Results in Table 18 above shows that apart from exchange fluctuations, the respondents noted

several other factors that affect the profitability of Mairye Estate Limited with 42.9%

revealing that reduction in demand for the products affects profitability whereas 27% said that

availability of substitutes has an effect on profits and 20.6% noted that stiff competition with

other companies has an effect on profits but only 9.5% revealed that political instability also

affects the profitability of the company because the buyers divert their demand to other stable

companies where the products can be exported without risk. The findings above therefore

implied that the demand for the products and competition from the rival companies affects the

profitability due to the reduction in sales of the company.

38

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION, RECOMMENDATIONS AND AREAS

FOR FURTHER STUDY

Introduction

This chapter presents the summary of findings, conclusion and recommendations about the

study findings and it is also arranged according to the study objectives which include

establishing the causes of causes of foreign exchange rate fluctuations, determinants of

39

profitability in Mairye Estate Limited and the relationship between foreign exchange

fluctuations and profitability of Mairye Estate Limited.

5.1 Summary of study findings

5.1.1 Findings on causes of foreign exchange rate fluctuations.

The study findings revealed that differentials in exchange rates and high levels of inflation

cause foreign exchange fluctuations. The terms of trade between the two trading partners also

cause exchange fluctuations. Most of the respondents also revealed that it is not easy to

predict the Uganda shilling against a dollar an implication that the dollar is always valuable as

against the Uganda shillings. Regarding the reasons for unpredictability of Uganda shilling

against a dollar, findings revealed that it was because of the forces of demand and supply for

the dollar in the currency markets and speculative demand for the dollar. This is in line with

Dwivedi, (2002) who notes that under the same currency rate, the nation loses on exports and

gain in imports. In the currency market, the demand of foreign currencies increases, therefore

causing the appreciation of foreign currencies.

Findings also revealed that the Uganda shilling fluctuates against the dollar which implied

that as the dollar gains value, the Uganda shilling continuously loses value in monetary terms.

The level of inflation and speculation were the main reasons why the shilling was fluctuating

against a dollar. The above findings are in line with Dwivedi, (2002) who also noted that

speculation or the anticipation of the market participants many a times is the prime reason for

exchange rate movements.

The findings are also supported by Steve Johnson, (2010) who revealed that if a nation has

over issued its currency which exceeds the demand in product purchasing, there will be

inflation. Inflation decreases the purchasing power of the people and therefore leads to

40

currency depreciation. He also noted that the change in inflation rate changes the demand and

supply in currencies, bonds, and currency value expectation. Inflation leads to higher product

price internally.

5.1.2 Findings on determinants of profitability in Mairye Estate Limited.

Findings revealed that exchange rate fluctuations had the most response regarding how they

affect the profitability of the company which implied exchange rate fluctuations were the

main factors that affect the profitability of Mairye Estate limited an indication that once the

fluctuations are unfavorable, the profits will go down.

Findings also revealed that sales volume by the company determines the profitability levels in

the company which implied sales volume was among the main determinant of profitability in

the company however, there are other moderating determinants of profit levels in the

company. This is line with (Buhl, 2002) who notes that the amount of sales determines

profitability in an organization.

On the consistency of profitability in Mairye Estate Limited, findings revealed that the level

of profitability was not consistent in the company. Several reasons were however given for

the inconsistency of profits in Mairye Estate Limited and these were said to be, unfavorable

exchange rate fluctuations and increased competition from similar exporters of flowers plus

inflation which however still brings out unfavorable exchange fluctuations as the main cause

of inconsistency of profitability in Mairye Estate Limited. This is line with Ariokot (2002)

who noted that profitability of a firm is affected by the following factors like competition,

costs of production and interest rates among others.

5.2.3 Findings on the Relationship between foreign exchange fluctuations and

profitability of Mairye Estate Limited.

41

Findings revealed that foreign exchange fluctuations affect the profitability of Mairye Estate

Limited which implied that there is a relationship between exchange fluctuations and the

profitability of Mairye Estate limited. It should be noted however that since the majority are

in support of the idea, exchange fluctuations are related to the profitability of Mairye Estate

limited. The fact that the profits are low, it implies that the exchange fluctuations are

unfavorable. The study findings also showed that exchange fluctuations have an effect on

profitability of Mairye Estate Limited. The findings showed that majority of the respondents

revealed that fluctuations lead to reduction in company’s profit margins and reduce operating

income of the firm. The above findings therefore implied that exchange fluctuations affect

profitability of Mairye Estate Limited but others identified the effect to be on the company’s

Sales volume which therefore justifies that exchange fluctuations affect a company’s

profitability. The study findings are in line with (Ajayi and Mougove, 1996) who found out

that stock prices and exchange rate are positively related.

The study findings are further supported by Katarikwe and Sebudde, (1999) who revealed

that frequent appreciation of a foreign currency against local currency makes it difficult to

retain local customers because of high prices of imported input that tend to affect prices of

their final products sold locally. This therefore implies that a company’s profitability

fluctuates because of fluctuations in currency being translated into fluctuating prices.

5.3 Conclusion

In a nut shell therefore, exchange fluctuations are related to the profitability of the company

and unfavorable fluctuations affect profits negatively whereas favorable fluctuations affect

profits positively. It should also be noted that the exchange rate of the currency in which a

portfolio holds the bulk of its investments determines that portfolio's real return. A declining

42

exchange rate obviously decreases the purchasing power of income and capital gains derived

from any returns. Moreover, the exchange rate influences other income factors such as

interest rates, inflation and even capital gains from domestic securities. Furthermore,

exchange is not the only determinant of profitability of a company and that is why factors like

competition, costs of production and substitutes among others are shown to also have an

effect of profits of a firm.

5.4 Recommendations

Regarding the study findings, the researcher recommended the following;

On the cause of exchange rate fluctuations, there is need for investors to have some

understanding of how currency values and exchange rates play an important role in the rate of

return on their investments since exchange rates are determined by numerous complex factors

that often leave even the most experienced economists sleepless. Export companies need to

adopt and start using a 'Forward Contract' to reduce the effect of fluctuations on their

businesses.

For Mairye Estate to increase profits, the company needs to increase sales volume for a better

profit margin since these are the main determinants of profitability in the company.

Increasing sales volume may appear to be an easy way of increasing profitability, but this is

not necessarily the case. If you increase your sales volume, you must at the same time

rigorously control costs, prices, capital employed, and your product/service mix. Be sure that

none of these four other components of profitability increases disproportionately; if they do,

increased sales reduce instead of increase profits.

Regarding the relationship between foreign exchange fluctuation and profitability, the

company needs to ensure that it struggles to have improved terms of trade since they

43

determine the rate of fluctuations in foreign exchange. The company also needs to ensure that

the government supports them by ensuring that it controls the rate of inflation which

fluctuates exchange rate and it also affects their levels of profitability in the long run.

5.5 Areas for further research

i. Foreign exchange risk and performance of multinationals

ii. Foreign exchange risk management and profitability of export companies

iii. Exchange policies and foreign exchange fluctuations

References

Abor, Joshua (2005). Managing foreign exchange risk among Ghanaian firms, Journal of

Risk Finance, United Kingdom.

Arora (2002), Long-Run Real Exchange Rates, in Handbook of International

Economics, ed. By Gene Grossman and Kenneth Rogoff, Vol. 3

(Amsterdam: North-Holland).

Black, John (2003). Oxford Dictionary of Economics. New York: Oxford University Press.

44

Buhl G, (2002). Exchange Rate Assessment: Extensions of the

Macroeconomic Balance Approach, Occasional Paper No. 167

(Washington, International Monetary Fund).

David Black (2003), Exchange Rate Fluctuations and Profitability of Organisations, New

York, Prentice Hall.

Don Hosfstrand (2006). Foreign Exchange Rates and Their Impact on Trade,

Investment and Profitability in the APEC Region, Occasional Paper No. 145.

Dwivedi, M, (2002) “Exchange Rate Economics: What’s Wrong with the Conventional

Macro Approach?” in The Microstructure of Foreign Exchange Markets, ed. By Jeffrey A.

Frankel, (Chicago: University of Chicago Press).

Eiteman P, (2008) "Real Exchange Rate Levels and Economic Development: Theoretical

Analysis and Empirical Evidence," Sao Paulo Business Administration School, Getulio

Vargas Foundation, 2007.

Eleftherioss, R, (2007). The price of one country's currency expressed in another country's

currency, Published by Houghton Mifflin Company.

Emmanuel T M, 2001). Speculation in the banking sector and exchange rates, Central

Banking-Uganda, 30 Jan 2001.

Flybjerg, B. (2008). An International Comparison of National Products and the

Purchasing Power of Currencies: A Study of the United States, the United

Kingdom, France, Germany, and Italy (Paris: Organization for European

Economic Cooperation).

Hsing, Y., (2004). Impacts of Fiscal Policy, Monetary Policy, and Exchange Rate Policy on

Real GDP in Brazil: A VAR Model, Brazilian Electronic Journal of Economics.

45

Jack Hirshleifer & David Hirshleifer (2005). Price theory and applications: decisions,

markets, and information. Cambridge University Press. ISBN 9780521818643.

http://books.google.com/books?id=VbrKgDK-rioC. Retrieved 20 December 2010.

Jennings, P, (2000). A Survey of Empirical Research on Nominal Exchange Rates,” in

Handbook of International Economics, ed. by Gene Grossman and Kenneth Rogoff, Vol. 3

(Amsterdam: North-Holland).

Massey, K. (2007). Interest Rate impact on Debt and company performance [Online].

Available: http://www.finweek.com.

O'Sullivan, A, Steven M. & Sheffrin (2003). Economics: Principles in action. Upper Saddle

River, New Jersey 07458: Pearson Prentice Hall. pp. 458. ISBN 0-13-063085-3.

Sheffrin M, (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458:

Pearson Prentice Hall. pp. 458. ISBN 0-13-063085-3.

Steve Johnson (2010), New world currency index launch, Published: October 24 2010 12:07 |

Last updated: October 24 2010 12:07, United Kingdom.

Subramaniam V, (2007), Economics/Currency fluctuations, University of Madras, India.

Questionnaire to employees

Introduction

46

I am Tumwebaze Dorothy Mbabazi a student of Makerere University and carrying out a study on a

topic Foreign exchange fluctuations on the Profitability of Mairye Estate limited as an export

company. I am requesting you kindly to spare me some of your valuable time and respond to my

questionnaire. All the information provided will be used for academic purposes only and treated with

utmost confidentiality.

Thank you

SECTION A

Demographic characteristics of respondents

1. What is your sex?

Male Female

2. How old are you?

Below 18 years 19-25 26-40 Above 40 years

3. What is your religion?

Christian Moslem None

4. Are you married? Yes No

47

5. How long have you worked with Mairye Estate limited?

Less than 1 year 1-5 years 6-10 years Above 10 years

SECTION B

Questions on foreign exchange rate fluctuations.

6. How do you define foreign exchange?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

7. What is exchange rate fluctuation?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

8. Is the rate of the Uganda shilling against dollar predictable?

Yes No

Give reasons for your answer above

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

9. In your view does the Uganda shilling fluctuate a lot against the dollar?

Yes No

Give reasons for your answer above

48

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

10. What are the causes of exchange rate fluctuations?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………..

……………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………

SECTION C

Questions on profitability of Mairye Estate Limited.

11. How do you define profitability?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

12. How does Mairye Estate Limited measure profitability?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

13. What Factors affect the profitability of Mairye Estate Limited?

49

……………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………

14 Is Mairye Estate Limited’s profitability consistent?

Yes

No

Give reasons for your answer above?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

15. Do exchange fluctuations affect the profitability of Mairye Estate Limited?

Yes

No

Give reasons for your answer above

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

SECTION D

Questions on Relationship between exchange rate fluctuations and the profitability of Mairye

Estate limited

50

16. In what currencies are your sales?

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

17. Is there a relationship between exchange fluctuations and the profitability of Mairye Estate

limited?

Yes No

Give reasons for your answer above

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

18. Do exchange fluctuations have any diverse effect on the profitability of Mairye Estate limited?

Yes No

Give reasons for your answer above

……………………………………………………………………………………………………………………………………………………………

…………………………………………………………………………………………………………………………………………………………

19. How do foreign exchange fluctuations affect the profitability of Mairye Estate limited?

……………………………………………………………………………………………………………………………………………………………

………………………………………………………………………………………………………………………………………………………..

20. What other Factors affect the profitability of Mairye Estate Limited?

51

……………………………………………………………………………………………………………………………………………………………

……………………………………………………………………………………………………………………………………………………………

………………………………………………………………………………………………… Thank you for your

cooperation

52