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Impact of Inventory Management on a Firm’s Financial Performance

A Review of Related Literature in fulfilment of the requirements for

Financial Accounting and Reporting

at

CENTRAL MINDANAO UNIVERSITY

College of Business and Management

Department of Accountancy

Submitted by:

Melch Cathleen M. Absuelo BSAccy - 2018300928

Kathlyn Kate M. Cruzante BSMA – 2018300144

Aira Jane C. Perez BSMA – 2018300072

Submitted to:

RAYMOND S. PACALDO, CPA, MSA

May 23, 2019

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Introduction

Inventory is the supply of raw materials, partially finished goods called work-in-progress

and finished goods, an organization maintains to meet its operational needs. It represents a sizeable

investment and a potential source of waste that needs to be carefully controlled. Inventory is

defined as a stock of goods that is maintained by a business in anticipation of some future demand.

The quantity to which inventory must fall to a signal that an order must be placed to replenish an

item (Sheikh,2018).

Small business owners need financial information from their operations to determine

whether the business is profitable. It helps in making decisions like whether to continue operating

the business, whether to improve business strategies or whether to give up on the business

altogether.

Since, inventory refers to the stock of the resources which are held to sales and/or future

production it can be also viewed as an idle resource which has an economic value. Better

management of the inventories would release capital productively. Inventory control implies the

coordination of materials controlling, utilization and purchasing. It is also the purpose of getting

the right inventory at the right place in the right time with right quantity because it is directly

connected with the production. This implies that the profitability of the firm is directly or indirectly

affected by the inventory management. (Klingenberg, Timberlake and Geurts, 2015).

Consequently, this paper aims to answer the importance of inventory management system relating

to the entity’s financial performance.

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Literature

In the journal entitled “Economic Order Quantity Model” by Kumar year 2016 stated that

inventories are the assets of the firm and at the same time they describe an investment. Such

investment needs a commitment of funds; thus a firm has to keep inventories at the accurate level.

If the stocks are too large, the firm loses the chance to employ the funds more efficiently. Likewise,

if they become too small, the firm might lose sales. Thus, there is an optimal level of inventories.

The economic ordering quantity is used to compute the optimum quantity that can be procured to

reduce the carrying and ordering costs.

A journal by Amahalu, Nweze and Chinyere revealed in 2017 the “Effect of Backflush

Accounting on Financial Performance of Quoted Food and Beverage Firms in Nigeria” that

backflush accounting has a positive and statistically significant effect on Return on Assets (ROA),

Return on Equity (ROE), and Earnings per Share (EPS) of food and beverage firms quoted on the

floor of Nigerian Stock Exchange at 5% level of significance.

“The Impact of Efficient Inventory Management on Profitability: Evidence from Selected

Manufacturing Firms in Ghana by Prempeh on 2016, showed that there is a significant positive

relationship between inventory management and profitability wherein it also plays a significant

role not only in the financial statement but also in the operational activities of the organization. It

is also stated that there should be optimum inventory maintained. This study also highlights that if

they could properly implement and monitor the norms and methods of inventory management,

they can maximize the profit with minimum cost.

Ogbo, Victoria and Ukpere acknowledged in their journal “The Impact of Effective

Inventory Control Management on Organisational Performance: A Study of 7Up Bottling

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Company Nile Mile Enugu, Nigeria” year 2015 presented the flexibility of an inventory control

management as an important approach to achieve organizational performance in which it includes

the following benefits, improved sales effectiveness, reduced operational cost and convenience of

storage and retrieval of material.

Liu and Wu (2018) emphasized in their journal “Reform of Inventory Standards,

Informatization and Inventory performance: An Empirical Study Based on Listed Manufacturing

Companies” that both information technology investment and changes in inventory criteria can

significantly improve the inventory performance of manufacturing companies. Moreover, after the

change of the inventory policies, the effect of corporate IT investment on the performance of

manufacturing companies’ inventory will increase.

Managing inventory costs is important to the firm because inventory produces no value for

the firm until it is sold, can hide inefficiencies in production activities and is a significant

investment according to the book of Kinney and Raiborn entitled “Cost Accounting Foundations

and Evolutions” year 2019.

Another literature about the effect of inventory management on financial performance:

evidence from Nigerian conglomerate companies in 2016 by Ahmed that the relationship between

inventory management and financial performance of conglomerate companies reveals that an

efficient management of the inventory cycle would enhance the profitability of the company.

In the journal by Lancioni and Howard “Inventory Management Techniques” on 2015

states that inventory management is an extremely important function to any business, since

inadequacies in control can result in serious problems. If inventories are managed in an inefficient
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manner, it is likely that delays in production, dissatisfied customers, or curtailment of working

capital will result.

Stated in the study “Effect of Inventory Management Efficiency on Profitability: Current

Evidence from the US Manufacturing Industry” of Shin, Ennis and Spurlin in 2015 that there is a

limited evidence of improved financial performance related to inventory management practices. A

lower ratio of inventory to sales for a firm is associated with higher profit margin for the firm. In

addition, small size firms can receive a larger benefit (as measured by profitability) form increased

inventory efficiency when compared to medium and large size firms. The importance of an

inventory management yielding the following benefits coping up with the increased sales,

satisfying the customers, to check the stock and to increase the sales in the journal of Sravani and

Rao named “Scope and Importance of Inventory Management Techniques in Business Operations:

A Systematic Review”, 2017.

In short, managing an inventory stated in Accounting Principles of Weyghandt, Kimmel

and Kieso, 2015 that it has been a key reason for the business’ past success and will very likely

play a huge part in the future profitability as well.

In the journal entitled “The Impact of Inventory Lead-Time on Demand: Evidence from

the Italian Retail Industry” in 2016 by Marino and Zotteri that using a good kind of inventory

management process is essential for any retail company. The daily transaction of goods in a retail

company is huge and it is important for the company to keep track on every single item that comes

to it and given to the customers. A big company with a proper market hold should definitely use

all the necessary procedures to check the inventory in a daily basis.

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In 2015, Shardeo uttered in his journal the “Impact of Inventory Management on the

Financial Performance of the Firm” that inventory management improves the level of customer

satisfaction since the customer wanted a product at least time as possible. Firms then must install

the optimal inventory control techniques or improve their asset turnover as much as possible.

A research demanded to reduce the product cost and improve the quality with reduced

failure rates. Accordingly, for a company to survive for a long run it should focus on the chain and

inventory area stated by Singh and Verma in “Inventory Management in Supply Chain, 7th

International Conference of Materials Processing and Characterization” on 2018.

Sitienei and Memba indicated in their journal entitled, “The Effect of Inventory

Management on Profitability of Cement Manufacturing Companies in Kenya” year 2015 that

entities inventory systems must maintain an appropriate inventory levels to enhance profitability

and reduce the inventory costs associated with holding excessive stock in warehouses.

Conclusion

In an entity, inventory is the quintessence for their operations. Based on the literature

previously mentioned, inventory management system has a positive effect on the entities’ financial

performance where it provides an increase in sales, high satisfaction among customers,

conveniently monitors the current updates of inventories which prevent big or unexpected losses.

Furthermore, having a good inventory management system may result to a stringent internal

control which would avoid fraud in the entity. Maintaining a good inventory management may

create a better net income that may attract new investors.

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On the contrary, having inventory management in a business is not yet proven to affect the

financial performance of an entity. In fact, some of the entity shows an increase even without using

inventory management, for they say using the procedure may take a lot of time and can often cause

agitation.
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References

Ahmed, A. D. (2016). Effect of inventory management on financial performance: Evidence from

Nigerian conglomerate companies. World Academy of Science, Engineering and

Technology Journal of Social, Behavioral, Educational, Economic, Business and

Industrial Engineering, 3182-3186.

Amahalu, N., Nweze, C., Chinyere, O. (2017). Effect of Backflush Accounting on Financial

Performance of Quoted Food and Beverage Firms in Nigeria. EPH - International Journal

of Medical and Health Science, 58-80.

Kinney, M. R., & Raiborn, C. A. (2019). Cost Accounting Foundations and Evolutions, Tenth

Edition. United States.

Kumar, R. (2016). Economic order quantity model. Global Journal of Finance and Economic

Management, Vol 5.

Lancioni, R.A. ; Howard, K. (2015). Inventory management techniques. International Journal of

Physical Distribution & Materials Management, Vol 8, 385-428.

Liu, J., Wu, J. (2018). Reform of Inventory Standards, Informatization and Inventory Performance:

An Empirical Study Based on Listed Manufacturing Companies. 2nd International

Conference on Culture, Education and Economic Development of Modern Society

(ICCESE 2018).

Marino, G., & Zotteri, G. (2016). The impact of delivery lead-time on demand: Evidence from the

Italian retail industry. Retrieved from http://porto.polito.it

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Ogbo, A., Victoria, O.I., Ukpere, W.I. (2015). The Impact of Effective Inventory Control

Management on Organisational Performance: A Study of 7up Bottling Company Nile Mile

Enugu,Nigeria. Mediterranean Journal of Social Sciences, 2039-2117.

Prempeh, K. (2016). The impact of efficient inventory management on profitability: evidence from

selected manufacturing firms in Ghana. International Journal of Finance and Accounting.

5 (1), 22-26.

Shardeo, V. (2015). Impact of inventory management on the financial performance of the firm.

IOSR Journal of Business and Management (IOSR-JBM), 1-12.

Shin, S., Ennis, K., Spurlin, W. (2015). Effect of Inventory Management Efficiency on

Profitability: Current Evidence from the US Manufacturing Industry. Journal of

Economics & Economic Research Education, 1.

Singh, D., Verma, A. (2018). Inventory Management in Supply Chain. 7th International

Conference of Materials Processing and Characterization, 3867–3872.

Sitienei, E., Memba, F. (2015). The effect of inventory management in profitability of cement

manufacturing companies in Kenya: a case study of listed cement manufacturing

companies in Kenya. International Journal of Management and Commerce Innovations.

3(2), 111-119.

Sravani, C., & Rao, C. B. (2017). Scope and importance of inventory management techniques in

business operations: A systematic review. Indo-Iranian Journal of Scientific Research,

165-173.
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Weyghandt, J.J., Kimmel, P.D., Kieso, D.E. (2015). Accounting principles, twelfth edition. United

States.