Inventory Management In A Manufacturing Company Finance Essay

This research work serves as a practical operating guide for those who wish to introduce effective inventory control in their organizations. More importantly, the research work studies the effect of inventory management on profitability, inventory and the associated costs as well as challenges encountered with keeping inventory.

The research work focused on the perspective of inventory control and management in Nigerite Nigeria Limited with a view to identifying lapses that may impact negatively on the performances of the manufacturing industry.

Questionnaires were administered to obtain data from the employees of the Nigerite Nigeria Limited for the purpose of analysis using some descriptive statistical techniques such as percentage. The result was further validated by using Statiscal Package for Social Sciences (SPSS)- Pearson Correlation.

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The results from the data analysis showed that Nigerite Nigeria Limited keeps inventory of raw-materials, components parts, semi-finished and finished goods for the purpose of production and generate sales; categorizes inventory into fast-moving and special items, and applies continuous inventory counting as well as spot-check by auditors. It was also discovered that the inventory valuation technique in use in the company is first in first out (FIFO). Also, the company’s replenishment procedure is Economic Order Quantity (EOQ) which minimizes the over all relevant inventory cost. The research concluded, based on the available data, that there is direct relationship between inventory management and final prices of products, the productivity of the company and the regular flow of materials. However, the study revealed that storage facilities constitute one of the major challenges of inventory planners. The company is thus advised to improve and monitor the condition of her storage facilities. This will ensure that orders are not outside the limit their storage capacity and ensure good condition of materials in store over a considerable. Similarly, the company is encouraged to adapt herself with the modern inventory forecasting techniques that would enable her to determine the future needs or demand of customers in order to determine the level of stock to keep.

TABLE OF CONTENTS

Page

Title Page —————————————————————————— i

Certification ————————————————————————— ii

Dedication —————————————————————————– iii

Acknowledgement——————————————————————– iv

Abstract ——————————————————————————– v

Table of contents ———————————————————————-vii-ix

CHAPTER ONE: INTRODUCTION

1.1 Background of the study 1-3

1.2 State of the problem 3-5

1.3 Purposes/Objectives of the study 5

1.4 Significance of the study 6

1.5 Research Methodology 6-7

1.6 Scope of the study 7

1.7 Limitation of the study 7-8

1.8 Organization of the study 8-9

1.9 Definition of terms 9-10

1.10 References 10

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction 11

2.2 Brief History of P.Z. Industries Plc 11-12

2.3 Literature Review 13-14

2.4.1 Management of Inventory 14-15

2.4.2. Inventory Control 15-16

2.5 Importance of Inventory Management 16

2.6 Role of Inventory Management 16-17

2.7 Reasons for Carrying on Inventory 17-18

2.8 Cost of Inventory 18-20

2.9 Inventory Levels 20-24

2.10.1 The Basic Economic Order Quantity (EOQ) 24-27

2.10.2 Formation of the Model (Graphical Approach) 27-28

2.10.3 Stochastic Inventory Model 28-31

2.10.4 Production Run: Economic Batch Quantity 31-33

2.11 Inventory Control Method – ABC Analysis 33-35

2.12 Materials Pricing 35-37

2.13 References 37

CHAPTER THREE: RESEARCH METHODOLOGY

3.1 Introduction 38

3.2 Restatement of Research Questions and Hypothesis 38-39

3.3 The Population 39

3.4 Sample Size and Sampling Design 40

3.5 Data Instruments 40

3.6 Methodology for Data Analysis 40-41

3.7 Limitations of the study 41

3.8 References 41

CHAPTER FOUR: ANALYSIS OF DATA

4.1 Introduction 42

4.2 Presentation and Analysis of Data 42-56

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSIONS AND RECOMMENDATIONS

5.1 Summary of Findings 57-58

5.2 Conclusions 59-60

5.3 Recommendations 60-61

5.4 Suggestion for Further Studies 62

BIBLIOGRAPHY 63

REQUEST AND SPECIMEN OF THE QUESTIONNAIRE 64-69

CHAPTER ONE

INTRODUCTION

BACKGROUND OF THE STUDY

Inventory figures in the balance sheet of companies, especially manufacturing firms, are of immense significance. Every naira (N) added or subtracted from the inventory value overstates or understates profit by the amount. Therefore, inventory management is of great importance to companies because it constitutes a vital and valuable item in the financial statement. This is because the inventory balance (value) in the financial statement has a direct effect on reported profit. (Pandey, 2004).

One widely used measure or parameter for managerial performance relates to Returns on Investment (ROI), which is profit after tax divided by total assets. Because inventory represents a significant portion of the total assets, a reduction of inventories can result into a significant increase in Return on Investment. Excessive inventory on the manufacturing floor tends to conceal a wide variety of problems. Moreso, inventory storage costs are typically very expensive, averaging 30 to 35 percent of the value of inventory itself. And in some cases, especially when and where inventory management is not taken seriously, storage costs are much than the cost of inventory. (Shim and Segel, 1999).

Therefore, for an organization to achieve its profitability objectives, its inventory management must be effective and very strategic.

Pandey (2004) opined that inventory management is of great importance to companies in that the majority of their operations revolve around the inventory resources. Hence, the need for a close examination of this aspect becomes imperative. Inventory control constitutes an integral aspect of financial control. The amount of funds that inventories represent in recent years has led to a growing emphasis on the importance of inventory management and control.

Inventory refers to any stock of items used within the production system or in the operation of the business. They include such items as basic raw materials, supplies of components and parts, work-in-progress and finished goods that are ready for delivery to customers.

Shim and Siegel (1999) assert that inventory accounts for a sizable portion of firm’s assets next to plants, building and equipment. It serves a definite function and if efficiently used, earns return like other assets. The return is expressed ultimately in terms of increased productivity, lower cost of production and avoidance of stock out costs which all translate to higher turnover and in turn higher profit for the organization.

Banjoko (2004) viewed inventory as the soul and livewire of any manufacturing organization. Poor inventory management can present a serious challenge to productive capacity. The overall objective of inventory management is minimizing the total cost associated with stock which in turn leads to higher profit. This is done by establishing two known factors: when to order and how to order. Also, different reasons have been advanced as to why an organization would want to hold on to a reasonable portion of its resources in the form of inventory.

Over the years, the study of inventory management has provoked a lot of interest from various groups including academics and industry practitioners. Consequently, a lot of models have now been developed to assist managers / organizations in planning and controlling their inventory. Thus, for large manufacturing concern with elaborate and complex inventory profile, models involving the use of computers are readily available while for relatively smaller ones, with simple inventory outlook, manual system involving normal recording would suffice.

It is pertinent to stress that whatever system of inventory management that is to be adopted, it should take the need of the organization vis-à-vis its cost – benefit relationship into account. A careful balance will result in the minimization of cost which ultimately would lead to the realization of the organizational objectives, that is, profitability and growth.

In a manufacturing company, the efficiency with which its inventory resources are managed is crucial to the attainment of its set objectives. Hence, it demands a great deal of attention from the management and all other levels of the organizational hierarchy.

1.2 STATEMENT OF PROBLEM

Inventory management is an essential factor in the satisfaction of customers needs at the right time. For an organization to achieve anticipated profit, it must satisfy its customers at all time.

This greatly depends on the adoption of effective and efficient inventory management policies that will help to lower production cost, and help the organization to meet customers demand at any point in time and smooth production runs of the firm, in order to achieve favourable profit level.

In recent time, failures of most organizations can be traced to poor inventory management and control because of the huge amount of funds that inventories represent on the balance sheet of organization.

It is the belief of the researcher to examine those factors which include, effective inventory management, that are imperative to organizational profitability.

1.3 PURPOSE OF STUDY

This study is concerned with effect of inventory management on profitability of organizations.

Other reasons are:

To determine the various types of inventory kept in Nigerite Nigeria Limited.

To determine reasons for keeping inventory in the company

To establish various costs associated with inventory and their effect on profitability.

To examine how inventory management affect productivity, production, sales revenue and profitability of manufacturing company.

To establish how inventories are categorized and stock taking is done in the company.

To determine what problems are associated with keeping inventory in the company.

To examine the forms of inventory control system adopted by Nigerite Nigeria Limited.

1.4 RESEARCH QUESTIONS

In attempting to establish a relationship between efficient inventory management and profitability of manufacturing companies, the following research questions were developed:

What types of inventory are kept in Nigerite Nigeria Limited?

Why is inventory kept in Nigerite Nigeria Limited?

How has inventory management affected profitability of the company?

What costs are associated with keeping inventory and their effect on profitability in the company?

What problems are associated with keeping inventory in the company?

How are inventory categorized in Nigerite Nigeria Limited?

What forms of inventory control system are used in the company?

1.5 SIGNIFICANCE OF STUDY

This study will bring to focus the benefits of having in place, an inventory management policy that would lead to profitability and growth of manufacturing companies. By extension, it will show the consequences of failing to pay attention to the management of inventory. It is expected that this study would produce greater awareness of inventory management within the manufacturing industry.

Finally, it also intended to alert actors in the manufacturing sector of the imperative of having a sound inventory management policy that will ensure the profitable existence of their organization. In doing so, it is intended that the economy will benefit since the growth of manufacturing sector is one of the indices for measuring the aggregate growth in the economy.

1.6 SCOPE OF STUDY

This study attempted to look at the effect of effective inventory management on the profitability of manufacturing companies in Nigeria. However, since it was difficult and cumbersome in terms of time, financial resources, logistics and other technical areas to examine the entire manufacturing companies in Nigeria, the researcher chose Nigerite Nigeria Limited. (a leading manufacturer of Building Roofing and Ceramic tiles in Nigeria) as a case study. Investigation has been restricted to concept of inventory management, motives for holding inventory, stock control, as well as problems associated with inventory management and how these impinge on production and consequently on profit.

1.7 DEFINITIONS OF TERMS

Cycle Time: This is the time between when an order is received and another order is placed.

Deterministic Model: This is a model which assumes complete certainty of situations. The values of all factors such as demand, usage, and lead time and so on are known exactly and there is no element of risk and uncertainty.

Downtime Production Cost: It is the cost incurred during the period production process was not in operation it is cost involved as result of disruption of operations. It is the cost of troubleshooting, reprocessing and restructuring.

Economic Order Quantity: It is a decision model that, under a given set of assumptions, calculates the optimal quantity of inventory to order.

Lead Time: This is the time between the time an order is made and the time the item is received.

Ordering Costs: These are costs of preparing and issuing purchase orders, receiving and inspecting the items included in the order, and matching invoices received, purchase orders, and delivery records to make payment.

Quality Costs: These are costs that result when features and characteristics of a product or service are not in conformance with customer specification.

Re-order Level: It is the fixed points between maximum and minimum stock levels where requisitions are raised for new purchases.

Review Period: It is the time between successive examinations of the inventory to determine what should be reordered.

Safety or Buffer Stock: This is a stock allowance to cover for error in forecasting the lead time or the demand during the lead time. The stock, in excess of average demand, is to compensate for variability in demand and lead time.

Stochastic Model: This is a model where some or all of the factors are not known with certainty and can only be expressed in probabilistic or statistical terms.

Stock Policy: This is a set of rules which determines how and when certain decision making concerning the holding of stock should be made.

Stock out Cost: These are costs involved when customers’ demand cannot be met because the stock is exhausted. They are the opportunity cost of not having a stock item when there is effective demand.

CHAPTER TWO

Central to the existence of any business undertaking, is the profit making motive. This is essential, if the business must survive and ultimately grow. The ability to realize this objective depends on how well available resources of the organization are effectively managed, and a critical component of these resources is the pool of inventory. Hence, it is logical to assert that the optimization in the use of inventory is a vital factor in the operational success of any firm and consequently, an important component of its management function.

The need for an effective control of inventories as a means of improving the performance of manufacturing companies cannot be over-emphasized. Inventory control, a vital element in the management of material is one of the most serious problems confronting modern organizations especially those organizations having a very high investment in inventory items. Effective and efficient inventory controls will therefore, no doubt, aid the organization by substantially improving its performance.

Effective inventory management requires the development of policies that will help to achieve an optimal investment in inventory. This can be achieved with the ability of the concerned managers to determine the optimal level of inventory necessary to minimize inventory related costs. The ability to determine this optimal lot size will bring about a competitive advantage for firms especially those operating under a much tensed environment. A good inventory management is essential to the success of a company because of the impact of inventory on the daily operations, and most importantly, the amount of money inventory represents in the budget of a company.

Over the years a great deal of literatures has been written on this aspect of management function. In this aspect, an attempt will be made to look through these literatures with a view to finding possible areas of application to the inventory management needs of Nigerite Company Limited and by extension the entire manufacturing sector.

2.1 THE CONCEPT OF INVENTORY

Inventory has been described “as idle resources”. Some authors literarily put inventory as “money on the shelves”. Banjoko (2004) posits that in an organization, the existence of these idle resources represents a sizeable proportion of its capital investment that is tied down. In a manufacturing firm, inventory refers to materials that contribute to or become part of a firm’s product output. Like in any investment situation, the motive is usually profit oriented. Hence, firms are prepared to keep inventory at a cost in the belief that the alternative of not doing so will be more costly or less profitable. The need to plan the level of this idle resource has been the pre-occupation of inventory management theorists.

According to International Accounting Standard (IAS 2), an inventory is defined as a “tangible property”:

Held for resale in the ordinary course of business

In the process of production for sale or

To be consumed in the production of goods and services.

Love (1983) defined inventory “as a quantity of goods or materials in the control of an enterprise and held for a time in a relatively idle or unproductive state awaiting its intended use or sale”.

2.2 INVENTORY MANAGEMENT AND CONTROL

According to Davis, Acquilano and Chase (2003), Inventory Management can be defined as the mechanism used to provide organization structure and operational policies for maintaining and controlling the products to be stocked, the minimum quantity, as well as the period for reorder of stock. Omolehinwa (1991) views inventory management as a managerial function that is concerned basically with planning and control of materials.

Control is a process by which events are made to conform to a plan. Therefore, to control material, there must be a plan of action. Planning focuses on such issues as what to store, where to buy, when to buy and how to buy. To be successful, inventory management should be given top management attention.

To a warehouse manager, controlling inventory means controlling its physical storage, location, age, security from theft, fire, moisture and the likes and maintaining information which provides tractability and accurate quantity record.

To a quality assurance manager, controlling inventory means preserving its fitness for use, which involves similar security measures and record – keeping requirement. To an accountant or auditor, inventory is controlled through the use of cost of quality, information that enhances proper asset valuation, determination of net income and other financial indicators.

Battersby (1970) identified three people whose mental attitude can affect the general level of inventory in an average organization.

They are: (1) The sales manager

The production manager

The purchasing manager

In an attempt to achieve efficiency within their respective departments; the personalities may cause stock to go up. These differences however are not insurmountable. Most of the conflicts evaporate when examined in the light of sound economic judgment. Arriving at a level between too much and too little stock is the major challenge to management. Management is constantly pre-occupied with the challenge of resolving the conflict inherent in balancing the opposing costs of having an inventory and not having inventory.

Ibitoye (1985) noted that though the ideal situation is not to hold inventory, it has been seen that it is not possible to attain this ideal situation because of the uncertainties under which business operates. Hence, stock holding cannot be avoided. Inventory management systems vary from one organization to the other. In a particular organization, it may be formal or informal, cheap or expensive. Yet in another, control may depend on the effort of a large control staff while in another the responsibility may rest with the plant manager.

2.3 MOTIVES FOR HOLDING INVENTORY

Different authors have advanced various reasons why business organizations hold inventory. Lucey (1996) gives the following reasons which, he said, are based on deliberate decision by management.

To ensure that sufficient goods are available to meet anticipated demand.

To absorb variation in demand and production

To provide a buffer between production processes. This is applicable to work-in-progress stocks which effectively decoupled operations.

To take advantage of bulk purchasing discounts

To meet possible shortage in the future.

To absorb seasonal fluctuations in demand

To enable production processes flow smoothly and efficiently.

As a necessary part of the production process

As a deliberate investment policy particularly in times of inflation or possible shortages.

Alternative reasons given by the author for stock accumulation which he described as less praise worthy are:

– Poor or non-existent inventory control resulting in over-large orders, being out of phase with production.

– Inadequate or non-existent stock records

– Poor liaison between the production control, purchasing and marketing departments.

Hadley and Whitten (2002) said that the fundamental reason why organizations carry inventories is that it is either physically impossible or economically unsound to have goods arrive precisely when demand for them arises. Without inventories, customers would have to wait until their orders are fulfilled from source or where manufactured. However, customers will not and cannot be allowed to wait for long period of time, for this reason alone the carrying of inventories is necessary to almost all organizations that supply physical goods to customers.

Olowe (1997) is of the opinion that if products are available and customer’s demand is immediately satisfied, prospective customers will not go elsewhere. However, if the firm is out of stock and cannot meet customer’s demand, there would be loss of customers’ goodwill. Loosing customers’ goodwill whether in trading or manufacturing setting is bad for business.

According to Drury (2002), the motive for holding inventory can be considered along the Keynesian postulates of the reasons for holding money. These are:

Transactions Motive: It occurs whenever there is a need to hold stocks to meet production and sales requirement and it is not possible to meet this requirement instantaneously.

Precautionary Motive: This is when a firm might decide to hold additional amounts of stocks to cover the possibility that it may have underestimated its future production and sales requirement. It only applies when future demand is uncertain. It is the need for production against uncertainty since we cannot predict demand with sufficient accuracy.

If goods could be obtained immediately and at no excess cost, then no inventories greater than those needed to satisfy the transaction motive would be required. This implies that if no cost is associated with stock out, then no safety or precautionary stocks are required. However, it should be noted that transaction stock must be supported by precautionary stock to ensure customer satisfaction.

Speculative Motive: When it is expected that future input prices may change, a firm might maintain higher or lower stock levels to speculate on the expected increase or decrease in future prices. This is of interest in terms of rapid price rise as well as if there is known change in cost or in the possibility of sales within a foreseeable time.

The possibility of profit through changes in prices, interest rates or other supply and demand conditions is as pertinent to stock of goods as it is to money. In general, quantitative models do not take into account the speculative motive.

2.4 PROBLEMS ASSOCIATED WITH THE MANAGEMENT OF INVENTORY

The strategic importance of inventory in an organization demands that necessary attention should be focused on its management. However, in the process of controlling cost, managers are constantly faced with a variety of problems which are associated with inventory management. Davis, Acquillano and Chase (1999) present some of the problems of inventory management as follows:

Forecasting inventory requirement. This represents a delicate phase in inventory planning. It requires the inputs of various functional units such as finance, marketing, production and purchasing departments to enable management come out with a forecast that will ensure that inventories are neither too little nor too much. It is necessary to make some estimate of future consumption to act as a guide and help the organization to plan its order.

Most organizations have storage problems due to lack of adequate storage facilities and this affects the quantity of inventory they carry. Management should ensure that the size of their storage facilities is considered during inventory planning to ensure that orders are not outside the limits of their storage capacity. The suitability of storage facilities in relation to orders demands critical consideration. This is to ensure that goods which require covered storage are not exposed to the air as this could have effect on the environment.

Effective inventory management in organizations is also affected by lack of inventory control system. Since stock is equivalent to cash, it follows that it should be carefully protected, counted and checked in similar way. There are many organizations where the inventory system displays looseness which would not be tolerated in a cash office in spite of the fact that the value of stock is usually greater than cash held.

Inventory planning must take note of the ease of accessibility of inputs. A crucial factor in this regard is the geographical location of the source of supply. In a country like Nigeria, where manufacturers are highly dependent on import as a source of their inventory needs, this has effect on the size and frequency of deliveries. Manufacturers like Nigerite Nigeria Limited can mitigate this problem by embarking on backward integration to provide substitute for imported raw materials. It can establish wheat farms in areas of the country where conditions are favourable.

2.5 INVENTORY ANALYSIS

Whatever system of operation that is established for inventory management, the procedures adopted in its implementation and the workers concerned matter a great deal on the expected result. The logical point therefore, before commencing any worthwhile inventory planning is to analyze the stock being held by an organization. By analyzing the stock held, management can best determine what amount of effort would be spent controlling the various ranges of stocks. The grouping of inventory into various categories for the purpose of effective planning and control is called Inventory Analysis. Banjoko, (2004) gave the following types of inventory analysis.

THE ABC ANALYSIS

The ABC method requires that an estimate be made of the total purchase cost for each item of stock for the period. Sales forecast is the basis used for estimating the quantities of each item of stock to be purchased during the period. Each item is then grouped in decreasing order of annual purchase cost. The top 10% of items is stock in terms of annual purchase cost are categorized as A items, the next 20% as B items, and the final 70% as C items. For example, if it is assumed that there are 10,000 stock items, then the top 1000 items in terms of annual purchase costs will be classified as “A” items and so on. In practice, it will be unnecessary to estimate the value of many of the 7000 C items, since their annual purchase cost will be so small it will be obvious that they will fall into the category.

V. E. D. ANALYSIS

V – Stands for Vital items. When these items are out of stock or when not readily available, production is completely brought to a halt.

E – Stands for Essential items when not available, there is temporary loss in the production process.

D – Stands for Desirable items. These are items which are necessary but their non-availability does not have any immediate disruptive effect on the production process.

2.5.3 F. S. N. ANALYSIS

Here the quantity and rate of consumption are analyzed and classified as:

F – Fast – moving items

S – Slow – moving items

N – Non – moving items

S. D. E. ANALYSIS

This analysis is useful where most inventory items are not only scarce but have to the imported.

S – Stands for Scarce items. These items are usually imported and also very short in supply.

D – Stands for Difficult items which are available in the market but are not easily accessible.

E – Stands for items which are Easily available. that is, mostly local items.

Each of the above analysis has its specific features, advantages and shortcomings. It is therefore left for management to choose any or a combination that would bring practical and optimum solution to control of inventory.

2.6 INVENTORY CONTROL SYSTEM

In an effort to provide an adequate, but not too much stock of materials at any particular point in time to allow for optimality in the use of organization’s resources, firms normally resolve to order for appropriate quantity of materials and decide on when to place such order. Inventory control system is thus the method of managing inventory resources for optimum result. The forms of inventory control system include:

– Re-order level or two bin system

– Periodic review system

– Just-in-time

2.6.1 RE-ORDER LEVEL OR TWO BIN SYSTEM

This is an inventory system