A Case Study Of The Ridge Regional Hospital Finance Essay

Published: 2021-07-08 18:05:04
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The objectives of the study were:
To examine the effectiveness of the existing inventory management system of the organisation.
To establish the correlation between efficient inventory management and profitability of the firm.
H0: There exist a relationship between profitability and inventory management.
H1: There exist no relationship between profitability and inventory management.
CHAPTER TWO
LITERATURE REVIEW
2.0 INTRODUCTION
A review of the existing literature on the subjects of both inventory management and profitability in healthcare brings up very vital theoretical concepts that underpin them.
Available literature indicates that a countless number of empirical and academic related research projects have been undertaken with an attempt to explain/establish the relationship between financial performance and inventory management of companies in different industries including manufacturing and service delivery. It is however interesting to note that in spite of the availability of enormous literature on the subject matter, there are only a few that explicitly focus on not-for-profit organizations, particularly health care institutions and hence the motivation to undertake this study.
It can however be agreed that the principles that underpin inventory, its management and their co-relation with profitability are largely the same regardless of the specific area of application. To facilitate a systematic review therefore, the available relevant literature is structured under the following headings:
Concept of inventory
Why hold inventory
Inventory Management and Control
Techniques for Controlling Inventory
Role of ICT on Inventory Management and Financial Performance
Challenges associated with holding inventory
Concept of Profitability
The correlation between inventory management and profitability of an organization
2.1 CONCEPT OF INVENTORY
Every organization invests a significant amount of its financial resources in inventory in view of the critical role it plays in the operations of businesses. Coyle et al. (2003) observed that inventory is an asset on the balance sheets of companies, hence a critical factor of success in most companies. Rishi Gokarn (2010) also noted that inventory is one of the largest and most important assets a manufacturing business possesses, and the turnover of inventory is one of the principal sources of revenue generation for a company. Inventory decisions directly affect the value of cost of goods sold and consequently play a pivotal role in determining the reported earnings of a company. As a result, a thorough analysis of inventory valuation and related accounts can provide a basis for assessing the financial position of a firm.
His assertion was supported by Hedrick et al. (2008) also argued that inventories are visible stocks of anything necessary to do business and that unless inventories are controlled, they are unreliable, inefficient and costly. Datta (2010) however explained inventories as stock of materials of any kind stored for future use. Inventories may generally be described as the lifeblood and heart of businesses since without them firms cannot operate effectively and efficiently (Asaolu et al, 2012).
Tersine (1994); Verwijmeren et al (1996) and McPherson (1987) also established that inventory constitutes a proportion of an organisation’s working capital tied up in the form of stock sitting in the stores or warehouses until the company makes use of it and that inventory forms about 20 to 40% of an organization’s total assets.
Within the parameters of healthcare, inventory may be unique in that they comprise the sum-total of medical and non medical items required for use in the health facility. The medical items comprises the ‘soft-goods’ (such as masks, gloves and cotton wools; items which are generally easy to store and non-bulky in nature) and medicines or parts and equipments (such as surgical tools and other various medical equipments). Stationeries, food items, linen and office equipment such as computers, scanners, printers and ink cartridges, all make up the non-medical items as identified by Zhi and Shaligram (2007).
Their study followed after that of Aptel and Pourjalali(2001) which concentrated on inventory as part of logistics required by hospitals and compared logistics parameters in hospitals in France and the USA. Their observation was that although hospitals require unexpected levels of inventory to enable them provide critical care, just-in-time (JIT) deliveries could be used to minimise cost of inventory in hospitals.
Nicholson et al (2004) further compared an in-house three-echelon distribution network and an outsourced two echelon distribution of non-critical medical supplies directly to the hospital departments resulted in inventory savings without an impact on quality of care.
The debate on the need to hold inventory in health facilities would obviously rage on as health facilities consistently aim at the balance between reducing the cost of holding inventory vis a vis ensuring that patients’ lives are not threatened due to the non-availability of critically required medical or non- medical inputs, commodities or equipment.
2.2 WHY HOLD INVENTORY
Schroeder (2000) stressed that inventory management has an impact on all business functions, particularly operations, marketing, accounting, and finance. He established three motives for holding inventories; transaction, precautionary and speculative motives. He asserted that the transaction motive refers to the need for a firm to hold stock to meet production and sales demands. He also explained the precautionary motive as a firm’s decision to hold extra amounts of stock to cover the likelihood of under approximating its future production and sales needs, which applies only when future demand is uncertain. Finally, he described the speculative motive, which entices firms to purchase larger quantities of supplies than normal in anticipation of making abnormal profits. He cited advance purchase of raw materials in inflationary times as a form of speculative behaviour.
In a related paper, Zaheeruddin M., (Undated), identified and explained reasons for maintaining inventory as Uncertainty, Time and Economies of scale. He stated that inventories are first maintained as buffers to meet uncertainties in demand, supply and movements of goods. He further explained that time lags present in the supply chain, from supplier to user at every stage, requires a firm to retain certain amounts of inventory to use in lead times. He cited that, in practice, inventory is to be held for consumption during 'variations in lead time' as lead time itself can be addressed by ordering many days in advance. He concluded that the ideal condition of "one unit at a time, at a place where a user needs it, when he needs it" principle tends to incur lots of costs in terms of logistics, and hence bulk buying, movement and storing admittedly brings in economies of scale.
Harrison and Van Hoek (2005) further indicated that while many firms had looked at the potential of synchronised direct supply to customers, many situations remain where this is not suitable. They explained that in view of the fact that it is not always possible to cost effectively reduce supplier lead times to match the short lead times required by customers, the customers may then need to be served from inventory rather than to order.
Asaolu et al, (2012), further presented the view that as demand can in fact not always meet supply, organizations hold inventory to enable them provide uninterrupted services to their cherished clients, despite the diverse implications of holding inventory. It is the authors’ view that firms equate "smooth implementation of production activities" and "effective and efficient service delivery" to items being readily available at the right price, quality, quantity, time and place. Inventory can therefore by extension be described as a necessary evil.
Christopher and Towill, (2001) also posited that it may be beneficial to hold strategic inventory at decoupling points in the supply chain to separate lean manufacturing activities (which benefit from a smooth flow) from the downstream swift response to volatile market places. This is to ensure that goods and services are ultimately available to clients at all times.
To conclude on the concept of why hold inventory, healthcare is an area admittedly different from manufacturing, industry and the other service sectors and needs to be acknowledged for its peculiar nature. As the care of a patient is a sensitive issue due to the volatile nature of services required of the hospitals, especially those providing acute care, minimum stocking to sufficiently handle situations like disease outbreak is important for hospitals (Zhi and Shaligram, 2007).
It is by extension important to note that unlike the other sectors of industry, a stockout of a vital drug or urgent replacement of a specifically required equipment (part) in a hospital may possibly have life-threatening consequences. It must be further stated, however, that the general reasons discussed above by all the other writers as to why inventory is held by the other sectors of industry are still largely applicable to the health sector.
2.3 INVENTORY MANAGEMENT AND CONTROL
The concept of inventory management has been evaluated at length across the broad spectrum of the manufacturing and service industries. As a global challenge for some time now, it has become a major concern for academia as well as industry practitioners since overall investment in inventory accounts for a relatively big chunk of a firm’s assets (McPherson 1987). In the same vein, Kinomans et al. (2011), as part of their research findings observed that "investment in stocks represents a major asset of most industrial and commercial organizations and therefore it is crucial that stocks are managed efficiently and effectively so that investments do not become necessarily large."
Coyle et al (2003) posited that effective management of inventory movement in the supply chain is one of the key success factors for businesses.
Adeyemi & Salami (2010) also noted that the principal aim of managing inventory is to find the balance between the controversial economics of inventory overstocking with its associated implicit and explicit costs on one hand against making goods and services available as and when and where they are required, in terms of quality and quantity so that the cost of inability to meet customers’ requirements will be averted on the other hand. They added that as one of the items with a huge value that appears on the assets column of the balance sheet of many businesses, inventory management deserves greater consideration.
Deveshwar and Modi (Undated) also concluded in their studies that inventory management spans everything from accurate record - keeping to shipping and receiving of products on time. They asserted that a properly maintained inventory management system can keep a company’s supply chain running smoothly and efficiently whilst its problems on the other hand can interfere with a company’s profits and customer service. Poor inventory processes and out-of-date systems could cost a business more money and could lead to an excess of inventory overstock that is difficult to move.
Kotler (2000) supports the above submissions by referring to inventory management as all the activities concerned with managing the levels of the different types of inventory namely raw materials, Work-in-progress (semi-finished materials) as well as finished goods to ensure that adequate supplies are made available so as to reduce the costs of over or under stocks.
Basically, inventory management consists of many components/functions and they include planning and controlling. The planning function principally decides in advance what to do and consists of determining the quantity of items to order, how often to order them (periodicity) and the ability to maintain both overall source-stock sink coordination and overall stock coordination in an economically efficient way. Inventory management processes encompass purchasing, receiving, issuing, classification, accounting, tracking accurateness, control, and maintenance (Adeyemi and Salami, 2010).
Keith et al. (1994) in their text also indicated that the major objective of inventory management and control is to inform managers how much of a good to re-order, when to re-order the good, how frequently orders should be placed and what the appropriate safety stock is, for minimizing stockouts. Thus, the overall goal of inventory is to have what is needed, and to minimize the number of times one is out of stock. Enough but not too much is the crucial objective.
The controlling function which essentially deals with measuring performance against predetermined standards and which is often described as stock control is discussed next. The importance of inventory control cannot be overstated even though it is notably one of the most difficult areas that firms wrestle with globally, mindful of the fact that if inventory is not controlled, it would control the organisation.
Eni (2001) defined inventory control as the problem of verifying the quantity, the value and the balance of the entire range of materials held in stock, to make it easy and possible to provide the exact quantities of materials in the Store at any given time. This should help the store-keeper (or the inventory controller, as the case may be) to tell how much was ordered (requested for), how many is used, what is remaining and when to place the next order so that the organisation would not lack materials to work with at any point in time.
Similarly, Sharma (2004) viewed inventory control as the means by which materials of the correct quantity and quality are made available as at when required with due regard to economy in terms of storage and costs (both ordering and working capital). He also opined that inventory control is the systematic ways of locating; storing and recording of goods in a manner that facilitates a desired degree of service in a firm at minimum ultimate cost. In his view, the aim of inventory control is to provide information on the accuracy of stock records and physical quantities, and evidence in support of the value shown in the balance sheet as well as the profit and loss statement. It would also reveal any weakness in the inventory keeping method in use, whilst disclosing any loss, fraud, or theft in the process of material handling. Any deterioration, obsolescence, slow movement or redundancy in the stocks on hand would also be identified. All the above information would influence and ensure firms’ effective decision making.
Ahuja (2002) and Martand (2009) also identified the objectives of inventory control to include minimizing the costs involved in purchasing; stocking and issuing of the supplies; reducing the number of order times for stock items to decrease pilferage, waste and over stocking; minimizing the investment and fluctuations in inventories while at the same time providing prompt order filling services for customers. They also provided that within the same logistical system, the minimum amount of inventory consistent with desired delivery capacity and total cost expenditure must be integrated and deployed; whilst ensuring adequate supply of products to customers and avoiding shortages as far as possible. They concluded by recommending the provision of a scientific base for both short and long term planning of materials and reserve stocks to cater for variations in lead (time) of delivery of materials.
On his part, Wild (2002) described inventory control as the activity which ensures the availability of items to clients. He cited that it synchronizes the roles of purchasing, manufacturing and distribution to meet the marketing needs of a firm. He explained that the roles also include the supply of current sales items, new products, consumables, spare parts, obsolete items and other supplies.
Adeyemi and Salami (2010), described stock control as following procedure set up at the planning stage to achieve the desired objective of maintaining optimum levels of stock. They observed that inventory control may include monitoring stock levels periodically or continuously and deciding what to do on the basis of information gathered and processed adequately. They counselled that management of any firm needs to strike an optimum investment in inventory in view of the fact that it costs much money to tie down capital in excess inventory. They also noted that attention in recent times has been on the development and design of suitable mathematical tools and approaches to aid the decision-maker in setting optimum inventory levels. They cited Economic order quantity (EOQ) model as one such tool that was developed to take care of the weaknesses emanating from the traditional methods of inventory control and valuation, and agreed that it had proven useful in optimizing resources and minimizing associated cost.
Josden (2009), in agreement with the above submissions noted that inventory control is concerned with reducing the total cost of inventory. He continued that the three major factors in the inventory control decision-making process are the cost of holding the stock, the cost of placing an order or the set-up cost of production and the cost of shortage.
Thompson (2010) agreed with Josden (2009) and espoused further that "the third component" is the most difficult factor to assess and is usually handled by instituting a ‘service point’ guideline or policy; for example a certain level of demand should be met instantly from stock."
In a further view, Benson and Ignou (2008) noted that inventory control is the system that warrants the provision of the required quantity of inventory with the right quality at the right time, with a little amount of working capital tied up. It involves the functions of purchasing, receiving, inspection, storage and issuing of inventory as well as appropriate stock management systems that guarantee a short lead time."
Keeping insufficient inventory may admittedly result in stock out of inputs for the provision of services, a subsequent loss of clients to competitors, erosion of the organisation’s goodwill, a reduction in sales volume, return on assets/investment and ultimately a reduction in profitability; all possible effects of holding inadequate inventory. On the flip side, we have overstocking inventory with its associated ‘huge cost’ as described above. It goes without saying therefore that managers of inventory in all sectors, the health sector included, need to determine exactly how much inventory will be just sufficient to meet customers’ expectations.
2.4 CHALLENGES ASSOCIATED WITH HOLDING INVENTORY
As discussed above, holding inventory can be a tricky venture as both overstocking and under-stocking have implications, making the identification of the right amount of inventory to hold a very challenging task for most businesses.
Zaheeruddin M., (Undated), simplified the main problems of holding inventories as risk and cost. He explained that holding of inventory involves blocking of a firms fund and incurring capital and other costs.
The key costs he identified in relation to holding inventory are capital costs, storage and handling costs. He explained capital costs to include the opportunity cost of investment and interest charges. These costs arise when a firm arranges for additional funds from either own funds or from outsiders to meet the cost of inventory when the firm’s financial resources are blocked as they hold stock. He further described storage and handling costs to include space rental charges and insurance premiums, which also constitute a significant part of inventory holding costs. He also provided that there is always the risk of price decline as the prices of inventory reduce by the effects of supply dynamics, competition or general depression in the market. He finally identified the risk of obsolescence as a possibility as stocks are held with inventory becoming obsolete as a result of improved technology and changes in customer requirements and tastes.
He then opined that an understanding of the impact of inventory carrying costs such as storage, insurance, tax, damage and obsolescence would enable a firm minimize the possible cost incurred. He recommended the performance of accurate cycle counting and the presentation of computerized inventory system report in a manner that allows effective management decision making.
On their part, Deveshwar and Modi (Undated) identified a number of challenges that are associated with inventory management. They discussed the more common problems and admitted that some occurred more frequently than others.
First, they drew from their observations that several companies put people who were either neglectful, lacking in experience or who did not have adequate training in charge of their inventory.
Further, they identified that the processes in use in the companies under review were narrow in scope and did not encompass most or all the aspects and factors of the company.
Also, they identified that an unrealistic or flawed business plan for the future could also pose a problem for inventory management. If a company does not accurately predict how well it is likely to do in the future, they could overstock their inventory. They offered that companies could guard against that by collating adequate data for analysis and decision making.
Additionally, they asserted that a supervisor in charge of inventory management should be diligent enough to check inventory levels regularly to ensure that the company stocks products adequately. Thus ability to anticipate shortages well ahead of time is a critical factor in achieving customer satisfaction.
Another major challenge they identified is the risk of the company falling victim to the "bullwhip effect" where a firm over-reacts to changes in the market. An instance is when the demand of a market changes, and a firm in panic overstocks their inventory anticipating that the new market conditions will move the inventory.
One interesting challenge they identified as confronting inventory management is having too much distressed stock in their inventory. Distressed stock refers to products or materials in inventory that are approaching their expiry and are therefore sold below the normal price before they expire. This mostly occurs in grocery stores where a particular food product nearing its expiry date is discounted in order to move it quickly before it expires.
They also admitted that having excessive inventory in stock and being unable to move it quickly is a challenge most businesses face. This was generally in view of the fact that, cash flows are associated with moving inventory and therefore a company’s inability to move inventory after buying a large quantity of products poses a big problem for the business as it ends up losing money.
Also, they noted that computer inventory systems can be very complicated and even though there are several inventory software programs available for business use, most of them are not user-friendly. The matter is further complicated by the fact that most companies fail to allocate time and money in personnel training to ensure effective use of the software.
Finally, they identified the challenge of misplacement of items in-stock. They perceived that this happens when the computer software accurately shows an item as being in stock, but it becomes impossible to locate this same item just because it is misplaced within the warehouse, or been placed at a wrong location within a store. This, they agreed could result in a decrease in profitability due to lost sales and even higher inventory holding costs as the item may need to be re-ordered. Again, the company may need to spend time for workers to track down the misplaced item.
Moorthy et al (Undated) in their study broached the topic from another dimension and grouped challenges associated with inventory management into four factors as discussed below:
First of all, the insurances, taxes and opportunity cost can be a challenge to managing inventory. This factor is dependent to a large extent on the value of the average quantity on hand. The higher the quantity, the more insurance premiums and taxes to be paid to the relevant parties. They also noted that the opportunity cost of holding inventory is the loss of capital gain on the money invested in inventory since this same money could have been invested in a relatively safer and more profitable venture.
Secondly, the inventory shrinkage could also be a challenge to inventory management. They explained that inventory shrinkage includes any stocked material which is purchased but not sold. In view of this, such inventory is vulnerable to theft or obsolescence in the warehouse. They also observed that even though most people do not acknowledge the true cost of loss of material there are far reaching implications to it.
They also identified the third factor as the "cost of counting" of inventory within the warehouse. They pointed out that this could vary from one item to another item depending on the size and packing. There is therefore the need to group the similar stock keeping units (SKU) that are to be stored in similar storage units. Mention was also made of the need to determine the labour cost of performing the actual stock counting, quantification of the time spent in counting and measurement of efforts put into keying the count information into the computer system.
Above all they viewed rental, utilities and handling costs. They admitted that some products take up more space, and are harder to handle compared with other products. They therefore advocated that items that take up more space should absorb more cost. There is therefore the need to determine the total space used to store material and the space currently being used to store the inventory. To do this the total cost of occupying the space by the total cubic is divided in order to determine the storage cost per cube. The cost of individual items can then be apportioned based on the cost of the cubic space assigned to them. They further indicated that lots of efforts are required in order to maintain the inventory items in the warehouse. They were therefore of the opinion that if this concept is clearly understood, it will result in a better and outstanding result.
It is evident from the foregoing that inventory management is saddled with several challenges and that these challenges, even though they are directly related to other industries such as manufacturing and trading, are also largely applicable to the healthcare industry.
Menon (2006), finally aptly provided the symptoms of poor inventory control to include high rates of order cancellation, excessive machine downtime due to material shortage, large scale inventories written down because of price decline, distress sales, widely varying rates of inventory losses, large writing down at the time of physical inventory taking, continuous growing inventory qualities; liabilities to meet delivery schedules and even production rate.
2.5 SYSTEMS & TECHNIQUES FOR MANAGING/CONTROLLING INVENTORY
An inventory management system provides information to efficiently manage the flow of materials, effectively utilize people and equipment, coordinate internal activities and communicate with customers. Inventory management does not make decisions or manage operations but provides accurate, verifiable and timely information to managers to enable them make well-informed decisions to manage their operations.
According to Zaheeruddin (Undated), an inventory system is the set of policies and controls that monitor levels of inventory and determine what levels should be maintained, when stock should be replenished, and how large orders should be.
A good inventory control system would minimize the possibility of delays in production, caused by lack of materials, and would permit a company to exercise economics in purchasing. This is essential for an efficient accounting system as it deters people who might steal materials from the factory. It is also desirable in the expedition of the production of a financial statement; as it allows for possible increase in output; ensures advantage of quality discount as it creates buffer between input and output; and insure against scarcity of materials in the market, whilst avoiding inventory build-up (Carter, 2002).
Kim and Schniederjans (1993) had previously identified in their study, three types of materials management systems in the healthcare system: conventional, just in time (JIT) and stockless. From their empirical testing, the authors discovered that JIT or stockless programmes can be implemented regardless of the size of the hospital. Effective materials managed and JIT deliveries can bring down healthcare costs (Heinbuch, 1995). Jarrett (2006) on his part added that implementation of JIT in hospitals can achieve significant cost reduction which can eventually bring down the cost of providing services.
In the healthcare delivery system, healthcare institutions need to hold some minimum levels of inputs to enable them provide healthcare services, especially during emergency situations. Healthcare institutions, including Ridge Regional Hospital thus make conscious efforts to hold sufficient amounts of inputs (inventory), in terms of drugs, non-drug consumables and equipment to enable the provision of acceptable health care services to its cherished clients. In attempting to meet this requirement, there is the tendency for the hospital to overstock some of these inputs consciously or unconsciously. At the same time, they may occasionally experience stockout of these inputs which leads to situations where quality of care is compromised with its associated dire consequences especially during emergency situations.
2.5.1 Techniques for controlling inventory
Jessop and Morrison (1994) indicated that although there are many systems for the control of inventory, both manual and automatic, there are in fact only two fundamental approaches on which these control systems are based. They continued that the two approaches are commonly called ‘action level’ approach and the ‘periodic review’ approach.
In a related paper, Zaheeruddin (Undated) related that a proper inventory control not only helps in solving the acute problem of liquidity but also increases profit and causes substantial reduction in the working capital of a firm.
He also identified the following as important traditional tools/techniques of inventory management and control; Determination of stock level, which includes Minimum stock level, Maximum stock level, Danger stock level, Average stock level , Reorder level and Hastening stock level. Other techniques include Determination of safety stocks, Economic order quantity (EOQ), A- B-C analysis (Always Better Control Analysis) and VED analysis (Vital Essential Desirable). (Zaheeruddin (Undated); Jessop and Morrison, 1995).
It is also notable that prior to the development of the current emerging inventory techniques, the Economic Order quantity (EOQ) was developed in an attempt to address some of the weaknesses that existed in the previous tools indicated above.
2.5.2 Economic Order Quantity
According to Verma (2010), one of the major inventory management problems yet to be resolved is the quantity of inventory to be added during inventory replenishment. He referred to economic order quantity as that inventory level, which minimizes the total of ordering and carrying costs.
He continued that if a company purchases in large quantities the carrying cost of inventory will be high in view of the high investment involved; whilst on the flip side, if items purchased are done in small quantities, frequent orders with related high ordering costs will result in high cost. Thus, the quantity to be ordered at any given time must be determined by balancing two costs, namely the acquisition cost and the carrying cost of inventories. He underscored the fact that purchasing in large quantities may reduce the unit cost of ordering; but warned that this saving may be more than offset by the carrying cost of inventory in stock when held for a longer period of time. He further indicated that the EOQ model attempts to determine the optimum quantity to order at a particular point in time in order to balance the cost of carrying and holding inventory and also ensure item availability whenever required. The most economic order size is determined by considering the inventory’s carrying, purchasing, as well as its ordering costs and usage rate.
He provided that the following assumptions need to form the basis for the EOQ model:
The usage of a particular item for a given period (usually a year) is known with certainty and that the usage rate is even throughout the period.
That there is no time gap between placing an order and getting its supply.
The cost per order of an item is constant and the cost of carrying inventory is also fixed and is given as a percentage of average value of inventory.
That there are only two costs associated with the inventory, and these are the cost of ordering and the cost of carrying the inventory.
Given the above assumptions, the EOQ model may be presented as follows:
EOQ - 2U X P
S
where,
EOQ = Economic Ordering Quantity.
U = Annual Consumption (units) during the year.
P = Cost of placing an order
S = Annual cost of storage of one unit.
Though EOQ is the most fundamental concept in making inventory policies, the inclusion of risk of uncertainty in the various cost estimations such as carrying and ordering as well as shortage costs, is more recent and is still undeveloped (Appadoo et al).
Bailey (1987) observed that EOQ formula is unsuitable for many stock control situations, for instance when demand is highly variable or seasonal. If price fluctuates, watching the market and seizing the moment matters more than balancing internal cost. If lead time is long or variable, making sure of supplies matters more. EOQ as a model therefore has some weaknesses in spite of the strengths it wields.
2.6 Role of ICT on Inventory Management and Financial Performance of firms
While ICT investment’s impact on a firm’s inventory and/or financial performance has been extensively studied in several academic disciplines, few studies have actually linked all the three variables (i.e. ICT investment, inventory, and financial performance) simultaneously. Also, the empirical evidence supporting the effect of ICT investment on financial performance is mixed (Kohli and Devaraj, 2003). Researchers have since coined it as the "profitability paradox" (Dedrick et al. 2005).
Carr (2003) argued that because ICT is not a rent yielding resource in a "resource based view" sense, but an infrastructure that is easily imitable, it at best only provides a rapidly eroding advantage to firms. Large investments in ICT do not basically result in higher performance and are not a source of competitive advantage. Other ICT researchers note that instead of directly affecting a firm’s financial performance, ICT investment’s impact is indirect through intermediate operational performance related to inventory turnover, product quality, and plant productivity (Banker et al. 1990; Barua et al. 1995; Melville et al. 2004). The mediating role of operational measures between ICT investment and financial performance is formalized as the "process-model" in the ICT literature. The process-model explicitly specifies that ICT investment leads to better financial performance indirectly through improving operational performance. In linking ICT investment, inventory and financial performance, the authors aimed at examining the process-model beyond its manufacturing origins into the retail and wholesale sectors.
They opined that identifying such cross-level relationships is of considerable importance to theory building because they signal a boundary condition; in spite of the fact that empirical analyses of such relationships remain scarce (Chen et al., 2005a).
In recent years, firms have invested substantial resources in new types of ICT, which have enabled them improve efficiency in and coordination of material-handling operations, thus reducing inventory levels. Highlighting the role of ICT, the Economic Report of the then President (2001, p.39) noted that "technologies that improve the dissemination of information enable companies to react more promptly to market signals and to economize on inventories (by sharing point-of sales data, for example)." Alan Greenspan, a former Federal Reserve Chairman, noted that the amazing surge of real-time information in recent years had sharply reduced the degree of uncertainty that firm managers grappled with, thus allowing businesses to remove large quantities of now needless inventory" (Greenspan, 1999).
At the firm level, a positive impact of ICT on inventory performance is upheld. Previous studies for instance, agreed that an increase in ICT investment resulted in higher inventory turns and lower inventory holding costs. A good number of case studies and anecdotal evidence have also supported the assertion that ICT enabled business partners share details relating to customer orders and inventory positions in supply chains. Such facilitation of shared information by ICT was expected to enable the effective management inventories and streamline operations.
(Vickery et al. 2003)
Capital investments normally include investment in warehouses, equipment, information technology (ICT) and logistics management systems. These capital investments result in better inventory allocation, a more efficient implementation of customer orders, and increase in inventory turns. Prior studies (Frohlich and Westbrook, 2002; Vickery et al., 2003) found that an increase in ICT investment resulted in higher inventory returns and lower inventory holding costs.
ICT Investments have enabled firms cut back on the quantities of inventory as a precaution against hiccups in their supply chain or a buffer against unexpected increase in cumulative demand (Ferguson, 2001). ICT investments may in addition increase inventory turns as the replenishment process is improved. Clark and Hammond (1997) illustrate that the adoption of a continuous replenishment process by food retailers, increased their inventory turnover by up to 100%. Automatic replenishment has however not been limited to the grocery industry; apparel retailers have also utilized automatic replenishing programs to improve inventory efficiency (King and Maddalena, 1998).
Finally, a study by (Kolias et al., 2011) on the Greek retail sector found that inventory turnover was positively correlated with intensity. The coefficient in their study for the supermarket sector was relatively higher than those for other sectors, as indicative of the importance of ICT investments in that sector and the resultant experience of improved product availability, reduction of stock-outs and less need to carry backup inventory resulting in lower inventory levels. With lower inventory investment, inventory turnover could be higher and increase financial profitability.
2.6.2 Emerging ICT inventory control techniques
A number of techniques/trends for more efficient management/controlling of inventory have emerged from the traditional techniques and they include Electronic data interchange (EDI), Enterprise Resource Planning (ERP) and outsourcing all of which work in tandem with Information Communication Technology (ICT). These techniques/systems have been discussed here under:
2.6.3 Electronic Data Interchange (EDI) and Inventory Management
According to Jessops and Morrison (1994), EDI is the name given to transmission and receipt of structured data by the computer systems of trading partners, often without human intervention. Many people apply the term ‘paperless trading’ to this process. The International Data Exchange Association defines EDI as ‘the transfer of structured data, by agreed message standards, from one computer system to another, by electronic means’. All kinds of data can be exchanged electronically, for example invoices, transfer of funds, enquiries, quotations, technical information and so on. The potential challenge with EDI is possible glitches with the computers which are supposed to communicate with each other and the need for proper configuration of the equipment accordingly.
Bailey (1987) observed that EDI between organizations is mostly used by Marks and Spencer, Sainburys, Tesco and many others in the UK to order goods, and this computer to computer method of ordering is increasing in popularity in recent times. Big savings in the cost of paperwork are expected, especially in import/export transactions where the cost of paperwork can be as much as 7% of the total contract cost.
2.6.4 Enterprise Resource Planning (ERP) and inventory Management
To enable managers make well informed operational and strategic decisions it is important for organisations to establish systems that provide timely and accurate information for employees at all levels of the organisation. Enterprise Resource Planning (ERP) is one of such systems and it integrates company database, business process as well as company structure. It is important to note that employees need time to understand and experiment with ERP and this could be efficiently done through employee education (Aasheim et al., (2009).
Enterprise resource planning can achieve the goal of instant management via the integration of information systems of the various departments like production, accounting, finance and human resources. After ERP implementation, businesses can successfully integrate the processes of the individual departments, reduce costs, improve effectiveness, further improve upon clients’ level of satisfaction, and also instantly share information with the whole firm (Kang et al., 2008; Pan and Jang, 2008). Additionally, enterprises can support and combine prior numerous traditional systems into a single system. The whole enterprise is able to share the same database which prevents duplication costs, and again avoids the collection and analysis of the same information (Ferrando, 2001).
In the ERP system, the sale module is often used and effective implementation would ensure accurate storage of sale information. Account receivable information would also be obtained easily and allow for timely account receivable management, resulting in increase in turnover. In the inventory module, ERP would set up the repurchase point, resulting in a decrease of the carrying cost and inventory quantities, whilst increasing the inventory turnover. ERP based on improvements of various segments of the firm’s operation would generally enhance efficiency and profitability of the firm.
However, the adoption of an ERP system, like other IT projects (Chua, 2009), may result in problems for the enterprise despite its aforementioned advantages. The complexity of the system may cost a lot of time and money. According to Gartner Group, 70 percent of adopters eventually either fail to use it properly or under utilize it. Poston and Grabski (2001) also realised in their study that there were no significant improvements in profits, reduction of expenditure nor productivity of the adopters. They however conceded that the sales cost ratio was improved in the third year of implementation. It was further proven in Nicolaou’s (2004) study that improvements in profits; e.g. return on assets (ROA) and return on investment (ROI)) only took place after the second year of implementation.
ERP implementation requires mandatory re-engineering of the firm’s processes as the adoption of the ERP system reorganizes operational activities. Operational efficiency would in effect be affected by the re-engineering process as it directly or indirectly impacts firm performance.
According to Vemuri and Palvia (2006), the implementation of ERP systems can improve the day-to-day operations and business processes of firms as ERP automates the business processes and increases work efficiency. ERP would for example reduce purchasing cost because it can be automated to check inventory safe stock and order materials where required. Most companies who use ERP change their business processes to suit the business of the ERP system in order to improve operation efficiency. ERP implementation is thus expected to improve business process and add firm value.
Shaio et al (2009), in their study compared the performance of business process, operational process efficiency and profitability from ERP pre-and post-adoption for long term in Taiwan.
They concluded from their findings that, business process, process efficiency, and profitability were not improved until four or five years after ERP system implementation in the firm. It is thus recognized that due to the complication of ERP and its impact on organizational structure, businesses only benefit from ERP after a long term period. Employees certainly need time to understand and experiment with ERP through the employee education as ERP integrates company database, business process and company structure (Aasheim et al., 2009).
2.7 CONCEPT OF PROFITABILITY
After all costs have been deducted from sales revenue, the balance is referred to as profit. Profit is a surplus of revenues over their associated expenses for an activity over a period of time. Terms like ‘earnings’, ‘income’, "return’ and ‘margin’ are usually used synonymously with profit. A firm’s management can thus control the firm’s revenue either through price on the one hand and or through costs on the other. This control may basically require increasing prices of goods being sold or reducing the costs associated with acquiring the goods that would be sold.
Many researchers have, over the years attempted to evaluate the concept in several industries.
Lyson (1996) and Adeyemi and Salami (2010) for instance posited that effective inventory management in any manufacturing firm is a sine qua non for increased profitability. They asserted that since up to about 70% of total funds employed are typically tied up in current assets, of which inventory is the most sizeable component, profitability would definitely be enhanced by inventory control through the reduction of storage and handling costs of materials. They then provided that proper management of inventory is reflected in a company’s return on investment (ROI) which they calculated using:
ROI = Profits × 100 %
Capital Employed
Ramakrishna, (2005); and Asaolu and Nassar, (2007) further provided that ROI can be maximized by either reducing the material cost; reducing the current assets via inventory of materials or can be optimized by increasing profits and reducing capital employed.
Profitability describes a firm, company, enterprise or an organization’s ability to make profit from all the business activities engaged in. It shows how optimally the management can make profit by using all the available resources in the market. According to Harward & Upton, "profitability is the ‘the ability of a given investment to earn a return from its use."
However, the term ‘Profitability’ is not synonymous to the term ‘Efficiency’. Profitability is aptly described as an index of efficiency; and is largely regarded as a measure of efficiency and by extension, a useful management guide to greater efficiency. Notably, profitability though an important yardstick for measuring efficiency, cannot be taken as a final proof of efficiency. It is possible to have satisfactory profits marking inefficiency and conversely, a proper degree of efficiency being accompanied by an absence of profit. The net profit figure may therefore simply reveal a satisfactory balance between the values received and value given as change in operational efficiency is in essence just one of the factors on which the profitability of an enterprise depends. Essentially, there are many other factors besides efficiency, which affect profitability.
One such factor that keeps rearing its significant head is inventory turnover. Inventory turnover, an important factor that gives impact to the cost and profit is calculated by dividing the cost of goods sold by the average stock and multiplying the product by the number of days in the year. It actually measures how quickly the firm moves the inventory through its warehouse.
Normally, most firms with about 20 – 30% gross profit should achieve an overall rate of five to six turns per year. Inventory turnover to all intents and purposes measures the number of times the firm sells their average investment in inventory each year. It is in actual fact, the number of opportunities the firm has to earn profit on the money they invest in inventory. It should hence be measured accurately.
Firms make profit by increasing the number of times they turn their inventory. Due consideration must be made however to the valuable discount, profitability in forward-buying opportunity and economic buying cycles. The discount given for various ordering size does not always results in the best value. Moorthy et al ( Undated).
2.8 The Relationship between Inventory Management and Profitability of the Organization
A significant number of academic and industrial researches have been carried out in relation to the presence of an existing link or otherwise between inventory management and profitability as assessed from different views.
According to Coyle et al (2003), changes in inventory levels have an impact on return on assets (ROA); thus, reduction in inventory usually improves ROA, which is a positive indicator of performance for current and potential investors. They continued that when sales decline, inventory levels often increase, which has a double-edged effect on profits, thus higher inventory holding cost as well as negative impact (decrease) in ROA.
Notably however, the financial success of the many evaluated firms in academia and industry is often credited to their ability to decrease inventory levels (increase inventory turns), whilst admitting that unreasonably low inventories can be as damaging to a firm’s profitability as unreasonably high inventories, and attempts to link absolute inventory levels to the stock price have had limited success (Chen et al. 2005a, 2005b, Lai 2005). Suffice to say therefore that there are mixed and some admittedly paradoxical evidence to the claim that inventory management is associated with financial performance.
In view of the limited understanding of the connection between inventory management and financial performance, only a few analysts and fund managers use inventories to predict/explain superior accounting returns. A rare exception is David Berman, a hedge fund manager who is cited in (Raman et al. 2005) as arguing strongly that the financial and stock performance of public retailing companies can best be predicted by analyzing the joint dynamics of inventory and sales and not merely by looking at the conventional operational metrics such as margins and inventory turns.
Abdulraheem et al. (2011) on a narrower study on inventory management in small business finance; sought to assess the impact of inventory management on selected small businesses in Kwara State, Nigeria. Based on an analysis of secondary data on selected small businesses spanning a 10 year period, they tested the relationship between inventory management and performance-based profitability of the selected small businesses. They reported a positive relationship between inventory level and profitability of small businesses; where the profitability of small businesses increased with the employment of effective inventory management. This finding agreed with the discovery of Grablowsky (1976) about the existence of a significant relationship between various success measures and the adoption of inventory management policies. Abdulraheem et al. (2011) thus concluded that small businesses were likely to generate higher profit if they put an effective inventory management system in place.
In a related survey, Dimitrios (2008) undertook a study in Greece to test the hypothesis that efficient (lean) inventory management leads to an improvement in a firm's financial performance. His sample period covered three years and spanned the three representative industrial sectors in Greece; food, textiles and chemicals. His preliminary results revealed that the higher the level of inventories preserved (departing from lean operations) by a firm, the lower its rate of returns. He further tested the findings by the use of pseudo-likelihood ratio test to verify the robustness of the linearity of the relationship and hit the limitation/implication that, it was difficult to isolate the effect of inventories even by using large samples and advanced methodologies given the great number of possible determinants of performance.
Also, Eroglu Cuneyt and Hofer Christian (2011) conducted a study in the US on Inventory Types and Firm Performance. The study, with its setting in the manufacturing sector noted that the effects of inventory management on firm performance, though well documented, had focused on the performance effects of total inventories and ignored the potentially deferential performance effects of raw materials, work-in-process, and finished goods inventories. Their research therefore investigated the effects of various inventory types on firm performance. The empirical analyses of data from US manufacturing industries revealed that the magnitude of the inventory–performance relationship varied by type of inventory and across industries. Their key finding was that raw materials inventories had a greater impact on firm performance than work-in-process and finished goods inventories. Their results posited that raw materials and finished goods inventories asymmetrically affect each other over time.
They also argued that inventory leanness is the best inventory management tool as it positively affects profit margins. Their study also found that the effect of inventory leanness on firm performance was mostly positive and generally non-linear and also implied that the effect of inventory leanness is concave; in line with inventory control theory that, there is an optimal degree of inventory leanness beyond which the marginal effect of leanness on financial performance becomes negative.
Salawati Sahari, Michael Tinggi and Norlina Kadri (2012) also in their study on the impact of inventory management on the performance of malaysian construction firms observed that; managers act rationally in managing their inventory efficiently if they are convinced that the practice enhances firm performance. Their finding was that inventory management was positively correlated with firm performance and that there was a positive relationship between inventory management and capital intensity.
Aghazadeh (2009) presented a correlation between company’s annual inventory turnover and its performance in the retail industry. Using an empirical model, the author found that future stock performance could be predicted by an indicator, which is the variance of annual inventory turnover of the firms. Having analysed the inventory turnover of various firms in different segments, the author concluded that if managers were able to control inventory turnover, both the firm’s stock performance and management quality would be affected positively.
Gaur et al. (2005) also in an interesting twist analyzed inventory turnover performance in the retail industry in view of the correlation of inventory turnover with gross margin; capital intensity and sales surprise are investigated. They developed several empirical models to test and strengthen their hypotheses and reported that inventory turnover was negatively correlated with the gross margin, positively correlated with the capital intensity with some exceptions, and positively correlated with the sales surprise. They found that inventory turnover in the retailing industry declined from 1985-2000.
By extension to the study of the Gaur et al. (2005), Gaur and Kesavan (2007) observed the impact of firm size and sales growth rate on inventory turnover performance in retail industry and found that inventory turnover was positively correlated with sales growth rate and growth rate was also correlated with firm size. They re-tested the hypotheses in Gaur et al. (2005) with a larger and recent data set, and further obtained consistent results with Gaur et al. (2005), demonstrating that inventory turnover was negatively correlated with gross margin, positively correlated with capital intensity, and positively correlated with sales surprise.
On the other hand, a study by Cannon (2008) introduced contradictory findings. That study focused on assessing the relationship between inventory performance and overall firm performance and argued that inventory performance should not be measured as a robust indicator of overall performance. Their study tested the incorporation of the firm’s annual percentage change in inventory turnover as a measurement for inventory management towards return on assets (ROA) as a measurement of performance. The study indicated that when the effects of time were taken into account, turnover improvement on average had a slightly negative effect on ROA. Additionally, they posited that turnover improvement exhibited a prominent random effect, with result indicating that approximately 95% of the firm’s turnover-improvement slopes would fall within a negative range. This meant that substantial variability existed across firms with regard to turnover improvement and its resultant performance effects, with some turnover improvement resulting in increased ROA and other turnover improvement decreasing ROA. (Cannon, 2008) further explored the turnover-ROA dynamic by introducing capital intensity as a potential source of variability. It was found that capital-intensive firms tended to be below average with regard to ROA and the variable’s presence in the model did not significantly alter the relationship between turnover improvement and ROA over time. This therefore lent additional weight to the conclusion not to support the hypothesis that improved inventory performance will be associated with improved overall firm performance.
In conclusion, a review of the literature confirms that although several prominent companies have created business value through successful supply chain management (e.g., Dell, Amazon.com, Wal-Mart and Zara; see Cachon and Terwiesch 2005), it is not immediately obvious whether the financial success of these companies can be in full or in part attributed to their ability to manage inventories. This is especially because the financial success of these and other companies is often attributed only to their ability to decrease inventory levels (increase inventory turns).

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