Title page

INVENTORY MANAGEMENT AND

FINANCIAL PERFORMANCE

By

K.T. Gunathilaka

MF/2011/3013

Department of Accounting and Finance

July 2016

Dissertation Presented to the Faculty of Management and Finance

of University of Ruhuna

in Partial Fulfillment of the Requirements for the Degree of

Bachelor of Business Administration

 Acknowledgement

I extend my sincere appreciation to my supervisor Mrs. M.S. Nanayakkara who

guided me from research proposal to the report writing. She really inspired,
motivated and assisted me during the process of this work. Special thanks to her
for the knowledge, wisdom, courage and determination she has granted me.

I am greatly indebted to my dear parents for their support, care and courage
during my study. I am so grateful my dear parents. My sincere gratitude further
goes to my dear parents, brothers and sisters and all friends for fellowship for
spiritual and moral support. And I also thank my management staff in my work
place for given freedom, time and courage for complete this piece of work

ii
 Dedication

I dedicate this thesis to my parent. Without their patience, understanding, support,

and most of all love, the completion of this work would not have been possible.

iii
 Table of Contents

Title page .................................................................................................................i

Acknowledgement ................................................................................................. ii
Dedication ............................................................................................................. iii
Table of Contents ..................................................................................................iv
List of Tables ....................................................................................................... vii
List of Figures..................................................................................................... viii
List of Acronyms ...................................................................................................ix
Declaration ............................................................................................................. x
Certification ...........................................................................................................xi
Abstract................................................................................................................ xii
CHAPTOR I ........................................................................................................... 1
INTRODUCTION ................................................................................................. 1
1.0 Research Background ....................................................................................... 1
1.1 Research Problem ............................................................................................. 3
1.2 Research questions and objectives ................................................................... 4
1.3 Methodology .................................................................................................. 4
1.4 Significance of the study ................................................................................... 5
1.5 Limitation .......................................................................................................... 5
1.6 Summary and Organization of the Chapter ............................................... 5
CHAPTOR II ......................................................................................................... 7
LITERATURE REVIEW ..................................................................................... 7
2.0 Introduction ....................................................................................................... 7
2.1 Techniques of inventory management .................................................................. 7
2.1.1. Basic Economic Order Quantity Model .......................................................... 7
2.1.2. Lean Inventory System ..................................................................................... 9
2.2 Concept of performance ....................................................................................... 10
2.3 Inventory management and firm’s performance ......................................... 11
2.4 Manufacturing sector in Sri Lanka and Inventory management ............... 13

iv
CHAPTER III ...................................................................................................... 14
METHODOLOGY .............................................................................................. 14
3.0 Introduction ..................................................................................................... 14
3.1 Research design ..................................................................................................... 14
3.2 Data collection ....................................................................................................... 14
3.2.1 Data collection method ................................................................................... 14
3.2.2 Study population.............................................................................................. 14
3.2.3 Sampling method and sample size .................................................................. 15
3.3 Data analysis and presentation. ........................................................................... 15
3.4 Inventory Management and Financial Performance Indicators ...................... 16
3.4.1 Inventory Turnover Ratio (ITR) ..................................................................... 16
3.4.2 Average Age of Inventory (AAI) ..................................................................... 16
3.4.3 Gross Margin................................................................................................... 16
3.4.4 Net Profit Margin (NP) ................................................................................... 17
3.5 Summary of chapter ............................................................................................. 18
CHAPTER IV ...................................................................................................... 19
DATA ANALYSIS AND INTERPRETATION ................................................ 19
4.0 Introduction ........................................................................................................... 19
4.1 Inventory and profitability of selected companies ............................................. 19
4.1.1. Average Raw materials, WIP and Finished goods over last years ............... 19
4.1.2 Average Gross Margin and Net Margin ......................................................... 20
4.1.3. Measurement of inventory management ....................................................... 21
4.2 Relationship between inventory management and financial performance 24
4.3 Findings of Regression Analysis ................................................................... 25
4.4 Summary of the chapter ....................................................................................... 26
CHAPTER V ........................................................................................................ 27
CONCLUSIONS AND RECOMMENDATIONS ............................................ 27
5.0 Introduction ..................................................................................................... 27
5.1 Key findings ..................................................................................................... 27
5.2 Conclusion........................................................................................................ 27
REFERENCES..................................................................................................... 29

v
APPENDICES ...................................................................................................... 30

vi
 List of Tables

Table 4.1: Descriptive Statistic1 ........................................................................................ 22

Table 4.2; Result of Correlation Analysi 1 ....................................................................... 24

Table 4.3; Results of Regression Analysi 1 ...................................................................... 25

vii
 List of Figures

Figure 2.1: EOQ with Constant Demand 1 ......................................................................... 8

Figure 4.1: total inventory 1 .............................................................................................. 20

Figure; 4.2 Average Gross Margin and Net 1 ................................................................... 21

Figure 4.3: Average Inventory Turnover R 1.................................................................... 22

viii
 List of Acronyms

AAI Average Age of Inventory

CA Current Assets

CL Current Liabilities

CSE Colombo Stock Exchange

EOQ Economic Order Quantity

GM Gross Margin

ITR Inventory Turnover Ratio

JIT Just – In- Time

MRP Material Requirements Planning

NP Net Profit

ROM Raw Materials

SPSS statistical package for social sciences

WC Working Capital

WIP Work In Progress

ix
 Declaration

I hereby declare that this dissertation is my own work and effort and that, to the

best of my knowledge and belief, it contains no material previously published or

written by another person nor material which has been accepted for the award of

any other degree or diploma of the university or other institute of higher learning,

except where due acknowledgment has been made in the text.

Signature of the student: ________________________________

Name of the student: K.T. Gunathilaka

Registration number of the student: MF/2011/3013

Date: 14.07.2016

x
 Certification

This is to certify that this dissertation submitted by K.T. Gunathilaka

(MF/2011/3013) in partial fulfillment of the requirement for the Degree of
Bachelor of Business Administration in Accounting at the Faculty of Management
and Finance of the University of Ruhuna is a record of the own work carried out
by the student under my supervision. This dissertation has been submitted with
my approval.

____________________________

Supervisor

Mrs. M.S. Nanayakkara

Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

____________________________

Head, Department of Accounting and Finance

Faculty of management and Finance

University of Ruhuna

xi
 Abstract

In present era competitive world having business is very important to control

various costs to sustain in the market. To sustain in the market, inventory
management plays an important role to make a control over the financial
statement of the organization. Effective inventory management is effect for the
overall performance of the manufacturing company. The manufacturing
companies retain inventory as Raw materials, Work in Progress and Finished
goods mainly and stock value takes a significant percentage of among all assets.
Main objective is this report find out the relationship between inventory
management and financial performance and find out the impact of inventory
management on financial performance in Sri Lankan manufacturing firms. This
study employed a descriptive research design and used quantitative method. All
relevant data get from the secondary sources such as annual report and published
articles. The target population was manufacturing firms In Sri Lanka while sample
size was 30% of the target population. The sampling design adopted was be
random sampling techniques and Data was analyzed by use of statistical package
for social science (SPSS) regression and correlation. Data was then presented
using tables and figures.

The empirical results revealed a positive relationship between financial

performance and Inventory management at 0.05 significance level. Further, they
showed that Inventory management had a significant effect on performance with a
beta coefficient of 0.743 in model 1 and 0.916 in model 2. The study suggests that
owners/managers of manufacturing firm effective inventory management as a
tactic to further their financial performance and in overall performance of their
organization.

Keywords: Inventory Management, Economic Order Quantity, Inventory

Turnover Ratio, and Average Age of Inventory. Financial Performance

xii
 CHAPTOR I

INTRODUCTION

1.0 Research Background

Working Capital (WC) is the heart of any organization because it directly affects the
liquidity and profitability of the company. Firms cannot operate day to day activities
without proper manage WC. WC deals with current assets and current liabilities.
When consider WC component, inventory is an important feature and it represent
higher amount than other current assets. So inventory management concept is most
valuable concept that can be increased firm’s performance and productivity.
Excessive levels of current assets can easily result in a firm’s realizing a substandard
return on investment. However firms with too few current assets may incur shortages
and difficulties in maintaining smooth operations (Horne and Wachowicz, 2000).
Therefore inventory also must handle accurately without excessive or very few levels.
Many of business firm’s main objective is maximizing the shareholder’s wealth. It is
necessary to generate sufficient profit to achieve organizational objectives. Therefore,
sufficient WC is necessary to sustain sale activity. This is referred to as the operating
cycle. The operating cycle can be said to be at the heart of the need for WC.

WC is the difference between Current Assets (CA) and Current Liabilities (CL).
Having CA provides insight about company’s liquidity. Liquidity is the length of time
until assets are converted to cash. It is an indicator of company’s ability to meet
financial obligations. The less liquid of the company is the lower its financial
flexibility to settle promising investment and expenses, and greater its risk of failure.
So inventory is a main component part of the WC and it is main expenses of
manufacturing firms in Sri Lankan context. Inventories refer goods held for sale as
part of a company’s normal business operations or goods acquired for sale. Inventory
represents one of the most important assets that most businesses process, because the
turnover of inventory represents one of the primary sources of revenue generation and
subsequent earnings for the company’s shareholders.
Inventories are the current assets which are expected to be converted within a year in
the form of cash or accounts receivables. Thus, it is a significant part of the assets for
the business firms. Actually, inventories are the goods that are stocked and have a

1
resale value in order to gain some profit. It shows the largest costs for the trading
firms, wholesalers and retailers. According to Vipulesh Shardeo (2015, p.01)
normally, inventory consists of 20-30% of the investment of the total investment of
the firm. Thus, it should be managed in order to avail the inventories at right time in
right quantity. 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. So, better management of the inventories would release capital
productively. Inventory control implies the coordination of materials controlling,
utilization and purchasing. It has 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.
According to Buffa and Sarin (2007) there are several reasons for keeping inventory.
Too much stock could result in funds being tied down, increase in holding cost,
deterioration of materials, obsolescence and theft. On the other hand, shortage of
materials can lead to interruption of products for sales; poor customer relations and
underutilized machines and equipment.
Inventories refer the finish goods, work in progress (WIP) and raw materials (RM)
normally. Most of businesses in Sri Lanka manage their inventory to gain strategic
benefits. To take a more benefits on inventory Company use several technics to
manage inventory. Most popular technics is Economic Order Quantity (EOQ) Model
in Sri Lanka context.
Colling (1990) argue that in the United States of America and other Western countries,
improvement in productivity was achieved through reducing the direct manufacturing
labour expenses cost per unit of output. This strategy was justifiable because of the
high labour content in many manufactured products. However, the ratio of unit cost
due to labour has constantly decreased in recent years. Even large manufacturing
firms, such as the United States (US) auto assemblers, purchase up to 60 percent of
the value of the product. This implies that management of raw materials inventories is
an area that shows great promise for productivity improvement. Japanese firms earned
more deserved attention in the mid-to late 1980s due to their notable performance on
quality and inventory management. The constant alert of the bar code being scanned
at a check out lane shows a pillar of modern system of inventory management stock
tracking. In the earliest days of shop keeping, merchants write down procurement or
2
they looked at how many units where gone at the day’s end and then did their best to
forecast future needs. The key skills where experience and intuition, but it remain an
imperfect method, even when applied to operations that where quite small by today’s
standards (Miller, 2010).
In this paper, all listed manufacturing companies at Colombo Stock Exchange (CSE)
of Sri Lanka are taken for the analysis. All company is Public Limited companies. In
the manufacture industry there are lots of inventories at different stages. So after
various discussions and analysis can see that really there is any impact of the
inventory management over the financial statement of the firm or not.

1.1 Research Problem

In today competition it become mandatory to keep large current asset in form of
inventories so as to ensure smooth production it is necessary to strike a balance
between all the inventories required for the production. In this paper study about how
manage existing inventory and to suggest ways for reducing the inventory cost there
by improving the profitability of the firm.
Most of studies and findings relating to the inventory management and financial
performance have been done in western countries and other countries In Sri Lankan
context haven’t sufficient research relating to this topic. Therefore researcher can
identify research gap in Sri Lankan context related to this topic.
Other problem is customized product. The trend towards product customization that
can be observed is the result of many changes in the business environment. Nowadays
Most of business firms survive their customer needs by using product customization
concept. Pine/Gilmore (1999) defines customization as “producing in response to a
particular customer’s desires.” Manufacturing companies are all difference with
respect to the way they meet the market demand. Some companies meet their
customer needs, anticipate customer’s demand and deliver finish goods from their
retained inventory. Other companies do not keep finish goods inventory and
manufacture new goods after receiving a tangible customer order. In here need of
retained finish goods inventory is not useful. But Raw Materials is more useful for
survive customer specific order.
The purpose of inventory management is to ensure availability of materials in
sufficient quantity as and when required and also to minimize investment in

3
inventories. Because of the large size of the inventories maintained by firms, a
considerable amount of funds is required to be committed to them. It is therefore
absolutely imperative to manage inventories efficiently and effectively in order to
avoid unnecessary investments. A firm neglecting the management of inventories will
be jeopardizing its long run profitability and may fail ultimately. The reduction in
excessive inventories carries a favorable impact on the company’s profitability.
Therefore firms have to manage inventory in correct manner for maximize
organizational performance.
The other thing is there are lots of techniques to manage inventory. But what is the
most useful and suitable techniques to reduced cost not clear. In this study decide
what the most applicable inventory management technics is in Sri Lankan context.
Therefore, this study examines the effect of inventory management system on
profitability.

1.2 Research questions and objectives

1. What is the relationship between inventory management and financial
performance in the manufacturing companies?
2. What is the impact of inventory management and financial performance in
manufacturing companies?
3. What are the most applicable and existing inventory management techniques
in manufacturing companies?

Objectives are,
1. To find out the impact of inventory management on financial performance in
manufacture firm in Sri Lanka.
2. To find out relationship between inventory management and financial
performance in the manufacturing companies
3. To identify existing inventory management techniques in manufacturing
companies.

1.3 Methodology
This research belongs to descriptive research design which used prior knowledge
about the problem situation. In this research, secondary data collection methods are
used to collect data. The secondary data is gathered from published journals,

4
published books and articles and some reliable websites. After collecting data from
the sources we correlate the inventory turnover with profitability of the firm using
correlation concept. We will find the Pearson correlation coefficient and analyze it to
show the impact of inventory management on the profitability of the firm.

1.4 Significance of the study

The study findings may be significant in the various ways is hoped that study findings
may be used as basis for further research and investigations in form of literature, The
findings may provide information to managers in manufacture firms especially on
knowing how to compare actual performance and inventory management and findings
may also be beneficial to other new researchers to investigate further about the impact
of inventory management on organizational performance of other organizations other
than manufacture firm in Sri Lanka.

1.5 Limitation
This study is based on only all public limited manufacturing companies at CES
among all large and medium scale manufacturing firm in Sri Lanka. So it may reflect
some partial view. In this study is considered only five years as the period of time
commencing from 2011-2015 and it is a short time period. Also, inflation is the most
crucial factor for financial terms. So, it is not considered in any type of interpretation.
Correlation technique is used as statistical tools to interpret the data. Mainly this
research based on secondary data so it effect to more limitation on data collection

1.6 Summary and Organization of the Chapter

First Chapter describe about significant of the topic, why this research do and about
knowledge gap which I am going to fill, research question and objectives,
methodology, limitation on this research and summery and organization of the
chapter.The second Chapter is literature review that focuses on the review of the
related literature in line with the study variables. The researcher mainly obtained the
theoretical available written data by different authors about the variables under the
study and the reviewed information.
The third Chapter is Methodology that presents the research methodology which
include; Research design , study population, study area, study variables, instruments
of data collection, data processing, sources of data and data analysis.

5
The fourth Chapter is findings and suggestion that presents and discuss the findings of
the study. The findings serve to reinforce the existing knowledge proven about the
relationship between inventory management and performance of manufacturing firm
in Sri Lanka. The fifth Chapter is conclusions that contains summary of the study
findings, conclusions, recommendations and suggestions for further studies. It
includes the summary of the study findings, conclusions and recommendations were
done in accordance to study objectives.

6
 CHAPTOR II

LITERATURE REVIEW

2.0 Introduction
Traditionally the academic literature on inventory focuses on production and
replacement as the principal determinants of inventory policy and management. In
here mainly focuses ordering cost and holding cost characterizes the approach of
Economic Order Quantity (EOQ) model represented inventory management. But In
recent years, buildup new concepts had been developed of Operations Management.
These more concept that Management oriented are material requirements planning
system (MRP), just – in- time (JIT) and ERP methods. Those new concept play more
important role in competitive business environment to determine optimal inventory
level.

This study investigates the effect of inventory management on firm performance. To

find out inventory performance, Inventory turnover ratio will be used and to measure
firm performance will be used profitability ratios. In general if affect other micro and
macroeconomics factor to firm performance in here consider only inventory
management that may influence to firm performance.

2.1 Techniques of inventory management

2.1.1. Basic Economic Order Quantity Model:

Economic Order Quantity (EOQ) is the cost of inventory that -minimizes the total
cost of inventory management that has long been the most widely used inventory
model. Its popularity is due to a combination of simplicity and wide applicability.
First introduced in 1913 by Ford W. Harris, an engineer with the Westinghouse
Corporation it has continued to be a key tool of inventory management for nearly a
century. But still R.H. Wilson is given credit for his early in- depth analysis of the
model (Arsham, 2006). The model is also known as the Wilson EOQ model.

7
 Figure 2.1: EOQ with Constant Demand 1
Source: International Journal of Innovative Science

Muckstadt et al., (2010) discussed that EOQ model was determined by minimizing the
total annual cost incurred by the company by virtue of its ordering cost and carrying
cost. The expression for total annual cost is:

TC= q/2 h +D/Q s

Where,
TC=total annual cost
Q=order quantity
D=annual demand
S=ordering cost
H=annual carrying cost per unit
Muckstadt et al., (2010) also said that the first component of this equation represented
the inventory management costs and the second component represents the ordering
cost. EOQ minimizes the sum of holding and setup costs. Differentiating with respect
to order quantity, the expression for EOQ was obtained as indicated in the equation
below.

Q = 2DCo/Ch

8
D = annual demand
Co = ordering/setup costs

Ch = cost of holding one unit of inventory

According to the Van Horne (1989), a company should introduce policies to reduce
lead time, regulate usage and thus minimize safety status. Therefore the finance
manager should ensure that only an optimum amount is invented in inventory to
achieve the trade of between profitability and liquidity (Pandey 1995). Materials
management is there a managerial process of counting planning, coordinating, control,
monitoring and motivation. Dave Plasecki (2001) defines EOQ model as an
accounting formula that determines the point at which the combination of order costs
and inventory costs are the least. EOQ is the number of units that a company should
add to inventory with each order to minimize the total cost of inventory, such as
holding costs, ordering costs and stock out costs. EOQ is used as part of continuous
review system in which the level inventory is monitored at all times and fixed
quantity is ordered each time the inventory reaches a specific reorder point (Lysons,
2012).

2.1.2. Lean Inventory System

Womack et al (2003) Lean production principle was pioneered. This principle was
linked with reduced inventories. Lean Management is getting more and more attention
in today’s highly competitive environment. In recent years, a number of systems have
been developed in the field of operations management to deal with excess inventory
problem. Management–oriented systems include the Just-In-Time (JIT) and Materials
Requirements Planning systems (MRP).
Just-In-Time refers to a collection of practices that eliminate waste. These
organization wide practices encompass the entire supply chain. The elements of JIT
include shared product design with suppliers and customers, movement towards
single sourcing proximate suppliers, reduced machine set- up times and total
preventive maintenance. It is an inventory strategy that is implemented to improve the
return on investment of a business by reducing inventory and its associated carrying
costs. In order to achieve JIT, the process must have signals of what is going on
everywhere within the process. JIT can lead to dramatic improvements in a
manufacturing organization’s return on investments, quality and efficiency. It

9
emphasizes that production should create items that arrive when needed, neither
earlier nor later.
Quick communication of the consumption of old stock, which triggers new stock to be
ordered, is key to JIT and inventory reduction. This saves warehouse space and costs.
The basic philosophy of JIT is that inventory is defined as waste. The technique was
first used by Ford motor company. It was subsequently adopted and publicized by
Toyota Motor Corporation of Japan in the 1950s.
MRP system is defined as product- oriented computerized technology aimed at
minimizing inventory and maintaining delivery schedules. It relates the dependent
requirements for materials and components comprising an end product to time periods
over planned horizon on the basis of forecasts provided by marketing and sales and
other input information (Lysons and Gillingham, 2003). This system is based on the
recognition that demands for an item may be dependent on the demand for other
inventory items. The emphasis is on the end product into which related parts are
incorporated. The inventory quantities required are specified on the basis of future
demand. The demand for inventory items is precisely determined from the master
production schedule for the end products. The operation of a lean inventory system
such as JIT and MRP result in relatively low inventory levels. The warehousing costs
and material handling costs are significantly reduced. This increases return on assets
through decreased conversion costs.

2.2 Concept of performance

Performance is a measure of the results achieved. Performance efficiency is the ratio
between effort extended and results achieved. The difference between current
performance and the theoretical performance limit is the performance improvement
zone. Performance assumes an actor of some kind but the actor could be an individual
person or a group of people acting in concert. The performance platform is the
infrastructure or devices used in the performance act (Malcom, S. 2005).

According to Likert (2003) there are two main ways to improve performance:
improving the measured attribute by using the performance platform more effectively,
or by improving the measured attribute by modifying the performance platform,
which in turn allows a given level of use to be more effective in producing the desired
output. Performance can be measured by obtaining the magnitude of a quantity, such
as length or mass, relative to a unit of measurement, such as a meter or a kilogram.

10
According to Halachmi, A, & Bouckart G. (2005); argued that financial ratios are
useful indicators of a firm's performance and financial situation. Most ratios can be
calculated from information provided by the financial statements. Financial ratios can
be used to analyze trends and to compare the firm's financials to those of other firms.
In some cases, ratio analysis can predict future bankruptcy.

2.3 Inventory management and firm’s performance

Empirical evidence related to the inventory management-performance relationship
produced also mixed results. Specifically, Milgrom and Roberts (1988) and Dudley
and Lasserre (1989) indicated that timely and informative customer demand data can
result in improved firm performance through reduced inventories.

Huson and Nanda (1995) proved that the improvement of inventory turnover led to an
increase in earnings per share.

Deloof (2003) documents a significant negative relation between gross operating

income and the number of inventories days for a sample of non-financial Belgian
firms during the period 1992-1996, suggesting that managers can create value for
their shareholders by reducing the number of inventories days to a reasonable
minimum.

Additional evidence from Belgium is provided by Boute et al. (2004), who found no
overall decrease of inventory ratios despite any increased focus on inventory
reduction.

Boute et al. (2006), who concluded that companies with very high inventory ratios
have more possibilities to be bad financial performers.

This is consistent with the findings of Shin and Soenen (1998), which reported a
strong negative relation between the cash conversion cycle and corporate profitability
for a large sample of public American firms.
Chen et al. (2005) by examining how the market values the firms with respect to their
various inventories policies, reported that firms with abnormally high inventories
have abnormally poor stock returns, firms with abnormally low inventories have
ordinary stock returns while firms with slightly lower than average inventories
perform best over time.

11
Furthermore, in a more recent study, Shah and Shin (2007) examined the empirical
associations among three constructs – inventory, IT investments and financial
performance – using longitudinal data that span four decades, where they conclude
that reducing inventories has a significant and direct relationship with financial
performance.
Dimitrios P. Koumanakos, (2008) prove that results obtained are less noisy while
performance gains and losses can be more plausibly linked to the strategy of
inventory policy and in the majority of sectors (food, textiles and chemical) and years
under investigation the relationship between profitability and inventory management
is negative and statistically significant at least at 10 per cent level of significance.

Koumanakos (2008) studied the effect of inventory management on firm

performances. 1358 manufacturing firms operating in three industrial sectors of
Greece, food, textiles and chemicals were used in the study covering period of 2000-
2002. The hypothesis that lean inventory management leads to an improvement in a
firm’s financial performance was tested. The findings suggests that the higher the
level of inventories preserved by a firm, the lower the rate of return.
Some researcher have found that there is a positive impact of inventory management
on financial performance and some are argue that there is negative impact of
inventory management on financial performance. These deferent opinion lead to more
research related to this topic and there is a research gap to fulfill. Effectively and
efficiency of inventory management depend on inventory management techniques,
survive business sectors and many of other environment factors. Therefore researcher
findings is different and should do research as far.
Colling (1990) in the United States of America and other Western countries,
improvement in productivity was achieved through reducing the direct manufacturing
labour expenses cost per unit of output. This strategy was justifiable because of the
high labour content in many manufactured products. However, the ratio of unit cost
due to labour has constantly decreased in recent years. Even large manufacturing
firms, such as the United States (US) auto assemblers, purchase up to 60 percent of
the value of the product. This implies that management of raw materials inventories is
an area that shows great promise for productivity improvement.

12
Japanese firms earned more deserved attention in the mid-to late 1980s due to there
notable performance on quality and inventory management. The constant alert of the
bar code being scanned at a check out lane shows a pillar of modern system of
inventory management stock tracking. In the earliest days of shop keeping, merchants
write down procurement or they looked at how many units where gone at the day’s
end and then did their best to forecast future needs. The key skills where experience
and intuition, but it remain an imperfect method, even when applied to operations that
where quite small by today’s standards (Miller, 2010).
(Arnold, 2000). In Nigeria, the size of industry, small, medium, and large scale has a
significant effect on both the numerical strength of staff and level of involvement in
inventory management of both raw material and the finished product. The type of
inventory system in practice in any organization depends on many factors among
which are economic stability of the place, infrastructural facilities available,
transportation network and many more which are called constraints.

2.4 Manufacturing sector in Sri Lanka and Inventory management

Small, medium and large manufacturing firms have in Sri Lanka and they used
variance techniques and practices to manage inventory as best level. EOQ model and
lean inventory systems are most popular among Sri Lankan manufacturing firms. The
impact of inventory management on finance performance depends on these inventory
management techniques. Limited number of research has related to this topic in Sri
Lankan context and there isn’t clear idea about this relationship.

13
 CHAPTER III

METHODOLOGY

3.0 Introduction
This chapter presents the research methodology which include; Research design, Data
collection method, study population, study sample, method of data collection, data
processing and data analysis.

3.1 Research design

This study employed a descriptive research design and used quantitative method. The
major objective of descriptive research is to describe something usually market
characteristics or functions. Descriptive research assumes that the researcher has prior
knowledge about the problem situation.
Some researcher argue that there is no relationship or impact of inventory
management on financial performance and some are found out opposite result. As an
example Fullerton etal. (2003) and Eroglu and Hofer (2011) provides empirical
support that firms have positive impact. Cannon (2008) indicated that when the
effects of time were taken in to account, turnover improvement on average had a
slightly negative effect on ROA. Kolias et al., (2011) explore that inventory turnover
ratio is negatively correlated with gross margin based on an econometric analysis
conducted on a sample of financial data for Greek retail firms for the period of 2000–
2005.
3.2 Data collection
3.2.1 Data collection method
Both primary and secondary data were the main sources of data to be used in the
study. Concerning the primary data collection method, the study used a questionnaire.
The researcher collected secondary information from different sources like; annual
report, text books, internet, newspapers, magazines, and journals.2013, 2014 and 2015
year statistics were taken to do this analysis.

3.2.2 Study population

Study population is all medium and large scale manufacturing firm in Sri Lanka.
According to Central Bank of Sri Lanka, if usable electric capacity is 50-500 Kwh it
categorized as a Medium Scale and if usable electric capacity is rather than 500 Kwh

14
it is a Large Scale firm. These manufacturing firms represent various industries such
as food and beverage, textiles, consumer goods and gems.

3.2.3 Sampling method and sample size

Sample design and procedure was based on random sampling. It is a probability
sample that ones in which members of the population have a known chance of being
selected into the sample. The study used random sampling techniques because it was
assumed to allow the researcher to select a sample with probably and easily select
proper sample. In here sample select randomly and select all listed manufacturing
firms at CSE among medium and large scale manufacturing firms. The researcher can
be eliminated sampling bias and accurate represent the target population by using
random sampling.

The researcher used a sample size of 35 respondents because as it was large enough or
the study to obtain reliable information. The study determined the sample size of the
respondents by using the following formula.

P= (F/N) x n.

Where;

F= Number in the category

N = Total population.

P = Number of respondents in the category obtained from the group

n = Total number of the respondents

3.3 Data analysis and presentation.

The study was guided by the two variables; Inventory management as an independent
variable and financial performance as a dependent variable. Inventory management
was measured by the ratios used Inventory Turnover Ratios (ITR) and Average Age
of Inventory (AAI). However during the study, performance was commonly measured
by Gross Margin (GM) and Net Profit (NP) of the company.

15
3.4 Inventory Management and Financial Performance Indicators
3.4.1 Inventory Turnover Ratio (ITR)
Kohler defines inventory turnover as “a ratio which measures the number of times a
firm’s average inventory is sold during a year”.

This ratio indicates the number of times the inventory has been converted into sales
during the period. Thus it evaluate the efficiency of the firm in managing its
inventory.it is calculated by dividing the cost of goods sold (COGS) by average
inventory.

𝐶𝑂𝐺𝑆
𝐼𝑇𝑅 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

The average inventory is simple average of the opening and closing balances of
inventory. (Opening+ Closing balances / 2). In certain circumstances opening balance
of the inventory may not be known then closing balance of inventory may be
considered as average inventory.

High inventory turnover ratio represents good inventory management since it implies
rapid movement of merchandise to lower inventory investment

3.4.2 Average Age of Inventory (AAI)

Average time taken in number of days for a firm to sell its inventory product. It is
calculated by dividing the average inventory by cost of goods sold and multiplying by
365 or by ITR dividing by the 365.

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐴𝐴𝐼 = 𝑋365
𝐶𝑂𝐺𝑆

Or

𝐼𝑇𝑅
𝐴𝐴𝐼 =
365

3.4.3 Gross Margin

This is a profitability ratio that can be measured profitability in relation to sales. It
measures the relationship between gross profit and sales and the higher value is good.
It calculated by dividing gross profit by sales and multiplying by 100.

16
 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝐺𝑟𝑜𝑠𝑠 𝑀𝑎𝑟𝑔𝑖𝑛𝑒 = 𝑋100
𝑆𝑎𝑙𝑒𝑠

3.4.4 Net Profit Margin (NP)

Net profit margin is the percentage of revenue remaining after all operating expense,
interest, taxes and preferred stock dividends have been deducted from a company’s
total revenue.

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝑁𝑃𝑀 = 𝑥 100
𝑇𝑜𝑡𝑎𝑙 𝑅𝑒𝑣𝑒𝑛𝑢𝑒

Quantitative and qualitative analysis method is used for this study. Quantitative data
analysis was helpful in data evaluation because it provided quantifiable and easy to
understand results. Quantitative data was analyzed through descriptive statistics in the
form of frequencies tallies and percentages. The statistics were being generated using
statistical package for social sciences (SPSS) and data obtained was communicated
through pie charts and tables. Qualitative data collect by using questionnaire.
Data was analyzed using mean, standard deviation, frequency tables, percentages, and
Pearson correlation and regression analysis.

H1; There is an impact of inventory management on financial performance.

Regression model was developed as follows.

The cross-sectional model used is 𝜋 = 𝛼 + 𝛽0 𝐼𝑇𝑅 + 𝛽1 𝐴𝐴𝐼 + 𝜀
Where
𝜋 - (mean) Financial Performance
𝛼 - Constant amount
𝛽0 – Inventory Turnover Ratios
𝛽1 – Average Age of Inventory
𝜀 - Error term
This Cross sectional model divided in to two model like as follow
𝐺𝑀 = 𝛼 + 𝛽0 𝐼𝑇𝑅 + 𝛽1 𝐴𝐴𝐼 + 𝜀 01
𝑁𝑃 = 𝛼 + 𝛽0 𝐼𝑇𝑅 + 𝛽1 𝐴𝐴𝐼 + 𝜀 02
GM is Gross Margin
NP is Net Profit

17
3.5 Summary of chapter
This chapter describe about how did formulated the research question, objectives, and
hypotheses and data collection method and sampling method and analytical
techniques. In here mainly mention that approach and procedure adopted by
researcher in describing, explaining and predicting a given phenomena.

18
 CHAPTER IV

DATA ANALYSIS AND INTERPRETATION

4.0 Introduction
This chapter presents and discuss the findings of the study. The findings serve to
reinforce the existing knowledge proven about the relationship between inventory
management and performance of Manufacture firms in Sri Lanka.

The chapter involves presentation, analysis and interpretation of the study results.
Data presented, analyzed and interpreted according to the research objectives.

4.1 Inventory and profitability of selected companies

Inventories constitute the most significant part of current assets of most of the
companies in Sri Lanka. Inventory related cost is the main costing part of
manufacturing firms and it directly effect to financial performance of firms. The
companies should considered new methods, techniques and strategies to control and
manage all inventories how can get a more profit and gains.

4.1.1. Average Raw materials, WIP and Finished goods over last years
All companies that included in to the sample are listed at CSE under the
manufacturing firm category and it included firm in the various sector such as food
and beverage, chemicals and domestic product. In here some companies have lots of
inventories such as ROM, WIP and Finished goods but some are not so. Retaining and
maintaining stock quantity is changes according to their nature of the firm. As an
example diamond manufacturing company not maintain huge quantity but their stock
value is high because that product are expensive in the current market. Some
manufacturing firms having mostly Row materials than other inventory for complete
the order requirements only. In here packing materials and other base compound is so
important and sometime have a little buffer stocks because changing the planning
productions.

This draft displays the total inventories such as ROM, WIP and Finish goods having
the total companies throughout from 2013 to 2015.

19
 8,000,000,000.00

7,000,000,000.00

6,000,000,000.00

5,000,000,000.00

4,000,000,000.00

3,000,000,000.00

2,000,000,000.00

1,000,000,000.00

-
2013 2014 2014

ROM WIP FINISH

Figure 4.1: total inventory 1

The figure 4.1; shows the all inventory part retained by listed manufacturing firms
under three years. It indicated companies mostly retained the ROM stock and then
retained finished goods. So ROM stock in most significant to the manufacturing firm
because company can survive it specific demand by using this ROM stocks.
Furthermore the companies have continually this stock at same level that mostly
ROM, WIP and Finished stock as respectively.

4.1.2 Average Gross Margin and Net Margin

Company’s profitability measured by using various profitability ratios and mostly
gross margin and net margin are used. Therefore this research used gross margin and
net margin as independent variables. Following figure displays about how GM and
NM changing throughout the years.

20
 25

20

15

10

0
2013 2014 2015

AGM ANP

Figure; 4.2 Average Gross Margin and Net 1

Figure 4.2 indicates information about how change GM and NP throughout three year
of 2013 – 2015. When carefully observe this chart, implies that average gross margin
is increased continually and ANP is not increased continually. Maximum AGM is
19.58% at 2015 and Maximum ANP is indicate as 7.4% at 2015. Average data get
from sum of profit margin divided by all number of respondents.

4.1.3. Measurement of inventory management

Efficiency and effectiveness of inventory management can measure by using
Inventory turnover ratios and average age of inventory. Following draft shows about
trend of Average inventory turnover and average amount of average age of inventory.

21
 120

100

80

60

40

20

0
2013 2014 2015

AITR AAAI

Figure 4.3: Average Inventory Turnover R 1

Average Inventory Turnover Ratios are 6.93, 6.75 and 6.01 respectively from 2013 to
2015 and it represent the time. It continually decrease and it trend is not good because
decreasing ITR effect to the effectiveness of selling activities. Average Age of
inventory result represent the number of days, and decreasing AAI is good. Average
data get from sum of ratios divided by all number of respondents.

4.2 Descriptive Statistic

Table 4.1: Descriptive Statistic1
N Minimu Maximu Mean Std.
m m Deviation
Statistic Statistic Statistic Statistic Std. Statistic
Error
ITR 88 -.52 1.62 .7098 .03648 .34221
GM 86 -.32 1.67 1.2045 .03648 .33834
AAI 88 .95 3.09 1.8529 .03645 .34195
NP 89 -.10 2.18 .7727 .05592 .52755
Valid N 83
Note: ITR is Inventory Turnover Ratio. GM is Gross Margin. AAI is Average Age of
Inventory. NP is Net profit
Source: Cell Contents of SPSS Package

22
The study sought to find out the impact of inventory management on financial
performance of manufacturing firms in Sri Lanka. The study covered all the listed
manufacturing companies at CSE under manufacturing firm category. The secondary
data was obtained from published annual report on web side of CSE. Summary of
frequencies, means and standard deviations was obtained and analyzed through a
computer SPSS Package. Total number of respondent is 90 and table 1 show
minimum statistic of ITR as -0.52 by Blue Diamonds Jewellery Worldwide PLC
because it’s inventory become sales slowly. Maximum statistic shows for AAI as 3.09
for ITR minimum company which blue diamonds jewellery worldwide PLC.
Table 1 shows the descriptive statistics of the inventory management via financial
performance, with a mean response of 0.7098 and std. deviation of 0.34221 for ITR
and a mean response of 1.2045 and std. deviation of 0.33834 for GM and number of
respondents (90). For AAI mean value is 1.8529 and std. deviation is 0.34195 and for
NP mean is 0.7727 and std. deviation is 0.52755.By careful observation of standard
deviation values, there is no much difference in terms of the standard deviation scores.
This implies that there is about the same variability of data points between the
dependent and independent variables.

23
4.2 Relationship between inventory management and financial performance
Table 4.2; Result of Correlation Analysis 1
ITR GM AAI NP
Pearson
1
Correlation
ITR
Sig. (2-tailed)
N 88
Pearson
-.222* 1
Correlation
GM
Sig. (2-tailed) .042
N 84 86
Pearson
-1.000** .221* 1
Correlation
AAI
Sig. (2-tailed) .000 .044
N 88 84 88
Pearson
.150 .512** -.152 1
Correlation
NP
Sig. (2-tailed) .164 .000 .160
N 87 85 87 89
*. Correlation is significant at the 0.05 level (2-tailed).
**. Correlation is significant at the 0.01 level (2-tailed).
Source: Cell Contents of SPSS Package

Table 2; is the Pearson correlation coefficient for inventory management and firm’s
financial performance. The correlation coefficient shows -.222 for ITR with GM. This
value indicates that correlation is significant at 0.05 level (2tailed) and implies that
there is a negative relationship between inventory management and financial
performance. The AAI correlated with GM positively, the correlation coefficient
shows as .221 at 0.05 significant level.
The correlation coefficient shows 0.150 for ITR with NP and it indicates that positive
correlation between Inventory management and financial performance. NP and AAI
correlation is -0.152 and it implies that there is a negative relationship between
inventory management and financial performance.

24
4.3 Findings of Regression Analysis
The objective of this study is to investigate the casual relationship between inventory
management and financial performance. For this purpose, both models were
developed to examine the combined influence of independent variables on GM and
NP respectively by using multiple regression technique.

Table 4.3; Results of Regression Analysi 1

Model 1 Model 2
R2= .049, F=4.199, P=.044 R2= .068 , F=3.144, P=0.048
Β t- value sig Β t- value Sig
Constant 0.743 .916
ITR -18.358 -1.545 .015 -009 -.842 .402
AAI 0.257 2.049 .018 -.001 -2.508 .014

Notes: statistical significance at 5%levels

Source: Cell Contents of SPSS Package

Table 3; shows regression coefficients and their statistical significance, of two models
namely Model 1 and Model 2. Results of both models were found statistically
significant. Model 1 accounted for approximately 4.9% of the variation of GM
(F=4.199, p <.044) and 6.8% variation of NP is explained in Model 2 (F=3.144, p
<.048). The ANOVA result for all variables indicates that there was a highly
significant relationship between the variables at F = 4.199 and P = 0.044 in model 1
and F=3.144 and P=0.048 in model 2. This implies that there is a strong relationship
between the two variables and the performance of the procurement function of
manufacturing companies in the Sri Lanka
The results indicate that AAI positively statistical significant at 5% level in explaining
financial performance in models 1 and AAI negatively statistical at 5% level in
explaining financial performance in model 2 respectively . This model 1 indicates
that AAI were correlated with GM at higher profitability and model 2 indicates that
AAI were correlated with NP at lower profitability.

The regression coefficients of ITR relating to GM and NP are -18.358 and -0.842
respectively in model 1 and 2. Thus, this confirms negative association with ITR and
25
financial performance at 5% significant level. This implies that increase of inventory
turnover will lead to realization of profit maximization objective.
Questionnaire sent to respondents by using E-Mail facility and received reply of 80%
among total respondents. In here some companies not use any inventory management
techniques or system and mostly used EOQ model some company for manage their
inventory. In addition to EOQ Model Company used JIT system for inventory control.

4.4 Summary of the chapter

This chapter explain the findings of study by using tables, draft and figures.
Descriptive Statistics, Linier regression and Pearson correlation information included
in this chapter.

26
 CHAPTER V

CONCLUSIONS AND RECOMMENDATIONS

5.0 Introduction
This chapter contains summary of the study findings, conclusions, recommendations
and suggestions for further studies. The summary of the study findings, conclusions
and recommendations were done in accordance to study objectives as follows.

5.1 Key findings

After testing of the hypotheses, it was discovered that there was There is lower
significant relationship between good inventory management and organizational
performance (r =.261, P<.05) and (r = .221, P<.05) in model 1 and 2 respectively.
There is negative correlation between ITR and GP and there is a positive relationship
between ITR and NP. There is a positive relationship between AAI and GM and
negative relationship between AAI and NP. Qualitative results from the majority of
respondents on the questionnaire revealed that the mostly using inventory
management techniques is EOQ model and JIT system.

5.2 Conclusion
This study examined the relationship between inventory management and
organizational performance in manufacturing firms in Sri Lanka. Its major objectives
are to investigate relationship between inventory management and financial
performance and find out the effect of inventory management on financial
performance. These objectives were guided by three research questions and one
hypotheses. The researcher questions and hypothesis were linked to existing theories
and views on inventory management. Data for examining the research hypothesis
were obtained through secondary sources such as annual report and other related
articles to sample of 30 respondent companies under study. The data collected were
adequately analyzed and presented in tabular forms, and accurate interpretation drawn
from them. SPSS techniques were used in the analysis of the data and testing the
hypothesis at 0.05 significant levels. The finding that emerged from the study showed
a significant relationship between effective inventory management system and
organizational performance. The research found out the EOQ model is the mostly
usable techniques for inventory management after mail result.

27
The negative relationship between inventory management and financial performance
implied by Ronald, H. (1999), who reported that inventory exists for this reason alone,
the relevance of the decision to be made. Carrying, holding or possession costs. These
include handling charges, labour and operating costs, insurance premium, breakage,
pilferage, obsolescence, taxes and investment or opportunity costs. In short any cost
associated with having as opposed to not having inventory is included. Other costs
may include ordering costs, or purchase costs, set-up costs, stock out and price
variation costs.

Implications

Results verified by the SPSS not confirm the existence of a robust linear relationship
Therefore, another parametric or a non-parametric model is needed to describe this
relationship in the manufacturing firms. This research is based on firm-specific financial data
got from primary sources, it has certain limitations that can be addressed in future research
using more detailed data sets.

Future research examining whether or not the reported in the financial statements earnings
and inventory levels under the various sector are manipulated would lead to a better
understanding of the relationship.

28
 REFERENCES

1. Cynthia, M., Amuhaya, M.,(2015) “An Analysis of the Effects of Inventory

Management on the Performance of the Procurement Function of Sugar
Manufacturing Companies in the Western Kenya Sugar Belt” , International
Journal of Scientific and Research Publications, Vol. 5, pp. 3-4
2. Dimitrios P. Koumanakos, (2008),"The effect of inventory management on
firm performance", International Journal of Productivity and Performance
Management, Vol. 57 Iss 5 pp. 355 – 369
3. Timothy, L., Patrick, B., Nebat, G. and Virginia, K. (2013) “The Impact of
Inventory Management Practices on Financial Performance of Sugar
Manufacturing Firms in Kenya”, International Journal of Business,
Humanities and Technology, Vol.3, pp.76-77
4. Ogbo, Ann I.,(2014) “The Impact of Effective Inventory Control Management
on Organisational Performance”, Mediterranean Journal of Social Sciences,
Vol.5, pp.109-111
5. Colling, D. (1990). Industrial Safety. Management and Technology.
Englewood Cliffs, NY: Prentice Hall.
6. Miller, R. (2010). Inventors Control: Theory and Practice. New Jersey:
Prentice Hall.
7. Vipulesh Shardeo (2015). IOSR Journal of Business and Management
(IOSR-JBM)

29
 APPENDICES

Appendix A: Questionnaire for the company Accountant

Dear Sir/Madam

I’m a student of Bachelor of Business Administration, Faculty of Management and

Finance, University of Ruhuna and currently conducting an academic research to find
out the impact of inventory management on financial performance in manufacturing
companies. Your company is selected as one of respondents in my sample. I’m kindly
requesting you to fill and forward this questionnaire ASAP.

Thank you very much for giving your precious information to the research.

Yours,

Sincerely,

Thilini Gunathilaka K.

University of Ruhuna,

Matara.

30
Questionnaire

Please tick mark (√) where necessary.

1. Do you have any inventory management system to control your inventory?

Yes No

2. What are the existing inventory management techniques used by the

company? (Ex; EOQ/ABC/Lean inventory system etc.)

3. How does the company determine the re-order level?

4. Do you think this existing inventory management system is suitable to

maintain the inventory efficiently?

Yes No

5. If no what do you suggest?

Introduce new system or technique

Formalize existing system

If you suggest any other please mention it.

31