In a recent post, we highlighted the pivotal role of inventory optimization within the oil and gas industry. Building upon this foundation, this article provides a more comprehensive exploration into the strategies for maintaining optimal inventory management. In addition, we show some practical guidelines aimed at enhancing efficiency and resilience in inventory control. Furthermore, we present recent research findings that meticulously analyze the multifaceted relationships between diverse inventory factors and their consequential impact on a firm's overall profitability.
Effective management of working capital is essential in the supply chain, where it plays a crucial role in reflecting a company's short-term financial health and supporting daily operations. Additionally, the implementation of ISO 9000, a collection of global quality management standards, ensures a consistent level of quality in products/services. Consequently, combining these practices has the potential to improve supply chain efficiency, promoting resilience and ensuring long-term success.
According to Filbeck and Krueger (2005), Working Capital is delineated as the variance between assets readily convertible to cash (Current Assets) and impending financial obligations requiring cash disbursement (Current Liabilities). The primary aim of working capital management is to uphold an optimal equilibrium among the different components of working capital. This facet of financial decision-making significantly impacts a firm's profitability. The management of working capital can be elucidated as an accounting methodology emphasizing the maintenance of appropriate levels for both current assets and current liabilities.
ISO 9000 stands out as the predominant meta-standard for enhancing quality within manufacturing supply chains. Chris et al. (2008) showed that the adoption of ISO 9000 contributes to the enhancement of material and cashflows in the manufacturing sector. Through an investigation involving 965 US manufacturing companies and the testing of various hypotheses, their findings revealed that ISO 9000 certified firms reduced the number of inventory days by 8.29% within a span of 3 years. Furthermore, they demonstrated a noteworthy decrease in receivable days and the overall operating cycle time for companies that implemented ISO 9000.
Supply chain efficiency is one of the most important performance dimensions in contemporary manufacturing. Supply chain efficiency does not only refer to overall supply chain cost, but also lead-time performance, delivery promptness, and inventory level. Hereafter, some definitions are presented to improve the fundamental comprehension of terms related to the supply chain.
- Cash Conversion Cycle: a metric that measures the time it takes for a company to convert its resources (such as inventory) into cash flows from sales. It encompasses the time it takes to sell inventory, collect receivables, and pay payables. A longer Cash Conversion Cycle may tie up capital and increase the company's reliance on external financing.
- Inventory / Total Assets: measures the proportion of a company's total assets that is tied up in inventory. A high ratio could lead to increased carrying costs and potential liquidity issues.
- Inventory Days: also known as Days Inventory Outstanding (DIO), represents the average number of days it takes for a company to sell its entire inventory during a specific period. A lower inventory days figure suggests efficient inventory management.
- Inventory Turnover: a financial ratio that measures how many times a company's inventory is sold and replaced over a specific period. A higher inventory turnover ratio is generally favorable, indicating that the company efficiently manages its inventory by quickly selling and restocking products.
- Payable Days: the average number of days a company takes to pay its suppliers for goods and services. Longer payable days can benefit a company by allowing it to hold onto cash for a longer period, improving cash flow and liquidity.
- Receivable Days: known as Days Sales Outstanding, represents the average number of days it takes for a company to collect payment from its customers. A lower-receivable-days can improve cash flow and reduce the risk of bad debts.
- Labor Productivity: a measure of how efficiently a company's workforce generates output. It is often expressed as the ratio of output to the number of workers.
- Sales General Admin Cost / Total Revenue: this ratio assesses the efficiency of a company's operations by measuring the proportion of sales revenue spent on selling, general, and administrative costs. A lower ratio indicates that the company is operating more efficiently.
Various studies have delved into the intricate relationship between financial metrics and a firm's profitability. In exploring these connections, researchers have unearthed valuable insights that shed light on factors influencing a company's financial success.
- According to Mekonnen (2011), a statistically significant inverse correlation exists between profitability and the average collection period. This outcome implies that companies can enhance their profitability by reducing the number of days accounts receivable remain outstanding.
- Ponsian et al. (2014) demonstrated through statistical analysis that there is a positive correlation between the cash conversion cycle and a firm's profitability. They also statistically established a highly significant positive association between the average payment period and profitability. Additionally, they provided evidence of a highly significant negative correlation between inventory turnover in days and profitability.
- Conversely, Sunjoko (2016) indicated that inventory turnover, total asset turnover, and average collection period do not impact profitability. However, they showed that fixed asset turnover and the current ratio have an effect on profitability.
- Filbeck, G. and Krueger, T.M., 2005. An analysis of working capital management results across industries. American journal of business, 20(2), pp.11-20.
- Lo, C.K., Yeung, A.C. and Cheng, T.C.E., 2009. ISO 9000 and supply chain efficiency: empirical evidence on inventory and account receivable days. International Journal of Production Economics, 118(2), pp.367-374.
- Mekonnen, M., 2011. The impact of working capital management on firms’ profitability. Unpublished Master Thesis, Addis Ababa University: Ethiopia.
- Ponsian, N., Chrispina, K., Tago, G. and Mkiibi, H., 2014. The effect of working capital management on profitability. International Journal of Economics, Finance and Management Sciences, 2(6), pp.347-355.
- Sunjoko, M.I. and Arilyn, E.J., 2016. Effects of inventory turnover, total asset turnover, fixed asset turnover, current ratio and average collection period on profitability. Jurnal Bisnis dan Akuntansi, 18(1), pp.79-83.
