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The Effect of Inventory Management on Firm Profitability and Operating Cash Flows a Case Study of Kenya Breweries Limited

The Effect of Inventory Management on Firm Profitability and Operating Cash Flows a Case Study of Kenya Breweries Limited

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LIST OF ABBREVIATIONS

 

CFO Cash flow from Operations
EOQ Economic Order Quantity
FG Firm Growth
FMCG   Fast-Moving Consumer Goods
FS Firm Size
GDP Gross Domestic Product
ICP Inventory Conversion Period
JIT Just in Time
KBL Kenya Breweries Limited
OE Operating Efficiency
ROA Return on Assets
SMEs Small and Medium Enterprises

ABSTRACT

 The main purpose of management of inventory is basically to try and balance the conflicting economics of not wanting to hold too much inventories or stocks. However, most managers ignore the saving potential that arise from proper management of inventories, trying to treat inventories as a necessary evil and not as an asset that require to be managed. As such, some firms do not or ignore to control their inventory holding, this usually leads to under stocking and causing the firm to stop or slow its production.

This finally results to firm’s ineffectiveness. This study sought to examine effect of inventory management on firm’s profitability and operating cash flows of Kenya Breweries Limited beer distribution firms in Nairobi County. The study employed a descriptive research design. Population of the study involved six Kenya Breweries Limited beer distribution firms in Nairobi County thus the study carried out a census of the six firms in Nairobi County. The study used secondary data, which was collected using a data collection sheet from six firms for a period of 10 years from the years from 2006-2015. The data collected was analyzed using ordinary least squares in form of regression equations via the statistical package for social sciences.

The study established a significant relationship between the management of inventory and the operating cash flows of Kenya Breweries Beer distribution firms in Nairobi County. The study concluded that inventory management significantly influences firm profitability and operating cash flows of Kenya Breweries beer distribution firms in Nairobi County, Kenya. The study recommended that the management of Kenya breweries ltd beer distribution firms in Nairobi County should adopt effective inventory management practices like just in time and material requirement planning. This is because such inventory management practices would improve their profitability and operating cash flows.

The Effect of Inventory Management on Firm Profitability and Operating Cash Flows a Case Study of Kenya Breweries Limited

CHAPTER ONE: INTRODUCTION

 1.1  Background of the Study

 Stock or Inventory constitutes a substantial proportion of the current asset group. It represents investments made for obtaining a return (Duru, Oleka & Okpe, 2014). Inadequate inventory has an adverse potential effect on the smooth running of the business, while excess inventory involve extra cost, which can reduce the firm’s profits (Panigrahi, 2013). Excessive stock is not desirable for longer periods because high inventory levels increase carrying cost and as inventory is increases; the profitability decreases (Priyank & Hemant, 2015). Hence, a suitable inventory control strategy will help in ensuring that the firms always keep an optimal amount of assets. Freeing frozen amounts in the form of stocks or inventories increases the firm’s efficiency in the use of its resource (Ziukov, 2015). As such, a well-functioning inventory system has a great effect on total firm’s performance as well as that of the firm’s managers (Akindipe, 2014).

Inventories are part of current assets, which are convertible to other forms of working capital (cash and other receivables) in less than one year (Milicevic, Davidovic & Stefanovic, 2010). The theory of inventory management involves making decisions that are in line with basic trade off among firm’s objectives, costs and other constraint (Mathuva, 2013). The economic order quantity theory, suggests that firms should maintain the quantity of inventory which provides the lowest total holding cost and acquiring cost (Milicevic, Davidovic & Stefanovic, 2010). Thus, inventory management is vital to for an effective and efficient firm. It is also important since it helps the firm in determination of the optimal amount of materials and goods a firm can hold at any given time (Kumar & Bahl, 2014).

Profit of an organization can easily be maximized with the help of an effective inventory management system in places. Profit maximization is all about cost minimization and revenue maximization. An effective inventory management improves the firm’s total performance through matching inventory management practices and a competitive advantages especially now that most organizations operates in a more competitive industries or sectors all over the world (Mahidin et al., 2015). The main goal and objective of inventory management system is to keep at the necessary required inventory at any time so that production runs smoothly without interruption whatsoever (Panigrahi, 2013). Inventory is the second largest assets as shown in the statement of financial position in brewery industry. It’s only exceeded by equipment and the physical facilities (Eneje, Nweze, & Udeh, 2012)

1.1.1 Inventory Management

 Inventory management refers to keeping or maintaining the firm’s stocks at a level that a firm will only incur the least cost consistent with other management’s set objectives or targets (Kwadwo, 2016). Inventory management is about ensuring that all input materials of production available to the firm are maintained at a level where production is not interrupted as well as ensuring that operational cost is kept at a minimal level without affecting operation efficiency (Eneje, Nweze, & Udeh, 2012). Inventory management entails planning, organizing, controlling and directing. All these coordinated efforts are meant to ensure achievement of efficiency in all operations of the firm. Such operations may include procurement, stocking and transportation (Akindipe, 2014). Mismanagement of Inventories may lead to significant financial problems for a firm (Muhayimana, 2015). Inventory management is of high importance in financial management decision.

This is because excess or shortage of this may bring danger to the company (Duru, Oleka & Okpe, 2014). The objective of inventory management is to maintain a system that minimizes total cost, while specifically, it establishes that the amount of stock to be ordered is optimal as well as the period between orders (Anene, 2014). Excess inventory consumes a lot of space, can increase possibility of spoilage, leads to a financial burden and loss while insufficient inventory has the potential of interruping business operations (Swaleh & Were, 2014).

Inventory management is vital and needed in various areas within the firm especially in a supply network so as to protect production against any disturbance of running out of production inputs or materials and goods (Ogbo, Onekanma & Ukpere, 2014). Management of Inventory is crucial to a firm since it plays a decisive role to enhance efficiency and improve the firm’s competitiveness ability against the firm’s competitors. Effective inventory management ia all about holding the right amount of inventory required by the business at any point in time (Swaleh & Were, 2014). Inventory management involve creation of a purchasing plan which will help to ensure that all items or materials are available when needed as well as and tracking the existing inventories and its use (Muhayimana, 2015).

1.1.2 Firm Profitability

 Profitability refers to money that a firm can produce with the resources it has. The goal of most organization is profit maximization (Niresh & Velnampy, 2014). The profitability shows the ability of a firm to generate earnings from the use of its assets for a certain period of time (Farah & Nina, 2016). Profitability involves the capacity to make benefits from all the business operations of an organization, firm or company (Muya & Gathogo, 2016). Profit usually acts as the entrepreneur’s reward for his/her investment. As a matter of fact, profit is the main motivator of an entrepreneur for doing business. Profit is also used as an index for performance measuring of a business (Ogbadu, 2009). Profit is the difference between revenue received from sales and total costs which includes material costs, labor and so on (Stierwald, 2010).

Profitability can be expressed either accounting profits or economic profits and it is the main goal of a business venture (Anene, 2014). Profitability portrays the efficiency of the management in converting the firm’s resources to profits (Muya & Gathogo, 2016). Thus, firms are likely to gain a lot of benefits related increased profitability (Niresh & Velnampy, 2014). One important precondition for any long-term survival and success of a firm is profitability. It is profitability that attracts investors and the business is likely to survive for a long period of time (Farah & Nina, 2016). Many firms strive to improve their profitability and they do spend countless hours on meetings trying to come up with a way of reducing operating costs as well as on how to increase their sales (Schreibfeder, 2006).

Profitability is used in measuring performance of the firm. Profitability is one of main aspects of financial reporting for many firms (Farah & Nina, 2016). Profitability is vital to the firm’s manager as well as the owners and other stakeholders that are involved or associated to the firm since profitability gives a clear indication of business performance. Profitability ratios are normally used to measure earnings generated by a firm for a certain period of time based on the firm’s sales level, capital employed, assets and earnings per share (EPS). Profitability ratios are also used to measure the firm’s earning capacity and considered as a firm’s growth and success indicator (Majed, Said & Firas, 2012).

The Effect of Inventory Management on Firm Profitability and Operating Cash Flows a Case Study of Kenya Breweries Limited

1.1.3 Operating Cash Flows

Operating cash flow is the cash made from the operations of the firm. It is usually defined as revenues less operating expenses (Rashvand & Tariverdi, 2015). Operating cash flow comprises of all the activities that leads to net profit determination (Nwanyanwu, 2015). Operating cash flow is the flow of cash that is availed from the core operations of a firm (Amuzu, 2010). Operating cash flows are normally considered as a source of company cash and indicates the efficiency with which a company allocates its accrual cash flow (Aliakbari, 2015).

Cash generated from operating activities is a clear reflection of transactional effect of cash that help in determination of a firm’s net income (Amuzu, 2010). Operating activities generally involve production and delivery goods and providing services (Duhovnik, 2008). Operating activities are the main firm’s income producing activities. They involve all transactions and activities or events which are used in computation of the firm’s net profit or loss (Nwanyanwu, 2015).

Operating cash flow is a measurement of the amount of funds a firm generates through its core business (Rashvand & Tariverdi, 2015). Operating cash flow is a more objective and a direct measure of firm’s liquidity position (Telmoudi, Ziadi & Noubbigh, 2010) and the operating cash flow can be determined either by a direct method or indirect method. Normally, cash flow to sales ratio is used to measure as to proxy for cash flow from operations. The cash flow to sales ratio is usually give cash flow as a percentage of sales ratio. This ratio is computed using the cash flow from operations.

1.1.4 Effect of Inventory Management on Firm Profitability and Operating Cash Flows

Inventory management policies and procedures are normally designed to ensure that a firm or an organization uses its inventory in a way that it is able to maximize its profit from the least inventory investment amount without encroaching or affecting customer’s levels of satisfaction (Anene, 2014). Inventory constitutes a large portion of total investment, it is vital that a firm adapts a good inventory management system to enable firm’s growth and enhancement of firm’s profitability (Anichebe & Agu, 2013). As such, the Economic Order Quantity (EOQ) theory states for a firm to maximize benefits from inventory management it should hold an optimal inventory, which minimizes both ordering cost and holding cost of inventories. The Just in Time (JIT) model proposes that firms should produce or to purchase products or components as they are required by customers or for use rather than holding stock (Sitienei & Memba, 2015).

A study by Koumanakos (2008) on effect of inventory management on performance of some firms established that a rate of returns is significantly affected by the level of inventory held. That is, high inventory level lowers the rate of returns. Khaled & Hayam (2016) studied the relationship that exists between management of inventory and the general firm’s performance. The study established that inventory to sales ratio affects organization performance negatively in the initial growth stage and the maturity stage; it exerts a positive and significant coefficient on performance in either the rapid growth stage or the revival stage. Further, Kwadwo (2016) investigated effect of efficient management of inventory on profitability of manufacturing firms. The study revealed that a significantly and positive correlation between raw materials inventory management and profitability of manufacturing firms in Ghana.

The Effect of Inventory Management on Firm Profitability and Operating Cash Flows a Case Study of Kenya Breweries Limited

In their study, Duru, Oleka and Okpe (2014) analyzed effect of inventory management on profitability and revealed that inventory turnover had significant and negative effect on the profitability. Additionally, Siyanbola (2012) also studied effect of stock valuation on profitability of manufacturing industries. The study established that high stock cost affects profit negatively and stock also affects the company’s profitability. Lwiki et al. (2013) also studied effect of inventory management practices on financial performance. The study established a positive and statistically significant correlation between management of inventory and return on sales.

1.1.5 Kenya Breweries Limited Beer Distribution Firms in Nairobi County

In Kenya, beer industry started way back in the year 1922. Thanks to the two brothers. That is, George and Charles Hurst from England who started the business of brewing beer in Kenya. The two brothers incorporated Kenya Breweries Limited (Export Processing Zones Authority, 2005). In Kenya, East African Breweries Limited, a subsidiary of Diageo, is the second largest listed company with a large market (KPMG, 2014). To date, Kenya’ beer industry is really flourishing and produces a high quality beer. This is mainly because of availability of production materials, cheap labor, the climate and so on (Export Processing Zones Authority, 2005).

Beer is classified under fast-moving consumer goods (FMCG). These are cheap products that do not stay long on shelf, and purchased on a regular basis by many consumers. These products have low profit margins to retailers. Retailers have to sell large quantities so as to make some good profit margins from such products (KPMG, 2014). A study by Mwangulu (2014) on factors influencing marketing of alcoholic beverages in Kenya established that alcoholic beverages firms should continue to predict its future by keenly and adjust to environmental changes especially the political environment, social environment, economic environment and so on. The major beer distribution firms in Nairobi County are Kamuhaha distributors, Bia Tosha distributors, Leah Africa, Veew Distributors, Ishano distributors and Rwathia distributors.

1.2  Research Problem 

The main goal of management of inventory management is all about balancing the conflicting economics of not wanting to hold less stock or too much stock at any point in time (Kumar & Bahl, 2014). Return maximization on investment of inventories present a considerable proportion of firm’s working capital which is a key function of the firm’s financial manager (Mathuva, 2013).

However, most managers ignore the saving potential that arise from proper management of inventories, trying to treat inventories as a necessary evil and not as an asset that require to be managed. As such, some firms do not or ignore to control their inventory holding, this usually leads to under stocking and causing the firm to stop or slow its production. This finally results to firm’s ineffectiveness (Anichebe & Agu, 2013). According to Schreibfeder (2006) many organizations usually fail to examine its investment in inventory. They most focus on maximization of returns.

In Kenya, more and more institutions including small and medium firms are increasingly adopting inventory management systems with the aim of achieving competitive advantage and enhancing their performance (Swaleh & Were, 2014). However, the main challenge today among firms in Kenya is about the need to enhance of efficiency and improving on effectiveness at the same time. Kenyan firms are known to have a poor inventory management techniques which has negatively affected the firm’s ability to service and satisfy their customers (Thogori & Gathenya, 2014). Thus, the need to study effect of inventory management on profitability and operating cash flows of beer distribution firms in Nairobi County.

In addition, several studies have been carried out on inventory management across the world and in Kenya too. A study by Folinas & Shen (2014) on effect of inventory turnover and inventory days on performance of the firms in United Kingdom’s agricultural machinery industry. The study revealed that inventory days are vital to financial performance of organizations, however to varying degrees. Additionally, Eneje, Nweze, and Udeh (2012) studied the effect of raw materials inventory management on profitability of brewery companies in Nigeria. The study established that efficient management of the raw material inventory significantly affects the profitability of the brewery firms in Nigeria.

In Kenya, Thogori & Gathenya (2014) examined the role of inventory management on the customer satisfaction and established that most firms in Kenya have poor management of inventory systems, which negatively affects the firm’s ability to satisfy their customers. Sitienei and Memba (2015) also explored the effects of inventory management on the profitability of the Cement manufacturing firms.

The study established a negative relation between inventory turnover, conversion period of inventory and storage cost with firm’s profitability. However, most of the inventory management research globally and in Kenya focus on inventory management of large- scale firms and mostly manufacturing entities thus ignoring supply and distribution firms. In addition, most of the studies focus on inventory management and profitability leaving out operating cash flows. Thus, the question: What are the effects of inventory management on firm profitability and operating cash flows of beer distribution firms in Nairobi County?

1.3  Research Objective

 To examine effects of inventory management on firm profitability and operating cash flows of Kenya Breweries Limited beer distribution firm in Nairobi County.

1.4  Value of the Study

This study is of great significance to management of beer distribution firms, as it will help them to establish whether inventory management affects their firms’ profitability and operating cash flows. The study will also be of significance to various policy-making organizations, which can use the findings to come up with policies on inventory management. Finally, the study will be of significance to researchers, as it will add on to the available empirical evidence on inventory management, firm profitability and operating cash flows.

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