Financial Management of Inventory

Article excerpt

FINANCIAL MANAGEMENT OF INVENTORY

Modern inventory management methods have not, until recently, been widely used by small businesses, even though the concepts are not difficult to understand or apply. Nevertheless, because small firms normally do not enjoy the same degree of financial stability or operational efficiency as larger competitors, the asset categories in which large amounts of capital are invested (such as accounts receivable and inventory) must be well-managed in order to maximize returns on investments.

Small firms are frequently subject to money constraints that prevent them from operating in the same way larger firms do. For example, small firms typically cannot hire experienced professionals to handle each major business function, and cannot afford the diversification of talent represented by a large staff, or the installation and implementation of sophisticated computer-assisted procedures.

Many techniques which could solve small business problems cannot be implemented unless costs can be covered out of normal cash flow. Yet the primary goal of a business, at least according to financial theory, is the maximization of the value of the firm. Studies have show that this goal may be realistic for large (Fortune 500) firms, but it is probably not as real a goal for small-business owner/managers, who tend of necessity to focus on day-to-day problems in order to maintain a positive cash flow and bank balance, whic in turn provide a satisfactory return to the owner for the effort and risk involved in the conduct of a business. Most small business are not incorporated (and if they are, their stock is not marketable), therefore, few owners actually make decisions based on effects on share prices or earnings per share. Rather, the emphasis is on profit and cash flow. Most small businesses strive to compete and survive against large competitors in a dynamic economy.

Because of the large investment a typical business msut make in inventory, the proper management of this asset can have a significant effect on the profitability of the firm. More efficient management of this account alone can enhance the firm's profits and profit margin.

The results of a survey of small business inventory management practices are presented in this article and compared with techniques commonly employed by large corporations. (Small businesses are defined for the purpose of this study as firms with annual sales under $10 million.)

DESCRIPTION OF SAMPLE

Data for this study were collected by means of a mail questionnaire distributed to three hundred randomly selected firms that were identified from the Yellow Pages in the telephone directories of the greater Norfolk-Portsmouth, and the Hampton-Newport News, Virginia, SMSAs. The firms were selected in five different distribution levels, with annual sales varying from under $50,000 up to $10 million. The firms employed up to three hundred persons, although more than 46 percent had less than ten employees. Of the three hundred businesses selected for the study, ninety-four, or 31 percent, responded. A breakdown fo the respondent firms by industry and size is given in table 1.

THE COMPROMISE

Previous studies of inventory control techniques have focused on Fortune 500-size firms, which tend to use sophisticated mathematical and statistically-based methods. However, even in large firms, the use of financially integrated inventory control methods is rather recent. One of the reasons for this is the split responsibility of the finance and production/inventory functions. The firm's financial managers concentrate on the allocation and efficient management of funds in various inventory categories (e.g., raw material, work-in-process, and finished goods), whereas production and inventory managers tend to be interested in the more efficient production of various finished goods items, with special attention given to employee production schedules, long production runs, and storage of finished goods. …