INVENTORY CONTROL AND PROFITABILITY IN AN ORGANIZATION: A CASE STUDY OF LABOREX (U) LTD EURAPHARMA
BY
NAKAMANYA REHEMA
07/U/11919/EXT
A RESEARCH REPORT SUBMITTED TO MAKERERE UNIVERSITY IN PARTIAL FULFILLMENT FOR THE AWARD OF A BACHELOR OF COMMERCE
DEGREE OF MAKERERE UNIVERSITY
AUGUST, 2011
DECLARATION
I, Nakamanya Rehema, declare that the work presented in this dissertation is entirely my original work and that it has never been submitted elsewhere for academic award or any other purpose.
Signature…………………………Date:………………………..
NAKAMANYA REHEMA
07/U/11919/EXT
APPROVAL
I the undersigned supervisor of this research paper accept that it is adequate for the ward of a Bachelor of Commerce degree of Makerere University.
Signature……………………………………. Date ……………………..
MS. MBATUDDE SHEILA
SUPERVISOR
DEDICATION
Praise is to ALLAH, the most glorified, who has blessed me with His endless mercy throughout the period of compiling this work. The piece of work is dedicated to my family members especially to my dear parents Mr. and Mrs. Byambi Ahmed who time and again encouraged me to work hard and strive for success, may ALLAH grant them paradise.
To my dear Auntie Hajat Hadija Byambi, brothers Abaas Mawanda and Kiyimba Umar for both financial and moral support throughout my education may ALLAH reward them abundantly.
ACKNOWLEDGEMENT
The successful completion of this study was as a result of a number of people who I am greatly indebted.
I express my sincere thanks to my supervisor Mrs. Mbatudde Sheila for her tireless efforts in guiding and supervising me during the research to see this work through. Her constructive criticism, encouragement, patience and understanding turned what seemed mountains to a platform, enabling me to accomplish this study successfully.
I am greatly indebted to Laborex (U) Ltd Eurapharma management who has given me vital information regarding the topic under study.
Further appreciation goes to my dear friends Ismael, Abdul who have helped to guide me whenever necessary during the pursuit of my academics.
My special thanks go to my best friends Najjuuko Aisha, Ishaq Ssekiziyivu and my dear nephews Rayan Mayanja and Bakunda Imran who have been a source of joy whose love has kept me going.
My heart felt thanks to my Uncle Ismail Mulaala for his love and daily prayers that he prayed for me during his time may his soul rest in eternal peace.
LIST OF ABBREVIATIONS AND ACRONYMS
A – Agree
D – Disagree
EOQ – Economic Order Quantity
JIT – Just in Time
SA – Strongly Agree
SD – Strongly Disagree
TABLE OF CONTENTS
DECLARATION
APPROVAL
DEDICATION
ACKNOWLEDGEMENT
LIST OF ABBREVIATIONS AND ACRONYMS
TABLE OF CONTENTS
LIST OF TABLES
ABSTRACT
CHAPTER ONE
1.0 Introduction
1.1 Background
1.2 Statement of the problem
1.3 Purpose of the study
1.4 Objectives of the study
1.5 Research questions
1.6 Scope of the study
1.7 Significance of the study
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
2.1 Inventory control techniques
2.2 Determinants of profitability
2.3 Relationship between inventory control and profitability
2.4 Conclusion
CHAPTER THREE
METHODOLOGY
3.0 Introduction
3.1 Research design
3.2 Sampling population
3.3 Sampling method
3.4 Sampling size
3.5 Sampling procedure
3.6 Sources of data
3.7 Data collection procedures
3.8 Data collection tools
3.9 Data analysis and processing
3.10 Problems encountered
CHAPTER FOUR
DISCUSSION AND INTERPRETATION OF FINDINGS
4.1 Introduction
4.2 Findings from General Information
4.3 Findings on objective one: To find out the various inventory control techniques in place
4.3 Findings on objective two: To establish factors that determines the level of profitability at Laborex.
CHAPTER FIVE
DISCUSSION, CONCLUSION AND RECOMMENDATION
5.1 Introduction
5.2 Discussion of research findings
5.3 Conclusions
5.4 Recommendations
5.5 Areas for further research
REFERENCES
APPENDIX 1
QUESTIONNAIRE
LIST OF TABLES
Table 1: Finding on sex of respondents
Table 2: Education level
Table 3: Response on professional qualification
Table 4: Respondents’ qualifications
Table 5: Results on just in time technique
Table 6: Results on Economic Order Quantity
Table 7: Results on ABC Analysis
Table 8: Results on factors that determine profitability
Table 9: Correlation
ABSTRACT
The study intended to find out the relationship between inventory control and profitability in an organization. The study objectives included: to find out the various inventory control techniques in place, to establish factors that determines the level of profitability at Laborex and to establish a relationship between inventory control and the level of profits in an organization.
A combination of descriptive, analytical and cross sectional survey design was used and this helped in collection of enough opinions from the respondents to achieve the objectives of the study. The study involved 5 respondents from the management level, 15 respondents who were the principal medical representatives, 20 respondents from the sales department and 10 respondents from the ware house (stores) who were expected to respond on behalf of the firm.Purposive sampling method was used in such a way that respondents from Laborex were chosen according to the departments they work with. Convenience sampling method was also used in order to arrive at respondents who were readily available. The sources of data were categorized into primary and secondary. Research analysis involved sorting an arranging of the data into respective groups and tables using frequencies and percentages to enable easy analysis. This also enabled the researcher to analyze responses from the respondents to be analyzed using statistical package for social science (SPSS) to establish the relationship between the two variables.
It was concluded that; respondents were in disagreement that the control techniques in place wereadequate, majority of the respondents were in disagreement that the level of profitability at Laborex(U) Ltd was satisfactory, there was a strong positive correlation between inventory control and the level of profits in an organization (r = 0.553** P < 0.01).
It was recommended that management should adopt practical and adequate inventory control techniquesto establish, maintain and control the levels of inventory techniques, management should ensure that it earn a return on investment in the company through positive gainsfrom an investment or business operation after subtracting for all expenses, management at Laborex (U) Ltd should adopt adequate inventory control techniques so as to enhance the level of profits.
1
CHAPTER ONE
1.0 Introduction
This chapter looks at the background of the statement of the problem, purpose of the study, objectives, research questions, scope and the significance of the study.
1.1 Background
Inventory control refers to the techniques used to ensure that stock of raw materials or other supplies, work in progress and finished goods are kept at levels which provide maximum service levels at minimum costs (Lysons, 2000).Inventory control and management also involves the supervision of the supply and storage and accessibility of items in order to ensure adequate supply without excessive over supply. It is concern of inventory control therefore to minimize inventory costs.
On the other hand, profitability has been defined as the ability to earn a return on investment in a business, Wood and Sangster (2002). Also Don (2006), defined profitability as either accounting profits or economic profits, therefore, all firms are set with certain objectives which all need to be met, for such a firm to continue in full operation. The return on investment has been referred to by the American Management Association (AMA) as a Gross Margin and has been defined as the percentage of profit general from the sale
of inventory after deducting the cost of sales (American Management Association Journal 2000, p.17).
Gross profit ratios henceforth indicate the average gross margin on sales of goods. A high percentage however does not necessarily result in large absolute figures of gross profit unless it is accompanied by a large sales volume. Gross profit is therefore the difference between sales and cost of goods sold. Cost of goods sold includes manufacturing costs, transportation and storage costs (Ray Wild, 2002).
Profit is a function of a variety of factors affected by the changes in sales volume, costs and price. Profit may also be affected by either increase or decrease in selling price, volume of sales, variable and fixed costs or a combination of all (Pandey, 2004). There are several factors which motivate a firm to hold inventory, different economists have talked about different motives for holding inventory such as to get cost advantage or price advantage or both and eventually a return on such an investment in inventory. The dilemma of how much inventory to maintain to avoid wastage of resources and obtain a higher return varies from one organization to another in different industries.
To achieve a high return on an investment is desirable, however not easily attainable yet a relatively low return on investment in inventory may indicate ineffective inventory control practices. This is normally associated with holding costs that may increase the overall operating costs of a firm (Ray Wild, 2002).
For example, Laborex (U) Eurapharma Ltd today is about to burn drugs worth one billion shillings (Audit report 2008-2009). This has been due to many drugs expiring before they are sold out and this has been blamed on inventory control practices. On top of the expired drugs the organization has to incur an extra expense of burning such drugs since it is a condition for National Drug Authority (NDA) to execute such an activity. Given such occurrences, profit levels of the organization have been adversely affected. It is upon this background therefore that a study should be carried out to investigate inventory control and the level of profitability of Laborex (U) Eurapharma.
1.2 Statement of the problem
Inventory control involves the techniques used to ensure that stock of raw materials or other supplies, work in progress and finished goods are kept at levels which provide maximum service levels at minimum costs (Lysons, 2000). However, despite such great benefits, Laborex (U) has failed to achieve high profit levels given the sophisticated inventory control system in place, there is evidence that Laborex (U) has lost of money approximately two billions (Audit Report, 2008-2009) in stock theft, expired drugs, drugs recalled from the market and under stocking. There is concern to investigate whether the inventory control techniques employed and procedures in place are effective, and whether inventory control has a relationship with profit levels.
1.3 Purpose of the study
The study intended to find out the relationship between inventory control and profitability in an organization.
1.4 Objectives of the study
- To find out the various inventory control techniques in place.
- To establish factors that determines the level of profitability at Laborex.
- To establish a relationship between inventory control and the level of profits in an organization.
1.5 Research questions
- What inventory control techniques are in place?
- What factors determine the level of profitability at Laborex?
- What is the effect of inventory control on the profitability levels of Laborex?
1.6 Scope of the study
The study investigated inventory control and profitability of Laborex (U) Eurapharma, therefore, the researcher interviewed management and staff of the organization and the results from therefore was taken conclusive from 2009 to date.
1.7 Significance of the study
The study is expected to be used as reference by other students who will be researching on a related topic.
The study will also help management explain why it has suffered such a loss and suggest ways how to mitigate such risks.
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
Inventory control refers to the techniques used to maintain the stock of raw materials or supplies, work in progress and finished goods are kept at levels, which provide maximum service levels at minimum costs (Lyson, 2000).
Inventory control techniques refers to methods employed by a firm to establish, maintain and control the levels of inventory items kept in the stores (Max Muller, 2003). The main aim of inventory control techniques is to ensure that costs associated with materials/stock are minimized. Among such costs include holding/carrying costs, ordering costs and purchase costs which sum up stock cost (Lalla, 2000). Handling and ordering costs can be kept at minimum amounts or controlled if the techniques in place could enable the organization to overcome the problems of overstocking and under stocking of material items.
Different business concerns may apply different inventory control techniques to meet specific requirements and circumstances; however, firms for inventory control (Horngrens et al, 2001) commonly use the following techniques.
2.1 Inventory control techniques
2.1.1 Two bin inventory system
This is a fixed order size system and is commonly used when materials are relatively inexpensive or non-essential. The material inventory is divided and placed in two separate compartments or bins. The first bin contains quantity of items that will be used between the time an order is received and the next order is placed. The second bin contains enough stock to cover the usage between to cover the usage between the dates of placing an order to the date of delivery (Hammurabi, 2001). New supply is ordered as soon as the first bin is empty. Wild (2002) observes that a two bin system helps reduce paper work as records are not maintained for each transaction, the reorder point can further be determined by visual observation, that is to say when stock in one bin is depleted, an order is initiated and demands are then filled from the second bin. Further, the system facilitates single bin usage since an order ca be triggered when the inventory level reaches a physical mark such as a painted line or a given volume level (for gasoline and other liquids) (Wild, 2002).
2.1.2 ABC Analysis/classification
This technique categorizes inventory/material items in three groups basing on value and materiality of inventory items that is A, B and C (Lysons 2000, Wild, 2002, Lalla, 2000).
Group A, this group represents a substantial amount of funds invested in inventory items of this group. The items in this group are critical to the functioning and operation of an organization and because of this, their level inventory levels must be monitored carefully. Wild (2002) observes that items in this category are usually relatively few but account for a relatively large portion of inventory cost or value.
Group B, the items in this group are important to the firm but they are not too critical, thus it may not be necessary to constantly monitor the level of all these items of inventory. Group B items are slightly larger in number however account for a smaller percentage of the total costs.
Group C, items in this category are not very important to the operations of the firm but still necessary. These items constitute the lowest of the total inventory and therefore a simple control.
A graphical representation of the ABC technique of inventory control.
Adapted from Operations Management by (Ray Wild 2002)
Although high usage rate does not necessarily mean high stock levels, fast moving items, that is to say, those which the usage rate is high and expensive items are likely to incur greater stock costs than slow moving inexpensive items. Consequently, we should aim to aim fast moving/expensive items since by doing so greater potential savings are possible (Ray, 2002).
2.1.3 Materials requirement planning (MRP)
This is a production planning technique that spells out or provides a list of materials that will be required at different production stages. It is an approach for coordinating the planning of material acquisition and production. MRP is a flow control system in the sense that it orders only what components are required to maintain the manufacturing flow. The approach begins by establishing the quantity and timing of finished goods demanded and then bases on this to determine the material units that will be needed at different stages in the production process. The master production schedule provides the list of finished goods that will be demanded at different periods. The production schedule therefore, enhances the production of the materials requirement plan. This control approach helps managers not replenish raw materials when they are not actually desired (Dury, 2000). The system functions by working backwards from the scheduled completion dates of the end products or major assemblies to determine the sates and the quantities of various components parts and materials that are to be ordered. The works well when a specific demand for a product is known in advance, the demand for items tied I a predictable fashion to the demand for other items (Michael, 2001).
The MRP technique is summarized in a diagram below
Adapted from Lysons Kenneth & Michael Gillingham (2001): Purchasing and Supply chain Management
2.1.4 Economic Order Quantity (EOQ) or Re-order quantity
Lysons (2000) defines EOQ as the optimal ordering quantity for an item of stock that minimizes costs. According to Bernard (2003), it is the quantity point at which carrying and ordering costs are not only minimum but also are equal. One of the major problems of inventory control is how much inventory of an item should be added when inventory is replenished. If the firm is buying raw materials, then it has to decide the lots in which it has to be purchased on each time of replenishment.
Brian Marchant (2003) while addressing the problems of procurement of the quantity and the time to buy, if more units are ordered at one time, fewer orders will be required in a year. This will mean a reduction in the total ordering costs. However, when fewer orders are placed, larger average stocks must be maintained, which leads to an increase in carrying costs/holding costs. The problem is therefore, one of trading off the costs of carrying large against the costs of placing more orders. The optimum order size will help in minimizing such costs. The optimum order size is therefore, the order quantity, which will result in the total amount of ordering and carrying costs being minimized. The optimum size in this case is known economic order quantity.
Lysons (2000) observes that for the EOQ to work effectively the following assumptions have to work side by side.