THINK INDIA JOURNAL

ISSN:0971-1260
Vol-22-Issue-33-December-2019

A study of efficiency of inventory management

using financial ratios
Navin Bhat*, Dr. Shailendrakumar Kale* and Prateek Shrivastava*
*Faculty Member, Thakur Institute of Management Studies & Research, Mumbai

ABSTRACT
Inventory is one of the most valued assets in any organization be it construction, manufacturing, retails or
inventory-intensive sectors. It is equally important for business of any size. Excess or shortages of inventory
can prove detrimental to the business. It is defined as the process of receiving, storing and consumption of
stock. These include the management of raw materials, materials in process, spare parts / components, and
finished products as well as warehousing and processing such items. Hence it becomes very essential to
track and manage inventory for the business to improve upon the cash flows and profitability. Key
Performance Indicators (KPI) are defined for inventory management as a quantitative measure to track and
measures the performance in inventory function. The research paper aims to study few of the critical KPIs
using financial ratios as a metrics to evaluate and track the performance. The research paper will take a
closer look, what are the indicators of performance which can be viewed from the financial statements,
which will help the organization to make better decision that will positively impact the business.
Keywords: Inventory, financial statements, cash flows and profitability.

INTRODUCTION
In any particular business unit or entity, we can see connection and interlinking of activities all functions.
Inventory, logistics and supply chain management form the backbone of any manufacturing business
concern. Hence these functions are critical and important to both finance, commercial and marketing and
distribution managers.
The inventory position of any organization impacts considerable supply chain and financial health of the
balance sheet. Hence to maintain optimal inventory has always been the key objectives of the organization
and they strive their best to avoid over stocking or under stocking of inventory in their warehouse. Inventory
is always dynamic and need careful planning from the stages of procurement to the stages of final delivery of
product to the customers. Various factors are being reckoned while planning, procurement, consumption and
delivery of the inventory and close monitoring and control plays vital role for managing it judiciously.
Majority of the organization are having separate department popularly known Inventory department which
oversees the operations for effective control and inventory management.
The main purpose of inventory management is to maintain inventory at optimal level to avoid over stocking
or under stocking of inventory because both the cases are unprofitable for business. Thus, management is
confronted with the following dilemma:
1. To keep inventory at sufficiently maximum level for smooth production and sales activities.
2. In order to maximize profitability, to minimize investment in inventory at minimum level
Hence it is imperative for the organization to set up a KPI for tracking the inventory in order to evaluate and
improve the performance.
OBJECTIVES OF THE RESEARCH PAPER
1. The objectives of the research paper is to study the critical KPIs relating to inventory management
2. Evaluation of the KPIs which will contribute towards minimizing the inventory and contribute towards
operations efficiency and profits.

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 THINK INDIA JOURNAL
ISSN:0971-1260
Vol-22-Issue-33-December-2019

LIMITATIONS OF THE STUDY

1. Data analysis has been carried out in five companies relating to FMCG sector.
2. The study is restricted to the analysis of inventory turnover ratio of the companies.
3. The study is restricted to 5 years (from 2014 to 2019)
4. Data has been computed from the figures appearing in annual reports
DATA COLLECTION
The data is collected from various secondary sources such as research papers, annual reports, company’s
website, articles, annual reports, etc.
3. REVIEW OF LITERATURE
(Nazar Sohail, 2018) mentioned that inventory problems of too great or too small quantities on hand can
cause business failures. Stock out situation of any critical inventory items in warehouse could bring
production bottlenecks and may result in disruption in production process. Inventory management indicates
the broad framework of managing inventory.
Dr. Srinivasa Rao Kasisomayajula , 2014) where it has been stated that overall analysis of inventory of all
units in the commercial vehicle industry in India is very good in their management of inventory. Among
the firms in the commercial vehicle industry Tata Motors Ltd occupies the first place in the managing
the inventory and there exists a strong correlation between sales and inventory thereby indicating good
administration of inventory. It is the largest asset among current assets in manufacturing concerns. Thus,
proper management of inventory is important to maintain and improve the health of an organization.
Efficient management of inventories will improve the profitability of the organization.
(Anajali Mishra & Harshal Anil Salunkhe Suryadatta, 2018) where it is stated that to have effective
inventory management system in place. The company should also try to implement modern inventory
management techniques like Just in Time (JIT) inventory system to save the time of the organization and will
help reduction of inventory holding cost in the organization. As the company Linamar India is already
following Lean manufacturing, now the company can also try and implement different manufacturing
techniques like TQM, Six Sigma etc.
(Basavarajappa MT, 2012) where it is stated that inventory turnover ratio increased from the year 2005 to
2007 (3.43 to 3.631) then there is decrease in 2008 and 2009 and finally increased in 2010. Also, to have
better information systems packages which will improve the efficiency of the management of inventory
control system?
INVENTORY KPI
A. Inventory Turnover Ratio
Inventory Turnover Ratio shows the number of times inventory is converted into revenue from operations or
rather how many times a company has sold and replaced inventory during a given period. It expresses the
relationship between the average inventory cost of goods sold from operations and average inventory. If a
company’s average annual inventory is Rs 4,000 crore and revenue is Rs 20,000 crore, it implies that the
company sold its inventory five times in a year.
The formula for its calculation is as follows
Inventory Turnover Ratio = Cost of Goods Sold from Operations / Average Inventory
Where average inventory refers to average of opening and closing inventory, and the cost of goods sold from
operations means revenue from operations less gross profit.
The cost of goods sold is the direct expense associated with production of goods. For the service industry,
cost of goods sold includes wages, benefits and taxes

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 THINK INDIA JOURNAL
ISSN:0971-1260
Vol-22-Issue-33-December-2019

In retail or wholesale business, the COGS include merchandise that was purchased from a Producer, plus the
expenses incurred in relation to acquisition, storing, and displaying inventory items.
 Significance of Inventory Turnover Ratio: Inventory turnover measures how quick a company sells
inventory and where the company stands with reference to the industry averages. A low turnover
implies excess inventory in the warehouse (means overstocking resulting in blockage of working
capital). Overstocking also implies there is poor marketing effort to dispose the goods in the market.
A high ratio implies either strong sales or insufficient inventory (chances of stock out is imminent) may lead
to lost sales leading to customer dissatisfaction.
If the inventory is held for considerable period of time, the carrying cost of inventory increases and hence
speeds of selling inventory is an important measure of company performance.
Data Analysis and Interpretation of Inventory Turnover Ratio of leading FMCG Sector in India
FMCG Companies 2019 2018 2017 2016 2015
ITC 6.03 6.13 7.05 6.10 6.43
Britannia Industries 14.58 15.78 14.41 21.29 21.24
Nestle India 11.70 11.29 10.13 10.33 12.06
Hindustan Unilever 15.78 14.93 14.60 13.25 12.57
(Source: Moneycontrol.com)
In the FMCG, sector, optimal inventory turnover is usually 8 or above, In the FMCG sector, goods are
generally classified as fast moving category and as a result, inventory moves very fast from the warehouse.
.
The inventory turnover ratio of ITC Ltd is consistent over a period of 5 years and ranges from 6.43 to 7.05
which reflects that the company is managing its inventory quite well and as the figures reflects there has
been no instances of overstocking of inventory.
The inventory turnover ratio of Britannia Industries Ltd had been very high during 2015 and 2016 and
suddenly it went down to 14.41 in 2017. Overall in comparison to the rest of the industries Britannia is the
highest in rating compared to other three companies
Nestle India has been consistent in managing and controlling inventory over five years with consistently
maintained the ratio around 11 thereby indicating company is having efficient control system with respect to
inventory management.
B. Days in Inventory (DIO)
Days in inventory ratio measures the average number of days the company holds its goods or inventory
before selling it. A day in Inventory is also known as Days inventory outstanding (DIO) and it varies from
one industry to industry.
DIO = Average Inventory / Cost of goods sold x 360
Or
DIO = 365 / Inventory turnover ratio
Example – A company X Ltd had an inventory turnover ratio of 8. Assuming 360 as the number of days in
the year, the company's days' sales in inventory was 45 days (360 days divided by 8).
Significance of DIO: Since inventory holding costs take significant investment, efforts are made any
organization to reduce level of inventory. Lower level of inventory will result in lower DIO ratio. Therefore
it is favorable to have lower values of this ratio. Higher value of DIO can prove to be unfavourable.

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 THINK INDIA JOURNAL
ISSN:0971-1260
Vol-22-Issue-33-December-2019

However, stock out situation can prove dangerous to the organization and it is advisable to have safe level of
inventory to avoid loss of sales. Hence low value of DIO may also not favorable for the business if it results
into loss of business.
DIO varies significantly differ from one industry to another. For example, entity which are dealing with
perishable items such as vegetables and fruits have very low values of days’ sales in inventory whereas
companies selling non-perishable goods such as automobiles have high values of days of inventory.
Days Inventory Outstanding analysis carried out in five FMCG sector and results of the analysis is explained
below:
FMCG Companies 2019 2018 2017 2016 2015 Average (in days)
ITC 60 59 51 59 56 57
Britannia Industries 25 23 25 17 17 21
Nestle India 31 32 36 35 30 33
Hindustan Unilever 23 24 25 27 29 25
ITC Ltd has the highest days in inventory outstanding (i.e. 57 days) compared to other FMCG sector and
lowest days in inventory outstanding is that of Britannia Industries (i.e. 21 days) thereby reflecting that
carrying cost of inventory at Britannia Industries Ltd is lowest compared to its competitors.
Days in Inventory outstanding ratio is very similar to inventory turnover ratio and both measure the
efficiency of a business in managing its inventory.
Few important KPI relating to inventory management are:
a. Stock to sales ratio – It represents the stock available for sale versus the stock that has been sold.
b. Cost of carrying or holding inventory –This particular metric is the cost of storing inventory over a certain
time period.
c. Rate of return – It tracks the percentage of orders that are returned from the customers.
d. Order pick, pack and dispatch accuracy – It takes care of the process relating to warehouse and where they
need improvement.
CONCLUSION
Inventory Turnover Ratio provides insight on how long working capital is tied up in the cycle of
procurement of raw materials or a finished product for sale through to selling the product. Inventory turnover
ratio varies from industry to industry and higher inventory turnover ratio indicates that business is carrying
excess inventory resulting in blockage of working capital in the organization. ITC Ltd has been managing its
inventory level well at its optimum level and it indicates that investment in working capital is higher
compared to its competitors In contrast Britannia Industries Ltd is having highest inventory turnover ratio
meaning that the company is holding a lower level of inventory with respect to sales.
REFERENCES
1. Anajali Mishra &Harshal Anil Salunkhe (2018),A Study of Inventory Management System of Linamar
India Pvt. Ltd, Pune,Amity Journal of Operations Management 3 (1), (35-41)
2. Basavarajappa MT (20120, An empirical investigation of inventory management practices of Mysore
Paper Mills Limited, International journal of research in computer Application and Management, 150
3. NazarSohail (2018), A Study of Inventory Management System Case Study, Journal of Advanced
Research in Dynamical & Control Systems, Vol. 10, 10-Special Issue, 2018
4. Dr. Srinivasa Rao Kasisomayajula (2014),International Journal of Engineering Research, Volume No.3,
Issue No.6, pp : 378-383
5. L.C. Jhamb, Inventory Management, Everest Publishing House

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ISSN:0971-1260
Vol-22-Issue-33-December-2019

6. Inventory Management – Principles and Practices by Narayan and Subramanian, 2008

7. www.moneycontrol.com

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