Effect of Cash and Inventory

Management on Profitability

Fin 201
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Course Code: Fin 201

Section: 03

Submitted To:
Sehel Somani

Lecturer

Department of Business Administration

East West University

Submitted By:

Imrul Hasan Arnab

ID: 2014-3-10-074

Department of Business Administration

East West University

Date of Submission: May 14, 2020

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Table of Content

1.0 Introduction...........................................................................................................................4
1.1 Background of the study ....................................................................................................4
1.2 Objective of the study ........................................................................................................4
2.0 Short Term Asset...................................................................................................................4
3.0 Profitability ...........................................................................................................................4
4.0 Cash Management .................................................................................................................5
4.1 Objective of cash management ...........................................................................................5
4.2 Functions of Cash management..........................................................................................5
4.2.1 Inventory Management: ...............................................................................................6
4.2.2Receivables Management: ............................................................................................6
4.2.3 Payables Management: ................................................................................................6
4.3 Importance of Cash Management .......................................................................................6
4.4 Limitations of Cash management .......................................................................................7
4.5 Impact of Cash Management on Profitability .....................................................................7
4.5.1 Cash Surplus ...............................................................................................................7
4.5.2 Cash Shortfall..............................................................................................................7
4.5.3 Account Receivable .....................................................................................................8
5.0 Inventory Management ..........................................................................................................8
5.1 Objectives of Inventory Management .................................................................................8
5.2 Importance of inventory Management ................................................................................8
5.3 Limitations of inventory Management................................................................................9
5.4 How to Efficiently Manage Inventories ..............................................................................9
5.4.1 Track all product information ......................................................................................9
5.4.2 Audit inventory ...........................................................................................................9
5.4.3 Prioritize inventory ......................................................................................................9
5.4.4 Track sells ................................................................................................................. 10
5.4.5 Economic Order Quantity .......................................................................................... 10
5.5 Impact of inventory management on profitability ............................................................. 10
5.5.1 Reduce Overhead ...................................................................................................... 10
5.5.2 impact on revenue and assets ..................................................................................... 10
5.5.3 Cash Flows:............................................................................................................... 11
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5.5.4 Losing inventory ....................................................................................................... 11

5.5.4 Overstating or understating of profit .......................................................................... 11
6.0 Conclusion .......................................................................................................................... 11
7.0 References........................................................................................................................... 12
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1.0 Introduction

1.1 Background of the study

Inventory is the stock of any item or resource used in an organization. As a component of supply
chain management, inventory management supervises the flow of goods from manufacturers to
warehouses and from these facilities to point of sale. A key function of inventory management is
to keep a detailed record of each new or returned product as it enters or leaves a warehouse or
point of sale. Inventory management helps organization to improve operational efficiency and
reduce cost.

On the other hand, Cash management refers to a broad area of finance involving the collection,
handling, and usage of cash. Even inventory management is a function of cash management. Cash
management helps the organization to avoid situations like “no hand cash”, which raise questions
about firm’s credibility and can often lead to shut down.

1.2 Objective of the study

The objective of the study is to find out the impact of cash management and inventory management
over the profitability in an organization.

2.0 Short Term Asset

Short term assets are those assets which have a lifetime one year or less than 1 year. A short term
asset is an asset that is to be sold, converted to cash, or liquidated to pay for liabilities within
one year. Short term assets are easier to convert into liquid which means these assets are easier
to convert into cash. The easier it is to convert the more liquid the asset is. Cash, inventories,
bank deposit, receivable etc. are short term assets.

3.0 Profitability

Profitability is ability of a company to use its resources to generate revenues in excess of its
expenses. In other words, this is a company’s capability of generating profits from its operations.
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profitability impacts whether a company can secure financing from a bank. Profitability attract
investors, make their market share more lucrative.

4.0 Cash Management

Cash management means the collection, distribution, management of cash in a way that maintain
firms’ liquidity so that the firms never go out of hand cash. It concerns managing the cash flows
within the organization. It helps the organization to calculate weather they have a cash surplus or
deficit and on basis of that they can take decisions like investments.

Cash is both the beginning and ending of working capital cycle, which is cash, inventories,
receivables, cash. Cash helps the business going and organizations have to hold on to a necessary
amount of hand cash for existence of the business.

4.1 Objective of cash management

There are a lot of objectives behind cash management. Some are given bellow:

• To ensure sufficient liquidity

• To meet working capital requirements
• To be able to meet short term requirements forming part of administrative activities
for running a business.
• To not use capital funds for short term requirements, thereby leading to capital
erosion.
• An indirect objective would be to ensure stakeholders wealth maximization which
serves as the basic premise for all the objectives.

4.2 Functions of Cash management

In an ideal scenario, an organization should be able to match its cash inflows to its cash outflows.
Cash inflows majorly include account receivables and cash outflows majorly include account
payables.
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Practically, while cash outflows like payment to suppliers, operational expenses, payment to
regulators are more or less certain, cash inflows can be tricky. So, the functions of cash
management can be explained as follows:

4.2.1 Inventory Management:

Higher stock in hand means trapped sales and trapped sales means less liquidity. Hence, an
organization must aim at faster stock out to ensure movement of cash.

4.2.2Receivables Management:

Receivable Management or Managing Accounts Receivables means collecting the payments due
for Sales in a timely manner. When an organization sell any services, products or solutions to a
clients or customers, they owe that organization money. Collecting that money is called
Receivables Management. The shorter the period the better for the organization as it improves cash
flow of the organization.

4.2.3 Payables Management:

Payable management refers to how an organization set its policies and the practices they maintain
in respect to their credit purchase. In other words when they are paying their debt to maintain the
cash flow is payable management.

4.3 Importance of Cash Management

• It allows business to be solvent enough to keep the company in business even during slow
activity.
• Helps to survive from falling in debt
• Allows adequate cash for purchases and other purposes.
• Ability to meet cash flow.
• Allows planning for capital expenditure.
• Allows for financing at better terms.
• Enables you to make special purchases and take advantage of business opportunities.
• Facilitates invest.
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4.4 Limitations of Cash management

• Controlling Level of Cash

• Controlling in-flow of cash
• Controlling out-flow of cash
• Optimal investment of excess cash
• The cash statement fails to present the net income of a firm for the period as it ignores non-
cash items which are considered by Profit and Loss Statement.
• Cash management only show and work with cash while the profitability of an organization
depends on non-cash items too.

4.5 Impact of Cash Management on Profitability

Cash management can affect profitability through various stage. Various situation of cash has
different effect on the profitability of an organization. Some are explained bellow:

4.5.1 Cash Surplus

Cash surplus is the cash that exceeds the cash required for day to day operations. Cash surplus can
have a positive impact on profitability. As the more cash surplus there is there is higher chance of
profit. As this surplus cash can be used for reducing debt and taking care of other expenses. Cash
surplus can also be reinvested and can generate more revenues. Cash surplus can also be used for
business diversification which can also increase profitability.

4.5.2 Cash Shortfall

Cash shortage leads a business to low profit sometimes even to losses. Cash shortfall means
company does not have enough cash for a planned activity. Cash is less than a financial obligation.
This can cause loss for the company. Which can raise question in the credibility of the organization.
It can reduce organizations reputation in the market, investors can lose their interest of investing
even market price of the share can drop.
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4.5.3 Account Receivable

Account receivable has an impact on cash and through that also has an impact on profitability. If
organization can get their receivable faster then their cash flow increases. But if the account
receivable amount become uncollectable than that create a bad debt expense which reduce profit
for an organization.

5.0 Inventory Management

Inventory management supervises the flow of goods from manufacturers to warehouses and from
these facilities to point of sale. A key function of inventory management is to keep a detailed
record of each new or returned product as it enters or leaves a warehouse or point of sale.

5.1 Objectives of Inventory Management

• main objective of inventory management is to maintain inventory at appropriate level avoid

excessive or shortage of inventory
• To keep inventory at sufficiently high level to perform production and sales activities
smoothly.
• To minimize investment in inventory at minimum level to maximize profitability.
• To minimize carrying cost of inventory.
• To keep investment in inventory at optimum level.
• To reduce the losses of theft, obsolescence & wastage etc.
• To make arrangement for sale of slow-moving items.
• To minimize inventory ordering costs.

5.2 Importance of inventory Management

• Inventory management let the organization know when a product is out of stock so that
they can stock it again. It helps organization to provide better service as their customer
does not have to return empty handed as there is always enough stock.
• It helps the organization to utilize their warehouse space better.
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• It improves efficiency and reduce purchase or production of products that are already in
stock
• Inventory control is consistent with safety and economic advantage
• Regular supply at reasonable prices builds customer confidence\
• Effective inventory control enhances market share
• Inventory control avoids costly interruptions in operation

5.3 Limitations of inventory Management

• Inventory management is an expensive system.

• It is a complex process and it takes time to understand how to operate.
• It only eliminates a very limited amount of business risk.

5.4 How to Efficiently Manage Inventories

5.4.1 Track all product information

Organization can keep track of all product and keep their information. Information like how much
of a certain product is in the stock, how much time it takes to get that product after an order, how
much is the storage size etc. can help organization to know when to order a product and how much
to order.

5.4.2 Audit inventory

Organization can efficiently manage inventory through schedule audit daily. This can help the
organization to know faster about which products they need urgently and which products they
should not order.

5.4.3 Prioritize inventory

Categorizing inventory into priority groups can help the organization to understand which items
they need to order more of and more frequently, and which are important to that business but may
cost more and move more slowly. Experts typically suggest segregating inventory into A, B and
C groups. Items in the A group are higher-ticket items that need fewer of. Items in the C category
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are lower-cost items that turn over quickly. The B group is what's in between: items that are
moderately priced and move out the door more slowly than C items but more quickly than A items.

5.4.4 Track sells

Organization need to adding up sales at the end of the day. Which items are sold and how many,
will let them know which product is selling faster. It will help them understand the reason behind
the increase sales of those products. If it is a seasonal reason then organization can stock those
products more in those seasons. Like in rainy seasons umbrella sales increase so organization can
stock more umbrella in monsoon.

5.4.5 Economic Order Quantity

Organization can follow EOQ or economic order quantity system for their inventory management.
It will help them to know about how much of an individual product they sell every month, after
how many days the product stock sell out, how much time does it take to re-stock, what quantity
they should order, what quantity they should hold etc. It helps the organization to keep track of the
inventories and to manage them better.

5.5 Impact of inventory management on profitability

5.5.1 Reduce Overhead

Less overhead refers to more profitability. Hidden overheads are often tied up in inventory. This
could be anything from counting stock, to organizing and transporting. By making inventory
management more efficient, some of these overheads can be reduced. Inventory management can
reduce this overhead and can show the actual inventory value. Which ultimately increase
profitability.

5.5.2 impact on revenue and assets

As inventory is counted as a short-term asset it generates revenue. Inventory management can

show the actual inventory amount and can list the actual ammou7nt of sales from the record of
production/purchase and current inventory. It helps the organization to know its revenue from
sales. This has an impact on the overall profit.
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5.5.3 Cash Flows:

If a business uses FIFO when prices are rising and inventories are also rising, COGS would be low
and net income would be higher. This can also increase tax payable. Which increase the overall
expense and can decrease profit.

5.5.4 Losing inventory

Businesses that have problems managing inventory can lose substantial amounts of profit.
When inventory is lost to theft, damage or mistakes, it is essentially like throwing profit away.
A business has to invest capital into the inventory to buy it. Unless the company turn around
and sell that inventory, they cannot recoup the initial costs or generate any profit. This makes
managing your inventory a top priority for the business.

5.5.4 Overstating or understating of profit

Inventory errors are problematic because they can cause two sequential financial statements to
be incorrect. When an inventory error occurs, it causes the current statement to be over or
understated. This can also impact in the profitability. As due to a misstating inventory there will
be a misstating profit.

6.0 Conclusion

In conclusion it can be said that both cash management and inventory management have a clear
impact on profitability of a business. Both cash management and inventory management can have
different impact based on different situations and circumstances. In those different situations and
circumstances, they can impact the profitability in both positive and negative way.

So, managing both cash management and inventory management is important for the organization.
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7.0 References

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