Hello, on page 19 of Book 3 of Schweser, it mentions the following about inventory to sales ratio: “The measure increases when business gain confidence in the future of the economy and add to their inventories in anticipation of increasing demand for their output. As a result, employment increases with subsequent increases in economic growth.”
In the CFA practice questions: Economics: Exeter Asset Management Case Scenario:, #1 answer solution is: “The Czech Republic shows a marked decline in the inventory-to-sales ratio. When this ratio decreases over time, the economy is likely to be strong in the next few quarters as businesses try to rebuild inventory.”
Did Schweser or CFA have a typo? When inventory to sales ratio decreases, is that an indicator of strong or weak economic growth?
Thanks
There have been a couple threads about this, see below. An argument could be made for either side, so hopefully if on an exam there will be some context to help…but at the end of the day CFAI always wins, so if not enough information is given in the question, a shrinking ratio indicates growth.
https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91365518
https://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91364766
if it helps
i ran into this in a schweser qbank question (on of the many 2100) and there is a classical theory and a modern theory to inventory mgmt, per the qbank:
classical is the situation you mentioned above, when inventory goes up that means theyre expecting great times
modern theory says that inventory/sales ratio being low could be due to modern day “just in time” and other efficient inventory mgmt systems.
Analyzing the usefulness of the inventory cycle has declined due to JIT inventory management, Tommy is correct. Think about Walmart, they hold virtually no inventory because they have systems that automatically order new goods when needed they don’t have to prepare as companies used to.
That being said, that’s not the point here. Here’s the deal - inventory cycle typically tops out before the economy slows or bottoms out before it picks up. I.e. it can be used as an indicator to view change. If it has been steadily increasing for the last several periods (inventory cycle is shorter) it can be a bearish signal. On the contrary, if it has been declining for several periods, it can be a bullish signal on the economy. Per the case it had been declining for several periods. You weren’t wrong in your analysis from schweser, your timeline was just off. Emerging from slower activity it will rise, but after many periods of rising, it’s going to top off, companies will sell off their inventories, cut jobs to compensate, etc.