another point of view...

Inventory - to - Sales Ratio so the traditional approach says that if this ratio is declining i.e. Inventory is going down…that’s a negative sign - and it’s because companies are expecting a weak economy and so reducing their inventory… similarly if this ratio is going up i.e. Inventory is increasing it’s because there is an expectation of improving economy and businesses are piling up their goods… but howcome this hasn’t been considered… If the ratio is going down - Inventory going down or sales going up…it’s a GOOD thing…because businesses are selling their stock quickly (declining inventory) which means sales is improving (increasing sales)… and vice versa if the ratio is going up - that means their stocks are piling up BECAUSE they’re not able to sell as fast (higher inventory and declining sales pushing the ratio up)… does that not make sense???


hahahha… thanks…that’s EXACTLY how I feel …sitting here studying at 11:00 pm on a friday night… you have no thoughts on the above?! something? anything?

If the ratio is going down - Inventory going down or sales going up…it’s a GOOD thing…because businesses are selling their stock quickly (declining inventory) which means sales is improving (increasing sales)… I think you might be referring to using Inventory Turnover Ratio ( cost of goods sold / average inventory) which is different from Inventory to sales ratio. Also a lower investory to sales could also be a from a more efficeint use of technology, suply chain mgmnt. etc

I had the same issue with this part of reading. I need some ppl to tell why this is true. I could understand it if they put this caveat " We are in the later stage of the cycle". Therefore, i would have interpret that companies stop order due to the fact they suspect that demand will slow. As result, they order less.

Wrote a whole post, but got it flipped around in my mind. OK I think I remember reading that it depends on where you are in the cycle. Hence early upswing - Ratio falling means sales rising - Good thing Late in the cycle - Ratio falling means companies getting rid of inventory - Bad thing Make sense or am i just confusing myself here?

I think I got it wrong in the earlier post. And I guess the cycle we need to consider is the inventory cycle not the economic cycle right? So inventory high after a period of being down means companies are optimistic which is a good thing. Inventory high at the end of the cycle only means lower sales which is bad. Any tips/insights about thins anyone?

I read somewhere that “the traditional interpretation” is that a decreasing inventory-to-sales ratio is a negative sign because businesses are preparing for a decrease in business. This is a traditional interpretation in the old days where it was difficult to monitor inventory levels hence businesses estimated the required inventory. In the CFAi text they mention that this method is becoming obselete because of the improved technology in monitoring inventory levels, which would point more in the direction of what you’re talking about… i think.

ok…i understand what all of you are saying…and I agree with the books’ explanations… but my point is…are my counter explanations completely wrong?

Hmm, I think this is what you’re talking about mumu: I think SV is on the right track. If we are in the middle of a recession and all of a sudden the inventory to sales ratio starts twitching upwards then businesses would appear to be getting ready for an upswing in sales. If we are in a steady growth period and then inventory starts to head downwards then that may indicate businesses taking a cautious approach. Best bet is to go along with what the CFAI text book tells you and write that in the exam :slight_smile:

CFAI V3 page 55 says: When inventory/sales ratio has moved down, the economy is likely to be strong in the next few quarters as business try to rebuild inventory. Otherwise, when the ratio has moved sharply up, as in 2000, a period of economic weakness can be expected.

I agree with you Mumu. In fact, I’ve never heard that inventory to sales increase indicates a strong outlook. In my grad program we had a course on economic indicators, and from what I’ve heard everyone’s looking for the INV / SALES to fall indicating that sales are drawing down inventories via growth in this conservative environment, thus pointing towards future growth as inventories are replaced. I think its clear that companies lack the crystal ball to predict sizeable economic downturns such as the present one. They always occur as a systemic shock for a reason, because they’re a shock, indicating that the company lacks the ability to lead the market. It is however believable that the market itself could drive strong unexpected sales that would draw down inventories pointing to a strong followup quarter as inventories are replenished the effects make their way through the system. Think of it from a converse perspective by looking at the housing collapse. Obviously, new home production continued despite a fall in new home sales right up until things got bad. Now, home sales are beginning to show positive signs yet new home starts are still down.

At the risk of sounding dumb & uninformed ( not to say unprepared) , May i know which reading are you reffering to? Dont remember ever seeing this.