inventory-sales ratio

a declining inventory to sales ratio is suggestive of good or bad outcome for the firm? i thought it should be rather good. just to explain my view consider this eg: Case 1: inventory (at month beg.) = 100, sales 20 therefore Inv / sales = 5 Case 2: inventory (at month beg.) = 100, sales 40 therefore Inv / sales = 2.5 To conclude: Inv/sales ratio is falling -> sales increasing -> so economy exptd to grow. but schweser suggests it to be otherwise. please clarify. thanks.

Business are supposed to be forecasting the economy right. Consumer spending is more or less supposed to be constant. Business spending is supposed to be volatile. So if business are forecasting upturn in business cycle, they load up on inventory and inventory/sales goes up. If businesses are forecasting a down turn in business cycle, they will try to lower their inventory in anticipation of less future sales. This will lead to lower Inventory to sales ratio. The argument here is about ability of businesses to forecast the business cycle. Hope this helps.

true. i get this logic … its fine. but just given a declining Inv/sales ratio, how is a CFA candidate expected to interpret it? - in terms of what the current ratios suggest (increasing ratio suggesting inventories rising faster than sales and businesses becoming overstocked) - or in terms of how firms are predicting the future economic prospects and adjusting their inventory levels becoz the 2 cases (as described above) will end up with opposite conclusons. how can one avoid this confusion under test conditions? thanks

You have to use the 2nd one in CFA level 3 exam. Thats the context of the material. In real life you can use which ever argument makes sense given the context. I understand the first argument you are making. But that interpretation is not how CFAI looks at it for level 3 exam. Hope it helps.