Inventory vs. Business cycles

When business cycles slow down, will inventory to sales ratio usually rise or down? (Both numerator and denominator lower…)

Declining confidence so inventory is falling?

Inventories generally lag sales.

When the business cycle slows, sales slow, but inventories are still high. They don’t drop till later.

When the business cycle picks up, sales increase, but inventories are still low; they don’t rise till later.

Thanks! Given business cycle is thought to be 9 to 11 years (according to CFA), can we say at the beginning of slowdown inventorry will start to accumulate because it lags sales. But, start to decline after inventory correction?


Frank’s question is a fair one. I would also say that inventory lags sales and hence that increasing inventory is a lagging indicator of a slowdown, and decreasing inventory a lagging indicator of a recovery. However, my understanding is that level iii curriculum is not clear about that and tends to indicate something totally different. I just have my notes with me, not the course, so maybe it’s my notes that are misleading. But i think i took them carefully and they indicate the following: If businesses reduce their sales forecast and start to view sales as too high, they will cut production to reduce inventory, hiring more slowly, leading to a slowdown in growth. If i understand the above well, it considers inventory as a leading indicator, even as a generating factor. Can someone please help me with this?

Now i am reading my notes about the phases of the business cycle and for the initial recovery phase it says : inventory cycle upswing may be simultaneous, or may even be the cause of recovery. So level iii curriculum really doesn’t seem to be treating inventory as a lagging indicator of the business cycle…

This is one of those instances where “it depends” comes into play.

Sales as a leading indactor. If they go down, you would expect Inventory to increase as vendors are unable to move the products they’ve already produced in anticipation that sales would be consistent with their expectations. If sales go up, you should expect inventories to fall as demand is higher than intially expected.

The above situation starts with Sales (cause) and inventory (effect) is the secondary impact.

However, an increase in inventory MAY be vendors stockpiling products in anticipation of an upswing in demand that will lead to higher sales. later on. This can happen during the late stages of a recession where sales are still low but other leading indicators show a recovery is beginning.

Thanks Galli!

Galli says it all. Instead of seeing it from the point of the leading or lagging indicator, there are simply 2 stages that are different , both having low inventory/sales ratio that are being talked about:

  1. Initial Recovery : The industry is emerging from slump. No body wants to add capacity but the early signs are benign. Older inventories are being pushed into the market, waters being tested. Hence the Inventories/Sales are lower. A little strangely, after this phase the inventories do indeed increase drastically on the wave of early upswings whicn naturally build euphoria and nobody wants to miss the opportunity and hence the Inventory/Sales ratio would increase drastically. Industies do not shy away from adding capacity.

  2. Slowdown : All symptoms of impending recession are flagrant. Companies learn the same and stop producing extra unit (From Indicator’s point of view, it is now a lagging indicator- as Magician points out). But I would not bother with the Indicator approach, instead would draw diagram (A bell curve, if you may like) and remember all the nodal points.

Works fine for me.

Falling inventory/sales ratio indicates that in the near future, businesses will try to rebuild inventory; as a result, economy is expected to strengthen in the next few years.

Sharply rising inventory/sales ratio indicates that in the near future, businesses will try to reduce inventory; as a result, economy is expected to weaken in the next few years.