How a wonky government stat can help predict where the economy is headed
How a wonky government stat can help predict where the economy is headed
Every month, the Census Bureau puts out a report tallying up the value of all of the product that businesses have in their inventories. That release also includes another figure: the economy’s inventory-to-sales ratio.
That ratio tells us how inventory levels compare to how much product businesses are selling. It can also tell us a lot about how the economy’s doing, and where it’s headed.
The basic idea behind the inventory-to-sales ratio is that it gives us a sense of how fast inventories are turning over.
“At the end of the day, you’re trying to minimize your inventory and maximize your sales, and you’re trying to do that as best you can,” said Pat Whelan, who handles imports for Sahadi Fine Foods, a grocery store and food importer based in Brooklyn.
Whelan said he doesn’t keep his company’s inventory-to-sales ratio handy on his desk at all times. But he said he always has a sense of what it is. That’s because if his inventories outpace his sales by too much, there are consequences.
“You can always have full inventory and extra inventory, but it’s going to cost,” Whelan said. “And that buffer, if you overdo it, hurts your profit.”
That’s because inventory costs money. Business owners have to buy it, often with borrowed money at today’s elevated interest rates. They also have to pay to store it and make sure it doesn’t go bad.
“We have that issue in the deli all the time,” Whelan said. “Because you think about it, you’re producing stuff in the deli, that’s got to go that day or the next day. You overdo that, it doesn’t even go anywhere. It goes right in the trash.”
Different sectors of the economy can have different inventory-to-sales ratios, said Jason Miller, a professor of supply chain management at Michigan State University.
“Your grocery store may be turning inventory more than once a month, which they need to because items are perishable, versus a clothing store may only turn their inventory every two months, or even every two-and-a-half months,” Miller said.
Miller said a lot of sectors have pretty stable inventory-to-sales ratios. But some have seen big spikes in recent years. That can be a sign that those sectors will slow down in the near future.
Take machinery, for instance, which includes construction, farm, and industrial machines.
“We’re at actually one of the highest inventories-to-sales levels that we’ve really been at in the last 30 years,” Miller said.
Miller said that means machinery wholesalers have been buying too much, and selling too little. As a result, they’ll probably try to reduce their inventory levels.
“That’s not a good sign if you’re a machinery manufacturer,” Miller said. “Because if demand is not only weaker, but companies are also drawing down inventory, that means their orders to you are going to be even less.”
If a sector of the economy has a high inventory-to-sales ratio, that’s also a sign that businesses in it might start offering discounts.
Nicole DeHoratius, a professor of operations management at the University of Chicago’s Booth School of Business, said that can ripple through supply chains.
For instance, if wholesalers offer markdowns on a product, then retailers might decide to load up on it.
“Then, they turn around and they’re having difficulty selling this to their own consumers, and then we would face markdowns in order to move the inventory along the way,” DeHoratius said.
A lot of sectors that struggled with high inventory levels during the pandemic used discounts to reduce their inventories, including clothing, furniture, and electronics.
“If you look at the ratios now, they’re relatively stable,” DeHoratius said. “And, for a variety of industries, mostly back to normal.”
DeHoratius said companies are still going to ensure that they have access to inventory in case sales spike like they did early in the pandemic. A furniture company, for instance, might contract with additional factories to add surge capacity.
“I might work with suppliers that are closer to me, so I have a shorter lead time, so that if there was a disruption, and they needed to ramp up production, it could get to me faster,” DeHoratius said.
DeHoratius said those are strategies that will help companies meet customer demand while keeping their inventory-to-sales ratios as low as possible.
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