Is there some simple way to memorize what happens in different phases of inventory and business cycles?
I feel like most of that stuff is pretty ambiguous, can’t find a way to internalize it.
This can be tricky. The inventory cycle is 2-4 years and the economic cycle is 9-11 years.
You could take a leading or lagging indicator approach to the I/S ratio:
Lagging: I/S ratio decreases as the economy heats up and consumers buy their products. I/S ratio increases as economy turns into a recession and consumers stop buying and inventory builds.
Leading: I/S ratio increases as the economy heats up as produces anticipate higher purchasing. I/S ratio decreases as economy turns into a recession as producers anticipate lower spending.
The text seems to favor the lagging approach so when in doubt go with that. But you have to take the question in the context that its given.
this is a good thread. can someone also explain the “classic” viewpoint on the I/Sales ratio vs the alternative viewpoint? i remember that popped up in a mock last year.
so is “lagging” the classical approach?
Not sure what the classical approach is.
But I did just re-read the section in the text. It’s a short read on page 51. They break it into 2 parts: the Inventory cycle and the inventory to sales ratio. They’re somewhat contradictory but just go with it:
Inventory cycle: Closely resembles the leading indicator approach. Inventories decline as the economy turns down as companies slow production in anticipation of a looming recession. Vice versa for the upside. From the text:
“In the up phase of the inventory cycle, businesses are confident about future sales and are increasing production. The increase in production generates more overtime pay and employment, which tends to boost the economy and bring further sales. At some point, there is a disappointment in sales or a change in expectations of future sales, so that businesses start to view inventories as too high. In the recent past, a tightening of monetary policy has often caused this inflection point. It could also be caused by a shock such as higher oil prices. Then, business cuts back production to try to reduce inventories and hires more slowly (or institutes layoffs). The result is a slowdown in growth.”
Inventory to sales ratio (I/S): Closely resembles the lagging indicator approach. From the text:
“When the inventory/sales ratio has moved down, the economy is likely to be strong in the next few quarters as businesses try to rebuild inventory, as in early 2004. Conversely, when the ratio has moved sharply up, as in 2008-09, a period of economic weakness can be expected. Note that while this indicator has been trending down because of improved techniques such as “just in time” inventory management, the 2- to 4-year inventory cycle is still evident.”
So there it is. When facing a question specifically on I/S ratio assume low I/S = good and high I/S = bad.
My bet is, if I/S is on the exam, it will be one of the most missed questions.
Its just such a small part of the curriculum that its easy to overlook (and easy to get backwards). Obviously, anyone reading this thread will get full marks on that question??
We f’n better.
Now let’s just a make a thread like this for all the fringe topics so we cover our bases
I think of inventory in relation to strength of economy like when I was a kid and had a lemonade stand at the school field day. We started out with a whole table full of lemonade slowly people started coming in to the event and getting lemonade and we were only 90% full of cups of lemonade, then when the event was in full swing it was hard to even keep 5 or 6 on the table because demand was so high (strong economy, low inventory) then when things slowed down towards the end and people started leaving for the day the table filled back up ( weak economy, high inventory).
Thanks for the explanation 