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Accounting for
Inventories
Inventories in the Crystal Ball
Policy makers, economists, and investors all want to know where the economy is headed. For example, if the economy is headed for a slow-down, it might be prudent on the part of the Federal Reserve to cut interest rates or for Congress to consider a tax cut to head off an economic downturn. Information on inventories is a key input into various decision makers’ economic prediction models. For example, every month the U.S. Commerce Department reports data on inventory levels and sales. As shown in the table below, in a recent month these data indicated an increasing level of inventories.
November Inventory and Sales

(billions of dollars, seasonally adjusted)
Total business inventories
Total business sales
Inventory/Sales ratio

1999
$1,145
$ 862
1.33

2000
$1,221
$ 896
1.36

Percent Change ϩ6.64% ϩ3.94%

More importantly, not only were inventories rising, but they were rising at a faster rate than sales. These data raised some warnings about future economic growth, because rising inventory levels relative to sales indicate that consumers are trimming spending faster than companies can slow production.1
These data also raised warning flags for investors in individual companies.
As one analyst remarked, “When inventory grows faster than sales, profits drop.” That is, when companies face slowing sales and growing inventory, then markdowns in prices are usually not far behind. These markdowns, in turn, lead to lower sales revenue and income, as profit margins on sales are squeezed.2 Research supporting these observations has found that increases in retailers’ inventory translate into lower prices and lower net income.3 Interestingly, the same research found that for manufacturers, only increases in