Inflation means that the buying power of currency decreases in an economy because the supply of currency has increased. While the factors that drive inflation are complex, its major effect is simple: prices increase across the board. The problem with predicting the effects of inflation on a business’s inventory is that there are always two distinct factors to consider. First is the actual effect of inflation, which is to decrease buying power. The second is the effect expectations of inflation can have on the spending of both consumers and businesses.
Essentially, whenever people anticipate having less buying power in the near future, they want to buy things now while their money is still valuable. The increased demand then causes prices to increase, and that’s how inflation starts. Put differently, the anticipation of inflation can itself be the cause of inflation.
Inventory Turnover Ratio
An inventory turnover ratio reveals how effectively a business stocks and sells products. A high inventory turnover ratio means that most or all of a business’s inventory was sold during a given period. In other words, the business managed its inventory well by stocking just enough products to meet customer demand. A low inventory turnover ratio, on the other hand, means a business stocked more products than it could sell during the given period. That’s usually bad because surpluses incur unnecessary storage and maintenance costs, therefore decreasing profitability.
Decreasing Inventory Turnover Ratio
If a business anticipates inflation, it might beef up its inventory now while prices are low. Its inventory will then be larger than normal, which means its inventory ratio will decrease. A business might increase its inventory in this manner for two reasons. First, if it buys inventory while prevailing prices are low and then waits to sell the inventory when prices are high, it increases its profit margin. Second, buying a large amount of stock at once keeps ordering costs low. This is especially true if inflation is about to raise ordering costs for future sales periods.
Increasing Inventory Turnover Ratio
On the other hand, inflation might increase inventory turnover ratios if customers expect an inflationary trend to continue. Recall that people who expect a currency’s value to drop want to buy items while their money still packs a punch. This might mean that stores will sell out of items more quickly. Theoretically, as prices increase due to inflation, demand should decrease in response. But fears of inflation, well-founded or not, can lead to runaway inflation, meaning stores can’t raise prices fast or high enough, and products fly off shelves as people start to panic.
There’s no simple way to predict the actual effects that inflation might have on inventory turnover. Even economists disagree about what causes inflation and how its various effects might alter a business environment or cancel each other out. The safest approach for business owners is to watch their market carefully and choose an inventory buying strategy that aligns with their best predictions.
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