Inventory and its Relationship with Profitability: Evidence for an International Sample of Countries
33 Pages Posted: 4 Sep 2013
Date Written: January 1, 2007
In this paper we empirically study inventory dynamics for a large sample of publicly held companies from nine countries in the Organization for Economic Co-operation and Development (OECD). Our goals are (i) to identify differences in inventory behavior across countries and across different types of inventories and (ii) to link inventory behavior with financial performance. We find that higher sales, accounts payable, product margins, sales uncertainty and sales growth are all associated with higher total inventories, both in the pooled sample and within most countries. Depending on the country, our model explains between 76% and 95% of the variation in the absolute inventory. Interestingly, we find that economies of scale in inventory management exist only in four countries out of nine in our sample, whereas four other countries exhibit diseconomies of scale an in the remaining country inventory is growing linearly with sales. Furthermore, we use a system of equations and a semi-parametric model to estimate the behavior of three different types of inventories across countries (raw materials, work in process and finished goods) and find similar results for the work in process and finished goods inventories. Surprisingly, the raw materials inventories exhibit a negative association with margins and accounts payable. We further link components of the cash cycle with accounting profitability as measured by return on sales (ROS). We find that, after controlling for other relevant segment- and firm-level effects, shorter total cash cycles, lower inventory levels and shorter accounts payable are all positively associated with ROS. Surprisingly, among the three inventory components, only raw materials inventories have a consistent and negative association with ROS.
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