There’s no stock answers when it comes to inventory management

The inventory management skills of businesses are likely to be severely tested in the midst of a fragile economic recovery.

UK businesses enjoyed 64 successive quarters of positive growth until early 2008. It was then reversed by six horrendous quarters, marking a cumulative fall in national output of 6% – the largest decline since 1931. Facing a situation unseen in recent times, future stock projections based on perceived demand, as well as sizing up booked stock to meet accounting norms, will prove to be tricky for business managers.

Data suggests that inventory levels are turning around after hitting an all time low in December 2008. A purchasing managers’ survey in January suggested that manufacturing output rose in December at its highest rate in over eight quarters. According to ONS data, industrial production was down 9.6% year-on-year for July 2009. However, by November, the decline had moderated to 6%. Much of it may be attributed to a rise in oil and gas production. But manufacturing enterprises also stemmed the annualised output decline rate from -10.7% in July to -5.4% in November, if gauged separately.

Howard Archer, chief UK economist at IHS Global Insight, advocates a cautious approach towards inter­preting medium-term statistics. “Production figures mirror a turnaround in the stock cycle, but it must be noted that this reversal is from historically low levels. What is occurring at present is a normalisation process of a return to pre-crisis inventory levels.”
Archer agrees with market consensus that the UK will come out of a recession in the fourth quarter of 2009, or first quarter of 2010. “While I do not see a return to a recession further down the year, businesses face a delicate task of deciding what stock levels to maintain in the present economic climate,” he said.

Business inventory can be a mixed blessing in even in the best of times, since it counts as an asset on balance sheets. In uncertain times, businesses, especially SMEs, are likely to have a reduced appetite for investing in stocking-up and insuring stocks.

Furthermore, UK GAAP and IFRS preference for FIFO (first in/first out) as opposed to LIFO (last in/first out) inventory accounting effectively cuts room for manoeuvre in terms of reporting lower net income and book value of inventories due to the effects of inflation. Hence, tax burden of inventories is also likely to give businesses some unappetising food for thought.

Even Bank of England governor Mervyn King sympathises with the forecasters’ dilemma. In a speech at the University of Exeter, he noted: “Over the past year, the UK economy has battled against headwinds of an intense monetary squeeze and a sharp fall in world trade, supported by tailwinds of a huge policy stimulus and a lower exchange rate. At this very early stage of the recovery, it is particularly difficult to judge medium-term prospects for the economy.

“Movements in macroeconomic data can sometimes bear a resemblance to old-fashioned disco dancing – sharp movements in unpredictable directions creating much excitement, accompanied by a good deal of noise.”

Reversal of the VAT cut, ancillary taxes and even effects of the recent cold weather are likely to shake-up forecasts. Finance still remains an issue for those with an inclination to stock-up. Lenders maintain that finance available to businesses has improved over the last quarter.

Specifically, on the subject of SMEs, the British Bankers’ Association said there was £573m of new structured-term lending by high street banks to small businesses in November, following on from £592m in October. Total high street lending stocks stands at £55.6bn, it added.

Anecdotal evidence indicates that banks are quoting high rates for business lending, in some cases ranging between 10-14% above the base rate, which is presently at a historic low of 0.5%.

However, bankers say under-pressure businesses are just not in the market for borrowing and adding to their debt burden.

In the wake of conflicting viewpoints, the Federation of Small Businesses is calling for an intermediary to be put in place. Such a body could then independently verify why a particular loan was denied or a higher rate of interest was quoted on a case-specific basis, according to a spokeswoman.
Stephen Gifford, chief economist at Grant Thornton, feels both sides have a point. “Banks are still rebuilding their balance sheets. After the financial crisis, business lending is more risk-weighted than before.

Hence, rates (charged or quoted) would reflect the level of risk banks take in financing a business project. Also, companies are being careful as the end of the fiscal year approaches and are not all that keen to take on more debt.”
Gifford notes that, once companies start rebuilding their stocks, it will improve GDP – albeit temporarily if demand is not sustained.

However, leverage-based inventory acquisition, in face of uncertain demand, high borrowing rates and dipping consumer spending, would be a non-starter for most businesses.

While they face choppy waters in 2010, their decisions could well shape the recovery.

Further reading:

Economics: Modern-day inflation requires new set of guidelines