The Effect of Nonlinear Inventory Turnover Ratio on Inventory Management Efficiency

This study examines the effect of nonlinear inventory turnover ratio on the inventory-performance relationship. The inventory turnover ratio is measured by the ratio between inventory and sales. The existing studies on the... [ view full abstract ]

This study examines the effect of nonlinear inventory turnover ratio on the inventory-performance relationship. The inventory turnover ratio is measured by the ratio between inventory and sales. The existing studies on the inventory –performance relationship assumed a linear relationship between inventory and sales: as firm’s sales increases, the quantity of inventory should also increase proportionately. The assumption, however, conflicts with the optimal inventory policy based on the economic order quantity model. As such, the linear inventory turnover ratio fails to recognize the fundamental inventory cost tradeoffs and cannot be considered as a good indicator of efficiency in inventory management. Assuming inventory turnover ratios are nonlinear, a few recent studies examined the inventory-performance relationship and reported conflicting results with the existing studies. In this study, we examine the nonlinear relationship between inventory and sales at the firm-specific level, using the panel data of U.S. manufacturing firms over the period of 1980–2014 collected from the Compustat database. Our results show that neither of the assumptions was prevailed over the sample period.