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On average, companies artificially reduce their inventories by up to six percent in time for the fiscal year-end. These are the findings of a study by Professor Kai Hoberg (Kühne Logistics University), Florian Badorf (Kühne Logistics University and Leuphana University of Lüneburg), and Lars Lapp (Boston Consulting Group). Based on extensive financial data from 4,877 companies listed on American stock exchanges, they examined the fiscal year’s influence on inventory levels.
Recent studies show that efficient inventory management can significantly boost companies’ financial success. In view of this information, the research team has studied the extent to which the fiscal year-end influences the inventory levels of manufacturing companies. The results showed that depending on the sector, companies reduce their inventories by between 3.3 percent and 8.6 percent on average before the fiscal year-end. The researchers controlled for other possible explanations such as sales fluctuation, company size, and margins. Both companies whose fiscal year corresponds to the calendar year and those whose fiscal year differs from the calendar year show such inventory reductions before the fiscal year-end. Companies chasing cash flow targets in particular tend to reduce their inventories to reach those targets. These companies reduce inventories by 17.5 percent on average.
Significant production level cutbacks
The team calls this phenomenon the “inverse hockey stick effect.” In contrast to the well-known increase in revenues at the end of a budget period resulting from discounts, inventories are reduced just in time for the fiscal year-end. However, the reduction in inventory is caused by mechanisms other than the ones related to revenue increases. Inventory holdings can be divided into three components: raw materials that have not been processed yet, semi-finished products that the company has already processed but are not ready to be sold, and end products that are ready for sale. The study showed that inventory levels of the third group, the products that are ready for sale, are reduced by 3.9 percent on average. Raw materials inventories also fall by 3.9 percent, but those of semi-finished products are reduced by 6.0 percent. This indicates that in preparation for the fiscal year-end, companies not only reduced their purchases from suppliers but also cut back their production levels.
Analysts view low inventories positively
There are many rational reasons for lowering inventory at the end of the fiscal year, explained Florian Badorf, a PhD candidate and supply chain analytics specialist: “Low inventory levels signal efficient inventory management to financial analysts, who are increasingly interested in operations-related KPIs. For companies that have lower sales in the first quarter of the new fiscal year relative to the remaining quarters such low inventory levels are sufficient for their production processes. And of course companies attempt to improve their cash flow by cutting back on purchasing and production, reducing their expenditures in the outgoing fiscal year.”
However, Professor Hoberg was more critical: “Inventories should be the result of carefully planning deliveries, production, and sales – not short-term balance sheet targets. Even if lower levels make taking inventory easier, artificially reducing purchases and production can have abstruse consequences. Companies no longer accepting deliveries from suppliers or implementing vacation shutdown just before the fiscal year-end, for example. In the new fiscal year, they make up for the lost output through overtime – all this so management can achieve its inventory targets on the balance sheet date and receive a full bonus.”
The article "The inverse hockey stick effect: an empirical investigation of the fiscal calendar’s impact on firm inventories" can be viewed in the pre-print section of the renowned International Journal of Production Research.
http://dx.doi.org/10.1080/00207543.2016.1269969
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