It might seem counterintuitive, but low inventory levels are often good, while high ones are bad. Here's why.
While a high inventory level might make a company appear well-positioned to meet demand, it's risky -- demand may suddenly plunge. Indeed, a large inventory may signal that demand has already slackened.
Products end up sitting on the shelves all the time. Fashion trends change, technological advances make current products obsolete, and the functional utility of some products vanishes after a certain time. A PC manufacturer with a large stock of older computers probably can't sell many of them, because buyers want newer models. A warehouse full of Christmas ornaments in January faces similarly bleak prospects.
Anything left sitting on a warehouse shelf costs money to hold and risks not being sold. Efficient companies try to maintain low levels of inventory. These levels permit quick reaction to market changes, minimizing the chances the company will get stuck with extra goods.
As you review a company's financial statements, it can be useful to compare the growth rate of inventories with the growth rate of revenues. You generally don't want to see inventories growing faster.
To read more about inventory and how to understand what it means for a business, check out:
