Purchasing Managers' Index

Purchasing Managers' Index (PMI) refers to an indicator concerning the economic activities carried out by the entities in the services and manufacturing sector. It is based on the monthly surveys in which the major developing nations participate. The primary purpose of this index is to help assess the economic health of the manufacturing or services industry. 

Every month, supply chain managers from 19 sectors participate in a survey. The process encompasses all activities, including upstream and downstream. The Institute for Supply Management (ISM) uses this survey data and publishes the PMI at the beginning of every month. This purchasing managers' index data gives beneficial insights to investors, business decision-makers, and market analysts. 

• Purchasing Managers' Index (PMI) refers to a survey-based measure of business activity in the manufacturing and service sectors.
• The input for the survey comes from different sectors labeled under the manufacturing and services niche.
• Suppliers use the PMI to determine the precise future demand for goods from a certain organization, and it also enables suppliers to estimate the number of items that customers already have on hand as inventory.
• The PMI is prepared based on the calculations done with respect to the weightage given to the Percentage of changes seen in the business conditions in the manufacturing and services industry.

The Purchasing Managers' Index reflects its role as an economic indicator, which provides financial information to analysts, investors, and decision-makers concerning the present plus future situations of a firm. The PMI is based on a monthly survey conducted and published by ISM. The leaders of more than 400 companies from 19 different sectors are asked to respond. These participants are chosen based on their contribution to the US economy. 

The survey puts forth questions related to various domains, including inventory levels, supplier deliveries, employment, production, new orders, and others, as applicable. The participants have the liberty to share information about the business conditions, any transformation they have noticed, or any deterioration in terms of any of the critical areas that they might want to bring to notice.

The survey also asks the business leaders about any change in their views about key business variability in comparison to the last month. After the survey is over, the PMI is calculated separately for the services and manufacturing sectors to prepare a composite index. PMI index ranges from 0 to 100, which indicates the following:

• If the PMI goes above 50, it indicates an expansion in the manufacturing and services sector.
• If the PMI goes below 50, it indicates a contraction in the manufacturing and services sector.
• If the PMI is 50, it reflects no changes in the manufacturing and services sector.

As the output for the changes can be positive, negative, or no change at all, each input from participants had some weightage, specifically considered in the stock market. The standard weightage for positive results is 1, while the same for no change is 0.5. However, when the change recorded is negative, the weightage is 0. These constitute three different diffusion indexes prepared using the inputs of the participants from different sectors participating in the survey. The results are then combined into a PMI.

PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)

Where:

• P1 = Percentage defining improvement
• P2 = Percentage depicting no change.
• P3 = Percentage reporting deterioration

Let us use the chart below to understand the topic:

Source

In the above chart, one finds that the PMI is below 50, which means the US economy with respect to the manufacturing sector has shrunk a bit. 

Let us consider the following instances to understand how the PMI is prepared:

Example #1

Suppose the authorities conducted the monthly survey and the respondents recorded responses that led to the figures below:

• Percentage defining improvement (P1) = 65
• Percentage depicting no change (P2) = 20
• Percentage reporting deterioration (P3) = 50

The formula, when applied, helped obtain the combined PMI:

PMI = (P1 * 1) + (P2 * 0.5) + (P3 * 0)

= (65*1) + (20*0.5) + (50*0)

= 65+10+0 = 75%

The final percentage of 75, which is above 50, indicated an economic expansion with respect to the contributions of the manufacturing and services industry.

Example #2

Let us take the example of PMI for the US economy, considering the above chart, indicating the scenarios in January and February 2023.

Thus, one can see that there is negative growth of PMI from:

• January 2023 to February 2023 by 0.63%, and
• 2022 to 2023 by -18.60 % 

In both instances, the US manufacturing sector has shrunk considerably.

PMI plays an essential role in the economy, as discussed below:

• Suppliers use it to know a specific company's exact demand for goods in the future.
• It also helps the suppliers gauge the number of products consumers already have with themselves as inventory.
• The PMI helps manufacturers determine the price of products for suppliers.
• Companies use PMI to plan their budget, manage staff counts, and estimate future cash flows.
• Investors use it as the foremost economic conditions indicator.
• If the PMI declines, orders will decline, and the manufacturer will have to reduce the price of its goods for the supplier and vice versa. 
• A firm develops its economic situation using the index in the US and identifies opportunities to do so. 

This has been a guide to what is Purchasing Managers' Index. We explain the concept using a chart along with how to calculate it, examples, & importance. You can learn more about it from the following articles –

• Flash Purchasing Managers’ Index
• ISM Manufacturing Index
• Market Index