What is "The Manufacturing Purchasing Managers' Index (PMI)"?

The Purchasing Managers' Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment. The purpose of the PMI is to provide information about current business conditions to company decision makers, analysts and purchasing managers.

BREAKING DOWN 'Purchasing Managers' Index - PMI'

The information to produce the PMI is gathered using monthly surveys sent to purchasing executives at approximately 300 companies. A PMI of more than 50 represents expansion of the manufacturing sector when compared to the previous month. A PMI reading under 50 represents a contraction, and a reading at 50 indicates no change. The Institute of Supply Management (ISM) generates the PMI each month. Although the ISM publishes several indexes, the PMI is the most widely followed and is sometimes referred to as the ISM index.

How PMI Impacts Management Decisions

PMI is a critical decision-making tool for managers in a variety of roles. An automobile manufacturer, for example, makes production decisions based on the new orders it expects from customers in future months. Those new orders drive management's purchase decisions about dozens of component parts and raw materials, such as steel and plastic. Existing inventory balances also drive the amount of production the manufacturer needs to complete to fill new orders and to keep some inventory on hand at the end of the month.

Suppliers also make decisions based on PMI. A parts supplier for a manufacturer follows PMI to estimate the amount of future demand for its products. The supplier also wants to know how much inventory its customers have on hand, which also impacts the amount of production its clients must generate. PMI information about supply and demand affects the prices that suppliers can charge. If the manufacturer's new orders are growing, for example, it may raise customer prices and accept price increases from its suppliers. On the other hand, when new orders are declining, the manufacturer may have to lower its prices and demand a lower cost for the parts it purchases.

A company uses all of this PMI information to plan its annual budget, staffing levels and to forecast cash flow.

Factoring in Imports and Exports

PMI also provides information on imports and exports, which are important statistics for businesses that operate overseas. Assume, for example, that the automobile manufacturer purchases steel in the United States and from China. If imports are increasing, that trend will have a negative impact on U.S. firms that sell the same product. On the other hand, if exports by parts manufacturers are increasing, a parts supplier may demand higher prices from U.S. companies that need to purchase its products.

Source: Purchasing Managers Index (PMI) Definition | Investopedia