Different levels of stock are mentioned in the stores records. The levels are: (a) Minimum level below which at any time the stock must not go; (b) Maximum level above which at any time the stock must not go; (c) Ordering or re-ordering level which if the stock is reached, the purchase requisition is needed to be sent to the buying department; (d) Danger level which if the stock is reached, then very urgent measure needs to be taken.
- Minimum Level:
- Nature of the Material: Minimum level must be maintained by the materials which are regularly stored. If a special item of material is to be purchased on a customer’s request, minimum level is not required to be fixed for that.
- The maximum time required from the date of order to the date of actual delivery: It is known as lead time. Provided the re-order point remains constant, the longer the lead time, the lower will be the minimum level.
- Rate of material consumption: The minimum rate, the maximum rate & the normal rate of consumption are to be taken into consideration.
- Maximum level:
- Rate of Material consumption.
- The lead time
- The maximum requirement of the material at any time.
- Nature of the material: The materials which deteriorate quickly should be stored as less as possible.
- Storage space available for the material.
- Price Economy- During the harvesting seasons, seasonal materials are cheap. So during the harvesting season maximum purchase is made & as a result the maximum level is high.
- Cost of storage & insurance
- Cost of the material & finance available: The maximum level is likely to be low when the material is costly. Also the maximum level should be high if the price is likely to be going up.
- Turnover of the inventory: The maximum level is low in case of slow moving material & the maximum level is high in case of quick moving material.
- Nature of supply: The maximum level should be as high as possible, if the supply is uncertain.
- Economic Order Quantity: Upon the economic order quantity, maximum level largely depends, because the quantity is decided & hence the maximum level is influenced by the economy order quantity unless otherwise contra indicated.
- Ordering or Re-ordering level:
- Danger Level:
The following factors are to be taken into consideration while fixing the minimum level:-
The following factors are to be taken into consideration while fixing the maximum level:-
Between the minimum level & the maximum level, this level is fixed. This level is fixed in such a manner that the requirement during the lead time is met by the excess of ordering level over the minimum level. Thus, while fixing the re-ordering level, the main factors to be considered are the minimum level, the rate of consumption & the lead time.
For working out the above levels, the following formula may be used:
Maximum level = Re-order level plus Re-order quantity minus (Minimum usage*Minimum order period)
Explanation: On the date on which the quantity is ordered, the actual stock level shall be received, will be the quantity ordered plus re-order level less the minimum consumption during the least lead time.
Minimum level = Re-order level minus (Normal usage*Normal i.e. Average re-order period)
Explanation: In case the usage is normal, by the time the actual delivery against the order is received, the level will not go below this.
Ordering or Re-ordering level = Maximum usage*Maximum delivery period
Explanation: Even if the maximum consumption takes place, by the maximum lead time the stock shall just reach zero level.
Average Stock level=1/2*(Minimum level plus Maximum level)
There is another level called danger level, in addition to the minimum, maximum & re-ordering level. Below the minimum level is this level & urgent measure is to be taken to replenish the stock when the actual stock reaches this level. The purchase quantity cannot be accurately fixed when the normal lead time is not available. So it is fixed in such a way that below the danger level, the actual stock does not fall by the actual lead time. This means that a cushion is contained by the minimum level so that the contingencies can be covered.
The danger level is fixed by some concerns below the re-ordering level but above the minimum level. If, as soon as the stock reaches the re-ordering level, the action for purchase is taken, the danger level bears no significance, except that, when the danger level, but not yet the minimum level, is reached by the stock, for the purpose of ensuring that the delivery has been received before the actual stock reaches the minimum level, a reference may be made to the purchase department.
When, below the minimum level, the danger level is fixed, it being reached by the actual stock, the detection of the defect in the system is done & the corrective measure becomes necessary. When, above the minimum level, the danger level is fixed, it being reached by the actual stock, to ensure that the stock may not go below the minimum level, preventive measures needs to be taken.
Example:
Two components A & B are used as follows:
Normal Usage 120 per week each
Minimum Usage 60 per week each
Maximum Usage 180 per week each
Re-ordering quantity A- 2000; B-3200
Re-ordered period B- 6 to 10 weeks; B-4 to 8 weeks
For each component, calculate:
- Re-ordering level; (b) Minimum level; (c) Maximum level; (d) Average stock level
Also on the difference in the levels for the two components, comment briefly.
Solution: (a) Re-ordering level = Maximum usage* maximum re-order period
A = 180*10 = 1800 units
B = 180*8 = 1440 units
Re-order level of B is lower because against 10 weeks of re-order period for A, re-order period for B is 8 weeks.
(b) Minimum level = Re-ordering level-(Normal usage*Normal re-order period)
Normal Re-order period is to be taken as the average re-order period
A = 1800-(120*8) = 840 units
B = 1440-(120*6) = 720 units.
Because of its lower re-ordering level, minimum level for B is lower.
(c) Maximum level = Re-ordering level +Re-ordering quantity-(Minimum usage*minimum re-order period)
A = 1800+2000-(60*6) = 3440 units
B = 1440+3200-(60*4) = 4400 units.
Because of its higher re-order quantity, maximum level for B is higher.
(d) Average stock level= (Minimum level+ Maximum level)/2
A = (840+3440)/2 = 2140 units
B = (720+4400)/2 = 2560 units.
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- Accounting for Materials
- ABC System/Selective Control System
- Average Cost Methods
- Centralized vs Decentralized Purchase
- Comparison of FIFO& LIFO methods, Next-in-First out (NIFO) Method
- Economic order Quantity (EOQ)
- General Accounting Entries for Materials
- Material Control
- Materials-Introduction
- Materials-Pricing the Issue
- Materials receipt & checking, Constituents of Material Cost
- Periodic Simple Average Method, Periodic Weighted Average Method
- Perpetual Inventory system
- Purchase Procedure
- Standard Price Method
- Stock Valuation
- Types of Stores
