Inventory Control Levels and Quantities
- Inventory control is the process of keeping the right number of materials, parts and products in stock to avoid shortages, overstocks, and other costly problems.
- It is concerned with the acquisition, storage, handling and use of inventories so as to ensure the availability of inventory whenever needed, providing adequate provision for contingencies, deriving maximum economy and minimizing wastage and losses.
- Control of inventory is exercised by introducing various measures of inventory control, such as ABC analysis fixation of norms of inventory holdings and reorder point and a close watch on the movements of inventories.
The Minimum Stock Level (MSL)
- The minimum stock level is the level below which the inventory of an item should never be
allowed to fall. - It is the lower limit of inventory and it must always be on hand for continued work.
- If the new balance calculated after an issue is at or near the MSL figure stated on the record, urgent action must be taken to ensure that new stock is delivered. MSL is also called safety or reserve or buffer stock.
- Formula for Minimum Stock Level
- The minimum stock level can be calculated by applying the following formula:
- Minimum Stock Level= Re Order Level – (Normal Usage X Normal Lead Time)
- Minimum Stock Level Worked Example
- Suppose we have the following information:
- Normal consumption = 300 units per week
- Normal delivery time = 7 weeks
- Reorder level = 2,400 units
- Minimum Stock Level= 2,400 – (300 x 7)
- = 300 units
The Reorder Stock Level (RSL)
- The reorder stock level is the lowest number or quantity of the item which should be in inventory before an order for replenishment should be made.
- It is a level above the MSL and at which action must be taken to ensure the order and delivery of new supplies of the item before the MSL is reached.
- It indicates when to order or reorder. It is necessary to protect against exhaustion of stock during the time gap between an order and the date of receipt of stock.
- The major factors to be considered in fixing this level for an item are:
- the time it takes for provision-demand documents to be prepared by warehousing personnel and forwarded to supply department;
- the time it takes for the supply department to place the replenishment order; and
- the time taken by the supplier to deliver the new stock (referred to as exstock).
- Reorder level can be calculated by applying the following formula:
Re-order Level = (Maximum Lead time x Maximum Usage)
- Worked Example:
- If the maximum usage is 130 units per day, minimum usage is 70 units per day and the lead time is 25 to 30 days.
- Worked Example:
- Re-order Level= (130 x 30)
- Re-order Level = 3900 units
Maximum/Higher Stock Level (HSL)
- The maximum or higher stock level is the level beyond which the inventory of an item should never be allowed to rise.
- Maximum level can be calculated by applying the following formula:
Maximum stock level= Re-order + (EOQ-Minimum Usage x Minimum Lead Time)
- Worked Example
- If EOQ=1000 units, Re-order level 3900 units, maximum usage is 130 units per day, minimum usage is 70 units per day and the lead time is 25 to 30 days.
- Maximum stock level = 3900+ (1000-(70X25))
- Maximum Stock Level= 3150 units
The Economic Order Quantity (EOQ)/ Re-Order Quantity
- By definition, EOQ is the lot size that minimises total annual inventory holding and ordering costs.
- EOQ is the lot size that makes annual inventory holding cost equal to annual ordering cost.
- It is thus the optimal ordering quantity for an item of stock that minimises costs while maximising the benefits of holding inventory.
EOQ=√(2x( annual demand x ordering costs per unit)
Carrying Cost per unit
Worked Example
Annual demand is 60,000 units, the ordering cost per order is $25 per order, holding cost is $3 per item per year, normal usage is 100 units per day, maximum usage is 130 units per day, minimum usage is 70 units per day and the lead time is 25 to 30 days. Compute the Economic Order Quantity.
EOQ=√(2x( annual demand x ordering costs per unit)
Carrying Cost per unit
EOQ=√(2x( 60,000 x 25)
3
EOQ=√(300,000)
3
EOQ=√(100,000)
EOQ=1000 units