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| By N2H | ||||||||||||||||||||||
Inventory management
August 9, 2008
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Minimum inventory Level
This is that level of an item of material, below which the actual stock should not normally be allowed to fall. It is fixed to ensure that the required quantity of each item of material is available in the stores at all times. To fix the minimum level, the following is taken into account:
- The average rate of consumption of the material
- The time required to obtain fresh supplies
- The reorder level
- The production material requirements
- The minimum quantity of materials which can be procured advantageously.
The minimum stock level is calculated as:
Re-order level – Average expected demand for the stock item during the lead time. This can be stated as:
Re-order level – (Normal consumption x Normal delivery time) where normal delivery time is taken as the average of maximum and minimum time taken for delivery.
Re-order level
This is the stock level fixed between maximum and minimum stock levels, at which an order for the replenishment of stock must be placed. The re-order level is generally higher than the minimum level to cover any emergency which may arise as a result of abnormal usage of materials or unexpected delay in obtaining fresh supplies. To fix this level, the following is taken into account:
- The consumption rate of material
- The margin of safety
- The normal delivery time or lead time
- The minimum level to be maintained
- Cost of storage and interest on capital employed in materials
- Provision for emergencies such as delay in supply and abnormal wastage.
Re-order level is calculated as:
Maximum consumption x maximum delivery time Or
Re-order level = Minimum Stock + Average consumption during normal delivery time. The re-order level is revised frequently considering any factors that are likely to change supply and demand for goods.
Maximum inventory Level
This is the level that should never be exceeded. This is to avoid undue investment of capital leading to a loss of interest, obsolescence of materials, and additional overheads in the form of higher rents, etc. It is determined by taking into consideration the following factors:
- Normal consumption rate of materials
- Time required to obtain new supplies
- Amount of working capital available
- Availability of storage space
- Economic order quantity
- Cost of storage
- Risk of deterioration
- seasonal considerations as to price and availability of material
- Insurance costs
- Other inherent risks associated with the materials and any restrictions that may be imposed by government.
Maximum order level can be determined by using the following formula:
Re-order level + Re-order quantity – (minimum consumption x minimum time for delivery)
Or
Maximum level= Re-order level – Consumption during the time required to get fresh supplies at minimum rate + Economic Order Size.
DANGER LEVEL
Some firms also use the danger level in respect of materials. Danger level is fixed at a point below the minimum level and represents the limit at which special steps must be taken to obtain emergent supplies of material i.e. sending a man personally to bring the required materials. When the stock of a particular item of materials reaches danger level, no further issues are made by the store keeper except on the special requisition approved by the works manager.
Danger Level = Normal consumption per day /per month etc X Time required to obtain emergency supplies.
Average stock level = Minimum Stock level + ½ (Re-order Quantity)
Inventory Control Systems
Red-line method: the simplest, since a red-line is drawn at the lower level inside an inventory bin then inventory is stacked and when the red-line shows, more inventory is ordered.
Two-bin method: Inventory is stacked in two bins. When the working bin is empty, inventory is drawn from the second bin and an order for additional inventory is placed.
Computerized inventory control system: the inventory is computerized and as inventory is withdrawn, they are recorded in the computer and the inventory balance revised. Orders are placed when the reorder point is reached.
Just-In-Time System: it automatically coordinates a manufacturer’s production with suppliers’ production so that raw materials arrive from suppliers just as they are needed in the production process. Also related to Outsourcing.
The Inventory policy must be coordinated with the firm’s manufacturing and procurement policies since the ultimate goal is to minimize total costs and inventory is just one part of the total costs.
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