Contents
Meaning
Stock level refers to the amount of goods or raw materials that should be maintained by businesses to continue their activities and avoid any situations like understocking or overstocking. Every organization should always keep an optimum amount of inventory to ensure the regular operation of its production activities.
Inventory acts as a bridge between production and sales of business and ensures a regular supply of finished goods to customers. Raw materials, work-in-progress, finished goods and various consumables like fuel and stationery are three important types of inventories that every firm needs to maintain.
Inventory managers should properly control the inventory and determine the optimum size to be always kept within the organization. Managers should consider various factors like storage space of firm, the frequency with which inventory is sold or used, risk of inventory getting outdated before it is used, insurance cost on inventory, etc. for deciding the right amount of stock. Major types of stock levels of inventory are as follows:
Types of Stock levels of Inventory
Minimum level
The minimum level of stock refers to the minimum quantity of inventory that should be always maintained within the business premises. It is also termed as safety level or precautionary level of inventory as this quantity is must to be maintained always to keep the organization functioning. If the stock level falls below this point, then the organization will stop working due to a shortage of materials.
It can be calculated using the formula:-
Minimum level of inventory = (Maximum usage × Maximum lead time) – (Average usage × Average lead time)
OR
Minimum Level of inventory = Re-order level – (Average usage × Average lead time)
Maximum level
The maximum level of stock refers to the maximum quantity of inventory a firm can hold and cannot exceed this level. Any quantity of stock beyond this level will be termed as overstocking which will have adverse effects on firm and results in high material cost. The maximum level is decided considering various factors like availability of capital and storage facilities, rate of consumption of materials, availability of materials, fluctuations in material price, the possibility of fashion change, etc.
It can be calculated using the formula:-
The maximum level of inventory = Reordering Level + Reordering Quantity – (Minimum Consumption x Minimum Reordering period)
Average stock level
The average stock level refers to the average quantity of stock held by companies for a given period of time. It offers a balanced solution and therefore is calculated and maintained by many firms. The average stock level is a level that is above the minimum level and below the maximum level.
It can be calculated using the formula:-
Average Stock Level = Minimum stock Level + 1/2 of Reorder Quantity.
Danger level
Danger stock level is one where the issue of material is temporarily stopped. It is an alarming situation for the organization and should always be avoided. If a stock level approaches danger level which is below a minimum level, management should take immediate action to acquire the required materials in less time.
It can be calculated using the formula:-
Danger Level of inventory = Average Consumption x Maximum reorder period for emergency purchases.
Re-ordering level
The re-ordering level is a point at which the company should start a new manufacturing run or place a new order with the supplier to procure materials. In simple words it is a level at which purchase order is place. It is a level that is fixed in between the minimum and maximum levels of inventory. Identifying the right reorder level is a must to avoid any understocking or overstocking. A purchase order is put before the stock reaches the minimum stock level.
It can be calculated using the formula:-
Reorder level or Ordering level = Maximum rate of consumption × Maximum reorder period.