Stock Levels, Calculation, Reasons

Stock Level refers to the different levels of stock which are required for an efficient and effective control of materials and to avoid over and under-stocking of materials. The purpose of materials control is to maintain the sock of raw materials as low as possible and at the same time they may be available as and when required. To avoid over and under-stocking, the storekeeper must fix the inventory level, which is also known as a demand and supply method of stock control. In a scientific system of inventory control the following levels of materials are fixed.

Re-order Level

Re-order level is a level of material at which the storekeeper should initiate the purchase requisition for fresh supplies. When the stock-in-hand comes down to the re-ordering level, it is an indication that an action should be taken for replenishment or purchase.

The re-order level is calculated as follows:

Re-order Level = Minimum Level(Safety stock) + (Average lead time x Average consumption)

Re-order Level = Maximum Consumption x Maximum Re-ordering Period

Minimum Level Or Safety Level

Minimum level or safety stock level is the level of inventory, below which the stock of materials should not be fall. If the stock goes below minimum level, there is a possibility that the production may be interrupted due to shortage of materials. In other words, the minimum level represents the minimum quantity of the stock that should be held at all times.

The minimum level is determined by using the following formula:

Minimum Level = Re-order level -(Normal consumption x Normal Re-order Point)

Calculation OF Minimum Level Or Safety Stock

Illustration

Re-order Period = 8 to 12 days

Daily consumption = 400 to 600 units

Minimum Level = ?

Solution,

Minimum Level = Re-order Level – (Normal Consumption x Normal Re-order Point)

= 7200 – (500 x 10)

= 2200 units.

Working Notes:

1. Re-order Level = Maximum consumption x Maximum Re-order Point = 600 x 12 = 7200 units

2. Normal consumption = (Maximum Consumption + Minimum Consumption)/2

   = (600+400)/2 = 1000/2= 500 units

3. Normal Re-order Period = (Maximum Re-order Period + Minimum Re-order Period)/2

   = (12+8)/2 = 10 days.

Average stock Level

Average Stock level shows the average stock held by a firm. The average stock level can be calculated with the help of following formula.

Average Stock Level = Minimum Level + (1/2Re-order Quantity)

OR

Average Stock Level = (Minimum Level + Maximum Level) / 2

Illustration

Re-order quantity = 2000 units
Minimum Level = 500 units
Average stock level = ?

Solution,

Average stock level = Minimum level + 1/2 x Re-order quantity
= 500 + 1/2 x 2000
= 500+ 1000
= 1500 units.

Danger Level

Danger level is a level of fixed usually below the minimum level. When the stock reaches danger level, an urgent action for purchase is initiated. When stock reaches the minimum level, the storekeeper must make special arrangements to get fresh materials, so that the production may not be interrupted due to the shortage of materials.

The formula for calculating the danger level is:

Danger Level = Normal consumption x Maximum re-order period for emergency purchase

illustration,

Daily Consumption = 100 to 200 units

Maximum re-order period for emergency purchase = 5 days

Danger Level = ?

Solution,

Danger Level = Normal consumption x Maximum re-order period for emergency purchase = 150 x 5 = 750 units.

Maximum Level

Maximum level is that level of stock, which is not normally allowed to be exceeded. Beyond the maximum stock level, a blockage of capital should be exercised to check unnecessary stock. The factory should not keep materials more than the maximum stock level. It increases the carrying cost of holding unnecessary inventory level. It is the opportunity cost of holding inventory.

The maximum stock level can be calculated by using the following formula:

Maximum Level = Re-order Level + Re-order quantity – (Minimum consumption x Minimum Delivery Time)

illustration

Re-order quantity = 1000 units

Re-order Level = 1500 units

Re-ordering period = 4 to 6 days

Daily consumption = 150 to 250 units

Maximum Level = ?

Solution,

Maximum Level = Re-order level + Re-order quantity – (Minimum consumption x Minimum Re-ordering period)

= 1500+1000(150 x 4)

= 1900 units.

Reasons of Maintaining Optimal Stock Level:

• Avoiding Stockouts and Production Delays

Maintaining an optimal stock level ensures that raw materials and finished goods are always available when needed, preventing production stoppages and order fulfillment delays. Stockouts can lead to missed sales opportunities, customer dissatisfaction, and reduced profitability. By keeping adequate inventory, businesses avoid disruptions in manufacturing, maintain a steady supply chain, and enhance customer trust. Inventory management techniques like Just-in-Time (JIT) and Economic Order Quantity (EOQ) help maintain the right balance of stock without overburdening storage capacity.

• Reducing Excess Inventory Costs

Holding excess stock increases costs related to storage, insurance, depreciation, and obsolescence. Overstocking ties up capital, which could be used for other business operations. It also increases the risk of damage, spoilage, or products becoming outdated, especially for perishable or technology-based goods. By maintaining optimal stock levels, businesses reduce warehousing costs, handling expenses, and potential write-offs while improving cash flow and financial efficiency. Demand forecasting and inventory turnover analysis help in maintaining appropriate stock levels.

• Enhancing Customer Satisfaction

Customers expect quick and reliable deliveries, and maintaining an optimal stock level ensures that orders are fulfilled on time. A lack of stock can lead to lost sales and customers switching to competitors. On the other hand, having excess stock can lead to outdated products that customers may no longer want. A well-managed inventory system ensures that products are available as per market demand, strengthening customer relationships and enhancing brand loyalty.

• Improving Supply Chain Efficiency

An optimized stock level streamlines procurement, production, and distribution processes. It prevents disruptions caused by supply chain issues such as delayed shipments, supplier shortages, or transportation bottlenecks. Proper inventory control ensures a smooth material flow, reducing lead times and ensuring uninterrupted operations. Techniques like Vendor-Managed Inventory (VMI) and Just-in-Time (JIT) help maintain balance in the supply chain, reducing waste and increasing overall operational efficiency.

• Preventing Material Wastage and Obsolescence

Overstocking increases the risk of perishable goods expiring, raw materials deteriorating, or finished products becoming obsolete due to changes in demand or technology. Maintaining optimal stock levels helps minimize waste, ensuring that older stock is utilized first through FIFO (First-In-First-Out) or LIFO (Last-In-First-Out) techniques. This is particularly crucial for industries dealing with food, pharmaceuticals, and electronics, where outdated inventory results in significant financial losses.

• Enhancing Working Capital Management

Inventory represents a significant portion of a company’s working capital, and excessive stock ties up funds that could be used for other critical business operations. Maintaining the right stock levels ensures that money is not locked in unsold goods, improving liquidity and financial flexibility. Proper inventory management allows businesses to reinvest in product development, marketing, and operational growth, leading to higher profitability and financial stability.

• Reducing Ordering and Carrying Costs

Ordering too frequently increases procurement costs, administrative work, and supplier dependency, while carrying excess stock raises storage, insurance, and handling costs. An optimal stock level strikes a balance, reducing both ordering and holding expenses. Inventory control techniques like EOQ (Economic Order Quantity), reorder point methods, and demand-based replenishment help in minimizing unnecessary expenses while ensuring a consistent supply of materials and goods.