Fixation of Stock Levels: Formulas

and Calculations
Read this article to learn about the formulas and calculations for fixation of
stock levels.

Formulas:
(i) Maximum Level of Stock = (Reorder Level + Reorder Quantity) –
(Minimum rate of consumption x Minimum reorder period)

Maximum Level may be alternatively fixed as Safety Stock + Reorder

Quantity or EOQ.

(ii) Minimum level of stock = Reorder level – (Average rate of consumption

x Average reorder period)

(iii) Safety Stock = (Annual Demand/365) x (Maximum Reorder Period –

Average Reorder Period)

(iv) Reorder level or Ordering level = Maximum rate of consumption ×

Maximum reorder period. Alternatively, it will be = safety stock + lead time
consumption

[lead time consumption will be = (Annual consumption -s- 360) × lead

time]

(v) Danger level = It is slightly below the minimum level. It is a level at

which special efforts should be made to obtain supplies of materials, i.e.

Minimum rate of consumption × Emergency delivery time

(vi) Average Stock level = (Maximum stock level + Minimum stock level) x
14 or Minimum Stock level + 14 Reorder Quantity.
Obviously, the Reordering level is below the Maximum level, and Minimum
level is below the Reordering level and the Danger level is below the
Minimum level. Safety Stock is above minimum level.

Important Elements:
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In above calculations, the following elements are important:

(a) Consumption Rate:
It is consumption or use of material per day (or per week) by production
department. These rates will be maximum and minimum, the simple
average of maximum and minimum rates is average consumption rate per
day or per Week.

(b) Reorder Period:

It is period between materials ordered and materials received. The average
reorder period is simple average of maximum and minimum reorder
periods.

(c) Reorder Quantity:

At the time of purchase of material, one of the important problems to be
faced is how much quantity of a particular materials to be purchased at a
time. If purchases are made frequently in small quantities it will result in
loss of trade discounts and economies in purchasing. On the other hand if
purchases are made in large quantities it will lead to over stocking and cost
of storage will be high. The ordering quantity should be economic and
reasonable by all aspects. It should be Economic Order Quantity (EOQ). The
calculation of EOQ has been discussed later on.

Illustration 1: [Fixation of stock levels]:

Two components A and B are used as follows:

Normal usage 50 units per week each

Minimum usage 25 units per week each

Maximum usage 75 units per week each

Reorder Quantity A 300 units; B 500 units

Reorder Period A 4 to 6 weeks, B 2 to 4 weeks

Calculate for each components:

(a) Reorder level,

(b) Minimum Level,

(c) Maximum level,

(d) Average Stock Level.

Solution:
(a) Reorder Level = Maximum Rate of Consumption x Maximum Reorder
Period.

A = 75 x 6 = 450 units

B = 75 x 4 = 300 units

(b) Minimum Level = Reorder Level – (Average Rate of consumption x

Average Reorder Period)

A = 450 – (50 – 5) = 200 units

B = 300 – (50 x 3) = 150 units

(c) Maximum Stock Level

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= (Reorder Level + Reorder Quantity) – (Minimum Consumption Rate x
Minimum Reorder Period)

A = (450 + 300) – (25 x 4) = 650 units

B = (300 + 500) – (25 x 2) = 750 units

(d) Average Stock Level = (Maximum Stock Level + Minimum Stock

Level)/2

A = (650 + 200)/2 = 425 units

B = (750 + 150)/2 = 450 units

Average Stock Level can also be calculated by the formula.

Minimum Stock Level + ½ of Reorder Quantity

A = 200 + ½ x 300 = 350 units

B = 150 + ½ x 500 = 400 units

Illustration 2:
If the minimum stock level and average stock level of raw material A are
4,000 and 9000 units respectively, find out its reorder quantity.

Solution:
Average stock level = Minimum stock level + ½ of Reorder Quantity

9000 = 4000 + of Reorder Quantity

½ Reorder Quantity = 9000 – 4000 = 5000

Reorder Quantity = 10,000 units

4 Major Types of Stock Levels of

Inventory (With Formula)
This article throws light upon the four major types of stock levels
of inventory. The types are: 1. Minimum Level 2. Maximum
Level 3. Danger Level 4. Average Stock Level.
Stock Level: Type # 1. Minimum Level:
This represents the quantity which must be maintained in hand at all times.
If stocks are less than the minimum level, then the work will stop due to
shortage of materials.

Following factors are taken into account while deciding

minimum stock level:
(i) Lead Time:
A purchasing firm requires some time to process the order and time is also
required by the supplier/vendor to execute the order. The time taken in
processing the order and then executing it is known as lead time. It is
essential to maintain some inventory during this period to meet production
requirements.

(ii) Rate of Consumption:

It is the average consumption of materials items in the industry. The rate of
consumption will be decided on the basis of past experience and production
plans.

(iii) Nature of Material:

The nature of material also affects the minimum level. If a material is
required only against special orders of the customer then minimum stock
will not be required for such materials. Wheldon has given the following
formula for calculating minimum stock level: Minimum stock Level = Re-
ordering Level – (Normal Consumption x Normal Reorder Period)

(iv) Re-ordering Level:

When the quantity of materials reaches a certain level then fresh order is
sent to procure materials again. The order is sent before the materials reach
minimum stock level.
Reordering level is fixed between minimum level and maximum level. The
rate of consumption, number of days required to replenish the stocks, and
maximum quantity of materials required on any day are taken into
consideration while fixing reordering level.

Re-ordering level is fixed with following formula:

Reordering Level = Maximum Consumption Rate x Maximum Reorder
period.

Stock Level: Type # 2. Maximum Level:

It is the quantity of materials beyond which a firm should not exceed its
stocks. If the quantity exceeds maximum level limit then it will be termed as
overstocking. A firm avoids overstocking because it will result in high
material costs. Overstocking will lead to the requirement of more capital,
more space for storing the materials, and more charges of losses from
obsolescence.

Maximum stock level will depend upon the following factors:

1. The availability of capital for the purchase of materials in the firm.

2. The maximum requirements of materials at any point of time.

3. The availability of space for storing the materials as inventory.

4. The rate of consumption of materials during lead time.

5. The cost of maintaining the stores.

6. The possibility of fluctuations in prices of various materials.

7. The nature of materials. If the materials are perishable in nature, then

they cannot be stored for long periods.

8. Availability of materials. If the materials are available only during

seasons then they will have to be stored for the future period.
9. Restrictions imposed by the government. Sometimes, government fixes
the maximum quantity of materials which a concern can store. The limit
fixed by the government will become the deciding factor and maximum level
cannot be fixed more than that limit.

10. The possibility of changes in fashions will also affect the maximum level.

Wheldon has suggested the following formula for calculating

maximum stock level:
Maximum Stock Level = Reordering Level + Reordering Quantity –
(Minimum Consumption x Minimum Reordering period)

Stock Level: Type # 3. Danger Level:

It is the level below which stocks should not fall in any case. If danger level
approaches then immediate steps should taken to replenish the stocks even
if more cost is incurred in arranging the materials. Danger level can be
determined with the following formula:

Danger Level = Average Consumption x Maximum reorder period for

emergency purchases.

Stock Level: Type # 4. Average Stock Level:

The Average stock level is calculated such as:
Average Stock Level = Minimum stock Level + 1/2 of Reorder Quantity.

Example:
From the following information, calculate minimum stock level,
maximum stock level and re-ordering level:
(i) Maximum Consumption = 200 units per day

(ii) Minimum Consumption = 120 units per day

(ii) Normal Consumption =160 units per day

(iv) Reorder period = 10-15 days

(v) Reorder quantity = 1,600 units

(vi) Normal reorder period = 10 days.

Solution:
Reordering Level = Maximum Consumption x Maximum Reorder period

= 200 units X 15 = 3,000 units Minimum Stock Value = Reordering Level –

(Normal Consumption x Nominal Reordering Period)

= 3,000 – (160 X 10) = 3,000 – 1,600 = 1,400 units

Maximum Stock Level = Reordering Level + Reorder Quantity – (Minimum

Consumption x Reorder period) = 3,000 + 1,600 – (120 X 10) = 3,000 +
1,600 – 1,200 = 2,400 units.

The three other factors must also be explained very carefully.