Page 243 - DMGT405_FINANCIAL%20MANAGEMENT

Unit 11: Inventory Management

Main consideration for fixation of minimum level of inventory: Notes

1. Information about maximum consumption and maximum delivery period in respect of
each item to determine its reorder level.
2. Average rate of consumption for each inventory item.

3. Average delivery period for each item. Average delivery period = ½ (maximum period +
minimum period)
Formula:

Minimum level of inventory = Re-order level – (Average rate of consumption ×
Average time of inventory delivery)
Maximum level = It indicates figure of inventory quantity held in stock at
any time.
The following are the considerations that govern the fixation of maximum level for various
inventory items:
1. It’s reorder level. The reorder itself depends on the maximum rate of consumption and
maximum delivery period.
2. The knowledge about minimum consumption and minimum delivery period for each
inventory item.

3. The figure of economic order quantity.
4. The availability of funds, storage space, nature of item and their price per unit are also
important.

5. For imported material since of their irregular supply, the maximum level should be high.
Formula used for calculation of maximum level of inventory
= Reorder level × Reorder quantity – (Minimum Consumption × Minimum reorder period)

Reorder level

This level is between minimum and maximum levels, such that before the material ordered is
received into stores, there is sufficient quantity on hand to cover with normal and abnormal
consumption situations. It is the level at what order for replenishment of stock should be placed.
The formula used for its calculation is as follows:

Reorder level = Maximum reorder period × Maximum Usage (or)
= Minimum level + (Avg. rate of consumption × Avg.
time to obtain fresh supplies)

Now, Avg. inventory level = Maximum level + ½ Reorder quantity
Maximum level + Minimum level
OR =
2

Did u know? What is Danger Level?
It is the level at which normal issues of raw material inventory are stopped and emergency
issues are only made.

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