Inventory is the heart and crux of a business. It is utilised to produce and sell its products and services. To run a business cost-effectively, it’s crucial to understand the different types of inventory levels.
What are the different levels of inventory?
The products a company stocks up in its inventory are vital assets for its business. Leaving them unaccounted or unattended might cause business losses in the longer run.
Minimum Level
Minimum inventory levels should be maintained at all times by a business for ensuring enough raw materials for continuing its production. Failing to meet this level might result in production outage due to stockouts. Once the demand, consumption rates and production time are available, the minimum level could be estimated using the formula below:
Minimum stock Level = Reordering level (Average usage x Average lead time)
Minimum inventory levels are unique pertaining to each business, and a business must consider the below supply chain elements-
· Type of Material – If a specific order consumes a particular type of material, such material doesn’t require minimum stock levels.
· Lead time – It refers to the time it takes for a business to receive the supplies. It is taken from ordering up to the time when such supplies arrive.
· Rate of Consumption – The material consumption rate trending in a specific industry depending on the past production run data.
· Reordering level – A reordering stock level is when the company’s inventory is required to be replenished before inventory reaches the minimum level. This level is usually fixed at a reorder point which is between the maximum and minimum stock levels and is calculated using the formula below:
Reordering level = Maximum consumption rate x Maximum reorder period
Maximum Level
Contrary to the minimum stock level, a business shouldn’t exceed the maximum stock level to avoid the situation of overstocking raw materials. Extra inventory could lead to high storage costs, stock discrepancies, disorganisation and pilferage. The maximum level could be computed using the formula below:
Maximum Level = Reordering level + *Reorder quantity – (Minimum usage × Minimum lead time)
*Reorder quantity = Average Daily Usage × Average lead time
The main factors a business needs to consider when fixing its maximum level are:
· Average daily use of raw materials
· Average lead time to obtain new supplies
· Storage space availability
· Reorder quantity
· Carrying cost of inventory
· Risk related to pilferage, obsolescence and deterioration of raw materials
· Maximum requirement of materials
· Fastest consumption rate of supplies
· Possible price changes of raw materials
· Shelf life of its raw materials
· Government restrictions
· Changes in consumer demand
Danger Level
A business shouldn’t have its inventory come close to danger level, as it implies the inventory is close to stockout. If the inventory reaches a dangerous level, the business has to expedite more materials, even if such practice involves extra fees.
The danger level is an alarming scenario in which businesses prefer to order supplies with the vendors that could deliver in the shortest time possible. The danger level isn’t ideal for placing purchase orders as companies order on an urgent basis, increasing the transportation charges and the overall cost of inventory.
The danger level could be computed using the formula below:
Danger level = Average consumption x Maximum Lead time for emergency purchases
Average Level
Apparently, from its name, the average level refers to the average level of raw materials available in the company’s warehouse at any point in time. The average level could be computed using the formula below:
Average level = Minimum stock level + (½ x Reorder quantity)
