Note on Stock Level or Inventory Management

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Meaning and Computation of Stock Level

Inventory is the stock which firm maintains to meet its future requirement for the production and selling. The basic reason for holding inventory is to keep up the production activities unhampered. Inventories are part of current assets, which are used within one year. In a normal course of business operation, manufacturing organizations maintain the inventory of raw materials, work-in-progress, finished goods, spare parts, suppliers, etc.

In the manufacturing concern, inventories make the bridge between the production and sales. Trading organizations are involved in buying and selling of goods. Therefore, inventory of trading organizations is unsold goods i .e. finished goods. Investment on inventory depends on certain risks and costs. Therefore, the inventory manager should try to maintain an optimal size of inventory without disturbing the production and sales needs.

Types of Inventories

Following are the important types of inventory:

  1. Raw materials: Raw material is a very important factor of production. It includes physical commodities used to manufacture the final product.

  2. Work-in-progress: Work in progress inventories are semi-manufactured products, which need more and more work before they are converted into finished products for sale. In other words, goods partially worked on but not fully done are called work in progress.

  3. Finished goods: Inventories of finished products are the stock of goods which are ready for the sales. Finished goods are required for smooth marketing operations of the products.

Objectives of Inventory Management

The objectives of inventory management are mentioned below:

  1. To regular supply of material: There should be a continuous availability of materials in the factory or finished goods for trade. The main objective of inventory management is to create required inventory so that production and sales process run smoothly.

  2. To minimization of over stocking: If a company keeps inventory without the proper analysis, there will be a chance of overstocking, which will increase the cost of carrying the inventories or under-stocking of inventories that create a problem in a smooth operation of a business. So, one of the main objectives of the inventory management is to minimize the risk caused due to overstocking of inventory.

  3. To reduce material losses: Inventory management focus to eliminate or remove the losses and misappropriation of materials. This is done by maintaining the proper stock of materials with utmost care.

  4. To minimize the costs: The proper maintenance of the information regarding inventories helps to make decisions like whether to take discounts or not, the size of an order to be placed, when to order, etc. The total costs associated with inventory management may be reduced by analyzing the lot size to be acquired, the offer of a discount on a various lot sized and the timing of order.

Reasons or Motives of Holding Inventory

Source: www.slideshare.net
Source: www.slideshare.net

The main reason or motive of holding inventory is to provide the required quantity of inventory to different departments as needed so that production / sales process does not get affected.

The motives or reasons of holding inventories are:

  1. Transaction motive: The manufacturing concerns need inventories of raw material and work in progress so as to make balance regular production activities. Similarly, the trading organizations need the inventories of finished goods for supplying the goods and services to the customers regularly. In this way, owning of inventories helps to have regular transactions.

  2. Precautionary motive: Due to different reasons like shortage of inventory with the supplier, distance relation with the supplier, disturbance in transportation, delay in inventory supply, etc. might take place. So, this motive helps to protect the industries from the risk of delay in goods, etc.

  3. Speculative motive: Generally, the price of inventories ris. So, the companies may keep an extra amount of inventory to get profit by selling the surplus inventory at a higher price than a purchase price. It creates risk when the price of inventories falls.

Techniques of Inventory Management

To achieve the objective of the inventory management, different methods are used such as stock level, economic order quantity, just-in-time purchase, perpetual inventory system, ABC analysis, etc. Stock level and economic order quantity are very popular methods of managing inventory.

Stock Level

Source: slideplayer.com
Source: slideplayer.com

Stock level is essential for the control of materials. Determination of stock level is required to avoid over and under stocking of materials. More amount of stocks and inadequate stocks both are harmful to the organization. Over stock results extra investment of capital and under stock affect the production. So, the organization should have adequate stock for a normal requirement.

Storekeeper must determine the stock level in such a manner that matches the requirement. Stock levels are maintained for standardized materials which are regularly used in an organization. In order to have good and proper control materials, the following techniques are used in cost accounting.

  • Re-order Stock Level

The manager has to decide when and where should be the next purchase made after the first purchase. When the quantity of material reaches at a certain figure new order is set to get material again and again. So, reorder level is that level of material where new order should be placed considering reorder period and the daily usage and rate. This level is fixed somewhere between the maximum and minimum level. If the inventory falls down the re-ordering level, store keeper began purchasing the fresh goods. It is also called re-order point.

Illustration:

Suppose,
Maximum consumption per day = 400 units
Minimum consumption per day = 200 units
Re-order period = 8 to 10 days
Then,
Re-order Level = Maximum consumption * Maximum re-order period
= 400 units * 10 days = 4000 units

  • Minimum Stock Level

Minimum stock level shows the minimum quantity of the material which must be maintained and protect in hand at every time. It is needed to avoid shortage of the material in the production. The stock of goods should not be below minimum level. In order words, the stock level is normally not allowed to fall below minimum level. While calculating minimum level, rate of consumption and nature of the material should be considered. It is necessary to arrange the minimum stock level due to the following reasons:

  • A manufacturing company does not face the shortage of the materials.
  • A trading company does not deals with the shortage of merchandise goods for re-selling.

Illustration:

Re-order Period = 8 to 12 days
Daily consumption = 400 to 600 units
Minimum Level = ?

Solution,
Minimum Level = Re-order Level - (Normal Consumption * Normal Re-order Period)
= 7200 - (500*10)
= 2200 unit

  • Maximum Stock Level

In store, stock should not exceed maximum level. It shows the maximum output of an item of material which can be held in stock at any time. The level of maximum stock is fixed to remove the problem of over stocking. Stock is normally not allowed to rise above maximum level. Stock exceeding this level will lead to blocking capital and unnecessary increase in stock holding cost. So, the maximum stock means the maximum quantity of an item of material which can be held in stock at any 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 * Minimum Re-ordering period)
= 1500 + 1000 ( 150 * 4 )
= 1900 units

Re-order Quantity

Re-order quantity is the quantity of material that is purchased each time. This is also termed as order size. The re-order quantity is also termed as economic order quantity if it can be acquired at the minimum cost.

Average Stock Level

Average stock level refers the normal or moderate stock level. If the store manager thinks that the demand and supply of inventory are normal or moderate, he / she recommend keeping stock at average level.

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

Solution,
Average stock level = Minimum level + 1/2 * Re-order quantity
= 500 + 1/2 * 2000
= 500 + 1000
= 1500 units

Danger Level

This is the level of material at which the issue of material is temporarily stopped. From this level, materials are issued for some abnormal situations only. The issue of material can be made against the special order form the top level. Since, it is a danger level, some serious actions should be taken to acquire materials.

Illustration:
Daily Consumption = 100 to 200 units
Maximum re-order period for emergency purchase = 5 days
Danger Level = ?

Solution:
Danger Level = Normal consumption * Maximum re-order for emergency purchase
= 150 * 5
= 750 units

References:

Koirala, Madhav et.al., Principles of Accounting -XII, Buddha Prakashan, Kathmandu

Shrestha, Dasharatha et.al., Accountancy -XII, M.K. Prakashan, Kathmandu

Bajracharya, Puskar, Principle of Accounting-XII, Asia Publication Pvt. Ltd., Kathmandu

  1. Cost accounting is the branch of accounting that deals with the classification, allocation, recording, summarization and reporting of costs.
  2. Minimum stock level shows the minimum quantity of the material which must be maintained and protect in hand at every time.
  3. Re-order quantity is the quantity of material that is purchased each time. 
  4. Minimum stock level shows the minimum quantity of the material which must be maintained and protect in hand at every time. 
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