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Q3. Discuss the relevance and factors that influence the determination of stock level.


Answer:
Most of the industries which are subjected to seasonal fluctuations and sales during different months of the year are usually different. If, however, production during every month is geared to sales demand of the month, facilities have to be installed to cater for the production required to meet the maximum demand.


During the slack season, a large portion of the installed facilities will remain idle with consequent uneconomic production cost. To remove this disadvantage, attempt has to be made to obtain a stabilised production programme throughout the year.

During the slack season, there will be accumulation of finished products which will be gradually cleared as sales progressively increase. Depending upon various factors of production, storing and cost, a normal capacity will be determined. To meet the pressure of sales during the peak season, however, higher capacity may have to be used for temporary periods. Similarly, during the slack season, to avoid loss due to excessive accumulation, capacity usage may have to be scaled down. Accordingly, there will be a maximum capacity and minimum capacity, consumption of raw material will accordingly vary depending upon the capacity usage.

Again, the delivery period or lead time for procuring the materials may fluctuate. Accordingly, there will be maximum and minimum delivery period and the average of these two is taken as the normal delivery period.

Maximum level
Maximum level is that level above which stock of inventory should never rise.
Maximum level is fixed after taking in to account the following factors.
• Requirement and availability of capital
• Availability of storage space and cost of storing
• Keeping the quality of inventory intact
• Price fluctuations
• Risk of obsolescence
• Restrictions, if any, imposed by the government
Maximum Level = Ordering level – (MRC x MDP) + standard ordering quantity
Where, MRC = minimum rate of consumption
MDP = minimum lead time

Minimum Level
Minimum level is that level below which stock of inventory should not normally fall.
Minimum level = OL – (NRC x NLT)
Where, OL = ordering level
NRC = Normal rate of consumption
NLT = Normal lead time

Ordering Level
Ordering level is that level at which action for replenishment of inventory is initiated.
OL = MRC X MLT
Where, MRC = Maximum rate of consumption
MLT = Maximum lead time
Average stock level
Average stock level can be computed in two ways
1.
2
minimum level + maximum level
2. Minimum level + 1 /2 of re-order quantity
Average stock level indicates the average investment in that item of inventory. It is quite relevant from the point of view of working capital management.

Managerial significance of fixation of Inventory level
• Inventory level ensures the smooth productions of the finished goods by making available the raw material of right quality in right quantity at the right time.
• Inventory level optimises the investment in inventories. In this process, management can avoid both overstocking and shortage of each and every essential and vital item of inventory.
• Inventory level can help the management in identifying the dormant and slow moving items of inventory. This brings about better co-ordination between materials management and production management on one hand and between stores manager and marketing manager on the other.
Re-order Point
“When to order” is another aspect of inventory management. This is answered by re-order point.
The re-order point is that inventory level at which an order should be placed to replenish the inventory.
To arrive at the re-order point under certainty, the two key required details are:
• Lead time
• Average usage
Lead time refers to the average time required to replenish the inventory after placing orders for inventory.

Re-order point = Lead time x Average usage

Under certainty, re-order point refers to that inventory level which will meet the consumption needs during the lead time.

Safety Stock
Since it is difficult to predict in advance usage and lead time accurately, provision is made for handling the uncertainty in consumption due to changes in usage rate and lead time. The firm maintains a safety stock to manage the stock – out arising out of this uncertainty. When safety stock is maintained, (When variation is only in usage rate)

Re – order point = Lead time x Average usage + Safety stock
Safety stock = [(Maximum usage rate) – (Average usage rate)] x Lead time.
Or
Safety stock when the variation in both lead time and usage rate are to be incorporated.

Safety stock = (Maximum possible usage) – (Normal usage)
Maximum possible usage = Maximum daily usage x Maximum lead Time
Normal usage = Average daily usage x Average lead time




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