As we know that the major goal of inventory control is to discover and maintain the optimum level of inventory investment. Hence, the management must try to check the over-investment or under-investment of capital in inventories. At the same time, the firm should not run short of inventories also. So, the determination of maximum stock limit is very important. As a matter of fact, these are two danger points that management usually wants to avoid.
Maximum Stock Level:
This represents the quantity of inventory above which should not be allowed to be kept. This quantity is fixed keeping in view the disadvantages of overstocking. The disadvantage of overstocking are :-
1. Capital is blocked up unnecessarily in stores so there will be loss of interest.
2. More warehouse space is needed so more rent will have to be paid.
3. There are chances or deterioration in quality because large stocks will require more time for use in the factory.
4. There is the possibility of lose due to obsolescence.
5. There is danger of depreciation in market values.
Factors to be considered while fixing Maximum Stock Limits
The maximum stock level is fixed by taking into account the following factors
1. Amount of capital available for maintaining stores.
2. Warehouse space available.
3. Rate of consumption of the material.
4. The time lag between indenting and receiving of the material.
5. Possibility of loss in stores by deterioration, evaporation etc. There are certain stores which deteriorate in quality if they are stored over a long period.
6, Cost of maintaining stores.
7. Likely fluctuations in prices. For instance, if there is the possibility of substantial increase in maces in the coming period, a comparatively large maximum stock level will be fixed. On the other hand, if there is the possibility of decrease in prices in the near future, stocks are kept at a very reduced level.
8. The seasonal mature of supply of material. Certain materials are available only during specific periods of the year, so these have to be stocked heavily during these periods.
9. Restrictions imposed by Government or local authority in regards materials in which there are inherent risks, e.g., fire and explosion.
10. Possibility of change in fashion and habit which will necessitate change in requirements of materials.
Minimum Stock Limit (Safety or Buffer Stock):
This represents the quantity below which stock should not be allowed to fall. The main purpose of this level is to ensure that production is not held up due to storage of any material.
Factors to be considered while fixing Minimum Stock Limits
The level is fixed for all items of stores and the following factors are taken into account of the fixation of this level.
(i) Lead time i.e. time lag between indenting and receiving of the material.
(ii) Rate of consumption of the material during the lead time.
For example, if the average rate of consumption of an item of store is 200 units per week and the past experience is that it takes four weeks to receive the item of store after placing an indent. In this case, minimum quantity will be 200 x 4 = 800 units, i.e., four weeks consumption of the material. If the indent is placed when the stock is less than 800 units, the present stock will be consumed before the new material is received and production will be hold up.
Re-ordering Level (Ordering Level):
It is the point at which if stock of the material in store approaches, the storekeeper should initiate the purchase requisition for fresh supplies of the material.. This level is fixed somewhere between the maximum and minimum levels in such a way that the difference of quantity of the material between the recording level and the minimum level will be sufficient to meet the requirement of production upto the time the fresh supply of the material is received.
Danger Level :
This means a level at which normal issues of the material are stopped and issues are made only under specific instructions. The purchase officer will make spacial arrangements to get the materials at danger levels so that the production may not stop due to shortage of materials.
Example : Suppose, in a factory the daily consumption of coal is 5 tons. The danger level is 20 tonnes. The lead time is 7 days. The minimum stock limit has been fixed at 50 tons. The maximum limit of coal has been fixed at 120 tons.