What is Minimum Level of Stock?
Minimum Level is also known as buffer stock level, safety stock level. When inventory balance falls below this level, production functions could be disrupted and the company may fail to deliver the product on due time. This is the lowest inventory balance that should always be maintained to avoid the chances of sudden stoppage of production.
Minimum Stock Level is considered as the precautionary level of stock. At this stage, the business entity should reorder the materials considering the probable lead time. Lead time is the expected time period of delivery of goods to the customer’s warehouse or at the production point. If management feels lead time could be longer than their estimated time period, alternative plan to be taken to avoid the production disruption.
The formula of Minimum Stock Level
Following are the formula to calculate the minimum stock of inventory:
Minimum Level of Inventory = Reorder Level – (Average rate of consumption x Average lead time)
or, Minimum Level of Inventory = (Maximum usage x Maximum Lead Time) – (Average rate of consumption x Average Lead Time)
Considerable points to Set Minimum Stock
The following points to be considered to fix the minimum level of inventory:
- Information about maximum consumption and maximum lead time to reorder
- Determine the average rate of consumption
- Information of sourcing of materials. The lead time of materials will vary in case of local market and foreign market. Lead time of foreign purchase will be longer than local market.
- Minimum level to be maintained for regular store items. For special order minimum level need not maintain.
- Minimum, Normal and maximum rate of consumption to determined
Examples of Minimum Stock
Example – 01:
ZXY Ltd. manufactures and sells special types of equipment for the motor vehicle. The equipment costs are $150 and are sold to the customers @ $200
The highest demand (maximum) is 200,000 units per year and the average demand for this equipment is 180,000 per year. The average lead is expected to 57 days and maximum lead time is expected to 64 days.
Requirements: Compute the MInimum level of stock of Special Equipment.
Minimum Stock Level = Re-order Level – (Average Demand x Average Lead Time)
Hence, Firstly we have to calculate Re-Order Level.
- Highest (Maximum) Demand per day = 200,0000/365 = 548 units per day.
- Normal (Average) Demand per day = 180,000/365 = 493 units per day
Re-order Level = Maximum demand x Maximum Lead Time
= 548 units x 64 days = 35,072 Units
Minimum Level of Stock = Reorder Level – (Average Demand x Average Lead Time
= 35,072 units – (493 units × 57 days)
= 35,072 units – 28,101 units
= 6,971 units
Following Data are collected from Nitol Motor Limited for your computation:
Annual demand for the Car is :
Maximum Demand is expected 2,550 units, Normal (Average) Demand is 1,785 units and Minimum Demand is 1,148 units.
Lead time is expected:
Maximum Lead Time is 110 days, Normal or Average Lead Time is 92 days and Minimum Lead Time is 78 days.
Compute Minimum Inventory Level of Nitol Motors Ltd.
Maximum Demand Per day = 2,550 units /365 days = 7 units per day
Average Demand Per Day = 1,785 units/365 days = 5 units per day
Minimum Level of Inventory = (Maximum Demand per day x Maximum Lead Time) – (Average Demand Per day x Average Lead time)
= (7 units x 110 days) – (5 units x 92 days)
=770 units – 460 units
= 310 units
Advantages of Minimum Level
- Reduces the holding cost of the company. Holding costs include utility costs, labor costs and other costs associated with to hold the materials in the store
- Reduces the pressure on cash flow for purchasing excess raw materials
- Reduces the chances of losses, defective, etc. due to always monitoring.