Minimum Limit or Minimum Level of Stock:

Learning Objective: 

1. Definite and explain minimum limit or minimum level of stock.
2. How is minimum limit or minimum level calculated?

Definition and Explanation:

The maximum stock limit is upper level of the inventory and the quantity that must not be exceeded without specific authority from management. In other words, the maximum stock level is that quantity of material above which the stock of any item should not normally be allowed to go. This level is fixed after taking into account such factors as: capital, rate of consumption of materials, storage space available, insurance cost, risk of deterioration and obsolescence and economic order quantity.

Formula:

Maximum level or maximum limit can be calculated by the help of following formula:

[Maximum limit or level = Re-order level or ordering point – Minimum usage × Minimum re-order period + Economic order quantity]

Example:

Normal usage	100 units per day
Maximum usage	130 units per day
Minimum usage	70 units per day
Re-order period	25 to 30 days
Economic order quantity	5,000 units
Calculate maximum limit or level. In order to calculate maximum limit of stock we must calculate re-order point or re-order level first. Ordering point or re-order level = Maximum daily or weekly or monthly usage ×  Maximum re-order = 130 × 30 = 39,000 units Calculation:   Maximum limit or level = Re-order level or ordering point – Minimum quantity used in re-order period usage + Economic order quantity = 3900 – (70 × 25) + 5,000 Danger Level of Materials or Inventory Stock: Definition and Explanation: Some enterprise also calculate danger level. When this level of stock is reached, then emergency steps are taken by the management to acquire material supplies. When danger level is reached, the try is made to purchase materials from the nearest possible source or place so that the workers and plant and machinery may not remain idle due to shortage of materials supplies. Formula: Danger level can be calculated by the help of the following formula: [ Danger level = Average daily requirement × Time required to get emergency supply ] Example: Normal usage or average requirement 700 units per day Maximum usage 800 units per day Minimum usage 600 units per day Re-order period 25 to 30 days Time required to receive emergency supplies 4 Days Calculate danger level. Calculation: Danger level = Average daily requirement × Time required to get emergency supply Economic Order Quantity (EOQ): Learning Objective:  Definite and explain economic order quantity (EOQ). How is economic order quantity (EOQ) calculated? Definition and Explanation: Economic order quantity (EOQ) is that size of the order which gives maximum economy in purchasing any material and ultimately contributes towards maintaining the materials at the optimum level and at the minimum cost. In other words, the economic order quantity (EOQ) is the amount of inventory to be ordered at one time for purposes of minimizing annual inventory cost. The quantity to order at a given time must be determined by balancing two factors: (1) the cost of possessing or carrying materials and (2) the cost of acquiring or ordering materials. Purchasing larger quantities may decrease the unit cost of acquisition, but this saving may not be more than offset by the cost of carrying materials in stock for a longer period of time. The carrying cost of inventory may include: Interest on investment of working capital Property tax and insurance Storage cost, handling cost Deterioration and shrinkage of stocks Obsolescence of stocks. Formula of Economic Order Quantity (EOQ): The different formulas have been developed for the calculation of economic order quantity (EOQ). The following formula is usually used for the calculation of EOQ. A  =  Demand for the year Cp   =  Cost to place a single order Ch  =  Cost to hold one unit inventory for a year * = × Example: Pam runs a mail-order business for gym equipment.  Annual demand for the TricoFlexers is 16,000.  The annual holding cost per unit is $2.50 and the cost to place an order is $50.  Calculate economic order quantity (EOQ) Calculation: Underlying Assumptions of Economic Order Quantity: The ordering cost is constant. The rate of demand is constant The lead time is fixed The purchase price of the item is constant i.e no discount is available The replenishment is made instantaneously, the whole batch is delivered at once. = 2,800 units