Fundamentals of Business

Controlling current assets

Stocks in trade Factors influencing stock levels there are two main factors influencing the optimum level of stocks to be held by an organisation:

1. Demand

There must be sufficient stocks to satisfy:
I. Normal production demands determined by the production cycle.
II. Anticipated growth in sales and production.
III. Abnormal demands, that is buffer stocks to allow for the unexpected.
These variables may be illustrated by reference to figure below. Which indicates hypothetical reorder level, bearing in mind assumed lead time, that is, time taken to order, receive and inspect stocks ready for use?

The line SP - SP represents irregularity and abnormality in sales and hence production demands over time; the required safety stock level or buffer stocks and the lead time to determine the stock level when reordering must take place.

2. Economic quantities

Orders must be made bearing in mind the following:
I) Costs involved in ordering and carrying stocks (naturally, any saving in this respect is of benefit to the organisation and directly improves the stock turn over ratio, any decision to place small orders must be made by reference to demand.
II) Economies of bulk purchases
Re-order level this is calculated as follows:
Re-order Level (ROL) = Average consumption rate x lead time
If materials already ordered are awaiting delivery when further re-orders are being considered, then the ROL will have to be adjusted
ROL = (Average consumption rate x Lead time) - Goods in transit