Various types of techniques are used in controlling the inventories. Some most popular and important techniques are as under:
(1) Re-order level (ROL), (2) Economic ordering quantity (EOQ), (3) ABC analysis, (4) Value analysis
Re-order level (ROL): Receiving and issuing of inventories are the common and recurring phenomena in a manufacturing organization. When the inventories fall below a particular level, they are replenished by the fresh purchases. The prescription of re-order level (ROL) is an important technique of inventory control. It fundamentally deals with ‘when to order’ to replenish the inventories. Re-order level is predetermined point, and when the existing stock of inventories reaches this point of falls below it, the purchase action is initiated to replenish them. The ROL is mentioned in the bin-card of each inventory item. What should be the quantity of replenishment order is also a matter of policy. Generally, size of the order is determined on the basis of the economic ordering quantity (EOQ) which is also an important technique of inventory control. Detailed treatment is given to this technique separately.
The re-order level is decided for each important item of inventory on the basis of following considerations:
1) Lead time
2) Average periodic consumption (daily consumption)
3) Safety stock
Re-order level is decided as under:
ROL=(Lead time x average daily consumption) + safety stock
Following data relate to one basic raw material item:
Lead time – 4 days
Safety stock – average two days consumption
Size of the order – 500 units
ROL=(Lead time x Average daily consumption) + safety stock
=(4 days x 50 units) + 100 = 300 units
The minimum level of the inventory will be the safety stock. The re-order level (300 units) is 200 units above the safety stock (i.e. 100 units). The order will be placed for 500 units when the stock reaches 300 units i.e. ROL. As it takes four days to get materials after placing an order, the fresh stock of 500 units will arrive at a time when the stock had reached to 100 units, i.e. the safety stock. Thus, the safety stock will be the minimum level of inventory.
The maximum level of inventory would be as under:
Maximum level = Safety stock + Reordering quantity
= 100 + 500 = 600 units
The ordering level is controlled through following techniques:
Two bin system: under this system, the inventory item is divided into two parts. One part is active one from which issues are made. The other part is kept reserved and touched only when the active part is exhausted. It is also known as the ‘bin reserve’ system. When the reserve part is touched, afresh order is placed to replenish the stock. The reserve part becomes active and the earlier active part which is exhausted is replenished with the fresh stock. The fresh order is placed for the fixed quantity. The quantity in the reserve part as a reordering level. It is not necessary to provide for two separate bins. It is a notional presentation. The two parts can be segregated even by the line. This method is applicable to low cost, high volume items which have consistent usage. This method does not involve any record keeping.
Mini-Mix system: Under the system, when the inventory times reaches to a predetermined minimum level, it is replenished by the fresh purchase up to the predetermined maximum level. The minimum level serves as a reordering point. The fresh order is placed for that much quantity which shows deficiency in maximum level. Thus, the size of the order is variable rather than fixed. Like the two bin system, this method is applicable to low cost, high volume parts with consistent usage.
Imprest System: Under this system, the reordering is made at regular time intervals. The maximum level of each item is predetermined. At a particular fixed period, say after one week, a fresh collective for all the items be placed. The size of the order will be decided on the basis of the shortages indicated by the existing stock in relation to the maximum level. Thus, the quantity of replenishment will exactly equate the quantity consumed during the period. The size of the order will vary considerably.