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(^250) Financial Management
By combining safety stocks and reorder points, the firm maintains a
buffer against unforeseen events.
Reorder point
Deliverytime Deliverytime Time
Inventory
(units)
Minimum
inventory level
Modified Ordering Systems
The re-order level system involves deciding a level of stockholding at which new purchase
orders shall be placed. This will be decided in relation to the normal rate of issues
during the normal purchasing lead time. The quantity to be ordered is constant, and an
order for that quantity will be placed whenever stock falls to the pre-determined order
level. The system thus responds quickly to variations in demand though there is a danger
that in doing so it may reflect purely short term or random fluctuations in sales.
The operation of re-order level system include the use of:
l A maximum stock level. This would correspond to the normal peak holding under
stable conditions. If the stockholding exceeds the peak level this provides a warning
that demand has been running below the rate expected when the EOQ was fixed.
The stock controller should then review the correctness of his standard purchase
order quantity
l a minimum stock level which, as suggested above, is probably the amount of the
safety margin.
The minimum stock level provides a warning of a potential out-of-stock position. When
a stockholding falls to that level the stock controller will review his outstanding purchase
orders and their due dates, and also the current trend of demand, and can then decide
whether additional emergency procurement is necessary.
Under the periodic review system purchase orders are placed at fixed intervals of time
but the quantity ordered can be modified to meet the rate of demand indicated by
current experience. This gives an opportunity for analysing the trend of demand, and
various techniques such as 'exponential smoothing' can be used in forecasting this trend.
The system does not respond rapidly to immediate needs, and it may therefore necessitate
a larger safety margin than the re-order level system.
Figure : Safety Stocks and Reorder Points