Re-Order Level (ROL) implies the material level at which purchase requisition is generated for a fresh supply of material. When the stock on hand, approaches the reorder point, the storekeeper takes action to replenish the exhausted stock. So, the difference between reorder level and minimum level will be adequate to meet the production requirement till the fresh supply is received.
On the contrary, Re-Order Quantity (ROQ) represents the size of the order, which is going to be placed by the entity with the selected supplier when the stock level touches reorder level. For this purpose, the determination of optimum and reasonable order size is substantial.
This written account will help you understand the major differences between re-order level and re-order quantity.
Content: Re-Order Level Vs Re-Order Quantity
|Basis for Comparison||Re-Order Level||Re-Order Quantity|
|Meaning||Re-Order Level implies the level at which new order should be placed for the purpose of restoration of stock.||Re-Order Quantity implies the size of the lot for which the order is placed when the stock of material falls to reorder level.|
|Determines||When to buy or place an order for materials.||How much quantity of materials are to be purchased at a time.|
|Factors Involved||Maximum consumption during lead time, lead time taken by supplier, safety level, replenishment period, etc.||Annual Carrying Cost, annual ordering cost, quantum of discount, etc.|
Definition of Re-Order Level (ROL)
Re-Order level represents the level of material lying between the minimum and maximum stock level, in essence, that before the stock of material ordered is delivered by the supplier and received into the stores, a sufficient quantity of material should be there to cover both normal as well as abnormal consumption situation. If the firm has an idea about the lead time, EOQ, and consumption pattern, Reorder level can be determined easily.
Reorder Level is set in such a manner that by reordering, when the stock of material reaches this point or level, then in normal circumstances, fresh supplies will come to the store, just before the level falls to a minimum level. So, at the time of fixing this level following factors are considered:
- Consumption rate
- Minimum level
- Delivery time, and variations in delivery time
Formula for Re-Order Level
In general, Re-Order Level is calculated using the following formula:
- Re-order Level = Maximum Consumption × Maximum Reorder Period
Further, if the maximum consumption is not known, Re-Order Level can also be calculated using an alternative formula:
- Re-order Level = Minimum Stock Level + (Average Rate of Consumption × Average Reorder Period)
If the company maintains safety stock it can be calculated as:
- Re-Order Level = Safety Stock + (Average Consumption per day × Average Lead Time)
Let us understand these terms in detail
|Maximum Consumption||Maximum consumption implies the maximum rate of consumption of material during a production activity.|
|Maximum Re-order Period||As the name suggests, it is the maximum time taken by the supplier to fulfill the order of materials, i.e. to deliver the stock to stores.|
|Minimum Stock Level||Minimum stock level is the least quantity of stock of materials that need to be maintained by the firm all the time.|
|Average Rate of Consumption||It is the normal rate of material consumption during production activity.|
|Average Re-order Period||The average time taken by the supplier to deliver the order to the factory’s stores is the average reorder period.|
|Safety Stock||Safety stock is the minimum additional inventory acting as a margin of safety or buffer stock, that helps in meeting the unexpected rise in consumption, due to a sudden increase in demand or uncontrollable delay in the delivery of the material.|
|Lead Time||It is the time interval between the placement of the order and receipt of delivery.|
Definition of Re-Order Quantity (ROQ)
Re-Order Quantity (ROQ) implies the size of the material lot, for which purchase requisition is prepared by the company’s stores department. At the time of determining the quantity to be re-ordered these factors are to be taken into account:
- Maintenance of the minimum level of stock
- Re-order level
- Minimum delivery time, and
- Total cost
When this quantity is set, the buyer of materials need not recalculate every time the number of materials to be ordered.
Think of a situation when purchases are made at short intervals in small lots, it will amount to a loss of trade discount and economies of purchasing, whereas if purchases are made in bulk, it will result in overstocking, and excess capital would be locked up in inventory as well as the cost of storage will be high. Hence, the ordering quantity needs to be economic and reasonable, while considering all the factors. In this way, the concept of Economic Order Quantity (EOQ) comes into the picture.
Therefore, Re-Order Quantity should be fixed in such a manner that the sum of carrying cost and ordering cost is the least. And to do so, Economic Order Quantity (EOQ) is calculated.
Economic Order Quantity
Order size in which the total of both ordering cost as well as carrying cost is minimum, so it is economical to order and also facilitates in maintaining the stock of materials at an optimum level at minimum cost. In other words, at EOQ, the total cost of managing inventory is minimum.
At the time of determining EOQ, the factors given below are taken into account:
- Average rate of consumption
- Ordering cost and holding cost of inventory
- Storage space availability
- Quantum of discount
- Interest on capital locked up in stock
- Risk of price fluctuation
- Cost of stock out
- Risk of deterioration, evaporation, etc
- Seasonal considerations
Formula for calculating EOQ
A = Annual usage
O = Ordering Cost
C = Carrying or Holding Cost
Let us understand these terms in detail:
|Ordering Cost||All the costs which are directly or indirectly related to the purchase or order of the material come under Ordering Cost. This may include the cost to invite quotations, documentation work, cost of stationery, employee cost directly attributable to the material procurement, transportation cost, and inspection cost.|
|Carrying Cost||The cost of holding or carrying average inventories on annual basis in the store is called carrying cost. This may include the cost of funds invested in inventories, insurance cost, cost of handling materials, interest on capital blocked in stores, maintenance of equipment cost, obsolescence, and cost of storage like salary, rent, stationery, etc.|
Points to Remember
- There exists an inverse relationship between order size and ordering cost, i.e. the larger the side of the order the lower will be the ordering costs because of fewer orders. Whereas the smaller the size of the order, the higher will be the ordering cost due to many orders.
- The relationship between order size and carrying cost is positive in the sense that the larger the size of the order, the higher will be the carrying cost due to high average inventory. Conversely, when the size of the order is small, the carrying cost will be low due to low average inventory.
Key Differences Between Re-Order Level and Re-Order Quantity
After having an in-depth discussion on the two, let us understand the difference between reorder level and reorder quantity:
- Reorder Level represents that level of inventory which when reached the order for refilling inventory must be placed with the supplier so that the required material is delivered before the entire stock of material comes to an end. On the contrary, Reorder Quantity refers to the size of the material lot for which order is placed with the chosen supplier when the level of stock falls to reorder level.
- While Re-Order Level is associated with the time element, Re-Order Quantity is associated with quantity.
- Re-Order Level helps in ascertaining when to buy or place the order for the material lot, whereas, Re-Order Quantity facilitates in determining how much quantity of materials to be purchased by the firm at a time.
- At the time of determining re-order level, factors like maximum consumption during lead time, lead time is taken by the supplier, safety level, replenishment period, are considered. On the other hand, to ascertain re-order quantity – annual carrying cost, annual ordering cost, quantum of discount, and many other factors are taken into account.
Que Limited provides the given information relating to material
Supply period: 5 to 15 days
Maximum usage: 20 units per day
Minimum usage: 10 units per day
Average usage: 15 units per day
Annual consumption: 5000 units
Ordering costs ₹ 20 per order
Purchase Price per unit is ₹ 50 and the storage cost is 10% of the unit value.
Now, with this information, we need to calculate Re-Order Level and Re-Order Quantity i.e. EOQ
Reorder Level = Maximum Consumption × Maximum Re-Order Period
= 20 × 15
= 300 units
= ₹ 5
In a nutshell, the re-order level is the order point of inventory which when reached, the action for material purchase needs to be initiated. On the other hand, re-order quantity is the size of the material lot which will be ordered to refill the used up material, at a time.