Reorder Point – Definition, Importance, Formula & Implementation

Editorial Note: We are an inventory management software provider. While some of our blog posts may highlight features of our own product, we strive to provide unbiased and informative content that benefits all readers.

A reorder point (ROP) is the minimum inventory level that triggers a replenishment order for a specific item. In essence, it’s a signal that says, “It’s time to restock!“

Reorder Point helps maintain optimal inventory levels. It is crucial as it avoids stockouts, optimizes inventory levels to reduce costs and spoilage, and improves cash flow by preventing excessive stock.

The reorder point is calculated by taking into account average daily sales, lead times, and safety stock.

The basic formula for calculating a reorder point is:

Reorder Point = Average Daily Usage * Lead Time + Safety Stock

Importance of Reorder Point:

Inventory is a crucial part of any business and the reorder point is an important part of managing that inventory. The reorder point is the point at which a business needs to reorder inventory to keep up with customer demand.

The reorder point is important because it helps businesses in keep your inventory in a balanced levels which to minimize costs, maximize profits, and business capability. Reorder point help to prevent stockouts. Stockouts can lead to lost sales, unhappy customers, and a hit to the business’s reputation.

1. Avoid stockouts:

Reorder point is the level of inventory that triggers a replenishment order. In other words, it’s the point at which you need to reorder more inventory to keep up with demand which helps to avoid stockouts and keep your business running smoothly.

To avoid stock outs, businesses need to monitor their inventory levels closely and place orders for new inventory as soon as they reach the reorder point.

2. Optimize inventory level:

Understanding and using reorder point is essential to maintain optimized inventory levels. The quantity of inventory at which you must reorder is known as your reorder point. You may prevent stockouts and maintain the smooth operation of your company by being aware of and leveraging your reorder point.

On the hand, too much stock can tie up capital, while too little can lead to disruptions in the supply chain.

The goal is to find the perfect balance of inventory levels so that you have enough stock to meet customer demand without tying up too much capital in inventory.

3. Improves inventory turnover:

The reorder point can assist firms in increasing their inventory turnover, which is a measurement of how rapidly inventory is sold and replaced, by preventing stockouts and overstocking. This may result in more profits, lower carrying costs, and better supply chain performance.

4. Improves cash flow:

Businesses can manage their cash flow better by preventing stockouts and overstocking by balancing inventory levels using reorder points.

5. Cost savings:

Reorder point is the inventory level at which a company orders more goods. The optimal inventory level is the balanced level between demand and supply that minimizes the total cost of inventory including purchase, warehouse space rents, carrying, operational costs.

Factors that Affect Reorder Point:

There are a few factors to consider when determining your reorder point.

First, you’ll need to know your average daily sales. This will help you determine how much inventory you need on hand to meet customer demand.

Next, you’ll need to take into account your lead time. Lead time is the amount of time it takes to receive new inventory from your supplier.

Finally, you’ll need to factor in safety stock. Safety stock is a buffer of inventory that you keep on hand in case of unexpected spikes in demand or delays in receiving new inventory.

Safety stock:

Safety stock is a term used in inventory management that refers to a level of extra stock that is maintained to mitigate the risk of stockouts. Stockouts can lead to lost sales, unhappy customers, and production delays, so it is important to have a safety stock buffer to protect against them.

There are a few different methods for calculating safety stock, but the most common is :

Safety stock=[maximum daily sales x maximum lead time] – [average daily sales x average lead time]

If,

Maximum daily sales=10 Pcs

Average daily sales=6 Pcs

Maximum lead time=5 Days

Average lead time=3 Days

Then the safety stock is:

Safety Stock = (10 x 5) – (6 – 3)

=50-18

=32 Pcs.

Demands/sales rate:

Sales rate is one of the key factors in calculating your reorder point. By understanding your sales rate, you can more accurately forecast future demand and ensure you have the inventory on hand to meet customer needs.

Lead time:

Lead time is the time it takes to receive an order and is a key input in calculating the reorder point. The reorder point is the point at which a company needs to replenish its inventory.

Lead time can also be affected by seasonal factors. For example, lead time might be longer in the summer due to vacations, or shorter in the winter due to holiday orders.

The reorder point is calculated by adding the lead time to the desired safety stock. Safety stock is the extra inventory that a company keeps on hand to avoid stock outs.

Reorder Point Formula:

The reorder point formula is a tool that inventory managers use to determine when to reorder stock. The formula is:

Reorder point = Safety stock+ (Average daily sales x Lead time in days)

Safety stock: Safety stock is a buffer of additional units that are kept on hand in case of unexpected spikes in demand.

Average daily sales: Maximum daily demand is the average number of units that are sold each day.

Average daily sales: Lead time is the number of days it takes for the new stock to arrive after an order is placed.

Maintaining reorder point ensures that there is perfect amount of inventory on hand to meet customer demand, while also avoiding the costly consequences of stock outs. By keeping a close eye on inventory levels and using the reorder point formula to guide reordering decisions, inventory managers can strike the perfect balance between too much and too little stock.

Fixed reorder point:

In a fixed reorder point, you can set a specific threshold for each item in your inventory and automatically generate a purchase order when that threshold is reached. This can take the guesswork out of reordering and help you keep your shelves stocked with the products your customers need.

Variable reorder point:

Variable reorder point is a technique for calculating the ideal time to reorder a product by taking into consideration both the lead time for a product (the amount of time it takes for a product to be delivered after an order is placed) and the product’s consumption/sales rate.

Reorder point calculator:

The reorder point calculator is a tool that helps you determine the perfect time to reorder inventory. By taking into account factors like lead time and safety stock, the calculator provides you with a customized reorder point that ensures you have the right amount of inventory on hand, at all times.

This calculator using the formula:

Reorder Point=Safety stock+Average daily sales* Lead time.

Safety stock: The reserve inventory that is kept on hand to account for unforeseen circumstances (e.g. an unexpected increase in demand).

Average daily sales: The average amount of sales made per day over a specific period of time.

Lead time: The time it takes to receive a new shipment of inventory after an order is placed.

Putting these three factors together will give a reorder point for an item using the reorder point formula. For example, let’s say safety stock for an item is 50 and your average daily sales are 10 units and your lead time is 5 days. This means you need to replenish your inventory when you reach 100 units.

Real-world Examples:

Some real-world examples of how to calculate reorder point:

• Example 1: A small business sells t-shirts online. The business has a lead time of 10 days and an average daily demand of 10 shirts. The business wants to have a safety stock of 50 shirts. To calculate the reorder point, the business would use the following formula:

Reorder Point = Lead Time Demand + Safety Stock

In this example, the reorder point would be 150 shirts. This means that the business should reorder t-shirts when the inventory level reaches 150 shirts.

• Example 2: A large retailer sells groceries. The retailer has a lead time of 5 days and an average daily demand of 1,000 items. The retailer wants to have a safety stock of 500 items. To calculate the reorder point, the retailer would use the following formula:

Reorder Point = Lead Time Demand + Safety Stock

In this example, the reorder point would be 1,500 items. This means that the retailer should reorder groceries when the inventory level reaches 1,500 items.

These are just two examples of how to calculate reorder point. The specific formula that you use will depend on the specific factors of your business. However, by understanding the basic concepts, you can use the formula to calculate the reorder point for any product or service.

Reorder Quantity:

Reorder quantity is the amount you have to order.

There are many different ways to calculate the reorder quantity for inventory, and the goal is to have enough inventory on hand to meet customer demand without incurring excessive carrying costs.

One common method for calculating the reorder quantity is to use the Economic Order Quantity (EOQ) formula. This formula takes into account the fixed costs of ordering and the variable costs of carrying inventory.

Another method is to use the Average Inventory Method. This method simply calculates the average amount of inventory that is used over a period of time and orders that quantity when inventory levels reach a certain point.

Ultimately, the best way to calculate the reorder quantity will vary depending on the specific business and inventory situation. The important thing is to select a method that meets the needs of the business and provides the desired level of customer service.

Economic order quantity (EOQ):

Economic order quantity (EOQ) is the amount of inventory that a business should order to minimize the cost of inventory and storage. This quantity is based on the company’s sales volume, production cycle, and the cost of inventory. The EOQ is the point at which the company’s ordering and carrying costs are equal.

A company’s ordering cost includes the cost of placing and receiving an order, as well as the cost of the materials. The carrying cost is the cost of storing the inventory, which includes the cost of the space and the cost of the materials.

The EOQ model is a simple way to determine the optimal order quantity for a company. This model takes into account the company’s sales volume, production cycle, and the cost of inventory. The EOQ is the point at which the company’s ordering and carrying costs are equal.

The EOQ model is a simple way to determine the optimal order quantity for a company.

EOQ = square root of: [2(demand)(order cost)] / holding costs.

Open to buy:

Open to buy (OTB) is a term used in the retail industry to describe the amount of money that a retailer has available to spend on inventory. It is calculated by subtracting the projected cost of goods sold from the current inventory levels.

Open to buy can be a useful formula for retailers to track their spending and ensure that they are not overspending on inventory. It can also help them to plan for future inventory needs.

OTB = planned sales + planned markdowns + planned end of month inventory – beginning of month inventory.

Fixed-Period vs Fixed-Quantity Inventory System:

There are two main types of inventory systems: fixed-quantity and fixed-period. In a fixed-quantity system, a company orders a set amount of inventory each time it runs low. This system is also known as the reorder point system. In a fixed-period system, a company orders inventory at set intervals, regardless of how much inventory is on hand.

The main advantage of a fixed-period system is that it can help a company save money on inventory costs. If a company knows it only needs to order inventory once per month, it can order larger quantities each time, which can lead to discounts from suppliers.

The main advantage of a fixed-quantity system is that it can help a company avoid stock-outs. If a company knows it will need 200 widgets every week, it can order 200 widgets each time it runs low, rather than waiting until it has zero widgets in stock. This can help keep customers happy and avoid lost sales.

Reorder Point in Practice: Use an inventory management system

To maintain reorder points you need sales history and demands. Demands are not fixed, it’s volatile; You need to calculate demands based on trends. It’s almost impossible in the manual inventory management system. A modern inventory management system programmatically keeps eye on sales trends and automatically calculate safety stock, and reorder point for your preferred periods, and reminds you by giving notifications about what you have to order and how many you have to order.

Conclusion:

There are a few factors that go into calculating the reorder point.

The first is the lead time, safety stock, which is the extra inventory a business keeps on hand in case of spikes in demand or unexpected delays in receiving new inventory.

The second is the sales rate, which is the average amount of an item that is sold over a specified period of time.

And the rest one is the lead time, which is the amount of time it takes to receive new inventory from the time an order is placed.

Related Post:

Safety Stock – Definition, Importance, Formulas & Implementation

There are a few different formulas that go into deciding how much safety stock you have to maintain. These include General formula,…

Read This Article