If you have set up a new business or have been selling items for years, you can still benefit from reorder point formula.
The guide will show you how to benefit from it and which numbers are required to generate inventory reorder point.
Starting from the basics, let’s learn what is meant by reorder point and understand with related reorder point formula example!
A reorder point related to unit quantity on hand initiates the purchase of a fixed amount of replenishment inventory. When the purchasing process and supplier fulfillment work accordingly, the reorder point will arrive at the replenishment inventory.
In simpler words, it directs you when to place an order, so you don’t run out of inventory on your website. This is precisely the same thing when the last on-hand inventory is fully used.
Reorder point relates to the level of the stock in your inventory that initiates you to reorder the item. The least amount of stock item is present in your business rack before replenishment is needed. This is because, to meet the client’s requirements.
For example, if you have a pharmacy business, and your reorder point for a Panadol is 10; therefore you are required to order more when 10 Panadol tablets are left,
Another reorder point formula example is that a company opts for two brands; if one supplier requires one day to deliver any order, and the other brand requires three days to deliver, then the company reorder point for the first brand would be when there is one supply left, and three days for the other supplier.
When you are a business owner, you must know when to order stock. It is more important than everything. If you order more when you have stock in your hand, it will lead to more stockpiling. This will increase your holding point too.
On the other hand, if you order when you have zero stock in hand, you might not be able to make as many sales as you can because it takes time to receive the order. The more time your vendor requires, the more sales you will be losing. When you set a reorder point, it will help you to optimize inventory and refill your stock of individual items at the right time. This results in meeting your business demands without going out of stock.
The reorder point formula is to multiply the average daily usage rate for an inventory item by the lead time in days to restock it. For example, XYZ international uses 25 units of its green widget every day. The number of days it requires the supplier to restock its inventory is four days.
Therefore, XYZ international will set the reorder point for the blue widget at 100 units. When the inventory balance declines to 100 units, XYZ will place an order, and the new unit might arrive four days later, just as the last of the on-hand widgets are being used up.
The inventory reorder point is based on average usage. Moreover, demand may spike up or below the average level. Therefore, there still be inventory on hand when the refill order arrives, or there might be a stockout condition for many days that interferes with sales or production. In order to guard against the latter condition, a company might alter the reorder point formula and add a safety shock. Now the formula becomes:
(Average daily usage rate x Lead time)+ Safety shock
The altered formula means that refill stock will be ordered soon, which significantly lessens the risk, indicating that there will be a stockout condition. However, this also means that a company might have an enormous investment in its in-hand inventory. Hence, there might be a trade-off between always having inventory available and funding a more considerable inventory asset.
Let’s understand it with reorder point formula example. If you sell perfumes, you are a perfume retailer and sell 200 bottles of perfume in a day. Your vendor is required one week to deliver each batch of perfume your order. When you keep enough stock for five days of sales, in case of an unexpected delay. Now, what can be your reorder point should be?
Safety stock: 5 days x 200 bottles=1000 bottles
ROP= (200 x 7) +1000 = 2400 bottles
In conclusion, you should order for the next batch of perfume when 2400 bottles are left in your inventory.
A business that follows lean inventory practices or is a just-in-time management strategy often doesn’t maintain a safety stock. In these cases, you can calculate reorder points when you multiply your daily average sales with your lead time.
Usually, when you don’t maintain a safety stock, your reorder level and frequency of your orders are higher than ever.
Reorder point formula: daily average sales x lead time
If you take the above perfume example when you don’t include safety stock, your reorder point formula should be:
Therefore, in this case, you should place an order for the following inventory when 1400 perfume bottles are left.
The reorder point relates to the threshold at which you are required to order more inventory. This prevents shortages and also inhibits overstock. The inventory reorder point formula helps you to calculate. Thus no overstocking and understocking of products happen.