Do you know how to calculate the optimal reorder point for your best-selling products? If not, you could be missing out on a lot of revenue or spending more on inventory carrying cost than necessary. Ordering at the correct time can ensure you always meet demand, helps with inventory reduction, and streamline your inventory control. Often stockouts are caused by insufficient inventory management practices including inaccurate demand forecasting, poor stock control management or incorrect replenishment. Buying the right products at the right time is crucial to avoid running out of stock and keeping customers happy. Effective inventory planning can also make or break profits. In this blog post we’ll look at how to calculate your reorder points and the benefits of making them a vital part of your inventory management strategy.
What is a Reorder Point?
The reorder point, or reorder level, is the amount of standing inventory on-hand that triggers a reorder. Essentially, when you hit this inventory number, you should reorder products to ensure you continue to meet demand without any gaps and optimize your inventory turnover ratio. It is a vital number for any inventory control manager to calculate. Reorder point is not a stable number, but is flexible based on sales trends and the demand cycle of a given product. This means you need to have an understanding of each product’s inventory levels and sales to optimize its reorder point. This is easily done using inventory management software that tracks everything you need to know about your inventory.
Reorder Point Formula
The objective of the reorder point is to achieve a balance between the goods investment cost and the risk of a stockout. The reorder point can be scheduled regularly (e.g., on a certain day of the week) or can be kept under continuous review.
Most companies choose the second option, since it’s more flexible. Plus, it takes into account product diversity and demand variability over time.
To calculate the reorder point, it’s necessary to bear in mind the following factors:
- Safety stock levels established to prevent stockouts. This is related to the level of service accepted within the company.
- Supplier lead time, or the time it takes the supplier to manage an order and ship the goods. It can also refer to the time needed to manufacture the merchandise. If purchase orders are issued to various suppliers, you have to consider all the lead times and, most likely, set various reorder points.
- Expected consumption of this product per the corresponding time unit (usually number of days). As seen above, these forecasts can stem from deterministic or probabilistic methods. Nevertheless, in both cases, this is a crucial factor when calculating the reorder point.
The following is the simplest reorder point formula:
Reorder point (ROP) = safety stock + (average consumption x supplier lead time)
Benefits of Using the Reorder Point Formula (ROP)
The order point (ROP) automatically activates the stock requirements. The ROP model is a useful decision-making tool and helps you optimize your inventory list and save administrative time. This fact allows you to focus on adding value to your organization while letting the system run automatically. Some of the advantages of using this system are:
- Ensure a higher service level, either with external or internal customers
- Avoid delays or bottlenecks throughout the supply chain
- Avoid getting the items too early
- Reduce inventory cost
- Optimize your inventory space
- Staff save time and focus on value-added activities
- Replace your feelings with facts and data
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Optimal Reorder Point & Optimal Reorder Point Formula
The optimal reorder point will maximize the profit you can make from your stock and avoid surplus inventory in your warehouse. This is the point at which you need to order products to replenish your stock. The formula to determine optimal reorder point is the same as above. The main difference is that you must calculate your reorder point for a product each day. This will update your data and let you determine the most optimal time for reordering. It also allows you to notice sudden shifts in demand and react accordingly.
Reorder Point Calculator
Reorder point calculators are a convenient choice if you have a large inventory with many SKUs. One may be a part of the inventory management software you use or you can use an Excel sheet with built-in formulas.
Reorder Point Problems and Solutions
Determining your optimal reorder point isn’t always easy. There are a number of issues that can hamper your ability to make the most informed decisions. Here are just a few of the issues you may encounter.
Safety Stock and Reorder Point
Safety stock is additional stock you keep on hand in the event that demand suddenly increases. The major issue here is that you may go through this stock more quickly than anticipated. This means you need to reorder earlier than anticipated. Luckily, that is exactly why you keep safety stock on hand. To combat any sudden shifts in demand and safety stock usage, track daily sales and recalculate your reorder points regularly. A perpetual inventory count is ideal for this, but taking an inventory cycle count is also a good choice if you still take physical inventory.
Lead Time and Reorder Point
Lead time is the second issue that may interfere with calculating your optimal reorder point. Unfortunately, you don’t have much control over lead time as it is dependent on the supplier and shipper. However, there are two ways you can prepare yourself for any issues in average lead time. First, by keeping an adequate safety stock on hand. That way you can still fulfill new orders and use batch picking while awaiting products in shipment. Second, calculate your reorder point daily to notice any fluctuations in lead time demand as they occur. This way you can order products earlier if you discover any issues when inventory forecasting.
Reorder Point Model
The reorder point model is an option for businesses that use perpetual inventory management and want to avoid any excess storage. It is a very strict inventory model and will only work for certain businesses.
It requires the following to be true about a business:
- Demand is relatively stable year-round. If there are seasonal shifts in demand, reorder points can fluctuate greatly and this model may not be able to keep up.
- Lead time is constant. If lead time shifts, your products may not arrive in time. Then, you run into issues with products that could turn into a backorder and your fill rate.
- Price per unit and order costs are constant. Costs should be constant for each SKU number so you can ensure you have enough cash on hand for full reorders.This is especially true if your suppliers require an MOQ (what does MOQ mean?).
- Suppliers can always meet demand. Not all suppliers can always fulfill the orders they receive. This can’t be the case if you run a business that orders and expects goods in an optimal time frame.
Bottom Line
Utilizing a reorder point system is one of the most widely used inventory management methods. It calculates how much stock to order based on a target re-supply time and desired safety margin. Calculating reorder points may not seem like fun, but they can help you get the most value out of your inventory. It’s a vital part of calculating your optimal economic order quantity. Use the information we’ve shared here to control your inventory and make informed decisions that increase your bottom line. One issue that you may discover when performing an inventory audit is that you have overstock in your inventory. This inventory should not be reordered and you should offload it to make more room for profitable goods.
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Tags: Calculators & Formulas
