Reordering products are easy, right? Well, not so fast. When it comes to determining reorder points, there’s a lot you have to consider. This is why many retailers use a reorder point formula. If you don’t know what a reorder point formula (ROF) is, it’s defined by a specific time for you to order new product.
Your reorder point is another super important retail metric you need to know.
How To Calculate Reorder Point?
- Calculate your lead time demand in days.
- Calculate your safety stock in days.
- Sum your lead time demand and your safety stock to determine your Reorder Point.
Now, to understand the math behind our reorder point calculator, let’s break this formula down.
You’ll have to know your lead time demand in order to get your reorder point. This refers to how long you’ll have to wait before new stock arrives. Ideally, you want to have enough in stock to satisfy customer demand until new stock arrives.
And you’ll need to know your safety stock, because that’ll protect you against any unexpected occurrences. Add your lead time demand to your safety stock… and voila! Once your stock levels hit the total, it’s time to place a new order to replenish your supply.
Lead Time Demand – (Cause Shipping Is Never Immediate)
It’s going to take time for new stock to arrive. While it would be great to get new stock instantly and one day we may see just that, stock takes time to arrive.
Even if you have products in stock, it can take your supplier time to pack your order and get it shipped over to you. This waiting time is referred to as “lead time.” As usual, we want to give you an example so you truly understand it.
Company A is located in the U.S. and they sell bracelets that are manufactured in Indonesia. We’re going to assume Company A is always stocked and the warehouse has bracelets already on hand. At the very least, it’s going to take a few days to pick and pack the bracelets. Once they’re picked and packed, it takes another 4 days to get to the port by truck. From there, it will take 21 days to travel from Indonesia to the U.S. From there, they could spend up to a week in customs and will take another 3 days to travel to a Company A warehouse.
Safety Stock – (Protection For The Unexpected)
While it’s awesome when everything runs smooth, things are going to happen and you have to expect the unexpected.
This can take the form of a sudden surge in demand after some unexpected celebrity endorsement, and now your product is selling fast. Or perhaps your supplier’s factory has experienced a breakdown and it’ll take a week for them to replace the damaged component and get their machine up and running again.
And here’s where safety stock comes in. Safety stock is buffer stock you carry as a last defense against unpredictable events that either deplete your stock (surge in demand), or unexpected manufacturing time (your lead time skyrockets because the supply chain breaks down). Of course you’d like to have enough safety stock to bring the likelihood of going out of stock down to zero, but most of the time that’s not financially viable. After all, safety stock IS for a rainy day that may never come! So how do we decide then on how much stock to keep on standby?
Here’s a simple formula that you can calculate based off your purchase and sales orders history:
Safety Stock = (Max Daily Usage X Max Lead Time In Days) – (Average Daily Usage X Average Lead Time In Days)
Let’s continue the story of Company A. On an average day, they sell 12 bracelets. But during weekends, they can sell as many as 17. As for lead times, their usual lead time is 41 days, but during typhoon season (yes, in Indonesia, they have typhoons) , it can go up to as high as 51 days.
(17 x 51) – (12 x 41) = 375
This means Company A needs to have about 375 units of safety stock on hand to guard against the unexpected (especially during typhoon season). Therefore, with 340 units in safety stock, selling nearly 80 bracelets on a good week (12 per day on weekdays and 17 on weekends), Company A will have enough stock to last a little over 4 weeks.
Your safety stock is a buffer for all the variations in demand and lead time you could potentially face, giving you enough stock on hand to weather unexpected occurrences. Everyone and their entire family wants your products? It’s time to sell your safety stock. Supplier needs an extra week because he’s caught in the middle of a typhoon? It’s time to sell your safety stock.
For those of you that have seasonal products, like Halloween costumes, you have to adjust your safety stock level to ready for your peak season demand. Once the peak season is over, you’ll want to begin reducing your safety stock levels, as more safety stock = higher carrying costs. After all, people are a lot less likely to be buying a new Halloween costume in the spring versus the month of October.
The Reorder Point Formula
Reorder Point = Lead Time Demand + Safety Stock
To complete the story of Company A, their reorder point formula would be:
470 (Lead time demand) + 375 (safety stock) = 845
So once their stock hits 845 bracelets, Company A will need to place a new order with their supplier. At 845 bracelets, they’ll have enough to last them as they wait for new stock to arrive (470), while holding enough stock (375) as a buffer against an unexpected surge in demand or supply chain problems.
Planning reorder points are a crucial part of inventory management. Setting your reorder point to the optimum amount lets you cut down on excess spending, while ensuring you’ll have enough stock for your customers even when things take an unexpected turn.
But how can you always ensure you’ll be able to place a fresh order whenever inventory levels hit the reorder point? Keeping tabs on how much you’ve sold every day is easy when you’re starting out with a single store. But as you start selling more and more, across different channels, manually recording every sale becomes a pretty exhausting chore. And if you only tally up your numbers on a weekly basis, missing the reordering point becomes a likely possibility.
If you’re concerned about missing your reorder point, you may want to consider inventory management software for your business. Why?
- Tracks your moving inventory across all channels
- Allows you to monitor inventory at anytime
- Once a product hits their reorder point, you get notified to place an order
- Avoid stock out and lost sales
When you can automate your inventory processes, you become more efficient and disciplined. You can avoid backorders and letting down your customers, not to mention all the lost sales you could lose by not having enough product.
When you can keep the products on the shelf, customers will appreciate that and those customers will return.
*Accelerated Analytics publishes resources like this to provide insights to different analytical metrics, data points and formulas. Please be aware, we’re not claiming that our POS reporting services will offer this example or any other metric, data point or formula. To learn exactly what our reporting covers, please feel free to schedule a demo or give us a call. Thanks for understanding.