A Reorder Point or ROP stands for the specific level of businesses’ stock where goods need to be replenished. A reorder point is correlated to your understocking errors as it can assist you in avoiding them by letting you know when a new order needs to be placed.
Importance of Reorder Points
Whether you own a business that resells inventory or a large business with thousands of warehouses, the reorder points may provide you with two main benefits:
1. Data-Driven Decisions
A ROP provides crucial information about your on-hand inventory thus it allows you to make fast and data-driven decisions about your inventory management.
2. Cut Cost
As mentioned, ROP is a tool that will endeavor to minimize your understocking errors while also avoiding overstocking your store or warehouse. Thus, by setting a ROP you will be able to optimize your inventory levels and replenish it when needed. Therefore, you’ll meet customer demand effortlessly while also saving a large amount of money from stocking inventory that would remain on the shelves.
How to Calculate it?
In order to properly calculate the reorder point for your inventory you need to know the following factors:
- Lead time: the period needed for the order to be fulfilled
- Safety stock: The amount of extra inventory that is kept on hand in order to prevent your business from running out of stock
- Daily average use: The total number of sales of the specific item per day
ROP Formula
Here’s the reorder point formula including the three variables mentioned above:
Reorder Point = (Daily average usage x Lead time) + Safety Stock
Let’s say a company sells 400 units of a particular product every day and the vendor needs 8 days to deliver the product. The company keeps a safety stock for 6 days of sales in case of unexpected errors. Here’s how the formula should be used for this case:
Lead time = 8 days
Safety stock = 6 x 400= 2.400 units
ROP = (400 x 8) + 2.400 = 5600 units
Therefore, the next order should be placed when the units of the particular product are equal to 5.600
ROP With Safety Stock
Reorder points typically include safety stock, as demonstrated in the previously discussed formula. Even if it is not explicitly stated, it is advisable to incorporate some allowance to account for unexpected events. If your business does not have a specific concept of safety stock it is still recommended to include a “safety stock” term in your equation.
In cases where you are not using a more complex model where lead times are derived from a distribution, it is worth considering the number of days you might have to wait for a slightly delayed delivery. How much would you sell during that period? This quantity could be used as a substitute for your safety stock number. In other cases, it can be added to your existing safety stock if late deliveries are a valid concern.
ROP Without Safety Stock
It is uncommon for a company to calculate reorder points without incorporating a safety stock factor or addressing the issues that safety stock resolves. However, it is not unheard of, and it can sometimes be a reasonable approach. If you are determining your reorder point (ROP) to manage resupplies from a warehouse that you own and control the logistics of, you may not require a safety stock to account for unexpected supply chain delays. While most businesses recognize the importance of safety stock, there are valid cases where reorder points can be calculated without including safety stock.