Reorder Points (ROP)
Inventory Reorder Points (ROP): What They Are & How They Help
How do you know when to order more inventory?
In the early days of your business, you probably used your instincts. Once every two weeks, you’d eyeball your stock, guess what you’d run out of in the next few days, and put in an order.
As your business gets busier and your responsibilities grow, running on instinct is not scalable. Your operations and product master data become more complex, and things start to slide.
For instance, you may come in one Monday morning only to realize you’re out of a key product. Customer orders are pouring in and you remember your supplier has a lead time of one week. In the meantime, all you can do is hope your customers will be patient or eat the cost of lost business.
In another scenario, you may notice that every week you’re overflowing with one set of products that become damaged or spoiled while consistently running out of another that you need to do stock replenishment.
So, how do growing businesses prevent this from happening?
By setting reorder points(also known as reorder level) based on historical data.
The definition of reorder point is the point at which you send a purchase order to your supplier or manufacturer.
Your gut doesn’t determine your reorder level or reorder level. Your historical data and lead times do. This approach ensures your business maintains healthy inventory levels at all times.
Another important feature of reorder points is that they are unique to every SKU. A common mistake business owners make is reordering everything at the same time, even though different products move at different rates. This strategy means that some products are ordered too often while other products aren’t ordered enough.
In this post, we’ll cover:
- >How to calculate reorder points formula
- >Where reorder points fit in your warehouse operations
- >How reorder points relate to safety stock
- >Reorder point formula variable fluctuation<
- >Why reorder point calculation is considered a best practice
How Do You Calculate the Reorder Point Formula of a Product?
Now that we know what a reorder point is and why it’s important, how do you actually determine what level of inventory should trigger a new order?
You can start by using the reorder point calculation formula:
Reorder point formula = Average daily usage * lead time
Let’s assume that your business sells computer keyboards.
Your average daily usage is the average amount of keyboards you sell every day. You can find this number by adding up your daily orders and dividing it by the number of days in the period. For instance, if you add up thirty days of orders and get 300, you would divide it by 30.
So your average daily usage would be 10.
Your lead time is the amount of time it takes a supplier to send the keyboards from the moment they receive a purchase order. Let’s assume for the purpose of this example that it takes your supplier 5 days, at the most, to deliver new keyboards.
So your lead time would be 5.
One you have this information, you simply multiply the two numbers together.
Your reorder point would be 50.
In other words, each time your stock hits 50 keyboards, you would send a purchase order to your keyboards supplier.
Businesses using reorder point calculator spreadsheets can find their reorder points in Excel by using the formula above in the spreadsheet holding their inventory data.
That said, this is not good business practice. For a growing warehouse or distribution center, managing inventory data in spreadsheets introduces challenges around version control, data analysis, and real-time inventory data retrieval.
Remember, there is a difference between a product’s reorder point and reorder quantity. Your inventory reorder point indicates when to order more stock. Your reorder quantity is how much additional stock you wish to order.
How Reorder Points Fit Into a Warehouse’s Major Business Systems
Warehouses and distribution centers focused on growth, efficiency, and scalability use warehouse management systems (WMS) and inventory management systems instead of Excel spreadsheets. These systems automate manual processes that are prone to human error or oversight. Ordering inventory is one example of an important process that can be automated with the right software.
For instance, reorder points are only useful when businesses act upon them. If your business knows the reorder point of keyboards is 50, but there’s no mechanism to alert workers when there are only 50 left, you’re back to square one: frantically calling your supplier when you realize you’re out of stock.
This is one of the main problems with calculating in reorder point calculator Excel spreadsheets. Someone has to export up-to-date data before the reorder point can be calculated. This is a step that will likely be overlooked when the warehouse is busy and, of course, busy periods are when businesses need inventory oversight the most.
On the other hand, a WMS can send a notification to a supervisor or manager to let them know that a specific product has hit its reorder level. Furthermore, warehouse managers can program their software to automatically send a purchase order to suppliers when a product hits the reorder level, bypassing the notification and approval process.
What Is the Relationship Between Reorder Points and Safety Stock?
Stockouts are expensive. Worldwide, stockouts cost retailers an estimated $984 billion in lost sales. In North America alone, businesses lose roughly $144.9 billion dollars.
The lesson is simple: Customers won’t wait for you to restock your shelves, so you better have what they’re looking for, when they’re looking for it.
Consequently, businesses have embraced something called safety stock, also known as buffer stock. It’s an in-case-of-emergency stock businesses keep in case there’s an unexpected increase in demand or shortage in supply.
When it comes to preventing stockouts, safety stock is the last line of defense. Your reorder level is your second-to-last line of defense. In other words, they both work toward the same goal. Reorder point formulas are all about prevention while stockouts are a cure.
Some businesses don’t include their buffer stock in their calculation of reorder point formula while other businesses do. Those that do simply adjust the formula to add their safety stock:
Reorder point formula = (Average daily usage * lead time) + safety stock
Like reorder points, buffer stock levels should be set using historical data, not gut feeling. Choosing to order the same excess amount of all products is an expensive strategy for one big reason: carrying costs.
Your carrying cost is the money you pay to keep inventory and it can be an enormous expense. Carrying cost include expenses like:
- Rent/storage space for products
- Labor costs for employees who manage or guard inventory
In addition, products that sit around for a long period of time have a higher chance of spoilage, damage, loss, or theft. You’ll face added risk in potential for reduced demand. After some time, moving some products becomes impossible, forcing businesses to write them off as a loss.
So, how can companies effectively calculate their safety stock?
Safety Stock = Desired Service Level * Standard Deviation of Lead Time * Demand Average
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Desired Service Level
Companies assign different service levels to different products. The service level represents the cost of missing out on a sale versus the cost of purchasing more inventory.
For most companies, service levels float somewhere between 90 and 100 percent. For instance, if your service level is 92 percent, you’re saying you want to fulfill orders for this product at least 92 percent of the time.
Once you have decided on your desired service level, you need to express it as a factor. You can convert your factor by using a formula in Excel (=NORMSINV (X%)) or by referring to a factor table.
Our 92% service level expressed as a factor is 1.41.
Standard Deviation of Lead Time
To find your standard deviation of lead time, you need access to historical data. The more data the better since you want your standard deviation of lead time to be an accurate reflection of reality.
While businesses have an official lead time from suppliers in their service level agreements, the exact number can vary from time to time. Some suppliers exceed expectations. If their SLA says 5 days, they more often than not deliver within 2 days. Other suppliers occasionally deliver late.
The standard deviation helps you express how reliable your suppliers actually are, so you can better calculate your buffer stock. This is why having ample historical data is helpful.
Let’s return to our keyboard example. Earlier, we used an average lead time on the assumption that there was no set service level agreement with our supplier. We calculated that, on average, our supplier fulfills our keyboard orders in 5 days.
In this case, we’re going to assume that our SLA is 15 days instead of 5. We would use this number, in addition to our historical data, to find our standard deviation.
|Actual Lead Time (in days)||Expected Lead Time (in days)||Deviance|
Table: Finding the standard deviation of lead time (Logiwa)
First, find the difference between the expected lead time and the actual lead time and place this in the deviance column. Then, add up all the deviations to find the standard deviation.
Your standard deviation = 5.
Then, divide your standard deviation by the number of orders (9) which gives you a standard deviation of 0.56.
Add this to your expected lead time of 15.
Your standard deviation of lead time is 15.56 days.
To calculate your demand average, choose a time period, determine how much product you sell in that time period, add up your units, and divide by the number of days in the time period. Demand forecasting strategy is an advance way to calculate future demand of your products as well.
If you sell 2,400 units in 30 days, your demand average would be 80.
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Calculating Your Buffer Stock
Finally, you can bring these variables together to determine your buffer stock.
Buffer Stock = Desired Service Level * Standard Deviation of Lead Time * Demand Average
Buffer Stock = 1.41 * 15.56 * 80
Buffer Stock = 1,755 units
When you’re finished, you can either think of your buffer purely as a safety net (and not include it in your reorder formula) or incorporate it into your reorder formula.
Be Mindful of Fluctuations in Inventory Reorder Point Variables
Keep in mind that the underlying metrics for calculating your inventory reorder points (e.g., lead time, average daily usage) are not static figures – they may change.
Some warehouses have software that automatically pulls real-time data to adjust inventory reorder points based on this underlying info.
If you have to enter a static reorder point into your order fulfillment software, be sure to schedule time once a month or once a quarter to recalculate your reorder points.
Calculating Reorder Points Are An Inventory Management Best Practice
Setting reorder points is an important part of inventory management. There are several inventory management practices that are unavoidably labor intensive, like conducting annual counts or cycle counts, so it’s important to automate whenever possible. Calculating inventory reorder points, tracking inventory levels and placing orders can be effectively automated using warehouse and inventory management software.
Using inventory reorder points as part of your inventory management strategy also helps you keep your distribution costs low. Some businesses who run their operations from multiple warehouses use the location of their warehouses as a strategy for cost savings.
For instance, their order management system’s order routing module identifies the delivery address for a customer and then pushes the order to the warehouse closest to that customer.
This way, the business saves on transportation costs. If reorder points don’t automatically trigger a purchase order, warehouses can no longer take advantage of this cost-saving strategy since the warehouse closest to a customer may be out of stock.
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