Safety stock calculation involves determining your service level, the standard deviation of lead time, and the average demand for a product. The purpose of a reorder point is to find and set the lowest stock level for an inventory item at which a new order should be put in, in order to avoid a stockout. When calculating ROP, lead time is mostly approximated using historical averages, in-depth analysis of the supply chain, supplier performance, etc. For fresh suppliers or in case of many unknowns, it might be a good idea to buffer this number higher by a small amount until the new supplier performance is determined. Rakesh Patel is the founder and CEO of Upper Route Planner, a route planning and optimization software. With 28+ years of experience in the technology industry, Rakesh is a subject matter expert in building simple solutions for day-to-day problems.
Shopify POS, for example, calculates ideal reorder points for products based on supplier lead times and the average number of sales per day. This ensures you know which products are running low on stock and have enough lead time to replenish inventory before quantities reach zero. Average delivery lead time is the average amount of time it takes for a shipment to arrive from the time the order was placed. Average delivery lead time changes with fluctuations in seasonal demand, the quantity ordered, and distance from the up-chain supplier. For a reasonable measure, take an average of the past three months of POs for the SKU item you want to set a reorder point for.
What is Reorder Point and Reorder Point Formula?
If it’s a sought-after item, these delays can often come at the worst possible time. To accurately calculate a product’s reorder point, it’s important to understand these factors and how they might impact your sales velocity. You also have enough safety stock units – to cover problems with Supplier B (or any point along the supply chain) or a sudden increase in demand. Your suppliers encounter trouble fulfilling an order – via shipping, manufacturing, or a shortage of raw materials. The safety stock ensures you can still fulfill orders if these happen while you wait for new inventory to arrive.
When the inventory balance declines to 100 units, ABC places an order, and the new units should arrive four days later, just as the last of the on-hand widgets are being used up. If you’re a business owner, knowing when to order more stock is important. If you order when you still have a lot of stock on hand, it will lead to extra stock piling up, which will increase your holding costs. If you order when you have zero stock on hand, you’ll be unable to make sales for as long as it takes to receive the order.
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Lead time demand is the amount of stock you would sell during the period it takes for your inventory to arrive from the supplier. Demand for products doesn’t cease when you run out of inventory, after all, so you need to find how many items you would sell if the stock were to run out. The ROP formula allows you to find the reorder point for all products in your inventory.
Download our free inventory management spreadsheet template to organize and track your inventory, saving you time and preventing costly mistakes. Unfortunately, these “glamorous” accomplishments aren’t representative of what you’ll encounter as part of daily operations. More often than not, the day-to-day of running a store consists of many repetitive – albeit critical – tasks, like managing inventory. There are a lot of memorable, one-off moments that are part of running a retail business.
How to Calculate Reorder Points with the ROP Formula
Multiply this number by the average time it takes for a supplier to deliver new inventory to you. There is always a time lag from the date of placing an order for material and the date on which materials are received. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered. Lead time is the number of days between when you place a purchase order with your manufacturer or supplier for a product and when you receive the product. Your lead time will be longer if your supplier is overseas as compared to a domestic or in-house production facility.
- The purpose of a reorder point is to find and set the lowest stock level for an inventory item at which a new order should be put in, in order to avoid a stockout.
- The harder part is putting together all of the metrics that contribute to lead time demand and safety stock.
- By reordering a predetermined amount of replenishment inventory according to demand forecasts, you can avoid sunk costs from inventory shrinkage and obsolescence.
- By contrast, ordering stock too soon is detrimental because you have to store that stock, which increases your holding costs.
- The more you calculate ROP for each product, the more accurately you can forecast demand in the future and ensure you use the reorder quantity formula correctly.
Due to unexpected seasonal demand, Exempli’s supplier was also running low on product, adding an additional 2 days to get stock in from their manufacturer. Plus, the trucks making the delivery were slowed down by bad weather, causing an additional day of delay. A reorder point (ROP) is the level of inventory at which an action is triggered to replenish that particular inventory stock. In other words, when your stock for a certain item falls to a certain level, the reorder point, you know it’s time to buy more.
Knowing [your] business, including target, risk, and cost, is the first and necessary step [to setting reorder points]. Then, having an accurate demand forecast helps you calculate the optimal reorder point. To achieve these goals, the retailer should have business and analytics teams work closely to find the solution for their own scenario. 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.