Balancing every aspect of business leads it to success. Even a little disbalance may lead to bigger issues and thus loss of revenue. Running out of inventory may lead to missing out on potential sales while excess inventory will lead to increased storage costs. So, here comes the ultimate solution is known as reorder point formulae.
The reorder point formula walks you through the thin line between enough inventory to meet your customer’s demand and overstock. This term helps you to understand if your inventory is too little, sufficient or more than needed.
Whenever anyone launches a new business, they fill up their inventory depending on the money they have, a bit of market research and the gut feeling. But after the first stock gets over, you should opt for the reorder point formula to make your reorder efficient and accurate.
Here again, comes the point when to reorder the stock. Should we reorder before or after the stock goes out? When is the right time? To help you out we have designed a simple rop formula to calculate reorder point.
How to calculate the reorder point?
- Calculate the safety stock in days
- Calculate the lead time demand in days
- Sum up both the safety stock and lead times to know your reorder point
So, let’s understand deeply and break this formula so that you can efficiently implement it in your business.
Safety Stock: For emergency when things go wrong
So, let me brief you about safety stock. Every retailer should maintain a safety stock to manage the demand. There might be a sudden surge of orders due to marketing and endorsement at that time if you go out of stock then it affects your brand image. Another chance is that your supplier is unable to deliver your product on time due to either bad weather condition or sudden manufacturing machine breakdown. This is the practicalities that you should consider while you are into the retail business. Keeping safety stock would help you manage with the demand without affecting your revenue and loss of the customer.
Go through this blog to have the detailed idea of safety stock
Safety Stock formula
Safety Stock = (Maximum daily usage X Maximum Lead time in Days) – (Average Daily Usage X Average Lead Time in Days)
Now let’s jump to lead time to complete our reorder point calculations
Lead Time demand
We have not yet reached a point where everything happens just at a finger snap. We still have to wait for some of the things to get manufactured and reach us. Likewise, the new stock doesn’t arrive immediately. Even if the product that you ordered is in stock, it will still take some time to pack and ship by your supplier. This waiting time is known as lead time which is the major factor of reordering quantity formula.
Let me explain you with an example, imagine a business in the United States sells shoes manufactured in India. The supplier always has stock and ready to ship the products instantly as the order comes in. It will probably take the supplier to pick the shoes and pack them. After that, the shoes are delivered by a truck till the port and it takes 4-5 days to reach the port. Then it takes almost 15-20 days for a ship to travel from India to the United States of America. Once the shoes arrive at the U.S. it takes another 5-7 days to clear the customs then another 2-3 day to deliver it to the warehouse.
So, calculating the lead time is very easy. You just need to add up everything.
2 + 5 + 20 + 7 + 3 = 37 days of sales
Since the seller will get the shipment after 37 days of the order, so he will need to maintain enough stock in his warehouse to cover these 37 days of sales.
But lead time is not only the factor you should focus, but it’s also the demand during the period. For example, the same seller sells an average of 310 shoes a month which means (310/31 = 10) 10 watches a day. So here the lead time demand for the seller would be (37 *10 = 370). Which means the seller would require 370 watches in stock until the next shipment arrives (This calculation is for normal days where nothing unexpected is happening).
So now let’s continue the story with safety stock.
On average the sellers sell 10 shoes a day. But during weekends they sell 15 shoes. The usual lead time for the seller would be 37 days, but during bad weather conditions and manufacturing shutdown, it can go up as high as 45 days.
So now applying the safety stock formula
(15 x 45) – (10 x 37) = 305
Which means the seller should maintain at least 305 units of safety stock in hand. So that they can guard their business against unexpected incidents. The seller would have enough stock that would last him for at least 4 weeks.
The safety stock will vary depending on the demand and lead time. If you got a bigger order then its time to use your safety stock. If the manufacturer has some unexpected issues with the machine then you can use your safety stock.
Suppose you have a product that is seasonal like a red T-shirt which sells more on valentine’s week and Christmas month. As the peak season is over, its time to reduce your safety stock as it will increase your storage and carrying costs.
The reorder quantity formula
Reorder Point = Safety Stock + Lead Time Demand
Let us again continue the story to understand better. The reorder point formula will be:
370 (Lead time demand) + 305 (safety Stock) = 675
Once the Seller’s stock hits 675 shoes, then it’s time to place a new order with the supplier. The 675 shoes will be enough to last until the new stick arrives (i.e. 370) while holding the safety stock as 305 against an issue or unexpected surge in demand.
The reorder point formula excels only when it is planned and calculated properly. The reorder point formula is a very crucial part of inventory management. The reorder point formula helps you cut down on excess spending at the same time ensuring that you will have enough stock for the customers even during the days where stock is unable to reach your warehouse on time.
So again here, if you have a single store, calculating the reorder point and maintaining it is easy. But doing this for multiple stores would be a bit difficult. For this, you should look for the inventory management system that has the option of reordering point formula.