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Maintaining proper inventory levels is an elegant dance that must balance consumer demand and supplier reliability. Storing too much inventory eats up your budget in terms of warehousing costs and available capital, but you also need enough inventory to account for unexpected demand or supply problems.
How do you strike the middle ground? By calculating reorder points for each product.
What is a reorder point (ROP)?
A reorder point (ROP) is the level at which inventory needs to be replenished so it doesn’t drop below a certain threshold where it is at risk of going out of stock.
Implementing reorder points allows you to trigger a new order so you don’t get close to running out of inventory. Setting accurate reorder points allows businesses to avoid having products out of stock while waiting for new inventory. By doing this, you ensure customers get their orders on time and have a positive brand experience.
Inventory management software will track your inventory and alert you when you reach your SOP. For example, here is what setting up reorder points in the ShipBob dashboard looks like.
Why is the reorder point important?
Reorder point calculation ensures that you don’t fall behind on your next batch of inventory. With an accurate reorder point for each SKU, you’ll always have enough stock on hand to satisfy customer demand — without overstocking and tying up excess capital in inventory.
Storing more inventory than what can be sold in a timely fashion is not a productive use of capital. Reorder points provide businesses with greater financial flexibility by allowing them to keep a minimum amount of inventory on hand without running out of product.
Conversely, it can be costly to replenish inventory when you completely run out. If you have to expedite getting product from your manufacturer, you’ll likely incur additional fees.
Too much inventory is expensive, but too little inventory can result in stockouts, which are harmful for your business. When orders are delayed or canceled because you don’t have the appropriate stock on-hand, you can lose customers and your reputation can suffer.
Having visibility into your inventory and set reorder points helps you know when to replenish inventory to prevent stockouts before it’s too late. Using an inventory management system can provide a holistic view of your inventory and keep track of reorder points for your SKUs.
Calculating reorder points goes hand in hand with having a clear idea of purchasing trends over a given time period. You should look into customer demand so you can understand when customers are more likely to purchase your products and you can forecast demand correctly. For example, if you sell sunglasses, you’re likely to see a peak in demand in the spring and summer, opposed to a ski goggles brand that will see a surge in demand in the fall and winter.
When you use data to forecast demand, you can set informed reorder points so you aren’t left without inventory during times of increased customer demand. 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.
What is the reorder point formula?
The reorder point formula is as follows:
Reorder Point (ROP) = Demand During Lead Time + Safety Stock
Reorder point formula is used by businesses to calculate the minimum amount of inventory needed to order more products so they can avoid running out of inventory.
How to calculate reorder points
So now you know the reorder point formula, but you might be wondering – what is demand during lead time? Or what about safety stock? In this section we break down ROP and tell you exactly how to calculate it.
Average daily sales
First you’ll want to calculate your average daily sales (which can also known as average daily usage) to understand how much of a certain product you’re selling per day. You’ll first choose a period of time to examine (e.g. 1 week, 1 month, etc). Then you’ll look up how many SKUs you sold during that amount of time and divide it by the number of days. To calculate this, you’ll use this formula:
Average Daily Sales = Total Sales / Number of Days
Demand during lead time
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 for getting new stock will be longer if your supplier is overseas as compared to a domestic or in-house production facility.
To find your average demand during lead time, just multiply the lead time (in days) for a product by the average number of units sold daily:
Lead Time Demand = Lead Time x Average Daily Sales
Safety stock, as the name suggests, is the extra “just in case” inventory you keep on hand to anticipate variability in demand or supply.
It’s important to keep adequate safety stock on-hand as demand can increase suddenly or problems with a supplier can prevent you from restocking inventory as quickly as you expected.
Safety Stock Level = (Max Daily Orders x Max Lead Time) – (Average Daily Orders x Average Lead Time)
To find the proper safety stock level for a given product:
- Multiply the maximum number of daily orders by the maximum lead time that may be required in case of supplier delays.
- Multiply the average number of daily orders by the average lead time.
- Subtract the result of Step 2 from the result of Step 1.
Now, back to our reorder point formula: Just add together the lead time demand and safety stock calculation, and, voila — you’ve calculated ROP.
Now, let’s put it all together. Here’s a real-life example of how to use the ROP formula.
Imagine you have a dog accessory business that sells bandanas in different colors . You want to make sure you have enough inventory for the upcoming season so you use the reorder point formula.
First you want to determine your demand during lead time by multiplying your daily sales by the lead time. You sell 20 red bandanas a day. It takes 5 days for you to get the bandanas from your supplier. Your demand during lead time is 100.
You keep 75 red bandanas on hand as safety stock.
Now, you can use the ROP formula: 100 +75 = 175
By using the reorder point formula, you know that when your inventory reaches 175 red bandanas, you need to replenish your inventory so you don’t experience shortages.
ShipBob keeps reorder points simple
Calculating ROP for each product can be time-consuming and challenging, especially if your inventory is patched together from several suppliers or you sell lots of products. ShipBob’s cutting-edge inventory management software and analytics tools make it easier than ever.
ShipBob is an order fulfillment solution that features built-in inventory management software, giving you precise control over your inventory. You can check inventory counts at each fulfillment center and set automatic reorder levels, so you are notified when stock is running low.
“Off the bat, I liked that I would be able to control multiple warehouses through one page with ShipBob. With my old 3PL, I could never just open a page and get the info I wanted. I had to click several times, then export it, and try to make sense of it. ShipBob lets you manage your inventory while providing important data in a very digestible way.”
Wes Brown, Head of Operations at Black Claw LLC
When you outsource fulfillment to ShipBob, all of your data is centralized in one place: your ShipBob dashboard. Our software tracks purchasing trends over time to help you with inventory forecasting based on seasonal demand, holidays, and more.
“ShipBob’s analytics tool is also really cool. It helps us a lot with planning inventory reorders, seeing when SKUs are going to run out, and we can even set up email notifications so that we’re alerted when a SKU has less than a certain quantity left. There is a lot of value in their technology.”
Oded Harth, CEO & Co-Founder of MDacne
ShipBob’s platform doesn’t just help with inventory control and forecasting, but generates powerful analytical reports covering all areas of your business. You can get inside the numbers and find new ways to improve supply chain efficiency.
Establishing reorder points frees up crucial capital and ensures your business is operating at maximum efficiency across inbound and outbound logistics. The most important and sometimes hardest part of calculating reorder points accurately is that you need reliable data for supply chain planning and provide an accurate picture of customer demand.
“So many 3PLs have either bad or no front-facing software, making it impossible to keep track of what’s leaving or entering the warehouse.
On the supply chain side, I just throw in what we placed at the factory into a WRO in the ShipBob dashboard, and I can see how many units we have on-hand, what’s incoming, what’s at docks, and so on. I can see all of those numbers in a few seconds, and it makes life so much easier.”
Harley Abrams, Operations Manager of SuperSpeed Golf, LLC
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Reorder point formula FAQs
Here are the most commonly asked questions about the reorder point formula.
What is the reorder formula?
The reorder point formula is as follows:
Reorder Point (ROP) = Demand during lead time + safety stock
When the reorder point is reached, a new order of product is necessary to avoid stockouts, depending on seasonality and forecast demand.
What is the difference between EOQ and reorder point?
Reorder points (ROP) and economic order quantity (EOQ) are different calculations aimed at measuring different aspects of your inventory. Reorder points are used to determine the lowest adequate inventory level without stocking out. EOQ is used to determine optimal order quantity and minimize inventory costs associated with holding and ordering costs.
Can the reorder point be greater than EOQ?
Yes, your reorder point can be greater than your economic order quantity, or EOQ.
Your ROP will be greater than your EOQ if you’re bulking up on safety stock. You may experience this prior to holiday sales or periods of seasonal demand.
What is the difference between reorder level inventory and reorder quantity?
Reorder level is the stock level at which you need to replenish a product so you don’t stockout. Reorder quantity is the ideal order quantity that minimizes inventory costs associated with ordering costs, carrying costs, and holding costs.