Stock replenishment is an important activity for all retailers. However, there are several things that retailers need to keep in mind while re-stocking their inventory and in this process, calculating the reorder point plays a very important role.
So what is reorder point, let’s understand that and also learn how to calculate it using a simple reorder point formula.
“A replenishment/reorder point is the unit quantity on hand that triggers the purchase of a predetermined amount of replenishment inventory.”
Reorder point hence becomes an indicator for the storekeeper to restock the items that are finishing up in the store. It is similar to the fuel reserve indicator that you have in your motor car or bike so that you can refuel it before you run out of fuel while driving.
Once the reorder point is hit, the shopkeeper places a new order for the refilling of items so that he can fulfill his future orders successfully without any halt.
“The end result being no interruption in production and fulfillment activities while minimizing the total quantity of inventory on hand.”
However, one important aspect to keep in mind is that each item/product in the store can have a different reorder point as the reorder point is calculated on the basis of the time taken for your supplier to deliver the products to you.
This brings us to the next important topic.
For calculating the reorder point you need a lead time, average daily usage rate, or selling rate of the product and safety stock with the vendor.
Lead time – is the time taken for the supplier to send the products once the vendor places the purchase order of items.
Average Daily sold units of the product – meaning on average the number of goods sold on a daily basis.
Safety stock – is a specific quantity of products kept aside so that they can be used in times of emergency or during stock-outs.
The formula for calculating reorder point is
Average daily sold units x Lead time
For instance, Star Mobile Shop sells 25 units of Samsung Smartphones every day and his supplier takes 4 days to send a fresh stock of Samsung Smartphones then what should be the reorder point for Star Mobile shop?
Therefore, using the above formula:
25 (average rate of daily sold units) x 4 days (lead time)= 100
The answer is 100 units need to be replenished by the Star Mobile shop from his supplier every 4 days.
However, in the above example, we are only considering the average number of units sold per day. In reality, this number can increase somedays or decrease some days because we all know that sales are fluctuating every day. So to cover up the sudden rise and fall in the demand for the product a company or shop needs to keep a safety stock. Hence, the reorder point formula can also include safety stock
(Average daily units sold x Delivery Lead time) + Safety stock
Continuing with our example of Star Mobile shop and using this reframed formula,
(25 x 4) + 25 = 125
Thus, we get the inventory reorder point as 125 units. If Star Mobile Shop’s stock for Samsung Smartphones falls below 125 units, then a new order should be placed.
Hope the above example has made it clear on how to calculate the reorder point.
Also, at this point, it is crucial to understand the reorder point only indicates the quantity at which you should place a new order for restocking the item(s). But for knowing how much quantity of a product must be ordered you need to use other methods like Economic Order Quantity method or Just-in-time method.