Having a truly efficient warehouse is a delicate balancing act of product quantities. Running out of inventory and missing out on potential sales is just as disastrous and wasteful as not having enough warehouse space to stock sufficient inventory. The reorder point formula helps you walk the thin line between having enough inventory to meet demand and tying up funds in unnecessary stock.
Harmonizing this balance isn’t as difficult as you might suspect. The reorder point formula is used in warehousing to forecast and to make sure you always have the right amount of product to meet demand. It is an essential formula for any warehouse because it ensures the product will be replenished in congruence with its sales. It also allows you to decrease your overhead costs by not tying up your money in excess stock.
Safety stock (AKA backup stock) is used to calculate reorder points because it is a warehouse’s safety net for inventory quantities to prevent stockouts.
As your inventory diminishes and you reach your reorder point, your safety stock becomes essential for holding you over until the next shipment of product comes in. This time between when you order the product and when it arrives in your warehouse is called your lead time. So naturally, the lead time demand is the product needed to supply your customer demand during this “lead time”.
Why Use the Reorder Point Formula?
Keeping the Goldilocks of inventory saves you money. It means more sales and fewer stock-outs, and better forecasting for efficient use of your warehouse space. Reorder points are vital for keeping a warehouse running optimally. You can use forecasting tools to predict needs and ensure you can meet demand and replenish stock efficiently.
In essence: it helps you determine a point in which you have enough inventory to survive the demand of sales while waiting for your next shipment to come in.
How to Calculate Reorder Points
So how do you calculate your reorder point? Well, you’ll first need to have a few things available.
You’ll need your lead time demand and your safety stock calculation to plug into the equation below.
Lead Time Demand + Safety Stock = Reorder Point
To find lead time demand, you simply multiply the lead time by your average daily sales. Lead time is the amount of time it takes from the point you request an order from your supplier and when it arrives in your warehouse. Many times suppliers provide lead times, however it’s best to use your own data to determine actual lead time. This means a more personalized and accurate number that you can rely on to calculate your other measures.
The slightly more complicated side of the reorder point calculation is safety stock which you can read more about here. For the sake of simplicity, it’s the difference between your max lead time demand and your average lead time demand.
Now, you’re ready to get started with calculating the reorder point using the formula. I’ve also given you a scenario below so you can see it in action.
If one of your bestsellers is an iPod, you want to make sure you always have iPods in stock. Your competition gets the sale if you are out-of-stock. Also, having too much stock means you don’t have room for your stereos, PC’s, and televisions.
- Lead time demand: 8 X 30 = 240 lead time demand iPods
- Lead time: you know it takes 30 days to receive a new shipment of iPods between the time of order.
- Average daily sales: you sell an average of 8 iPods a day
- Safety stock: because they’re relatively small, you like to keep a safety stock of 10 iPods as backup.
So, your reorder point would be 240 + 10 = Reorder Point. In this case, you should reorder more iPods when you get down to 250 iPods.
Implementing Reorder Points
To be competitive in the eCommerce industry, you have to offer a consistent level of products and service. To do this, you need to be on top of your inventory to prevent stockouts and overstocks.
Viewing, exporting, or printing easy to read reports is easy to do and calculated automatically for you in a warehouse management system like SkuVault. From there, you can easily evaluate which products need reordering, and make your purchase orders accordingly. And, no more worrying about stock-outs, because an automated system is taking care of business for you. This means customers can rely on you as a vendor, and you can have a reliable customer base.