A fragile balance between overstock and under-stock is called a perfect inventory level.
Finding this balance is a challenge for each retailer, from a small grocery shop to a multi-million dollar business. The larger the company becomes, the more difficult it is to balance demand and supply. Buying too much stock and storing it in your warehouse will tie up your money, and on the contrary, under-stocking may disappoint your customers and lead to lost sales. The perfect inventory is a combination of three elements - right place, right time and right quantity.
“Customers want anything anytime anyway and anywhere. Do not irritate them with delayed or cancelled orders”
How to measure the perfect level of inventory and strike the right balance? How to know the exact time of the next supplier order placement? By calculating a reorder point formula.
The reorder point is a very important indicator that helps you to gauge demand fluctuations and match it with your sales. Knowing your reorder point makes your warehouse replenishment smart, conscious and smooth.
So, here comes the definition.
A reorder point (ROP) is the minimum quantity of goods necessary to have at the moment of reordering - in other words, a quantity that stimulates reordering. If the reorder point is accurately calculated, a business does not suffer from a damaged supply chain, where supply, sale and delivery work smoothly and effectively, bringing you profits and minimizing your investment into “dead” stock.
Reorder point shall be calculated for each SKU.
Each product has its own sales history, demand trends and seasonal demand fluctuation. The retailers work with dozens and hundreds of suppliers, and all of them have different delivery and shipment times. That is why having reorder point data for each supplier and each SKU is essential to always be on a safe side and to ensure you always have enough inventory to satisfy your customers appetites. Everyone knows that delayed orders and stockouts damage your reputation and irritate your customers who want anything anytime anyway and anywhere.
Reorder point is not an intuitive indicator, it is a mathematical formula, and one of the main inventory control methods.
The formula of Lead time demand is simple, you need to multiply lead time and average daily consumption.
Lead time is a number of days while your goods are being delivered to your storage. Lead time is being measured from the moment of putting an order to your supplier. Lead time indicator is very important, as shipping and logistics can be unstable during holiday seasons, bad weather conditions or unplanned demand increases.
In this case, you will calculate the reorder point on the basis of two average indicators. However, demand can be very unpredictable and unstable, so the experts recommend adding a third indicator to make a formula more sophisticated and reduce a risk of stockouts. So, the updated formula is:
Safety stock is a number of goods needed as a safety buffer in your warehouse.
To calculate safety stock, you need to know the maximum daily consumption for the SKU, the maximum lead time in days for this SKU, the average daily consumption of this SKU and the average lead time.
You need to multiply the maximum daily consumption and maximum lead time (number 1), and then multiply the average daily consumption and average lead time (number 2). To get a safety stock number, you need to subtract the second number from the first number. This difference is a safety stock level.
You have a grocery shop selling wine from Italy. You need to find your reorder point to make your inventory planning easier and more structured. Reorder point is different for each SKU, so let’s calculate it for a standard bottle of Chianti (SKU).
Usually, it takes 20 days for the bottles to be shipped from Italy, 35 days during busy holiday seasons. Here come your average lead time - 20 days, and maximum lead time - 35 days.
People love Italian wine and eagerly buy it, so usually you sell 10 bottles per day, 15 bottles during festivals, holidays and vacation seasons. So, your average daily consumption per unit is 10, maximum daily consumption is 15.
Your safety buffer is (15x35) - (20x10) = 525 - 200 = 325 bottles.
Let’s proceed. When do you have to call Italian winemakers and place the next order for Chianti? Let’s calculate the reorder point.
(20 x 10) + 325 = 525 bottles
So, when your warehouse has 525 bottles of Chianti, you need to pick up a phone and place an order.
Importantly, reorder point should be calculated for each SKU in your inventory, which is very time and effort-consuming.
That is why we would recommend you to use automated inventory management systems instead of manually-run spreadsheets.
Automated systems use smart techniques and inventory management algorithms for sales tracking and demand forecasting, so they can effectively analyze your reorder points for each SKU, across all your sales and warehouse locations in seconds!