The reorder point formula and calculating safety stock
How little is too little? That’s exactly what your Reorder Point will help you determine. Let’s talk about the concept of reorder points, safety stock, and how to put those numbers together to make sure you have the right amount of stock on-hand.
When you start your business off you’re probably making orders based on your gut instinct and the available capital on hand. Basically, you’re trying to buy enough to stock to keep your shelves and back room full, and then aiming to get sell out of that stock before you consider re-ordering.
However, as you get a few months into your business and your history of purchase and sales orders grows, a better, smarter way of re-ordering will become available to you. This is the Reordering Point.
How can I calculate my reorder point?
The thing to know about a reorder point is that it’s not a static number. It’s based on your own purchase and sales cycles, and it varies on a per-product basis. However, once you have a handle on patterns in your purchase and sales orders for a particular product, you’re ready to start putting the variables together.
The reorder point formula is:
Calculating average daily unit sales
Take the case of Archon Optical and their Ghost glasses. Here are the sales of the Ghost over the last three months:
If we total those numbers, we get 190 total units sold over the past 90 days. That means that the daily sales for the Ghost is 2.11 per day.
Calculating average delivery lead time
Average delivery lead time is simply the amount of time it usually takes for your shipments of a particular product to arrive. You’ll want to have a couple of purchase orders on-hand to check the numbers for this, as the delivery times can vary based on the quantity you order, as well as when you order it. There are a few different ways to calculate this, but averaging things out over the past few months can help provide some context.
In the case of Archon Optical, here are a few purchase orders for the last three month of Ghost shipments:
If you add the total delivery time (15 days ) and divide it by the number of orders (3 orders), then that’s an average lead time of five days for the product to arrive.
Calculating how much safety stock to keep on hand
Safety stock is simply the minimum quantity on-hand quantity that your business can tolerate. The idea of safety stock is similar to the idea of a reorder point, which is the stock quantity at which you will generate a new purchase order for that product. A reorder point can be the same as your safety stock number, but it’s usually a little higher to factor in the lead time.
A good reorder point ensures that your business never dips below your safety stock level, but a good safety stock level means that your quantity never hits zero while people still want to buy that product.
Some numbers you’ll want to take into account as you decide on a safety stock level are: average daily sales and the daily average that product used in work orders (if applicable).
At Archon Optical, the safety stock is based on the idea of having enough stock for two weeks, or 14 days. Since the average daily sales for the Ghost are 2.11 (as calculated earlier on this page), that means the safety stock for Ghost is about 14 x 2.11 = 29.54, or 30 if you round the number up. After all, nobody really orders 0.54 pairs of glasses.
Putting the numbers together
Now that we’ve got all of the Archon Optical numbers down, we’re ready to put together a reorder point for the Ghost.
This means that, once the quantity on-hand for the Ghost glasses hits roughly 40 or 41, the people at Archon Optical know to put in another purchase order for more of the product. Because they’ve built an average delivery lead time into the reorder point, the extra Ghost glasses should arrive before Archon ever dips below the amount of safety stock.
However, even if there are production shortages or delays in shipment, the safety stock that Archon Optical has put in place means that they can continue to sell the Ghost for two weeks before they run out of stock.
Setting up automatic reminders for reorder points
Reorder points are incredibly powerful for keeping your business running smoothly, but they’re no use to you if you don’t action them in a timely manner.
If you’re a spreadsheet user, you can use conditional formatting for the quantity value of specific cells. It’s a bit of work to set up because you’ll have to set it up for each individual cell, but you can set Excel up so that cells turn red the moment they dip below your reorder point, which will warn you when you need to start on a new purchase order.
However, things can get even easier if all of your inventory and purchase orders are kept in the same software. inFlow Inventory can track the reorder point and even a reorder amount for you, and it puts all of the products that need to be re-ordered on one screen, for easy viewing. inFlow can also store your vendor information, so you can start new purchase orders without ever leaving the application.
Try the FREE edition today and stop worrying about running out of stock!