Inventory87

Reorder Point Formula and Safety Stock: A Complete Guide

Posted by ThomasLast Updated June 28th, 2024
— 8 minutes reading

Whether you’ve just started a new business or sold products for years, anyone can benefit from using the reorder point formula. This post will show you what that is, why it’s useful, and which numbers you’ll need to generate a reorder point.

Check out this short clip from our new podcast for a quick rundown of reorder points and safety stock and their importance in inventory management.

Secret Life of Inventory | Reorder Points and Safety Stock

How to calculate your reorder point

The reorder point (ROP) is the minimum stock level a specific product can reach before you are prompted to order more inventory. But I’m sure you already knew that!

A reorder point is not a static number. A reorder point is based on your purchase and sales cycles and varies by product. However, once you have a handle on the patterns of a product, you’re ready to start putting the variables together.

The reorder point formula is daily unit sales multiplied by delivery lead time, with some safety stock for good measure. Below, you can see what the reorder point formula looks like written out:

The reorder point formula video

If you’re the type who likes to watch instead of read, we’ve created a video version of this post. The examples are slightly different, but the formula is the same. Peter covers the reorder point formula in just three minutes:

Why is setting a reorder point so important?

Before we get into the reorder point formula, let’s quickly review the importance of reorder points. Here are some of the ways reorder points will help your business:

• Avoid stockouts—Stockouts occur when a business runs out of inventory and can no longer process a customer’s request for purchase. Obviously, this will lead to dissatisfied customers who won’t wait around for you to restock. They’ll simply take their business elsewhere, probably for good.
• Avoid overstock—The flip side of stockouts is carrying excess inventory. The carrying costs associated with excess inventory add up quicker than you may realize and will eat into your bottom line.
• Reduce shipping costs—By setting proper reorder points, you can avoid the need for frequent orders, which will save you a ton in shipping costs over time.
• Improve forecasting—With accurate reorder points, you’ll be able to anticipate your business needs, which will ultimately lead to less rushed orders or last-minute panic buying.

Calculating average daily unit sales

OK! Now that we understand why the reorder point formula is so vital let’s take a closer look at it. The first variable in the reorder point formula is simple. It’s the average amount of a specific product you sell on any given day. To help illustrate, let’s examine the fictional company 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 180 total units sold over the past 90 days.

That means that the average daily sales for the Ghost is 2 per day.

Calculating average delivery lead time

Another component of the reorder point formula you’ll need is the average delivery lead time. This is the time it usually takes for product shipments to arrive. You should have a couple of purchase orders handy to check the numbers. Delivery times can vary based on your order quantity (larger orders could take longer to ship). When you place the order, it also affects the lead time (compare orders during a busy and slow season). There are different ways to calculate this, but a three-month average is a good start.

Here are a few Archon Optical purchases for the last three months of Ghost shipments:

Add the total delivery time (15 days ) and divide it by the number of orders (3). That’s an average lead time of five days for the product to arrive.

In this example, the lead time is calculated on the vendor level, not at the item level. It does not account for multiple receiving locations or different lead times per item.

How to calculate safety stock quickly

When you calculate a product reorder point, you’ll need to account for safety stock. Safety stock is a surplus of products your business would keep in case of an emergency. For example, maybe you saw a random spike in your sales numbers, or there was an extreme delay in delivery times due to unforeseen circumstances.

When you decide on a safety stock level, you’ll want to consider average daily sales and the daily average you use the product in work orders (if applicable). Lead time is also essential to safety stock.

You can get more granular when calculating your safety stock, but here is a simplified way. First, multiply the maximum number of daily orders by the maximum lead time. Then, multiply the average daily orders by the average lead time. The difference in these two numbers will be your safety stock.

For example, Archon Optical’s historical data shows that their top sales on Ghost glasses in a single day was 4, and the longest they waited for a shipment was 10 days (4 x 10 = 40). They also calculate that their average daily sales over a year for the Ghost glasses is 2, and they wait, on average, 6 days for a shipment to arrive (2 x 6 = 12). In this case, their safety stock would be 28 (40 – 12 = 28).

If you’re dealing with a product that has a shelf life, you should consider changing safety stock levels to days rather than weeks.

[We’ve also written a more detailed article on safety stock if you’d like to calculate it based on lead-time demand.]

Putting the reorder point formula together

Now that we’ve got all the Archon Optical numbers for the Ghost glasses, we’re ready to put these numbers into the reorder point formula. Here’s what that looks like:

When the quantity on hand for Ghost glasses hits 38, Archon Optical knows to place a purchase order for more. Because they’ve built an average delivery lead time into the reorder point, the extra Ghost glasses should arrive before Archon dips into their safety stock.

Even if there are production shortages or shipping delays, Archon Optical’s safety stock will give them padding to fall back on, which will ensure they don’t encounter any stockouts.

Setup reorder points in a spreadsheet

Reorder points are vital to keeping your business running smoothly, but they’ll only work if you’re prepared to reorder on time. You can setup a formula somewhere in your inventory list with the reorder point formula, so you can make quick calculations for your products individually.

If you’re a spreadsheet user, you can use conditional formatting for the quantity value of specific cells. You can set Excel or Google Sheets so that cells turn red when they hit a reorder point. This will effectively warn you when you need to start on a new purchase order. You can also set up a formula somewhere in your inventory list with the reorder point formula, so you can make quick calculations for your products individually.

We know it can be challenging to keep track of all these formulas, so we decided to create a handy Inventory Formula Cheat Sheet with 7 of the most common formulas.

Download your inventory cheat sheet now!

Reorder faster with inFlow

Unlike spreadsheets, inFlow was designed specifically for working with inventory. Quantity and reorder point fields are built into the software, which saves our customers a lot of setup time.

inFlow has a Reorder Stock window, which identifies which products need reordering, and creates new purchase orders with just one click.

If you’d like to implement reorder points with tailored suggestions for your business, we can help with that too!

inFlow has a Recommended Reorder Point report that examines your sales data and recommends reorder points for your products. It also factors in goods in transit (GIT), which are products that have been ordered from a vendor but haven’t been received yet.

Whether you’re just starting out with reorder points or fine-tuning them, inFlow can help! With inFlow there is no need for the reorder point formula at all! The best part is, using inFlow can help with so much more than just reorder points. inFlow integrates with over 95 different applications, such as Shopify, Amazon, and Quickbooks Online, to name just a few. If you want to set up a complete barcoding system, inFlow can do that too! Read our Ultimate Barcoding Guide to learn about barcodes and how to start barcoding your business.