The reorder point is the minimum quantity of existence of an item, so that when the stock reaches that quantity, the item must be reordered. This term refers to the level of inventory that triggers an action to replenish that particular inventory..
If the purchasing process and vendor fulfillment on your delivery work as planned, the reorder point should result in your inventory replenishment arriving just as the last available inventory runs out. Thus, production and sales activities are not interrupted, while minimizing the total amount of inventory on hand.
A reorder must be reordered before inventory runs out, but ordering too early will cost more to store these items in excess. If the order is placed too late, the insufficiency will generate dissatisfied customers who will look for that product in the competition.
Setting the reorder point helps reduce inventory costs, as well as ensuring that there is always enough stock for customers, even when things change unexpectedly.
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The two factors that determine the reorder point are:
- The demand during the lead time, which is the inventory required during the lead time.
- The stock security, which is the minimum level of inventory to keep as protection against possible shortages due to fluctuations in demand or delivery time.
It is calculated as follows:
Reorder point = Demand during delivery time + safety stock.
You need to know the demand for the item during the delivery time, because that is how long you will have to wait before new stocks arrive..
The replacement does not come immediately. Even if the supplier has the items available in stock, it will take time to pack the order and even longer to ship. This waiting time is what is known as the delivery time. Have:
Demand during delivery time = average daily demand x delivery time in days.
The average daily demand is calculated by taking the total demand in a given period (monthly, yearly, etc.), dividing it by the number of days that this period has.
The following image shows the inventory model with reorder point:
The reorder point may be different for each inventory item, as the items may have different demand and may require different delivery times to receive their replenishment from the supplier..
The formula for the reorder point is based on averages; therefore, demand at any given time may be above or below its average level.
The supplier can also deliver before or after the scheduled days, and some inventory may remain available when the replacement order arrives, or a shortage condition may arise that prevents it from being produced or sold..
The determination of stock Security involves evaluating between the risk of shortages -which implies a dissatisfied customer and lost sales- and the increased costs associated with having additional inventory.
The stock Security is calculated taking into account the quantity of the article necessary to cover a variation in demand and a supplier risk. The safety stock can also be calculated with the mathematical formula:
- Average daily demand Dm
- Standard deviation of delivery time σD
- Average delivery time D
- Standard deviation of demand σDm
- Safety factor u (from 0 to 4)
A company sells an average of 100 staplers per month. Every month you order from your supplier. The supplier delivery time in the last 6 months has varied from month to month as follows:
To calculate the average daily demand, the units of staplers sold during a month are divided by 30 days.
100/30 = 3.33 average daily sales.
To get the average delivery time, the delivery times are first added together.
(8 + 11 + 9 + 6 + 7 + 5) = 46 days.
This result is divided by the number of orders placed, which is 6 because the orders were placed monthly.
46/6 = 7.67 average delivery time.
Taking the averages of daily sale and delivery time, the stock of security. For our purpose, the stock security is 20 staplers. Therefore, for this example the reorder point would be:
(3.33 x 7.67) +20 = 45.54
When inventory is reduced to 46 staplers, a restock order must be placed.
Timewear in the United States sells watches made in China. The supplier always has his warehouse full of watches ready to be shipped at any time.
It takes the supplier a couple of days to collect and pack the watches. After that, the watches travel five days in a truck to the port.
The boat trip from China to the US takes about 30 days. When the watches arrive, they spend a week in customs and then three days traveling to the Timewear warehouse..
Calculating delivery time is easy; you just have to add all the times:
2 + 5 + 30 + 7 + 3 = 47 days of delivery
Since it takes Timewear 47 days to get a new shipment of watches, you will need to have enough stock on hand to cover these 47 days of delivery..
You need to know the demand during this period. Timewear sells an average of 300 watches per month (300/30 = 10), for which they would sell approximately 10 watches per day.
Therefore, the demand for Timewear at delivery time is 47 × 10 = 470. This means that Timewear will need 470 watches until its next shipment arrives, if nothing unexpected happens..
Sometimes unexpected things happen. There may be a sudden increase in demand and the product sell out quickly, or perhaps the supplier experienced a problem and it will take an extra week for their delivery time. This can be reviewed in the company's sales and purchase order history:
Timewear on a typical day sells 10 watches, but on weekends they can sell up to 15.
Their typical delivery time is 47 days, but during typhoon season it can be as long as 54 days..
(15 × 54) - (10 × 47) = 340
This means that Timewear needs to have an additional 340 units of stock security to guard against the unexpected. The reorder point would be:
470 (delivery time demand) + 340 (stock security) = 810
When your stock reaches 810 watches, Timewear will need to place a new order with your supplier.
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