When to source more products from suppliers?” It’s more of a complex problem than a question to anyone involved in inventory management. Whether you are a small business owner or a sophisticated brand, figuring out when you should reorder from the supplier is one of the most complex decisions. It’s because one must meet the balance between goods not running out of stock nor getting excess, increasing the inventory cost. This is where the concept of reorder point comes in. Curious to know more about it? Dive into this exclusive guide!
Part 1. What Is a Reorder Point (ROP)?
Reorder point (ROP) refers to a certain level of any product in the inventory at which more units of product must be sourced so that it doesn’t get out of stock. By carefully setting up the reorder point level, businesses can ensure none of their customers leave disappointed due to that frustrating ‘Out of Stock’ tag.
However, this concept isn’t limited to businesses that purchase products for resale. It can also be useful for storefront locations of well-developed businesses where the supplier is the company’s warehouse or factory. So, the storefront owners must manage inventory well enough to figure out when they need to request more from the supplier.
Part 2. Reorder Point Formula
Following is the reorder point formula:
Reorder point (ROP) = Demand During Lead Time + Safety Stock
Calculations based on this formula will give an idea about when a product’s stock must be replenished to prevent it from running out.
Part 3. How to Calculate Reorder Point?
Though we have listed the basic formula, you might wonder what that safety stock or demand during lead time means. If that’s the case, let’s figure it out!
Average Daily Use
The first step in determining ROP is calculating average daily sales, i.e., how much of a specific product you sell daily. For this purpose, select a certain period, say a week, a month, etc. Then, figure out how many SKUs you have sold during that period and divide it by the total number of days in the span.
Here’s the formula:
Average Daily Sales = Total Sales / Number of Days
Demand During Lead Time
Lead time refers to the number of days between placing a purchase order and receiving it. Your lead time will certainly be longer if your supplier is overseas and less if it’s local or you have an in-house production facility. To calculate demand during lead time, simply multiply the lead time for a certain product by the average daily sale of that product.
Here’s the formula for the evaluation of lead time:
Lead Time Demand = Lead Time x Average Daily Sales
Safety Stock
As the name suggests, safety stock refers to the extra inventory one keeps for dealing with the anticipated variability in supply and demand. For instance, if a business knows the supplier is taking a leave or not producing any goods in the coming month; it will source that month’s inventory in advance. Alternatively, if there’s some expected increase in demand, like a sudden surge of smog raising demand for masks, safety stock can come in handy. It’ll give you an edge over competitors with no lead time required to meet customer needs.
Here’s the formula for safety stock calculation:
Safety Stock Level = (Maximum Daily Orders x Maximum Lead Time) – (Average Daily Orders x Average Lead Time)
Once you have calculated both the safety stock and demand during lead time, add them to obtain the Reorder point.
Real-Life Example
Let’s develop a better understanding of reorder points with a real-life calculation example! Imagine Company A sells wallets throughout the year. The goal of the company is to stock enough inventory so that their product doesn’t run out in the upcoming month. Here’s how reorder point calculation can help them.
Begin with the determination of demand during lead time. Suppose company A sells 200 units of their wallet, and they need 10 days to obtain more supply from their supplier. So, the demand lead time will be:
Demand lead time = 200×10 = 2000
The business plans on keeping at least 75 wallets as safety stock. So, the reorder point becomes:
ROP = 2000 + 75 = 2075
Now, when the inventory falls below the mark of 2075, company A will order more to prevent a stock shortage.
Part 4. Why Is Reorder Point Important?
By now, you should have developed a proper understanding of the reorder point and its calculation. Let’s now figure out why ROP is important for businesses.
Prevent Shortage of Stock
Inventory management revolves around keeping the right amount of inventory at any time. By right amount, we mean the product is neither in excess nor at risk of stockout. This saves you from potential customer loss due to stock shortages, causing order cancellation or delays.
With the accurate calculation of reorder points, you can enjoy visibility into your inventory and know when to source more products. You can also rely on an inventory management system to give real-time updates on inventory and keep track of ROPs for your convenience.
Reduced Inventory Costs
Most businesses stock up more inventory than they require, leading to increased overhead on inventory costs. This can be significantly reduced by reorder point calculations, which offer flexibility to keep as minimal inventory as possible yet meet the customer’s demands in time.
Moreover, reorder points can also save you from the hassle of obtaining products in a hurry from suppliers due to shortages, keeping you from incurring additional fees.
Accurate Demand Forecasting
Reorder points also help with accurate demand forecasting. They can provide valuable data regarding sales patterns and customer demand, which can be utilized to refine future stocks, making your inventory planning more precise and efficient.
Improved Supplier Relationship
With constant order placements, you can improve your relationship with suppliers, becoming their regular customer. They can even offer you discounted prices, better terms, or priority services. This will eventually help your business succeed in the long run.
Keep Reorder Point Simple with NextSmartShip
Do you want to skip the need for manual calculation of reorder points, or is your inventory taking up loads of your time? It’s time to partner with a reliable 3PL service like NextSmartShip. This innovative platform takes up the responsibility of order fulfillment, ensuring smart inventory management via an inventory management system.
But that’s not all; NSS can also package your goods and ship them to customers, saving you from loads of hassle. The best part? You will get real-time inventory updates, and your customers will receive real-time order tracking updates.
Conclusion
Reorder points estimate when a company must order more products from a supplier to avoid running out of stock. With a precise calculation of ROP, businesses can obtain significant perks. It saves them from inventory cost overhead due to storage of excess inventory, customer dissatisfaction due to products being out of stock, and much more. Thus, ROP is indeed an important inventory term for both online and offline businesses selling physical products.
However, you can partner with 3PL services, like NextSmartShip, for seamless inventory management. They will employ an automated inventory management system to let you enjoy hassle-free management when receiving real-time updates based on automatically calculated reorder points. Hope you found this info helpful; stay tuned for more!
