What is Reorder Point and Reorder Point Formula?
Every manufacturing business out there is facing questions like "How many units of materials should I order from my supplier?", "When should I place my next supply order?" or "When should I place a new manufacturing order?". When you start a new business then your first orders are probably placed on a gut feeling. Gut feeling can only take you so far. As soon as you start calculating reorder points you take your reordering efficiency to a whole new level.
A good reorder point ensures your stock levels never fall below the desired minimum (safety stock). Reorder point calculation formula and safety stock calculation formula are in a way two sides of the same coin. Safety stock describes the amount of inventory a business keeps in the warehouse to protect against spikes in demand or shortages in supply. We have a separate blog post with a good example available here in case you want to read up on how to calculate safety stock levels.
What is a Reorder Point?
Reorder point is the metric that answers the question: "When is the right time to order more materials from suppliers or finished products from manufacturing?" When stock level falls below Reorder Point then a new order should be placed immediately.
Reorder point ensures that your business typically does not dip below your safety stock levels. Therefore, a reorder point is typically a little higher than your safety stock level to factor in the lead time. But how much higher? It depends on the average lead time of your reorder and the average demand during the lead time period. Why is that?
Firstly, it's because when you place a new order it does not arrive at your warehouse immediately. It may take weeks or even months for the order to be processed and shipped to your desired location. This delay in delivery is called "lead time".
Secondly, during the lead time, you keep using the quantities still left in your warehouse for your manufacturing or sales operations. Thus, a good reorder point needs to take into account also how much quantity of the ordered item is actually left in your warehouse by the time reorder actually arrives. Only this way it is possible to avoid inventory levels falling below the desired minimum (safety stock).
How to calculate Reorder Point?
If you already have your safety stock level calculated (see the formula here (LINK) in a blog post) then Reorder Point calculation is pretty straightforward.
Reorder Point = (Average Daily Usage x Average Lead Time Days) + Safety Stock
For example, if your manufacturing uses approximately 10 quantities of raw material per day, it takes a week for a reorder to arrive and the safety stock level for that raw material is 50 units, then reorder point is at (10x7)+50 = 120 units. If the inventory level of the raw material falls below 120 units then a new order should be placed.
If you need a shortcut to calculating Reorder Point without knowing your Safety Stock level then use the formula below:
Reorder point = Maximum Daily Usage x Maximum Lead Time Days
Just estimate the maximum quantity of products or materials you need per day and multiply the figure by maximum expected lead time for purchasing or manufacturing activities. There you have it.
When calculating reorder point levels pay attention to changes in underlying metrics. Daily usage and lead time are not figures carved in stone. They may increase as your business grows and they may fluctuate depending on whether you are approaching high season or low season. Thus, you should recalculate reorder point levels from time to time. A good tip to follow would be to revisit these calculations in every 3-4 months.
To sum it up, using a production and inventory management software allows a company to set reordering points for each product or material variant that are automatically tracked. Software flags the product and material variants that have dipped below reordering point automatically allowing you to easily identify the areas that require action. The best solution for this is to use a cloud manufacturing software like Katana MRP.