Inventory management is a critical aspect of running a successful business, especially when it comes to ensuring products are readily available right when your customers need them.

One of the most effective strategies to avoid running out of stock and to maintain a healthy supply chain is understanding and setting the right reorder points for your business.

Keep reading for a deeper understanding of the concept of reorder points, why they are important, and how you can calculate them correctly to keep your business running smoothly

Table of Contents

1. What is a reorder point?

2. Why is the reorder point important?

3. How to calculate your reorder point

4. Factors influencing reorder point calculation

5. Common mistakes in setting reorder points

6. How to optimize your reorder point strategy

7. Manage your inventory with reorder points

8. Frequently asked questions 

What is a reorder point?

A reorder point (ROP) is the inventory level at which a new order should be placed to replenish stock before it runs out. It’s a crucial figure that helps businesses maintain a balance between having enough inventory to meet customer demand and not overstocking, which can tie up capital unnecessarily.

The reorder point ensures that you restock at the right time, reducing the risk of running out of inventory, which can lead to lost sales and customer dissatisfaction.

Why is the reorder point important?

The reorder point plays a vital role in inventory management because it helps businesses accomplish the following:

Prevent stockouts

Running out of products can damage your brand reputation and affect customer loyalty. A well-calculated reorder point ensures you always have enough inventory to meet demand.

Reduce holding costs

Overstocking leads to high holding costs, such as storage fees, warehousing costs, and insurance. Depending on the type of product you carry, you may also run the risk of depreciation or expiration before you can sell it.

By optimizing reorder points, businesses can avoid tying up capital in excess inventory and the expenses associated with taking care of it.

Improve cash flow

Effective inventory management through accurate reorder points can free up cash that can be used for other business operations, like marketing or new product development.

It also prevents you from having to scramble at the last minute to urgently get more inventory in, which could end up costing you more than if you had planned for it.

How to calculate your reorder point

The basic formula for calculating a reorder point is:

Reorder point (ROP) = Lead time demand + Safety stock

Lead time demand

This is the amount of stock you expect to sell during the lead time (the time between placing an order and receiving it).

Calculate this by multiplying your average daily sales by the lead time in days.

Safety stock

This is extra inventory kept to account for fluctuations in demand or supply delays. It acts as a buffer to avoid running out during unpredictable events.

Example calculation

If your average daily sales are 20 units and your supplier takes 5 days to deliver, your lead time demand is 20 x 5, which is equal to 100 units.

If you want to keep 20 units as safety stock, your reorder point would be 100 + 20, which is equal to 120 units.

Factors influencing reorder point calculation

Several factors can affect your reorder point calculations, including:

Lead time variability

If your supplier's delivery times vary, you may need to adjust your safety stock levels to account for delays.

Demand variability

Fluctuations in sales demand can impact the accuracy of your reorder points. Higher variability may require you to keep more safety stock on hand just in case.

Supply chain disruptions

Issues such as production delays, shipping and delivery problems, or supplier changes can necessitate adjustments to your reorder points.

Common mistakes in setting reorder points

Avoid the following common errors when trying to establish the right reorder point for your business.

Ignoring demand variability

Using average demand without accounting for peaks — such as during the holiday season — can lead to stockouts during busy periods.

Not updating reorder points regularly

Failing to regularly review and adjust reorder points can result in outdated inventory practices that don’t reflect current demand trends.

Overlooking supplier performance

Inconsistent supplier lead times can cause discrepancies in your inventory, leading to stock shortages.

How to optimize your reorder point strategy

Optimizing your reorder point strategy can be a delicate balancing act, but there are some things you can do to increase your chances of success:

Automate inventory tracking

Use inventory management solutions like QuickBooks Online to monitor stock levels in real time and adjust reorder points automatically based on sales data.

Review reorder points regularly

Reevaluate your reorder points at least quarterly, or whenever there are significant changes in sales or supplier performance.

Communicate with suppliers

Keep an open line of communication with your suppliers to understand their lead times and potential delays at certain times of the year.

Manage your inventory with reorder points

Setting accurate reorder points is essential for efficient inventory management and smooth business operations. By understanding how to calculate and adjust your reorder points, you can prevent stockouts, reduce costs, and improve your overall supply chain performance.

Start by evaluating your current inventory practices and implementing these strategies to optimize your reorder point calculations.

Need help getting started? Sign up for QuickBooks Online for the guidance and support you need to ensure your inventory is always optimized.