Holding too much stock on hand ties up capital and eats into business profits with increased carrying costs. At the same time, running out of stock causes slow order fulfilment, the potential for missed sales, and lost revenue.

One way to determine when you should order more inventory items is to calculate reorder points (ROP). Knowing how to do it can save you time and money. 

The reorder point is a supply chain and inventory management technique businesses can use to guide this delicate balancing act. It improves inventory operations, avoids stockouts, and maintains ideal inventory levels.

What is the reorder point?

The reorder point represents the inventory level at which it’s most efficient for you to submit an inventory order to your supplier. The safety stock level is the minimum number of units a company needs to have in stock to fill sales orders or meet production targets. Once inventory dips below the calculated reorder point, replenishment is triggered through a new purchase order.

At the same time, you’re minimising the inventory in stock and maintaining good cash flow. When you reach the reorder point, although your inventory is low, you have enough inventory on hand to meet your customer demand while your supplier fills and delivers your new order.

Why should your business know its reorder points?

Knowing reorder points allows you to keep your ordering and shipping costs low. You’re ordering in enough time to avoid extra expenses for rush deliveries, and you’re satisfying your customers’ needs with the inventory you have on hand, which means your cash flow stays steady. Primary business benefits of re-order points include the following:

Cost control

Inventory carrying costs typically account for 15-30% of total inventory costs. This affects the profit margin on goods sold. To protect profits, businesses can use the most optimal reorder levels to keep storage and warehousing costs low.

Optimal inventory levels

You can avoid sunk costs from inventory shrinkage and obsolescence by reordering a predetermined amount of replenishment inventory according to demand forecasts.

Supply chain optimisation

The reorder point calculation considers delivery lead time from suppliers. This is part of supply chain management. By keeping track of average delivery lead time, you can identify your most reliable and least reliable suppliers and make more informed procurement decisions.

Improved forecasting

To accurately calculate reorder points, you’ll need strong sales volume records and trends over a certain period. As you build this body of data, you can improve forecasting to meet customer demand better. Calculating your inventory fill rate will also help you forecast the rate at which your business can fulfill orders to meet supply and demand.

Now, let’s see how to find the reorder point.

How does the reorder point formula work?

First, let’s define all the components that make up this equation by looking at a reorder point example calculation.

Components of the reorder equation

Average daily sales or usage

Average daily sales is the average number of units sold or used per day over a defined period. Three months or 90 days is a good starting increment to use. A retailer would measure the average number of units sold, while a manufacturer would calculate the average number of components used per day.

Let’s say you sold:

• 40 units of an item in March
• 60 in April, and 
• 46 in May.

Over those three months (or 92 days), an average of 1.5 units were sold daily.

Average delivery lead time

Average delivery lead time is the average time it takes for a shipment to arrive from when the order was placed. Average delivery lead time changes with fluctuations in seasonal demand, the quantity ordered, and distance from the up-chain supplier. 

For a reasonable measure, take an average of the past three months of POs for the SKU item you want to set a reorder point for. If your sales cycle is longer or shorter, adjust accordingly.

Safety stock

Safety stock is the amount of inventory a business holds to mitigate the risk of shortages or stockouts. The safety stock calculation is the difference between the maximum daily sales/usage and lead time and the average daily usage and lead time.

Let’s say a manufacturer used 10 units of a component on their busiest day of production. The longest time the supplier would take to deliver this component is 15 days. And let’s assume that the average daily use is 1.5 units and the average lead time is 12 days.

The manufacturer should hold 132 safety stock units to avoid bottlenecks in production.

The reorder point formula in action

Now, we’ve got all reorder point sub-metrics ready. Let’s continue with the manufacturer example and calculate the reorder point.

Reorder point means the manufacturer should reorder this component when the stock falls to 150 units. By doing so, the company can prevent stockouts and avoid dipping into safety stock while they wait for new stock to arrive.

How to use the reorder point formula in your business

If you have at least one procurement cycle and one sales cycle worth of data.

Businesses with a limited number of products can start with excel spreadsheets and format cells to turn red when inventory levels reach the reorder point.

Working with dozens or hundreds of spreadsheets can be time-consuming and error-prone for growing retailers, manufacturers, or wholesalers. If your business falls into this category, consider the benefits of inventory management software.

A modern inventory management system can bring greater efficiency to inventory processes through automation and digital tools. 

For example, real-time inventory tracking allows staff to see what’s in stock, what’s on order, and where each item is located. Software tools can also collect and present purchase orders, sales fulfilment, and demand forecasting data on a single-user dashboard.

This information prevents inventory managers from manually searching through spreadsheets and crunching numbers. 

Some inventory management tools also enable businesses to generate customised reports on inventory stock.

This can be done by:

• Item
• Vendor
• Delivery date
• Assembly

Rich inventory insights empower businesses to fine-tune their reorder points and overall inventory management processes.

Final thoughts

Keep in mind that reorder points are not static. Sales volumes fluctuate, and supply delivery times vary. Demand for particular product lines may grow or fall.

To maintain an accurate reorder point, check the underlying metrics, like average daily sales/usage and average lead time, at least once per quarter. If you have a high season and low season, or seasonal bad weather that slows down deliveries, factor this in.

Managing, ordering, and tracking inventory efficiently helps keep customers happy and boost your bottom-line profits. Having the right Inventory management system simplifies your responsibility. 

In this regard, Quickbooks provides the tools you need. Visit our pricing page to view plans and try a 30-day free trial of QuickBooks.