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 time 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) that averages out to 1.5 units sold on average per day.
Average delivery lead time
Average delivery lead time is the average amount of time it takes for a shipment to arrive from the time 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 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.
(Max. Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time)
Let’s say a manufacturer used 10 units of a component on their busiest day of production. The longest time it would take the supplier 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.
(10 x 15) – (1.5 x 12)
150 – 18 = 132
The manufacturer should hold 132 safety stock units to avoid bottlenecks in production.