Reorder Point | Optimize Inventory with Reorder Point

What is a Reorder Point?

Before we get into the details of Reorder Point, what is the definition, formula, importance, benefits of Reorder Point, let me share a small anecdote.

One manufacturing company that produced rolled steel products, ran out of stock of a commonly used bearing. It took almost 12 hours for the company to arrange for the common bearings and production came to a grinding halt till then!

Now, if you consider it carefully, the cost of the bearing was minor, but the resultant impact of production coming to a halt was huge.

The order was delayed and the customer was very unhappy with the company. It not only resulted in a loss of revenue but the reputation of the company was adversely affected.

Could this situation have been avoided? Yes, it could have been easily avoided if they had well-defined inventory management practices in place and specified “Reorder Point” to ensure smooth production.

Are you facing situations of stockouts in your company? Make a Small Change, Define Reorder Point Now!

What is Optimum Inventory? Why is it important to maintain optimum inventory?

Optimum inventory is the ideal quantity of inventory a manufacturing company should have at any given point in time, to ensure continuous and smooth production

If the company orders stock when they still have a lot of stock on hand, it leads to Overstocking. This is a situation where the excess stock may be lying idle without being used for a long time and effectively results in high storage costs.

On the other hand, if the company does not order till the stock is exhausted, it will end up with situations of understocking or stock outs results. Like in the example above it can lead to production coming to a halt, delays in orders, loss of time & revenue as well as customer dissatisfaction.

To prevent overstocking & understocking, it is important to determine the right level of stock so that you can replenish inventory at the right time, and meet the production targets without having to face the risk of going out of stock.

How does Reorder Point help in inventory optimization?

Wikipedia mentions Reorder Point (ROP) is the level of inventory which triggers an action to replenish that particular inventory stock.

Thus, Reorder Point is the minimum level of inventory or level of stock at which the company must place orders for purchase and refill the stock to avoid situations of stock out or understocking.

A manufacturing company has a lot of items such as raw materials, consumables, and capital items. Each item has a different consumption pattern. Inventory items may be procured from local, regional, national, or global suppliers so they will have different lead times and so on. Moreover, companies may follow different planning methods such as Past Consumption Basis, Fixed Inventory Level & Manual Forecasting for different items based on their inventory practices.

Reorder Point helps to determine the best and most effective amount of inventory to yield minimum overall cost based on various planning methods, thus helping in inventory optimization.

Let us now see what factors to consider while determining Reorder Point, and formula to calculate the same in different planning methods.

What are the factors to take into consideration to Calculate Reorder point?

You must know when to order each item in your inventory because each item will have a different usage rate, lead time for procurement, and so on. While we will learn how to calculate Reorder point, we cannot ignore certain other terms which go hand in hand with it. These terms are Lead Time, Consumption Rate, Safety Stock, Reorder Quantity, and Max Stock.

To be able to accurately calculate the Reorder Point for each item, you’ll need to have a good understanding of the following terms as well as the knowledge of the demand planning method used for each item:

Lead time: Lead time is essentially the time taken by your vendor/supplier to fulfill your order. It is the time between the initiation of purchase requests and acquiring of goods into inventory. This helps determine how many days in advance, you need to place an order.

Safety stock: Safety stock is the minimum buffer stock that must be retained to avoid a situation of stockout – in case the order does not arrive on time for unforeseen circumstances.

Consumption rate: The daily average usage or consumption rate of the particular item is important to know how many units will be required each day till the new stock arrives.

Reorder Quantity: It is the quantity to be ordered for a particular item. Reorder quantity should provide a balance between quantity, discounts, freight, storage costs, and working capital requirements.

Max Stock: Max Stock is the maximum stock quantity determined for a particular inventory item. The inventory level for any item should not exceed Max Stock Quantity.

Reorder Point Formula for Different Demand Planning Methods

Let us now understand how companies calculate the Reorder Point / Reorder Level, Reorder Quantity, Safety Stock & Max Stock Level based on their demand planning methods with the help of some examples. Given below is a one-glance summary of how Reorder Point or Reorder Level is calculated in various demand planning methods.

How to define Reorder Point for Inventory based on Past Consumption Basis

ITEM = HAND GLOVES

Average Consumption = 10 Gloves Per Day
Material Issue Frequency = Monthly
Lead Days = 5 Days based on the source of supply
Safety Days = 2 Days based on the source of supply

Reorder Point = [(Lead Time + Safety days) x Per Day Consumption Rate]
= [(5+2) x 10] Therefore Reorder Point = 70 Nos.
Reorder Quantity = [Consumption pattern x Average consumption per day]
= [30×10] Therefore Reorder Quantity = 300 Nos.
Max Stock = [(Reorder Level + Reorder Quantity) – (Consumption Rate x Lead Time)
= [(70+300) – (10*5)] Therefore Max Stock = 320 Nos

How to define Reorder Point for Inventory based on Fixed Inventory Basis

Identify items for which fixed/max stock is always maintained.
Order will be placed once the inventory level goes below the Max/Fix level.
This approach is usually taken for items like spare parts.
In this case, Reorder point and Reorder quantity will trigger at the same time.

Item Name = Bearing X and the Fixed / Max Stock = 10 Nos.
Reorder Point = Whenever Bearing Stock goes below 10 Nos.
Reorder Quantity = [Max Quantity – available quantity] = [10-9] Therefore Reorder Quantity = 01 No.

How to define Reorder Point for Inventory based on Manual Forecast Basis

Identify the items that need to be forecasted for a certain period and set the predicted reorder
quantity for that period. In this situation, the Reorder point will be triggered based on Period and not quantity.

Example: If ‘Packing Material’ of 20 units is predicted to be required on 1-October and Lead days are 10 days
Reorder Point = [planned date – lead days] i.e., 1 October – 10 days = 20 Sep
Reorder Quantity = [predicted or planned quantity] = 20 units

Summary:

Defining the Reorder Point plays a pivotal role in avoiding situations of stockouts and ensuring smooth production. Calculate Reorder Point to ensure optimum inventory in your company.

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