When a company needs to place an order to avoid the risk of running out of an item, that level of stock is known as the “reorder level.” It is based on the supplier’s typical replenishment time, the item’s maximum usage during that time, and the need for safety stock. It is also known as reorder point.
The quantity of the order to be placed on a new purchase order for the specific item is the reorder quantity. The ordered quantity or number of units must be as few as possible while taking into account a variety of costs, including those related to placing the order, transportation, carrying costs, etc. The quantity that, given typical usage, strikes the best balance between various elements like quantity discounts, freight, storage costs, and working capital requirements is known as the reorder quantity.
Why is a reorder level important?
Reorder levels are crucial because they enable a company to maximize productivity and perhaps even revenues and profits. This is so that the company can run efficiently while avoiding pitfalls like product waste by ordering the proper amount of inventory. Reorder levels that are precise also aid in lowering carrying costs, or the costs related to keeping stock. Rent, insurance, and potential spoilage are some carrying expenses that can be avoided or reduced with prudent reorder levels. Calculating the reorder level can also be a good way to ensure consistency among team members when multiple people are in charge of placing orders.
What is a reorder level?
The level at which inventory must be replenished to maintain profitable operations is known as a reorder level. By accurately and efficiently calculating this level, your business can ensure that it places the exact right amount of product orders at the exact right time, potentially maximizing revenue and minimizing loss due to factors like wastage. Depending on whether a business decides to keep a safety stock or extra product to account for potential shortages between orders, the formula used to determine reorder levels can change.
If you don’t keep a safety stock, use the following formula to determine your reorder level:
Reorder level = average demand × lead time
If you do keep a safety stock, the formula for reorder level is as follows:
Average demand minus lead time plus safety stock equals reorder level.
How to calculate reorder level
Here are some methods you can use to determine the reorder level for your own business or organization:
1. Identify your average demand
You must first determine the typical demand for a given good or material. This refers to the quantity or number of a specific item you sell or use over a certain period of time. This could be several retail items each day, week, or month, such as plates, shoes, computers, and so forth. It could also refer to an amount of material used over time, such as flour used in a kitchen or wood used in manufacturing.
Because demand may fluctuate from one time period to the next, consider calculating your inventory usage over several of your chosen time periods and averaging those numbers. This might be particularly true for businesses or products that are reliant on environmental factors, like snow tires in the winter versus summer or hot and cold drinks in a restaurant or cafe.
2. Figure out your lead time
Lead time is the period of time after placing your order before you receive a shipment of inventory. Use the same time unit you used to determine your average demand to calculate your lead time. You should determine your lead time in days, for instance, if your average demand is 50 items per day. If your demand was 50 items per week as calculated, your lead time would be measured in weeks. If deliveries are regular, you can probably quickly determine your lead time by looking at your order and delivery records.
If delivery times fluctuate, consider a large number of orders and delivery times, then average those lead times. You could also use different lead times if outside influences affect how long it takes to receive a delivery; for example, out-of-season vegetables may take longer to receive because they are shipped from a greater distance, or an item shipped by air may take longer during periods of bad weather.
3. Determine whether you keep a safety stock
It’s important to ascertain whether or not you maintain a safety stock because you will use a different formula for your reorder level if you do. A safety stock is a quantity of goods or materials that a company keeps on hand in case they run into problems, like an unexpected spike in demand or a delayed delivery. To determine whether your inventory has a safety buffer, compare the amount of stock you keep on hand to the amount you sell or use.
Additionally, you might work with a business executive to determine whether your organization has a policy of maintaining a safety stock available and whether you should factor this into your reorder level. When making or suggesting changes to your inventory levels, be sure to communicate them clearly.
4. Apply the reorder level formula
Calculate your reorder levels using the appropriate formula, taking into account your average demand, lead time, and safety stock. If you need a refresher, the formula for reorder level without a safety stock is as follows:
Reorder level = average demand × lead time
If you do decide to keep a safety stock, use the formula below:
Average demand minus lead time plus safety stock equals reorder level.
Remember to keep your average demand and lead time in the same unit of time. For instance, your lead time should be expressed in days if your demand is expressed in products per day. Your lead time should be the same if your demand is calculated weekly. Think about working together to complete your calculations or asking a teammate to check them for accuracy.
5. Assess and adjust as necessary
Finally, review your reorder level calculations and make any necessary adjustments. You may need to adjust your reorder level in light of the increased demand if, for instance, you notice you are out of stock before your next order ships. You might need to adjust your reorder level if orders start arriving earlier or later.
Reorder level calculation example
Here is an illustration of the reorder level formula in use to help you with your own calculations:
A nearby clothing store wants to know how many long-sleeve shirts they should reorder. By counting how many shirts they sell in a certain amount of time, they first determine their average demand. They determine that they sell an average of 20 shirts per day after calculating sales for several days in light of the fluctuating demand.
Next, they figure out their lead time. Their supplier and shipping service are typically dependable, and it typically takes seven days after placing an order for a shipment to arrive. Despite the fact that seven days can be expressed as one week, they remember to express time in days in order to match the method they used to calculate their average demand.
Customers are frequently content to wait for the arrival of the next order of shirts at this particular retailer, and it is expensive to store extra inventory. So they are aware to use the following formula for their reorder level:
Reorder level = average demand × lead time
When they enter their unique data into the formula, it appears as follows:
Reorder level = 20 shirts per day x 7 days
Because their next order will likely arrive just as they are running out of shirts in stock, the retailer knows to place an order when they have 140 shirts in stock.
Re Order Levels
FAQ
What is reorder level formula?
Reorder level = average demand × lead time. If you do keep a safety stock, the formula is as follows: Reorder level = average demand x lead time x safety stock Remember to keep your average demand and lead time in the same unit of time.
What is reorder level in EOQ?
The term “economic order quantity reorder point” is abbreviated as “EOQ reorder point.” It is a formula used to determine the quantity of inventory to order that will cost the ordering entity the least overall.
What is minimum reorder level?
The reorder point (ROP) is the minimum stock level or inventory for a particular product that, when reached, prompts the reordering of additional inventory. The lead time required to replenish inventory is taken into account when determining the reorder points for various SKUs to prevent inventory levels from dropping to zero.
