Maintaining optimal inventory levels is a constant balancing act. Too much stock ties up valuable capital and warehouse space, but too little leads to stockouts, missed sales, and frustrated customers.
To keep things level, you need to know when to reorder goods. That’s why using the reorder point (ROP) formula is crucial. It lets you strike the perfect balance and stock the right amount of inventory at the right time.
In this guide, we’ll delve into the intricacies of the ROP formula, its significance in inventory management, and practical tips for implementation. We’ll also explore how Fishbowl’s inventory management software can streamline this process and make reordering a breeze.
Understanding the reorder point formula
An ROP is the inventory level that indicates you’re running low on an item and need to order more. It considers various inputs to find the optimal time to place an order, ensuring you’re never caught off guard by unexpected demand or supply chain disruptions.
The ROP formula is:
ROP = (Unit Sales Per Day x Lead Time) + Safety Stock
Let’s break down each component of this formula:
1. Unit sales per day
This is the average number of units you sell each day. Accurate calculation of this metric is crucial, as it determines how long it will take to diminish your stock and it also sets the ROP. Calculate this by analyzing your sales data over a specific period, considering seasonality, trends, and any upcoming promotions that might affect demand.
2. Lead time
This is the duration (in days) between placing a purchase order with your supplier and receiving those goods in your warehouse. Lead time depends on several factors:
- Supplier location: If your supplier is overseas, the lead time will be longer than if they’re located domestically.
- Shipping method: Expedited shipping options like air freight have shorter lead times than standard sea freight.
- Customs and regulations: Customs clearance and regulatory processes can add to the lead time for international orders.
- Supplier’s production capacity: If your supplier has a backlog of orders, it may take longer for them to fulfill your order.
3. Safety stock
Safety stock is the buffer stock you maintain to account for unexpected fluctuations in demand or unforeseen disruptions in the supply chain. It acts as a security measure, ensuring you have enough inventory to cover the following:
- Demand variability: Customer demand can be unpredictable, with sudden spikes or dips, so it’s important to have a little extra on hand.
- Lead time variability: Even with reliable suppliers, lead times vary due to unforeseen circumstances like weather events or transportation issues. Safety stock provides a cushion to cover these delays.
- Supply chain disruptions: Natural disasters, political instability, or other unforeseen events can disrupt the supply chain. Safety stock ensures you have enough inventory to weather these storms.
How do I calculate the reorder point?
Calculating the ROP involves determining the values for each component of the formula:
1. Daily sales
Analyze your historical sales data to calculate the average number of units sold per day. Review your past sales records, ideally over a significant period, to identify trends and patterns that may influence demand, such as seasonality or promotions.
While you can do this manually with spreadsheets, inventory management software like Fishbowl can automate this calculation, saving you time and reducing the risk of errors. Fishbowl also provides tools to help you analyze sales trends and forecast future demand, making it easier to set accurate ROPs.
If you’re calculating average daily sales manually, here’s a simple formula to use:
Unit sales per day = Number of sales / Number of days
2. Lead time
Gather information from your suppliers or analyze past purchase orders to determine the average lead time for each product. Include the time it takes for your supplier to process the order, prepare the shipment, and for the shipment to reach your warehouse. You should also factor in order processing time, shipping time, and potential delays due to customs or unforeseen circumstances. If lead times are inconsistent, it’s wise to use the longest lead time in your calculations to avoid stockouts.
Here’s how to determine your average lead time:
Average lead time = Total number of days to deliver / Total number of orders
3. Safety stock
This is your insurance against the unexpected. Calculate the appropriate safety stock level based on projected sales, demand variability, and lead time variability. You can use statistical methods or leverage Fishbowl’s built-in tools to determine the optimal safety stock.
The higher your desired service level (e.g., 95% probability of not stocking out), the more safety stock you’ll need. Your safety stock strategy is also affected by each product’s type. Some goods are more prone to spoilage or obsolescence than others, so bear that in mind when setting their safety stock levels.
A simple way to calculate your safety stock — before taking into account the considerations mentioned above — is this formula:
Safety stock = (Maximum daily sales x Maximum lead time) – (Average daily sales x Average lead time)
Reorder point formula example calculation
Once you have these values, plug them into the ROP formula to calculate the inventory level at which you should reorder.
Imagine you run an online electronics store specializing in high-end headphones. For a popular model, you have the following data:
- Daily sales: 7 units/day
- Lead time: 5 days
- Safety stock: 35 units
Plugging these numbers into our ROP formula looks like this:
ROP = (7 x 5) + 35 = 70
That means you should reorder headphones when your stock levels reach 70 units.
The importance of the reorder point formula
Here’s more on why accurate ROP calculations are important:
- Prevent stockouts: Stockouts are the nightmare of any business because they result in immediate lost sales. But the damage doesn’t stop there. Even a single stockout could send customers to your competitors, eroding brand reputation and diminishing customer trust. By calculating the precise inventory level at which you need to reorder, you ensure that you replenish your stock before it runs out, keeping shelves stocked and customers happy.
- Optimize inventory levels: The ROP formula helps you find the ideal inventory level that satisfies customer demand without over or understocking. By striking the right balance, your capital isn’t sitting idle in a warehouse.
- Improve cash flow: By minimizing overstocking through accurate ROP calculations, you can invest that surplus of cash in marketing campaigns to attract new customers, research and development to create innovative products, or expansion efforts to reach new markets. This is especially important for businesses with limited resources, as optimizing cash flow can be the difference between stagnation and growth.
- Reduce lead times: Customers expect rapid order fulfillment, and accurate ROPs ensure you receive new stock before your current inventory depletes. You can fill orders quickly and easily when you aren’t waiting on shipments or trying to rush order goods. Plus, by meeting or exceeding customer expectations for delivery speed, you build loyalty and encourage repeat business.
Easily calculate reorder points with Fishbowl
While you can calculate ROPs manually, Fishbowl’s inventory management software simplifies the process and offers a range of additional benefits. By automating the calculation of daily sales, lead time, and safety stock, our software eliminates the risk of human error and ensures more accurate projections. This saves you valuable time and resources so you can focus on other critical aspects of your business.
Fishbowl’s advanced algorithms go beyond simple calculations — they also determine the most cost-effective ROPs for each product in your inventory. It can even help you calculate the economic order quantity (EOQ) to minimize inventory costs while avoiding stockouts.
Plus, Fishbowl’s seamless integration with QuickBooks provides a holistic view of your business operations, making it easier to manage your finances and inventory. Book a demo today to experience the transformative power of Fishbowl for your inventory management.