The reorder point is a specific inventory level that prompts the action to order new stock. For businesses managing physical products, this figure supports smooth operations. It acts as an internal trigger, ensuring that replenishment happens before inventory is depleted. Properly managing this helps a company prevent stockouts, which can lead to lost sales, and also helps avoid the costs of excess inventory, such as storage fees and potential obsolescence.
The Reorder Point Formula
The calculation for the reorder point combines two main components into a single formula that provides a data-driven signal for when to replenish inventory. The equation is: Reorder Point = Lead Time Demand + Safety Stock. Understanding this formula is the first step toward preventing both stock shortages and unnecessary overstocking.
“Lead Time Demand” represents the total stock you anticipate selling during the period between placing an order with a supplier and receiving it. “Safety Stock” is the additional inventory you keep on hand as a buffer against unexpected events, such as a surge in customer demand or supplier delays.
Each part of this formula addresses a different aspect of inventory risk. Lead time demand accounts for the expected, while safety stock prepares you for the unexpected.
Calculating Lead Time Demand
Lead time demand quantifies the amount of stock you expect to sell while waiting for a new order to arrive. It is based on historical data and provides a baseline for your inventory needs. The formula is: Lead Time Demand = Average Daily Sales × Average Lead Time.
To find your average daily sales, you need to look at past performance by analyzing sales data from the last 30 to 90 days. Total the number of units sold during that period and divide it by the number of days. For example, if you sold 600 units over 60 days, your average daily sales would be 10 units.
The other variable, average lead time, is the time it takes for your supplier to deliver your order, measured in days. To calculate this, review your past purchase orders and record the time elapsed between placing the order and receiving the goods for each one. Sum these individual lead times and divide by the number of orders to find your average.
Determining Your Safety Stock
Safety stock is the inventory buffer a business holds to mitigate the risk of stockouts caused by uncertainties in supply and demand. This extra inventory acts as a cushion, protecting you if sales unexpectedly surge or if a supplier delivery is delayed. Without this buffer, any deviation from your average sales or lead time could result in empty shelves and lost revenue.
The standard formula for calculating safety stock is: Safety Stock = (Maximum Daily Sales × Maximum Lead Time) – (Average Daily Sales × Average Lead Time). This formula quantifies the worst-case scenario for your inventory consumption during the replenishment period and subtracts the expected consumption.
To use this formula, you must identify four distinct variables from your historical data. “Maximum Daily Sales” is the highest number of units of a product sold in a single day within a recent period. “Maximum Lead Time” is the longest time, in days, you have ever had to wait for an order to arrive from your supplier. These figures are then contrasted with your average daily sales and average lead time.
This calculation isolates the inventory needed to cover deviations from the norm. By multiplying the maximums together, you determine the total stock that could possibly be depleted in a worst-case replenishment cycle. Subtracting the lead time demand leaves you with a precise quantity for your safety stock.
Putting It All Together With An Example
To best understand how the reorder point is calculated, it helps to walk through a practical example. This process combines the lead time demand and safety stock calculations into a final, actionable number. Let’s imagine a business that sells a specific type of coffee mug.
First, we need to establish the variables based on historical data:
- Average Daily Sales: 10 mugs
- Maximum Daily Sales: 15 mugs
- Average Lead Time: 7 days
- Maximum Lead Time: 10 days
With these numbers, we can proceed with the calculations in a step-by-step manner.
Step 1: Calculate Lead Time Demand
The first calculation is for lead time demand, which tells the business how many mugs it will likely sell while waiting for the next shipment. The formula is Average Daily Sales × Average Lead Time.
Lead Time Demand = 10 mugs/day × 7 days
Lead Time Demand = 70 mugs
This means that under normal conditions, the business can expect to sell 70 mugs from the moment it places an order until the new inventory arrives.
Step 2: Calculate Safety Stock
Next, we calculate the safety stock needed to buffer against unexpected sales spikes or shipping delays. The formula for this is (Maximum Daily Sales × Maximum Lead Time) – (Average Daily Sales × Average Lead Time).
Safety Stock = (15 mugs/day × 10 days) – (10 mugs/day × 7 days)
Safety Stock = 150 mugs – 70 mugs
Safety Stock = 80 mugs
This calculation shows that the business should keep an additional 80 mugs on hand to cover potential variability.
Step 3: Calculate the Reorder Point
Finally, we add the lead time demand and the safety stock together to find the reorder point. The formula is Reorder Point = Lead Time Demand + Safety Stock.
Reorder Point = 70 mugs + 80 mugs
Reorder Point = 150 mugs
The result means that as soon as the inventory of coffee mugs drops to 150 units, it is time to place a new order with the supplier.
Factors That Influence Your Reorder Point
The reorder point formula provides a static number based on historical data, but real-world conditions change. Several external factors can influence your calculations, requiring you to periodically review and adjust your reorder point. It is not a “set it and forget it” metric; it must evolve with your business.
Demand volatility is a primary factor. Seasonal changes, such as higher sales of winter coats in the fall, or promotional events can cause temporary spikes in sales. Market trends or even viral social media posts can shift demand unexpectedly, which will change your sales figures.
Supplier reliability also plays a large role. If you work with a supplier who is consistently late with deliveries, your average and maximum lead times will increase. This forces you to hold more safety stock to compensate.
Finally, your own business growth will naturally require you to update your reorder point. As your company expands and sales increase, the historical data you used will become outdated.