A Reorder Point system is an inventory control that helps businesses maintain an appropriate inventory level and avoid shortages. This system works by requiring managers to order more products when the current supply of products falls below a predetermined amount.
The ROP system can be applied to almost any product, but it is most commonly used in manufacturing where many components or raw materials are involved.
This post will discuss how an ROP system functions, its formula, calculation, and advantages.
Reorder Point is a popular inventory control method. The ROP system monitors your inventory levels and orders more when the level drops below a certain point.
Some companies also include safety stock in their calculations to ensure they never run out of product. There are many benefits to using this system, including increased efficiency and reduced costs for over-ordering or under-ordering products.
That will help ensure no interruption in the production and save on extra costs.
The reorder point differs because every item has its importance and a usage rate in the production process.
It also is dependent on several other factors such as discounts, the delivery time of the item, safety stock, and so on.
With the evolution of ERP, this process is automated and hence very simple to perform. All the crucial is tracked in the system and is taken care of.
Early ordering also helps cut down high costs put forth by vendors and administers good negotiation.
Reorder point formula
Below is the formula for finding reorder point,
Reorder point = (Average lead time in days X Average daily usage )+ Safety Stock
Lead time is the difference between a purchase order issued and product delivery.
Safety stock is the number of materials or products to be stocked in the warehouse in unexpected emergencies.
Calculation of reorder point
To calculate reorder-point, you need to calculate lead time in days and safety stock.
Example of calculating ROP
For example, let us assume a company sells wooden dolls. For that, it needs wooden pieces. To produce one doll, the company requires one pack of wooden pieces.
The company requires ten wooden pieces per day to produce ten dolls. But when the company does maximum production, it requires 14 packets per day.
Once the company places the purchase order, it takes 16 days to deliver the wooden pieces. However, sometimes delays happen in supply. Hence lead time extends up to 22 days.
The company takes, on average, five days to produce one doll, but occasionally it takes ten days to make one doll because of the delay in the production process.
That makes company sales, on average, ten dolls per day. Sometimes, it will be 30 dolls per day, depending on the demand.
Now, we put all data in the form of a table.
First, we calculate safety stock for packets of wooden pieces.
Safety Stock of packets = (Maximum lead Time in days X maximum daily usage) – (Average lead time in days X Average daily usage)
= (22 X 14)-(16 X 10)
Safety stock of Dolls = (10 X 30)-(5 X 10)=250
Reorder point of packets= (Average lead Time in days X Average daily usage )+ Safety Stock
= (16 X 10)+148=308
Reorder point of dolls = (5 X 10)+250=300
Advantages of reorder point
Getting accuracy in finding the reorder point in inventory control has the following advantages.
- One of the key benefits of this system is that it allows a smooth inventory flow with no halts in between. This further builds on the inventory discipline of your business.
- It makes space to identify procurement issues and helps resolve them, leading to a smoother process.
- Makes sure that the stock is available and thus avoids any production glitches.
- Unnecessary expenditure in stocking and maintaining the inventory is reduced.
- It helps the business to make appropriate decisions by helping to track the entire procurement procedure.
What is Buffer stock?
Buffer stock is a system that purchases and holds stocks to avoid decreasing the price below a target range during good collecting time and releases stock to prevent increasing of price above the target level during wrong collecting time.
How do you calculate buffer stock?
To calculate buffer stock, you need to calculate the following variables. They are
- Desired service level
- The standard deviation of lead time
- Average demand
The formula for Buffer stock is = Desired service level X Standard deviation of lead time X Average demand.
Let us have a look at the calculation of variables.
Calculation of desired service level
Service level varies from product to product of an organization. Generally, the service level of an organization’s product lies between 90% to 100%.
Let us assume that your company’s service level is 92%. Then, we need to convert it into factors. That is 1.41.
How to find the standard deviation of Lead time?
Historical data is crucial to calculating the standard deviation of lead time. For example, your vendor may have a lead time in their service level agreement. Sometimes this lead time changes.
Some vendors exceed the lead time mentioned in the service level agreement. Some suppliers deliver early.
For example, assume that the lead time in the service level agreement is 20 days. Some suppliers supply after 20 days and others supply within 20 days.
Now we use historical data to determine the standard deviation of lead time.
First, you need to find the difference between expected lead time and actual lead time to get deviance (shown in the above table). Then add all the deviance, which is equal to 5 days.
Now, divide it by the number of orders, that is 10. That gives a standard deviation of 0.5. Now add this to the expected lead time.
Twenty days +0.5 days = 20.05 days is your standard deviation of lead time.
- It helps you to calculate accurate buffer stock
- It shows the reliability of your suppliers
Calculation of average demand
To calculate the demand average, you need to determine the number of products you can sell in a given period.
Now assume that you will sell 300 products in one month. That means 300 products in 30 days. Then your average demand will be 3000/30 = 100 products.
Now your buffer stock = 1.41 x 20.05 X 100 = 2827 UNITS
You can integrate it into your reorder point calculation.
Safety stock is the inventory that a company holds in its warehouse to avoid a shortage of materials during the sudden increasing demands.
It applies to both raw materials and finished final products. If your suppliers supply raw materials on time, your production process does not disturb.
But in reality, some of your suppliers may not be able to deliver the materials on time because of their problems.
In this case, it is difficult to you to meet your customer’s demands on time. So it is better to have some safety stocks.
To have an undisturbed production process, if you hold more inventory, that is waste only. However, it will be a cost burden to the company since you need to have more space in the warehouse for that excess stock and pay a salary to the laborers handling the inventory.
So, a company must have a good balance between safety stock and overstock. Reorder point helps to maintain this balance.
What is the formula for safety stock?
Safety Stock = (Maximum lead Time in days X maximum daily usage) – (Average lead time in days X Average daily usage)
The efficient periodic review system is vital in determining to reorder points and achieving order-up-to-level inventory control.
The Reorder Point system is one of the most widely used inventory control methods. It calculates how much stock to order based on a target re-supply time and desired safety margin.
If you’re looking for help with your ROP, you can use the formula given above to calculate it. In addition, this post has some helpful strategies, including why it’s essential to have more than one reorder point available, which can be tailored based on the type of business you are running.