To do uninterrupted production, you require sufficient inventory. You may have a question, how to restore inventory automatically? You can get an answer through this article.
It is all about reorder point, its definition, formula, calculation, and its advantages.
Reorder Point (ROP) system is a process where the inventory is restored as soon as the existing stock hits a specific bottom.
This will help in ensuring that there is no interruption in the production and also saves on extra costs.
Given the fact that every item has its own importance and a usage rate in the production process, the reorder point differs for every item.
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 in cutting 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 time 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 case of unexpected emergencies.
Calculation of reorder point
To calculate reorder point, you need to calculate lead time in days and safety stock.
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.
Now, the company requires on average 10 packets of wooden pieces per day to produce 10 dolls. But when the company does maximum production, it requires 14 packets per day.
Once the company places the purchase order, it takes on average 16 days to deliver the wooden pieces. Sometimes delays happen in supply. Hence lead time extends up to 22 days.
The company takes on average 5 days to produce 1 doll, but occasionally it takes 10 days to produce 1 doll because of the delay in the production process.
Company sales on average 10 dolls per day, sometimes it will be 30 dolls per day depending on the demand.
Now, we put all data in the form of the 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
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 in resolving the same leading to a smoother process.
- Makes sure that the stock is available at all times 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 avoid increasing of price above the target level during bad collecting time.
How do you calculate buffer stock?
To calculate buffer stock, you need to calculate the following variables. They are
- Desired service level
- 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 a product of an organization lies between 90% to 100%.
Let us assume that your company’s service level is 92%. We need to convert it into factors. That is 1.41.
How to find the standard deviation of Lead time?
Historical data is very important to calculate the standard deviation of lead time. You may have a lead time from your vendor in their service level agreement. Sometimes this lead time changes.
Some vendors exceed the lead time that they have 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 other suppliers supply within 20 days.
Now we use historical data to find out the standard deviation of lead time.
You need to find the difference between expected lead time and actual lead time first to get deviance (shown in the above table). Then add all the deviance that is equal to 5 days.
Now, divide it by the number of orders that is 10. This gives a standard deviation of 0.5. Now add this to the expected lead time.
That is 20 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 find out the number of products you can sell in a given period of time.
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 number of 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 then your production process does not disturb.
But in reality, some of your suppliers may fail to deliver the materials on time due to their internal problems.
In this case, it is difficult to you to meet your customer’s demand on time. So it better to have some safety stocks.
To have an undisturbed production process if you hold more inventory, then that is waste only. It will be a cost burden to the company.
Because you need to have more space in the warehouse for that excess stock and you need pay salary to the labors who are handling the stock.
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 key in determining to reorder point and achieving order-up-to-level inventory control.