You have a great new product on the shelves, and it’s selling fast. Every customer purchase means more revenue, but also brings your inventory levels lower. Of course you’ll reorder before it goes out of stock, but if you order too early, you’ll need to spend more on storing these excess items. If you order too late, you’ll be facing disappointed customers who’ll look to your competitors.
The question then is: When is the right time to order more stock?
To help you out, we’ve designed a reorder point calculator. It’ll let you know exactly when it’s time to place an order for a new shipment of products.
To understand the maths behind our reorder point calculator, let’s break this formula down.
You’ll need to know the lead time demand, because that’s how long you’ll have to wait before new stock arrives - you’ll want to have enough to satisfy your customers while you wait! And you’ll need to know your safety stock, because that’ll protect you against any unexpected occurrences. Add your lead time demand to your safety stock… and voila! Once your stock levels hit the total, it’s time to place a new order to replenish your supply.
New stock doesn’t arrive immediately. Even if your products are in stock, it’ll take your supplier time to pack your order and even more time to ship it over to you. This waiting time is what’s known as “lead time”.
So let’s put things into perspective. Imagine a business (let’s call it J Timewear) in the United States sells watches manufactured in China. Assuming the supplier is always in stock and has a warehouse full of watches ready to ship at a moment’s notice, it’ll probably take the supplier a couple of days to pick and pack the watches. After that, the watches spend another five days in a truck to the port, and from there, it takes about 30 days for a ship to travel from China to the U.S.. Once the watches arrive, they spend another week in customs, and then another three days travelling to J Timewear’s warehouse.
Calculating the lead time is easy: Just add everything up!
2 + 5 + 30 + 7 + 3 = 47 days of sales
Since it takes J Timewear 47 days to get a new shipment of watches, they’ll need to have enough stock on hand to cover these 47 days of sales.
But knowing the lead time alone isn’t enough. You’ll also need to figure out the demand during this period. Assuming J Timewear sells an average of 310 watches a month (310/31 = 10), they’d be selling about 10 watches a day.
So the lead time demand for J Timewear is (47 x 10 = 470)... meaning J Timewear will need 470 watches to tide them over until their next shipment arrives, if nothing unexpected happens.
But sometimes, unexpected things happen. This can take the form of a sudden surge in demand after some unexpected celebrity endorsement, and now your product is selling fast. Or perhaps your supplier’s factory has experienced a breakdown and it’ll take a week for them to replace the damaged component and get their machine up and running again.
And here’s where safety stock comes in. Safety stock is buffer stock you carry as a last defense against unpredictable events that either deplete your stock (surge in demand), or unexpected manufacturing time (your lead time skyrockets because the supply chain breaks down). Of course you’d like to have enough safety stock to bring the likelihood of going out of stock down to zero, but most of the time that’s not financially viable. After all, safety stock IS for a rainy day that may never come! So how do we decide then on how much stock to keep on standby?
Here’s a simple formula that you can calculate based off your purchase and sales orders history:
Let’s continue the story of J Timewear. On an average day, they sell 10 watches. But during weekends, they can sell as many as 15. As for lead times, their usual lead time is 47 days, but during typhoon season (yes, in China, they have typhoons) , it can go up to as high as 54 days.
(15 x 54) - (10 x 47) = 340
This means J Timewear needs to have about 340 units of safety stock on hand to guard against the unexpected (especially during typhoon season). Therefore, with 340 units in safety stock, selling about 80 watches on a good week (10 per day on weekdays and 15 on weekends), J Timewear will have enough stock to last a little over 4 weeks.
Your safety stock can cater for all the variations in demand and lead time, providing you with enough stock on hand to weather unexpected occurrences. Everyone and their entire family wants your products? It’s time to sell your safety stock. Supplier needs an extra week because he’s caught in the middle of a typhoon? It’s time to sell your safety stock.
If your product is seasonal, like school supplies, you’ll have to adjust your safety stock level to cater to peak season demand. Once the peak season’s passed, it’s time to reduce your safety stock levels again, as more safety stock = higher carrying costs. After all, people are a lot less likely to be buying a new set of school stationery in the middle of summer holidays as opposed to right before a new semester begins.
To complete the story of J Timewear, their reorder point would be:
470 (Lead time demand) + 340 (safety stock) = 810
So once their stock hits 810 watches, J Timewear will need to place a new order with their supplier. At 810 watches, they’ll have enough to last them as they wait for new stock to arrive (470), while holding enough stock (340) as a buffer against an unexpected surge in demand or supply chain problems.
Planning reorder points are a crucial part of inventory management. Setting your reorder point to the optimum amount lets you cut down on excess spending, while ensuring you’ll have enough stock for your customers even when things take an unexpected turn.
But how can you always ensure you’ll be able to place a fresh order whenever inventory levels hit the reorder point? Keeping tabs on how much you’ve sold every day is easy when you’re starting out with a single store. But as you start selling more and more, across different channels, manually recording every sale becomes a pretty exhausting chore. And if you only tally up your numbers on a weekly basis, missing the reordering point becomes a likely possibility.
If missing the reordering point sounds like it’ll be a concern, you may want to look into getting an inventory management software system for your business. It’ll track your inventory movement across all channels, and once your stocks hit the reorder point, you’ll be prompted to place a new purchase order. That way, you won’t have to keep worrying about keeping an eye on your inventory with the software doing your work for you.
Automating your inventory processes means everyone wins. You won’t need to put items on backorder and tell your customers “Oh, I’m sorry, we’re out of stock and we can’t get new stock for another week” and disappointing them. As for your customers, they’ll soon know that you’re a seller that’s always able to deliver, and now that you’ve won their trust, they’ll always be coming back for more.
Read next - Introduction to Carrying Costs