Deciding how much of an item to order to maintain an adequate stock level is always a balancing act when you run a business. If you don't order enough, you risk running out and may be unable to meet customer needs. Purchase too much stock and you'll waste money holding excess inventory. Worse yet, you may lose perishable goods that sit on the shelves too long. Using a reorder level or reorder-point formula allows you to calculate the reorder quantity accurately and keep your inventory system running smoothly and efficiently.
To calculate reorder quantity, multiply your average daily item usage by the average lead time for your orders over a certain period.
The purpose of the inventory-point calculation is to identify when the amount of a particular item has dropped to the point where you need to place an order with the supplier. This inventory level is the one at which you have just enough of the item left to last until the reorder arrives to replenish the stock level. Theoretically, this approach is ideal because it allows you to meet customer demand while tying up a minimum of working capital in inventory. However, it presupposes that demand for a product will be constant and deliveries will always arrive on time. In the real world, shipments are sometimes late or customer demand spikes unexpectedly. It's wise to include an extra amount of inventory, typically called safety stock, to safeguard against these events.
You need two pieces of information to calculate a reorder quantity: average daily usage and average lead time. Choose an appropriate period such as the previous 90 days and add up the number of units of the item used each day. Divide by the number of days in the measuring period to find the average daily usage. For example, suppose you sold 225 widgets during the last 90 days. Divide 225 by 90, and you get an average daily usage of 2.5 widgets.
To calculate average lead time, add up the number of days from the time you made reorders to the time they arrived. If you made four purchase orders for widgets in the last 90 days and it took six, eight, eight and 10 days respectively for the orders to arrive; total the number of days, divide by four, and you get an average lead time of eight days.
There are several ways to choose a figure for safety stock. One standard method is to add an extra day's usage. In the example, the average daily usage is 2.5 widgets. The average lead time is eight days, but one delivery took two extra days. To include an allowance for safety stock, add in two days worth of widgets, or five additional widgets.
The formula for reorder quantity is the average daily usage multiplied by the average lead time. The reorder point is the reorder quantity plus the allowance for safety stock. If average daily sales of widgets is 2.5 and the average lead time is eight days, the reorder quantity equals 20 widgets. The reorder point therefore is 20 plus another 5 widgets for safety stock. In other words, when the inventory level reaches 25 widgets, it's time to place the reorder with your supplier.