Reorder Point Defined: Formula & How to Use (2024)

As a business sells inventory, an important decision is: When should we order more productsfrom our suppliers? From small boutiques and large superstores to online shops andeverything in between, this is a nearly universal problem for businesses selling physicalgoods, avoiding running out of inventory while keeping excesses to a minimum. Having asystematic way to deal with this recurring question can lower both costs and anxiety levelswhile ensuring there's enough inventory to meet customers' needs.

What Is a Reorder Point (ROP)?

A reorder point is the level of inventory at whicha business should place a new order or run the risk that stock will drop below a comfortablelevel, or even down to zero — leaving customers unhappy and orders unfulfilled.Usually, ROP refers to buying inventory to replenish stock. But the concept is not limitedto businesses that buy inventory for resale (e.g., buying at wholesale prices and selling atretail). Reorder point logic and math can also apply to storefront locations of largebusinesses where the "supplier" is a warehouse owned by the same company, as wellas to buying items from suppliers to make the products your business then sells.

Why Is Reorder Point Important?

Reorder points are important for two main reasons. First, reorder points allow a business tomake fast, low-stress, data-driven decisions about ordering inventory, without having tostart from first principles every time. A simple, rules-based approach saves time andreduces the possibility of costly mistakes in inventorymanagement.

Second, identifying and using a reorder point to trigger inventory resupply helps a businessoperate more efficiently by balancing two competing needs. If a business reorders too much,too soon, it will be spending money before it needs to, while also incurring costs to carrythe extra inventory, some of which may never be sold (especially for products nearing theend of their life cycle). On the other hand, if a business waits too long to reorder ordoesn't order until the inventory is already needed, lag times between order placementand receipt of the goods will create stockouts (i.e., out-of-stock events where a businesshas to turn customers away or orders aren't fulfilled).

Reorder Point Explained

Reorder point is necessary because we don't live in the hypothetical business worlddescribed in an Economics 101 textbook, a world with perfect information and no transactioncosts or need for inventorycontrols, and no need to keep more inventory on hand than what your customers needimmediately. In this theoretical world, you'd be running a business with no need forinventory, placing orders as the customers come to you and having your customers servedinstantly. But in reality, there aren't enough trucks to ship a single toothbrush at atime; and if there were, those trucks wouldn't get to your stores instantly; and evenif you did have an infinitely large fleet of warp-drive-equipped delivery trucks, it wouldbe quite costly.

In the real world, businesses aim to place bulk orders in advance of when those orders willbe needed. Businesses plan for the customers they expect to serve while accounting foruncertainty and variation, usually with "safety stock"— inventory kept on hand in addition to what they think they'll need to servetheir anticipated flow of customers. Safety stock helps serve unexpected surges in demand(e.g., an increase in customers or the same customers with unusually high needs for a givenproduct).

ROP sets an inventory level for restocking that accounts for lead times and operational"friction." The simplest way to think about it is this: If your inventory is at alevel where, if you placed an order right now, you'd expect to just be reaching zeroinventory (or down to only your safety-stock cushion) when your order arrived, thenit's time to reorder.

How Are Reorder Points Used?

Reorder points are used as thresholds or trigger points. When inventory reaches the levelspecified by the ROP, that means it's time to act. In some cases, this step can even beautomated (though if actual money is changing hands, and you're not just getting aresupply from your own warehouse, it's usually best to have a human double-check thedecision). Reorder points simplify and streamline the business decision of when to reorderinventory.

Using reorder points is very easy, if you have an inventory management system in place thatgives you a real-time view of inventory. It's just a matter of placing new orders whenyour inventory drops to the reorder point level. The more complicated part is determiningwhat those reorder points are, which is a function of the variables that go into a reorderpoint calculation.

Reorder Point Inputs

There are three key variables, or inputs, to consider in a basic reorder point calculation.For example, in a simple scenario where the business is ordering inventory to then sell tocustomers (that is, the business isn't ordering components for a production process tocreate inventory), those variables are:

• Daily sales velocity: How much of this item are you selling every day?
• Lead time: How long does it take from the time you place an order withyour supplier until the items you ordered are ready to be sold to your customer? To makethe math easy, make sure this is measured in the same time units as sales velocity(usually "days" is appropriate, but some businesses may find another unit oftime works better).
• Safety stock: This is the amount of buffer or contingency inventory youalways want to have on hand. It's a rainy-day stash of extra inventory that cancover a sudden surge in demand or an unexpected delay in deliveries. The exact amount ofsafety stock you want is usually the result of a separate determination; including thisin your reorder point calculation helps relieve some of the uncertainty.

Some businesses include other inputs, such as the standard deviations of sales velocity andlead time. Adding such fancy math is useful when using more complex models and assumptions,which are often best for situations where sales and lead times vary quite a bit. But thethree variables above form the core of almost every ROP calculation.

Note that the size of the order isn't one of the key variables or the result of thecalculation. Reorder points are fundamentally about the timing, not the size, of yourorders.

Reorder Point Formula

The reorder point formula must accomplish a complex mission: It must make sure you'rereordering in sufficient time so you (1) don't run out of stock and (2) don't dipbelow your safety stock unless something unexpected happens, while (3) also making sureyou're not ordering so early that business costs rise unnecessarily.

Using the three-variable model, the formula is:

Reorder point = (daily sales velocity)× (lead time in days) + safety stock

In English, that says to reorder when inventory equals the amount you expect to sell duringthe time it takes to get your order from the supplier, plus your safety stock (which servesas a cushion for unexpectedly high demand or slow deliveries). In other words, it calculatesthe point where if you don't reorder, your inventory will drop to unacceptably lowlevels — or to zero, if you don't have safety stock.

How to Calculate a Reorder Point

To illustrate: Let's say you run a popular neighborhood coffee shop that also sellsjewelry made by a local artist. Jewelry isn't your main business, but you do wind upselling four pieces per day. You've determined that you always want to have a safetystock of 20 pieces (maybe the most you've ever sold in a day is 14, which is 10 morethan your daily projection, plus you want another 10 on display at all times to showcase theofferings). And your supplier, the local artist, needs a fair amount of lead time to fill anorder: five weeks. What should your reorder point be?

Looking at the formula — (sales velocity) x (lead time) + safety stock — youmight plugin 4 x 5 + 20 and get 40. But remember, the sales velocity and lead time must be in the sameunits of time. If you're selling four per day and need five weeks (i.e., 35 days, or 7days for 5 weeks) for your order to arrive, you can expect to sell 4 x 35 = 140 pieces ofjewelry while you're waiting for your resupply. Putting everything in days, thecalculation comes to:

Reorder Point = 4 × 35 + 20= 160 pieces of jewelry

When your inventory is down to 160 pieces, that's when you need to order more from yoursupplier. It might seem like a lot for a product that only moves four units a day, but inthis case it's the long lead time that drives the result.

ROP With Safety Stock

Reorder points usually incorporate safety stock, as shown in the standard formula justdiscussed. Even if they don't do so explicitly, it's good to build in someallowance to cover uncertainty and unexpected events. If your business doesn't have aconcept of safety stock (or a similar concept that serves as a cushion in your inventorylevels), you may still want a "safety stock" term in your equation. If you'renot going to go with a more complicated, probabilistic model where lead times are drawn froma probability distribution, then you may want to think about how many days you might have towait for a delivery that's late but not shockingly so. How much would you sell overthat period? That number could serve in place of your safety stock number, or even be addedto your safety stock if late deliveries are a legitimate concern.

ROP Without Safety Stock

It's rare that a company will calculate reorder points without any safety-stock factoror acknowledgment of any of the issues a safety stock addresses. But it's not unheardof, and it's not always unwise. If you're calculating your ROP to figure out whento resupply from a warehouse you own, using logistics mostly under your control, you may notneed a safety stock to account for unexpected delays in the supply chain. You may also be selling productsthat are ordered very far in advance — maybe you sell to big conferences that planyears ahead of time, or to people planning weddings a year in advance. Last-minute rushorders might be so rare, and expensive to plan for, that they're not worth considering.Most businesses won't want to ignore the need for safety stock (or at least the logicbehind it), but there are valid and useful cases of reorder points that omit safety stock.

6 Reorder Point Strategies

A reorder point is a fairly straightforward concept, but successful implementation requirespaying attention to nuance and details about the business, suppliers and customers. Here area few strategies that will help you turn theory into practice.

1. Don't ignore your reorder point. The most important strategy forsuccessfully implementing a reorder point is to consistently execute on it. The benefitof a reorder point is that it tells you when you need to reorder, but it only works ifyou actually reorder at that point.
2. Err on the side of caution. You won't necessarily be able toreorder at exactly your reorder point every time, unless you're using automatedsoftware to place orders. That being the case, would you rather reorder when you'reapproaching your ROP, or after you've already passed it? The answer will depend onwhat's more costly to you: having too little inventory or too much. If yourinventory is perishable, you may be more inclined to wait, while if your on-site storagecosts are low and demand is highly variable, you're probably better off orderingbefore you hit the reorder point.
3. Use sales forecast knowledge to improve your formula. Multiplying dailysales times lead time works well if lead times and daily sales are constant through theweeks and months and years. But suppose lead time is three days, and you know that salesare higher on weekends. You'd be better off using your expected sales over the nextthree days in the formula, rather than your average daily sales, because what looks likeperfectly fine inventory on a Monday may be insufficient on a Friday morning going intoa busy weekend. In some cases, you may even want to look a few days further than yourlead time to see what's coming.
4. Be practical about the calendar. In the previous example, sales go upon weekends. But what if, on top of that, the lead time isn't three days but threebusiness days? You can't place an order on Thursday and have it come on Sunday, sothe actual lead time would be longer. Anything you need for the weekend would have to bein by Friday or you can't sell it on Saturday or Sunday. This means you need toorder your weekend supplies by Tuesday, which, in turn, means you need to be lookingalmost a week ahead and not just three days when deciding when and how much to order.
5. Pay attention to order quantities. If you find yourself constantlyhitting your reorder point, you may not be ordering a high enough quantity with eachreorder. Conversely, if managing your on-site inventory is becoming difficult or costlydue to how much you have, and you're not reordering very often at all, you may haveset the quantity too high. Reorder points are about timing, not quantity, but thatdoesn't mean quantity isn't important. If you're struggling with orderquantity, economic order quantity (EOQ) calculations, which are designed to find a givenbusiness's optimal order quantity, may be useful.
6. Don't over-optimize at the expense of other parts of yourbusiness. When applying a new concept, it's easy and understandable totry to get as much value out of it as possible. But the goal of any implementation isimproving your business, not optimizing an individual metric or process at any expense.Say you own a store selling art supplies. You have reorder points for paint brushes,paints, canvases and a hundred other items. If most of them come from the same fewsuppliers, it might be cheaper, and much better for your supplier relationships, togroup orders together in fewer, larger orders. But if you have a separate reorder pointalert set up for every item, you may wind up placing a new order every few hours.You'll be optimizing for not having too much or too little inventory, but at a muchhigher cost than storing a few extra paint brushes so you can place fewer large orders.In this specific example, you might just place orders for anything getting close to itsreorder point — maybe anything under 150% or even 200% of the calculated reorderpoint gets a reorder in your larger, more infrequent purchases. Reorder points should beintegrated into your business processes to ensure sufficient inventory levels, but theyshouldn't supersede other priorities.

Keep Reorder Points Simple With NetSuite

A reorder point is a simple concept, but when you have dozens or hundreds of reorder pointsacross different types of inventory, as well as nuances derived from forecasts, logisticsand supply-chain issues, it can get complicated to track. NetSuite Inventory Managementsoftware can be a big help in monitoring inventory levels for many products (e.g.,SKUs, for a lot of businesses) and applying more complex reorder point logic. One advantageof installing a platform like NetSuite's to monitor your ROP thresholds is that it alsointegrates with the rest of your inventory management activities and data. Having everythingin one place reduces the need for humans to move data and run analyses, and, in doing so, italso reduces the potential for errors to creep into the data.

Conclusion

Reorder points are a valuable tool for making sure you have sufficient inventory on hand foryour customers without having so much inventory that it becomes costly and unmanageable.Even simple calculations can yield valuable guidelines, and further customization can turn achallenging part of inventory management into an almost automatic process that rarelydemands much worry or intervention. Investments in setting up smart reorder points today canyield dividends in efficiency for years to come.

Reorder Point FAQs

How do you calculate a reorder point?

The details may vary according to a business's specific circ*mstances, but a reorderpoint is calculated by adding your safety stock level to the amount of inventory youanticipate selling during the time it takes to receive an order after placing it.

What are EOQ and ROP?

ROP stands for reorder point, which tells a business when to place an order (where the"when" is given in terms of current inventory levels). EOQ stands for economicorder quantity, which determines how much to buy when placing those orders.

What is the ideal reorder point?

The ideal reorder point is one where the ordered inventory will arrive before you dip below acomfortable level, but not so early that storing and tracking it becomes a problem.Inventory that arrives too early is especially problematic with perishable inventory, suchas meats and produce.

How do you calculate reorder point with example?

A simple reorder point calculation is daily unit sales multiplied by lead time betweeninventory order and its arrival in days, plus safety stock. So, if a business sells 30printers a day and its supplier takes 10 days to deliver an order, and it wants safety stockof at least 25 printers, then the reorder point is 30 x 10 + 25 = 325 printers. This meansthe business must reorder printers when it has 325 left in stock, or it will risk dippingbelow its safety-stock level before the new printers arrive.