Running a business is complex. Even just managing the day-to-day can have you running circles, and this focus on immediate needs can make it difficult to think long term. However, if you don’t stop to consider the big picture, you might ultimately not have a business to run.
Stocking product requires you to think ahead, and it’s not sufficient to order materials the moment you run out. If you order too soon, you’ll be stuck with a high inventory carrying cost, as stock simply sits on store shelves or in your warehouse, waiting for future orders to come through. The question then becomes: how can you correctly manage inventory flow?
How to Calculate Your Reorder Point
Your reorder point is when you have just enough stock to last (and fulfill customer orders) until the next shipment comes in. It’s the lowest quantity of an item you can have on hand before you will be alerted that it’s time to order more.
Reorder Point Formula
In order to figure out your reorder point, you’ll need a couple of pieces of information:
- Average daily unit sales: How many units do you sell per day, on average?
- Lead time: How long does it take for an order to arrive from your supplier?
If you know the number of days it takes to receive new items and the number of sales you will probably make during those days you’re waiting, you’ll be able to tell the minimum to keep on hand to meet demand. This is the formula you’ll use:
Reorder Point = (average daily unit sales x lead time in days) + safety stock
For example, let’s say that Sandy sells 20 seashells at the Sea Shack per day, on average. It takes 5 days for her supplier to provide her with another order of clean shells. The first part of her formula fills in as follows:
Sandy’s Reorder Point = (20 X 5) + safety stock = 100 + safety stock
In order to complete the formula, we’ll need to figure out Sandy’s safety stock.
How to Calculate Your Safety Stock
“Safety stock” is your emergency stock — a buffer amount of inventory meant to carry you through fluctuations in demand. In keeping with the previous example, maybe there’s a sandcastle festival, and the Sea Shack is selling more shells than usual. Or perhaps Sandy’s supplier runs into some problems of their own, so it takes extra time to get the next order to her. In either case, Sandy would dip into her safety stock to keep her business running, despite the change of circumstances.
Safety Stock Formula
In order to figure out your safety stock, you’ll need to know the following information:
- Maximum daily usage: How much do you sell on your busiest days?
- Maximum lead time: What’s the longest number of days it could take for your order to arrive?
Using that information, the formula for safety stock is:
Safety Stock = (maximum daily usage x maximum lead time in days) – (average daily usage x average lead time in days)
Let’s say that the Sea Shack sells more seashells on the weekend. On Saturdays, Sandy sells 40 shells, on average. Additionally, Sandy’s supplier is having trouble finding shells to clean, so they won’t be able to send her anything for 10 days.
Sandy’s Safety Stock= (40 X 10) – (20 X 5) = 400 – 100
= 300
So Sandy should have 300 shells as part of her safety stock in order to prepare for emergencies.
Now we can plug in Sandy’s safety stock from earlier.
Sandy’s Reorder Point = 100 + 300 = 400
This means that when the Sea Shack only has 400 shells left, Sandy should place a new order with her supplier.
Reorder Point Calculator
Your reorder point is not static. It is different for every product, and might even vary with the season. Depending on your business, keeping track of your own inventory and calculating these dynamic safety stock and reorder points manually ranges from time-consuming to practically impossible. Even if you run an ecommerce shop and you track inventory digitally, managing reorders still takes a significant amount of time. You’ll need to put in the work to account for every item sold.
Inventory management software is an easy solution. Business can change on a dime, so being able to view and adjust your inventory anywhere is an advantage. This is especially true if you’ve got multiple locations or employees who need to access your inventory data out of office.
The first step to long-term success is to figure out each item’s safety stock and reorder point in order to give you an idea of how often you should be ordering. No matter what you sell, keeping track of your inventory is essential to make sure that you’re saving money on storage costs without constantly running out of product.