The good news: Calculating your brand’s reorder point and the amount of safety stock you need at any given time doesn’t require a degree in accounting.
When you have a handle on the concepts and how to perform the required calculations, you can find the right answers to how much safety stock you need on hand and when to reorder any product you sell. Further, by using these formulas and putting reordering guidelines in place, you can prevent supply chain backups, extended wait times for customers and other inventory-related issues that can turn into headaches.
This knowledge, now more than ever, is essential to running a seamless operation.
The COVID-19 pandemic has illustrated the need for every successful business to have an inventory management system. State- or country-based shutdowns can stop production at a moment’s notice, leaving you with limited options to get the stock necessary to meet customer demand.
Similar to the buying frenzies that began for hand sanitizer, toilet paper and sanitizing wipes, an unexpected event can trigger a large section of customers to want a product you offer. If you have a product listed on your website but don’t have any in your warehouse, you can expect customer service issues and even damage to your online reputation.
In this article, we’ll review your reorder point, how to calculate it and the amount of safety stock you should have at any given time so you can stay ahead of the game.
What is Reorder Point?
To understand how to put together a reorder point planning strategy, let’s identify some key concepts that factor into the process.
A reorder point is simply the unit quantity that triggers your system to restock a particular item before running out.
Depending on the complexity of the system and the level of inventory automation you’ve incorporated, when the system recognizes there’s only a certain amount of product in stock, it will remind your purchasing department to order more. Or, it’ll simply issue an automated purchase order on its own.
The reorder point is usually based on past sales to help you realistically predict the future sales of the item. While it cannot account for issues and delays that can occur in the real world, it does provide you with a reliable way to ensure your warehouse stays stocked.
Calculating the reorder point and planning your inventory needs around it helps you eliminate long lag times. Plus, it eliminates the chance of popular items getting back-ordered.
What is Safety Stock?
Another concept that is crucial to a reorder point planning strategy is safety stock.
Safety stock refers to the items in your inventory that are kept on hand as a sort of buffer. If for some reason you’ve miscalculated the reorder point or some kind of supply chain breakdown occurs, you can use the safety stock to meet your customer service or shipping deadlines and keep customers happy. Many businesses keep a safety stock of the most popular items on hand in the warehouse to fulfill orders of this product without delays.
You may be asking yourself why calculating a reorder point and keeping safety stock on hand is so important. Here are two reasons:
- Ordering too much of a product that proves to be unpopular or a product that isn’t ready to go to market will result in you spending more on the storage and marketing of these excess items.
- If there’s no reorder point in place and you order more of an item after you’ve seen increased demand from customers, it may be too late. This could leave your business with disappointed customers who may shop elsewhere and drop any brand loyalty they had to you.
The fact is, issues with ordering and having the right items in stock can cost you — money and otherwise — in various ways.
Understanding the Reorder Point Formula
The reorder point formula is used to calculate your reorder point accurately instead of guessing or waiting until stock runs out.
To get this number, you’ll first need to determine how many sales are made on an average day, and the amount of lead time needed to restock popular items. You can use your recent sales figures and purchase orders to determine each of the averages.
Once you’ve determined your averages, multiply the average daily unit sales by your delivery lead time. Add this number to the amount of safety stock you have in the warehouse; this will give you the number of units that should trigger the reorder process.
For example, if a doll sells an average of five units per day, and the delivery lead time to stock more of these dolls is two weeks, the warehouse manager would multiply 5 by 14, for a total of 70. Next, they will add the number of dolls routinely kept in safety stock to the total.
In this example, the warehouse keeps 50 dolls in safety stock, making the total 120 dolls. When there are only 120 dolls left in stock in the warehouse, the manager will have to order more to keep the supply chain running without any delays.
If you’re unable to calculate the reorder point on your own due to a lack of existing data or another issue, you can use an online reorder point calculator to help give you a guideline.
These tools help you access your inventory needs, but they’re also only as accurate as the numbers you input. Be sure to check your numbers often and keep them based on your last month of sales to account for any seasonal variation.
How Much Safety Stock Do You Need?
It depends on your numbers and industry.
When deciding on the right amount of safety stock to keep in your warehouse, consider the number of average daily sales and the lead time to stock more of these items.
Your safety stock needs to cover the normal reordering time to get more of any given item in stock without customers having to wait. However, if you have too much safety stock, you risk it staying in your facility for too long.
What is a Good Inventory Turnover Ratio?
Looking at how quickly items sell is a vital part of this process. It helps you stop overbuying and prevents you from taking up space in your warehouse with items that aren’t selling — leaving more room for the items your customers do want. Learning how to calculate a brands unique inventory turnover rate is fundamental to maintaining balanced inventory.
To calculate your inventory turnover ratio, take the average inventory, and divide it by your annual cost of goods sold (COGS).
A high turnover ratio typically indicates a product is selling well, while low turnover may indicate the product has stalled in terms of popularity and sales. You want to strive for a high turnover rate, as a low one carries many associated holding costs that can detract from the bottom line.
Strategies for Reorder Point Planning
Building a reorder point planning strategy doesn’t have to be overwhelming. It can be simple for small businesses or those just starting out:
- To begin, you can calculate the reorder point of each product, and then
- Set reminders in your system to place a new purchase order when you reach the appropriate amount of units in stock.
However, as your business grows larger and you have multiple locations to keep track of, it can be harder to keep track of it all — from the products you have in stock to what the lead time is for each one to when they need to be re-ordered.
Note: Seasonal trends and other standard deviations can also affect your reorder point over time, meaning you may have to recalculate regularly to keep these numbers accurate.
When you get to this size, you may want to consider an inventory management software system. If you have businesses with multiple locations or several warehouses, this will help you pull inventory or keep track of a more complex reorder point plan. It will track every aspect of the inventory cycle, from the time it's ordered to when it arrives at your warehouse, and even once it ships out to a customer.
Crunch Those Numbers
Knowing your online store's safety stock and reorder point will help you run your business more seamlessly.
You can save money and better forecast shopping trends. And with a proper reordering point planning strategy in place, you can cut operating expenses, improve customer service and spend less time overall on warehouse management.
So organize and crunch those numbers — again, no accounting degree required — to set your store up for success.