In short
Reorder point = (average daily sales × lead time in days) + safety stock
- Average daily sales: how many units you normally sell per working day.
- Lead time: the days from placing an order until the goods are in your godown and can be sold.
- Safety stock: extra units to cover a slow supplier or an unusually busy week.
Compare the reorder point with available stock (on hand minus what is already reserved for customers), not with what is physically on the shelf.
The three inputs
1. Average daily sales
Take the units actually delivered over a recent, normal period, for example the last eight to twelve weeks, and divide by the number of working days in that period. Leave out one-off bulk orders that will not repeat, and work out a separate figure for seasons that are clearly different, such as Ramadan or the months before Eid for many trading businesses.
2. Lead time
Measure it from your own records rather than the supplier’s promise: the date you placed each recent purchase order against the date the goods were received. Include transport and unloading. Note both the usual lead time and the longest one you have seen recently.
3. Safety stock
Safety stock absorbs the two things that go wrong: you sell faster than average, or the supplier delivers late. The longer and less predictable the lead time, and the more your daily sales vary, the more safety stock you need. There are several ways to size it, compared below.
Worked example
The product and figures are invented to show the arithmetic.
A distributor sells basmati rice in 25 kg bags from one godown.
| Input | Figure | How it was found |
|---|---|---|
| Bags delivered | 864 | 12 weeks, 72 working days |
| Average daily sales | 12 | 864 ÷ 72 |
| Busiest day | 18 | Highest single day in the period |
| Usual lead time | 5 days | Most purchase orders |
| Longest lead time | 8 days | Slowest recent purchase order |
Lead-time demand is what you expect to sell while waiting for the order: 12 bags × 5 days = 60 bags. Without safety stock, the reorder point would be 60, and any delay or busy day would mean running out.
Choosing safety stock
Three common approaches, from simplest to most data-hungry, applied to the example above:
| Method | Safety stock | Reorder point | When it suits |
|---|---|---|---|
| Days of cover: average daily sales × extra days you want to cover (here 3, the gap between usual and longest lead time) | 12 × 3 = 36 | 96 | Most products. Easy to explain and review. |
| Worst case: (busiest day × longest lead time) − (average day × usual lead time) | 144 − 60 = 84 | 144 | Products you must never run out of. Ties up the most cash. |
| Statistical: based on how much daily sales and lead times vary, and the service level you want | Depends on your data | — | Fast-moving products with a long, reliable sales history. |
The statistical method sets safety stock from the variation in demand and lead time and a target cycle service level (the chance of not running out before the next delivery arrives). The NC State Supply Chain Resource Cooperative tutorial listed below explains the formula. For most small and medium trading businesses, days of cover reviewed every month is a sensible starting point.
How much to order
The reorder point tells you when to order. To decide how much, set a maximum stock level: the most you are willing to hold, considering godown space, cash, supplier pack sizes and minimum order quantities. Each order then tops stock back up to that maximum.
In the example, with a reorder point of 96 and a maximum of 300 bags, an order placed when 90 bags are available would be for 210 bags.
Common mistakes
- Comparing with on-hand instead of available stock. Units already promised to customers cannot be sold again.
- Setting a level once and never reviewing it. Sales and supplier lead times change; review fast movers monthly and others each season.
- Using the supplier’s quoted lead time. Use the lead times in your own receipts.
- One level for very different godowns. A busy city godown and a small branch godown sell at different rates.
- Counting in the wrong unit. Make sure the level is in the same unit you stock, for example cartons rather than pieces.
Doing it in Stockroot
- Open the product and set its reorder level and, if you want, a maximum stock level. Both are set per product and apply in each warehouse.
- When a product’s available quantity (on hand minus reserved) in a warehouse falls to or below the reorder level, it is marked Low stock and appears in the low-stock alerts, with a suggested quantity of reorder level minus available.
- Choose Reorder low stock to open a draft purchase order for every product that needs it. Quantities top up to the maximum stock level if set, otherwise to the reorder level, priced at average cost. Pick the supplier, adjust, and confirm.
Because the level is set per product, a business with very different godowns should set it for the warehouse that sells the most and keep an eye on the others. More on low stock and reordering in Stockroot, and on purchase orders.
Sources
- Supply Chain Resource Cooperative, NC State University, “Reorder point formula: Inventory management models, a tutorial”, 30 January 2011. Explains safety stock, lead-time variability and cycle service level versus fill rate.
- Stockroot product behaviour is described from the application as of the date at the top of this page.