Your warehouse contains 120 units on hand. Your customer consumes about 20 units per day. Your vendor takes four days to fulfill your purchase order. The warehouse doesn’t appear to be in trouble, but what you really want to know is when to issue the next purchase order so inventory doesn’t run out before the goods are delivered.
In simple terms, the reorder point is the point at which you need to order more inventory. Let’s say that you have an average demand of 20 units per day and a vendor lead time of four days. You expect to sell 80 units before you receive a new shipment. Therefore, your reorder point is 80 units. That means when your inventory drops to 80 units, you need to order.
This equation only works if your units match up. Don’t multiply weekly demand by lead time measured in days. Also, be aware that four working days is not always equal to four days. Weekends can delay vendor processing or transit times. Always convert the units of demand and lead time to the same measurement before doing any math. That alone will save you from many headaches that seem like inventory issues down the road.
You also assume your demand and lead time are fairly consistent. The fact is, it’s harder for the real world to cooperate. Demand may spike without warning. Vendors may take longer to issue a PO. Carriers may drop the ball. Safety stock can help protect you against such disruptions. For example, if you have 20 units of safety stock on hand, your reorder point is now 100 instead of 80. Keep safety stock separate from the reorder point itself to make it easier to understand its role.
Don’t confuse the reorder point with your order quantity. The reorder point tells you when you need to order. The order quantity tells you how many units you need to order. The minimum order size of the vendor, available warehouse space, warehousing costs, demand forecast, and outstanding POs all play a role in determining the order quantity. If you don’t separate the two, you can end up with too much inventory even though the reorder point appears accurate.
Make a quick spreadsheet of your inventory. Start with a balance of 140 units. Set your demand at 20 units per day. Decrease inventory by one day at a time. Note the inventory level at the reorder point. Now, increase the lead time to six days. Recalculate your reorder point. The reorder point moves from 80 units to 120 before safety stock is added. That shows you how an inventory that appears to be meeting a consistent forecast might still require you to order earlier due to a higher lead time.
If you can describe your reorder point in one sentence, namely, average demand during lead time plus any safety stock, then you are on your way to making sure that this number doesn’t confuse you with your order quantity. And if you can quickly confirm the unit measurements, as well as the demand/lead time periods, you’ll find it easy to tweak things along the way.