No matter what business you run, it is essential to take special responsibility for your work to get the maximum benefit. It is necessary to work in such a way as to encourage the client to make a repeat order. Therefore, many companies must do everything to avoid a sharp decrease in goods in their warehouses.
A particular indicator called reorder points (ROP in short) is used to control the number of goods in warehouses. Let’s figure out what reorder points are, how to calculate this indicator correctly, and what it is generally used for.
What do Reorder Points mean?
Reorder points (ROP) represent the minimum inventory required to meet your business objectives and run the business on a new level without constant restocking. This indicator displays the necessary amount of inventory to avoid a lack of goods in stock.
Different parameters are used in carrying out calculations. Among them, the following are taken into account:
- time to replenish orders;
- guarantees that the product stock will not reach zero in any period;
- setting points to check the availability of inventory in stores, maintaining their optimal quantity until a new batch arrives and there is no shortage.
ROP is necessary to work at different levels of business. This is a performance indicator that allows you to determine the profitability of a business, calculate costs and revenues, and optimize all procurement costs.
The calculation uses the reorder point form, an equation used by various businesses to determine the minimum amount of inventory before the next order and delivery. It contains the following leading indicators:
- safety stock of products for the period until the next deliveries;
- delivery time of the order by the supplier.
These indicators are summed up to obtain the most accurate assessment of the situation. The reorder point fully reflects the features of a particular line of business, allowing you to determine its needs and optimize costs.
Reasons for using the Reorder Points indicator
The reorder point is a critical metric that is used to estimate the cost to a business of purchasing products. ROP is needed to calculate the right amount of inventory to meet market demand and ensure that customers are supplied without excess or shortage.
The reorder point is essential for the following reasons:
- Cost reduction. Keeping a large inventory of products is expensive. It is difficult to sell a them in a short time without losing capital. Reorder points help to ensure the profit of the enterprise, stabilize the financial situation, and select the optimal number of products at no cost.
- Reduced risks of shortages. A large number of reserves require significant expenditures for their maintenance. A small amount of stock leads to a lack – you have to wait until suppliers deliver the inventory and products. Customers can go to competitors during this time. Reorder assessment ROP will help assess possible risks and prevent shortages.
- Forecasting. The correct calculation of reorder points helps identify trends in consumer sentiment and trace the leading indicators for a specific period on all levels. The more accurately the ROP is calculated, the more correctly it is possible to use the available tools and levels to evaluate the effectiveness of procurement.
It can be concluded that reorder points (ROP) are the primary tool to do business in trade at all levels, which helps optimize costs, use the available tools correctly, provide the entire range for buyers, and establish communication with suppliers.
Keeping proper financial records is time-intensive and small mistakes can be costly. BooksTime makes sure your numbers are 100% accurate so you can focus on growing your business.
What do you pay attention to in calculating the ROP?
The reorder point level is calculated using a unique formula. It considers the volume of daily sales and suppliers’ delivery time of products. It is recommended to assume a certain amount of safety stock to reduce the risks of shortages in trade. All businesses can use the same ROP formula to get the result. Let’s try to understand how to calculate the lead time and insurance premiums in more detail. These indicators and levels take into account many external and internal parameters.
Lead time calculation
Product lead time and delivery time are taken to purchase and deliver the product to the customer. The longer this period, the earlier you need to issue it with the supplier. To understand the demand for a particular product or inventory, suppliers need to consider the lead time for delivery and the number of units of products that shoppers buy daily.
ROP safety stock
This indicator is used for ROP calculations by suppliers. You need to understand the factors that can prevent the timely fulfillment of the order and replenish stocks in the warehouse in the required quantity. Safety stock is an indicator that takes into account possible logistical problems. This reserve is used just in case to cover the buyers’ needs.
To calculate the required ROP value of the safety stock, you need to pay attention to the following parameters:
- multiply the number of orders completed daily by the lead time with possible delays – it helps reducing the risk of delays by ensuring a small number of products and inventory in stock in anticipation of delivery by suppliers;
- multiply the average number of orders per day by the time of their implementation – then it will be possible to approximately estimate the effectiveness of logistics processes when working with suppliers and transport companies;
- find the difference between the above results to get the ROP via formula.
Safety stock is the main parameter that affects adjusting the amount of product stock in the warehouse. Reorder points are a necessary tool used in business on all levels. With the help of specialists, it will not be difficult to calculate the ROP formula. They use software that makes all analytical processes more accessible and transparent.
Reorder Points Formula
In practice, let’s study the formula for calculating the reorder point. To begin with this ROP formula, you need to take the average amount of the product that is sold on any given day in the store with the supplier. These figures are summed up to determine the average number of sales for a particular period.
The average delivery time is the time it takes to deliver the product to the store. You need to have several sample orders on hand to check all the figures.
Delivery time varies depending on the number of goods and other features. Large shipments take much longer to deliver. Also, the speed of delivery depends on seasonality, the characteristics of the supplier, its location, and the chosen route. All these processes are taken into account to determine the average time spent on the delivery of products and inventory.
Add the total delivery time, and divide it by the average number of orders to determine the delivery time using this formula.
It would help if you considered some subtleties to calculate the reorder point and safety stock quickly. This is important to ensure that there are always enough products and inventory in stock to be sold in the store.
When making a decision, it is necessary to count the average number of sales per day and the average value of a particular product or inventory used in work. Delivery lead time also plays an important role in replenishing reserves and reducing the risk of shortages, which suppliers use.
Let’s calculate the ROP formula. It looks like this:
ROP = (Average daily unit sales x Delivery lead time) + Safety stock
For example, the company sells 18 units of the product every day. The time for delivery is 3 days. Safety stock is 15 – this is the amount of product to decrease lack. So, the ROP is (18 x 3) + 15 = 69. This number is the reorder point of the company’s product.
Reorder points are essential metrics to keep your business running smoothly. It will not be possible to optimize the cost of purchasing products and inventory without this stuff. You can work with spreadsheets and other automated tools to streamline all calculations.
Reorder Points advantages
The reorder point is a kind of switch that indicates when a new batch of products needs to be ordered. Benefits of using this indicator include:
- increasing the level of confidence on the part of buyers;
- constant availability of inventory in stock;
- no commissions for urgent orders and savings;
- less capital on excess inventory in warehouses;
- the higher margin for suppliers;
- ease of forecasting and transparent calculations.
You can calculate the reorder point yourself manually using the ROP formula. It takes a lot of time. You can turn to specialists who will help simplify the task.
Calculating reorder points is essential for any business level that operates in the retail industry. Using formulas to calculate ROP, you can calculate sales efficiency. Performing all of the above tasks by hand is quite tricky. For this, it is better to use automated tools. Automation of processes will help arrange orders for goods, increase the business level and win customers’ trust. Then the buyers will return again and again, happy to make purchases.
Author: Charles Lutwidge