What is the Reorder Point?
The reorder point is the point to which inventory is allowed to fall before a purchase order for further supplies is placed.
A business will not want to run out of inventory as this will lead to lost sales, on the other hand holding too much inventory means cash is tied up in funding the inventory. By calculating the reorder point, a business can ensure that the minimum inventory is held while maintaining a level to satisfy demand.
The reorder point formula is given by:
The lead time is the time in days it takes between the inventory being ordered from a supplier and it being delivered to the business. The normal daily usage is the average rate at which the inventory is used in units. The safety inventory is the number of units of inventory held as a buffer to allow for errors in the lead time and usage.
For example, if the normal usage is 20 units per day and the lead time is 14 days, and a safety inventory of 50 units is needed, then the reorder point calculation gives 50 + 20 x 14 = 330 units. When the inventory reaches 330 units, the reorder point inventory has been reached and a purchase order should be drawn up to order more.
For further information see the Wikipedia inventory reorder point definition.
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