When a customer places an order, you want to be sure you have the inventory item they want in stock. If you don’t, you can’t fulfill their order. This result is lost sales, frustration, and the possible defection of a customer to a competitor. You can avoid this by keeping enough stock on hand and setting thresholds for when to replenish stock.
Safety stock and reorder points are two inventory control strategies used to manage these issues. Each has its own formula, and can help you place purchase orders that will meet customer demand in a timely, efficient fashion. Here’s an overview of reorder points and safety stock, including how to calculate them.
What is safety stock?
Safety stock, also known as buffer stock, is the extra physical inventory a company holds to lower the risk of stockouts. This guards against upswings in demand, increased lead times for deliveries from vendors, and supply chain disruptions. Safety stock ensures you have an inventory cushion in case you need to wait for backorders from suppliers, for instance.
Business owners typically want to hold buffer stock and strive to maintain a minimum safety stock level at all times. Safety stock is not to be confused with excess stock. Excess inventory takes up space in stores and warehouses that could be used for other purposes. It comes with unexpected carrying costs, as well as the risk of expiration or obsolescence before sale. (Old or obsolete inventory is sometimes called dead stock, and it often eats into a business’s profit.)
What is a reorder point?
In inventory management, the reorder point (ROP) is the threshold at which new orders must be placed to prevent stockouts. Some inventory managers manually set reorder points based on historical data, but many now use inventory management software for reorder point planning. Humans or software applications forecast reorder points based on factors such as lead time demand (or the anticipated number of units sold before new stock arrives), average daily sales, and desired safety stock levels.
How to calculate safety stock
Determining how much safety stock you need requires some homework.Before calculating safety stock value, collect the following inputs:
- Maximum daily sales. The highest number of units you sell in a day, based on past sales data.
- Maximum lead times. The maximum lead time you anticipate during the reorder process combines supplier lead times (the amount of time, in days, it takes a supplier to fulfill your order) with delivery lead time (the amount of time, in days, needed for the order to travel from your supplier to you).
- Average daily sales. Calculate average daily demand (or average daily unit sales) by reviewing sales order history: Divide the number of orders by the number of days in your accounting period.
- Average lead time. This combines the average lead time of your suppliers with the average delivery lead time once your supplier ships the goods.
Then, plug these into the safety stock formula:
Safety stock = (maximum daily sales x maximum lead time) – (average daily sales x average lead time)
How to calculate reorder point
You can set accurate reorder points with a formula based on your average demand, lead times, and safety stock level. To set reorder points, start by determining the following inputs:
- Average sales rate. The average rate at which you sell or use up the product over a specified time period—sometimes called your daily sales velocity. Calculate this by dividing the number of units sold by the number of days in a specific time period.
- Lead time. The time, in days, it takes for your supplier to deliver the ordered items after you place an order.
- Safety stock. Safety stock refers to the buffer stock you keep on hand to account for changes in demand or lead times. Calculate safety stock for a particular item with the formula described above.
Place these inputs into the reorder point formula:
Reorder point = (average sales rate × lead time) + safety stock
Nearly all inventory management software can quickly make a reorder point calculation based on historical sales trends, supplier data from past purchase orders, and your present inventory levels. But as long as you have access to the formula inputs, you can calculate your brand’s reorder point on your own.
Reorder point strategies
- Fixed reorder point
- Lead time demand reorder point
- Seasonal reorder points
- Just-in-time (JIT)
- ABC analysis
Inventory planners can use different reorder point calculations to keep shelves stocked and customers satisfied. Here are five reorder stock strategies and how they work:
Fixed reorder point
A fixed reorder point strategy establishes a constant reorder point (i.e., predetermined inventory level) based on historical data and experience. For example, you may decide to always reorder a particular item when your current stock falls to 50 units. You can also establish a minimum order quantity to streamline delivery. This approach is easy to implement but may not account for shifts in demand and lead time.
Lead time demand reorder point
Lead time demand reorder point considers both the average demand rate and swings in demand, ensuring you have enough stock to cover your needs during the lead time. This method requires knowledge of manufacturing time and supplier delivery times, which together comprise product lead times.
Seasonal reorder points
Businesses with seasonal demand patterns may set reorder points that account for fluctuations in demand. For instance, if you sell surfboards, you may need higher reorder points and to hold more safety stock to meet the increased demand during the summer months. Conversely, during the winter offseason, you may lower your reorder point and reorder level to avoid overstocking.
Just-in-time (JIT)
The JIT strategy aims to minimize inventory by ordering new stock only when it’s needed, typically in small quantities. The reorder point in JIT is set very close to the point where you’re out of goods, meaning you keep very little safety stock on hand. Because an item’s reorder point varies from month to month or even week to week, JIT is best suited for businesses with reliable and predictable supply chains.
ABC analysis
In ABC analysis, inventory managers categorize products into three groups (A, B, and C) based on their importance or value to the business. You can then set different reorder point strategies for each category. For example, you may have a higher safety stock and reorder point for high-value “A” items to ensure you never run out, while you can manage lower-value “C” items with a more flexible strategy. You can always recategorize items based on evolving market trends.
Safety stock vs. reorder point FAQ
What is the difference between safety stock and reorder point?
Safety stock is a pre-set amount of goods (either finished products or raw materials) that a business keeps on hand as a buffer. A reorder point is a threshold at which a business orders more inventory.
Is safety stock included in reorder points?
Yes, safety stock is included in the reorder point formula, which is: Reorder point = (average sales rate × lead time) + safety stock.
What is the relationship between turnover rate and reorder point?
Turnover rate, or average sales rate during a specific period of time, is an input in the reorder point formula, along with lead time and safety stock quantity.
Why is it important to have safety stock?
Keeping safety stock on hand can help ensure that your business has the inventory to meet a sudden surge in customer demand. It also allows you to keep up with market demand if your wholesale suppliers experience delays in manufacturing or shipping.
