Reorder point

Reorder point

The reorder point is the level of inventory when a fresh order should be made with suppliers to bring the inventory up by the Economic order quantity (EOQ).

Continuous Review System

The reorder point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instantaneous replenishment of stock the level of inventory jumps to the original level from zero level.

In real life situations one never encounters a zero lead time. There is always a time lag from the date of placing an order for material and the date on which materials are received. As a result the reorder point is always higher than zero, and if the firm places the order when the inventory reaches the reorder point, the new goods will arrive before the firm runs out of goods to sell. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered.

The two factors that determine the appropriate order point are the delivery time stock which is the Inventory needed during the lead time (i.e., the difference between the order date and the receipt of the inventory ordered) and the safety stock which is the minimum level of inventory that is held as a protection against shortages due to fluctuations in demand.

Therefore:

Reorder Point = Normal consumption during lead-time + Safety Stock.

Several factors determine how much delivery time stock and safety stock should be held. In summary, the efficiency of a replenishment system affects how much delivery time is needed. Since the delivery time stock is the expected inventory usage between ordering and receiving inventory, efficient replenishment of inventory would reduce the need for delivery time stock. And the determination of level of safety stock involves a basic trade-off between the risk of stock-out, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory.

Another method of calculating reorder level involves the calculation of usage rate per day, lead time which is the amount of time between placing an order and receiving the goods and the safety stock level expressed in terms of several days' sales.

Reorder level = Average daily usage rate x lead-time in days.

From the above formula it can be easily deduced that an order for replenishment of materials be made when the level of inventory is just adequate to meet the needs of production during lead-time.

Example

If the average daily usage rate of a material is 50 units and the lead-time is seven days, then:

Reorder level = Average daily usage rate x Lead time in days = 50 units x 7 days = 350 units
When the inventory level reaches 350 units an order should be placed for material. By the time the inventory level reaches zero towards the end of the seventh day from placing the order materials will reach and there is no cause for concern.

Re-order point = Average Lead Time*Average Demand + Z*SQRT(Avg. Lead Time*Standard Deviation of Demand^2 + Avg. Demand^2*Standard Deviation of Lead Time^2)

Reorder point = S x L + J ( S x Rx L)WhereS = Usage in unitsL = Lead time in daysR = Average number of units per orderJ = Stock out acceptance factorThe stock-out acceptance factor, `F', depends on the stock-out percentage rate specified and the probability distribution of usage (which is assumed to follow a Poisson distribution).

[Theory and Problems in Financial Management - M Y Khan, P K Jain]

References


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