Reorder level of stock
Reorder level of stock (also known as reorder point or ordering point) in a business is a preset level of stock or inventory at which the business places a new order with its suppliers to obtain the delivery of raw materials or finished goods inventory.
Every business has to maintain a certain level of raw materials or finished goods in its store. This is done in order to sustain the continuity of production in case of raw materials and the continuity of sales in case of finished goods. For this purpose, the business must set a specific level at which it should place a new order with the suppliers of inventory.
The two formulas used to calculate the re-order level are given below:
1. When the business does not need to maintain safety stock:
Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days, weeks or months)
2. When the business needs to maintain a safety stock:
[Maximum demand or usage (in days, weeks or months) × Maximum lead time (in days, weeks or months)] + Safety stock
What is lead time?
The timing difference between placing an order with the supplier and arrival of the goods is known as the lead time.
What is safety stock (also known as buffer stock)?
In some scenarios, it may be unlikely that the reorder level could be estimated accurately. This is because the demand and the lead time of the goods could differ than the usual trends and in that case the business may run out of stock. So, a level of safety stock is set to avoid such a condition. It is also known as buffer stock.
Example 1 – reorder level without safety stock
The David IT Store sells 500 laptops on an average in a week. The maximum demand in a week is 523 laptops. If, the lead time is 4.5 week then the reorder level would be:
Reorder level = Maximum weekly usage × Lead time in weeks
= 523 units × 4.5 weeks
= 2,354 units
It means that every time the number of laptops decreases to 2,354, the David IT Store must place a new order.
Example 2 – reorder level without safety stock
A business manufactures tires. The average demand for the business is 645 tires/week and the maximum demand is 670 tires/week. To manufacture one tire 3 kilos of rubber is required as raw material. So, the production department of the business requires a maximum of 2,010 (= 670 × 3) kilos of rubber per week. If the lead time to get rubber from the supplier is 1.5 weeks then re-order level would be:
Reorder level = Maximum demand per week × Lead time in weeks
= 2,010 kilos × 1.5 weeks
= 3,015 kilos
The production department must place a new order when the raw material (rubber) reaches 3,015 kilos.
Example 3 – with safety stock
The following information belongs to Kim Kardashian Clothing Outlet:
Usage or demand
- Minimum demand: 390 sweaters per month
- Average demand:420 sweaters per month
- Maximum demand:435 sweaters per month
- Safety stock: 120 sweaters
- Minimum lead time: 1.2 months
- Average lead time: 1.5 months
- Maximum lead time: 1.75 months
Required: Compute reorder level of Kim Kardashian Clothing Outlet.
Reorder level = (Maximum demand × Maximum lead time) + Safety stock
= (435 units × 1.75 weeks) + 120 units
= 761 units + 120 units
= 881 units
Note for students:
In this article, we have used maximum usage/demand and maximum lead time figures to compute reorder level. Mostly, a similar approach is adopted in cost/managerial accounting educational materials. However, some businesses use average usage/demand and average lead time figures for computing the reorder level of their stock.
If a question regarding reorder level is asked in the examination, the students should provide a note similar to this one at the end of their solution.
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