Reorder Level vs Reorder Quantity: Setting Both Correctly

The reorder level (also known as the reorder point) is the inventory threshold that triggers a new purchase order. When your stock level falls to this point, it's time to reorder to avoid a stockout before the next shipment arrives. It is calculated based on your average daily usage and the lead time (the time between placing an order and receiving it).

For example, if you sell 50 units of a product per day and your supplier takes 7 days to deliver, your reorder level would be 350 units (50 x 7). This means you should place an order when your inventory drops to 350 units, even though you still have some stock on hand.

Setting the reorder level too low increases the risk of stockouts, leading to lost sales and unhappy customers. Setting it too high results in excess inventory, tying up capital and increasing storage costs. Therefore, accurate calculation is crucial for effective inventory control.

The reorder quantity is the number of units you order each time you replenish inventory. Unlike the reorder level, which focuses on when to order, the reorder quantity determines how much to order. It directly impacts your inventory holding costs and ordering costs.

A common method to determine the optimal reorder quantity is the Economic Order Quantity (EOQ) model, which balances ordering costs (e.g., shipping, processing) and carrying costs (e.g., storage, insurance, spoilage). The EOQ formula is:

EOQ = √((2DS)/H)

Where D = annual demand, S = ordering cost per order, and H = holding cost per unit per year.

For instance, if your annual demand is 10,000 units, ordering cost is $50 per order, and holding cost is $2 per unit per year, your EOQ would be approximately 707 units. Ordering less than this increases ordering costs, while ordering more increases carrying costs.

Understanding the differences between these two metrics is essential for proper inventory control. Here are the main distinctions:

• Purpose: Reorder level triggers the reordering process; reorder quantity determines the order size.
• Calculation basis: Reorder level uses lead time and daily usage; reorder quantity uses demand and cost factors.
• Impact: Reorder level affects stockouts and customer service; reorder quantity affects inventory costs and cash flow.
• Frequency: Reorder level is recalculated when demand or lead time changes; reorder quantity is recalculated when costs or demand change.

By setting both correctly, you ensure that you order the right amount at the right time, optimizing your inventory levels.

Setting your reorder level accurately requires a clear understanding of your demand and lead time. Here’s a step-by-step guide:

1. Determine average daily usage: Calculate the average number of units sold or used per day over a defined period (e.g., 30 days).
2. Measure lead time: Record the time from placing an order to receiving it, in days. Include supplier processing and shipping time.
3. Calculate safety stock: To account for variability in demand and lead time, add a safety stock buffer. This can be based on historical data or a simple formula like (Max daily usage × Max lead time) – (Average daily usage × Average lead time).
4. Compute reorder level: Use the formula: Reorder Level = (Average Daily Usage × Lead Time) + Safety Stock.

For example, if average daily usage is 20 units, lead time is 5 days, and safety stock is 40 units, your reorder level is 140 units. This means you place an order when stock drops to 140 units.

Regularly review your reorder levels, especially if your demand or supplier lead times change. Seasonality, promotions, and market trends can significantly impact your calculations.

To set the optimal reorder quantity, you need to balance cost factors. Here’s how to do it:

1. Calculate your annual demand (D): Estimate the total units you expect to sell or use in a year.
2. Determine ordering cost (S): Include all costs associated with placing an order, such as administrative, shipping, and receiving costs.
3. Determine holding cost (H): Include costs of storing inventory, such as warehousing, insurance, depreciation, and opportunity cost of capital.
4. Apply the EOQ formula: Use the formula mentioned earlier to find the optimal order quantity.

For instance, if annual demand is 5,000 units, ordering cost is $100, and holding cost is $5 per unit, the EOQ is √((2×5000×100)/5) = √(1,000,000) = 1,000 units. Ordering 1,000 units each time minimizes total inventory costs.

Keep in mind that EOQ assumes constant demand and costs. In practice, you may need to adjust for quantity discounts, storage constraints, or fluctuating demand. Some businesses use periodic review systems or min-max systems, but EOQ remains a foundational tool.

Even experienced managers can make errors in setting these parameters. Here are common pitfalls to avoid:

• Ignoring safety stock: Failing to include safety stock in your reorder level can lead to stockouts during demand spikes or supplier delays.
• Using average lead time without variability: If your supplier is often late, your reorder level will be too low.
• Setting reorder quantity based on gut feeling: Without using EOQ or other models, you may over-order or under-order, increasing costs.
• Not updating regularly: As your business grows, demand and costs change. Review your reorder levels and quantities at least quarterly.
• Overlooking carrying costs: Many businesses focus on ordering costs and forget the significant expense of holding inventory.

Avoiding these mistakes will improve your inventory control and bottom line.

Manual calculations are prone to error and time-consuming. Modern inventory management software can automate the process, adjusting reorder levels and quantities based on real-time data. These tools track sales, lead times, and costs, and can even generate purchase orders automatically when stock hits the reorder level.

Benefits of using software include:

• Accuracy: Reduces human error in calculations.
• Time savings: Frees up staff to focus on other tasks.
• Scalability: Easily handles large product catalogs.
• Data-driven insights: Provides analytics to refine your inventory control strategy.

When choosing software, look for features like demand forecasting, lead time tracking, and integration with your e-commerce or ERP systems.

Mastering the reorder level and reorder quantity is fundamental to effective inventory control. The reorder level tells you when to order, while the reorder quantity tells you how much to order. By calculating both correctly, you can minimize costs, prevent stockouts, and keep your customers satisfied.

Start by analyzing your current inventory metrics, apply the formulas discussed, and consider implementing inventory management software to streamline the process. Regularly review your settings to adapt to changing business conditions.

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