It is important in inventory management to determine an appropriate re-order point (ROP), which is the minimum stock level at which additional quantities should be ordered to avoid stock-outs. When inventory level reaches the order point, a new order should be placed.
In determining the ROP the following three factors need to be considered:
- Demand – quantity of inventory used or sold each day;
- Lead Time – time (in days) it takes for an order to arrive when an order is placed; and
- Safety Stock – the quantity of inventory kept on hand in case there is an unpredictable event like delays in lead time or unexpected demand.
If the demand is constant and the lead time is known, then the ROP is calculated using the following formula:
- ROP = Daily Usage x Lead Time (in days)
If a safety stock is maintained, then the ROP is:
- ROP = (Daily Usage x Lead Time (in days))+Safety Stock