What is the Reorder Level Formula?

The reorder level formula is that inventory level at which an entity should issue a purchase order to replenish the amount on hand. When calculated correctly, the reorder level should result in replenishment inventory arriving just as the existing inventory quantity has declined to zero. To calculate the reorder level, multiply the average daily usage rate by the lead time in days for an inventory item.

Modified Reorder Level Formula

The reorder level assumes a constant rate of inventory usage, which is frequently not the case. For example, if usage levels spike periodically, the reorder level will be too low, so that there will be no inventory on hand when it is needed for production purposes. Conversely, if actual usage declines, this reorder system will result in having too much inventory on hand. To guard against a stock out condition, it may be useful to include an allowance for additional stock on hand, as well as to replace the average daily usage rate in the reorder level formula with the maximum daily usage rate. Thus, the modified reorder level formula is:

(Maximum daily usage rate x Lead time) + Safety stock = Reorder level

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Reorder Level Adjustments

The reorder level formula can produce incorrect results when the purchasing department replaces an existing supplier with a new one. When this happens, there is a good chance that the lead time for the new supplier will differ from that of the old one - either longer or shorter. If the new supplier has a shorter lead time, then the company will end up with extra inventory on hand, which is a wasteful investment in working capital. Conversely, if the new supplier has a longer lead time, then the company is more likely to have a stockout condition, which can impact its sales. Because of this issue, the purchasing department needs to notify the person in charge of maintaining the reorder level formula whenever a supplier is replaced; this will trigger an ongoing analysis to determine the appropriate lead time to include in the formula for the new supplier.

Example of the Reorder Level Formula

For example, Wilberforce Products experiences average daily usage of its black widget of 100 units, and the lead time for procuring new units is eight days. Thus, the reorder level is 100 units x 8 days = 800 units. When the black widget inventory level declines to 800 units in stock, Wilberforce should order more units. By the time the additional units arrive in eight days, the on-hand inventory balance should have declined to zero.

Advantages of the Reorder Level Formula

The key advantages of using the reorder level formula are as follows:

Prevents stockouts. The formula ensures that inventory is replenished before it runs out, avoiding disruptions in production or sales.
Optimizes inventory levels. The formula prevents overstocking, reducing storage costs and minimizing tied-up capital.
Enhances customer satisfaction. The formula guarantees timely fulfillment of customer orders by maintaining adequate stock levels.
Supports efficient planning. The formula facilitates more accurate procurement and production scheduling, reducing emergency orders.
Improves cost management. The formula lowers carrying costs and reduces expenses associated with expedited shipping for emergency orders.
Simplifies decision-making. The formula provides a clear and systematic trigger for when to reorder, reducing reliance on guesswork.
Adaptable to changing conditions. The formula can be adjusted to reflect changes in demand patterns, lead times, or safety stock requirements.
Minimizes operational interruptions. By maintaining consistent inventory levels, the formula prevents disruptions in production or service delivery.
Boosts efficiency. The formula streamlines inventory management processes, freeing up resources to focus on other business priorities.