Reorder Point System Homework Help, Tutoring
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Reorder Point System
Reorder point may be defined as the level of inventory when fresh order should be
placed with the suppliers for procuring additional inventory, equal to the economic
order quantity. The reorder point is a signal that informs when to place an order.
Calculating the reorder point requires knowledge of the lead time between order
and receipt of merchandise. It may be influenced by the months of supply or total
dollar ceilings of the inventory to be ordered or held.
Re-order Point = Lead time in days x average daily usage of inventory
Lead time is time normally taken in receiving delivery after placing orders with suppliers
Lead time is time normally taken in receiving delivery after placing orders with suppliers
Example: Average daily consumption for a firm is 10,000
units. The number of days required to receive the delivery of inventory after placing
an order is 20 days.
Reorder point = 10,000 units x 20 days => 200,000 units.
This means that the firm should place the order for replenishing the stock of inventory as soon as the level reaches 200,000 units
Reorder point = 10,000 units x 20 days => 200,000 units.
This means that the firm should place the order for replenishing the stock of inventory as soon as the level reaches 200,000 units
Safety Stock
Safety stock implies extra inventories that can be drawn down when actual lead time
and/or usage rates are greater than expected. It can be defined as the minimum additional
inventory to serve as a safety margin or buffer to meet an unanticipated increase
in usage resulting from an unusually high demand and or uncontrollable late receipt
of incoming inventory.
Determination of Safety Stock
The financial manager should determine the appropriate level of safety stock on
the basis of a trade-off between the following two costs associated with it:
- Stock-out costs
Stock-out costs refer to the cost associated with the shortage of inventory. It is an opportunity cost of losing the benefits that would have been gained if stocks were there. - Carrying costs
Carrying costs are the costs associated with the maintenance of inventory.
The larger the safety stock, the larger would be the carrying costs and vice versa.
The larger the safety stock, the smaller would be the stock-out costs. So, based
on the stock-out costs and carrying costs, safety stock will be determined attaining
a trade-off between the two.
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