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How to Set Reorder Points

We partnered with Todd McCormick, Owner of Keystone Climbing Consultants, to help keep your retail cash flow healthy.

How to Set Reorder Points

By: Todd A. McCormick, Owner of Keystone Climbing Consultants

If you’re a coffee drinker, you know how terrible a morning is without your coffee. In our house, when we have less than a week’s worth of coffee it goes on the grocery list so that we can replenish our supply and avoid a coffee-less morning. You should keep your retail shop stocked the same way, especially your top selling SKUs! Most POS systems allow you to set reorder points and run reports based around those numbers. Setting these points and knowing how to run and read these reports can help you maintain an efficient ordering process. Why not just wait until you see that you are low or out of a product? The issue with this approach is the amount of time that you go without product, which means lost sales!

Let’s say your top Friction Labs SKU is Unicorn Dust in the 10oz variety and to keep the math simple, you start with two cases (24 bags), and you sell that stock in the first 24 days of the month. Your average daily sales for this product is 1 bag per day. If it takes 6 days to replenish this product, then waiting until you notice you’re out means you’ll miss 7 days’ worth of sales in a month (lead-time plus an extra day for noticing you’re out and placing your order). If this happens every month, then after a year you’re losing out on $2,100 in sales or about $1,050 in profit just from this one item!! There’s a better way to handle your purchasing and help you minimize lost sales.

When your inventory hits 0 in week 11 you’ll miss out on sales of this product until it’s restocked, 7 days later.

First, let’s define a few things. There are five numbers that are used for calculating reorder points: reorder minimum, target quantity, case quantity, turns, and lead time. 

  • Minimum reorder point is the level at which your POS system triggers that it’s time to buy a product; for coffee in my house that’s when we have less than a week’s worth left, and for products in your retail shop that will depend on average daily sales and lead-time for a given product. 
  • Target quantity is the level you want your inventory to be at after your next order arrives, which is determined by figuring out how many weeks-of-stock (WOS) you want to have on hand. 
  • And case quantity is the number of units that come in a case; like if you buy water for your facility, that usually comes in cases of 24. Most distributors won’t let you break up cases of certain products. For Friction Labs, I always prefer to buy by the case even though they allow you to purchase singles or packs, because I get the best margin if I buy in cases. So for the facilities that I manage, I set case quantity to 12 for Friction Labs 10oz varieties.
  • Lead time is the amount of time it takes to receive a product from your supplier, I was assuming about a week lead time (6 days) in the Unicorn Dust example. 
  • Turns is how many times you sell through your inventory in a given period, typically in a year. If you keep selling 24 bags of chalk every month, no more no less, and buy 24 bags each month, then you’d turn that inventory 12 times. More turns also means more time spent putting together purchase orders, but less space required to store extra inventory. Unless there’s a very efficient ordering process in place, your buyer would be extremely busy if every item was set to turn 12 or more times per year (they’d need to have every item on at least one PO per month). 

Now let’s redo the Unicorn Dust example utilizing reorder points to make the ordering process more efficient and recoup those lost sales. First, let’s start with how many WOS you want to carry. This will depend on how much space you have in your warehouse or back stock room to hold inventory, as well as factors like how much money is available for purchases. Typically, retailers prefer 3-4 turns of their inventory per year, but again this depends on several other factors. This would be about 12 to 16 WOS (52 weeks in a year divided by 4 turns = 13 WOS). For slow moving items, you don’t need a lot of inventory on hand, so you might be ok with fewer turns (and more WOS). And for faster moving items, you would need a lot of space to store 3-4 months’ worth of inventory, so you might be ok with more turns (and fewer WOS). Chalk moves consistently throughout the year, isn’t affected too much by seasonality, and boxes of chalk take up a lot of space in a storage room, so I like to keep my chalk a little higher at about 4-5 turns per year.

Here’s an example list of assumptions for our Unicorn Dust 10oz:

  • Turns = I want 5 per year
  • Case Quantity = 12 per case (I like to get those 50% margins!!)
  • Lead-time = 7 days
  • Average daily sales = 1 bag per day

Step 1, determine WOS: 5 turns per year for my Unicorn Dust 10oz means I need to hold about 10 WOS (52 weeks in a year divided by 5 turns is a little over 10 WOS)

Step 2, determine target quantity: I need 70 bags of chalk (1 bag per day times 7 days a week times 10 WOS) to hold 10 WOS. But 70/12 (cases of 12) is just a little under 6 cases, so I round up and get 6 full cases (72 bags) to make sure I have at least 10 WOS when I place my order.

Step 3, determine reorder minimum: Average daily sales are 1 bag per day and my lead time is about a week, so I’ll set my minimum reorder point to 8, assuming it’ll take me a day to place the order and it’ll ship out the next day (lead-time plus one extra day for ordering). 

Step 4, order when necessary: When I see Unicorn Dust 10oz hit my reorder report it’s because my stock has fallen to 8 or less. Now I’ll place my order and it’ll show up right as I’m selling my last bag from my previous order. Or ideally, even a few days before selling your last bag so that you never actually run out.

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Notice that your inventory level never goes all the way to 0. When it falls below your minimum, you place an order for it and if you have your minimum and lead-time set appropriately, then you get replenished before you run out. This keeps you from having those weeks of missed revenue from this product.

Voila!! We have recouped $1,050 in profit each year just by making sure this one item doesn’t run out. Think about the increased profit if you apply this to all your products!!

A skilled and experienced buyer will keep an eye on sales and adjust reorder points throughout the year to match the demand of every product in your shop. They will also set reorder points for products from the same vendor using the same turns and lead-time (but keep in mind that case quantity and average daily sales are dependent on each product). If you do this, then when you see one item from Friction Labs hit your reorder report, it’s likely time to order other items from them as well. Ordering in this way will also help spread out shipping charges and save you time by placing fewer orders.

Never run out of chalk, avoid missed sales, make the most of shipping costs, and increase sales and profit from your retail shop! Applying the same principles at home keeps all the coffee drinkers happy, too!

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