7.2.3 Re-order point (ROP)
As sales are made the inventory levels held by the business fall until, if not replaced, they become zero. Most businesses place orders for replacement inventory before stock is exhausted; and, as inventory approaches zero fresh supplies will be received, thus avoiding out-of-stock situations.
The period between the time that we start the reordering process and when we receive the goods and have them available for sale is referred to as lead-time.
The demand or sales during this lead-time determines the appropriate re-order point or the inventory level at which the re-order process begins. (This assumes no safety stocks are being held). The following example illustrates how the re-order point is calculated.
Example
Suppose a company sells 5000 units of a certain product at a constant rate over 250 working days in a year. The company has estimated that it takes 15 working days from the start of the ordering process to receipt of the goods in its warehouse. If we assume that no safety stocks are to be held, at what inventory level does the company start the re-ordering process?
Answer:
Average demand per day = 5000/250 = 20 units per day
Given that the lead-time is 15 days,
Then the demand during lead-time is 20 x15 = 300units
Therefore, the ROP is 300 units
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