SLIDE 1: Economic Order Quantity, Reorder Point Formula and Safety Stock

OBJECTIVES

1. Define and explain the EOQ formula, the Reorder Point formula, and the concept of Safety Stock.

2. Interpret and explain how the EOQ formula, Reorder Point formula, and Safety Stock are used in
inventory management.

3. Students will be able to apply the EOQ formula, Reorder Point formula, and Safety Stock concept to
real-world scenarios and calculate the optimal quantity of inventory to order, the stock level at which
inventory needs to be replenished, and the extra inventory held to mitigate supply and demand risks
and prevent stockouts.

SLIDE 2:

Objective 1: Define and explain the EOQ formula, the Reorder Point formula, and the concept of
Safety Stock.

Popularized by Ford Whitman Harris (August 8, 1877 – October 27, 1962) was an American production
engineer who derived the square-root formula for ordering inventory now known as the economic order
quantity.

SLIDE 3: What Is Economic Order Quantity?

Economic order quantity (EOQ) is the ideal quantity of units a company should purchase to meet
demand while minimizing inventory costs such as holding costs, shortage costs, and order costs. This
production-scheduling model was developed in 1913 by Ford W. Harris and has been refined over time.
The economic order quantity formula assumes that demand, ordering, and holding costs all remain
constant.

Inventory cost refers to the total expense a business incurs for obtaining, storing, and managing its
inventory. It's not just the initial purchase price of the items you sell. Here's a breakdown of what it
typically includes:

Ordering costs: This covers the expenses related to placing and receiving orders, like employee time
spent on ordering, transportation costs, and any fees associated with the purchase.

Carrying costs: These are the expenses incurred for storing unsold inventory. This includes warehouse
rent, utilities, insurance, taxes, security, and even the cost of potential spoilage or obsolescence.

Shortage costs: These are the costs associated with not having enough inventory to meet customer
demand. This could involve lost sales, backordering costs, and customer dissatisfaction.

By understanding inventory costs, businesses can make informed decisions about how much inventory
to keep on hand. This helps them strike a balance between having enough products to meet customer
needs and avoiding excessive holding costs.

SLIDE 4:

Objective 2: Interpret and explain how the EOQ formula.

SLIDE 5: Let's consider a hypothetical scenario for a restaurant.

Sample Computation for EOQ in a Restaurant

This sample computation demonstrates how the EOQ formula can be applied in the restaurant The EOQ
model can help restaurants optimize their inventory levels, minimize storage costs, and ensure that they
can meet customer demand without overstocking or running out of essential items

Given:

 Annual demand (D) = 10,000 units (assumed to be food items or supplies)

 Setup cost (S) = ₱25,000 (assumed to be the cost of placing an order)

 Holding cost (H) = ₱5 per unit per year (assumed to be the cost of holding one unit of
inventory for a year)

Findings: This means that the restaurant should consider ordering approximately 10,000 units of the
particular item to minimize costs and meet demand efficiently.

SLIDE 6: What the Economic Order Quantity Can Tell You

The goal of the EOQ formula is to identify the optimal number of product units to order. If achieved, a
company can minimize its costs for buying, delivering, and storing units. The EOQ formula can be
modified to determine different production levels or order intervals, and corporations with large supply
chains and high variable costs use an algorithm in their computer software to determine EOQ.

EOQ is an important cash flow tool. The formula can help a company control the amount of cash tied up
in the inventory balance. For many companies, inventory is its largest asset other than its human
resources, and these businesses must carry sufficient inventory to meet the needs of customers. If EOQ
can help minimize the level of inventory, the cash savings can be used for some other business purpose
or investment.

The EOQ formula determines the inventory reorder point of a company. When inventory falls to a
certain level, the EOQ formula, if applied to business processes, triggers the need to place an order for
more units. By determining a reorder point, the business avoids running out of inventory and can
continue to fill customer orders. If the company runs out of inventory, there is a shortage cost, which is
the revenue lost because the company has insufficient inventory to fill an order. An inventory shortage
may also mean the company loses the customer or the client will order less in the future.

SLIDE 7: In the hospitality and tourism industry, the Economic Order Quantity (EOQ) formula can be
used to optimize inventory management and minimize costs. For example, hotels and restaurants can
use the EOQ formula to determine the optimal quantity of food and supplies to order to meet demand
while minimizing costs. The EOQ formula takes into account the demand rate, setup costs, and holding
costs of inventory. The reorder point formula and safety stock are also important in the hospitality and
tourism industry to ensure that there is always enough inventory to meet customer demand. For
example, hotels and restaurants can use the reorder point formula to determine when to order more
inventory to avoid stockouts. Safety stock is the extra inventory held to mitigate supply and demand
SLIDE 8: Limitations of EOQ

The EOQ formula assumes that consumer demand is constant. The calculation also assumes that both
ordering and holding costs remain constant. This fact makes it difficult or impossible for the formula to
account for business events such as changing consumer demand, seasonal changes in inventory costs,
lost sales revenue due to inventory shortages, or purchase discounts a company might realize for buying
inventory in larger quantities.

SLIDE 9:
The next presenter is ma’am DIAZ, she will be reporting the Reorder Point Formula and Safety Stock

SLIDE 10: Whether you’ve just started a new business or sold products for years, anyone can benefit
from using the reorder point formula. As a business sells inventory, an important decision is: When
should we order more products from our suppliers? From small boutiques and large superstores to online
shops and everything in between, this is a nearly universal problem for businesses selling physical goods,
avoiding running out of inventory while keeping excesses to a minimum. Having a systematic way to deal
with this recurring question can lower both costs and anxiety levels while ensuring there's enough
inventory to meet customers' needs.

SLIDE 11: What Is a Reorder Point (ROP)?

 A Reorder Point (ROP) is the minimum level of inventory that a company must maintain to meet
customer demand. It is the time when a company needs to restock its supply of raw materials,
components, or completed goods.
 A reorder point is the level of inventory at which a business should place a new order or run the risk
that stock will drop below a comfortable level, or even down to zero — leaving customers unhappy
and orders unfulfilled.

SLIDE 12:

 The ROP is calculated by taking into account the lead time and the desired safety stock.
 The ROP is crucial for effective inventory management as it saves holding costs and prevents
stockouts, overstocking, and lost sales by ensuring that sufficient stock is always available in the
inventory.
 The ROP is used to trigger the replenishment process to reorder that particular inventory.
 The ultimate goal of the ROP is to maintain an amount of inventory at a level that can always meet
customer demand.

SLIDE 13: Why Is Reorder Point Important?

Reorder points are important for two main reasons.

First, reorder points allow a business to make fast, low-stress, data-driven decisions about ordering
inventory, without having to start from first principles every time. A simple, rules-based approach saves
time and reduces the possibility of costly mistakes in inventory management.

SLIDE 14: Second, identifying and using a reorder point to trigger inventory resupply helps a business
operate more efficiently by balancing two competing needs. If a business reorders too much, too soon, it
will be spending money before it needs to, while also incurring costs to carry the extra inventory, some
of which may never be sold (especially for products nearing the end of their life cycle). On the other
hand, if a business waits too long to reorder or doesn't order until the inventory is already needed, lag
times between order placement and receipt of the goods will create stockouts (i.e., out-of-stock events
where a business has to turn customers away or orders aren't fulfilled).
SLIDE 15: Reorder Point Explained

In the real world, businesses aim to place bulk orders in advance of when those orders will be needed.
Businesses plan for the customers they expect to serve while accounting for uncertainty and variation,
usually with "safety stock" — inventory kept on hand in addition to what they think they'll need to serve
their anticipated flow of customers. Safety stock helps serve unexpected surges in demand (e.g., an
increase in customers or the same customers with unusually high needs for a given product).

In the real world, businesses face challenges such as imperfect information, transaction costs, and the
need for inventory controls. These challenges make it necessary to use a Reorder Point (ROP) to manage
inventory levels effectively. The ROP is the minimum level of inventory that a company must maintain to
meet customer demand. It is calculated by taking into account the lead time and the desired safety
stock. The ROP is crucial for effective inventory management as it saves holding costs and prevents
stockouts, overstocking, and lost sales by ensuring that sufficient stock is always available in the
inventory. In the restaurant industry, managing inventory of perishable items can be challenging due to
the short shelf life of these items. The ROP can be used to optimize inventory levels for perishable items
by ensuring that the restaurant has enough inventory to meet customer demand without overstocking or
running out of essential items. Common challenges in managing inventory of perishable items in the
restaurant industry include shelf life management, seasonal demand, temperature control, quality
control, and handling returns and waste. By using the ROP and safety stock, restaurants can optimize
their inventory levels, minimize costs, and ensure that they can meet customer demand without
overstocking or running out of essential items.

SLIDE 16: How Are Reorder Points Used?

Reorder points are used as thresholds or trigger points. When inventory reaches the level specified by
the ROP, that means it's time to act. In some cases, this step can even be automated (though if actual
money is changing hands, and you're not just getting a resupply from your own warehouse, it's usually
best to have a human double-check the decision). Reorder points simplify and streamline the business
decision of when to reorder inventory.

Using reorder points is very easy, if you have an inventory management system in place that gives you a
real-time view of inventory. It's just a matter of placing new orders when your inventory drops to the
reorder point level. The more complicated part is determining what those reorder points are, which is a
function of the variables that go into a reorder point calculation.

SLIDE 17: Reorder Point Inputs

There are three key variables, or inputs, to consider in a basic reorder point calculation. For example,
in a simple scenario where the business is ordering inventory to then sell to customers (that is, the
business isn't ordering components for a production process to create inventory), those variables are:

SLIDE 18: 1. Daily sales velocity: How much of this item are you selling every day?

2. Lead time: How long does it take from the time you place an order with your supplier until the items
you ordered are ready to be sold to your customer? To make the math easy, make sure this is measured
in the same time units as sales velocity (usually "days" is appropriate, but some businesses may find
another unit of time works better).

3. Safety stock: This is the amount of buffer or contingency inventory you always want to have on hand.
It's a rainy-day stash of extra inventory that can cover a sudden surge in demand or an unexpected delay
in deliveries. The exact amount of safety stock you want is usually the result of a separate
determination; including this in your reorder point calculation helps relieve some of the uncertainty.

Some businesses include other inputs, such as the standard deviations of sales velocity and lead time.
Adding such fancy math is useful when using more complex models and assumptions, which are often
best for situations where sales and lead times vary quite a bit. But the three variables above form the
core of almost every ROP calculation.

Note that the size of the order isn't one of the key variables or the result of the calculation. Reorder
points are fundamentally about the timing, not the size, of your orders.

SLIDE 19: Why is setting a reorder point so important?

Before we get into the reorder point formula, let’s quickly go over the importance of reorder points.
Here are some of the ways reorder points will help your business:

Avoid stockouts – stockouts occur when a business runs out of inventory and is no longer able to
process a customer’s request for purchase. Obviously, this will lead to dissatisfied customers who aren’t
going to wait around for you to restock. They’ll simply take their business elsewhere, probably for good.

SLIDE 20: Avoid overstock – the flip side of stockouts is carrying excess inventory. The costs associated
with excess inventory add up quicker than you may realize and will eat into your bottom line. Setting up
a reorder point on your products will ensure you’ve got just enough of the things you need when you
need them.

SLIDE 21: Reduce shipping costs – by setting proper reorder points, you can avoid the need for frequent
orders, which will save you a ton in shipping costs over time.

SLIDE 22: Improve forecasting – with accurate reorder points, you’ll be able to anticipate your business
needs, which will ultimately lead to less rushed orders or last-minute panic buying.

SLIDE 23: Calculating average daily unit sales

If we total those numbers, we get 180 total units sold over the past 90 days. That means that the
average daily sales for the Ghost Glasses is 2 per day.

SLIDE 24: Calculating average delivery lead time

Average delivery lead time is the time it usually takes for product shipments to arrive. You should have a
couple of purchase orders on-hand to check the numbers. Delivery times can vary based on your order
quantity (larger orders could take longer to ship). When you place the order also affects the lead time
(compare orders during a busy and slow season). There are different ways to calculate this, but a three-
month average is a good start.

Here are a few Archon Optical purchases for the last three months of Ghost Glasses shipments:
Add the total delivery time (15 days ) and divide it by the number of orders (3). That’s an average lead
time of five days for the product to arrive.

In this example, the lead time is calculated on the vendor level, not at the item level. It does not account
for multiple receiving locations or different lead times per item.

The reorder point formula must accomplish a complex mission: It must make sure you're reordering in
sufficient time so you

(1) don't run out of stock and

(2) don't dip below your safety stock unless something unexpected happens, while
(3) also making sure you're not ordering so early that business costs rise unnecessarily. Add the total
delivery time (15 days ) and divide it by the number of orders
(4). That’s an average lead time of five days for the product to arrive.

SLIDE 25: How to calculate safety stock quickly

Safety stock is similar to a reorder point, but it’s a surplus/excess quantity to ensure you don’t run
completely out of stock if there are delays.

When deciding on a safety stock level, you’ll want to consider: average daily sales and the daily average
that the product used in work orders (if applicable). Lead time is also essential to safety stock.

We’ll keep things simple by calculating based on two weeks of extra demand (14 days). This two-week
estimate is based on what we’ve seen from other small businesses. If you’re dealing with a product that
has a shelf life, you should consider changing safety stock levels to days rather than weeks.
Since the average daily sales for the Ghost are 2 (as calculated earlier on this page), the safety stock for
Ghost is about 14 x 2 = 28.

Putting the reorder point formula together

Reorder point = (Average Daily Unit Sales) × (Delivery Lead Time) + Safety Stock

Now that we’ve got all of the Archon Optical numbers down, we’re ready to put together a reorder
point for the Ghost.

When the quantity on-hand for Ghost glasses hits 38, Archon Optical knows to place a purchase order
for more. Because they’ve built an average delivery lead time into the reorder point, the extra Ghost
glasses should arrive before Archon ever dips below the amount of safety stock.

Even if there are production shortages or shipping delays, Archon Optical’s safety stock ensures they can
sell Ghost glasses for two more weeks before running out of stock.

In other words, it calculates the point where if you don't reorder, your inventory will drop to
unacceptably low levels — or to zero, if you don't have safety stock.

Conclusion

Reorder points are a valuable tool for making sure you have sufficient inventory on hand for your
customers without having so much inventory that it becomes costly and unmanageable. Even simple
calculations can yield valuable guidelines, and further customization can turn a challenging part of
inventory management into an almost automatic process that rarely demands much worry or
intervention. Investments in setting up smart reorder points today can yield dividends in efficiency for
years to come.

SLIDE 26: KEY TAKEAWAYS

How do you calculate a reorder point?
The details may vary according to a business's specific circumstances, but a reorder point is calculated
by adding your safety stock level to the amount of inventory you anticipate selling during the time it
takes to receive an order after placing it.

What are EOQ and ROP?

ROP stands for reorder point, which tells a business when to place an order (where the "when" is given
in terms of current inventory levels). EOQ stands for economic order quantity, which determines how
much to buy when placing those orders.

SLIDE 27: What is the ideal reorder point?

The ideal reorder point is one where the ordered inventory will arrive before you dip below a
comfortable level, but not so early that storing and tracking it becomes a problem. Inventory that arrives
too early is especially problematic with perishable inventory, such as meats and produce.

SLIDE 28: How do you calculate reorder point with example?

A simple reorder point calculation is daily unit sales multiplied by lead time between inventory order
and its arrival in days, plus safety stock. So, if a business sells 30 printers a day and its supplier take 10
days to deliver an order, and it wants safety stock of at least 25 printers, then the reorder point is 30 x
10 + 25 = 325 printers. This means the business must reorder printers when it has 325 left in stock, or it
will risk dipping below its safety-stock level before the new printers arrive.

SLIDE 29: ROP With Safety Stock

Reorder points usually incorporate safety stock, as shown in the standard formula just discussed. Even if
they don't do so explicitly, it's good to build in some allowance to cover uncertainty and unexpected
events. If your business doesn't have a concept of safety stock (or a similar concept that serves as a
cushion in your inventory levels), you may still want a "safety stock" term in your equation. If you're not
going to go with a more complicated, probabilistic model where lead times are drawn from a probability
distribution, then you may want to think about how many days you might have to wait for a delivery
that's late but not shockingly so. How much would you sell over that period? That number could serve in
place of your safety stock number, or even be added to your safety stock if late deliveries are a
legitimate concern.

ROP Without Safety Stock

It's rare that a company will calculate reorder points without any safety-stock factor or acknowledgment
of any of the issues a safety stock addresses. But it's not unheard of, and it's not always unwise. If you're
calculating your ROP to figure out when to resupply from a warehouse you own, using logistics mostly
under your control, you may not need a safety stock to account for unexpected delays in the supply
chain. You may also be selling products that are ordered very far in advance — maybe you sell to big
conferences that plan years ahead of time, or to people planning weddings a year in advance. Last-
minute rush orders might be so rare, and expensive to plan for, that they're not worth considering. Most
businesses won't want to ignore the need for safety stock (or at least the logic behind it), but there are
valid and useful cases of reorder points that omit safety stock.
6 Reorder Point Strategies
A reorder point is a fairly straightforward concept, but successful implementation requires paying
attention to nuance and details about the business, suppliers and customers. Here are a few strategies
that will help you turn theory into practice.

NOTE: Don't ignore your reorder point. The most important strategy for successfully implementing a
reorder point is to consistently execute on it. The benefit of a reorder point is that it tells you when you
need to reorder, but it only works if you actually reorder at that point.

Err on the side of caution. You won't necessarily be able to reorder at exactly your reorder point every
time, unless you're using automated software to place orders. That being the case, would you rather
reorder when you're approaching your ROP, or after you've already passed it? The answer will depend on
what's more costly to you: having too little inventory or too much. If your inventory is perishable, you
may be more inclined to wait, while if your on-site storage costs are low and demand is highly variable,
you're probably better off ordering before you hit the reorder point.

Use sales forecast knowledge to improve your formula. Multiplying daily sales times lead time works well
if lead times and daily sales are constant through the weeks and months and years. But suppose lead
time is three days, and you know that sales are higher on weekends. You'd be better off using your
expected sales over the next three days in the formula, rather than your average daily sales, because
what looks like perfectly fine inventory on a Monday may be insufficient on a Friday morning going into
a busy weekend. In some cases, you may even want to look a few days further than your lead time to see
what's coming.

Be practical about the calendar. In the previous example, sales go up on weekends. But what if, on top of
that, the lead time isn't three days but three business days? You can't place an order on Thursday and
have it come on Sunday, so the actual lead time would be longer. Anything you need for the weekend
would have to be in by Friday or you can't sell it on Saturday or Sunday. This means you need to order
your weekend supplies by Tuesday, which, in turn, means you need to be looking almost a week ahead
and not just three days when deciding when and how much to order.

Pay attention to order quantities. If you find yourself constantly hitting your reorder point, you may not
be ordering a high enough quantity with each reorder. Conversely, if managing your on-site inventory is
becoming difficult or costly due to how much you have, and you're not reordering very often at all, you
may have set the quantity too high. Reorder points are about timing, not quantity, but that doesn't
mean quantity isn't important. If you're struggling with order quantity, economic order quantity (EOQ)
calculations, which are designed to find a given business's optimal order quantity, may be useful.

Don't over-optimize at the expense of other parts of your business. When applying a new concept, it's
easy and understandable to try to get as much value out of it as possible. But the goal of any
implementation is improving your business, not optimizing an individual metric or process at any
expense. Say you own a store selling art supplies. You have reorder points for paint brushes, paints,
canvases and a hundred other items. If most of them come from the same few suppliers, it might be
cheaper, and much better for your supplier relationships, to group orders together in fewer, larger
orders. But if you have a separate reorder point alert set up for every item, you may wind up placing a
new order every few hours. You'll be optimizing for not having too much or too little inventory, but at a
much higher cost than storing a few extra paint brushes so you can place fewer large orders. In this
specific example, you might just place orders for anything getting close to its reorder point — maybe
anything under 150% or even 200% of the calculated reorder point gets a reorder in your larger, more
infrequent purchases. Reorder points should be integrated into your business processes to ensure
sufficient inventory levels, but they shouldn't supersede other priorities.

I sincerely appreciate the opportunity to share this information with you, and I'm open to any questions
or further discussion. Once again, thank you for your time and attention

Sample Computation: EOQ for Hotel Mini-Bar Items-Water

Here's another example demonstrating EOQ for a specific hotel inventory item:

Scenario:

The hotel minibar uses a popular brand of bottled water (500ml size) that sells well. We want to
determine the ideal order quantity.

Demand (D): The minibar goes through 20 bottles of water per day on average. With 100 rooms and 365
days, the annual demand is: 20 bottles/room/day * 100 rooms * 365 days/year = 730,000 bottles/year

Ordering Cost (S): The cost of placing an order with the beverage supplier, including delivery fees, is
estimated to be Php 150 per order.

Holding Cost (H): The cost of storing and handling water bottles per year is estimated to be Php 0.25 per
bottle (considering storage space and potential expiration).

Computation:

Calculate EOQ:

EOQ = √(2 * D * S / H) = √(2 * 730,000 bottles/year * Php 150/order / Php 0.25/bottle/year)

EOQ ≈ 3,464 bottles (round to nearest whole number for ordering purposes)

Interpretation:

Based on this calculation, the hotel should ideally order approximately 3,464 bottles of water at a time.
This minimizes the combined cost of ordering and holding inventory for this specific minibar item.
Additional Considerations:

Minimum Order Quantity: The beverage supplier might have a minimum order quantity. The hotel might
need to adjust the EOQ to meet this minimum.

Space Constraints: Storing a large quantity of water bottles might require additional storage space. The
hotel might need to consider this in their ordering decisions.