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.
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.
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