Setting a reorder point - rop, Finance Basics

Setting a Reorder Point - ROP 

Once the order quantity has been determined, the next question to be settled is when to place the order. If an order is released and it takes three weeks before the order is received, there must be sufficient stock held to ensure that there are no stock outs. This level of stock is referred to as the order point. When the stock level falls to the ROP release an order for quantity Q. This is illustrated in this figure.

 L = lead time = the time between releasing and receiving the order.

In the example of the desk lamps, if the lead time were three weeks and the average demand were 1000/52 = 19.2 per week = 57 (set the ROP at 60 units).

There are a number of managerial points to note: 

  • This model can be applied when items are not related (independent of each other) as is the case with products in a retail store: light bulbs and bags of cement or tins of beans or bandages
  • The model cannot be applied for semi-finished parts or raw material where there are linkages between products and components
  • The model's 'efficiency' is altered if the assumptions are incorrect, this may be the case if demand fluctuates or costs alter over short periods
  • If we know the fluctuations of the weekly or monthly demand quantity from past data, we can apply a standard deviation to the demand figure and establish a buffer stock in addition to the ROP which would accommodate these variations
  • The total cost calculation is relatively insensitive to variations in the order quantity (Q). As the curve is relatively flat around the minima (see lower figure on page 324), the EOQ may change without affecting the total cost.
  • This means that the EOQ calculated is always an approximation.


So, if the EOQ = 267.82, order 300. 

  • Sometimes you may find staff order EOQ quantities without understanding the limitations inherent in the model
  • Bif discounts are offered for minimum order quantities, we must calculate the total costs associated with the EOQ order and the discount quantity in order to determine which approach offers the least cost overall
  • The terms economic order quantity (EOQ) or economic batch quantity (EBQ) or economic lot have the same meaning - the more common term however is EOQ.
Posted Date: 3/14/2013 5:50:45 AM | Location : United States

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