How does a reorder point work?
The stock level that triggers a new purchase order. When on-hand units hit that number, you place the next buy so goods can arrive before the shelf goes empty.
Definition
A reorder point is the on-hand quantity that tells you it is time to buy more. On the books, this is a buying rule that watches the inventory line, not an account of its own.
Nothing posts to the general ledger when the trigger fires. The quantity is simply low enough that you send a purchase order.
Each business can set a different number for each item. The idea is the same: buy again before the bin is empty.
The rule lives in a stock report, a spreadsheet, or the ordering screen. It does not appear as its own line on the statements.
Where it shows up
Balance Sheet: Related to the inventory line, which the trigger watches.
P&L: Related to stockouts that cut sales if the trigger is too late.
See also: Safety Stock · Purchase Order · Stockout
When you look at your Balance Sheet, you will not find a reorder-point line. You will find inventory, and the trigger is a quantity you compare against that stock.
If inventory is at or below the number, the next step is to order. The statements have not changed yet.
The profit and loss statement is silent at the moment of the trigger. It feels the result later if the number was too low and missed sales follow.
A trigger set too high means you carry extra units for longer. Cash sits in stock instead of the bank, even though no new account was created.
Cash does not move when you decide to order. It moves later, when you pay the vendor for the goods that arrive.
How it works
Setting and using the trigger takes four steps:
- Measure daily use: Count how many units of the item you use or sell in a typical day.
- Measure the wait: Note how many days the vendor takes to deliver after you order.
- Multiply, then add a buffer: Daily use times the wait is the stock you will burn through while the next order is in transit. Many businesses add a buffer on top so a busy week or a late truck does not empty the shelf. The trigger is that expected-use figure, plus any safety-stock buffer you hold.
- Order at the trigger: When the on-hand quantity reaches that number, you issue a purchase order. The books still have not moved.
A maker applies the same watch to raw materials inventory. Each material can have its own number.
The purchase order is the document, not the accounting entry. Vendors ship later; receiving is when inventory and accounts payable both rise.
If the trigger is too low, units hit zero before the delivery. If it is too high, you ordered earlier than you needed, and extra stock sits in current assets.
You can set a different trigger for every item. A slow seller and a fast seller should not share one number.
Example
A restaurant kitchen uses about one 50-pound sack of flour a day. The mill delivers two days after an order.
The kitchen sets the reorder point at two sacks. When two sacks remain, the cook sends a purchase order for ten more sacks.
Each sack costs $20, so the order is $200. No journal posts on the day the trigger fires.
Two days later the mill drops ten sacks at the back door. The kitchen records the receipt:
Debit: Inventory $200
Credit: Accounts payable $200
Inventory (an asset) and accounts payable (a liability) both go up by $200. The reorder point did not create that entry; receiving the flour did.
The Balance Sheet is larger on both sides. The profit and loss statement has not changed, because the flour is still in the bin.
Common mix-ups
A reorder point is not safety stock. Safety stock is the extra buffer; the reorder point is the on-hand number that tells you to buy, and it can include that buffer. The Example on this page uses none: one sack a day times a two-day wait gives a reorder point of two sacks.
A reorder point is not the order quantity. The trigger says when to order; how many units you buy is a separate choice.
A reorder point is not a general-ledger account. You will not debit or credit a line named after it when the trigger fires.
Related terms
- Safety Stock: Extra inventory held as a buffer against demand or supply swings.
- Economic Order Quantity: The order size that minimizes combined ordering and holding costs.
- Purchase Order: The document authorizing a purchase from a vendor at agreed terms.
- Stockout: Running out of an item customers want to buy.
- Inventory: Goods held for sale or used to produce goods for sale.
- Days Inventory Outstanding: The average number of days inventory sits before it sells.
- Backorder: A confirmed customer order that cannot ship until stock arrives.
- Raw Materials Inventory: Purchased materials waiting to enter production.