Knowing how to calculate safety stock is one of the most critical knowledge in starting a business. To calculate your safety stock, you need to multiply the service level value, the standard deviation of lead time, and the average demand of your business together.
As a sourcing company with ten years of credibility, we are experts in assisting clients to maintain safety stock inventories. We’ll share our knowledge about what a safety stock is, why you need it, and how you can do a safety stock calculation for your own business.
So, don’t miss out and continue reading!
Safety Stock Definition
Safety stock is an extra stock or quantity of a product stored to prevent inventory stockouts. A safety stock acts as insurance that you can always meet the desired service level even when there’s uncertainty on-demand or lead time.
Why do you need a safety stock?
Having a safety stock inventory prepares you against two main uncertainties in the supply chain: lead time and demand uncertainty.
- Demand uncertainty
Being able to provide even if there’s a spike in demand will prevent you from losing customers.
Say there was a sudden storm in your area, and you sell umbrellas. Customers will trust you if you can provide for every one of them despite having a higher demand than usual.
Take it from me. Being prepared under any uncertainties is what sets you apart from your competitors.
- Lead Time Uncertainty
Even a slight deviation of lead times can negatively affect your customer’s satisfaction.
Imagine you’re a customer driving an hour to eat in a popular restaurant only to find out that they don’t have enough stock to accommodate you. All because of delayed delivery.
As a customer, won’t that make you really upset?
It’s easy to use up stocks, but it’s tough to gain a customers’ trust again once you lose it, so you should avoid letting safety stock decline.
What is the safety stock formula?
Now that you’ve learned about the importance of having a safety stock. I’ll share with you the formula that my team and I have been using to compute it.
Safety stock = (Max Daily Use x Max Lead Time) – (Ave Daily Use x Ave Lead Time)
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How to Calculate A Safety Stock？
To know how much safety stock you need, follow these basic steps. These steps will let you know how to find the values you need to input into your formula or safety stock calculator. And don’t worry. These steps only require basic math. So I assure you it’s not that complicated.
Step1：Find your lead time set of data.
In safety stock, lead times refer to the time it takes for your restock inventory orders to arrive once your business has stockouts.
To calculate your lead time, you need to know these three numbers:
- Estimated lead time
- Actual lead time
- Lead time variance
Example
A supplier estimated that it would take 20 days for stocks to arrive. But the stocks’ actual delivery was after 25 days.
In this case, the estimated lead time is 20, the actual lead time is 25, and the lead time variance is 5.
Step2：Calculate lead time’s standard deviation
Standard deviation is used to have a more accurate estimated range of the average delay of your inventory orders. Instead of calculating one reorder data only, you use several data from your previous orders.
Example
We will stick to the same estimated supplier lead time of 20 days for this example. Here are the data of 3 different orders from the same supplier.
Order 1:
Actual lead time: 22
Lead time variance: 2
Order 2:
Actual lead time: 25
Lead time variance: 5
Order 3:
Actual lead time: 22
Lead time variance: 2
From this set of data, calculate the average variance value. To do this, find the sum of the lead time variance.
2 + 5 + 2 = 9
Then, divide this number by the number of orders we used in this set. For this example, we used three orders, so we need to divide the sum by three.
9 ÷ 3 = 3
Lastly, add this number to the estimated lead time. Our estimated lead time for this was 20.
20 + 3 = 23.
23 is now the standard lead time deviation in this example.
Step3：Understand your average demand
To calculate your average demand, calculate how much you’re able to sell in a certain amount of time. For instance, every month.
To calculate an average demand based on monthly data, find how many units of goods were sold for one whole month and divide this by the number of selling days.
Example
If 300 units were sold in April:
300 ÷ 30 selling days = 10
The average demand in this example is 10.
Step4： Determine your established service level
To do this, decide on the percentage of the service level you want to achieve. Once you have a number in mind, find a normal distribution chart to find the value corresponding to your service level.
Example
If we aim for a 90% service level, the corresponding value would be 1.28.
Step5： Use the safety stock formula.
Safety stock formula: Safety stock = Z x ∑LT x D
The meaning of variables in the basic safety stock formula:
Z: service level value
∑LT: standard deviation of lead time
D: Average demand
Plot the values that you got earlier into your safety stock calculations.
For our example, our stock formula would be:
1.28 x 23 x 10 = 294.4; thus, we need at least 294 units in our safety stock levels.
Knowing how to use the safety stock equation to calculate the safety stock level that you need is crucial. Proper stock management will prepare you no matter what happens in the future demand.
- Having excess safety stock for your sales volume.
Some businesses fail to properly conduct a safety stock calculation. They have way too much safety stock in fear of stockouts, increasing the inventory cost.
- Not having adequate safety stock.
On the other hand, some stores have much lower safety stock than required. So when a lead time variability unfortunately happens, they can’t fulfill even the average expected demand.
This is why I constantly remind my clients to calculate safety stock using the formula I’ve mentioned above. Using that formula is essential as it prevents you from having too much stock or an adequate one. If you know your optimal safety stock levels, investing in extra inventory and keeping safety stock won’t massively increase your inventory costs.
FAQs about Safety Stock
1. What is the difference between buffer stock and safety stock?
Buffer stocks are excess stocks of a product stored to control its total market price in the supply chain. On the other hand, safety stocks are extra stocks held by a business to prevent stockouts.
2. What is the importance of safety stock?
Safety stock is important in fulfilling customer satisfaction. Even when the demand average suddenly spikes or your delivery doesn’t arrive on the average expected time, you will still have enough stocks for your customers.
3. Who needs to calculate safety stock?
Supply chain managers and business owners need to calculate their safety stock. Calculate safety stock using formulas to reach your average sales even when the expected lead time of your cycle stock is delayed.
What’s Next
Whether you’re a retailer of raw materials or finished goods, you need to know about safety stock levels. Setting safety stock inventories will allow you to continue your business even when lead times are delayed or demand spikes suddenly.
Are you looking for a reliable company to help you find the best suppliers for your safety stock inventory? Contact us, so we can help you!
