Developing an effective inventory management system can be incredibly challenging. You’ll need to make sure you have enough stock to fulfill all of your orders, provide excellent customer service, and keep your cash flow up. In order to do this, you’ll need to develop a safety stock formula. Many retailers will just guess how much safety stock they need, but in order to really stay on top of demand, you’ll need to create a safety stock formula.
What is Safety Stock?
Safety stock is the amount of extra inventory you consistently keep available to account for fluctuations in customer demand. It creates a buffer during periods of high demand and ensures that you’ll be able to fill your customer orders on time. If you don’t have safety stock available and demand spikes unexpectedly, you won’t be able to fill customer orders in a timely manner. This is called a stockout and can result in huge financial losses for your company.
Customer demand is very volatile and can be very difficult to predict as a result. Using a safety stock formula can help you better anticipate upcoming demand and ensure that you have the stock that you need.
Anticipation Inventory vs Safety Stock
Safety stock is often confused with anticipation inventory. These are both forms of extra inventory that are kept on hand, but they serve different purposes. Safety stock is used to fulfill unexpected spikes in demand.
Alternatively, anticipation inventory is used to fulfill expected spikes in demand. For example, many retailers will use anticipation inventory for winter holidays or back-to-school season, where demand is consistently higher.
How Safety Stock Improves Inventory Management
A reliable safety stock formula can make a huge difference when it comes to streamlining your inventory management. Not only does safety stock save your company money in the long run, but it also improves warehouse efficiency and helps you provide better customer service.
Reduces Supply Chain Uncertainties
By consistently keeping safety stock in place, you’ll be able to compensate for the normal uncertainties that crop up during the course of supply chain management. It’s very normal for demand from customers to fluctuate, but supply stock can also help you account for uncertainties from your suppliers. Supplier lead times can fluctuate due to unforeseen challenges on their end. Having a safety stock formula ensures that you don’t pass these delays on to your customers.
Improves Customer Satisfaction
Providing a great customer experience is crucial for any successful business. When you have a stockout, you’ll leave customers in the challenging situation of having to wait for the product they need. If you’re consistently struggling with stockouts, this can have a negative effect on your reputation overall. It also means that your team will need to spend time on damage control, which means they have less time to spend on other essential tasks.
Saves Money
While ordering extra inventory does require you to spend more money upfront, think of it as an investment in your businesses’ future success. Stockouts are incredibly costly, as customers usually aren’t willing to wait for an item to come back in stock. A stockout could even result in a customer switching to one of your competitors. Losing a loyal customer compounds the amount you’ll lose in sales over time.
An efficient safety stock formula prevents these sales in the long run and helps you keep your cash flow steady. However, it’s also important to make sure you aren’t buying too much safety stock, as this can be financially unnecessary. Using a safety stock formula can help you find the right balance.
6 Safety Stock Formula Calculations
Safety stock is designed to account for fluctuations in customer demand and supplier lead times. Both of these factors are variable, which can make it difficult to determine just how much safety stock you need to keep on hand. However, there are several different formulas you can use to calculate your safety stock.
These formulas can help ensure that you have enough safety stock on hand.
Simple Safety Stock Calculation
If your lead time and customer demand are fairly stable, you can use this safety stock formula to determine how much to order. With this calculation, you will multiply the number of products you sell per day by the number of days of additional stock you would like to have.
If you sell 25 items per day but want to have 10 days of safety stock available, you should order 250 items. While this formula is simple, it is also very inexact and doesn’t account for fluctuations in supply and demand.
Standard Safety Stock Calculation
This calculation is more exact than the previous one, and it is the one that is used most often by retailers. This calculation accounts for wider variations in lead time to give you a better buffer.
To make this calculation, you’ll need to look at past sales data to determine the maximum number of units sold each day as well as the average number of units sold each day. Then, you’ll look at supply data to determine the maximum lead time and your average lead time. Then, you can plug these figures into the formula.
This formula is:
Safety stock = (maximum sale x maximum lead time) – (average sale x average lead time)
Demand Uncertainty Calculation
If you struggle more with fluctuations in demand than fluctuations in supply time, this formula could be a good option for you. You can calculate this formula using months, weeks, or days, but make sure you’re using the same time period for both figures.
This formula is:
Safety stock: standard deviation of demand x square root of average delay
To find the standard deviation of demand, look at your average demand in a sales period, compared with the square of each month’s difference. You’ll then find the average of each square and use the square root of that deviation as the standard deviation.
Lead Time Uncertainty Calculation
This is another very popular way to calculate safety stock and accounts for high variability in lead times.
The formula is:
Safety stock = Z x average sales x lead time deviation
Z is the service level that you want to provide, which is highly subjective based on your business. In most cases, it’s above 90 percent. Then you’ll multiply that by your average sales in a given period and the standard lead time deviation in that period.
Uncertainty on Demand and Lead Time Calculation
There are some scenarios where both your demand and lead time are highly variable, which requires a more complicated calculation.
This calculation is:
Safety stock = Z x SqRt((Avg. Lead Time x (Standard Deviation of Demand)^2 + (Avg. Sales x Standard Deviation of Lead Time)^2)
This calculation will require you to know the average lead times and standard deviation of lead times.
Dependent Lead Time Calculation
If your lead time is dependent on your demand or vice versa, you may want to use this final calculation. It accounts for the fact that these two variables are linked in this scenario.
The formula is:
Safety stock = Z x Standard Demand Deviation X SqRt (Average Lead Time) + Z x Average Sales X Standard Lead Time Deviation
Final Thoughts
Keeping the right amount of safety stock on hand is crucial to keeping your business running during periods of high demand or uncertain lead times. There are so many different safety stock formulas you can use to calculate this number depending on your businesses’ unique challenges.
Working with a third-party logistics (3PL) partner like Print Bind Ship can help you streamline your operations and keep up with demand more efficiently. Contact us today for a free consultation!