Safety Stock Definition, Importance, Formulas & Implementation

Like many other kinds of business decisions, there is no one-size-fits-all formula that will work for all businesses, so choose the method that works the best for your business. The main goal of safety stocks is to absorb the variability of customer demand. Indeed, production planning is based on a forecast, which is (by definition) different from the real demand. By absorbing these variations, safety stock improves the customer-service level.

  • The business then puts any safety stock that’s left back into long-term storage, and continues to fulfill orders using the new inventory.
  • Customers are always happy because stores never run out of popular products.
  • Too little and you risk running out of inventory and disappointing customers.

This could mean the time period between orders or how long a production cycle takes. A quick and easy way to calculate your cycle stock is to subtract your safety stock from your on-hand stock. Safety stock is inventory that a business holds to mitigate the risk of shortages or stockouts. Think of it as a type of insurance for when demand spikes or there’s a material shortage. Businesses can use a safety stock formula to make data-driven decisions about managing inventory levels to maximize profits.

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Whether you are a small retailer or a global omnichannel retailer, knowing how to calculate safety stock is vital. There is a misconception that having enough safety stock will prevent all stock-outs. In reality, buffer stock can prevent the majority of stock-outs, but not all of them. You should monitor your inventory what is par value of a bond level frequently by looking at the standard deviation time. However, for accuracy and precision, retailers use more advanced solutions like analytics software to account for their business-specific factors. This is a choice often made to save money on upfront costs; purchasing, transportation, and storage.

If seasonality is a significant cause of demand variability, cycle stock should be periodically adjusted to reflect the forecast demand during the various high and low periods. A company’s ideal safety stock level will be based on its tolerance for stockouts. A CSL is the percentage of cycles in which a company hopes to not have stockouts. The number of sigma required to achieve the CSL is called the service-level factor, or Z factor. Some products will have little variability and thus a very narrow histogram.

Why do you need safety stock?

It is determined by several factors like lead time variability, forecast accuracy, and service level. Each place has a demand pattern of its own, and you have to adjust it accordingly. There are a number of software programs available that can help you manage your inventory and safety stock levels. These programs can track your sales data, help you forecast future demand, and even place orders with your suppliers automatically.

Upgrade to a Plus level membership and take advantage of additional benefits and savings with discounts on all your certifications. The following formula is the way to calculate the number of “safety days”. Avoiding an out-of-stock situation is critical for direct-to-consumer brands. Not only do you lose sales when you run out of a SKU, but you may also lose customers for good. If you want to avoid out-of-stock scenarios no matter what, you may end up on the opposite end of that spectrum and overstock your products. Imagine while most of your customers default to stores that are out of stock but you have stock, think about the free quality traffic you will be getting.”

Additional channels, vendors, and a multitude of influencing factors require advanced analytics solutions to handle and accurately compute. You need to know how to calculate safety stock so that you actually have enough to meet demand without going overboard and incurring over-stock costs. Calculating the appropriate safety stock level in the face of variable customer demand requires some basic statistics knowledge. Safety stocks provide a buffer between actual demand and the number of supplies on hand at any given time. The goal is to ensure enough items are in stock to cover unexpected fluctuations in demand. Using the safety stock calculation above may not be suitable for every type of business.

Safety Stock with EOQ (Economic Order Quantity)

The dreaded one-size-fits-all approach to calculating optimal stocking level formulas. Every retailer has specific parameters they work within when managing inventory. As such, the approach to finding an optimal stocking level formula varies from retailer to retailer. Demand (D) is the number of units a business orders for a specific period, usually annually. Safety stock, on the other hand, is the amount of stock a business should hold in reserve at all times (as a buffer) to be able to continue fulfilling orders if a business runs out of regular stock. Stockouts and backorders can also cause customers to cancel orders (which costs your business revenue), or even leave negative reviews to discourage others from purchasing in the future.

Safety Stock Guide: Using the Safety Stock Formula to Avoid Stockouts

For example, suppose there’s a product in your inventory that you order 100 units at a time. Once the inventory for that product comes down to 15 units, it triggers a new order of 100 units. Based on past customer demand for that product and the time it typically takes to receive that inventory, the 15 units will suffice. Likewise, if a business owner usually sells 25 phone cases per day and wants to have 10 days worth of safety stock, they would need to have 250 phone cases stored (25 products x 10 days). Creating a safety stock will also delay stockouts from other variations, like an upward trend in customer demand, allowing time to adjust capacity. But instead of hedging against uncertainty, it represents a prediction of demand increase.

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From ever-changing consumer demands to supplier delays and outages, there are countless factors that can make it difficult to determine reorder points and standard deviation of demand. Having an optimal amount of safety stock ensures you can address demand surges without inventory holding costs being too high. Make sure to periodically update your safety stock based on fluctuations in demand and supplier timelines. Amount of safety stock should be managed in tandem with customer expectations. For example, if Safety Stock is too low to meet customer demands, it should be communicated to the customer.

This inventory is maintained so that a company has sufficient units on hand to meet unexpected customer and production demand. Safety stock does not just involve finished goods; it can also be applied to raw materials, to guard against delays in the delivery of materials from suppliers. Higher safety stocks may be warranted during periods of supply restrictions, to guard against missing or short supplier deliveries. It should also be managed with customer expectations and regularly reviewed to ensure it is set appropriately for the business’s goals. If their levels are not managed properly, it can lead to unfulfilled customer demands, supply chain disruptions, lost sale, and increased inventory costs.

In other words, companies over stock inventory, so they won’t run out of popular products. Using an inventory management software program can help you ensure you always have the right amount of stock on hand, so you can avoid stockouts and missed sales. It ensures that companies have enough inventory on hand to meet customer demand, while also avoiding excess inventory. Frequent stockouts leave customers in difficult situations, resulting in supply chain bottlenecks if components are unfulfilled or upset customers if there is not enough stock to meet demand. In short, it’s important to be smart about safety stock in order to keep supply chains moving.

Keeping stock levels at the optimal levels is valuable and worth paying a high warehouse manager salary for. That’s why inventory management software is used for all types of inventory, manufacturing inventory, demand planning software, and MRO inventory included. Vendor managed inventory agreements and smart pipeline inventory management can help stem a lot of miscalculation. Inventory turnover is one of the KPIs(Key performance indicator) in terms of inventory management that indicates how quickly businesses sell through its inventory. Reorder point is the level of inventory at which a company must place a new order to replenish stock. Reorder quantity is the amount of inventory that a company must order to replenish stock.

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