How to Calculate Safety Stock- Step by Step Guide
Businesses that know how to calculate safety stock are in the best position to serve their customers and to meet changing supply and demand levels.
Managing inventory levels can be one of the biggest challenges operations managers face. There is a delicate and fine balance that needs to be struck when managing supply - carrying too little inventory can cause delays in customers not receiving their products and carrying too much inventory takes up precious storage space and increases carrying costs.
That's why it's important for managers to consider storing safety stock to help mitigate the effects of fluctuating consumer demand. Safety stock refers to holding an extra layer of stock to offset any sudden surges in demand. Having this extra inventory helps to reduce the risk of this product becoming out of stock.
Safety Stock Formula
When determining the appropriate level of safety stock, it's important to first find the standard deviation before proceeding with the calculations to determine the exact variations in supply and demand.
To calculate the standard deviation, follow these four steps-
1. Calculate the average of a set of data.
2. Find the sum of the average and the data from the set.
3. Take that total and divide it by the sample proportion to get the variance figure.
4. Add the variance to the average.
Once this calculation is completed, it can be applied to the formula for calculating safety stock, which can be expressed as-
Z x sLT x D avg
Where Z refers to the desired service level, sLT refers to the standard deviation of lead time, and D avg refers to the demand average.
Calculating the optimal volume of safety stock is easy to understand once all of the figures are in place and can be done in four steps.
Determining Service Levels
The service level is a figure that attempts to represent the desired probability of not experiencing a stockout. The higher this service level figure is, the more safety stock is needed to be held in inventory to prevent the risk of running out. The constantly changing nature of supply and demand can make it difficult to predict the correct level of safety stock necessary to meet the demands of customers.
For example, let's say we're determining the safety stock of N95 medical masks. While the typical retail industry average for service level stands around 90%, these masks are more high priority so a 95% service level is used. These service level percentages represent the probability of avoiding a stockout and is expressed as a service factor. Using the chart below, we can see that a 95% service level equates to a service factor figure of 1.64.
|Service Level||Service Factor|
Calculating Lead Time
Lead time refers to the total amount of time it takes to restock an item and can either be a fixed or variable figure. Ideally, it's best to have the maximum lead time possible but it usually varies and can be dependent on a number of things, such as the efficiency of the vendor itself. When the expected lead time varies from its actual time, this difference is referred to as the variance.
For instance, continuing with the example of N95 medical masks, if the expected lead time is 3 days, but, due to a worldwide shortage, the actual time is closer to 9 days. The difference here would be a variance of +6.
To find the standard deviation of lead time, all of the variances should be added up and then divided by the number of sample portions or batches of orders. Finally, this figure would then be added to the average expected lead time. In our example, the total variance would be +6, the number of orders placed would be 1 (6/1=6), and the average expected lead time would be 3, bringing our standard deviation for lead time (sLT) to 9.
Calculating the Demand Average
Lastly, calculating the demand average should give clarity into how many units of product are needed per day to calculate safety stock. To determine this figure, all of the units sold that month would be divided by the number of purchasing days.
Going back to the example of N95 masks, if two orders of 10,000 units are placed during the month, in order to find the demand average, the two orders of 10,000 units would be added up (20,000 units), then divided by the number of purchasing days (30) for a total demand average of 667 units of daily sales.
Now that all of the figures have been accounted for, calculating the safety stocks of N95 masks becomes a simple matter of plugging in these figures into the formula.
Z sLT D avg
01.64 9 667 = 9,845 units
7 Tips to Keep in Mind
To best optimize safety stock levels, it's also beneficial to keep the following tips in mind-
1. When managing inventory control, there can be uncertainty around levels of supply and demand. This is why it is important to use formulas that are more dynamic and aren't very fixed to certain figures.
2. Checking safety stocks regularly and making sure that the correct amounts are in stock is the best way to ensure consistency.
3. Improving the quality of forecasts is another great way to ensure that a more true safety stock figure is in place. This will help to reduce too little or too much safety stock.
4. Releasing fewer products or actively promoting less popular products is a great way to help stabilize the demand for your products.
5. Ensure that suppliers and vendors are sticking to agreed-upon deadlines to ensure that the products arrive on time and enough safety stock is in inventory.
6. Reducing the variance in the lead times is a crucial aspect of optimizing safety stock levels.
7. Inventory management is far too complex to track on a piece of paper or spreadsheet. Utilize inventory management software to automate the process of replenishing inventory as well as producing accurate inventory reports.
Benefits of Using Software
Operations managers have a lot to deal with and constantly checking in to calculate safety stock can be a tedious task. That's why with the rapid advancement of technology, businesses are now able to turn to inventory management software to do the work for them. Here are just a few benefits of how inventory management can improve workflow-
- The software makes certain that the inventory is adjusted every time a sale is processed, which helps reduce the risk of overselling.
- It eradicates human error in inventory calculations and creates more efficient vendor relationships through better accounting for lead times.
- It helps businesses find the right balance between too little stock and too much stock.
- What is Inventory Management? A Primer for Small Businesses
- How to Calculate Safety Stock- Step by Step Guide
- Inventory Loan- Is It Right For Your Business & How Can You Apply?
- How to Calculate and Manage Inventory Cost in 4 Steps
- How to Price a Product for Retail and Maximize Profits
- 5 Retail Inventory Management Strategies to Improve Efficiency
- What to Know Before Investing in Retail Inventory Management Software
- What is Supply Chain Management and Why is it Important?
- What is the Difference Between Perpetual and Periodic Inventory?