Don’t let stock-outs tarnish your business’s reputation. Discover the best safety stock calculations to ensure you never miss a sales opportunity again.
Running out of stock is bad for your business and, most importantly, your customers. Getting your inventory planning wrong can lead to missed sales opportunities and a damaged reputation. To avoid these unwelcome scenarios, businesses have a vital ally in the form of safety stock!
In this post, we’ll unlock the power of calculating safety stock to help you meet your inventory optimization goals.
Table of contents:
What is safety stock?
Safety stock is the additional amount of stock you must order to protect your business from experiencing the risk of stock-outs. It accounts for variability in lead times, production issues, and unexpected fluctuations in demand. Safety stock enables businesses to optimize inventory and deliver the agreed inventory quantity to the customer on time.
Formula to find out your safety stock
Calculating safety stock involves considering various factors such as lead time, demand variability, and the desired service level. The commonly used formula is:
Basic Safety Stock Formula
Safety Stock = (Z-score x Standard Deviation of Demand during Lead Time) + Average Demand during Lead Time
or
Safety stock = (Z * σ * √LT)
Where:
- Z = Z-score based on the desired service level (fill rate)
- σ = Standard deviation of demand (to assess demand fluctuations)
- LT = Lead time (time taken for items to arrive after ordering)
When would you use this formula? When you want to maintain your set fill rate % or standard service level. Using this safety stock formula, you need to consider the standard fluctuations in demand and the lead time.
A practical example:
- Z (for a 90% service level) = 1.28
- Standard Deviation of Demand (σ) = 15 units
- Lead Time (LT) = 10 days
- Safety Stock = (1.28 * 15 * √10) ≈ 61 units
For a 90% service level, with a standard deviation of 15 units in demand and a lead time of 10 days, you should maintain approximately 61 units of safety stock.
Alternative safety stock formula
Periodic review model
Safety stock = (Z * σd * √(T + L))
Where:
- σd = Standard deviation of demand during the review period
- T = Review period
- L = Lead time
When would you use this formula? When your business follows a periodic inventory review approach to managing inventory, the review period is either weekly or monthly. This formula helps assess how much demand fluctuates during the review period, the duration of the review process, and the lead time required to restock.
Economic Order Quantity (EOQ) with safety stock: This formula combines the EOQ model with safety stock to minimize total inventory costs.
The EOQ is calculated by taking the square root of 2 X the annual demand for a product X the cost of placing an order divided by the cost of holding one unit of inventory for a year. This formula helps businesses find the ideal order quantity that minimizes inventory costs.
By combining the EOQ formula and safety stock, your business can optimize its ordering quantities to achieve cost efficiency while mitigating the risk of stock-outs due to unexpected demand spikes or supply disruptions.
Example of manual safety stock calculations
If you’re not using inventory management software that automatically calculates the math for you on a product-by-product and warehouse basis, here are some basic considerations:
Calculate the forecast accuracy per group of products.
You can’t obtain the product level with this approach but start by looking at your total sales vs. expected sales per product group. This indicates whether this is predictable and can be categorized as a Very High, High, Medium, or Low error per group.
Here are a few steps to help with your calculations:
1. Forecast accuracy by product group
Calculate the forecast accuracy per group of products by comparing your total sales versus expected sales for each product group. Categorize the error as Very High, High, Medium, or Low.
2. Estimate supplier reliability
Estimate the reliability of each supplier in terms of quantity and delivery date. Rate each supplier as Very Bad, Bad, OK, Good, or Excellent.
3. Schedule of products and safety stock
Create a schedule for products per warehouse that will carry safety stock. Include lead time, preferred vendor, and product group for each product. Ensure to incorporate your ABC classification from earlier.
4. Create additional sheets for forecast and supplier information
Set up extra sheets for forecast accuracy estimates and supplier reliability lists. These will help you apply VLOOKUP in Excel for future calculations.
5. Allocate percentages for risk categories
In these sheets, allocate a percentage for each risk category (supplier risk and forecast error). For example, high supplier risk may be represented by 0.9, while low risk is 0.5. Similarly, high forecast error may be 0.9, and low error would be 0.5.
6. Assign fractions for abc categories
Allocate fractions for each ABC category, assigning the highest protection factor (e.g., 0.9) to category A, and a lower factor (e.g., 0.7) to category C.
7. Update the main schedule with fractions
Update your main product schedule per warehouse to include VLOOKUP for ABC, supply risk, and forecast risk. Multiply these fractions by the lead time (in days or months) to determine your safety stock in days or months.
8. Final safety stock calculation
Use the calculated safety stock to buffer your forecasts, taking supplier performance and forecast accuracy into account. Keep in mind, this is a starting point and may need adjustments for more accuracy.
Watch how Netstock optimizes your inventory
Tips for calculating safety stock
- Keep safety stock dynamic: Regularly review and adjust based on changing demand and supply conditions.
- Not all stock requires safety stock – Focus on high-value, high-turnover items.
“Being able to adjust safety stock based on statistical modeling improved our inventory fill rate from 90.9% to 98%” – Senior Sales and Operations Manager – The Little Potato Company
When to use safety stock
Three common scenarios
- Supplier delays: When lead times extend beyond expectations.
- Partial deliveries: Suppliers ship less than ordered.
- Sudden demand spikes: Social media trends or seasonal surges increase demand unexpectedly.
Common mistakes in safety stock management
Avoid these pitfalls:
- Applying a one-size-fits-all approach:Different products require different safety stock strategies.
- Ignoring seasonality: Adjust safety stock for holiday peaks and trends.
- Not updating safety stock levels: Supply chains evolve, and so should calculations.
- Overreliance on historical data: Consider real-time trends.
- Overlooking supplier performance: Reliable suppliers may reduce the need for excess safety stock.
- Setting unrealistic service levels: Overstocking for 99.9% service levels is costly.
- Ignoring carrying costs: Excess stock ties up capital and increases storage costs.
- Manual calculations for large inventories: Use inventory management software to improve accuracy.
How safety stock improves inventory management
- Reduces uncertainty: Acts as a buffer against supply chain disruptions.
- Enhances customer service: Prevents stock-outs and boosts satisfaction.
- Supports seasonal demand: Helps manage peak sales periods efficiently.
- Optimizes replenishment: Streamlines inventory processes.
- Balances cost savings: Prevents overstocking and minimizes storage expenses.
Maintaining the right safety stock levels is critical for SMBs. Too little safety stock risks lost sales, while too much ties up valuable capital. An inventory management solution automates these calculations, ensuring you stock the right products at the right time.
FAQ
Why is safety stock important?
Safety stock acts as a buffer to prevent stockouts due to unpredictable demand or supply chain disruptions. It ensures smooth operations and customer satisfaction.
How do I determine the right safety stock level for my business?
Safety stock depends on factors like supplier reliability, forecast accuracy, demand fluctuations, and lead time. A structured approach using ABC classification and risk factors helps determine appropriate levels.
What is the ABC classification method?
ABC classification categorizes inventory based on value and frequency of use.
- A-items: High-value, low-quantity products requiring tight control.
- B-items: Moderate value and demand, requiring periodic monitoring.
- C-items: Low-value, high-quantity items with minimal control needs.
What is forecast accuracy, and how do I improve it?
Forecast accuracy measures how close predicted sales are to actual sales. Improve it by analyzing historical data, segmenting product groups, and adjusting forecasts based on demand trends.
How do I assess supplier reliability?
Supplier reliability is evaluated based on on-time deliveries, order accuracy, and consistency. Assign ratings (e.g., Excellent, Good, OK, Bad, Very Bad) based on past performance.
Can I automate safety stock calculations?
Yes! Inventory management software can automate safety stock calculations using real-time data, demand forecasting, and supplier performance metrics.
What role does lead time play in inventory management?
Lead time is the duration between placing and receiving an order. Longer lead times require higher safety stock, while shorter lead times reduce the need for excess inventory.
How can I use Excel for inventory calculations?
You can use VLOOKUP, IF statements, and formulas to automate stock level tracking, supplier performance assessments, and forecast accuracy calculations.
