JonnyParker
March 11, 2024
Inventory management isn’t an exact science. Consumer demand shifts on a dime, causing supply shortages, increased order volumes, and the dreaded stock out.
Fortunately, you can mitigate these risks using the safety stock formula, which reveals how much excess product you need to effectively address a supply chain failure.
Learn how to calculate safety stock and what benefits the formula provides your business and customers.
Want to see how Fishbowl can improve your business?
What’s safety stock?
Safety stock is the excess product you keep at your warehouse to safeguard against supply chain failures and other common emergencies.
Typically, you’ll use forecasting tools and calculations like the lead time formula and inventory turnover ratio to determine how much stock to keep on hand and when to reorder. Under ideal conditions, you’ll always have just enough inventory to meet demand until the next order arrives.
But if something goes awry, you’ll run out of inventory before the next shipment. That’s where safety stock comes into play.
What’s safety stock inventory?
Safety stock inventory refers to the stock beyond predicted demand. Imagine you run demand forecasts for one of your most popular products. According to your predictions, you should order the SKU in batches of 1,000 units and reorder every 30 days.
However, using the safety stock formula, you determine that your safety threshold is 100 additional units. As such, you requisition 1,100 units on the initial order and 1,000 units on subsequent orders until market demand dictates an inventory change.
If your next shipment is delayed and you have to cut into the 100-unit safety stock threshold, you’ll need to replenish it on the subsequent order.
Why should you use the safety stock formula?
Regularly using the safety stock formula leads to improved inventory management results. Here are a few more pointed benefits of determining and keeping the right amount of excess stock.
Reduce stock outs
Maintaining safety stock makes your organization less susceptible to stock outs and shortages. If an item’s demand suddenly increases, you tap into the buffer while you await more units from the supplier.
Optimize warehouse space
Safety stock is meant to guard against disruptions, but that doesn’t mean you should overstock all the most popular products. Blindly overordering ties up too much capital and overwhelms the warehouse.
The safety stock formula lends a method to the madness, revealing how much more of each SKU you need to order based on demand trends. That way, you make the most of your finite warehouse space and optimize business agility.
Forecast demand
Continuously re-evaluating safety stock levels will allow you to ensure that your inventory matches current supply and demand conditions. And you can use formula variations to forecast customer service and shipping needs. These insights help you anticipate sales surges throughout the year and result in better inventory management efficiency.
Adapt to seasonal trends
Safety stock isn’t a static figure. The formula helps you adjust inventory levels in accordance with predictable trends, such as pre-holiday spikes and transaction surges on Cyber Monday.
Prioritize customer satisfaction
Customers who visit your store or website expect to find their favorite products readily available. The safety stock formula helps you ensure hot-ticket items are on hand to consistently meet consumer expectations.
Fulfill orders faster
Safety stock enables your business to fulfill orders faster, even if you’re waiting for a replenishment delivery. If you run out of primary inventory, you turn to the reserves to bridge the gap.
The standard safety stock formula
The most common formula is:
Safety stock = (maximum daily sales x maximum lead time) – (average daily sales x average lead time)
Suppose a business has the following sales and lead time data:
- Maximum daily sales: 120 units
- Maximum lead time: 10 days
- Average daily sales: 100 units
- Average lead time: 7 days
Here, you’d calculate like so:
Safety stock = (120 x 10) – (100 x 7)
According to this calculation, you should keep an additional 500 units on hand to avoid stock outs.
How to calculate safety stock: 6 methods and related formulas
The standard formula is a reliable starting point, but you can also vary your approach based on your unique circ*mstances. Consider these alternative methods and formulas to use depending on the team’s needs.
1. Standard deviation
This analysis uses the standard deviation of demand and lead time to provide a buffer for variability:
Safety stock = Z x standard deviation of demand x lead time
In this formula, “Z” represents the Z-score associated with the desired service level you want to maintain. This method is useful in environments with predictable lead times and demand variability.
Think of the Z-score as a safety net that tells you how much extra inventory you should keep on hand amidst demand fluctuations. So to make sure you have enough units to account for variance — compensating for when people buy more than expected — and satisfy customer demand 95% of the time, the Z-score will indicate how much extra inventory you’ll need.
2. Average-max
The average-max method calculates safety thresholds based on the difference between the maximum and average demand (or lead time), as shown in the example for the standard safety stock formula. This approach is useful if your business experiences large fluctuations in demand or lead time.
Suppose you sell about 500 units a month on average and 1,000 in your most productive month. Using the average-max method, you’d subtract the average sales from the maximum, meaning you’d need to maintain 500 units more than the average to avoid a shortage.
3. Variable demand
This approach specifically accounts for the variability in demand while keeping the lead time constant. The formula fluctuates based on demand variance over a set period:
Safety stock = standard deviation of demand x square root of average delay
The variable demand formula particularly benefits businesses with significant lead times or drastic fluctuations in customer demand. It’s also useful in industries with fast product life cycles, such as fashion (which capitalizes on short-term trends) and technology (since tech quickly becomes obsolete).
4. Variable lead time
Conversely, this formula focuses on lead time variability while assuming demand remains constant. It’s particularly useful for companies facing supply chain uncertainties because by accounting for variability in lead times, companies can better prepare for unexpected delays in receiving supplies. This ensures operations continue smoothly, even when the supply chain faces disruptions.
Here’s the formula:
Safety stock = Z x average sales x lead time deviation
5. Economic order quantity
Use the economic order quantity (EOQ) and safety stock formulas together to obtain additional insights about ideal inventory thresholds. The EOQ is the ideal amount of stock the business should purchase to minimize inventory costs:
EOQ= √DS/H
Where D equals annual demand for the product (in units), S is the cost associated with placing an order for more inventory, and H is your holding cost per unit per year.
6. Reorder point
The reorder point method helps you determine when to reorder based on lead time demand plus safety stock. Finding the reorder point with safety stock involves both the average demand during lead time and the amount of reserves on hand. Here’s the formula:
Reorder point = (average daily demand x lead time) + safety stock
Stock out risks
Stock outs can happen to virtually any eCommerce brand, but the following issues make a business more susceptible.
Poor demand planning
If initial forecasts are inaccurate, you risk an inventory shortfall. So you must implement measures to gather better data regarding demand, inventory, and consumer trends. An all-in-one inventory and sales management solution like Fishbowl consolidate important business data and provide more accurate forecasts.
Unexpected demand fluctuation
An unexpected sales boom is great for your bottom line, assuming you can keep up and deliver. Otherwise, surprise demand spikes quickly burn through the primary inventory and any excess on hand.
By keeping a close eye on customer trends, you’ll usually see demand spikes coming a few days in advance, giving you extra time to prepare for the surge.
Inadequate inventory management
If your warehouse faces damaged, miscounted, or lost stock, you have an inventory management problem. Such issues are typically linked to a process or software issue. Upgrading to a modern inventory management solution may alleviate stock visibility and control issues.
Inaccurate replenishment timing
You need to be proactive about reordering. Don’t wait until you’ve tapped into your safeties to reorder — ideally, you should have another shipment arriving just as the primary inventory is running dry. Remember, safety stock is a buffer for emergencies. It’s not meant for routine usage.
Prevent stock outs with Fishbowl
Fishbowl’s inventory management software provides unmatched stock level visibility to prevent outages and better serve your customers. The platform consolidates key processes, making it easier to manage sales, warehouse, tracking, and manufacturing.
Speaking of warehousing, Fishbowl Warehousing can automate purchasing, order approval workflows, and vendor management to enhance overall visibility.
Stop the recurring nightmare of stock outs and shortages. Make the leap to Fishbowl and modernize your inventory management strategy.
