Safety stock is a very important part of inventory management. It's also one of the more complex parts to understand, so I'm going to break it down for you in this article! Have fun learning about safety stock and why it's necessary for your business! This post will help you better manage your inventory levels.
The Formula For Safety Stock & How To Calculate It
There are several different safety stock formulas, but they all employ similar approaches to figure out how much more items you should order. Here's what you should know before making your decision.
To generate an accurate estimate, you'll first need access to your sales history and analytics. If required, you can guess, but keep in mind that an incorrect estimate can lead to mistakes and overstock. In Using inventory management software, that information should be readily available; it may be more difficult if you're using spreadsheets.
To calculate safety stock, you'll need to understand the following terms:
- Lead time: The time it takes for a shipment to arrive at your warehouse after you order it.
- Daily Usage: How many items you sell each day.
- Level of Service: A percentage representation of the desired level of service. It indicates the probability of averting a stockout in this case.
- Demand: It is defined as the number of products sold at a particular time.
- Average: The middle value in a set of data is called the average. An average can assist you in figuring out how well your products sell or how frequently you receive shipments.
- Standard Deviation: The standard deviation of your lead time is commonly measured in a safety stock formula.
Keep in mind the distinction between cycle stock and safety stock as well. The former is inventory intended to be purchased by consumers, whereas safety stock is a margin of error to rely on when things go wrong. Separate computations should be made for them.
3 Methods To Calculate Safety Stock
There are several ways for evaluating safety stock, each with its own set of advantages and disadvantages. Let's discuss in detail 3 of those methods. Also, you can use inventory management software as an added tool for these calculations.
Safety Stock Calculator
You could try the safety stock calculator first if you're searching for a quick and easy answer. 4 things need to be entered in the calculator to do the calculation:
- Maximum daily usage in units
- Full lead time in days
- Average everyday use in units
- Average lead time in days
This simple formula is the first and most straightforward approach for manually estimating safety stock levels.
(Maximum Daily Usage x Maximum Lead Time) - (Average Daily Usage x Average Lead Time)
Let's take an example: Imagine your company sells ten products each day on average and has a 14-day lead time. During peak periods, however, you may sell up to 15 products per day, and inventory shipment delays can cause things to arrive at your warehouse to take up to 18 days. Here's how the formula works.
(15 × 18) - (10 × 14)
It raises your safety stock level to 130, indicating that you'll need to have 130 additional units on hand to cover shipping delays or periods of high demand.
Because the method is so simple, it's ideal for small companies. On the flip side, calculating it can be difficult because average lead time is variable, and outliers can substantially skew the statistics. Large businesses may require a more complex formula to account for more items and a more extensive range of supply and demand.
Learn more about Supply Chain Challenges And Solutions
Using the "King" Formula
What if you want to target a specific level of service? This number can be calculated using the more complicated "King" formula. It's as follows:
Z × σLT × D-avg
Z is your desired service level, LT is your lead time standard deviation, and D-avg is the average demand for a product in this calculation. It takes a little more math for this one, but it's just a matter of filling in the variables.
The target probability of preventing a stockout is the service level (Z). The bulk of products have an 85 percent to 90 percent service level, with critical commodities reaching 95 percent or higher. The more service level you choose, the more money you'll have to spend.
You'll need to convert it to a service factor with the NORMSINV function before utilizing it in this formula—round to the closest hundredth decimal using this calculator or Excel's NORMSINV function. So, if you want a 95 percent service level, you'll need a service factor of 1.64.
Then there's σLT, which is the standard deviation of lead time. You'll need an accurate representation of the delivery variance because suppliers rarely deliver products at the same intervals.
You'll need your estimated lead time and the shipments' actual time to compute the standard deviation. Then record the variation for each shipment, which is the number of days it took over or under the estimated period. Negative numbers arrive late, while positive numbers arrive early.
Total the deviations and divide by the number of shipments you measured. The standard deviation is calculated by adding this by the expected time.
Assume that you expected a shipment to arrive in 14 days, but it came in 15, 12, 17, 14, and 19 days (or a variance of 1, -2, 3, 0, and 5). It gives you a standard deviation of 15.4 percent.
Finally, it would be best if you determined average demand. Choose a time, such as a week or a month, or your usual lead time. Make a list of how much you've sold at each interval. Divide the total sales volume by the number of days you tracked.
Your demand average is 50 if you sell 1500 stock in a month (on average, you sell 50 units per day).
Let's now plug all of the instances into the formula.
1.64 × 15.4 × 50
As a result, you'll have a safety stock of 1,262.8 (or 1263). That's about how much you'll need if you desire a 95% service level, get shipments every 14 days, and sell 1500 items on average per month.
This formula is a little more complicated, but it is pretty beneficial. The critical issue is that only well-established companies will have the requisite statistics to obtain accurate findings. This formula also presupposes that demand does not vary with lead time, which isn't usually the case.
Making a forecasting error by overestimating the intended service level might have disastrous consequences. It's better to buy too little than to waste hundreds of products, so keep your estimates reasonable until you've gotten the hang of buying additional stock.
We hope that this article has helped you learn more about safety stock and how it can help your business. If there's anything else we need to cover, let us know! And don't forget to check out all of our other helpful articles on inventory management for small businesses!