How to calculate safety stock? Safety stock formula and calculation.
From the very safety stock definition, it’s clear that it’s an emergency stock meant to help you account for emergency circumstances, meaning anything that can make you run out of the product. Some examples are breakdowns of production machinery, any weather-related troubles affecting your stock or deliveries, unpredicted surges in your product’s popularity leaving your supplier unable to match demands…Basically, anything unexpected.
The truth is supply chain problems do happen, and as a retail business, you need to be prepared to face them. Backorders work, but they come with a risk losing out on sales and customer loyalty. So, how do you protect your business against unexpected incidents without upsetting customers and compromising your professional reputation? This is where calculating safety stock comes handy.
So, what is safety stock? Safety stock is an inventory formula retailers use to determine the emergency stock – the extra stock of products they need to have in case of unforeseen circumstances that can put them on the verge of selling out. You’d want to have enough products to help you weather the storms, but not too much so that you don’t end up with the carrying costs that are too high for your sales level. While this sounds fairly straightforward, the trick is to know how to calculate inventory in order to determine the optimal stocking level. It’s important to remember that the sales don’t only have to cover the sold products’ own carrying costs, but the carrying costs of the safety stock as well.
Safety stock calculation is no rocket science really. You just need to have your purchase and sales orders history handy. Once you do, use this simple safety stock formula, also known as “inventory equation”:
Safety stock = (Maximum daily usage * Maximum lead time in days) – (Average daily usage * Average lead time in days).
Here’s a retailer’s inventory formula example to illustrate how the safety stock calculator works:
A souvenir retailer “From Russia With Love” based in the New York City sells Gzel tea sets from Russia. On an average, it takes about 40 (average lead time in days) days to get the tea sets made and shipped from Russia to NYC. The company sells about 15 sets a day (average daily usage), but on good days sales can go as high as 25 (maximum daily usage). Unfortunately, in Russia, they have snow storms and the roads are not always reliable, which sometimes results in longer lead times, up to 55 days (maximum lead time in days).
Now, how to calculate inventory with that? Using the safety stock equation above their optimal stocking level formula would be:
(25 x 55) - (15 x 40) = 775
With this, we have determined that the From Russia With Love souvenir store would need to carry about 775 tea sets as safety stock at all times (especially in winter when the weather conditions in Russia are harsh).
This is basically all there is to know about how to calculate safety stock. Your stock holding formula will help your business navigate safely through all the fluctuations in demand and lead time.
Depending on the products you’re selling, you may need to adjust that stock holding formula to seasonal changes. During the peak seasons, sales may increase drastically requiring a bigger safety stock. But, once the peak season is over, you would want to start reducing your safety stock levels to lower your carrying costs.
It is essentially another term in inventory management used to describe a level of extra stock that is kept to account for uncertainties in supply and demand or the risk of stockout.
So, now that you know what a safety stock level is and how to calculate average stock level and determine exactly how much safety stock you need - use that when deciding on your reordering quantity.