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Calculate Safety Stock

How to Calculate Safety Stock: A Complete Guide?

Inventory is a critical part of any business. It’s what ensures that you have the necessary supplies to keep your operations running smoothly. However, inventory can also be very costly. That’s why it’s important to manage your inventory wisely, and one way to do that is by calculating your safety stock.

However, if you are starting or are new to the concept of safety stock, it could be difficult for you to understand everything there is to know about it. Safety stock is an important aspect of inventory management, but it can be complex.

This guide will teach you everything you need to know about safety stock, including what it is, how to calculate it, and why it’s important. So if you are ready to learn more about safety stock, this article is for you!

What is Safety Stock?

Safety stock is a type of inventory that is maintained to protect against stock-outs. It’s insurance for your business, in case something unexpected happens and you need more inventory than you currently have on hand.

For example, let’s say that you are a retailer who sells t-shirts. You might keep a certain amount of safety stock on hand in case there is a sudden surge in demand for t-shirts (such as if a celebrity is seen wearing one of your t-shirts). This way, you won’t run out of t-shirts and lose potential sales.

Safety stock can be expensive, so it’s important to calculate the right amount. You don’t want to have too much safety stock, as that would tie up too much capital, but you also don’t want to have too little, as that could lead to stock-outs.

In simple words, safe stocks are a type of safety cushion that businesses maintain in their inventory to protect themselves from potential stock-outs.

How Can Safety Stock Improve Inventory Management?

Now when it comes to inventory management, there are two types of businesses: those that use a just-in-time (JIT) inventory system and those that don’t.

Businesses that use a JIT inventory system try to keep only the necessary amount of inventory on hand, as they believe that having too much inventory ties up too much capital. On the other hand, businesses that don’t use a JIT inventory system often keep more inventory on hand, as they believe that it’s better to have too much inventory than to run out of stock.

Most businesses use a combination of both JIT and non-JIT inventory management. For example, a business might keep a certain amount of safety stock on hand, but they might also use a JIT system for their main inventory.

There are benefits and drawbacks to both JIT and non-JIT inventory management. However, one of the main benefits of using safety stock is that it can help you strike a balance between the two.

Let’s take a look at how safety stock can improve inventory management:

Safety stock can help you avoid stock-outs

If you don’t have enough inventory, you might run into the problem of stock-outs. This can be a major issue, as it can lead to lost sales and unhappy customers. However, if you have safety stock, you can avoid this problem. The main reason behind this using safety stock is to have a buffer in case of emergencies. If something unexpected happens and you need more inventory than you currently have on hand, your safety stock will help cover the shortfall.

Safety stock can help you reduce the cost of inventory

If you have too much inventory, it can tie up a lot of capital. This is because you are paying for inventory that you might not even need. On the other hand, if you have too little inventory, you might run into the problem of stock-outs (as we discussed earlier). Safety stock can help you reduce the cost of inventory by striking a balance between these two extremes. By having just enough safety stock on hand, you can avoid the cost of excess inventory, while still having enough inventory to avoid stock-outs.

Safety stock can help you improve customer satisfaction

As a business owner, you never want to disappoint your customers. If you run out of stock, it can lead to lost sales and unhappy customers, however, if you have safety stock, you can avoid this problem. By having safety stock on hand, you can be sure that you always have the inventory you need to meet customer demand. This will help improve customer satisfaction and keep them coming back for more.

Safety stock minimizes the effects of supply disruptions

Similar to how safety stock can help you avoid stock-outs, it can also help you minimize the effects of supply disruptions. If your supplier is having trouble keeping up with demand, your safety stock will help cover the shortfall. It is a common thing that happens quite frequently in manufacturing businesses. So if you have safety stock, you can rest assured knowing that your business will be able to weather the storm.

Safety stock reduces administrative and staff hours

If you constantly have to worry about inventory levels, it can take up a lot of your time. However, if you have safety stock, you can free up some of your time. This is because you won’t have to constantly check inventory levels and place orders as often. Instead, you can focus on other aspects of your business such as marketing and sales. In addition, having safety stock can also reduce the number of staff hours required to manage inventory, which can lead to cost savings.

Increased efficiency in the workplace

Safety stock not only reduces the amount of time spent on managing inventory but can also lead to increased efficiency in other areas of the workplace. For example, if employees are constantly having to stop their work to search for inventory or place orders, it can lead to disruptions and decreased productivity. However, if you have safety stock, you can avoid this problem. By having the inventory you need on hand, you can keep employees focused on their work and improve workplace efficiency.

So these are 7 ways safety stock can improve inventory management. As you can see, there are many benefits to having safety stock on hand. If you are not currently using safety stock, we recommend giving it a try. You might be surprised at how much it can improve your business.

Why Use the Safety Stock Formula?

To get the most out of your safety stock, you need to know how much safety stock to keep. You don’t want too much or too little safety stock because it can lead to higher holding costs or lost sales. You can use a formula to calculate how much safety stock you need for your business.

The main reason to use the formula is that it takes the guesswork out of calculating safety stock. By using a formula, you can be sure that you are striking the right balance between too much and too little safety stock.

This way you can meet the needs of your customers while also minimizing the cost of inventory. But if you create safety stock just using your instincts and “gut feeling”, there is a big chance that you will get it wrong. So it’s always better to plan safety stocks using strategies and formulas.

Risks & Challenges Related to Safety Stock

While safety stock can offer many benefits, there are also some risks and challenges associated with it. Here are some of the risks and challenges you should be aware of before implementing safety stock in your business:

Higher inventory costs

One of the biggest challenges of keeping safety stock is the increased cost of inventory. When you keep more inventory on hand, it will naturally cost more money. So you need to be sure that the benefits of safety stock outweigh the costs. One way to settle this is by doing a cost-benefit analysis. This will help you to determine if the benefits of keeping safety stock are worth the increased costs.

You can run out of safety stock

Another risk of keeping safety stock is that you can always run out of it. If demand unexpectedly increases or there are delays in the supply chain, you might find yourself without the safety stock you need and this can lead to lost sales and unhappy customers. So it’s important to monitor your inventory levels closely and reorder safety stock before it runs out.

Your safety stock might not get sold

Another challenge of keeping safety stock is that it might not get sold. This is because the inventory you keep as safety stock might not be in high demand. As a result, it can sit on your shelves for a long time and eventually become obsolete. To avoid this, you need to carefully choose the products you keep as safety stock. Make sure to choose products that are in high demand and likely to sell quickly.

You need space to store safety stock

Another challenge of keeping safety stock is that you need enough space to store it. If you don’t have enough space, it can lead to higher inventory costs and decreased efficiency in the workplace. So before you implement safety stock, make sure you have enough space to store it. You can do this by renting a storage unit or using an existing room in your office or warehouse.

More work for employees

Another challenge of keeping safety stock is that it can lead to more work for employees. This is because employees will need to track and monitor inventory levels more closely. They will also need to reorder safety stock when it runs low. So before you implement safety stock, make sure you have the resources and manpower to manage it.

Read Also: How to Prevent and Avoid Chargebacks

Safety Stock Calculation: Different Formulas

Now that you know the risks and challenges associated with safety stock, you might be wondering how to calculate it. There are different formulas you can use to calculate safety stock, the most common ones are the following:

Average – Max Formula 

The first safety stock formula is the Average–Max Formula. This formula is used to calculate the average demand and the maximum demand for a product. To use the Average–Max Formula, you need to know the following information:

  • The average demand for a product
  • Maximum demand for a product
  • Lead time for a product

Once you have this information, you can calculate safety stock using the following formula:

Safety stock = (Maximum sale x Maximum lead time) – (Average sale x Average lead time)

Normal Distribution with Uncertainty About the Demand 

If there is a fluctuation in demand, you can use the Normal Distribution with Uncertainty About the Demand formula to calculate safety stock. To use this safety stock formula, you need to know the following information:

  • The standard deviation of demand
  • The average delay

The Normal Distribution with Uncertainty About the Demand formula is as follows:

Safety stock = Standard deviation of the demand x the root of the average delay

Normal Distribution with Uncertainty on the Lead Time

If the lead time is the only variable in the demand and you are using a Normal Distribution, you can use the Normal Distribution with Uncertainty on the Lead Time formula to calculate safety stock. If you want to use this safety stock formula, you’ll need this information:

  • Z (Z is the desired service level)
  • Average sales
  • The lead time deviation 

The formula of Normal Distribution with Uncertainty on the Lead Time is as follows:

Safety stock = Z x Standard deviation of the lead time x Average sales

Normal Distribution with Uncertainty On-demand and Independent Lead Time 

This method is best used when there is a lot of uncertainty about both how much people want your product and how quickly they need it as they both work independently of each other. In simple words, the demand and lead time are not related.

The Normal Distribution with Uncertainty On-demand and Independent Lead Time formula is as follows:

Safety stock = Z x sqrt(Average LTx(Demand Standard Deviation) squared + (Average Sales x Lead Time Standard Deviation) squared)

Normal Distribution with Uncertainty on Demand and Dependent Lead Time 

And lastly, we have the Normal Distribution with Uncertainty on Demand and Dependent Lead Time formula which is used when demand and lead time are related to each other. In other words, the lead time is based on the demand. For example, if you increase the demand, the lead time will also increase.

The Normal Distribution with Uncertainty on Demand and Dependent Lead Time formula is as follows:

Safety stock = Z x Demand Standard Deviation x Sqrt (Average LT) + Z x Average Sales x Lead Time Standard Deviation

How to Choose the Right Formula for Your Safety Stock?

Now that you know the different formulas for calculating safety stock, you might be wondering which one you should use. Here are a few things you should consider before choosing a safety stock formula:

1. The type of business you have 

The formula you want to use highly depends on the type of business you have. If you have a manufacturing business, the Average–Max Formula will be the best option for you. However, if you have a retail business, the Normal Distribution with Uncertainty About the Demand formula will be the best option.

2. Popularity

The second thing you need to do is figure out how popular your product is. If you are selling a product that is in high demand, you might want to keep a higher level of safety stock on hand. On the other hand, if you are selling a product that is not in high demand, you can get away with keeping less safety stock on hand.

3. Fluctuations in Demand

You also need to take into account fluctuations in demand when you are trying to decide how much safety stock to keep on hand. If there are big swings in the demand for your product, you will need to keep more safety stock on hand. On the other hand, if the demand for your product is relatively stable, you can get away with keeping less safety stock on hand.

4. The Cost of Keeping Safety Stock

You need to consider the cost of keeping safety stock on hand. If the cost of keeping a certain level of safety stock is too high, it might not be worth it. You need to strike a balance between the cost of keeping safety stock and the benefits of having it. This way, you can make sure that you are not spending too much on safety stock and that you are still getting the benefits of having it.

Also Read: Self-Employed vs. Small Business Owner

5. Lead Time

Finally, you need to take into account the lead time when you are trying to decide how much safety stock to keep on hand. The lead time is the amount of time it takes for you to get more products from your supplier. If the lead time is long, you will need to keep more safety stock on hand. On the other hand, if the lead time is short, you can get away with keeping less safety stock on hand.

So before you pick up a formula for your safety stock calculation, ask yourself these questions:

  • What type of business do I have?
  • How popular is my product?
  • What are the fluctuations in demand like?
  • What is the cost of keeping safety stock?
  • What is the lead time?

Once you have answered these questions, you will be able to pick the right formula for your safety stock calculation. You can also set up a team or hire professionals to help you with your inventory management and safety stock calculation. This way, you can be sure that your safety stock levels are always where they need to be.

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