What is safety stock? Definition, Importance, Formula

Despite the many benefits of safety stock, this inventory management strategy comes with a few challenges small-business owners should be aware of too. Consumer demand can rise and fall depending on the season, current events, and shopping trends. And while it can be difficult for small-business owners to predict consumer demand, safety stock can give companies extra time to replenish stock when demand spikes. It is important to keep only a limited supply of safety stock based on your estimations of the previous years and predictions for the current year.

If your desired service level is 95%, you’ll need to get shipments about every 14 days, and sell 1,500 products (on average) each month. Despite inventory management myths that state the contrary, safety stock is essential for your business. That’s because even the best data analysts in the world can’t accurately predict customer desires or unexpected mishaps along the supply chain. In today’s highly competitive xero accounting software global economy, inventory has become the focus of improvement for many companies. Cutting safety stock levels is one obvious area where savings can be made and e-commerce businesses with large stock ranges are often tempted to reduce safety stock across the board. To improve inventory management, conduct regular inventory audits of both inventory levels and standard procedures for handling inventory.

If the reorder point was calculated correctly, these automatic reminders enable you to time replenishment perfectly. Other costs are intangible, and result in an opportunity cost to your business. Customers who are ready to buy but find their desired product is out of stock may not purchase anything, which is a lost sale. That customer may also go to a competitor, which can result in lost sales in the future.

Safety stock definition

Customer demand for the products you sell can increase for many reasons. Would you like to learn more about safety stock and other types of small-business inventory? Check out Business.org for The Ultimate Guide to Small-Business Inventory Management.

  • Feel free to reference the first formula on this list for more information on calculating Z or σLT.
  • Anticipation inventory ensures you have all the inventory/supplies you need, well in advance of your expected sales.
  • The goal is to hold just enough safety stock to avoid either of these two extremes.
  • If you’re looking for a fulfillment partner with an intelligent inventory management solution, talk to one of our fulfillment specialists today.

Fortunately, safety stock can help mitigate these inventory management challenges, as well as prevent stockouts. Check out our guide to learn more about the benefits (and a few risks) of safety stock, as well as how to calculate safety stock levels for your small business. The safety stock formula aims to keep the least amount of buffer and safety stock while reducing extra inventory levels as needed.

Safety Stock: Definition, Examples, Disadvantages and How to Calculate it?

If you have consistent sales numbers and your supplier’s lead time rarely deviates from the average, the standard safety stock formula is ideal for you. Small-business owners can gauge the optimal amount of safety stock over time, depending on current consumer demand, lead times, and other factors. In today’s highly competitive business environment, it’s essential for small-business owners to prioritize customer satisfaction.

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A company’s ideal safety stock level will be based on its tolerance for stockouts. So, as an example if you set a service level of 50% it means that you have a 50/50 chance of selling more or less than the ‘average’ month of sales. Firstly, safety stock calculations are not intended to eliminate all stock outs —just the majority of them. This safety stock calculation is a very simple formula, and you must also track and calculate for changing conditions. Your business won’t always run like clockwork, and it can be difficult to stay on top of your numbers. They can also jump to a competitor’s website faster than if they were window shopping at brick and mortar shops.

Safety stock calculation example

So, it is relatively simple to see how this reorder point calculation can be bought into action once your safety stock levels are ascertained. For example, if company leaders decide that the company can tolerate stockouts during no more than 10% of the cycles, that sets service level goal at 90%. While designing for a higher service level—say, 98% would result in fewer stockouts, this requires significantly more safety stock.

Basic Safety Stock Formula

Inventory management is one of the biggest challenges facing today’s small-business owners. From ever-changing consumer demands to supplier delays and outages, there are countless factors that can make it difficult to determine reorder points and standard deviation of demand. Once you’ve done the math using real data, you’ll likely need somewhere to store this additional inventory. There are several automated solutions on the market, however, enclosed systems can ensure your safety stock is protected from the risk of theft or damage. It’s important to think about how much safety stock you actually need and what situations would force you to dip into your safety stock. This will help you understand how much to buy to decrease your risk of stockouts and protect yourself against lead time variability.

Fixed safety stock is when companies create a set inventory level for each SKU. More simply, it’s a predetermined number of buffer units you keep for each individual SKU. The variable demand formula is well-suited for brands with reliable lead times but experience demand variability throughout the year (possibly due to seasonality). Even when you devote energy and attention to your inventory forecasts, sometimes they don’t turn out quite as accurate as you’d hoped. More specifically, you might see a surge in demand that your forecasts didn’t anticipate — meaning your stock levels suddenly take a dip. In the world of ecommerce, running low on stock is somewhat inevitable.

There are four key variables you’ll need in order to calculate safety stock. This can require a substantial safety stock if there are ongoing problems with the upstream production process. An inventory control system like Lightspeed POS can help you manage stock levels with ease. According to the calculation, you need to keep an extra 280 patio umbrellas in stock to prevent a stockout due to shipment delays or an unexpected uptick in sales. First, when you pour money into inventory, your cash is stuck in that inventory until you sell it.

Importance of Safety Stock

And during the holidays or when specific trends are rising, being the only seller of a hot item can make gaining long-term conversions much easier. Any company that sells physical products will always be open to interruptions in their supply chain. Eventually, someone is going to miscalculate the demand for a product or something will go wrong in a shipment — causing everything to arrive late. Keeping all data in one place, carefully controlled with in built monitoring tools can take the pressure off inventory managers and reduce workload.

A lower score means you’ll have higher chances of running out of stock. For instance, if you select a Z score of 2.33, there is a 99% chance that you won’t face a stockout situation. Creating a safety stock will also delay stockouts from other variations, like an upward trend in customer demand, allowing time to adjust capacity. If your average and maximum daily sales haven’t changed in years, but the supplier’s lead time tends to fluctuate, Heizer and Render’s formula might suit you best. The standard deviation in lead time (σLT) is the frequency and degree by which your supplier’s average lead time differs from the actual lead time. The goal is to hold just enough safety stock to avoid either of these two extremes.

The same goes in case of a supply chain issue, like a material shortage. For example, microchip shortages in 2021 significantly increased the time customers had to wait for a new car, made some features unavailable, and drove prices up. If you sell more of a given product than you expected, your supply chain is disrupted, or your merchandise gets damaged, safety stock allows you to keep selling that product regardless. Without safety stock, your customers may end up disappointed because the item they want isn’t available. With too much safety stock, however, you’ll have a risk of spoilage, dead stock, and high storage costs. Amount of safety stock should be managed in tandem with customer expectations.

Anticipation inventory is a necessary piece of the inventory management puzzle, because it reduces the risk of stockouts, lost sales, and disappointed customers. Anticipation inventory ensures you have all the inventory/supplies you need, well in advance of your expected sales. Anticipation inventory is the extra finished goods or raw materials businesses purchase to meet an anticipated spike in demand. In other words, companies maintain anticipation inventory when they expect a change in demand in the near future.

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