Safety stock is the buffer that helps manufacturers keep serving their customers when disruptions occur. Here is how it works.
What Is Safety Stock?
Safety stock is the level of extra inventory that is kept to reduce the risk of stock-outs caused by shifting supply, demand, or both.
Companies that make to order can continue delivering their products within the promised lead time by using the safety stock of materials when suppliers are unable to deliver within their usual timeframes.
Companies that make to stock can continue delivering products from safety stock when sales are greater than expected, or when production is down, and they can continue production when suppliers are unable to deliver materials within their usual timeframes.
Having a mathematically defined safety stock and reorder point can help keep promises to customers during issues that could cause disruptions in your supply chain.
Read more about Reorder Point: What is Reorder Point and Reorder Point Formula?
The Dos and Don’ts of Safety Stock
It is essential to maintain a feasible amount of safety stock. Here are ways how you should and should not approach it.
- Use safety stock to mitigate risks of demand and lead time uncertainties.
- Use it together with a reorder point.
- Find a balance between service level, customer availability rate, and carrying costs.
- Use mathematical formulas to define optimal safety stocks for your materials.
- Use safety stock to mask issues in inventory management, forecasting, production, logistics, or supplier unreliability.
- Keep insufficient safety stock – you will risk being unable to fulfill orders, which could result in lost sales and customer turnover.
- Keep too much buffer – you will most probably keep customers happy, but a higher level of safety stock immediately means higher inventory costs, extra cash stuck as inventory, and in time, spoiled, expired, or damaged goods.
How to Calculate Safety Stock?
There are many different ways to calculate safety stock, but we will go over six of them, starting from the simplest.
Two Simple Formulas
For both of these simple formulas, you’ll need to know the:
- Average lead time in days (LTavg)
Your vendor’s average lead time is the average time it takes from purchase order to arrival.
You can pull that data from the Procurement -> Vendors -> A vendor’s reports -> Purchase Terms report or by analysing your previous Purchase Orders at Procurement -> Purchase Orders section of your MRP system.
- Average demand per day (Davg)
To get your average demand, just pull the statistics Procurement -> Statistics section of your MRP system.
In this example, we have used 100 pieces of tabletops in a quarter, that is, on average, 66 working days. So we’ll divide the number of items sold by the number of days to get the average demand per day.
The average demand for tabletops is 1.5 per business day.
The Basic Formula
This is the easiest and most inaccurate method (other than just improvising) to determine safety stock.
To use it, you will have to predetermine the number of safety days you’re going to need to be able to respond to a spike in demand or inconsistencies in supply.
Let’s say you use 1.5 units of tabletops per day and your vendor’s average lead time is 5 business days.
Based on previous experience, you set the safety net at 10 days.
This means the safety stock for the tabletop should be 1.5 x 10 = 15 units.
WARNING: This method is not the most accurate due to the necessary safety days being derived from experience, not from rigid data analysis.
The Average – Maximum Formula
To calculate safety stock with it, you need to know your maximum lead times as well as your maximum demand.
You can determine your maximum lead time by looking at your Procurement -> Purchase orders section in your MRP system.
Tick the box for “Delay” from the “Choose columns” drop-down menu.
Then add the average lead time to the largest delay of the material you are trying to calculate safety stock for.
Now you have the material’s maximum lead time.
You can find the maximum demand much in the same way.
Just take the month-by-month data from your Procurement -> Statistics section.
Let’ say you use 100 units per month on average, but your maximum monthly use this year has been 130.
And your average lead time is 5 days, but the maximum has been 6.
Convert the monthly demand to demand per business day.
There are 22 business days each month on average, so the average demand is 100/22=4.55 units/day, and the maximum is 130/22=5.91 units/day.
That means your Safety Stock should be (6 x 5.91) – (5 x 4.55) = 35.46-22.75=12.71
Let us round it up and that makes your optimal safety stock 13 units.
Formulas for specific variables
Here is where we will start applying some proper math.
Apart from your material’s average lead time and average demand, for the following formulas, you will have to know its:
- Service level factor (Z)
The service level shows the percentage of cases when you can continue normal business despite of any disruptions, i.e. you do not run out of stock. For example, service level 95% means that in 5% of cases your materials will arrive so late that the safety stock has been exhausted, and thus, production (and/or sales) has stopped. According to the desired service level, choose the Z factor from the following table.
- Lead time standard deviation (σLT)
You can find the standard deviation in lead times by looking at your average lead time and your actual lead times. Get your actual lead times by comparing the Expected Dates with the Arrival Dates and adding the difference to the average lead time of the vendor.
Here’s an example:
We find that the standard deviation of the lead time is 2 days. (E.g. function STDEV can be used in Excel and Google Sheets for calculating it.)
- Demand standard deviation (σD)
Demand standard deviation can be calculated by using the example from lead time standard deviation – just replace the Actual Lead Times with Actual Demand per day, and the Average Lead Time with Average Demand per day. See the day-to-day “Materials used in shipped goods” statistics to find the Actual Demand.
Always remember to use the same units of time measurement throughout your equations, e.g. only days or only months, otherwise your results will be unusable.
Formula for inconsistent lead times
In case you have consistent demand but inconsistent lead times, you can calculate your necessary safety stock with this equation.
Formula for inconsistent demand
If your lead times are like clockwork but demand fluctuates, use this formula to calculate your safety stock.
Formula for independently variable demand and lead times
If both your sales and lead times vary independently of each other, you can use this formula for your calculations.
Formula for dependently variable demand and lead times
In case your demand and lead times fluctuate while being dependent on each other, use this formula.
Source of formulas: Crack the Code, P. King, APICS Magazine (2011)
Having a safety stock could prove to be a lifeline in uncertain times, but it is always necessary to rely on numbers and analysis when you set your buffers.