Safety Stock: How to Use the Safety Stock Formula
Businesses must take steps to keep their customers satisfied. This includes ensuring that they have their most popular products stocked for demand. But markets can sometimes be unpredictable.
In some cases, suppliers can fail to deliver orders as requested. In other cases, customer demand for a product can suddenly spike beyond your projections. In either case, not having enough products is a disaster. You disappoint your customers and fail to take advantage of extra profits.
You can avoid this outcome by building up safety stock for your key products. Let us break down what safety stock is and how to use the safety stock formula now.
Here’s What We’ll Cover:
Safety Stock in Short
Your basic safety stock level is extra inventory you purchase to both:
- Cover any sudden spikes or fluctuations in demand from your customers
- To protect yourself against uncertainties in supply and unexpected delays
- To prevent the risk of stockouts, which keeps your customers happy
Think of safety stock or buffer stock as extra products you have on hand just in case. Maintaining a good supply of safety stock is an excellent practice for the supply chain management.
For example, imagine that you sell a popular line of shirts for your apparel business. The shirts are the most popular product you provide. One day, your supplier informs you that they won’t be able to restock you for another week.
You can then use your safety stock inventory to keep up with demand. Your customers are none the wiser. Because of this, your brand reputation is maintained and you keep making a profit. Over time, you can gradually order more shirts from the manufacturer to rebuild your safety stock.
Why Is Safety Stock Important for Your Business?
The benefits of safety stock are clear. They protect your business from:
- Frustrating or angering your customers during stock outs
- Losing profits due to supply chain instability
- Not being able to take advantage of a spike in demand for a new product. With safety stock, you can take temporarily increase profits while ramping up production
In other words, they ensure that your business can keep running as usual even if there are supply chain concerns behind the scenes.
Supply chain issues will happen. At some point, you may not receive a shipment of products on time or at all. This can be due to global events, supplier mismanagement, or incorrect orders. But safety stock and help you manage these periods without losing money or customer trust.
Given time variability, it may take a long time frame for normal stock levels to return. Enforcing safety stock requirements in your company is always a wise idea.
The Safety Stock Formula
The safety stock formula is a mathematical equation you can use to calculate how much extra stock you need in order to build up safety stock. Technically, there are a few different safety stock formulas. But the below safety stock calculation is the easiest to use and the most reliable across industries.
Here's the safety stock calculator equation in brief:
- (maximum daily usage – average daily usage) x lead time
Now let’s break down the terms of the formula one by one.
The maximum daily usage is simply the maximum daily usage of a given product or item. You should be able to find this by reviewing your records. Find the day when you sold the most of a given product. That’s your maximum daily usage.
The average daily usage should also be found in your accounting or inventory management software. It’s the average demand or number of units you sell across a product’s lifespan. Actual demand is, of course, subject to variability in demand depending on lots of factors.
The lead time is how much time you need to place a replacement order and for the supplier to deliver that order. In most cases, this is an average delay measurement.
Actual lead time can vary depending on the demand average, current inventory levels, and more. It may be wise to calculate this with maximum lead time factories in. That way, you compensate for any major time deviation you can predict.
For example, say the manufacturing company in the above example takes 2 weeks to deliver new shirts to the company. In that case, those shirts’ lead time is 2 weeks plus how long it took the company to place the replenishment order.
So, to reiterate:
- Take the maximum units of a product you’ve recorded in your supply management software
- Subtract the average daily usage of that product
- Multiply the resulting value by the average lead time period
- The resulting number is how many units you should purchase for adequate safety stock
How to Use a Safety Stock Formula
It’s best to use the safety stock formula ahead of time. If you try to use the formula when you are already in a supply chain crisis, your products won’t get there fast enough.
Smart business owners will use the safety stock formula in times of plenty. They’ll be more than prepared with optimal safety stock if a supply chain crisis ever strikes. Doing this early will also spread out inventory costs for additional stock so their budgets can handle it.
Try to use the safety stock formula for all your major products and for new products that you plan to launch. You never know which product will be a major hit with your customers!
In the end, building up safety stock for your major or popular products is a good idea. It’s just another part of smart supply chain management and a good way to protect yourself from future economic upheaval. Remember to use the safety stock equation regularly and ahead of time for the best results.
Find more guides to help you run your business on our resource guide.