To calculate safety stock, work out your average daily use for a product and multiply it by its average lead time – how long it takes, in days, to arrive once you place an order. Then subtract this number from your maximum daily use times your maximum lead time. The result is the safety stock number for that product.
What is the safety stock formula?
The safety stock formula is therefore:
[maximum daily use x maximum lead time] – [average daily use x average lead time] = safety stock.
How to calculate Safety Stock in Excel
You can calculate safety stock in Excel by setting up your spreadsheet as per the image below. In the cell where you want your safety stock figure calculated for each product (SKU), type the formula:
- Column B is the maximum number of units you’ve used (sold) of a product in a day
- Column C is the average number of units you use (sell) of a product in a day
- Column D is the maximum number of days it takes to receive goods of that type once you place a new order
- Column E is the average number of days it takes to receive goods of that type once you place a new order
- 2 is the number of the row for that SKU
The safety stock formula can be calculated in Excel with a simple table.
Ideally, once a safety stock figure is set for each product, an inventory management system such as Unleashed is used to manage stock within ideal levels.
Understanding the safety stock formula
The safety stock formula is intended to work in conjunction with the reorder point formula. The reorder point is the level of stock at which you ought to reorder more stock (or components, in the case of manufacturers). By including a buffer based on the maximum number of sales made over the maximum number of days of lead time, the safety stock formula provides an important cushion. Essentially the safety stock formula answers the question:
“If – after I reorder my supplies – I somehow sell the most I’ve ever sold, every day, for the longest number of days my stock has taken to get to me, then how much stock will I need to avoid completely running out?”
Safety stock levels for manufacturers
If you’re in the business of manufacturing then you need to factor time taken for production into your maximum and minimum lead times. By looking at lead times in this way they will still be a measure of how long it takes you to get stock into your warehouse ready to be shipped out to a buyer.
Be sure to also include any time taken for setting up production, as well as transport times between your factory and your warehouse if these are in different locations.
The safety stock formula is used to set ideal stock levels for manufacturers, wholesalers, retailers and distributors.
Recap: What is safety stock and when should I use it?
Safety stock is a buffer of inventory held to protect against stock-outs. Safety stock can be used if:
- Demand exceeds a sales forecast
- Production output is less than planned
- Supply chain disruption results in long lead times
Why is safety stock important?
The purpose of safety stock is to avoid stock-outs, whereby a product can’t be supplied for sale, its delivery after purchase is unreasonably held up, or a component isn’t available during manufacturing. Stock outs negatively affect a business in several ways.
1. Stock outs and customer satisfaction
Stock outs can be deadly to customer satisfaction, with some business types affected more than others. Running out of one shoe colour variation might not affect a clothing manufacturer unduly. Whereas a B2B business that relied on a small number of high value sales could be dramatically affected by not being able to fulfill a big potential sale.
2. Stock outs and revenue
Beyond customer satisfaction, stocks also directly affect a business’ bottom line – after all you can have the best marketing campaign in the world, but if your product is not available when the consumer wishes to buy, then their money will undoubtedly go to your competitors.
3. Stock outs and efficiency
Stock outs that occur during the manufacturing process are also very detrimental to a business. Running out of a single component typically halts production, with the run either held up – raising labour costs relative to output – or else being split, so that something else can be made while you wait for the missing stock to arrive. Splitting a production run like this adds an inefficient extra breakdown and start-up stage.
Ordering excess safety stock can be costly.
The downsides of safety stock
While avoiding stock outs is important, it should be pointed out that there are serious downsides to holding safety stock as well.
Holding inventory costs money – both because the stock itself must be purchased, tying up capital – and because higher volumes of inventory require more warehouse space, as well as staff and other costs such as insurance.
Holding excess inventory can also lead to significant losses through wastage, as many types of inventory can spoil or devalue over time: foods, beverages and medicines all fall into this category. While others can break, go out of fashion, or become redundant. A company making toys or consumer electronics, for example, would need to carefully balance the risk of a potential stock out against the risk of holding excess inventory that never sells.
Who needs to calculate safety stock?
The actual job description of the person setting safety stock levels varies with the size and nature of a company. In small companies it may be the owner or general manager who decides on optimal safety stock levels. While in a larger business this might be set by production managers, warehouse managers, or a logistician.
Pain points that lead to setting safety stock levels
Often the person who decides on a safety stock figure does so because one of two things happens:
- The finance manager or CFO decides that too much capital is being tied up in inventory, and asks that stock levels be reduced as much as possible, or
- Regular stock outs are damaging the business.
Setting ideal safety stock levels is a balancing act.
Should you calculate safety stock for every SKU?
Not every product will require a buffer of safety stock – indeed it can be harmful to a business to hold so much inventory that they never run out. However this is a decision that must be made company by company, and the simplistic answer is that you should set a safety stock level for any product or component that you can’t afford to run out of.
Working with safety stock in inventory management software
In Unleashed’s inventory management system, safety stock comes into play when setting minimum stock levels for products.
To work out your minimum stock level for each product, or SKU, you need to calculate the reorder point for each item. This is a level of stock that is calculated by factoring in both the safety stock level and the average quantity used between ordering stock and it arriving in the warehouse.
Once the reorder point has been decided it can be set in Unleashed, with reordering managed easily by running a key inventory report – the Reorder Report – as per the video below.
Calculating safety stock in a growing business
Article by Greg Roughan in collaboration with our team of inventory management and business specialists. Greg has been writing, publishing and working with content for more than 20 years. His writing motto is ‘don’t be boring’. His outdoors motto is ”I wish I hadn’t brought my headtorch’, said nobody, ever’. He lives in Auckland, New Zealand, with his family.