Safety Stock 101: Formula, Cost & Risks Explained

Proper levels of safety stock can mitigate risk and prevent stock outs. This is the number you would likely order on a typical purchase order since it’s what you need to replenish stock with average customer demand. Some business owners overcompensate with too much inventory because they never want to miss out on a sale or have production downtime. It’s an understandable fear, but you can lower your inventory costs and improve your margins without compromising your high service levels. Once in-store inventory is running low, a replenishment order can be placed, and ideally, you have enough buffer stock to last until that order is fulfilled, without incurring out-of-stocks. Small-business owners might choose to have safety stock on hand for a variety of reasons.

  • Safety stocks provide a buffer between actual demand and the number of supplies on hand at any given time.
  • Failing to convert them is inexcusable lost revenue and a poor reflection on your business.
  • You want to maximize sales, deliver orders on time, and provide an experience that drives customers to leave you glowing reviews.
  • Minimum stock is the minimum number of units of a SKU that a business should have on hand in its regular stock to meet customer demand.

While CSL is an indication of the frequency of stockouts without regard to the total magnitude, fill rate is a measure of inventory performance on a volumetric basis. In this example, if the company does not have any safety stock, and only 130 rolls of cycle stock, there will be enough stock to satisfy demand during only half the cycles in the year. Calculating the appropriate safety stock level in the face of variable customer demand requires some basic statistics knowledge. That’s why it’s important to approach safety stock calculations through numbers instead of emotions and fear. Rely on data from your POS, market research, conversations with suppliers, and demand forecast to make the most informed safety stock call.

Stock types related to safety stock

Setting safety stock levels to zero means that the retailer plans to bring just enough inventory to stock in-store shelves. 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 the safeguard between plausible and tangible demand and is kept diligently by organizations to meet unexpected production as well as customer demands.
  • But it doesn’t take into account stock which is still in production and not yet ready for sale.
  • This is a choice often made to save money on upfront costs; purchasing, transportation, and storage.
  • Safety stock is a way to keep a cushion in your inventory levels to make sure you don’t run out of items if your inventory forecast isn’t perfect.
  • Fortunately, there’s a simple safety stock formula to help you order enough product to avoid out-of-stock issues, secure inventory replenishment, and normal distribution.
  • Customers are always happy because stores never run out of popular products.

Instead, compile historical data to determine the appropriate amount of safety stock your business needs. Things to consider in this calculation are your lead time and service levels as well as the changing landscape of brick and mortar shopping what are current assets definition to ecommerce. Safety stock, also known as buffer stock, is the inventory you buy to prevent shortages when demand is greater than expected. With safety stock on hand, you can fulfill orders with this additional inventory without delay.

Would you like to learn more about safety stock and other types of small-business inventory? Check out for The Ultimate Guide to Small-Business Inventory Management. Safety stock, buffer inventory, and anticipation stock sound well and good. The Z score, also called the desired service factor, is a way to decide how confident you want to be about having enough stock. It is a value that you select so that you don’t face a stockout scenario. A lower score means you’ll have higher chances of running out of stock.

Definition of Safety Stock

They can also jump to a competitor’s website faster than if they were window shopping at brick and mortar shops. With so many orders flooding in, the business quickly begins fulfilling orders using its regular inventory. When the stock hits its reorder point, the business places an order for another 5,000 units of the product.

When you have a shortage but do not have enough safety stock, you will face a severe problem. In other words, safety stock works as an “insurance” against shortages. And if all these variables have a significant impact, you need a formula like Greasley’s method to account for them all. A Z score of 1.65, which equals a 95% chance you won’t have a stockout, is considered acceptable even for important stock.

Reasons to Keep Safety Stock

As a result, finding the right balance between too much and too little safety stock is essential. It is possible to fine-tune the level of safety stock needed, based on a statistical analysis of historical demand records and future demand estimates. However, this can be an expensive and time-consuming approach, so it is more common to set a fixed safety stock level, and review the adequacy of this level from time to time. Pareto analysis can be employed to revise safety stock levels on a more frequent basis for only the most heavily-used inventory items. These customers are so sales-ready, they’re literally trying to give you their money. Failing to convert them is inexcusable lost revenue and a poor reflection on your business.

Safety Stock Definition, Ways to Calculate It & Pros and Cons

The size of the safety stock depends on the type of inventory policy in effect. An inventory node is supplied from a “source” which fulfills orders for the considered product after a certain replenishment lead time. In a periodic inventory policy, the inventory level is checked periodically (such as once a month) and an order is placed at that time as to meet the expected demand until the next order.

A third-party logistics (3PL) provider, like ShipBob, can provide you with real-time tracking of stock levels and formulas to set reorder points and safety stock. Using historical sales data, we can help you calculate your ideal reorder quantity and how much safety stock you need to avoid stockouts, while storing your inventory and fulfilling your orders. Some inventory managers use rules of thumb to govern safety stock amounts, such as the guideline that safety stock levels should equal 10-20% of cycle stock or two weeks’ worth of coverage. However, determining the appropriate safety stock level should be a bit more nuanced because it depends on supply and demand variability. Time-based calculation allows you to calculate safety stock levels over a specific time period based on future demand forecasts. The amount of safety stock that an organization chooses to keep on hand can dramatically affect its business.

What is the Safety Stock Formula? Calculating Optimal Levels and Storage Methods

Safety stock inventory is extra product kept on hand to account for unexpected delays from suppliers. Safety stock is always held in warehousing when there is uncertainty in supply. It’s an effective insurance policy against stockouts, AKA running out of raw materials inventory, finished goods inventory, or packaging. Greasley’s formula takes both lead time and demand fluctuations into account, which provides a more accurate way of calculating safety stock. But it doesn’t take into account stock which is still in production and not yet ready for sale. Remember, you cannot always predict the correct quantity to hold on to.

Then, from your documents, you see that you received 10 deliveries with an average lead time of 35 days and a maximum of 40 days. If you have too much safety stock, you can’t make a profit because you’re paying to store the inventory and it’s not selling. But if you don’t have enough safety stock, customers can’t get what they want and your business will lose sales. In the guide “Logistical Management,” authors Donald Bowersox and David Closs use the term performance cycle (PC) to denote the total lead time. For procuring raw materials, PC includes the time to decide what to order, communicate the order to the supplier, manufacture or process the materials, deliver them, and place them in inventory.

On the flipside, if customers know they’ll always find what they need, whether online or in-store, they’ll confidently keep coming back to you. Customer loyalty increases revenue, improves your brand reputation, sparks word-of-mouth marketing, and helps you gather valuable feedback. Shortage of materials, manufacturing issues, and problems in transport (like port congestion) are just a few reasons you may not be able to get your products as quickly and reliably as usual.

Safety stock helps you hold the right amount of buffer stock in case of unforeseen circumstances, so make sure you don’t default it to zero. 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. A simple formula may work if you are a smaller retailer, or if you have especially consistent sales levels.

Imagine you’re a customer driving an hour to eat in a popular restaurant only to find out that they don’t have enough stock to accommodate you. Customers will trust you if you can provide for every one of them despite having a higher demand than usual. Allison Champion leads marketing communication at Flowspace, where she works to develop content that addresses the unique challenges facing modern brands in omnichannel eCommerce. She has more than a decade of experience in content development and marketing.

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