What Is Safety Stock? How to Calculate It?

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Is the possibility of running out of stock giving you nightmares? Or the potential empty shelves at the store driving you to make catastrophic inventory decisions?

Let us tell you that you’re not alone. Almost every business into product offering dreads these two scenarios. That’s because such situations can not only drive your customers away but drastically reduce their loyalty. That, apart from the lost sales and revenues.

What’s the solution, you ask?

Safety stock is your answer.

From lowering the lost sales rate to striking a balance between the ever-changing demand and supply ratio, safety stock can mitigate a lot of risks.

In this article, we’ll discover what safety stock means along with its importance. We would also understand safety stock formula to help your business attain a positive gross margin return on investment.

Shall we begin?

» What is Safety Stock?

In the simplest terms, safety stock is the additional stock retail businesses purchase other than their regular cycle of stock. The aim is to reduce the possible risk of going out of stock.

Retail businesses typically store their safety stock in their warehouse. Doing so helps them avert or minimize the impact of situations, such as sudden fluctuations in consumer demands, inaccurate inventory predictions, and faulty demand forecasts. Not just that, safety stock comes in handy to tackle problems of delays from suppliers as well as other supply chain uncertainties.

What’s interesting is that you can calculate safety stock using different formulae. While it may sound simple, in reality, it is a bit complicated. There are multiple factors to consider for each retail business. Besides, it can greatly vary based on your niche. We’ll see more details on it in the dedicated section of this blog.

Safety stock is also popularly known as “backup inventory” or “buffer stock.”

» Importance of Safety Stock For Your Business

Every retail business needs to maintain sufficient inventory levels to thrive. For that, it is crucial to efficiently plan and manage inventory. That’s where safety stock comes into the picture. Whether you’re into finished products or raw materials, safety stock can either make or break your inventory management process, and thus, your business success.

If you’re wondering why you should go for a buffer stock, here are a bunch of reasons:

› Prevents extreme scenarios

One of the primary goals of keeping a safety stock in place is to meet the sudden high demand for goods. At the same time, buffer stock provides you with a safety net when there are delays from your suppliers for varied reasons.

In both these situations, you can easily and immediately cater to the customers with a buffer stock in the warehouse. Customers won’t have to wait for their favorite products. And you’d be saved from last-minute, expensive stock replenishment. The result? You can successfully avert the condition of stockouts, as well as understocking.

› Facilitates uninterrupted manufacturing

If you’re a manufacturer, a buffer stock of raw materials can be your savior in more ways than one. Imagine the consignment of your raw goods getting stuck midway in the supply chain, stalling your production process entirely. Or you don’t have enough finished products ready in the warehouse during peak sale season due to process delays. Such blunders can lead to lost sales and clients.

› Helps power up your supply chain

With a safety stock in place, delayed deliveries from your suppliers won’t bring your operations to a halt. Furthermore, problems or fluctuations in your regular transportation won’t drive your customers away from your business. If there are any changes in the quality of goods from your new suppliers, you can afford to wait it out without the fear of lost sales. Backup inventory, thus, supercharges your supply chain so you can continue offering your clientele a frictionless experience.

› Boosts consumer satisfaction

Safety stock is a key to avoiding stockouts and product shortages. That way, you can fulfill orders, exceeding customer expectations. Such a reliable offering, in turn, elevates customer satisfaction as well as trust in your brand. This trust and satisfaction further fuel repeat purchases, earning you loyal customers. All of that, together, boosts your reputation in the market, making you stand out amongst your competition.

› Strengthens your sales & marketing arm

All your efforts on the sales and marketing fronts can backfire if you don’t have sufficient stock on hand. With a buffer stock, though, that’s not the case. You can ideate, plan, and execute specific marketing campaigns to drive sales with a powerful safety stock strategy. You know you can fulfill the demand boost these channels would generate, and win over your customers.

Think of it like a calculated risk - creating campaigns or running offers keeping an eye of precision on your additional stock levels. Doing so further strengthens your customer relationships, along with your brand position.

» What is an Ideal Safety Stock Level?

No two businesses are same. Neither are their goals and requirements. And it holds true even if they belong to the same sector. With these basic facts, it is sensible to say that the ideal level of safety stock would vary from business to business.

The ideal safety stock level would depend upon multiple factors, including the type and size of the business, product demands, inventory offered, and service level requirements and expectations.

Take, for example, your local grocery store and a high-end shoe brand store. The former would require a bigger buffer stock than the letter.

Similarly, the same apparel brand in a metro city would have a greater level of safety stock than their store in a non-metro city.

Wondering how to determine a practical safety stock level then?

Fortunately, we have multiple safety stock calculation formulas to rely on.

» How to Calculate Safety Stock?

Calculation of safety stock would require you to have precise data on factors that are essential for the formula to give accurate results. The average lead time of your vendors is one such parameter. Vendor lead time, also referred to as LTavg, is nothing but the time takes between placing a PO (purchase order) and its delivery to your warehouse/store location.

Another critical component is the average demand for a product on a daily basis. It’s often called Davg. Let’s assume, you sell 120 pieces of a product range in 30 days. That way, the daily demand volume of that product line would be: 120 divided by 30 = 4. So, your Davg, in this case, would be 4.

Based on the above parameters, here’s one of the formulas you could use:

Safety Stock = Average Daily Demand or Davg * Average Lead Time or LTavg

The second formula for the safety stock calculator is as follows:

Safety Stock = (Number of Stock Sold Per Day) x (Stock on Hand for Days)

This is the most commonly used formula to determine the safety stock benchmark that works for your business. Using it for the above example, assuming you have 8 days of stock on hand, the safety stock would be:

Safety stock = 4 * 8 = 32 units

Your buffer stock in this case will be 32.

The third formula to calculate safety stock is as follows:

Safety Stock = (Maximum Usage Per Day * Maximum Lead Time in Days) - (Average Usage Per Day * Average Lead Time in Days)

The maximum usage would be the highest number of sales of a particular product for a stipulated timeframe. Let’s assume it to be 150 pieces for a span of 30 days. Maximum lead time would be the highest lead time that particular product line has taken to reach you. Suppose it’s 5 days while the average lead time is 3 days.

That way, the maximum per-day usage or demand of that product would be 150/30 = 5 units.

And the average demand for that product per day would be 120/30 = 4 units.

Using it in the formula, this is how it would look like:

(5*5) - (4*3) = 25 - 12 = 13

Your safety stock, in this case, would be 13 units.

All of it seems overwhelming?

Well, thankfully, you don't have to do it all of these calculations manually. There are many powerful supply chain management software systems available out there to simplify and streamline this task.

» How to Select the Best-Fit Formula for Your Business?

Since every business has its unique demands and requirements, the most effective safety stock formula differs from one entity to the other. It would largely depend on your distinct needs, expectations, and the factors that affect your inventory and sales.

Therefore, before choosing a formula, it’s wise to get clarity on the following:

Your inventory management capability
Analysis of sudden spikes and drops in the demand and sales of your product offerings
Consistency of your vendor lead times
The type of your inventory: seasonal or evergreen

It’s as much important to ensure you’re collating precise data for accurate decision-making. Data accuracy is also critical for realistic demand forecasts. Using a robust supply chain and inventory management tools might help.

» The Bottom Line

Safety stock at its core is critical to avoid situations of stockouts or inventory shortages. It is a buffer stock you need to meet the fluctuating demands to promptly cater to your customers, ensuring continued customer loyalty. At the same time, it helps you tackle the uncertainties encountered in the supply chain process, such as supplier delays.

Safety stock also makes sure your sales cycle runs smoothly. The best thing is that not all your products require a buffer stock; it’s only needed for certain essential, popular, or highly in-demand items.

While calculating safety stock can be tricky, a thorough analysis of your existing data, including user trends and vendor patterns, may help arrive at a feasible, near-accurate number.

Safety Stock: Your Practical Guide to Maintaining a Feasible Level