The Definition of Safety Stock
The definition of safety stock or buffer stock in inventory management is the amount of extra inventory a business keeps on hand to protect against stockouts. Safety stock can refer to spare parts, raw materials, or finished products that are held in reserve for use at a later time. It is especially used when a part is unavailable or when demand is unpredictable.
Safety stocks provide a buffer between actual demand and the number of supplies on hand at any given time. The goal is to ensure enough items are in stock to cover unexpected fluctuations in demand.
Ways to Calculate It
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.
That is why most businesses use some formulas in order to calculate the amount of safety stock they need. These are the two most common and easy ways to estimate your safety stock:
Basic Safety Formula
This is the most basic method to determine your buffer stock. You basically want to secure a certain number of days in which you will have the needed supplies.
The following formula is the way to calculate the number of “safety days”.
If a product of yours has an average of 50 sales per day and you want to have a safety stock worth 3 days, the calculation is 50 (products) x 3 (days worth of stock). Thus for 3 days, your safety stock will be 150 products.
Average – Max Formula
This formula helps you find out the amount of average max units you need in a certain time. The formula is the following: (maximum sale x maximum lead time) – (average sale x average lead time).
This method needs well-kept and updated documentation of your products’ sales per day. Let’s say that over a 12-month period you sold 12,000 items, so your daily sales were 12,000 (products) / 365 (days): 33 items.
The maximum sales per month are 1200 items, so 39.5 items per day. 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.
Using the above formula (39.5 x 40) – (33 x 35) you will find that you need a safety stock of 425 items for 12 months.
Advantages of Safety Stock
Safety stock can minimize the impact of a shortage. 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.
Safety stock makes it easier to respond to changing demand levels because you have more flexibility when orders are placed. If you don’t have enough safety stock, then you may find yourself placing orders too early when demand is low or too late when inventory runs out.
It also helps them avoid running out of products and having dissatisfied customers. If a customer wants a specific product, but can’t find it in the store, they are likely to go elsewhere to buy it.
Disadvantages of Safety Stock
The most obvious is that it’s expensive. It takes up space on the shelf and in your warehouse, which means that you need more storage space and more capital to build up a larger inventory.
In addition, safety stock is frequently wasted because it doesn’t sell until the next season or quarter. That can happen even though there was enough demand for it during the current season or quarter. In other words, having an accurate inventory and safety stock will save you money. If there was an overstock of sweaters during December and January, you may find yourself stuck with them for months until spring comes around again and people start repurchasing them.
Finally, safety stock can become obsolete before it sells out completely. For example, if you have an excess of obsolete electronic components sitting on your shelf for six months, then those parts will be useless by the time they are finally sold off at a deep discount or thrown away altogether