However, if there is a sudden demand surge for an item with very little safety stock, you might not be able to fulfill the orders. Above, we showed you how to use the safety stock formula to set your safety stock levels more accurately. Yet another way you can calculate safety stock is to express it as a percentage of your lead-time demand.

Essentially you are aiming to calculate the average max units you need at any one time. The retail industry aims to maintain a typical service level of between 90% and 95%, although this does depend on the product being sold. As mentioned How To Calculate Safety Stock? Safety Stock Formula And Calculation before,  a higher service level is a risk as it increases the amount of stock being held. Because of this, factoring in the cost of inventory stockout is important for understanding the role safety stock plays in the ordering process.

Tips for Optimizing Inventory for Your Ecommerce Website

All of the variables are just that – variable, and over time things change. Products become less popular, pricing changes, lead times can be volatile. So, the average daily usage rate is 3000 per month, so around 100 per day. Whereas implementing more detailed safety stock calculations can have a huge impact across a very large range of stock where a large number of stock outages can cause significant disruption.

What is the formula for safety stock calculation?

Safety stock is calculated by multiplying your desired service factor (Z score) by the standard deviation in lead time (𝜎𝑑𝐿𝑇), which is the degree and frequency by which the average lead time differs from the actual lead time.

Sales Volume highlights the number of units of the product that is sold each week. Quite simply, lead time is the time measured between starting and finishing a process. Factors within this process might include submitting a purchase requisition, approval time, emailing vendors, delivery time from the vendor, incoming inspection time, and the time it takes to put on the shelf. Although this approach takes into consideration standard deviation, it does not take account of time by including it as a variable in the equation (Emmanuel-Ebikake, 2015).

How 3PLs implement the safety stock formula to maintain optimal stock

It’s an understandable fear, but you can lower your inventory costs and improve your margins without compromising your high service levels. The first is lead time, which is how long it takes to receive stock after ordering it. Second is the demand rate, which is how many items you sell in between orders for that item. Your pipeline inventory can be calculated by multiplying your lead time by your demand rate. Think of the clothes stores put on mannequins or storefront window displays. Typically psychic stock is calculated by taking the difference between the total inventory on hand and the sum of cycle stock and safety stock.

  • That person is now either going to buy from a competitor or not buy at all.
  • This should be used where you are in a position where the only variability you need to protect against is demand variability, and you have strong historical data are available.
  • As a business owner, one of your biggest nightmares is missing out on sales because of stockouts.
  • That reduces the chances of holding excess safety stock and can reduce the need for safety stock by optimizing inventory management across the board.
  • For some retailers, a safety stock calculation can simply be a gut-feeling, an educated guess at what they think is right.

These four types of stocks stand out amongst other  inventory classifications and types you can use to lower inventory costs. For businesses that experience a great deal of uncertainty, we recommend method 5, normal distribution with uncertainty on-demand and independent lead time. It’s useful in this scenario because it factors in both lead time uncertainty and sales uncertainty. This formula is incredibly useful when there is a great deal of uncertainty. For businesses operating with these unstable factors, safety stock is extremely important. Ensuring that you have safety stock seems like a win-win, but it’s important to be aware of the risks related to safety stock.

How to use the safety stock formula

In essence, you are decoupling each part of your manufacturing process, so they aren’t dependent on each other to operate. Implement an IMS to gain greater inventory control, and less costly mis-ships. Dr. Muddassir has received a PhD in Management Science from Lancaster University Management School. Applying the same formula as the previous examples, we have a reorder point of 1345 pieces. “Z’ represents the number of orders that a company expects to fulfill in the given period. Get started today with a free real-time demo to learn more about Finale Inventory.

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Unpredicted market fluctuations can cause the cost of your goods to increase suddenly. This can be due to a sudden scarcity of raw materials, an increase in price of raw materials, unexpected demand surges in the market, new competitors, or new government policies. If you’ve got enough safety stock during these unpredictable situations, it can help you avoid the costs of buying stock at higher prices without sacrificing sales. Safety stock protects you against the sudden demand surges and inaccurate market forecasts that can happen during a busy or festive season. It serves as a cushion when the products you’ve ordered take longer to reach your warehouse than you expected.

Implementing measures to gather more accurate data and use better tools to analyze it can improve demand forecasting, positioning your business to be able to fulfill every order. The formula for how to calculate the amount of safety stock you need is actually quite simple whether you use software or an inventory sheet template. The safety stock with variable demand formula is best for situations where the lead time is reliable, but the demand varies. Safety stock mitigates the risks and consequences of stockouts, allowing your supply chain to proceed as usual even after cycle stock runs out. If you have positive numbers in your variance category, they represent the number of days over the expected times. If you have negative numbers in the category, then the delivery arrived earlier than the expected time.