What is Safety Stock?
Safety stock is the extra stock available with manufacturing companies to meet surges in market demand and counter delays in the supply chain, aimed at minimizing the risk of running out of stock and consequently reduce lost sales opportunities.
Safety stock requires organizations to balance inventory and inventory-related costs while maintaining desired service levels. To calculate safety stock accurately, you must use an appropriate inventory safety stock formula, which can be easily applied with the help of industry-built ERP software.
What Is The Importance of Safety Stock Management?
As reported in the Economic Times, air conditioner manufacturers faced a shortage of 400000 to 500000 units due to a sudden rise in demand amid heatwave conditions, leading to a potential loss of Rs.1200-1500 crores. This clearly highlights why calculating safety stock accurately is critical for manufacturing companies, taking into account external as well as internal factors affecting the industry.
Safety stock is an important aspect of inventory management as it allows organizations to continue their operations uninterruptedly using ERP software, despite unforeseen events. Moreover, it ensures that you can maintain your market share and meet desired service levels. Let’s discuss the various reasons why you need to maintain safety stock.
1. Uncertain Demand
Despite the best demand projections, there is always a chance of a sudden demand rise which can catch you off guard, impacting production continuity and causing delays in delivering customer orders. The problem gets bigger when you have many products and SKUs to manage.
2. Supply Disruptions
Your business can be impacted by both internal and external disruptions in supply. Internal factors may include mismanagement by vendors and machinery breakdowns. External factors could be logistical delays and natural disasters. Safety stock provides much-needed protection against disruptions.
3. Inaccurate Forecasts
While demand forecasting tools in your manufacturing ERP software play a critical role in analyzing sales data and generating forecasts for your production managers, factors such as market trends and competition can lead to forecasting errors, if not properly accounted for.
4. Customer Satisfaction
You would never want to turn a customer away as it means lost sales opportunities. You also want to make sure that customer orders are delivered on time and they get what they want. Safety stock across products helps you maintain higher customer service levels, forging long-term customer relationship.
5. Market Share
In today’s competitive environment, losing an important customer may significantly impact your revenue. And for every lost sale, you also lose a portion of the market share. Safety stock management with inventory management software allows you to maintain your market share.
6. Inventory Cost
Accurate calculation of safety stock helps minimize costs related to inventory management and fulfill orders faster. By avoiding frequent instances of last-minute unplanned procurement, you can make cost-effective purchases using procurement software. Plus, you can effectively utilize warehouse storage.
7. Vendor Relationship
Many suppliers prefer predictability in orders as it gives them time to plan better and optimize their cost and production schedules. Safety stocks offer that window where you can place timely orders to suppliers, thereby improving your relationship and reducing lead times.
What Are The 5 Factors Affecting Safety Stock Calculation?
The amount of safety stock to maintain varies by product and industry. Nonetheless, these five factors play a crucial role in calculating safety stock.
1. Demand Variability
Does your product demand vary significantly month-on-month? What external factors impact your demand, such as seasons, market cycles and more? No matter the variability, using the best ERP software in India can help you calculate precise safety stock while accounting for these factors.
2. Lead Time Variability
Lead times can differ across suppliers and managing these differences can become challenging without safety stock. For example, a specialty chemical manufacturer catering to the automotive coatings industry can ensure adequate safety stocks for multiple raw materials like binders, solvents and additives using ERP for chemical industry.
3. Desired Service Level
There’s always a tradeoff between maintaining adequate safety stock and limiting investments in inventory. Higher safety stock means more working capital tied up in inventory. That’s why, knowing what level of service your customers expect is important when calculating safety stock.
4. Data Availability
How accurately you are able to calculate safety stock levels will depend on the quality of inventory data available within your organization. Whether you have proper systems in place that can collect and analyze data will make all the difference in your inventory strategy.
5. Forecast Accuracy
Evaluating forecast accuracy using methods such as root mean squared error (RMSE) and mean absolute percentage error (MAPE) can minimize errors in safety stock calculation. You can also benefit from AI/ ML techniques that can enhance forecast reliability, increasing the accuracy of safety stock.
Read: What is Demand Forecasting?
Safety Stock Formula: How To Calculate Safety Stock?
Various methods are available for calculating safety stock. We’ll discuss some of the most widely used methods below.
1. Fixed Formula
This is a basic safety stock formula. In this method, a fixed inventory level is set for every SKU in your inventory basket. As this method does not take into consideration lead time and demand variability, it is a relatively simpler method to calculate safety stock as compared to other formulae. Here’s the inventory safety stock formula for this method.
Fixed Safety Stock = Number of safety days x Average daily sales or maximum daily sales
2. Average – Maximum Formula
Average-Maximum safety stock method prevents inventory stockouts by considering maximum and average daily sales as well as maximum and average lead time. Based on your sales and lead time data in ERP software, the following formula can be applied to calculate the safety stock.
Average-Max Safety Stock Formula = (Max Daily Sales x Max Lead Time) – (Avg Daily Sales x Avg Lead Time)
3. Demand Variability Formula
This method calculates safety stock solely based on demand variability as per the historical data available. Your ERP software calculates the standard deviation of demand fluctuation over a given period. This method also requires you to choose the right Z-score based on the desired service level. A higher Z-score corresponds to a higher service level, requiring more safety stock to cover potential fluctuations in demand over the lead time.
Demand Variability Safety Stock Formula =
Formula
Where
Z = Z-score
PC = Performance cycle or total lead time
T1 = Determines the time (e.g., days, weeks) over which demand variability is measured
σD = The standard deviation of demand
4. Lead Time Variability Formula
Also known as the Heizer Render formula, the primary concern here is mitigating lead time variability, which is achieved by considering the standard deviation in lead time and the desired service level or Z-score. Use the formula below to calculate safety stock.
Lead Time Variability Safety Stock Formula = Z score x standard deviation in lead time (σLT)
5. Demand and Lead Time Variability Formula
One of the most effective methods of safety stock calculations is the demand and lead time variability formula, commonly known as Greasley’s method. This method considers both fluctuations in demand and variability in lead times to calculate the safety stock, making it a significantly accurate method. It allows inventory managers to test different inventory scenarios using ERP solution and arrive at a suitable level of safety stock. The formula is as follows:
Inventory Stock Formula= Z score × standard deviation in lead time (σLT) × average demand (D avg)
6. Safety Stock Formula with EOQ
The safety stock can also be calculated using the concept of economic order quantity (EOQ). Used for ensuring cost-effective purchase, EOQ is the ideal lot size to order that brings down total inventory costs, ordering costs and inventory holding costs.
For example, food manufacturers are subject to stringent food safety regulations and need to manage perishable goods. ERP for food industry enables them to ensure compliance by maintaining adequate safety stock to ensure production continuity and safeguard against spoilage risks, whereas EOQ calculation using ERP for food and beverage industry ensures cost-effective ordering.
7. Safety Stock Reorder Point Formula
Reorder point is the point at which you order raw material inventory so that you don’t have to use your safety stock. To calculate reorder point, you must take into account supplier lead time so that the raw material reaches your production facility before you start consuming your safety stock inventory.
Here’s the formula to calculate the reorder point.
Reorder Point=(Average Sales × Lead Time)+Safety Stock
What Are The Common Challenges and Best Practices In Safety Stock Calculation?
It can be struggling to calculate the right safety stock if not done right. What should you do to ensure accurate safety stock? Find out here.
1. Outdated Safety Stock Levels
Are you relying on historical data to calculate safety stock when your industry has undergone considerable changes? Manufacturers must review these changes and update demand forecasts and lead time values in their ERP software. Also, instead of using the average demand, use demand forecasting methods to factor in seasonal trends and other demand factors.
2. Supply Chain Risks
Global supply chains can be severely affected in the event of natural disasters and regional conflicts. Safety stock needs careful adjustments in the short to medium term, especially for critical parts, to avoid inventory shortage. For example, the shortage of semiconductor chips triggered by the Covid-19 pandemic became more critical for automobile players not using automotive ERP.
3. Excess Safety Stock
While it is important to have buffer stock to meet uncertain situations, having an excess of it only adds to your inventory carrying costs and increases incidences of dead stock. That’s why you must aim to strike a balance between cost efficiency and customer service levels by optimizing your safety stock levels.
4. Wrong Formula
Although there are multiple formulas to calculate safety stock, using inappropriate formula does more harm than good. Choosing the right formula requires understanding demand and lead time variability. Find out what service levels your customers expect. In many industries such as pharmaceutical industry, you need to adjust for product shelf life with the help of pharma ERP software. Also, you must test and refine your calculations based on real-world performance.
5. Limited Stakeholder Collaboration
Accurate safety stock calculation mandates effective collaboration among procurement, sales and operations teams. A centralized cloud ERP system plays a key role in promoting collaboration among teams, ensuring all relevant data inputs and insights are factored in when planning safety stock. Even remote teams can effectively collaborate with on-site teams.
Also Read: What is inventory holding costs?
Maintain Optimum Inventory Levels With Sage X3 ERP
Safety stock helps you efficiently meet demand spikes and lead time delays. Carefully planning safety stock levels for your inventory and following best practices ensures you are better prepared to maintain production continuity and desired service levels.
Sage X3 is a flexible and scalable ERP software that helps you implement a comprehensive inventory management strategy. It automates safety stock calculations for organizations with multi-product and multi-SKU manufacturing assembly lines besides ensuring end-to-end supply chain management.
FAQ
1. What is Inventory Safety Stock Formula?
Inventory safety stock formula is an inventory management technique that helps you make safety stock calculations to protect against inventory shortages caused due to production problems and logistic and vendor delays.
2. How To Calculate Safety Stock?
A safety stock level for a product or an SKU is calculated by using the right formula that suits your operational requirements, including demand patterns and supplier lead times.
3. Can We Use Safety Stock When Demand Is Uncertain?
Yes, your safety stock protects you against unexpected demand rises and help you ensure production continuity and maintain desired service levels on par with industry benchmarks.
4. What Are The Benefits of Maintaining A Safety Stock?
Your organization benefits in the following ways by maintaining a safety stock.
- Improves customer satisfaction
- Optimizes service levels
- Meets unexpected demand
- Maintains production continuity
- Prevents inventory shortages
- Acts as a buffer against supply chain disruptions
5. What Are The Drawbacks Of Using Safety Stock?
Despite numerous advantages, there are a few disadvantages you must be aware of during safety stock planning. Some of the drawbacks of using safety stock are:
- Increased inventory carrying costs
- Risk of obsolescence
- Tied up working capital
- Warehouse space limitations
- Complex management and adjustments
6. What Is The Example of Safety Stock?
Consider an example of a food manufacturing company that manufactures potato chips. The average daily consumption of potato for manufacturing potato chips is 20 quintals and the lead time of potato supply is 5 days. Assuming there are possible delays, the manufacturer would want to keep safety stock of potato for 2 days to prevent disruption as follows:
Safety Stock Formula = Daily Usage × Additional Lead Time
Safety Stock = 20 quintals x 2 days = 40 quintals
Thus, 40 quintals of safety stock offers a safety net against possible delays.
7. What Is Z-score In Safety Stock Calculations?
The Z-score is a statistical measure that indicates how many standard deviations a data point is from the mean. In safety stock calculations, it represents the desired service level i.e. the probability of not running out of stock. For a desired service level of 95%, Z-score is 1.65.
