We live in the real world, where supply chains don’t always function perfectly. If you work in trade or manufacturing, you understand how crucial it is to quickly meet customer demands. Halting sales and waiting for supply chain issues to resolve is simply not an option. Doing so risks losing not only profits but also the customer themselves.
For such situations, there is safety stock — a “Plan B,” a reserve you can rely on when supply delays or sudden demand surges threaten to leave you without products. The key point to highlight here is balance. Safety stock must be sufficient to help you weather crises, but it’s equally important not to overstock, as excessive storage costs can eat into your profits. Every additional item in stock increases expenses.
Accurate safety stock calculation will help you maintain not only your sales but also your financial stability. There are several methods for calculating safety stock, and we will explore each one below to help your business minimize the risk of shortages while avoiding excessive reserves.
What is Safety Stock?
Safety stock is the reserve quantity of goods that a company keeps in its warehouse to protect against unforeseen supply chain disruptions. It serves as a kind of “safety cushion,” helping to prevent stockouts caused by delivery failures or unexpected spikes in demand. This reserve ensures business stability even in uncertain conditions, allowing you to respond quickly to emergencies and avoid unforeseen losses.
Safety stock may be needed in situations such as:
- Sales are growing faster than anticipated;
- Suppliers are unable to deliver a new batch of goods on time.
The reserve allows you to continue sales until the new batch of goods arrives. Not only does this help you avoid financial losses, but it also strengthens customer trust in your business.
How safety stock helps in inventory management:
Protection against supply disruptions: No matter how reliable your suppliers are, there is always a chance of delays due to logistical issues, unforeseen disruptions, or force majeure events. Safety stock ensures that you maintain product availability in your warehouse until the next shipment arrives.
Preventing customer loss: When a product is out of stock, potential customers may choose to buy from competitors. This results in a loss of both revenue and customer loyalty. Safety stock helps maintain uninterrupted service, ensuring that your customers can get the products they need when they need them.
Smoothing seasonal demand fluctuations: During holidays or seasonal sales, demand can spike significantly. With safety stock, you can prepare in advance for peak periods, ensuring you can meet the increased demand without the risk of running out of stock.
Compensating for demand forecast inaccuracies: Today, retail companies operate in an environment of high market volatility and unpredictable consumer behavior. Safety stock serves as a reserve in case actual demand exceeds forecasts. This is especially important for fast-moving products, where even a small increase in demand can lead to stockouts.
Ensuring continuous production operations: In manufacturing companies, safety stock of raw materials and components helps prevent downtime that may occur due to material shortages. This is especially critical for businesses with high levels of automation, where any disruption in the process can lead to significant losses.
Why is Accurate Safety Stock Calculation Important?
An incorrect safety stock level can lead to two opposite but equally undesirable situations:
- The warehouse is overloaded with reserve stock.
- There is not enough safety stock to cover the growing demand.
Stocking up on products in advance may seem like a safe solution. However, this approach creates many problems. If you store large amounts of reserve stock, you’ll need to invest more money in warehouse rent, maintenance, and management. Excess stock also ties up working capital that could be used for other business needs. It’s better to invest it in development, marketing, or purchasing more in-demand products. And when it comes to products with limited shelf life or those susceptible to obsolescence, excess inventory may lose its value before it can be sold.
A lack of stock also leads to negative consequences. If your customer can’t find the product they need, they will turn to your competitors. For you, this means not only a loss of revenue but also damage to your reputation. What’s worse, you risk losing a loyal customer. For manufacturing companies, a shortage of materials can lead to halting production processes, missing order deadlines, and incurring losses.
Accurate safety stock calculation helps avoid these extremes. By balancing between excess and insufficient inventory, your business can optimize costs and ensure customer satisfaction, even in the face of external disruptions.
Formulas for Optimal Safety Stock
As we can see, safety stock has its limitations and requires a balanced approach. It’s important not only to determine its necessity but also to accurately calculate the optimal quantity.
Before we move on to the formula, it’s important to consider several key factors when planning safety stock:
Volume of daily or weekly sales: By understanding how much product you sell within a specific period, you can determine the minimum required safety stock.
Frequency of deliveries: If your suppliers ship products regularly and quickly, you can reduce the amount of safety stock. However, for irregular deliveries or shipments with long lead times, a larger reserve is needed.
Warehouse capacity: The size of the warehouse and the ability to increase storage space also play an important role. A small warehouse may limit the amount of safety stock, while a larger warehouse allows for more flexibility in responding to demand changes.
Product characteristics: It’s important to consider the properties of the products, such as shelf life, seasonality, or storage conditions. Products with a limited shelf life require more frequent restocking and in smaller quantities to avoid spoilage. More durable products can be stored in reserve for longer periods.
Without considering these factors, safety stock management becomes ineffective and can lead to either excess inventory or stockouts.
There are several safety stock formulas, each adapted to different conditions and business needs. Let’s go through each of them.
1. Basic formula
The simplest safety stock formula is based on daily sales volume and the number of days for which a reserve is needed. This method is straightforward and suitable for cases where the business is not subject to significant demand fluctuations and the delivery times are predictable. The formula looks like this:
Safety Stock = Average Daily Sales × Reserve Days
Example:
Your daily sales volume is 50 units. You want to have a safety stock that will cover demand in case of a 7-day supply delay.
50 units × 7 days = 350 units
Thus, your company only needs to maintain a safety stock of 350 units.
2. Average-maximum formula
The safety stock is calculated based on the difference between the maximum and average demand over a chosen period. It accounts for demand spikes, making it suitable for seasonal businesses or companies with frequent demand fluctuations. The safety stock equation for the “average-maximum” method looks like this:
Safety Stock = (Maximum Sales × Maximum Lead Time) − (Average Sales × Average Lead Time)
Example:
Over the course of the year, your store sells 14,600 units of a product. On average, this is 40 units per day. The maximum monthly sales volume is 1,400 units, which equals 46.7 units per day. There were 8 shipments over the year. On average, the product took 30 days to arrive from the supplier, with a maximum delivery time of 35 days.
Substitute the data into the formula:
Safety Stock = (46.7 × 35) − (40 × 30)
After rounding, we get 435 units.
3. Safety stock formula accounting for demand uncertainty
This method is useful when demand for a product is variable, but the lead time remains stable. The following formula is used to calculate safety stock:
Safety Stock = Standard Deviation of Demand × Square Root of Average Lead Time
The standard deviation of demand is a value that shows how much demand fluctuates relative to the average value.
The average lead time is the time it takes for the product to be delivered from the supplier.
How to calculate:
Calculate the standard deviation of demand: find the average demand. To do this, divide the total monthly demand by the number of months. To calculate demand variability, square the difference for each month, then find the average of these squared differences.
Calculate the variability of lead time: find the average lead time, then take the square root of the average of the squared differences.
Substitute the obtained values into the safety stock formula.
4. Safety stock formula considering lead time uncertainty
This formula is suitable for cases where demand is stable, but there is uncertainty regarding lead times. In this case, the standard deviation of lead time is taken into account. The formula is as follows:
Safety stock = Z × Average sales volume × Lead time deviation
Z here is the service level coefficient, which indicates how much the business wants to meet demand.
As for the average demand and lead time deviation, we have outlined their calculation above.
5. Safety stock formula considering uncertainty in lead time and demand (independently from each other)
In situations where both demand and lead time can fluctuate independently of each other, a more complex approach is used. It takes into account both sources of uncertainty. The formula is as follows:
Safety stock = Z × sqrt((Average LT × (Standard deviation of demand)²) + (Average sales × Standard deviation of lead time)²)
6. Safety stock formula with consideration of uncertainty in lead time and demand (dependent on each other)
If demand and lead times are dependent (for example, high demand may lead to delays in deliveries), a method that accounts for this dependency is used. The formula is adjusted to consider the interrelated changes:
Safety stock = Z × Standard deviation of demand × √(average LT) + Z × Average sales × Standard deviation of lead time
Which Safety Stock Formula to Choose?
If the demand for goods is predictable and you just want to account for possible delays in delivery, use the basic formula. It is simple to implement and allows maintaining the minimum necessary stock. However, the formula has its limitations. It does not take into account:
✔ Seasonal fluctuations in demand.
✔ Variability in delivery times.
✔ Uncertainty caused by external factors.
For more accurate planning, it is advisable to use formulas that account for fluctuations in demand and delivery times.
If your business sells a small quantity of products, the “average – maximum” method is optimal. It helps determine the average maximum number of units that can cover demand in any unforeseen situation.
For a business with moderate sales volume and stable deliveries, the formula that accounts for demand fluctuations is suitable. It will help determine the level of safety stock in case of a sudden spike in demand.
In conditions of significant uncertainty, the formula that accounts for both demand and delivery fluctuations works best. This type of safety stock is ideal for managing complex supply chains or businesses with international logistics, where delivery delays or sudden demand changes are common occurrences.
Remember, the success of your calculations directly depends on the quality of the input data. Working with inaccurate or insufficient information can lead to forecasting errors. You risk overstocking your warehouse or ending up with empty shelves. Therefore, regardless of the formula you choose, make sure to verify the quality and quantity of your data before calculating your safety stock.
How to Calculate the Reorder Point for Safety Stock?
In inventory management, it is important not only to maintain an adequate stock level but also to replenish inventory in a timely manner. The reorder point helps to determine in advance when to place a new order before the current safety stock runs out.
The following formula is used to calculate the reorder point:
Reorder Point = Safety Stock + Average Sales Volume x Lead Time
How to Reduce Costs of Safety Stock?
Safety stock in inventory management is not just about calculating the required volume but also about continuously monitoring and adjusting it throughout the operational cycle. Proper organization of safety stock will help you balance product needs and optimize storage costs. Below, we’ve outlined a few tips that may help you with this.
Review the frequency of deliveries
By reducing the lead time, you can decrease the warehouse space required for safety stock and lower storage costs. Additionally, with smaller volumes on hand, you will need fewer employees to handle large batches. This also helps reduce risks. For example, ordering products with a limited shelf life more frequently but in smaller quantities ensures that they do not spoil in the warehouse.
Create a distribution center
For large companies with multiple warehouses and sales points, it makes sense to consider creating a distribution center. Due to demand fluctuations, stock at some locations may deplete quickly, while at others it may remain unused. By transferring safety stock from the locations to the distribution center, you can significantly reduce its volume. This way, you can send goods to where they are most in demand, especially in cases of unforeseen changes in demand.
Automate inventory management
Automated inventory management systems allow real-time tracking of inventory levels in warehouses, taking into account deliveries, shipments, and sales. This helps accurately forecast demand and adjust safety stock as demand changes, without the need for manual recalculations.
The analytical tools of the system allow forecasting demand based on sales data, trends, seasonal fluctuations, and other factors. This enables more accurate planning of safety stock, reducing the likelihood of shortages and excess inventory. Moreover, modern systems like Ysell.pro can automatically generate supply orders when inventory levels reach the minimum threshold.
Safety stock is primarily an investment in stability. It ensures uninterrupted sales and protects your business from financial losses. Make sure your data is up to date, your calculations are accurate, and your stock strategy is adaptable to current challenges, and you’ll be able to handle any unforeseen situations.
Frequently Asked Questions
1. What is safety stock and why is it needed?
Safety stock is an additional amount of inventory kept in stock to protect against unforeseen situations, such as fluctuations in demand or delivery delays. Its purpose is to ensure the stability of business processes and minimize the risks of stock shortages.
2. How is EOQ (Economic Order Quantity) related to safety stock?
EOQ, or the Wilson formula, is a method used to determine the optimal order quantity that minimizes the total costs of ordering and holding inventory. Safety stock, on the other hand, is a reserve that covers the risks of unexpected demand spikes or supply delays. Unlike EOQ, safety stock is not focused on cost optimization but acts as a safeguard for the business.
3. Why is it important to consider safety stock when using EOQ (Economic Order Quantity)?
Although EOQ helps efficiently plan regular orders, it does not account for uncertainties such as:
✔ Sudden supply chain disruptions.
✔ Demand fluctuations, especially during seasonal periods.
✔ Forecast errors or sharp market changes.
Without considering these factors, businesses may face situations where products run out before the next shipment arrives, leading to losses. Adding safety stock compensates for these risks, ensuring flexibility in operations.
4. Why is it important to calculate the reorder point for safety stock?
The reorder point indicates the moment when a new order should be placed to maintain the optimal level of safety stock.
5. What factors determine the size of safety stock?
The level of safety stock depends on:
✔ fluctuations in demand;
✔ lead time;
✔ forecast accuracy;
✔ seasonality;
✔ service level requirements;
✔ risks associated with supply.
6. How often should the safety stock level be reviewed?
The safety stock level should be reviewed regularly, especially when there are changes in seasonal demand, fluctuations in sales volume, and alterations in supply and logistics conditions. This helps maintain a balance between excess inventory and the risk of stockouts.
7. Is it possible to completely eliminate safety stock?
Safety stock is not necessary for every business. Startups often struggle to accurately forecast demand and supply, so purchasing reserve stock may become a financial burden for them. For large companies, however, this approach is risky. Eliminating safety stock can lead to losses due to stockouts.
