Safety Stock: Formula, Calculation, Explaining
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Safety Stock: Formula, Calculation, Explaining
Being a successful retailer means following some fundamental rules: control your sales, know your demand, manage your inventory and remember that your customer is a king. These are very basic principles that hold its validity throughout the years. Technologies are becoming more and more developed, consumers are becoming more and more demanding and e-commerce has made sales as diversified as never before. However, these rules remain the core principles each retailer needs to adhere to.
Customers today are demanding and educated, they are used to the highest levels of customer experience, they perfectly know what do they want and when do they need it. They are not accustomed to waiting. And modern competitive world has everything to offer them. The smartest and the fastest business wins.
How to be the smartest? How to have your goods shipped on time, keeping your profits high and expenses low? How to know your demand and manage your warehouse? Inventory management is an answer. Today’s inventory management systems and techniques will help you organize your inventory turnover smoothly and effectively - they will determine your demand and replenish the shelves of your warehouse, without putting too much on them, and without leaving them empty.
However, there are still external factors and unpredictable force majeure circumstances that are far beyond the control of any inventory management system. These are heavy weather conditions that can affect transportation and logistics, human errors and mistakes, machinery failures which can cause delays in supply or lost sales. It happens. And what is the most dangerous, it can cost you a loss of reputation or customer loyalty.
Safety stock is the first-aid solution for any unexpected trouble. Safety stock can keep you prepared for any snowstorm or machine engine stop, or even a sudden surge of consumer demand (which is not a trouble at all, but remember that you must be prepared to meet it!)
So, what is safety stock?
Safety stock (sometimes called “buffer” stock) is an extra inventory stored on the warehouse shelves in case of unexpected or emergency events. Safety stock helps retailers to escape the out-of-stock situation caused by unforeseen delays, force majeure, errors in demand calculation or sudden leap of customer activity.
The quantity of safety stock shall be enough to survive any turbulence and keep clients happy. At the same time, you must not store too much safety stock, as storage costs can tie up your operating assets and finances. So, here comes a question - how is safety stock calculated?
Safety stock calculation
What is the optimal safety stock level? To calculate it, you need to have some indicators which can be found in a sales record and inventory replenishment history. These indicators are lead time and daily usage.
Lead Time
Put very simply, a lead time is the total amount of time it takes to deliver goods from a supplier to your warehouse (basically, a timespan from placing the order to receiving it to your warehouse).
Imagine a situation when a supplier and a retailer have an agreement, which foresees that the supplier accepts orders on Fridays only. A retailer places his order on Monday. So, the ordering delay is 4 days. Supply usually takes 3 days. So, in this case, the lead time will take 7 days, a sum of supply delay and ordering delay, or, in other words, time which is needed to complete the order from its beginning to an end.
Lead time formula:
Daily usage is the number of goods (items) sold per day. So, here is the simple safety stock calculation:
Maximum daily usage (items) x Maximum lead time (days) - Average daily usage (items) x Average lead time (days) = Safety stock (items)
Example:
A cake shop in Paris is selling Swiss chocolates. Usually, goods are delivered from a chocolate factory in Switzerland to a French cake shop in 3 days (this is the average lead time, a time spent between order placement and its fulfillment by the Swiss confectioners). Cake-shop sells 15 chocolates per day (this is an average daily usage), however during a festive Christmas or Easter season sales usually increase up to 25 pieces a day (this is a maximum daily usage).
Winter weather can be rather unpredictable and snowfalls cause delays in chocolate delivery, so sometimes it takes 10 days to get the goods (so, this is the maximum lead time).
So, using the safety stock formula we get the following: (25x10) - (15x7) = 145
Paris cake shop needs 145 chocolates to keep as a safety stock.
Safety stock is not a static number, it is subject to change with the fluctuations of demand, delivery times, etc.
Smooth inventory turnover is built on a balance of orders and sales. Understanding safety stock helps to measure another strategically important indicator, called reorder point. Reorder point is an essential measure, a balance between the right amount of inventory, overstock, and stockout.
Inventory management systems can calculate the levels of safety stock and reorder point automatically, as well as analyze sales dynamics, control trends and produce real-time reports.
Irma ShypuliaRetail Optimization Expert
