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Safety Stocks: Its Importance and Calculation

Do you remember the childhood days when we used to keep all our extra savings from the pocket money, in another pouch? So that we can use it to spend on some special occasions.

And now grown up as a retailer, we fear the state of running OUT-OF-STOCK!. Thus to avoid this situation and to be on the safer side, Safety Stocks becomes a necessity.

Safety stock is basically the extra inventory beyond consumers demand. Sellers knows this term well and hence it’s essential for all the retailers to have it and know exactly how much amount is required to be kept as safety stock.

Managing inventory nowadays is not a cumbersome process when you’ve got an excellent inventory management software to help you determine how much safety stock is required to lower the risks of unexpected stock-out and demand situations.

Now let’s dip our toe’s into understanding the safety stock calculation and what are the scenarios where safety stocks play a vital role in having your business running smooth.

 

Safety Stock Calculation

For safety stock calculation you need to know a few terms to be used in the safety stock formula:

  1. Maximum daily usage: The maximum number of products sold in one day
  2. Maximum lead time in days: The maximum time your suppliers take to deliver the inventory to you or warehouse.
  3. Average daily usage: Average number of products sold in one day
  4. Average lead time in days: Average time your suppliers take to deliver the inventory to you or warehouse

The formula goes this way for the safety stock calculation,

Safety Stocks=  (Maximum daily usage * Maximum lead time in days) – (Average daily usage * Average lead time in days)

For example, your business is of selling notebooks. On an average daily selling of those notebooks is around 35. It takes approximately 7 days to replenish the stock again.

Now let’s say exam season has arrived and the demand for notebooks has raised. You observed that on a particular day the number of notebooks sold went up to 60 in a day. Also due to bad weather, your supplier wasn’t able to supply to notebook stocks to your warehouse in the estimated time and you received it after 12 days.

So for the notebooks, the safety stock level would be:

Safety Stocks   =  (60 * 12) – (35 * 7)

  =  475

This means you need to have about 475 unit of safety stocks on hand at any time (particularly when the exam seasons are going or your city’s weather condition changes frequently). With 475 safety stock, you’ll be able to sell at least 35 notebooks per day for more than 12 days (i.e max lead time).

Well, this was just one scenario where safety stock can be used. Now let’s comprehend it a bit more and know what are other situations where safety stocks come into the picture.

 

1)  Prices of raw material increases

Safety stocks prevent from stock outs when there is high variation in demand and supply. But what if the prices of the raw material whose product you sell touch the stars?

So if this type of situation arises and in that instance, if your inventory has got safety stock then you’ve no idea how much money will be saved. Still wondering how this would work? This example would solve all your confusions:

Suppose you are ‘Handmade-Bag’ seller, and because of the government’s new policy, the prices of cotton, leather and other fabrics (raw material) which are required to make a bag have increased. Eventually, it has made a great impact on the prices of the bags you sell.

If the cost of bags is $10, due to inflation it became $15. Imagine if you have a safety stock of 100 units which were bought at $10 (before inflation). Your total purchasing amount would be 100*10= $1000. And if you didn’t have safety stock in the inventory then you had to purchase the bags at $15, whose total purchasing amount would be 100*15=$1500.

Net loss = $500

I hope the confusion is clear now.

 

2)  The supplier is unable to supply

There are multiple reasons that your supplier may fail to deliver the product on time, some of which are even reasonable and contractually acceptable.

It is possible that some natural disaster prevented sellers from being able to deliver the product. Say, for instance, an earthquake or tsunami has seriously damaged your seller’s factory and the finished goods prior to shipment.

For such cases having a safety stock with you on hand tends to be a business-saving gem.

 

3)   Demand goes beyond expectation

A lovely situation for sellers at the beginning, but eventually becomes unlovely as time progresses.

Safety Stock - high_demand

There are several reasons like:

  • Product’s craze has suddenly grown
  • The price of that product falls down
  • The need for a product rises
  • Price of the product is going to rise in future

In such cases, your calculation of keeping a particular stock in inventory may get altered and the risk of low-level in the inventory for that selective product arises. Having safety-stocks on hand, in these type of unexpected rise in demand, earns you more profit by achieving your consumers need.

 

Conclusion

Safety stock acts a cushion when you fall from the high-rise building of unexpected elements in the market. Thus having that cushion in your warehouse and inventory management system, especially when there is high fluctuation rate, could help you bypass many or any unwanted circumstances.

There is a thin line between safety-stocks and excess-stock. Hence to determine the perfect amount, efficient safety stock calculation is a necessity.

Always remember more safety stocks the higher carrying and maintaining cost. Therefore, if you master the art determining what level of safety stocks should be kept in your inventory, then good sales are just numbers which would keep on increasing.

 

Abhishek Biswas

Abhishek Biswas

A Listener, who speaks less and writes more. Will choose Pizza over anything. Doing non-technical stuffs, with a degree in technical field. Has stage fear thus prefers "Stealth-mode" conversation, also the Content Curator at Orderhive.

2 Comments

  1. rapid tone youtube Posted January 2, 2019 at 5:43 am | Permalink

    My brother suggested I might like this blog. He was totally right.
    This post actually made my day. You can’t imagine simply how much time I had spent for this info!
    Thanks!

  2. Nayna yadav Posted February 10, 2019 at 9:25 am | Permalink

    Dear Abhishek,
    I got the complete understanding of safety stock, what’s the need, how to calculate, the diff bent excess stock n safety stock…
    Good one.

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