A Guide to Safety Stock

Inventory management is a balancing act. Business owners must walk the tightrope between carrying just enough inventory for optimal cash flow and carrying too little or too much, causing its own set of problems. Luckily, businesses can use safety stock to act as a kind of safety net in these situations.

Ensuring the correct inventory levels can be one of the most essential yet challenging tasks for a business. This guide will help organizations improve their inventory management, calculating safety stock, the reorder point and economic order quantity.

What is Safety Stock?

Safety stock refers to the products that are held in reserve in a business’s inventory. Companies possess safety stock to protect against stockouts or sold-out products and mitigate the risk of fluctuating supply and demand.

Safety stock cannot prevent all out-of-stocks from happening; however, it can reduce the amount considerably during fluctuations in demand. They act as a buffer for when your cycle stock runs out. Cycle stock is the typical level of stock you expect to sell in that period. Businesses will need to find a balance between customer service and inventory costs when considering safety stock levels.

What is the Difference Between the Reorder Point and Safety Stock?

The reorder point is the minimum threshold an inventory reaches before further products are ordered to replenish the supply. The safety stock helps bridge the gap between low inventory numbers and the reorder point when the new products are delivered and reshelved.

Only keeping a set amount of stock and then using the reorder point to replenish when needed can help businesses save money on inventory safety stock carrying charges.

Why Do Businesses Need Safety Stock?

Safety stock is good practice in inventory management. Companies choose to hold safety stock to ensure they have enough of the products that customers want most. These days when someone can’t find what they need in a store, they will go online or to another store to purchase their goods rather than wait for the business to replenish their stock.

Overall, businesses use safety stock inventory for a number of reasons, as it:

  • Protects against stock outs: Businesses can lose half of intended purchases from customers when a stockout happens. For that reason, companies keep safety stock to protect against losing sales. Stockouts can also decrease customer loyalty and trust, as customers stop relying on the business for their particular needs.
  • Mitigates long lead times: When a product is running out of stock and hits the reorder point and businesses purchase more, they must factor in the time for delivery and restocking. In that interim time, safety stock can keep the products on the shelf long enough for the next order to arrive.
  • Offsets forecasting errors: Demand forecasting helps businesses determine how much of a product they should order for a period. However, if inaccurate forecasting results in undersupplying, safety stock can offset this miscalculation without risking customer satisfaction.
  • Improves efficiencies in the supply chain: Safety stock lowers the need to order and reorder products in a given period. By possessing enough inventory, employees won’t have to waste more time looking for products or reordering goods during high customer demand, ensuring a higher service level overall.

How to Use Safety Stock Inventory

Safety stock inventory can be tricky, as businesses must determine how much extra stock they can hold without racking up inventory holding expenses. When it comes to perishable inventory, safety stock levels are even more of an issue as businesses must account for expiration dates and spoiled goods. Therefore, small businesses must understand how best to use safety stock to ensure a balanced system.

Inventory processes should always be kept up to date and all employees routinely trained on the inventory’s best practices, including restocking processes and reordering procedures. Routine inventory checks can help identify deadstock, the stock that won’t sell and is considered wastage, and inventory levels to see if any safety stock is needed.

Companies should opt to hold safety stock inventory in one central location rather than in multiple locations to make it easier to replenish products when needed. Business owners and managers should regularly review their inventory levels, lead times, and demand averages to ensure the correct amount of cycle and safety stock.

Businesses will need to figure out how much of each product they should hold in reserve to reduce inventory safety stock carrying charges. The proper safety stock calculations can help improve inventory management.

How to Calculate Safety Stock

Owners and inventory managers must determine the optimal stock to hold without incurring high carrying costs to get the most out of safety stock. They can use the safety stock formula to calculate the ideal level of inventory.

To determine the safety stock level required for a specific product, you will need to know the daily usage of that product, as well as the lead time for reordering the product. It is always best to keep track of the demand average, standard deviation, and maximum lead time average of all of your business’s products. With that in mind, you can use the safety stock formula below:

[Maximum Daily Usage of Product x Maximum Lead Time of Product]-[Average Daily Usage of Product x Average Lead Time of Product] = Safety Stock

This safety stock calculation can then be used to determine the reorder point for that product. The reorder point calculation illustrates how many days the business will go before reordering the product and starting the safety stock on hand. This formula is as follows:

Safety Stock + Average Sales x Lead TIme = Reorder Point

Safety Stock Formula and Economic Order Quantity (EOQ)

The economic order quantity, EOQ, calculates the least expensive number of units to order. This calculation is also known as the Wilson formula. Businesses can use EOQ to meet demand while reducing the costs of ordering and holding inventory. The aim is to hold as little stock and safety stock while reducing extra inventory as needed to cover market demand without increasing overhead costs of product delivery and storage.

To determine the EOQ or optimum lot size, you will need to know three variables:

  • Holding costs: Total cost of holding inventory, including storage, employee salaries, opportunity costs, and depreciation
  • Annual demand: Market demand of the product
  • Setup cost: Total cost of each order, including shipping and handling fees

With these three factors in mind, businesses can use the following Economic Order Quantity formula:

EOQ = Square Root of [2 x Annual Demand x Setup Cost / Holding Cost]

By using the safety stock calculation alongside the economic order quantity formula, businesses can keep a balanced inventory and their desired service level at the same time. To help your business keep track of its inventory and financial needs, try using QuickBooks Online.

Using software that combines accounting tools and inventory tracking is a great way to keep your safety stock and reorder points in harmony. Join the millions of other users that have improved their businesses when you sign up for free today.

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