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What is Safety Stock? Meaning & Formula
inventory management

What is Safety Stock? Meaning & Formula

Inventory management is a balancing act. Business owners must walk the tightrope between carrying enough inventory levels for optimal cash flow without carrying too much or too little. Businesses can use safety stock as a safety net in these situations.

Ensuring the correct inventory levels can be a business's most essential yet challenging task. This guide will help organisations improve inventory management by calculating safety stock levels.

What is safety stock?

Safety stock refers to the products held in reserve in a business’s inventory. Companies use this method to protect against stockouts or sold-out products and mitigate the fluctuating supply and demand risks.

Safety stock cannot prevent out-of-stock events from happening. However, it can considerably reduce the risk of them occurring during the fluctuations in average lead time in demand variability (from supply chains). 

They act as buffer stock for when your cycle stock runs out. Cycle stock is the typical level of stock you expect to sell in that period. Businesses must balance sales volumes and inventory holding costs when considering stock levels.

What is the difference between the reorder point and safety stock?

The reorder point is the minimum threshold inventory level before ordering more products. The safety stock helps bridge the gap between low inventory numbers and the reorder point when the new products are delivered and reshelved.

Keeping a set amount of stock and then using the reorder point to replenish when needed is valuable. It helps 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.

Overall, businesses use safety stock for several reasons. Safety stock:

  • Protects against stockouts: Businesses can lose half of the 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, 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 waste more time looking for products or reordering goods during high customer demand, ensuring a higher overall service level.

How to use safety stock inventory

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

Inventory processes should always be kept up to date and all employees routinely trained on inventory best practices, including restocking processes and reordering procedures. Routine inventory checks can help:

  • Identify and manage deadstock, 
  • Identify the stock that won’t sell and is considered wastage, and
  • Identify inventory levels to see if any safety stock is needed.

Companies should opt to hold inventory in one central location rather than 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 must determine how much 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 levels without incurring high carrying costs. 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 and the average lead time for reordering the product. 

It is always best to keep track of your business's products' demand, standard deviation, and maximum lead time average. 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

Save time on calculating your safety stock by using our free Safety stock calculator

This safety stock calculation can then 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 safety stock formula aims to keep the least amount of buffer and safety stock while reducing extra inventory levels as needed. This is to cover market demand without increasing overhead costs of product delivery and storage.

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

  • Holding costs: Total cost of holding inventory, including storage, employee salaries, opportunity costs, and depreciation.
  • Annual demand: Market demand for 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. 

Using software that combines accounting tools and inventory tracking is a great way to keep your safety stock and reorder points in harmony. Join other users that have improved their businesses when you sign up for QuickBooks with a free 30-day trial. Our highly efficient software is just what you need to run your business smoothly.