How to Calculate Safety Stock

In today's world of stock management there is an almost ubiquitous focus on minimizing inventory costs. Safety stock, by it's very nature is often seen as a drain on the corporate balance sheet. By definition, safety stock is required to protect the business against process failure. Inaccurate demand forecasting and failure in supplier delivery performance can both result in stock outs and safety stock is required to act as a buffer to protect the organization.

Inventory analysts, when controlling stock set the minimum stock level at the lowest stock level that an organization is prepare to tolerate, this is usually set at greater than zero in order to counter delivery delays or spikes in demand. If safety stock was not present stock outs could occur which could be drastic to production runs or even worse risk delays to the end customer. Safety stock then is a necessary evil because it assumes that demand can not accurately be forecasted and/or suppliers fail to deliver on time (both common business scenarios). The level of safety stock will vary from one organization to another but typically balances the cost of stock holding on one hand against the cost of stock outs on the other.
The graph above shows a common occurrence in stock management as on day 3 the stock goes below the re-order point triggering a purchase order however the stock continues to be consumed and on day 7 hits the safety stock with the new inventory arriving on day 8

taking the stock above the reorder point.

A number of common determinants exist for calculating safety stock they are availability e.g. the probability of not running out of stock during the reorder stage and the service level i.e. ratio of demand filled against total demand. Interestingly both methods may yield different results. Also within a manufacturing scenario there may be a requirement to build additional manufacturing cycle time into the safety stock as there it may not be as simple as calculating the safety stock required to

manage  until the vendor's shipment arrives at the warehouse. Manufacturing may also invest more towards mission critical items that could serious impact production runs.

Establishing levels of safety stock for organizations with very dynamic demand can prove difficult. Demand forecasting is often set from past experience coupled with information from the corporate sales team.

Safety stock ensures that if actual usage exceeds a forecast then the customer remains satisfied. However the cost of achieving this is may be considered prohibitive and many organizations develop a service level/availability for example 95% availability is in simple terms a level of stock outs that the organization is comfortable with both financially and from a customer service stance.

When calculating safety stock complex algorithms can be utilized in order calculate an adequate service level this will general include the holding cost of inventory, lead time/capacity constraints. There are a variety of papers available online which develop this concept.

Comprehensive software tools also exist to support inventory levels. Suppliers such as http://www.barloworld-logistics.com and http://www.logility.com/ provide tools that can plan inventory models based on varying attributes (such as service levels) as these tools can analyze demand profiles, stock movements, lead times across multiple channels, warehouses etc producing a thorough analysis of the inventory and required safety stock.

Safety stock is an important element in most inventory management models, ensuring that the safety stock is accurate can require detailed analysis of both requirements and cost to ensure that the customers' expectation and corporate costs are managed accordingly