To avoid costly stockouts and to improve customer satisfaction, having adequate safety stock is key. In this guide, we will look at what safety stock is, how to calculate it, why it’s important, and some of its associated risks.
What Is Safety Stock?
Safety stock, also sometimes called buffer stock or “just-in-case” inventory, is the amount of inventory a retailer needs to keep on hand to reduce the risk of stockouts. Safety stock is essentially a safety net so you always have enough inventory in stock to meet demand, even when small unexpected spikes occur.
How to Calculate Safety Stock
To calculate how much safety stock you need, you can either use the safety stock calculator we have below or you can do the math by hand with a safety stock formula.
Safety Stock Calculator
Input the following information and press the “Calculate Data” button to see your safety stock needs.
Safety Stock Formulas
If you would rather do your safety stock calculation by hand, you can use one of the following formulas to determine your needs.
The basic safety stock formula accounts for only two variables—your daily sales and your lead times. The formula is as follows:
Safety stock = (max daily sales * max lead time in days) – (average daily sales * average lead time in days)
Daily sales refers to your total sales revenue in dollars, whereas lead time is how long it takes inventory to arrive, from the moment you place an order with a supplier to the moment you receive that order.
Here’s an example to show you how to calculate using the basic safety stock formula:
Let’s say you sell specialty pet accessories and treats. While you carry an array of products, you’re really known for your specialty pet beds, so you need to determine the appropriate safety stock for your pet beds—especially because of their popularity.
On average, you sell two pet beds per day. On your best day, you sold 10 pet beds. Your average lead time is two weeks, but it can be as long as four weeks during the busy season. Plugging these numbers into the safety stock formula looks like this:
So, you would want to have 252 pet beds in stock at any given moment.
Standard Deviation Formula
The standard deviation safety stock formula (also known as the King method) is essentially an upgraded, more accurate version of the basic safety stock formula. Though much more complicated, this method can be helpful if you are interested in leaner operations or looking to avoid excess inventory carrying costs:
Safety stock = Desired service level * Standard deviation of lead time * Demand average
Here’s what each of those variables means:
- Desired service level: A business’s target probability that inventory on hand can meet real customer demand. Most retailers aim for a service level between 90% and 95%. To turn this percentage into a number you can use for your calculation, use a standard normal table, where the Z number is your desired service level. So, to maintain a 95% service level you would use 1.7—this number is referred to as the desired service factor.
- Standard deviation of lead time: Lead time fluctuates because of a variety of internal and external factors. The standard deviation of lead time accounts for these variations. To get this number, first calculate your average lead time. Then, take the difference of each lead time from the average, square them, find the average of those numbers, and then the square root of that number is your standard deviation in lead time.
- Demand average: The average amount of products purchased by customers for a given time period.
Fixed Safety Stock
Fixed safety stock doesn’t really have a formula or calculation. Fixed safety stock is when you set a number for safety stock and leave it at that—it’s not necessarily based on retail metrics or math, with levels often based on intuition.
While this safety stock method is a less accurate way of calculating appropriate safety stock levels, if you have a small operation with stable lead times and predictable, flat demand, this method would work fine for you.
The time-based method of calculating safety stock accounts for the future, including projected demand and sales. This method is ideal if you anticipate high growth:
Safety stock = (projected max daily sales * max lead time in days) – (projected average daily sales * average lead time in days)
Why Safety Stock Is Important
Safety stock is a key part of good inventory management and setting your business up for success. Don’t believe me? Here is a rundown of all the reasons why safety stock is important for retailers.
- Mitigate costly out-of-stocks: When you have an appropriate level of safety stock, you can weather periods of unexpected spikes in demand, helping you to avoid lost revenue to stockouts.
- Improve customer satisfaction: Safety stock helps ensure that you have the products customers want so they don’t face the disappointment or frustration that comes with out-of-stock inventory.
- Inform reorder points: Reorder points are an important element of inventory management for small businesses, as these alert retailers when it is time to place an order for a low-in-stock item. When you pay attention to your reorder point, you’re less likely to fall victim to rush fees and operational mayhem.
- Weather demand fluctuations: Unforeseen circumstances and elements outside of your control cause spikes and dips in demand—this reality is inevitable for almost every business owner. Safety stock helps you sail through these fluctuations in demand and sales.
- Avoid pitfalls of the supply chain: Shipping times continue to lengthen and supply chains less certain than they were five years ago. Safety stock can help you not feel the impacts of delays and long wait times because it ensures you have some reserve inventory to get you through.
Risks of Safety Stock
While it’s important to have sufficient safety stock, there are some challenges to keep in mind so it doesn’t end up costing you.
- Carrying costs: It costs money to hold on to inventory due to storage and warehousing costs, employee wages, etc. In fact, generally speaking, carrying costs account for 20%–30% of your inventory’s value—and the longer you hold on to it, the higher your carrying costs will be. If you have too much safety stock, you risk incurring higher carrying costs.
- Aging or expiring inventory: Some inventory is not evergreen and expires with age—think perishables and seasonal items. If you have excess safety stock in these categories, you might not be able to sell through them before it’s too late. You can pull an inventory aging report to get more insight.
- Missed opportunities because your capital is tied up: When you have money tied up in safety stock inventory, you can’t put that to other things—like hiring new roles, investing in a new store location, or expanding your product collection, for example.
- Changes in lead time: As mentioned above, lead times can fluctuate. If you don’t use a safety stock formula that accounts for lead time variation, you may find yourself stuck in a stockout without a way to restock in a timely manner.
- Too little safety stock: Another risk with safety stock is setting the quantity too low. This puts you in an extremely risky situation where you can easily be made a victim of stockouts, unpredictable fulfillment, and spikes and demand.
Safety Stock Frequently Asked Questions (FAQs)
Click through the questions below to get answers to some of your most frequently asked safety stock questions.
Safety stock is designed to help retailers mitigate against stockouts that are caused by spikes in demand and supply chain delays.
Say you own a clothing store and have 20 units of white tee shirts in storage. One week, one of your stores sees a massive spike in white T-shirt sales and runs out at their location—but you aren’t out of stock yet and can continue meeting demand by pulling out your reserved safety stock.
Yes, safety stock is part of keeping the right products in stock at the right times, so it is part of your inventory management strategy.
In general, all your evergreen products should have safety stock that you can reach for in times of need, but you can determine for yourself if you need safety stock for seasonal, low-demand, and perishable products based on seasonality/expiration and relative demand.
Calculating safety stock and ensuring you have enough buffer to make it through unexpected spikes in demand and sales is essential to protecting your retail business. Safety stock mitigates harmful stockouts and keeps your business operations flowing smoothly so you can focus on growing and improving your business instead of putting out fires.