Everything You Need to Know About the Safety Stock Formula
What is Safety Stock?
It's always reassuring to have a safety net.
Whether it’s bungee jumping, skydiving or even a bottle of just-in-case sunscreen when you go on vacation.
There’s nothing worse than picking up a nasty streak of sunburn because you ran out of sunscreen.
And manufacturing is no different.
Okay, well it is a little different.
Which is why in manufacturing the safety net is called something else...
Safety stock describes the amount of inventory a business keeps in the warehouse to protect against spikes in demand or shortages in supply.
From a manufacturer’s perspective, safety stock principles can and should be applied to both raw materials and final products.
This ensures the availability of materials for production and products for delivery.
The point is that your customers get their deliveries on time, and safety stock is there behind the scenes making it happen.
Otherwise you might end up with a dreaded stock-out and many a waiting, unhappy customer.
It’s not as bad as trying to sleep with a sunburnt back, but it certainly comes close.
Why is Safety Stock Important?
Most manufacturers employ some kind of minimum inventory management principles.
In a perfect world, your suppliers always deliver on time and your sales do not fluctuate unexpectedly. So, your company would never run out of stock.
Sadly, we do not live in a perfect world.
In reality, your suppliers can run into delivery problems due to one-off events or mistakes. It’s not always in their control either, so no point bearing a grudge and getting sulky.
The manufacturing world is a slippery one, where anything can come up at any time.
You can find that from time to time you may fail to meet your weekly manufacturing targets.
Sometimes your sales are also affected by seasonal effects and unexpected marketing successes or failures.
Don’t panic: all of this is normal.
Manufacturers carry safety stock for these very reasons.
The causes of stock issues can be broken down to the following:
— Fluctuating manufacturing lead times;
— Customer demand changes; and
— Flawed forecasting.
Unexpected spikes in any of the above are difficult to predict.
The supply chain is full of surprises – some fun, others not so much.
Due to this uncertainty, having some safety stock in reserve helps you deliver on time and keep your customers satisfied.
PRO TIP: Many modern manufacturers are cutting out the middleman and selling their products directly to customers. Knowing how to calculate your safety stock is just the tip of the iceberg, get ahead of the competition by understanding how Shopify inventory management works.
The Cost of Safety
Despite the importance of safety stock, it does come at a cost.
Lean manufacturing principles guide you to eliminate waste, and excessive stock is a waste as there are many costs to holding excess inventory.
Examples include renting additional warehouse space, paying salary to people handling the stock, the risk of stock expiring or becoming outdated, and much more.
Also, excess inventory means your cash is tied up and it can be of great benefit to cut carrying costs.
Thus, every manufacturer needs to find a good balance between having enough safety stock to weather the storms, but not so much that it would break your bank.
Below is an example of a monthly sales cycle of a company where the safety stock helps to mitigate spikes in sales.
There are far too many manufacturers that try to do guesswork and estimations with their stock levels. But as far as their instinct might take them, the chances are that they are either in excess or risking stockouts.
The point of safety stock is mitigating these risks and margins of human error.
That’s why calculating safety stock has a method and formula to follow.
It takes into account both the amount of time it takes for your purchases to come through, and the average amount of sales you have in a specified period.
The calculation is easy providing you have reliable purchase and sales order histories available.
Here is the safety stock formula:
Safety Stock = (Maximum Daily Usage x Maximum Lead Time Days) - (Average Daily Usage x Average Lead Time Days)
Ultimately the safety stock is going to be produced for you in the units that you keep the materials in. You know then what the amount of safety stock is and can set the reorder point appropriately (we’ll get to that later).
First let’s take an example to put a face to the formula.
Let's say there is a hidden workshop on a distant asteroid.
They produce and sell hand-crafted Jedi Lightsabers to customers across the galaxy.
As you well know, forging a lightsaber is a complex process that requires number of rare components.
One key component of a lightsaber is a Kyber crystal.
Every lightsaber needs one.
So, let's assume the workshop operates with the following characteristics:
— Production on average consumes 10 packs of Kyber crystals per day to produce 10 lightsabers;
— Maximum production capacity allows the consumption of 14 Kyber crystals;
— It takes on average 14 days for Kyber crystals to arrive from a Kyber crystal mine on a faraway planet once the purchase order is placed;
— Historical data reveals that delays in supply (read: Sith supply raiding parties) occasionally push the lead time up to 21 days;
— It takes on average 5 days to produce one lightsaber, however blockages in production (read: Jedi swordmasters called on a mission) sometimes result in a 10-day production cycle; and
— On average 10 lightsabers are sold per day, however demand peaks (read: school starts in Jedi Academy) occasionally push the daily sales volume to 30 lightsabers per day.
The table below sums it up nicely.
Maximum Daily Usage
Maximum Lead Time Days
Average Daily Usage
Average Lead Time Days
The safety stock level for Kyber crystals would be:
(14 x 21) - (10 x 14) = 154 units
And the safety stock level and for Lightsabers would be:
(30 x 10) - (10 x 5) = 250 units
As the manufacturing process consumes on average 10 crystals per day then the workshop has a bit more than two weeks of raw material inventory available to guard against the unexpected.
As the workshop sells on average 10 lightsabers per day then the workshop has a bit less than one month of ready-made product inventory available to weather unexpected occurrences.
That was simple enough, right?
Just note that with the safety stock calculation you should always pay attention to changes in underlying metrics.
Maximum daily usage and average daily usage are not figures carved in stone.
They increase as your business grows and they fluctuate depending on whether you are approaching high season or low season. Thus, you should recalculate your safety stock levels from time to time.
A good tip to follow would be to revisit these calculations every 3-4 months.
That way you can always be confident that your customers are not going to be inconvenienced by pesky stockouts.
Safety Stock vs Reorder Point
The safety stock has been calculated.
All the hard work is done, so now what?
Well we can use our safety stock figures to set reorder points for purchases.
A lot of businesses get safety stock and reorder points mixed up. But this can devalue the whole exercise because your reorder point is not necessarily the same as your safety stock.
You can imagine your safety stock to be your reserve for a rainy day. It shouldn’t be used for production or sales, except when it has to be.
What you want to do is set the reorder point slightly higher than the level of safety stock.
But there’s a little more to it than that.
Which is why we’ve written a whole blog post on reorder point and the reorder formula, that goes through the subject from top to bottom.
PRO TIP: There is software like a Shopify order management system that can help you calculate your safety stock levels and reorder points.
Safety Stock Inventory
So now you know the safety stock definition.
But more importantly you know how much safety stock you need to keep readily available in your warehouse (and so do the Jedi sword masters working on that distant asteroid)
Now comes the easy bit of incorporating it into your Smart Manufacturing Software.
In Katana you can set reorder points and manage your stock levels seamlessly with your entire workflow.
No more tedious back and forth between spreadsheets required.
Katana gives you all the data and tools you need to set the optimal stock levels for lightsabers and anything else you happen to produce.
And after all, having safety stock of lightsabers is a life-and-death question for the Jedi.
It’s important you get it right.
I mean, you would not want an angry-looking Jedi banging on your factory door inquiring about a late delivery, would you?