Safety Stock: Definition, Benefits, and How to Calculate It in Warehouse Management

Proper and accurate stock management is one of the most important factors for business growth. The biggest challenge in warehouse management is the lack of stock availability. To prevent this from happening, one effective solution a company can implement is maintaining safety stock.

Stock shortages can occur for various reasons, including inaccurate record-keeping, the presence of dead stock, or fluctuations in market demand. Therefore, it is crucial for businesses to store backup inventory in the warehouse to minimize the risk of stockouts.

Definition of Safety Stock

Safety stock is an inventory buffer prepared by a company to prevent stock shortages during uncertain market demand conditions. Factors that significantly affect this type of inventory often require a certain lead time before the ordered goods arrive.

In a trading company’s accounting system, the safety stock method is used to calculate the quantity of a particular product. For that reason, specific calculations are needed to ensure the inventory level can meet customer demand.

Benefits of Safety Stock

Safety stock is a special method used to calculate the quantity of goods so the company can meet consumer demand, especially important in responding to dynamic market needs.

The benefits of applying safety stock in inventory management include increasing profits, preventing market demand fluctuations, and assisting business management, particularly in production scheduling. In addition, there are several other benefits of implementing safety stock, such as:

Avoiding Demand Surges

Safety stock affects inventory levels, one of which is helping to prevent delays in stock deliveries from suppliers. Moreover, it is useful in avoiding stock shortages when the market becomes unstable. With this in mind, companies can anticipate demand fluctuations that, if left unaddressed, could harm the business.

Determining the Right Inventory

One way for companies to determine the correct inventory level is by implementing a safety stock system. Customer history data can illustrate market demand for a product, and through this system, companies can maintain the right stock levels, neither excessive nor insufficient.

The issue of inventory quantity in companies can lead to stockouts if the number of goods is too small. Some factors that may cause stockouts include:

1. Market demand fluctuations

2. Inaccurate demand forecasting

3. Highly variable lead times

Therefore, one effective solution to prevent stockouts is to apply a safety stock system.

Increasing Customer Numbers

Implementing safety stock provides companies with the advantage of increasing customer numbers. This happens because the company can meet every consumer demand, especially during times of demand fluctuation.

Another impact of implementing safety stock is improved customer satisfaction. By providing reliable service and fulfilling every order, the company strengthens its relationship with customers, turning them into loyal buyers.

Streamlining the Production Process

Safety stock implementation enables companies to create and execute production schedules on time. As a result, production processes won’t be disrupted by stock shortages.

This method also helps minimize potential fraud in warehouse inventory management or during production. Additionally, safety stock can be used to calculate the quantity of specific products.

Increasing Profits

One of the key benefits of applying safety stock is the ability to maximize the use of available inventory to increase profits. When companies can accurately forecast demand and determine precise inventory levels, they can focus more on expanding their customer base while boosting profitability.

The Relationship Between Safety Stock and Reorder Point (ROP)

Safety stock is a special method used to calculate the quantity of goods needed to meet consumer demand. In essence, inventory activities are highly influenced by dynamic market interest. Therefore, companies need to maintain reorder point data.

A reorder point is a specific threshold set by the company as an indicator that it’s time to restock raw materials to prevent stockouts in the warehouse. Through the reorder point, companies can determine the safety stock threshold, since inventory represents a key asset to fulfill customer demand.

By knowing the adequate inventory level, companies can ensure accurate and timely order fulfillment. Moreover, it helps prevent overstock situations that may cause losses.

Several Safety Stock Calculation Formulas

Basic Safety Stock Formula

To determine the amount of safety stock needed, companies must calculate the inventory currently stored in the warehouse. One basic formula used to determine safety stock is:

Safety stock = (Maximum daily sales × Maximum lead time) – (Average daily sales × Average lead time)

The formula includes several key variables:

1. Maximum daily sales: the highest number of units sold in a day

2. Maximum lead time: the longest time required by the supplier to deliver inventory

3. Average daily sales: the average number of units sold per day

4. Average lead time: the average delivery time required by the supplier

It’s important to note that this formula only provides an average estimate of the safety stock needed. Therefore, it is not suitable for forecasting inventory requirements during dynamic seasonal demand periods.

Fixed Reserve Inventory Formula

Fixed reserve inventory is based on the best-case scenario, where this calculation ignores supplier delivery times or demand fluctuations. Typically, this method is used by companies with consistent demand and a stable supply chain. The formula is as follows:

Fixed reserve inventory = Number of days × Average daily sales OR Maximum daily sales

Time-Based Calculation

Time-based safety stock calculation helps estimate the backup inventory needed over a specific period. To ensure accuracy, two parameters are required:

1. Historical product demand and sales data

2. Forecasted demand for the future

This approach is generally used by companies with stable demand and consistent product supply. However, it does not consider unexpected events that might disrupt order fulfillment.

Heizer and Render Formula

If a company experiences varying supplier schedules but excludes fluctuations in product demand, the Heizer and Render formula is the right approach to determine the required safety stock. The formula is:

Safety stock = Z-score × Standard deviation in lead time (σLT)

Important points to consider when using this formula:

1. Z-score represents the desired service level. A higher Z-score means a lower probability of stockouts, and vice versa.

2. Standard deviation in lead time (σLT) represents how much the supplier’s average lead time differs from the actual lead time.

Greasley Formula

The Greasley method calculates safety stock based on supplier lead time and product demand fluctuations. This formula expands on the Heizer and Render method by including the demand factor. The formula is as follows:

Safety stock = Z-score × Standard deviation in lead time (σLT) × Average demand (Davg)

This calculation includes three main variables: Z-score, lead time variability, and average customer demand.

Economic Order Quantity (EOQ) Formula

Economic Order Quantity (EOQ) represents the ideal stock level a company should maintain to minimize inventory-related costs, including storage, shortage, and ordering costs. The EOQ formula can also be used to help determine the required safety stock. The formula is:

EOQ = √(2 × Ordering cost per order × Demand rate / Holding cost)

Here’s an example scenario for easier understanding:

If you sell 1,000 units of a product per year, with a fixed ordering cost of 5,000 and a storage cost of 4,000, your EOQ would be 50.

Optimizing Warehouse Management with Accurate Safety Stock Using Prieds WMS

Having backup stock can be highly beneficial for companies when calculated accurately. To determine the required amount of backup inventory, companies need to calculate their safety stock. This allows them to optimize warehouse management while avoiding both stock shortages and overstocking.

As a customizable WMS (Warehouse Management System) provider, Prieds offers efficiency solutions for warehouse management through seamless integration between hardware and software.

The wide range of features available in Prieds WMS helps companies manage warehouse inventory, from calculating raw material procurement, optimizing warehouse storage space, and determining reorder points, to calculating the right amount of safety stock based on company needs.

You can learn more about safety stock and warehouse management by consulting with the Prieds expert team. Get a WMS system with top-level security and user-friendly features tailored to your business needs.