How to Calculate Safety Stock

Safety stock is a term that is used to describe the amount of inventory or stock that is kept on hand in order to reduce the chance of a temporary shortfall of materials from taking place. Also known as buffer stock, this type of inventory is helpful in dealing with sudden upswings in demand or just for making sure there are enough raw materials and supplies on hand to keep production going while waiting for the next scheduled delivery of materials from a supplier. There is no single universally accepted formula for calculating safety stock, with different companies considering factors that are relevant to their industry and corporate culture. Most methods will involve consideration of such factors as average daily usage and the lag time between order placement and delivery.

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Steps

    1
    Determine the demand for the essential stock items. This usually involves calculating what is known as the average daily usage for each item. A common approach is to utilize the total usage of that item for a specified period, such as 1 calendar month. By dividing that total usage by the actual days in that month, you will arrive at the average usage per day.
    2
    Predict changes in demand. By considering factors such as historical usage of the stock for the same periods over the last 5 years and also allowing for anticipated shifts in consumer orders for the upcoming period, it is possible to have a good idea if there will be a substantial change in the average daily usage of the stock items. When factors indicate that an upswing in demand will occur, use that information to adjust the projected average daily usage to determine how many units should be ordered and to also create a workable schedule for recurring orders.
    3
    Identify lag time between the placement of orders and the projected delivery dates. Work with vendors to determine the average amount of time required to process orders of a specific quantity, beginning with the order date and ending with the projected arrival date. This will help you adjust the quantity of the orders to make sure there are enough materials on hand to keep production going until each subsequent order is processed and is received.
    4
    Allow a percentage difference for material defects. Doing so means that if the operation normally requires replacement of 10 units of a certain component each week, you will assume that 2 of those 10 ordered units may be defective in some manner and could slow production. To avoid this, increase the quantity on your orders to allow for this possibility until there is a sufficient safety stock to offset potential component defects for at least 2 subsequent order periods.
    5
    Make some allowances for delays in deliveries. Factors beyond the control of the shipper such as a natural disaster may cause an order to be delivered several days later than originally anticipated. Allow for this by setting the minimum reorder limits on the safety stock so that enough materials are still on hand to maintain production for a short period in spite of the delay.
    6
    Review usage of the safety stock on a regular basis. Schedule the reviews to take place at least once a month, although weekly or biweekly may also be a viable option for companies with a high rate of production. Note any changes that indicate an upswing in the average daily usage that was not originally projected, and use that data to adjust the quantity for scheduled orders that have not yet shipped.

 Tips

    Maintaining an equitable amount of safety stock is possible even if there is the need to use stringent inventory control standards to avoid incurring additional tax obligations. As long as there is enough stock on hand to keep the operation going until orders for new materials or parts are received, the amount of stock is adequate.
    The purpose of safety stock is to prevent costly interruptions in the production process. Projecting the use of this cushion of stock items may have to do with raw materials used in a production process, replacement components essential to the operation of equipment and even the inventory of lubricants and other petroleum products necessary to the efficient operation of the machines.