How to Calculate Safety Stock Level for Retail Businesses
How to Calculate Safety Stock Level for Retail Businesses
Supply chain problems happen all the time. Machinery breakdowns, adverse weather, a surge in product demand, or a pandemic are all unpredictable events that could lead to your products being unavailable.
In all cases the impact on a business will be negative. But business owners can’t just cross their fingers and hope for the best when it comes to determining safety stock levels that will help them when disasters strike.
How do you protect your business against such unforeseen circumstances? Retailers know that simply back-ordering cannot save them from a major interruption. Instead, they often apply a safety stock formula to protect their business from inventory failures. Here’s a guide on why you need safety stock and how to calculate the right level you should have.
What Is Safety Stock Level?
As the name suggests, safety stock, sometimes called buffer stock, is the emergency extra stock that a business uses in case of unforeseen circumstances that interrupt the supply chain.
Safety stock level is an inventory formula retailers use to determine how much extra their inventory needs on top of regular amounts.
Retailers do this to make sure they have enough to keep on their shelves for a certain period, usually enough time to weather the storm. While the most obvious approach would be to stock more products in general, determining safety stock is more complicated than that.
When completing safety stock calculations, the tricky part is deciding on an amount that’s just right, not too high or too low. Too much in stock will lead to a strain on finances because it ties up business capital. Too little stock may end up being insufficient for the period of the interruption. Not to an increase in stock may lead to all manner of logistic problems such as lack of storage and inadequate transportation methods
Inventory typically includes two types of stock: Cycle stock and safety stock. Cycle stock is fairly straightforward, providing the buffer between when stock is sold and replenished.
For example, a store will usually have some extras in storage just in case there is a surge in demand for a product. This is different from a safety stock formula that covers both changes in demand and lead times.
How To Determine Safety Stock Levels
Several formulas can be used, but ultimately how to calculate safety stock will depend on your specific business. The two simplest calculation methods that can be used for most retail businesses are:
1. Basic Safety Stock Formula
This method is based on the number of days that a business would like to be catered for in case of a supply breakdown. It is a simple method showing how to calculate safety stock with lead time.
The formula is:
Average Sales* x Safety Days = Safety Stock
*Average sales are reached by dividing sale quantities by the lead time
The point of the calculation is to determine how much you will need to order from your supplier in total, i.e, your reorder stock. So If you have an average sale of 100 quantities per day for a product, and you want to have 5 days of the average sale in safety stock with a lead time of 10 days: Your safety stock will be 5 x 100 quantities: 500 quantities.
Your reorder quantity is your Safety Stock + Average Sales x Lead time so in this case, you will reorder 500+100 x 10= 1,500 quantities.
2. Average – Max Formula
This simple safety stock formula, also known as “inventory equation”, is a little more complicated than the basic method of how to calculate safety stock.
The formula used here is:
Safety stock = (Maximum daily usage x Maximum lead time in days) – (Average daily usage x Average lead time in days)
For example, if you have sales over 12 months with a total of 12,000 pieces, an average per month of 1000, that means you sell about 33 pieces per day. On a good day, you can move a maximum of 39.5 pieces.
For these items to be delivered to you it takes your supplier about 35 days, but sometimes can delay up to 40 days. Maybe they had transport issues, or their production isn’t as efficient isn’t as it should be, thus the extra time.
The formula of this safety stock:
[maximum sale (39.5 pieces) x maximum lead time (40 days)] – [average sale (33 pieces) x average lead time(35 days)]
Your safety stock will be 427 pieces.
But remember that you must calculate inventory, AKA, your order point, which is always the same formula:
Safety stock + average sale (or average forecast) x average lead time: 1578
With this, we can determine that your store would need to carry about 1578 pieces as safety stock at all times.
The Benefits of Safety Stock
While many retailers know how to determine safety stock level for their business, the practice is not common especially among small and medium-sized businesses. However safety stock is important for all businesses for many reasons:
1. Protects Against Supply Variations
We’ve discussed this at length, but it doesn’t hurt to mention more ways your supply chain can break down. There could be a snowstorm that means your products don’t get to you, or a major power outage could set your manufacturer’s timeline back by a week. It’s called an interruption because it is unexpected, and it could happen in all manner of ways. Having safety stock ensures your business operations continue smoothly even with such hitches in the back end.
2. Compensates in Case of Inaccurate Forecasts
Businesses often carry extra stock for periods such as holidays, events, and seasonal shopping. Sometimes, the demand surpasses your forecasts and this is where safety stock comes in. With the extra inventory in place, businesses can replenish shelves without missing a beat or a customer.
3. Prevents Disruptions
One problem in a business can have a devastating domino effect and running out of stock is right up there on the list of big dilemmas for businesses. Not only does it lead to disarray in the finances, the rush to replenish shelves can lead to poor quality products and other mistakes. Knowing how to determine safety stock and making sure you have it is key to business survival.
4. Improves Customer Retention
At the end of the day, the goal of safety stock is to keep the customer happy. According to a study published by the Council of Supply Chain Management Professionals, 21% to 43% of shoppers went to another store when they couldn’t find a product rather than looking for a substitute in the same store.
Common Pitfalls of Safety Stock Management
Even with the formulas that simplify how to calculate safety stock levels, setting the correct inventory can be tricky. A lot of businesses come up with different approaches to it, some to simplify the process or even to cut costs. These are some common pitfalls inventory managers should watch out for:
1. Setting Safety Stock to Zero will Reduce Inventory
Having extra inventory means more capital is tied up, so sometimes business owners reduce their safety stock altogether. This frees up money for other business processes. While it may seem like a simple solution for when money is tight, a supply interruption could cost your company much more than the cost of the extra inventory. Retailers worldwide lose $984 billion worth of sales due to unavailable items.
2. Using a Textbook Safety Stock Formula
There are many safety stock formulas, what you use for your business is determined by your industry, business size, nature of products, and so on. One problem inventory managers do is to use oversimplified stock formulas without accounting for their inadequacies. For example, the “Average – Max” formula does not take into account the type of product. It also doesn’t account for the level of risk that comes with some products like perishable goods.
3. Reducing Safety Stock When Average Supplier Lead Time Reduces
While safety stock is designed to prevent shortages when there is an interruption in supply and demand, how fast or slow your supplier replenishes your stock should not change your safety stock. These changes can be translated to your cycle stock but the amount you order for safety stock should remain the same.
4. Safety Stock Covers for all Interruptions
There are many reasons for stock-outs, and expecting your safety stock to cover for every situation could lead to inaccurate calculations. Overshooting your levels could lead to excess inventory while underestimating leads to shortages. Business owners should try to balance between the two, but also accept that stock-outs are inevitable from time to time and have back up plans in place.
Hopefully, this guide highlights the importance of safety stock for business efficiency. Calculate your safety stock and keep your business running with Revel Systems’ intuitive enterprise POS. Revel features powerful management tools, integrated inventory management, sales reporting, and more in a single platform. Contact us to learn more about how we can help your retail business thrive and get your free demo.