What is a safety stock?
When storing and temporarily storing goods for production or sales, it is very important to find appropriate inventory levels. Many companies and production facilities therefore have their own inventory managers who are tasked with this difficult job of ensuring uninterrupted production and shipping. It also aims to prevent too much capital from being tied up, which happens when inventory levels are unnecessarily high. In addition, the costs for storage then also increase.
One of these stock levels is the safety stock, also called minimum stock, reserve stock or iron stock. If the stock falls below this level, there is a risk that demand can no longer be adequately met. Production can suffer as a result, but sales can also be lost or customers may abandon the company.
The advantages of a safety stock are:
- Protection against unexpected changes in demand and / or incoming goods
- Protection of production and the supply chain
- Delivery failures can be avoided
- Protection against inventory uncertainties
How is the safety stock calculated?
The safety stock serves as a buffer for each stored product. Therefore, it is calculated in addition to the basic stock. This means that production and delivery capability can always be guaranteed, even if there are uncertainties.
Such uncertainties can be deviating stocks, for example, if there is less of a product in the warehouse than there should be. But different procurement times, volatile demand and the difficulty for forecasts also play a role. Therefore, it is particularly important to correctly assess the base stock so that an appropriate safety stock can be added to it. Just the right balance must be found to still provide enough buffer but not add too much extra cost.
Three different methods can be used to calculate the safety stock:
- Fixed safety stock
- Time based calculation
- Statistical calculation
Calculation forms in the overview
- The fixed safety stock is the simplest way to calculate this stock level. A fixed number of articles or goods is defined, which must then be in stock at all times. Most often, however, the individual items are not considered separately, but the entire inventory as one. This can result in high inventory costs, or even supply bottlenecks when demand fluctuates.
- In time-based costing, the safety stock is calculated for a specified period of time. For example, a weekly average for goods issues is then calculated. The value of this weekly average must then be in stock at least once additionally. However, in this calculation there is no connection to the time needed to procure the goods. As a result, larger quantities are often stored than necessary, which also ties up more capital.
- In the statistical calculation, the optimum safety stock is determined using a probability calculation. Both past inventory values and demand forecasts play a role and are included in the calculation. The results are usually better than those of time-based or fixed costing. In addition, many warehouse management systems already calculate the safety stock themselves using this method.
An example of the calculation of the safety stock
In practice, there is a simplified formula that includes both the replenishment time and the daily demand.
If a stored item has a daily issue of 600 pieces and the time for replenishment covers 7 days, this calculation results:
1/3 x consumption in the replacement period = safety stock
so
1/3 x (600 pieces x 7 days) = 1,400 pieces of safety stock
