Calculate Safety Stock: Three Different Ways
- 3 Ways to Calculate Safety Stock
Determining appropriate inventory levels is one of the most important and most challenging tasks faced by operations managers. If you carry too much inventory, you tie up money in working capital; if you don’t carry enough inventory, you face stock outs and reduced service levels.
There must be a balance between inventory costs and customer service. One key challenge and an important piece in the puzzle is to calculate safety stock levels to achieve your desired customer service levels.
Safety stock is defined as inventory that is carried to prevent stock outs and back order situations. Stock outs stem from factors such as fluctuating customer demand, forecast inaccuracy, and variability in supplier lead times. Many companies look at their own demand fluctuations and assume that there is not enough consistency to predict future variability.
There are 3 main ways to calculate safety stock levels for your inventory. Many companies have different methods to arrive at their desired safety stock calculation number. Let’s take a look at the three primary ways to find the right calculation for your inventory management:
3 Ways to Calculate Safety Stock
Fixed safety stock
Companies can set a fixed level of safety stock for their goods. This number may be based on the judgment of the operations manager or on assumed stock level calculations. It’s often set on an aggregated level and not on the individual item. This method may lead to high inventory costs or stock-outs since demand is not always constant or similar for all the items in the group for which the aggregation is done.
Time-based safety stock level is used to calculate the stock required over a fixed period. In addition to the cycle stock, usually a percentage or a week’s average sales is added. This method also has a drawback, particularly when items are slow moving, as there is no connection to lead-time. It can result in a large amount of unnecessary capital tied up in safety stock, which becomes excess stock sitting in warehouses.
The mathematical approach, which uses mathematical theories of probability, imposes order and regularity on aggregates of more or less disparate elements. Different statistical calculations are presented in literature and they will provide better results than the fixed and time-based safety stock calculations. Keep in mind that different mathematical methods are more or less difficult to implement, both manually and in your software solution.