Balancing Stock Levels: How to Use Safety Stock in Your Forecasting Strategy

Inventory control is one of the most significant and challenging aspects of operating a business. Holding too much inventory decreases working capital; at the same time, having too little inventory is dangerous because it leads to stockout, lost sales, and dissatisfied customers.

To overcome this, there is a need to identify a balance between the amount of money invested in stock and service level targets – the availability of the right product/service at the right time. The key to this dynamic is Safety stock in inventory management.

Safety stock, also referred to as buffer stock inventory, a reserve against the fluctuation or anything unpredictable that may happen to disturb the established order in demand or supply. It is important to have this extra stock in inventory, whether in the form of WIP or raw materials or finished goods as it is crucial in fulfilling the required service levels.

Consider this scenario:

An online retailer consistently sells 100 units of a popular gadget daily. Suddenly, a viral social media post causes demand to spike to 150 units per day. Without adequate safety stock, the retailer risks losing sales and disappointing customers. This example underscores the importance of maintaining appropriate safety stock levels.

Calculating Optimal Safety Stock Levels

The formula for calculating safety stock is straightforward but requires careful input:

(Maximum Daily Usage x Maximum Lead Time) – (Average Daily Usage x Average Lead Time).

It assists the businesses in cases of calculating the extra inventory that should be ordered; in order to avoid stockouts.

To use the safety stock formula effectively, you’ll need:

1. Maximum Daily Usage
2. Maximum Lead Time
3. Average Daily Usage
4. Average Lead Time

Let’s break down each component:

1. 1. Maximum Daily Usage: The number of sales or usage of the product by consumers in a single day. Factors to consider include:
   • Seasonal spikes
   • The effectiveness of marketing initiatives
   • Historical sales trends
2. 2. Maximum Lead Time: The maximum time taken by any delivery made by any supplier. This can vary due to:
   • Production delays
   • Shipping times
   • Customs clearance
   • Natural disasters or geopolitical events
3. 3. Average Daily Usage: Calculate this by dividing total usage over a period (e.g., a year) by the number of days in that period. Be sure to:
   • Account for seasonality
   • Exclude outliers that might skew the data
   • Consider using a moving average for more accurate results
4. 4. Average Lead Time: The typical delivery time from suppliers, calculated by average lead times across multiple orders. Best practices include:
   • Tracking each supplier’s performance individually
   • Using weighted averages for frequently used suppliers
   • Regularly updating the data to reflect current conditions

Factors Influencing Safety Stock Levels

Safety stock requirements vary depending on multiple factors, including:

• Demand Fluctuations: Uncertain products require high buffer inventory levels since demand becomes unpredictable.
• Lead Time Reliability: Stable suppliers allow for lower safety stock; inconsistent ones necessitate larger reserves.
• Target Service Levels: Higher service levels generally lead to higher levels of safety stock.
• Seasonality: Stock up for the expected higher or lower demand points.
• Perishability: Some products might need special handling since they can easily go bad within certain time frames.
• Product Value: Stock frequency is usually elevated for expensive items to justify minimal holding costs.
• Supplier Performance: Unreliable suppliers increase the need for buffer stock.
• Forecast Accuracy: Appropriate demand forecasts allow avoiding the need for a large safety stock.

Advancing Safety Stock Management with Dynamic Tools

Modern inventory solutions like Merchmix simplify and enhance safety stock management through automation and advanced analytics.

• Tailored Calculations: Safety stocks are determined at the SKU level using demand specific forecasting methods including normal, Poisson and/or negative binomial distribution.
• Real-Time Lead Time Tracking: Purchase order histories are controlled and for any deviation, the safety stock or purchase order quantity is automatically adjusted.
• Continuous Updates: The safety stock required is adjusted every day based on changes in the variability of demand, the service levels, the supplier, and the accuracy of forecast.

Therefore there is no need for manual calculations or entering figures into ERP systems. Instead, Merchmix handles all the calculations for you. Click here to know more.