Inventory management isn’t an exact science. Consumer demand shifts on a dime, causing supply shortages, increased order volumes, and the dreaded stock out.
Fortunately, you can mitigate these risks using the safety stock formula, which reveals how much excess product you need to effectively address a supply chain failure.
Learn how to calculate safety stock and what benefits the formula provides your business and customers
What’s safety stock?
Safety stock is the excess product you keep at your warehouse to safeguard against supply chain failures and other common emergencies.
Typically, you’ll use forecasting tools and calculations like the lead time formula and inventory turnover ratio to determine how much stock to keep on hand and when to reorder. Under ideal conditions, you’ll always have just enough inventory to meet demand until the next order arrives.
But if something goes awry, you’ll run out of inventory before the next shipment. That’s where safety stock comes into play.
Here’s an example: Imagine your demand forecast indicates you’ll sell 1,000 units this month and that you need to reorder every 30 days. But then demand increases unexpectedly, or your supplier delays your shipment. By factoring in safety stock, you can account for these scenarios. In this case, you may decide to order 1,100 units instead of just 1,000, leaving you with a 100-unit buffer.
How safety stock improves inventory management
Safety stock is a key component of effective inventory management. Keeping some extra stock on hand prepares you for those unexpected moments when demand spikes or things get delayed. Here’s how it benefits your business:
- Prevents stockouts: It’s the safety net that keeps you from running out of products during busy times or supply delays.
- Improves ordering: With extra stock, your inventory manager can reorder at just the right time, avoiding overstocking and running out.
- Maximizes warehouse space: Instead of overloading your warehouse, safety stock maintains a balanced inventory that fits your space and needs.
- Cuts unnecessary costs: Safety stock helps reduce carrying costs by ensuring you’re not overordering, but still have enough to cover demand.
- Keeps customers happy: Having the right stock on hand means you can always meet customers’ needs, leading to higher satisfaction and repeat business.
The importance of safety stock
Regularly using the safety stock formula leads to improved inventory management results. Here are a few more pointed benefits of determining and keeping the right amount of excess stock.
Reduce stockouts
Maintaining safety stock makes your organization less susceptible to stockouts and shortages. If an item’s demand suddenly increases, you tap into the buffer while you await more units from the supplier.
Optimize warehouse space
Safety stock is meant to guard against disruptions, but that doesn’t mean you should overstock all the most popular products. Blindly overordering ties up too much capital and overwhelms the warehouse.
The safety stock formula lends a method to the madness, revealing how much more of each SKU you need to order based on demand trends. That way, you make the most of your finite warehouse space and optimize business agility.
Forecast demand
Continuously re-evaluating safety stock levels will allow you to ensure that your inventory matches current supply and demand conditions. And you can use formula variations to forecast customer service and shipping needs. These insights help you anticipate sales surges throughout the year and result in better inventory management efficiency.
Adapt to seasonal trends
Safety stock isn’t a static figure. The formula helps you adjust inventory levels in accordance with predictable trends, such as pre-holiday spikes and transaction surges on Cyber Monday.
Prioritize customer satisfaction
Customers who visit your store or website expect to find their favorite products readily available. The safety stock formula helps you ensure hot-ticket items are on hand to consistently meet consumer expectations.
Fulfill orders faster
Safety stock enables your business to fulfill orders faster, even if you’re waiting for a replenishment delivery. If you run out of primary inventory, you turn to the reserves to bridge the gap.
The standard safety stock formula
The most common formula is:
Safety stock = (maximum daily sales x maximum lead time) – (average daily sales x average lead time)
Suppose a business has the following sales and lead time data:
- Maximum daily sales: 120 units
- Maximum lead time: 10 days
- Average daily sales: 100 units
- Average lead time: 7 days
Here, you’d calculate like so:
Safety stock = (120 x 10) – (100 x 7)
According to this calculation, you should keep an additional 500 units on hand to avoid stockouts.
How to calculate safety stock: 6 methods and related formulas
The standard formula is a reliable starting point, but you can also vary your approach based on your unique circumstances. Consider these alternative methods and formulas to use depending on the team’s needs.
1. Standard deviation
This analysis uses the standard deviation of demand and lead time to provide a buffer for variability:
Safety stock = Z x standard deviation of demand x lead time
In this formula, “Z” represents the Z-score associated with the desired service level you want to maintain. This method is useful in environments with predictable lead times and demand variability.
Think of the Z-score as a safety net that tells you how much extra inventory you should keep on hand amidst demand fluctuations. So to make sure you have enough units to account for variance — compensating for when people buy more than expected — and satisfy customer demand 95% of the time, the Z-score will indicate how much extra inventory you’ll need.
2. Average-max
The average-max method calculates safety thresholds based on the difference between the maximum and average demand (or lead time), as shown in the example for the standard safety stock formula. This approach is useful if your business experiences large fluctuations in demand or lead time.
Average-Max Formula
Here’s the average-max formula:
Safety stock = (Maximum daily usage × Maximum lead time) − (Average daily usage × Average lead time)
Let’s say you usually sell 500 units a month, but one month you hit 1,000. You’d subtract the average from the max and stock that difference — in this case, 500 extra units — as a buffer.
3. Variable demand
This approach specifically accounts for the variability in demand while keeping the lead time constant. The formula fluctuates based on demand variance over a set period:
Safety stock = standard deviation of demand x square root of average delay
The variable demand formula particularly benefits businesses with significant lead times or drastic fluctuations in customer demand. It’s also useful in industries with fast product life cycles, such as fashion (which capitalizes on short-term trends) and technology (since tech quickly becomes obsolete).
4. Variable lead time
Conversely, this formula focuses on lead time variability while assuming demand remains constant. It’s particularly useful for companies facing supply chain uncertainties because by accounting for variability in lead times, companies can better prepare for unexpected delays in receiving supplies. This ensures operations continue smoothly, even when the supply chain faces disruptions.
Here’s the formula:
Safety stock = Z x average sales x lead time deviation
5. Economic order quantity
Use the economic order quantity (EOQ) and safety stock formulas together to obtain additional insights about ideal inventory thresholds. The EOQ is the ideal amount of stock the business should purchase to minimize inventory costs:
EOQ= √DS/H
Where D equals annual demand for the product (in units), S is the cost associated with placing an order for more inventory, and H is your holding cost per unit per year.
6. Reorder point
The reorder point method helps you determine when to reorder based on lead time demand plus safety stock. Finding the reorder point with safety stock involves both the average demand during lead time and the amount of reserves on hand. Here’s the formula:
Reorder point = (average daily demand x lead time) + safety stock
Stockout risks
Stockouts can happen to virtually any ecommerce brand, but the following issues make a business more susceptible.
Poor demand planning
If initial forecasts are inaccurate, you risk an inventory shortfall. So you must implement measures to gather better data regarding demand, inventory, and consumer trends. An all-in-one inventory and sales management solution like Fishbowl consolidates important business data and provides more accurate forecasts.
Unexpected demand fluctuation
An unexpected sales boom is great for your bottom line, assuming you can keep up and deliver. Otherwise, surprise demand spikes quickly burn through the primary inventory and any excess on hand.
By keeping a close eye on customer trends, you’ll usually see demand spikes coming a few days in advance, giving you extra time to prepare for the surge.
Inadequate inventory management
If your warehouse faces damaged, miscounted, or lost stock, you have an inventory management problem. Such issues are typically linked to a process or software issue. Upgrading to a modern inventory management solution may alleviate stock visibility and control issues.
Inaccurate replenishment timing
You need to be proactive about reordering. Don’t wait until you’ve tapped into your safeties to reorder — ideally, you should have another shipment arriving just as the primary inventory is running dry. Remember, safety stock is a buffer for emergencies. It’s not meant for routine usage.
Supplier delays
Even slight delays in the supply chain can cause shortages, especially if you’re relying on certain products to meet demand. To avoid this, stay in regular contact with suppliers, build buffer stock, and stay alert for potential disruptions.
Limitations of the safety stock calculation methods
While safety stock formulas keep your inventory management in check and avoid costly stockouts, no technique is perfect. Each comes with its own challenges, depending on your business model, supply chain, and how predictable (or unpredictable) your demand and lead time are.
Here are some common obstacles to watch out for:
1. Overreliance on historical data
Most methods — especially those based on average-max or standard deviation — depend heavily on past performance. But in fast-moving industries or during unusual events, yesterday’s data may not reflect tomorrow’s needs. A sudden shift in demand, a change in your supplier’s speed, or a new trend could make your sales forecast obsolete.
2. Assumes a normal distribution
The standard deviation method assumes that your demand and lead time follow a normal distribution, meaning they vary predictably around an average. In real life, that’s not always the case. If your inventory patterns are erratic or seasonal, this method could give misleading results.
3. Inflexible to real-time changes
Most traditional stock calculation formulas don’t adapt quickly to changes in the market or supply chain disruptions. Without real-time inputs from inventory management software, your replenishment strategy could lag behind what’s happening, leading to stockouts or excess carry costs.
4. Ignores external variables
Things like supplier reliability, global shipping delays, or sudden shifts in customer behavior aren’t usually factored into basic formulas. Even the best stock calculator might not capture how an unexpected event could disrupt your supply chain management.
5. Doesn’t always factor in economic trade-offs
Some methods focus purely on avoiding stockouts without balancing the cost of holding extra inventory. This can lead to higher inventory costs, especially if you store raw materials or slow-moving goods. Not every company can afford to prioritize service level over cost.
6. Requires skilled interpretation
Even with a solid equation, poor interpretation can throw off your entire stock management strategy. An experienced inventory manager still needs to monitor patterns, adjust for variance, and use the right formula based on real conditions.
Supplementary formulas for safety stock calculations
In some cases, traditional safety stock formulas may not give you the flexibility or accuracy you need — especially when demand patterns are complex or your supply chain faces high uncertainty. These alternative methods help refine stock calculations and improve overall inventory management for businesses with more advanced forecasting needs.
Here are four supplementary formulas to consider.
1. Binomial distribution
If your sales process involves a series of yes-or-no decisions, like whether a customer makes a purchase, the binomial distribution can be a helpful tool. This method is well-suited for businesses with frequent, smaller sales events, like retailers.
Binomial distribution models the probability of a specific number of sales over a set period, based on the likelihood of a customer buying your product. You can estimate how much inventory to keep on hand to reduce the risk of running out of stock.
2. Gamma distribution
When sales patterns aren’t predictable and tend to fluctuate heavily, the gamma distribution can be a better fit. It’s ideal when demand tends to be skewed, like in seasonal spikes or unexpected surges.
This approach accounts for extreme changes in demand, offering the information you need to keep enough safety stock during unpredictable periods.
3. Poisson distribution
For products with infrequent but high-impact sales, like emergency supplies, the Poisson distribution might be your best bet. It calculates the likelihood of sales happening at specific intervals.
Poisson distribution is especially useful for businesses that deal with rare but significant events where running out of stock could cause major disruptions.
4. McKinsey method
The McKinsey method combines multiple factors — like historical demand, inventory cost, and your desired service level — to create a comprehensive safety stock strategy. While it’s a bit more complex than the standard approach, it helps businesses find a balance between having enough inventory to meet demand and keeping carrying costs under control.
This method is excellent for teams using inventory management software or those with access to more advanced tools and data.
How to choose the right formula for safety stock
Choosing the right safety stock formula depends on several key factors that impact your inventory needs. Here’s how to approach it:
- Understand your demand variability: For products with fluctuating sales, like seasonal items, you need a formula to handle unexpected demand spikes. A higher safety stock level helps you prepare for these fluctuations.
- Consider differing lead times: If your suppliers are unpredictable or have long lead times, adjust your formula to account for delays. A formula that adds extra buffer stock for longer lead times can prevent stockouts during waiting periods.
- Account for your customer service goals: If customer expectations are high — for example, they want next-day delivery — you need a formula that provides a higher service level. This means keeping more inventory on hand to ensure fast order fulfillment and a lower risk of stockouts.
- Factor in how often you reorder stock: The frequency of your stock orders impacts how much safety stock you need. Ordering more frequently means you can reduce safety stock levels. But if orders are infrequent, you need more to cover the time until the next shipment.
- Balance inventory costs: The right formula also considers the cost of holding excess stock. While you want to avoid stockouts, don’t tie up too much cash in inventory. Aim for a formula that balances avoiding stockouts and minimizing storage costs.
Prevent stockouts with Fishbowl
Fishbowl’s inventory management software provides unmatched stock level visibility to prevent outages and better serve your customers. The platform consolidates key processes, making it easier to manage sales, warehouse, tracking, and manufacturing.
Speaking of warehousing, Fishbowl Warehousing can automate purchasing, order approval workflows, and vendor management to enhance overall visibility.
Stop the recurring nightmare of stockouts and shortages. Make the leap to Fishbowl and modernize your inventory management strategy.