What is Safety Stock? - Formula, How to Calculate & Examples

Buffer stock or safety stock act as insurance against fluctuating demands in the market. These stocks help eliminate the hassle of shortage in stock. With sufficient stock in reserve, the chances of turning away customers due to depleting inventory are minimum. Safety stock covers you until the next batch of stock which is ordered arrives and hence serves demands.

It is a buffer amount which serves uncertainties such as inventory forecasts or inaccurate demand, financial constraints, supplier delays, etc. These stocks help mitigate the consequences or risks of stockouts. You continue with your supply chain in the usual way even when cycle stock may run out.

Safety stock is important in business for the following reasons:

• First, these stocks protect against surging demands, which are irregular.
• Second, it effectively prevents loss of sales.
• Third, it helps save expenses in a business.
• Finally, these stocks help deal with unpredictable and fluctuating prices in the market.

Reasons which suggest safety stock improves inventory management follow as under:

• Compensation for Forecast Inaccuracies: Buffer stocks help maintain a consistent pattern of forecasts. These help decision-makers frame more accurate forecasts across businesses.

• Improving Supplier and Retailer Relationships: Maintaining safety stock in inventory management helps incorporate a steady workload where avoiding rush orders. In addition, these provide ample time and space for suppliers and retailers to frame forecasts at ease and work accordingly.

• Increasing Efficiency: Buffer stocks are steady and administer efficient operations even when there are disruptions in supplies. These even ensure the smooth functioning of the warehouse staff and suppliers.

• Maintaining Market Share: Buffer stocks help maintain market share, holding the ground against competitors. These stocks minimise the risks of fast-depleting stocks addressing a sudden rise in demand led by the failure of a fellow competitor.

• Ensuring Customer Satisfaction: Maintaining buffer stocks is one of the best ways to gain customer satisfaction. When customers can depend on a company without worries about stockouts, that would ensure loyalty and further advertisements on their part.

In order to calculate buffer stock, the following safety inventory formula is useful:

[maximum daily use x maximum lead time] – [average daily use x average lead time] = safety stock.

For example:

Here, it is necessary to determine the average daily use for a product and multiply it by its average lead time (how long it takes, in days, for stocks to arrive once you place an order). Then subtract this number from your maximum daily use times and multiply it by your maximum lead time. The result is the safety stock number for that product.

If the maximum number of Product X sold by a company is 80 and the average number of products sold in a day is 45. Whereas, the maximum time taken to receive Product X after placing a fresh order is 10 days and the average time taken to receive the product is 6 days. The safety stock calculation will be as follows:

(80 x 10) - (45 x 6) = 530

Some examples of safety stock may include the following:

• A company performing research on the market demand makes an estimate that the demand for raincoats is near 1000 units every month. Given that the demand for raincoats is never constant, the company may keep 100 units of raincoats as safety stocks. The company might increase the number of safety stocks depending on peak or lean demands.
• Businesses may maintain a lower safety stock level if they have similar products in stock. For instance, if a business deals in umbrellas and raincoats, it can keep a safety stock of one item less than the other. This can be done as they can easily direct the customers to other stocks as both products can be used interchangeably.

Following are the common challenges and risks to address regarding buffer stock:

• Safety Stock Is Static: These stocks do not grow with businesses; hence, inventory managers must review the numbers of safety stocks regularly and adjust as necessary.
• Standard Safety Stock Formulas: The same may not apply to all operational strategies and industries. It may especially happen when there are multiple unknown variables.
• Excess of Safety Stock: Keeping excess stock may mean less room for new products or current cycle stock. Moreover, holding excess stocks may cater to considerable business expenses.
• Letting Safety Stock Decline: Maintaining adequate stock must be a priority avoiding speculations such as decreasing the amount of safety stock when the average lead times go down. This must be avoided as other factors may cause inventory issues.

When a company maintains a safety stock, it awaits both pros and cons of the given calculation system. Therefore, it is necessary to be mindful of both these concepts described above to ensure keeping a steady buffer stock to serve the demand surge whenever it occurs.