Safety stock explained: how much inventory is enough?

When managing inventory, it's important to calculate safety stock levels. Find out how to do it – and how a WMS can help.



In the business world, there's a lot of talk about "future-proofing". It's a broad term that covers everything from upskilling to automation.

But there's a type of future-proofing that's a little more mundane and no less important: safety stock.

Safety stock acts as a buffer. Stock too little and the customer doesn't get what they want. Stock too much and you've got tied-up capital at best and unshiftable dead stock at worst.

Getting the right amount is a balancing act. So, how do you walk the trapeze without falling off and breaking the bank?

In this guide, we look at how to calculate the safety stock your warehouse needs, the factors that affect it and how a warehouse management system (WMS) can help.

What is safety stock?

Safety stock is extra inventory. It's held in a warehouse to prevent stockouts if demand suddenly spikes or supplier deliveries are delayed.

Preventing stockouts is essential for meeting customer demand. It protects against the unexpected. And done right, it helps you balance two things:

1. The need to fulfil all your sales
2. The need to keep your capital liquid and not tied up in unmoving stock
   
   

How do you calculate safety stock?

There are three main ways to calculate safety stock: the max-min formula, the statistical formula and the automated formulas within a WMS.

1. Max-min formula

The max-min formula is the most basic approach. To make this calculation, all you need are maximums and averages for sales and delivery times. The formula is:

Safety stock = (maximum daily sales x maximum lead time) – (average daily sales x average lead time)

First, you multiply the highest number of units sold in a single day by the longest number of days it takes for an order to arrive from your supplier.

You then subtract this amount from the combined total of your normal daily sales volume and the typical number of days a delivery takes.

2. Statistical formula

The max-min formula works as a rule of thumb. A more precise and sophisticated approach folds in a customer satisfaction target and the standard deviation or variability of daily demand.

The formula is:

Safety stock = Z × σd × √LT

In this formula, "Z" represents the service level. "σd" shows how much daily sales deviate from your average. "√LT" gives you the square root of your average delivery lead time in days.

This gives you a more nuanced insight into the safety stock you need.

3. Automated formulas

Another approach is to use a modern WMS, which can perform safety stock calculations automatically.

Traditionally, these kinds of calculations were carried out using an enterprise resource planning (ERP) system. But a high-quality modern WMS will combine some of an ERP's functions with the traditional functions of a WMS (picking, packing and receiving).

A WMS can automatically calculate and manage safety stock levels on a SKU-by-SKU basis. The calculations are based on sales history and lead times.

Manual spreadsheets are swapped for automated data-driven calculations that factor in daily demand, average consumption and replenishment thresholds. The result is a precise buffer that helps you plan effectively.

And because a WMS works in real time, thresholds for replenishment are updated dynamically. This means your reorder triggers are based on up-to-the-minute sales data rather than static figures that were right yesterday but possibly not right today.

What factors might influence how much safety stock you need?

In some cases, demand is steady. But it's often vulnerable to variability – fluctuations that necessitate a buffer in the form of safety stock. The amount of variability will affect how much safety stock you need.

The same goes for your lead times, availability targets, seasonal demand spikes and forecast accuracy.

The safety stock needed can also be affected if you stock perishable goods. These can limit the safety stock you can realistically accommodate before it needs binning and replacing.

Why it's important to get the right amount

Too little stock is a problem. First and foremost, customers can't get what they want – and if they can't get what they want, they're likely to defect to a competitor.

But the simple loss of revenue isn't the only problem. There are also losses to be absorbed because of wasted ad spend, staff overtime, returns processing and even paying extra shipping for panicky restocks.

Too much stock is a problem, too. It ties up capital – capital that could be spent on bills or any of the myriad things that could drive your company forward.

And as well as tying up capital in stock, you're paying a premium for the holding costs. Rent, insurance, security – all is going to waste on inventory that could well turn into deadstock.

Finally, overstocking takes up space. This slows down order fulfilment and limits the amount of available space for popular and fast-moving items – the heavy hitters that warehouse staff need to have at their fingertips. 

How a WMS can help

A modern cloud-based WMS can shift your way of calculating safety stock from a static number to a constantly updated SKU-by-SKU buffer – one that reflects exactly what's happening on the warehouse floor.

Each SKU can be studied according to its:

• Historical demand
• Demand variability
• Supplier lead time
• Lead-time variability
• Current inventory
• Stockout history
• Seasonal changes in demand.
  
  

This gives you fine-tuned insights into the amount of safety stock you need and can also automate reorder points. Combined with the other benefits of a WMS, this gives you the visibility, data-backed insights and smooth workflows you need to boost customer satisfaction.

Our WMS solutions

Minster WMS is a UK-based provider of cloud-based WMS software.

Are you looking for an inventory management platform that keeps you one step ahead of customer expectations? Our CORE and EDGE solutions include overstock warnings and forecasting models to help you gain visibility and control over your procurement process.



Book a demo today to see them in action.