What is the safety stock formula? The safety stock formula is therefore: – = safety stock.
- 1 What is the difference between safety stock and safety lead time?
- 2 What is the formula for lead time usage?
- 3 How often should you calculate safety stock?
- 4 Is safety stock the same as EOQ?
- 5 How to calculate stock ratio?
- 6 What is the Z formula for safety stock?
How do you calculate the safety stock?
The general formula – This is the most simple and commonly used method to calculate safety stock. It calculates the average safety stock the company needs to hold during a stockout scenario, but it doesn’t consider the seasonal fluctuations of demand.
How does lead time affect safety stock?
Inventory is a highly visible asset and, in many companies, also the largest asset. In today’s highly competitive global economy, inventory has become the focus of improvement for many companies. Inventory typically includes: cycle stock and safety stock.
Cycle stock provides the buffer between replenishment deliveries and is fairly straightforward. Safety stock protects against variability in both demand and lead times. Therefore, setting the correct levels of safety stock is tricky and requires a thorough understanding of its drivers. In our engagements, we have seen many inventory management professionals develop interesting approaches to managing and reducing their safety stock.
Here, we will discuss some of the common pitfalls in those approaches. Pitfall 1: Setting safety stock to zero will reduce inventory In some of our recent engagements, we observed that some supply chain professionals reduce safety stock to zero. They believe that they can reduce inventory if they set their safety stock to zero and in most cases, their inventory level did go down but so did their service level.
For most companies, this unwanted side-effect will end up costing them much more than the cost of some extra inventory. Therefore, we must better understand the relationship between safety stock and service level to effectively reduce inventory without reducing the service level. The most commonly used safety stock calculation is as follows.
The equation shows that the safety stock level is the multiplication of service level and variations in demand and lead time. In order to have zero safety stock, the z-score of the service level will have to be zero or variations in demand and lead time have to be zero. Assuming that average lead time, average demand, the standard deviation of the lead time and the standard deviation of the demand stay the same, any safety stock reduction will surely result in service level reduction. Pitfall 2: A textbook safety stock formula works for my supply chain One common mistake for many inventory practitioners is to use a textbook formula without fully understanding its range of applicability.
For example, the safety stock formula described above is the most commonly used formula in inventory management today. This model will calculate the necessary safety stock to achieve a target service level provided that both lead time and demand are normally distributed. This model does not take into account the upstream failure rate, reorder period, or order quantity requirements which are part of cycle stock.
Therefore it is not recommended to use only this model if the upstream failure rate, reorder period, or order quantity requirements are significant business constraints in your supply chain. Pitfall 3: Safety stock declines as average supplier lead time declines Safety stock is designed to prevent stock-outs when there is variability in your demand and supply.
Case 1: Supplier A has an average lead time of 15 days and the standard deviation is 10 days. Case 2: Supplier B has an average lead time of 24 days and the standard deviation is 1 day.
Assuming the receipt period equals the total lead time, which supplier will reduce your safety stock? In both cases, you have to safeguard your inventory for 25 days, but the safety stock values are different for each of them. When you plug the values into the safety stock equation, Supplier B will have the lowest safety stock.
Since you know that the lead time is 24 days, your cycle stock will be ordered in such a way to satisfy the demand for 24 days and you only need to safeguard your supply with a safety stock for 1 extra day which is the variability here. But in case of a 15 day lead time with 10-day variability you are sure that the product will reach you at an average of 15 days, but it may take up to 25 days so you will order your cycle stock so that it satisfies 15 days demand and safety stock to safeguard for the extra 10 days variability.
So the variability of your lead-time increases your safety stock. The same principle also works in the case of demand. The variability of your demand increases your safety stock. Let us look at an extreme case, if your supplier says he will have no lead time variability and your demand forecaster says he has predicted the demand perfectly, then you will have no use for the safety stock since you know what amount you need and how long it takes for your supplier to ship it to you. Safety stock is designed to prevent the majority of the stock-outs, not all of them. You can design your safety stock to satisfy your customer service level but there will always be stock-outs. One of the main variables when calculating safety stock is the service level.
As shown in the graph, safety stock increases with the customer service level. When the service level values reach above 95% the safety stock number increase exponentially. Statistically speaking, the safety stock is infinite for a 100% service level. The safety stock equation is designed to deal with variability.
Variability means you cannot assure the lead-time of your suppliers and cannot forecast your demand perfectly. If you could do that, you wouldn’t need safety stock at all. With safety stock, sometimes you overshoot your inventory level and sometimes you fall below your predictions.
The first case leads to stock-outs and the second case leads to excess inventory. We can argue that in the second case we will never experience stock-outs and have 100% customer service level. But it doesn’t mean the safety stock was calculated for this scenario. The second case occurs because of the variability.
It costs you more when you have inventory on hand which has no demand. To sustain this, we should always have a balance between cost and service level. We can slowly improve our service level by decreasing our variability but with the limited practical resources, we will always have stockouts at some point in time.
The bottom line is stockouts are inevitable but we can keep them to a minimum by reducing variability. Conclusion Variability along the supply chain has a large impact on inventory requirements that is often not realized. Reducing inventory often requires understanding which drivers are the most important in your supply chain and alleviating them in order to improve overall performance.
Source: OPS Rules Blog: Insights into Supply Chain and Operations Strategy Related: Principals of Inventory Management
How do you calculate lead time in stocks?
Lead Time Formula – There isn’t one way to calculate lead time, but the most common is to subtract the order request date from the order delivery date. Lead Time (LT) = Order Delivery Date – Order Request Date When dealing with inventory management, you’ll include the supply delay and the reordering delay.
What is the difference between safety stock and safety lead time?
Safety Stock and Safety Time – One way to ensure order fulfillment is by using safety stock – that extra edge used as a buffer between orders and on-hand inventory that allows a company to achieve high service levels and maintain customer satisfaction.
- The retention of safety stock is an attempt to capture forecasted demand for a product.
- However, the caveat is that you understand that demand in the first place.
- Safety time is an attempt to leverage lead times to ensure that materials and supplies arrive just in time for the correct production level.
It may be based on actual lead time if there are few, or even a single, component and supply is predictable. Or a company may use a more that includes considerations such as internal review, supplier lead time, transportation, and other factors.
What is the formula of stock?
How is common stock calculated? The formula for calculating common stock is Common Stock = Total Equity – Preferred Stock – Additional Paid-in Capital – Retained Earnings + Treasury Stock.
What is the 50% rule of safety stock?
What percentage of inventory should be safety stock? – The percentage of inventory that should be safety stock will vary from business to business. For most businesses, about 50% of the average amount of inventory you use during your reorder lead time is a sufficient amount of safety stock.
What is safety time lead time?
Safety Lead Time – Engineering Data Control – MRP glossary of Production scheduler Asprova Safety Lead Time It is a lead time which set as a buffer against fluctuations in accidental error for various kinds of lead time. It is usually added to Manufacturing Lead Time of manufactured items in order to make up for lost time.
What is Z in safety stock formula?
Use the safety stock formula Z refers to your desired service level factor. ∑LT refers to the standard deviation in lead time. D is the average demand.
What is the relationship between lead time and inventory?
Lead time in inventory management is the lapse in time between when an order is placed to replenish inventory and when the order is received. Lead time affects the amount of stock a company needs to hold at any point in time.
What does 1 hour lead time mean?
Lead time refers to the number of hours or days between placing an order and delivery. Cycle time refers to the number of hours or days it takes to manufacture a unit.
What is the formula for lead time usage?
Lead Time Calculator If you’re looking to check how to calculate lead time in your company, our lead time calculator is the perfect place! Do you have a store, and you want to know the lead time of your supply delivery? Or maybe you ordered something, and the producer sent you an email saying that the lead time is 60 days, and you have no idea what it means? Worry no more – you’re in good hands! We will give you the lead time definition and explain why companies use it.
- In manufacturing, lead time means the time necessary for processing, preparing materials, manufacturing, and delivery of an order. Generally, it consists of three periods:
- Lead time = pre-processing + processing + post-processing,
- Pre-processing is a time needed for, handling the order, making sales order, and preparing supplies;
- Processing is a period when you make or collect the order. You may also know it by cycle time*; and
- Post-processing is the time of delivery.
Lead time processes are also categorized in a different, more detailed way:
- Order lead time (OLT) – the time from receiving to delivering a customer order (you can calculate it by subtracting the dates of these two events or adding pre-processing, processing, and post-processing).
- Order handling lead time (OHLT) – the time from receiving a customer order to creating a sales order.
- Manufacturing lead time (MLT) – the time from creating a sales order to having it ready for delivery.
- Production lead time (PLT) – the time from starting the physical production to having a finished product ready for delivery.
- Delivery lead time (DLT) – the time from having a finished product to having it delivered to a customer.
To understand how all these categories overlap look at this scheme: As there is more than one way to approach calculating lead time, our calculator has three modes:
- Manufacturing lead time ;
- Order lead time ; and
- Supply chain management lead time,
The first two are connected to manufacturing. Which one should you choose? Let’s look at a lead time calculation example. If you own a restaurant, select the first option, and estimate three periods:
- Pre-processing – the time it takes a waiter to take an order and type it into the cash register;
- Processing – the time it takes the chef to make the food; and
- Post-processing – the time it takes the waiter to pick up the food from the kitchen and get it to you.
To make any conclusions from estimated lead time, measure it a few times, and calculate the average. Then, you can compare how fast your employees work or check which dishes take the longest. Based on that, you will know which employee deserves a raise and which dishes should be removed from the menu or have a higher price.
- The day you placed an order; and
- The lead time of a company.
You can also check if their lead time was longer or shorter by inputting the day of placing an order and delivery day. Go to the next paragraph to find out when and how to calculate the supply chain management lead time.
- In supply chain management (or inventory management), we tie the lead time to the amount of stock the company needs. It consists of two periods:
- Lead time = supply delay + reorder delay,
- supply delay is the time between ordering and getting the supplies; and
- reorder delay is the time you have to wait before reordering the supplies. That’s because some suppliers carry out orders once a day, a week, or a month.
Let’s say you own a restaurant where you use a rare and expensive ingredient. The person who sells it takes orders once every two weeks, and the delivery takes a day. To calculate lead time, input the correct numbers into our calculator:
- supply delay = 1 day
- reorder delay = 14 days
Input that to the lead time formula, and you’ll get: Lead time = 1 + 14 = 15 days Next to, it’s one of the most important factors to consider, to prevent shortages or overstock. If you already know the lead time, you can check in our the day you’ll get supplies.
- project management When we talk about lead time in project management, we mean the period when two (or more) activities overlap. If you schedule some tasks at the same time, you could accelerate the end of a project.
- journalism In journalism, lead time is the time it takes you to work on a piece. That includes doing research, writing, and editing.
- medicine In medicine, it’s the period between detecting disease through screening and the time the symptoms would lead to a diagnosis. For example, tests such as, or cytology cause long lead time for detection of cancer.
You now know what lead time is. But you may not know that it is associated with two other terms: takt time and cycle time. Takt time is the time that you can spend on a product, so you meet the demand. Cycle time is the time it takes you to finish one product,
- What’s the difference between cycle time and lead time? Well, cycle time only refers to processing, making, or collecting an order.
- So, in manufacturing, it’s synonymous with processing,
- We hope you enjoyed our lead time calculator! We highly recommend exploring our other time and productivity calculators.
: Lead Time Calculator
What is 30 day lead time?
Scenario 2: The lead time is equal to days of stock – This is a happy medium. Right after receiving products from a supplier, you should review your stock place another purchase order. This means fewer items in transit at any given time because as soon as you get an order in, you place another order.
How often should you calculate safety stock?
Breaking some Eggs – To reduce the size and complexity of the decisions, start with identifying some hard limitations. The two most common ones are limitations forced upon you by the systems and the available data. For example, if safety stocks are not calculated by any system, it usually ends up in an Excel sheet.
Eeping this sheet up to date is a lot of manual work, and companies in this situation will recalculate safety stocks once or twice a year. Naturally, this leads to significant inefficiencies, with lots of product stocking out and simultaneously other products with lots of obsolete stock. If you don’t have a system, recalculating this infrequently will be your only practical choice until you do implement one.
If you do have a system that calculates safety stocks, the highest frequency it could make sense to recalculate is equal to the demand forecast time granularity. For example if your forecast is calculated in weekly time buckets, you could consider recalculating safety stocks on a weekly basis or less frequent, but not more frequently.
Whether it makes sense to do so is covered further below. At least you know that if your forecast is in monthly buckets you will not update safety stocks more often than once a month. Note : that having some clever mechanism to split a monthly forecast into weekly buckets does not count. It will cause both large forecast errors (in weekly granularity) and simultaneously cause safety stock errors.
Other limitations are frequently imposed by the legacy ERP transactional system in use, and how it was implemented:
- The most common limitation of such systems is that safety stocks and reorder levels can only be provided as a single number for each item/location, rather than as a time series of numbers. As a direct result there is a greater need to recalculate often than would otherwise be the case; explained further below.
- The choice of whether to use safety stocks from advanced inventory management systems or instead have these provide reorder levels to the transactional system is typically determined by the fact that one is setup to be calculated from the other and the calculation cannot be disabled without side-effects. Ideally advanced inventory systems should provide the reorder level, since they are more accurate and can be used directly without further calculations in the transactional system.
- Similarly the choice of using units or a time coverage to specify inventory targets is frequently imposed by the transactional system: it may take one or the other but not both. But many such systems do accept either, however may treat one better than the other. For example, some items may have direct or indirect demand (from a customer or from another internal warehouse), or independent or dependent demand (for the item itself or for a kit, finished good or assembly which has the item in its bill of materials). Some transactional systems are setup to only consider direct, independent demand when converting a time coverage into units. For those items that have indirect or dependent demand the units will be incorrect in such cases. You may have no choice but to provide targets in terms of units.
- Various other limitations may be imposed by the choices made during implementation of the transactional system. You will need to determine which ones exist in your specific case.
Take stock of all the rules dictated in your situation. At this point you may already have no choice left and you can unambiguously determine your best recalculation frequency. If you do have some degrees of freedom left, the following provides some rules of thumb to pick your best option.
Is safety stock the same as EOQ?
The safety stock is calculated based on the rounded EOQ. If normal distribution is applied the final determination of the EOQ and the safety stock is an iterative process with gradually increasing or decreasing values—depending on the rounding profile (else increment of 1).
What is the best way to calculate stock?
Price/book ratio – Another useful metric for valuing a stock or company is the price-to-book ratio, Price is the company’s stock price and book refers to the company’s book value per share. A company’s book value is equal to its assets minus its liabilities (asset and liability numbers are found on companies’ balance sheets).
How to calculate preferred stock?
What is Cost of Preferred Stock? – The Cost of Preferred Stock represents the rate of return required by preferred shareholders and is calculated as the annual preferred dividend paid out (DPS) divided by the current market price. Considered a “hybrid” form of financing, preferred stock is a blend between common equity and debt – but is broken out as a separate component of the weighted average cost of capital ( WACC ) calculation.
How to calculate stock ratio?
How to calculate stock to sales ratio – The stock to sales ratio can be calculated by dividing the average inventory value in a certain period of time by the net sales achieved in that same period of time. Stock to sales ratio = Average stock value / Net sales value This can be turned into a percentage by multiplying it by 100.
To calculate average stock value, simply add your beginning inventory value and ending inventory value together, and then divide that sum by 2. Average stock value = ( Beginning inventory + Ending inventory ) / 2 To calculate net sales, simply find your gross sales valuation (total sales before discounts and returns) and subtract from it the value of all returned sales.
Net sales = Gross sales – Sales returns All the figures needed to calculate stock to sales ratio can be found in the company’s income statement, balance sheet, and other financial statements. Let’s walk through an example. Suppose a company sells pans.
Is safety stock the same as reorder point?
Originally published on Katana MRP blog, Safety stock describes the amount of inventory a business keeps in the warehouse to protect against spikes in demand or shortages in supply. From a perspective of a manufacturer, safety stock principles can and should be applied for both raw materials and final products to ensure availability of input for production, and goods for delivery. In a perfect world, your suppliers always deliver on time and your sales does not fluctuate unexpectedly. So, your company would never run out of stock. In reality, your suppliers run into delivery problems due to various one-off events, from time to time you fail to meet your weekly manufacturing targets, and your sales is affected by seasonal effects and unexpected marketing successes or failures.
Also, sometimes unexpected spikes in demand are difficult to forecast. Supply chain is full of surprises. Due to this uncertainty, having some stock in reserve helps you keep your customers satisfied. However, safety stock comes at a cost. Lean manufacturing principles guide you to eliminate waste, and excessive stock is a waste as there are many costs to holding excess inventory.
Examples include renting additional warehouse space, paying salary to people handling the stock, the risk of stock expiring or becoming outdated, and much more. Also, excess inventory means your cash is tied up. Therefore, every manufacturer needs to find a good balance between having enough safety stock to weather the storms, but not so much that it would break your bank.
The calculation is relatively easy in case you have reliable purchase and sales order history available. Safety Stock = (Maximum Daily Usage x Maximum Lead Time Days) — (Average Daily Usage x Average Lead Time Days) Let’s say there is a workshop in United States selling hand-crafted backpacks via eCommerce shop to customers globally.
The backpacks are produced mainly from leather sourced from Mexico. One pack of leather procured includes material for one ready-made backpack. The business model operates with the following characteristics.
The production on average consumes 10 packs of leather per day to produce 10 backpacks, however, maximum production capacity allows to consume 14 packs of leather per dayIt takes on average 14 days for leather packs to arrive from Mexico once the purchase order is placed, however, historical data reveals that delays in supply occasionally push the lead time up to 21 daysIt takes on average 5 days to produce one ready-made backpack, however, blockages in production sometimes result in a 10-day production cycleOn average 10 backpacks are sold per day, however, demand peaks occasionally push the daily sales volume to 30 backpacks per day
Table below sums it up nicely. Safety stock level for leather packs would be (14 x 21) — (10 x 14) = 154 units and for backpacks (30 x 10) — (10 x 5) = 250 units. As the manufacturing process consumes on average 10 packs per day then the workshop has a bit more than two weeks of raw material inventory available to guard against the unexpected.
As the workshop sells on average 10 backpacks per day then the workshop has a bit less than one month of ready-made product inventory available to weather unexpected occurrences. When calculating safety stock levels pay attention to changes in underlying metrics. Maximum daily usage and average daily usage are not figures carved in stone.
They increase as your business grows and they fluctuate depending on whether you are approaching high season or low season. Thus, you should recalculate your safety stock levels from time to time. A good tip to follow would be to revisit these calculations in every 3–4 months.
So now you know how much safety stock you need to keep in your warehouse readily available. However, how to determine when should you place a new purchasing order for raw materials or manufacturing order for a ready-made product? A good reorder point ensures that your business typically does not dip below your safety stock levels and a good safety stock level means that your quantities never hit zero in case the unexpected happens.
Therefore, a reorder point is typically a little higher than your safety stock level to factor in the lead time. The formula for calculating Reorder Point builds on the Safety Stock formula explained above with the addition of factoring in the lead time for a new order.
- Reorder Point = (Average Daily Usage x Average Lead Time Days) + Safety Stock Continuing with the example above the reorder point for leather packs would be at (10 x 14) + 154 = 294 units and for backpacks at (10 x 5) + 250 = 300 units.
- Therefore, once the quantity in the warehouse for leather packs or backpacks hits roughly 300 units, the company should place a new purchasing or manufacturing order respectively.
As the average lead time is built into the reorder point the new shipment of leather packs from the supplier or freshly manufactured backpacks from the workshop should arrive before the quantities in warehouse dip below the safety stock levels. However, in case of production shortages or delays in supply, the safety stock should ensure that the inventory levels will not fall to zero and work in manufacturing can continue and shipments to customers can be sent undisturbed.
Using a production and inventory management software allows a company to set reordering points for each product or material variant that are automatically tracked. Software flags the product and material variants that have dipped below reordering point automatically allowing you to easily identify the areas that require action.
Read more on katanamrp.com, More similar topics and discussions in our BLOG,
What is minimum safety stock?
Minimum Safety Stock. The quantity that defines the lower limit for safety stock. This value cannot be exceeded. The safety is checked to see if it is greater or equal to this lower limit.
What is the Z formula for safety stock?
Z × σLT × D avg – Z is the desired service level, σLT is the standard deviation of lead time, and D avg is the demand average. Don’t be intimidated. The simplest method for calculating safety stock only requires a four-step process to calculate these variables.
What is the formula for safety stock and reorder point?
Key Takeaways –
- A reorder point (ROP) is the lowest number of units of an item that a company needs to have in stock to make sure they do not run out and can keep fulfilling orders.
- The ROP calculation takes into account an item’s average lead time, its demand rate, and its safety stock level if a company utilizes safety stock.
- The reorder point formula is ROP = (lead time x demand rate) + safety stock level. Lead time and sales velocity or consumption are sometimes grouped together into a metric known as lead time demand.
- Recommendations for implementing reorder points include prioritizing SKUs with which to set them up, keeping your ROPs regularly updated, not overprioritizing their importance, and investing in capable inventory management software.
- Modern MRP-systems can largely supplement or totally replace the ROP method. Which method to use and when should be considered carefully as per use case.
How do you calculate safety stock Z factor?
Download Article Download Article Safety stock, or buffer stock, is the amount of extra inventory you need to keep avoid a shortfall of materials. It is important to calculate your safety stock carefully because while too little stock will result in shortages, too much stock will inflate your inventory costs. Luckily, there are ways to determine how much safety stock you will need on hand.
- 1 Look to historic demand and demand variability to determine how to avoid stockouts. The following calculations will predict the stock necessary to achieve a certain cycle service level – i.e. the percentage of supply cycles that will result in a stockout.
- 2 Determine average demand. Average demand is the total quantity of a material or goods required each day over a fixed period. A common approach is to check the total usage of that item for a specified period, such as one calendar month or the interval between ordering and delivery of stock, and then divide by the days in that month to find usage per day. For many items — such as long-established brands in a grocery store — historical demand will provide the best guide to calculating demand. Advertisement
- 3 Consider future demand for particular stock items. Sometimes it makes more sense to consider future demand. For instance, if you manufacture car transmissions and have received a large order, you will want to factor that order into demand. In this case, you might consider calculating average demand and then adding in the demand created by the large order.
- 4 Calculate demand variability. Average demand can only tell you so much. If demand fluctuates dramatically from month to month or day to day, you will need to include that in your calculations so that you will have enough stock to cover surges in demand.
- Start with the average demand over a period of time (i.e. a week, month or year). For our example, let’s say it is 20 units per month.
- Determine the absolute difference between each data point and the average. For example, if monthly demand was 8, 28, 13, 7, 15, 25, 17, 33, 40, 9, 11, and 34 units, the differences from 20 would be: 12, 8, 7, 13, 5, 5, 3, 13, 20, 11, 9, and 14.
- Square each difference. In our example, this would yield: 144, 64, 49, 169, 25, 25, 9, 169, 400, 121, 81, and 196.
- Calculate the average of the squares.E.g.121
- Take the square root of the average. This is your standard deviation of demand.E.g.11
- 5 Determine your service factors, aka Z-scores. The service factor, or Z-score, is based on the standard deviation of demand. A Z-score of 1 will protect you from 1 standard deviation of demand. So in our example, since the standard deviation of demand was 11, it would take 11 units of safety stock in addition to normal stock to protect against one standard deviation, yielding a Z-score of 1.22 units of safety stock would yield a Z-score of 2.
- 6 Decide on the Z-score you are looking for. The higher your Z-score, the less likely you are to have a stock-out. In choosing a Z-score, you will want to balance customer service and inventory cost. You will want a higher Z-score for stocked units with greater value to your business.
- Z-Score of 1 = 84%
- Z-Score of 1.28 = 90%
- Z-Score of 1.65 = 95%
- Z-Score of 2.33 = 99%
- 1 Factor in lead time to account for supply variability. The lead time is the time from when you decide to produce or order an item until the time at which the item is on hand and ready for sale to the end customer. There are several factors that can cause lead time to vary:
- Production delays — If your own production process is variable, this may impact the lead time. In addition, the production process of the products you are ordering may vary.
- Material defects — If you order 10 units and 2 are defective, you will have to wait for the additional 2 units.
- Delivery delays — Shipping times can be expected to vary slightly at the best of times, and unexpected events like natural disasters or strikes can further delay delivery.
- 2 Sync your stock with your supply delivery cycle. To do so, you will need to adjust your standard deviation of demand to match the lead time period. Multiply your standard deviation of demand (calculated in Part I, step 4) by the square root of the lead time.
- This means if you calculated standard deviation on a monthly basis, and lead time was 2 months, you would multiply the standard deviation by the square root of two.
- Using our previous example, this means: 11 x √2 = 15.56.
- Make sure to convert lead time to the same unit of time measure that you used to determine standard deviation of demand. For example, if you calculated standard deviation on a monthly basis and lead time was 10 days, you would want to convert lead time to,329 months — i.e.10 divided by 30.42 (the average days in a month).
- 3 Put it all together. We can combine formulas to determine safety stock based on demand with lead time factored in as follows:
- Safety stock = Z-score x √lead time x standard deviation of demand
- In our example, to avoid stockouts 95% of the time, you would thus need 1.65 (the Z-score) x √2 (lead time) x 11 (standard deviation of demand) = 25.67 units of safety stock.
- 4 Calculate safety stock differently if lead time is the primary variable. If demand is constant but lead time variable, then you will need to calculate safety stock using the standard deviation of lead time. In this case, the formula will be:
- Safety stock = Z-score x standard deviation of lead time x average demand
- For example, if aiming for a Z-score of 1.65, with average demand constant at 20 units per month, and lead times over a six month period being 2, 1.5, 2.3, 1.9, 2.1, and 2.8 months, then Safety Stock = 1.65 x,43 x 20 = 14.3 units.
- 5 Use a third equation to account for independent variation in both lead time and demand. If lead time and demand vary independently of one another (i.e. the factors leading to variance are different for each), then safety stock is the Z-score multiplied by the square root of the sum of the squares of demand and supply variability, or:
- Safety stock = Z-score x √
- In our example: safety stock = 1.65 x √ = 29.3 units.
- 6 Sum the calculations based on lead time and demand variability if the two factors vary dependently. That is, if the same factors impact lead time and demand variability, you will need to sum the individual safety stock calculations in order to assure yourself of adequate safety stock. In this case:
- Safety stock = (Z-score x √lead time x standard deviation of demand) + (Z-score x standard deviation of lead time x average demand)
- In our example: safety stock = 25.67 + 14.3 = 39.97 units.
- 1 Reduce the amount of safety stock you need to save money. Having too much stock on hand will increase inventory costs, so it is ideal to run a lean supply chain. Remember: the goal is not to prevent all stockouts, but to balance customer service goals and inventory costs.
- 2 Monitor your use of safety stock. Is the model performing as expected? If so, you should be using safety stock in about half of your supply cycles. If you are using safety stock less, you may be able to cut back on how much you hold.
- 3 Decrease variability in demand. Demand tends to vary more than lead time and has a much greater impact on the safety stock equation. Smoothing out demand variability will allow you to hold less safety stock. Demand can be shaped through adjusting price, lead time, or the content of the products being produced.
- 4 Work to reduce lead time. If lead time were zero, then you would need no safety stock, as product could be produced instantly upon demand. Of course, lead time can never be reduced to zero, but lowering it as much as possible is the best way to run a leaner business. This means both tightening your supply chains and your production processes.
- 5 Shift customer service targets. If a high level of customer service is not required — i.e. stockouts will not cause your business to lose customers — then you can adjust your Z-score downward to lower the amount of safety stock you need on hand.
- 6 Implement an order-expediting process. This process allows you to more rapidly produce or deliver goods in order to prevent stockouts. As a result, your company will not need to carry as much safety stock, which is particularly helpful when the stock in question costs a lot to produce, and thus costs more to carry in inventory.
- 7 Consider shifting to a make-to-order (MTO) or finish-to-order (FTO) production process. If your customers are willing to accept longer lead times, which is often the case for things they do not purchase regularly, then MTO will allow you to eliminate most safety stock, while FTO will allow for less differentiation in safety stock versus carrying finished inventory.
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- Be sure you understand the formula you are using and check to make sure it is working properly. If you go three or four months without dipping into safety stock, or conversely if you have two or more stockouts in a six month period, then you should re-evaluate the amount of safety stock you carry.
- There are several other methods to calculate safety stock, but all are based upon using standard deviations to determine demand and lead time variability.
Advertisement Article Summary X To calculate your safety stock, look at the historic demand for a specific item. If you know you have a large order for that item coming in, you should factor that in on top of your average demand. Since demand can fluctuate dramatically, you should use a spreadsheet to calculate the standard deviation in demand over a period of time.