Safety stock and reordering
Your safety stock and reorder point help you determine how low your stock can get before you need to order more.
If you don’t reorder when you reach your reorder point, you’re likely to run out of stock. Safety stock contributes to your reorder point by accounting for things like: delays in shipping, sudden increases in demand, and inventory loss due to damage or theft (also called “shrink”).
You can do a lot of math and forecasting to figure out a very precise safety stock and calculate demand multipliers, but that won’t be the focus of this article. What we’ll provide here is a quick, helpful formula for calculating safety stock, and an explanation of what goes into it so that you can get right back to managing your small business.
Safety stock as part of your reorder point
Here’s a quick recap of the reorder point formula, but expanded to show how we propose calculating safety stock.
You’d use this formula on a per-product basis, because most products will have differences in their lead time and daily demand. This formula uses a few variables, so let’s break them down.
Lead-time demand is the amount of demand (in units sold) that builds up before your next purchase order comes in to replenish your stock. We’re calculating lead-time demand based on delivery lead time * average daily unit sales.
The delivery lead time is the average time in days that it takes for new stock to arrive after submitting an order. As a more concrete example, if the fictional Archon Optical regularly orders the Interceptor sunglasses on Monday and the shipment arrives on Friday, then the lead time is four calendar days.
Forecasting demand is one of the areas where you can do a lot more math to figure out seasonal demand changes, but most businesses end up looking at the past few weeks or months. For our purposes, we’re simplifying this to average daily unit sales during a sales quarter, to provide a general average demand for that product. We’ve chosen sales quarters because they can match overall sales seasons, but you can shorten or lengthen this period of time to better suit your product’s demand.
Calculating average daily unit sales is the total unit sales of a product in that quarter, divided by the number of days in that timeframe. So if Interceptor sunglasses sold 180 pieces over the past 90 days, then that’s an average of 2 Interceptor units sold per day.
If we take lead time * average daily unit sales, we arrive at our lead-time demand for Interceptor sunglasses:
Safety stock as a percentage of lead-time demand
When we previously wrote about the reorder point and safety stock, we had suggested the most common approach: estimating a safety stock level based on current demand. This involved multiplying the average daily sales by a specific time period, like 14 days (two weeks). That’s an extra two weeks worth of stock based on the amount usually sold. But this timeframe is really based on gut feel, and doesn’t account for how long it takes to get more product (lead time).
Another way you can calculate the safety stock is to express it as a percentage of your lead-time demand, which is based on your sales and also factors in how long it take to receive more product. Reordering products is always a balancing act: order too much and your space and cash are tied up in products, but order too little and you’ll risk missing potential sales.
Our recommendation is to initially set safety stock at 50 percent of the lead-time demand; if you’re still running out of stock or reordering too often, you can increase that to 60 or 70 percent. If you’re regularly overstocked, you can lower safety stock to 30 or 40 percent of lead-time demand.
Given lead-time demand of 8 units, the safety stock for Interceptor sunglasses would be 4 units (50% of 8 units).
Finally, since our reorder point formula is lead-time demand (8 units) + safety stock (4 units), this leaves us with a reorder point of 12 units for the Interceptor sunglasses.
That safety stock of 4 units helps to safeguard against completely running out of stock in the event of the glasses arriving broken, or a shipment running a little late.
This isn’t a catch-all formula for ensuring you’ll never run out of stock, but it should help to keep from running out of stock the majority of the time.
Reorder easily with inFlow Cloud
Once you’ve calculated your safety stock and lead-time demand, you can enter your reorder point straight into inFlow Cloud for Windows. inFlow will automatically add your products to a Reorder Stock screen whenever your quantities start to run low.
Interested? Click here try inFlow Cloud for free!