Safety stock in inventory management and control
Safety stock is the inventory ordered or carried in stock in excess of what the expected demand will be. Its purpose is to absorb any internal or external supply and demand shocks to the supply chain. It can also help mask or cover other problems present in the supply chain temporarily such as excessive downtime and maintenance issues.
Safety stock can be determined in many ways. Some businesses or operations determine safety stock levels by past history of events, a certain number of days of demand, as a percentage of periodic order sizes, or through a probabilistic model.
If operations or the supply chain is fairly reliable or not as complex, historical safety stock levels or a certain number of days as buffer stock is as reliable measure to establish the required safety stock. If demand is unstable and the supply chain is complex and relies on several third party providers then it could be beneficial to use a probabilistic model in determining the required safety stock.
Safety stock Probability model
Calculating the required safety stock using a simple probability model can be easily done in Microsoft excel, on a statistics calculator or a cumulative distribution table.
The data needed before performing the calculation is:
-The average demand per time period.
-The standard deviation of demand per time period
-The assumption that demand is normally distributed
Calculating the safety stock level:
1-Decide to what level of probability you would like not to run out of stock.
For example if it is required that 95% of the time stock doesn't run out, this also means that only 5% of the time stock will actually run out.
2- Using Microsoft excel enter the following formula into a blank cell:
Where p is the probability of not running out, in this case 95% or 0.95
3- The number of standard deviations will be displayed required to achieve this probability level. In this example this would evaluate to 1.6448 standard deviations
4-Multiply the number obtained in step 4, the number of standard deviations, times the standard deviation of demand obtained during the initial data collection.
This is a simple but effective safety stock calculation model which can also be integrated into other inventory management models such as EOQ or any other multiple order or single order inventory models. It can also be found in some inventory software packages.
When safety stock is present in inventory warehouses and it is rarely used or there is an excess safety stock holding, it can incur large inventory and holding costs that can outweigh the advantages of having it in the first place. It is important that most of this stock is also correctly rotated and managed in order to reduce write-offs and obsolesce.
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