Oct 25, 2018
Do you know how to calculate Safety Stock?
Managing your company’s supply chain requires some tricky calculations. But all too often, planners and management will rely more on more intuitive understandings of how to plan their inventory instead of doing the math. For example, here’s a common intuition that we hear all the time from purchasers and planners:
“Management says we have to carry three months of stock because our lead time is three months.”
This makes sense, doesn’t it? If it takes three months to get the inventory into your warehouse, you have to carry at least three months of inventory or you will run out before the next order arrives. Right?
You can actually run a much leaner warehouse than you might think. What if you can order every two weeks? That means that on average, you’ll have six orders “on the water” at any given time. But it also means that you will only ever carry two weeks of inventory at any given time.
You might say that it’s a very risky choice because if any one of those six “on the water” orders gets delayed, you’ll run out of inventory. And you’re absolutely right. That’s why it’s best practice to keep a certain amount of Safety Stock for exactly that risk.
But you would have to keep Safety Stock, even if you carried the full three months of inventory. If that shipment came in late, you would have been in trouble in any case.
Be careful, though: you’ll have to carry more days of Safety Stock for more frequent orders, because there are increased risks. But in the end even carrying another week of Safety Stock, combined with your two weeks of Cycle Stock, you only have to carry three weeks (or 22%) of the inventory of the three months (plus seven days of Safety Stock).
So you can actually run a pretty lean warehouse, even if your supplier is three months away from delivering any orders. By doing the calculations, you can formulate a workable plan. Better still, your CFO will love you for reducing the capital tied up in inventory, and your stock turns will climb up dramatically.
Let’s apply this lesson to your future planning needs. Consider calculating the proper Safety Stock level for all of your important items. How much time would it take you to put together those calculations? Would you know how to adjust the calculations if there are changes to your supply chain? Do you use any type of inventory management software and does it help you keep your inventory levels properly balanced?
Getting your Safety Stock right – having just enough to mitigate risks and keep fill rates up, but not so much as to bury your working capital in excess stock – is a key part of a planner’s daily job. Managing this type of dynamic environment and making calculations using data from your ERP isn’t impossible, but it’s incredibly time consuming and error prone when done manually.
If your levels are out of whack, or you spend too much time trying to figure out your Safety Stock levels, you need to consider using a better tool to do the job.