Safety Stock Calculation

Safety stock is an additional quantity of inventory kept to prevent stockouts due to demand fluctuations and lead time variability. It ensures that there is enough stock available even when demand exceeds forecasts or when suppliers delay deliveries.

The formula for calculating safety stock is:

Safety Stock = Z * sqrt((σd² * LT) + (D² * σLT²))

Where:

• Z = Service level factor (e.g., 1.645 for a 95% service level)
• σd = Standard deviation of demand
• LT = Average lead time
• D = Average daily demand
• σLT = Standard deviation of lead time

The formula accounts for:

• Fluctuations in daily demand (σd)
• Uncertainty in lead time (σLT)
• Required confidence level (Z-factor)

Example of Safety Stock Calculation

Let's assume the following values:

• Z = 1.645 (for a 95% service level)
• σd = 50 (standard deviation of demand)
• LT = 10 days (average lead time)
• D = 200 (average daily demand)
• σLT = 3 (standard deviation of lead time)

Now, applying the formula:

Safety Stock = Z * sqrt((σd² * LT) + (D² * σLT²))

= 1.645 * sqrt((50² * 10) + (200² * 3²))

= 1.645 * sqrt((2500 * 10) + (40000 * 9))

= 1.645 * sqrt(25000 + 360000)

= 1.645 * sqrt(385000)

= 1.645 * 620.16

= 1019.76

Final Safety Stock = 1020 units (rounded)

Interpretation:
This means the company should keep at least 1020 units of safety stock to maintain a 95% service level. This ensures they can meet unexpected demand fluctuations and lead time variations without running out of stock.

By adjusting the service level factor (Z), businesses can balance the trade-off between inventory holding costs and stockout risks.