Why safety stock is needed:
- Stock to protect against variation in Supply or demand (only in case demand is bigger that the forecast)
- Its purpose is to prevent disruptions in manufacturing or customer deliveries
- Stock maintained to provide a required customer service level.
- Safety stock can be maintained on finished goods level, but also at component / raw material level.
Safety Stock Calculation – Theory
- One of the most widely accepted methods of calculating safety stock uses the statistical model of Standard Deviations of a Normal Distribution of numbers to determine probability
- This statistical tool has proven to be very effective in determining optimal safety stock levels in a variety of environments, instead of using “best guess” of “trail & error”
- The basis for this calculation is standardized, however, its successful implementation generally requires customization of the formula and inputs to meet the specific characteristics of our business.
- k = Factor of required Service Level
- σ = Standard deviation of forecast error
- T = Inventory review period
- L= Supplier Lead Time
- x2 = Mean Demand (= demand per period)
- Var(L) = Variance of supplier leadtime
list of the variables and the terminology used in safety stock models:
Term used in statistical analysis to describe a distribution of numbers in which the probability of an occurrence, if graphed, would follow the form of a bell shaped curve
Normal distribution – Example
- Weight of an egg: 50g
- Averaged out of a Chicken farm over one week
- Variance: 25 g
- Results: most of the eggs are around 50 g
Used to describe the spread of the distribution of numbers. Standard deviation is calculated by the following steps:
1) determine the mean (average) of a set of numbers
2) determine the difference of each number and the mean
3) square each difference
4) calculate the average of the squares
5) calculate the square root of the average
In safety stock calculations, the forecast quantity is often used instead of the mean in determining standard deviation.
Standard Deviation – Example
Lead time is the amount of time from the point at which you determine the need to order to the point at which the inventory is on hand and available for use. It should include supplier or manufacturing lead time, time to initiate the purchase order or work order including approval steps, time to notify the supplier, and the time to process through receiving and any inspection operations.
Lead time demand
Forecasted demand during the lead time period. For example, if your forecasted demand is 100 units per day and your lead time is 12 days your lead time demand would be 1200 units.
Consistent forecasts are also an essential part of the safety stock calculation. If you don’t use a formal forecast, you can use average demand instead.
Desired service level expressed as a percentage.
Factor used as a multiplier with the Standard Deviation to calculate a specific quantity to meet the specified service level.