Safety stock is a term in inventory management that stands for an amount of product ordered to account for a variety in consumer demand. When inventory is ordered, it is important to minimize the difference between the demand for your product and the amount of product you have, both in stock and on order. Therefore, an equation can be used to determine what a reasonable amount of safety stock should be ordered in addition to the quantity needed to maintain a base stock level. Below are instructions to calculate the safety stock on paper once you know all your variables, and a link to a safety stock calculator in Microsoft Excel.
How to Calculate a Standard Loss Function
Before you can calculate your safety stock, you must determine the standard loss function. Subtract the desired fill rate from 1.
Multiply this sum by the demand, which is the amount of items that will be consumed or bought.
Multiply this sum by the time between orders. Write this sum down and set aside.
Add the time between orders (from Step 3) with the lead time. This is the time between your reorder decision and renewed availability.
Take this sum to the 1/2 power.
Multiply this sum by the standard deviation. See the Resources section below for steps to calculate the standard deviation.
Divide the sum from Step 3 by the sum from Step 6. This is the standard loss function.
How to Calculate Safety Stock
Refer to a lookup table and determine what the variable "z" for the standard loss function is.
Take the sum from Step 5 in the previous section (which is the time between orders plus the lead replenishment time taken to the 1/2 power) and multiply it by the standard deviation.
Multiply the sum with variable "z" found in Step 1.
This sum is the safety stock.
There are multiple factors that can make calculating safety stock difficult. Suppliers have unforeseen difficulties that will affect lead time. Consumers demand will fluctuate.