October 17, 2006
Volume 2 Issue 83

Calculating The Right Amount of Safety Stock…Part 2

   In last weeks Issue, Issue 82, we discussed how to calculate safety stock using your reorder point and a predetermined percentage of the average number sold during the lead time. We found out that although this method will work it has some flaws when you get to extreme measures like: products with long but very reliable lead times and with fairly consistent amount sold or products with very short lead times and significant variations in amount sold. In this week’s issue we will be explaining how to calculate safety stock when looking at the difference between your products forecasted and the actual past sales and lead times. It can be very easily defined as: The greater the difference between your forecasted number and your actual number the more safety stock you will need for that item. We then will take those numbers and tack a customer service level number to them and then depending on your desired customer service level is the amount or safety stock you should carry.  

   Before we can calculate any numbers we need some historical numbers to use as a basis for our calculations. To get accurate numbers it is suggested that you use some where between 3-6 months of sales data and the last 3 stocking receipts as a basis for lead time. Let’s take the hams that we used in Issue 82 to see an example of how this works.

   We first need to get some historical information on the hams. We will be using the products monthly number this time instead of using the daily number as we did in previous issues.

  As you can see from the graph we now can see exactly how off our forecasted numbers were. After you find this historical data you then need to find the average difference between all the months.

NOTE: In this calculation you do not want to include any months that have a negative difference (your actual sales was below your forecasted sales). Safety Stock is used to protect against shortages. We do not want to add more safety stock when we will end up with extra stock anyway.

   Now that we have calculated that you have an average difference of 8 pieces per month we now have to find the difference between your forecasted lead time and actual lead time. In calculating this amount you will need to look at the last 3 stock receipts for that product. You really should not go back any further than 3 receipts because their could have been a lot of different problems that could have occurred to increase a lead time and in turn misrepresent your lead time average.

   As we did with the sales data you then have to find the average lead time difference and again remember that you do not want to include any negative numbers. A negative number will indicate that the product came in before the forecasted lead time and again safety stock is a way to protect against shortages. You usually will not be short if an item comes in early.

Now that we have our average difference of sales per month as 8 pieces and our average lead time difference of 3 days we can calculate the total safety stock for the item in any month. The first number you need to calculate is how many pieces you are expected to sell per day. Let’s say for example that in May our forecasted sales per day are 7 pieces. You then multiply that by your average lead time difference number that we already calculated to find how many pieces of product you would sell when your inventory is late to come in:

7 Pieces Per Day Forecasted Sales in May x 3 Days (Average Lead Time Difference) = 21 Pieces Safety Stock

 The final step to calculating your safety stock is taking your forecasted sales in average lead time period and adding your average difference in sales:

       21 Pieces Sold (inventory late) + 8 Pieces (Average difference in sales) = 29 Pieces Safety Stock

After all of these calculations are done you can safely say that you will need an 29 pieces of safety stock on hand to protect you from being out of stock. Now, we said have said before that safety stock is done to help customer service. There is a very simple way, put forth by John Schreibfeder, of making your safety stock be directly related to the customer service level you want to achieve. Your customer service level is defined as the % of line items for stocked products shipped by the promise date.  According to John, that % is connected to a “Deviation Multiple” that is multiplied to your safety stock level. Here is a graph that John put together for different levels of customer service.

Basically what the graph says is that, for example, if you want achieve a 95% customer service level you should multiply your safety stock by 2. So let’s say that we want to achieve a 97% customer service level with our hams. You multiply our safety stock of 29 by 3 and your new safety stock is 87 pieces.

29 Pieces Safety Stock x 3 (Deviation multiple for 97% customer service level) = 87 pieces

There is one warning that must be understood with using the customer service level model. The higher you want your customer service level the more stock you have to carry, so your carrying cost will be higher.  You need to decide what the best is for your company and how much money you are willing to spend.

This way of calculating safety stock is more involved that the way described in Issue 82. But it reflects the variations in the market conditions and therefore better predicts if a particular product needs more or less safety stock. Even better is if your computer system calculates when to reorder your stock, you won’t have to worry about performing and calculations at all. In next weeks issue we will be discussing how computer software calculates safety stock. 

Using The Right Amount Of Safety Stock Will Save You Money On Out Of Stocks

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