Safety Stock - Example Calculation

Example Calculation

A commonly used approach calculates the safety stock based on the following factors:

• Demand rate: the amount of items consumed by customers, on average, per unit time.
• Lead time: the delay between the time the reorder point (inventory level which initiates an order) is reached and renewed availability.
• Service level: the desired probability that a chosen level of safety stock will not lead to a stockout. Naturally, when the desired service level is increased, the required safety stock increases as well.
• Forecast error: an estimate of how far actual demand may be from forecasted demand. Expressed as the standard deviation of demand.

The calculation:

1. Z: NORMSINV(Service level), for example Z=1.64 for a 95% service level

2. Safety stock: {Z*SQRT(Avg. Lead Time * Standard Deviation of Demand^2 + Avg. Demand^2 * Standard Deviation of Lead Time^2)}

3. Re-order Point (ROP): Average Lead Time*Average Demand + Z*SQRT(Avg. Lead Time * Standard Deviation of Demand^2 + Avg. Demand^2 * Standard Deviation of Lead Time^2)

Notes:

• Italicized section of the ROP formula is safety stock
• The first term in the ROP formula (Average Lead time*Average Demand) is the average demand during the lead time.
• The second (italicized) term is the term that allows for the safety stock. In other words, the optimal safety stock level.
• The sqrt(avgleadtime) is needed to scale the standard deviation of the demand period to the length of the lead time period.