Safety Stock: What Is It and Why Is It Important for Retailers?

While the pandemic-induced global supply chain crisis has wreaked havoc on many industries, the retail industry has been particularly hard hit. Retailers are having a difficult time meeting customer demand due to delays in inventory shipments. 

In times like these, when you don’t know for certain when new inventory will arrive, it’s critical to have safety stock on hand. But how do you determine how much of a buffer you’ll need? That’s where the safety stock formula comes into play.

In this guide to safety stock, you’ll learn:

• What safety stock is
• Why it’s important for retailers to have safety stock
• Reasons to not have safety stock
• How to calculate safety stock
• How inventory control systems simplify retail inventory management

What is safety stock?

Safety stock is extra inventory retailers keep on hand as a buffer. Retailers may decide to have safety stock for a number of reasons, including inventory shrinkage, selling inventory faster than expected, shipping delays, and general supply chain interruptions.

Check out our inventory management guide for other important inventory concepts you should know like inventory turnover ratio, among others. 

Why is safety stock important for retailers?

You can think of safety stock as a type of insurance for retailers. It helps ensure you always have what you need to sell. When you have extra inventory on hand, you can avoid stockouts, which are frustrating for both your operations and your customers.

For retailers, stockouts mean they can’t meet customer demand because they don’t have enough products to sell. Ultimately, stockouts result in an opportunity loss, because the business is missing out on revenue it could have been generating had it had more inventory. 

While you could turn stockouts into a waitlist to recoup lost revenue, that involves a lot of extra administrative work, which could have been avoided if you’d had safety stock.

For customers, stockouts are frustrating because they can’t get what they want, when they want it. If your store can’t meet a customer’s needs, and another store can, you may lose that customer’s business for good. 

Reasons to not have safety stock

You don’t need to have safety stock on hand for all of your products. Instead of making a blanket rule that you need buffers for every item in your inventory, it’s better to be strategic about it. Here are some reasons why having safety stock may not be the best option for your business.

First, when you pour money into inventory, your cash is stuck in that inventory until you sell it. If you’ve invested too much in safety stock, you may not have enough cash on hand to pay for other things that come up, like an unexpected repair or a business expansion opportunity.

Second, retail inventory management is time consuming and costly. The more inventory you have, the more you have to spend on holding costs, like storage units or warehouse space and related labor expenses.

You may not need safety stock for products that always sell at a consistent rate. Instead, invest in extra units of items that sell in unpredictable surges from time to time.

Finally, you may not need safety stock if your suppliers are consistent with how many units they can produce, and how quickly they can deliver it. Additionally, having the ability to acquire the same product from several suppliers means you can have a back up plan and don’t need extra inventory. 

How to calculate safety stock

Now let’s take a look at how to calculate safety stock. The formula for safety stock, or figuring out how many extra units you should have on hand just in case, is:

Units of Safety Stock = (Maximum Daily Usage * Maximum Lead Time) – (Average Daily Usage * Average Lead Time)

Let’s take a closer look at what each of the components of this formula means. 

Maximum daily usage is the maximum number of units of the product in question you would ever sell in a day. You can use historical point-of-sale (POS) system data to figure this out. If you’re just getting started with your business, look at daily sales of the item, then add a buffer to be safe.

Maximum lead time is the longest it could take for a shipment of that product to reach you from the supplier. Review past data to find the longest it has ever taken for that vendor to fulfill an order and deliver it to you.

Average daily usage simply means how many units of a product you sell each day, on average. You can also find this figure in your POS reports. If your POS doesn’t offer that data point, simply divide the number of units you sell in a typical month by 30, the number of days in a month.

Finally, average lead time is how long it usually takes for a new shipment of that product to reach you. Don’t just go by the lead time that your vendor estimates. Instead, look at your records to see how long past shipments have actually taken.

By plugging those figures into the safety stock formula, you’ll learn how many units of inventory you need to keep on hand in case you go through your stock faster than expected and/or it takes longer than usual for the new shipment to arrive.

Safety stock calculation example

Let’s put the safety stock formula into practice by doing a sample calculation. Let’s say you run a home improvement store. Summer is around the corner, and you want to make sure you have enough safety stock for patio umbrellas, one of your best-selling products, so you can meet demand for this seasonal favorite.

First, you need to find your maximum daily usage, so you look at sales reports from the last three summers. By examining this data, you see that the most patio umbrellas you have ever sold in one day is 15. 

Maximum Daily Usage = 15 umbrellas per day

Next, you need to identify your maximum lead time. You review inventory logs from the past few years and find that two summers ago, due to the global supply chain crisis, you once had to wait three weeks, or 21 days, to receive a new shipment of patio umbrellas.

Maximum Lead Time = 21 days

By revisiting your patio umbrella sales reports, you find that on average, you sell five umbrellas each day.

Average Daily Usage = 5 umbrellas per day

And, by revisiting your inventory logs, you see that a new shipment of umbrellas typically takes seven days to arrive.

Average Lead Time = 7 days

Now let’s input those figures into the safety stock formula.

Units of Safety Stock = (Maximum Daily Usage * Maximum Lead Time) – (Average Daily Usage * Average Lead Time)

Units of Safety Stock = (15*21) – (5*7) = 315 – 35 = 280

According to the calculation, you need to keep an extra 280 patio umbrellas in stock to prevent a stockout due to shipment delays or an unexpected uptick in sales. 

How inventory control systems simplify retail inventory management

Keeping track of inventory, reordering new stock at the right time, and making sure you always have extra inventory on hand is a challenging part of running a retail business. However, when you have inventory management software, you can manage stock more easily. Here’s how.

An inventory control system helps you know what you have in stock at all times. With inventory software, you can track inventory levels and SKUs across multiple locations, whether you’re in your store, at home, or on the go.

An inventory system can also alert you to when it’s time to reorder stock. After calculating and setting a reorder point, you can get automatic notifications when you’re low in stock and need to replenish it to avoid a stockout. 

Reordering becomes easier with an inventory control system. With built-in purchase orders and integrated vendor catalogs, you can order directly from your POS system. You can even manage purchasing from multiple vendors and for numerous locations with master orders from Lightspeed POS. 

Inventory systems also give you access to powerful data, which can help you make informed business and purchasing decisions. For example, you can customize reorder points so you always know when you need to restock. You can also use negative inventory reports to keep an eye on which items you need to replenish safety stock for. With an inventory control system, you can also understand margins and costs more easily with built-in reports.

Inventory control systems streamline running a store and free you up to do things that only you can do for your business. 

Prepare for the unexpected with safety stock

The global supply chain crisis has made demand from customers skyrocket and lead times for new shipments slow down. By keeping extra inventory in stock, you can make sure your store always meets customer demand. Calculate safety stock for any products you think are vulnerable to demand surges or fulfillment delays. Then, buffer your inventory by always keeping extra stock around.

An inventory control system like Lightspeed POS can help you manage stock levels with ease. Watch a demo today.