Free Calculators

Safety Stock Formula:
Safety Stock = ( Maximum daily use × Maximum lead time ) − ( Average daily use × Average lead time )

Where:

• Maximum daily use is the highest amount of inventory typically used in one day.
• Maximum lead time is the longest lead time it might take to receive inventory.
• Average daily use is the typical daily usage of inventory.
• Average lead time is the usual time it takes to receive an order.

Explanation of the Formula:

Maximum daily use × Maximum lead time: This represents the worst-case scenario, where you experience the highest demand and the longest delay in receiving stock. It gives the upper bound of the inventory you might need to cover this scenario.

Average daily use × Average lead time: This part represents your expected or typical usage, considering normal daily demand and normal lead times.

The difference between these two values is the safety stock required to handle any fluctuations in demand or lead time that exceed the typical average. Essentially, it helps to account for unexpected spikes in usage or longer-than-normal delays in replenishment.

Why Use This Formula?

Planning for uncertainty: This formula is particularly useful when you have fluctuations in both demand and lead time. It accounts for the variability of these factors by setting aside extra inventory to cover extreme cases.

Simple and practical: Unlike more complex models involving standard deviations and z-scores, this approach is straightforward and can be applied when the data is available (maximum/average usage and lead time).

Example:
Let’s say:

• Maximum daily use is 100 units.
• Maximum lead time is 5 days.
• Average daily use is 80 units.
• Average lead time is 4 days.

Inventory turnover is a key metric that measures how efficiently a company sells and replaces its inventory during a specific period. It indicates how often a company’s inventory is sold and replaced over a given timeframe (usually a year). A higher inventory turnover ratio suggests that a company is selling its inventory quickly, while a lower ratio could indicate overstocking or slower sales.

Formula for Inventory Turnover:

$$\text{Inventory Turnover} = \frac{\text{Cost of Goods Sold (COGS)}}{\text{Average Inventory}}$$

Where Average Inventory is calculated as:

$$\text{Average Inventory}=\frac{\text{Beginning Inventory Value}+\text{Final Inventory Value}}{2}$$

 

Breaking it Down:

• Cost of Goods Sold (COGS): This is the direct cost of producing or purchasing the goods that were sold during the period. It typically includes the cost of materials and labor directly tied to production.
• Beginning Inventory Value: The value of the inventory at the start of the period.
• Purchases Made: The total value of inventory bought during the period.
• Final Inventory Value: The value of the inventory at the end of the period.

Step-by-Step Explanation:

1. Calculate Average Inventory: To determine the average inventory, you take the sum of the beginning inventory and final inventory values and divide by 2. This helps smooth out fluctuations in inventory levels over time, providing a more consistent measure of the amount of inventory on hand during the period.

    

   $$\text{Average Inventory}=\frac{\text{Beginning Inventory}+\text{Final Inventory}}{\mathrm{2<span\; style="font-family:\; Georgia,\; \text{'}Times\; New\; Roman\text{'},\; \text{'}Bitstream\; Charter\text{'},\; Times,\; serif;"></span>}}$$

    

2. Inventory Turnover: The inventory turnover ratio is calculated by dividing the Cost of Goods Sold (COGS) by the Average Inventory.

    

   $$\text{Inventory Turnover}=\frac{\text{COGS}}{\text{Average Inventory<span style="font-family: Georgia, 'Times New Roman', 'Bitstream Charter', Times, serif;"></span>}}$$

    

COGS = Beginning Inventory + Purchases During the Period – Ending Inventory

Here’s how each part of the formula works:

1. Beginning Inventory: This is the value of the inventory that a business has at the start of the accounting period. It includes goods that were not sold during the previous period and are carried over into the new one.
2. Purchases During the Period: This refers to any inventory that was bought or produced during the current period. This could include raw materials, finished goods, or additional stock purchased for resale.
3. Ending Inventory: This is the value of the inventory that remains unsold at the end of the accounting period.

How the Formula Works:

The formula calculates the cost of the goods that were actually sold during the period. To break it down:

• You start with the inventory you had at the beginning of the period.
• You add any new purchases made throughout the period.
• Then, you subtract the value of the inventory you still have at the end of the period.

The difference between these amounts represents the Cost of Goods Sold (COGS), which is the total cost of the goods that were sold to customers during the period.

Example:

Let’s say:

• Beginning Inventory = $10,000
• Purchases During the Period = $15,000
• Ending Inventory = $8,000

Now, using the formula:

COGS = $10,000 + $15,000 – $8,000 = $17,000

This means the business’s cost of the goods sold during the period is $17,000.

This COGS is important for calculating gross profit and helps to understand the direct costs involved in producing or purchasing the products that were sold.