Safety stock refers to the extra amount of inventories or materials that companies must maintain primarily to avoid a situation known as stockout. A stockout basically means running out of inventories and other supplies. Keeping extra stock reserves is a standard practice among companies involved in manufacturing, merchandising and logistics services.

Importance of Safety Stock

Having sufficient stock reserves is vital to ensure continued business operations, especially if demand for the company’s products has unexpectedly surged. However, apart from customer demand, there are other circumstances in which having extra inventories and supplies can protect against business disruptions. Logistical delays, broken down machinery, substandard quality of raw materials and even labor disputes can all interrupt a company’s supply chain. Maintaining extra levels of inventory can provide a buffer against the devastating effects of these events. In other words, having a safety stock allows a company to meet customer demands even if unforeseen events occur. There are a few ways to determine the level of extra stock reserves that you can use in your business.

Fixed Safety Stock

Fixed safety stock is the most basic method used in estimating the level of extra stock reserves. Here, you need to talk with the people involved in your day-to-day production processes. Based on their experience, they will have a firm grasp of how much extra inventories or materials your business needs to keep. Rather than rely on statistical calculations, your production manager can provide an estimated figure based on what actually works for your business. One advantage of using this method is that you can easily change the level of stock reserves to take into account seasonal customer demands or product phase-outs. On the downside, this method may prove inefficient for big companies with hundreds, if not thousands of items in their inventories.   

Time-Period Based Method

Under this method, safety stock is calculated based on the required number of inventory items or supplies needed for a particular period. Therefore, the number of items that are typically used or sold in a day will be multiplied by 7 or 30 to find out the required extra stock for a week or month, respectively. Basically, the reserve stock level is established using the predicted number of items needed for a week, month or even year. The starting point used in time-period based method can be determined using statistical analysis or actual demand and usage.

Percentage of Demand during Lead Time

Lead time is the period that passes from the moment that you place your order for inventory items or supplies to the moment that the goods arrive in your warehouse. This is a very crucial period in your supply chain because you could risk running out of stock while your orders are in transit. So, for many experts in logistics, it is just wise to calculate your safety stock as a percentage of the demand for your products or materials that typically occur during that time.

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