Safety stock is the minimum inventory level to be maintained at any given time to ensure zero stock-out situations, thereby mitigating any likely loss of sales and customers. The buffer covers up for instances when delivery of fresh stock gets delayed or when demand for a particular item is higher than normal. In other words, it takes care of uncertain market demand and supply scenarios. Setting up and maintaining safety stock inventory for a particular product category is an important aspect of inventory management.
Generally, safety stock units aren’t used for regular business transactions. They are set aside only to counter abnormal demand or business scenarios. When safety stock has been tapped into, the business would have most certainly put in a fresh stock reorder. Safety stock should be set optimally and is used along with lead demand to arrive at an inventory’s reorder point. If set too low, safety stock may not evade a stock-out scenario. And if set too high, holding the stock would become a significant expense.
Calculating Safety Stock
To calculate an item’s safety stock, its maximum per day usage and lead time, and average per day usage and lead time should be considered. Let’s understand this with an example.
An American firm imports leather jackets from a seller based in Italy. It takes close to 30 days (average lead time) for the jackets to reach America from Italy. The American seller sells three leather jackets per day on average (average usage per day). The sales could increase on holidays or weekend by up to 10 per day (maximum usage per day). At times, the goods’ delivery could be delayed due to unforeseen circumstances by 40 days (maximum lead time).
The U.S. seller’s safety stock level should therefore be (maximum usage per day x maximum lead time) – (average usage per day x average lead time) or (10 x 40) – (3 x 30) = 310. Safety stock levels could go up during season and can be reduced when the peak demand period is over. Some companies may arrive at safety stock numbers by adding up the average monthly sales of a product for the last three or more months. Certain firms may even consider total sales spanning years.