SAFETY INVENTORY: CHARACTERISTICS, HOW IT IS CALCULATED, EXAMPLE - DUDAS - 2025

The safety stock is the additional quantity of an item that a company keeps stored in inventory to reduce the risk that the article will be exhausted. It is used by logistics specialists to describe an additional inventory level that is held to lessen the risk of a raw material shortage caused by supply and demand uncertainties.

It acts as a reserve in case sales are higher than planned and / or the company's supplier cannot deliver additional units at the expected time.

Source: pixabay.com

Proper levels of safety inventory allow business operations to proceed according to plans. A safety inventory is maintained when there is uncertainty in demand, supply, or manufacturing performance, serving as insurance against stock-outs.

There are additional carrying costs associated with the safety inventory. However, the maintenance cost could be less than the cost of not delivering a customer's order on time or having to stop a production line.

characteristics

-Amount of safety inventory

Too much safety inventory can result in high inventory maintenance costs. Also, products that are stored for too long can spoil, expire, or break during the storage process.

On the other hand, too little safety inventory can lead to lost sales and a higher rate of customer churn.

As a result, finding the right balance between too much and too little safety inventory is essential.

-Inventory policy

Newspaper

In this policy, the inventory level is periodically verified and at that time an order is placed to satisfy the expected demand until the next order.

In this case, the safety inventory is calculated considering the risks of supply and demand instability during this period, plus the replenishment time.

Continuous

In this policy the inventory level is continuously controlled and orders are placed at any time. In this case, the safety inventory is calculated considering only the risk of replenishment time.

This policy can lead to a smaller safety inventory, in addition to ensuring higher levels of service.

However, it is much more difficult to implement, which is why most organizations using traditional planning tools opt for the periodic inventory policy.

-Importance

Compensate for forecast inaccuracies

The less accurate the forecast, the more safety inventory will be required to ensure a given level of service.

You may have a constant demand for a certain item, but you can sell more than expected in a month. With safety inventory, you don't sacrifice the level of customer service.

Protect against unforeseen variations

If a supplier closes unexpectedly for a week or if there is an interruption to an order in transit, safety inventory does not waste time fulfilling customer orders.

Supply chains are getting longer and globalized, with more and more instances that could cause serious disruptions.

How is it calculated?

Calculating the safety inventory doesn't really require a lot of science. You only need to have the purchase history and the sales order history available. Once you have it, use this simple safety inventory formula, also known as the "inventory equation":

Safety Inventory = (Maximum Daily Usage x Maximum Delivery Time in Days) - (Average Daily Usage x Average Delivery Time in Days).

First, the maximum daily use of the material is multiplied by the maximum delivery time in days. Then the average daily use of the material is multiplied by the average delivery time in days.

Finally, to determine the safety inventory, the difference between the two previous multiplications is calculated.

Calculation example

A New York-based Russian souvenir shop sells Russian tea sets. On average, it takes around 40 days (average delivery time) to obtain and ship the tea sets from Russia to New York.

The company sells about 15 sets per day (average daily use), but on good days sales can go up to 25 (maximum daily use). Unfortunately, in Russia there are snow storms, resulting in delivery times of up to 55 days (maximum delivery time).

Using the safety inventory equation above your optimal inventory level formula would be: (25 × 55) - (15 × 40) = 775.

The Russian souvenir shop would need to have about 775 tea sets as safety inventory at all times.

Example

Suppose there is a US-based business called Shawls M, which sells hand-woven cashmere shawls, produced by artisans in Mongolia.

On average, it takes about 55 days (average delivery time) to get the shawls from Mongolia to America. Shawls M sells about 10 shawls per day (average use). On weekends and holidays they can sell up to 14 shawls (maximum use).

Unfortunately, Mongolia has sandstorms, which results in delivery times of up to 60 days (maximum delivery time). So, for Shawls M the safety inventory levels would be: (14 × 60) - (10 × 55) = 290.

This means that Chales M would need to have around 290 units of safety inventory at all times, especially during the spring when sandstorms abound.

Conclusions

With an additional 290 units in stock in safety inventory, selling about 78 shawls a week (10 per weekday plus 14 per day on weekends), Shawls M will have enough inventory for just over three and a half weeks.

The safety inventory is there to protect Chales M against all fluctuations in demand and delivery time. It will protect the company from all unexpected events.

Depending on what is being sold, you may need to pay attention to the seasons. For example, an increase in demand can be observed at Christmas.

Perhaps shawls tend to sell quite a bit in December, being excellent Christmas gifts, tripling the demand. Therefore, by December, Chales M must ensure that it has enough safety inventory to satisfy this expected tripling of demand.

However, once the peak season is over, the level of the safety inventory should begin to be reduced.

References

1. Tradegecko (2019). What is safety inventory and how do you calculate it? Taken from: tradegecko.com.
2. Wikipedia, the free encyclopedia (2019). Safety inventory. Taken from: en.wikipedia.org.
3. Harold Averkamp (2019). What is safety inventory? Accounting Coach. Taken from: accountingcoach.com.
4. Maggie Bendis (2019). 4 Reasons for Carrying Safety Inventory Inventory. Eazy Inventory. Taken from: eazyinventario.com.
5. How to calculate safety inventory? Safety inventory formula and calculation. Virto Commerce. Taken from: virtocommerce.com.