Sunday, August 17, 2008

Safety stock and effective inventory management

Theoretically, it should be easy to determine when to reorder a stocked item from a supplier. If you know that customers will order ten pieces of the product each day, and you know that it will take seven days to get the shipment from the vendor, you should reorder the product when there are seventy pieces on the shelf.
This quantity is appropriately called the "order point." But the order point formula contains one more element: safety stock. Safety stock provides protection against running out of stock during the time it takes to replenish inventory. Why is this protection necessary?
* Demand is a prediction based on past history, trend factor(s), and/or known future usage of a product. The item's actual usage will probably be more or less than this quantity. Safety stock is needed for those occasions when actual usage exceeds forecasted demand. It is "insurance" to help ensure that you can fulfill customer requests for a product during the time necessary to replenish inventory.
* The anticipated lead time is also a prediction, usually based on the lead times from the last several stock receipts. Sometimes the actual lead time will be greater than what was projected. Safety stock provides protection from stock outs when the time it takes to receive a replenishment shipment exceeds the projected lead time.
The safety stock quantity allows you to satisfy customer demand for the product until the replenishment shipment arrives from the supplier
How Much Safety Stock Do You Need?
When a replenishment shipment arrives, the available quantity is usually somewhere in the shaded area of the graph. Notice that the safety stock quantity is in the middle of the shaded area. Half the time you will use some or all of the safety stock before the replenishment shipment arrives. The other 50% of stock receipts will arrive before you use any of the safety stock. On average, the full safety stock quantity is always on the shelf when the replenishment shipment arrives. It is, on average, "non-moving" inventory.

A distributor puts inventory in her warehouse to sell it to customers. Profits from these sales are necessary to pay the distributor's expenses and provide a return on her investment. With this thought in mind, it seems as though it would not be a good idea for a distributor to intentionally have non-moving inventory in stock.

On the other hand, keep in mind the goal of effective inventory management:"Effective inventory management allows a distributor to meet or exceed his (or her) customers' expectations of product availability with the amount of each item that will maximize the distributor's net profits."
Safety stock is, in reality, an expense of doing business. But it is necessary to ensure good customer service. To maximize profits, we must carefully control all expenses, including safety stock. Therefore, we want to achieve our customer service goals with the least possible amount of safety stock.

1 comment:

Peter Phillips said...

redThis post is very informative and it will be helpful to many. For any handicraft business setting up the pricing and managing the inventory is very important and this can be done by craft software.