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What is Safety Stock and Re-order Point? How to calculate it?

Safety Stock: An extra stock kept by the company to minimize the risk of stock-out. It acts as a cover against supplier lead time, production lead time, customer demand etc of uncertain activities which affects the stock level. It helps to continue the production activities. It is also known as buffer stock.

Formula:

Safety stock = (Maximum daily usage*Maximum lead time) – (Average daily usage*Average lead time)
OR
Safety Stock = Z*standard deviation lead time* average daily demand

Where,
Z = service level

Stock-out: It is a situation when stocks are not available for sale or at the time of requirement.

Lead Time: It is a time gap between issuing the purchase order and receiving the ordered product.

Reason to maintain Safety Stock:
·         It is good to maintain safety stock when the lead time (time between issuing the purchase order and receiving the ordered product) will increase.
·         When the demand of the products fluctuate very frequently.
·         When there is a gap between forecasting the stock level and actual level.
·         It helps to fulfil the demand of a product at the right time.
·         It helps the company to maintain the sales level.

Example: Company ABC Ltd. Maintain a safety stock to eliminate the stock out situation. Find out the safety stock quantity with the help of given data of expected inventory level and actual inventory level.

Month
Quantity  sold
Expected inventory level
Actual inventory level
 January
200
8
10
February
360
8
16
March
120
8
7
April
100
8
3
May
420
8
6
June
600
8
8
  The service level is 84% i.e. 00.99

Solution:

Month
Quantity  sold
Expected average inventory level
Actual inventory level
Variance
 January
200
8
10
+2
February
360
8
16
+8
March
120
8
7
-1
April
100
8
3
-5
May
420
8
20
+12
June
600
8
8
0
Total
1, 800


16

Now, divide the total variance with number of order that is 6.
16 / 6 = 2.66
Add 2.66 (standard deviation) with expected average inventory level that is 8 to find out the lead time.
Average Lead time= 2.66+8
= 10.66
Average daily unit sold = 1, 800 / 30
= 60 units
Safety stock = Z*standard deviation lead time* average daily demand
= 00.99*10.66*60
= 633.204 or 633 units

Re-order Point: It is a point where company ordered the stocks again before the stocks kept in warehouse are finished. It is a good method to eliminate the stock-out situation and maintain the goodwill in the market. Re-order quantity is a minimum amount of products available in a warehouse when company again issues the purchasing order.

Formula:
Re-order point = (Average daily unit sale*delivering lead time) + safety stock

Example: A chocolate Company XYZ wants to know the re-order point to replenish the inventory for maintaining the sales level and goodwill of the company. The Company sell 100, 60,110 and 510 chocolates in 4 months. The maximum chocolate sell by the company is 200. The production time taken by manufacturer is  2 days it includes the packaging time also and the chocolates delivered to supplier in 4 days and the supplier deliver to the company in 3 days. It is assumed that the maximum lead time is 11 days. Find out the re-order point and safety stock.

Solution:  Average daily usage of unit = (100+60+110+510) / 4
= 195 units
Average lead time = 2+4+3 = 9 days
Safety stock = (Maximum daily usage*Maximum lead time) – (Average daily usage*Average lead time)
= (200 * 11) – (195 * 9)
= 2, 200 – 1, 755
= 445 units
Re-order point = = (Average daily unit sale*delivering lead time) + safety stock
= (195*9) + 445
= 1, 755 + 445
= 2, 200 units



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