/ MEDIA STATEMENT / This content is not written by Creamer Media, but is a supplied media statement.
Most manufacturers carry an inventory of stock that consists of cycle stock, which will be used based on demand forecasts. And they might also have excess inventory on hand to ensure that they won’t run out of stock if there is more demand than they anticipated.
Sometimes referred to as “just-in-case” inventory, this extra stock serves as a buffer against unexpected demand, slow delivery from suppliers, or other unforeseen issues. This so-called “safety stock” can be a double-edged sword since it can contribute to customer satisfaction but also create cash flow problems for the business. We recommend using MRP systems, to keep inventory under control.
Here are a few things to consider about keeping extra stock just in case you need it:
What is cycle stock inventory?
A company’s cycle stock inventory is the portion that’s available to meet the anticipated demand in a certain period. Because businesses fulfill a customer’s order from the cycle stock inventory, this type of inventory is crucial to meeting the customers’ needs.
Cycle stock inventory is the part of the inventory that retailers and manufacturers use to meet their regular sales orders or forecasts. As part of a company’s total on-hand inventory, cycle stock is that portion that replaces older stock items as they are sold or used.
Cycle stock inventory plays an important role in a business’s accounting records. As goods are sold, cycle stock inventory is replenished, and the stock that is sold creates cash flow from the revenue it generates and from the customers’ payments. Cycle stock inventory is also part of a company’s total assets on the balance sheet.
What is safety stock?
Safety stock is the inventory that companies carry in case actual demand exceeds their sales forecast. Since just-in-time inventory systems came into being, businesses have been ordering smaller quantities of materials more frequently. The idea is that these companies can eliminate stock rooms or warehouses by only buying what they need for the next day or two. Some companies even have inventory delivered several times each day.
Unfortunately, not every company can take advantage of the just-in-time inventory system. There may be issues with the proximity of the suppliers or with materials that are difficult to ship. In those cases, a safety inventory system, in which they purchase more stock than they anticipate selling, guarantees that they will be able to meet any unexpected orders.
Why is Safety Stock Important?
Safety stock can be critical in manufacturing, not only to meet unforeseen demand but also to stay on target when machining errors or engineering changes require extra material. If a company cannot get replacement material quickly, expensive setups might have to be torn down to keep workers busy on another project. Safety stock could save considerable time and money in these cases.
Because it’s nearly impossible to predict with certainty how much stock a company will need and how much is available at any given time, the primary advantage of safety stock is that it helps to ensure sufficient materials are available for production or products for the customer.
Businesses can try to make accurate forecasts, but in many industries, demand is a variable that’s affected by:
- Seasonal effects
- Unexpected or “rush” work
- New customers coming onboard
- Old customers leaving
Also, it can be difficult to rely on an expected level of materials since suppliers often have problems meeting demand requirements and might not always be able to make timely deliveries. With all these uncertainties, sometimes it makes sense to have a reserve inventory (safety stock), so a company can get through any problems they’re having with either demand or supply.
How can companies calculate safety stock?
If a company has its history of purchase and sales orders, safety stock calculation is not all that complicated. Here is the safety stock formula, which is sometimes called the “inventory equation”:
Safety stock = (Maximum daily usage x Maximum lead time in days) – (Average daily usage x Average lead time in days).
Here’s an example to help understand the safety stock calculation:
A manufacturer sells pipe fittings to the United States Navy. On average, it takes around 30 days (average lead time in days) to get fittings made and shipped. The Navy uses about 200 fittings each day during normal maintenance operations (average daily usage), but the number could increase to 300 per day during building projects (maximum daily usage). Sometimes, however, the manufacturer gets large orders from the private sector and the lead times can increase to 45 days (maximum lead time in days).
By using the safety stock equation, the optimal stocking level would be:
(300 x 45) - (200 x 30) = 7,500
The manufacturer would need to keep about 7,500 fittings in inventory as safety stock. The safety stock formula should help the manufacturer to withstand the fluctuations in demand and lead time.
But there is a downside to keeping safety stock
While keeping an amount of inventory in reserve allows a company to ride out any difficulties with demand or supply, it does come at a cost. It can be expensive to hold reserve inventory, and the more safety stock a business holds, the more expensive it becomes.
Here are some of these costs:
- Renting storage space
- Wages for warehouse workers
- Security costs
- The costs of stock that become dated or obsolete
Some estimates indicate that holding inventory is between 20% and 40% of the cost of the stocked material. And these are ongoing expenses, so businesses are faced with deciding between safety against demand and supply changes and reducing inventory costs.
Manufacturing software could be the answer
Companies can enhance demand forecasts with inventory software solutions. The software uses historical data and considers factors such as the lifecycle of the product, seasonal fluctuations, and projected trends, to come up with accurate cycle stock levels.
These inventory solutions, available at reasonable costs through manufacturing software such as Enterprise Resource Planning (ERP) or Manufacturing Resource Planning (MRP) systems, can track and calculate inventory levels and minimize the need for carrying safety stock. When companies consider the substantial costs of keeping excess inventory, they find that this software is typically a worthwhile investment.
This infographic about the top 7 mistakes to avoid when searching for ERP / MRP / Manufacturing software might help you on your software search.