Inventory safety stock is described by the Chartered Institute of Management Accountants (CIMA) as “the role of ensuring that adequate items are held in stock levels to fulfill all needs without maintaining unreasonably large stockpiles.”
To put it simply, safety stock is an extra product kept in the warehouse to avoid running out of inventory. It acts as a buffer against demand changes.
You might also like
Article Content-
- How does Safety Stock work?
- Stock-Out Inventory
- Levels of quantity
- Management of just-in-time (JIT) inventories
- Control of Inventory Using Relative Classification
- Using Ratio Analysis
- Physical Regulations
- Conclusion
How does Safety Stock work?
Making a balance between adequate supply and surplus is the goal of safety inventory. To maintain a continuous manufacturing flow, the stock should be enough to satisfy production needs.
Insufficient stock results in a loss of income and goodwill and halting production. Contrarily, inventory needs money to buy, store, and maintain goods that run the danger of being out-of-date or stolen, among other things. So, let’s study the foundations of safety stock.
Stock-Out Inventory
A stockout happens when there needs to be more inventory to provide the customer. The organization incurs both monetary and non-monetary expenses due to the stock-out scenario.
A company loses reputational value, earnings, and overhead expenses due to running out of stock. Long-term financial loss could result from it, even if there were no short-term losses. This is when buffer stock’s importance in inventory management comes into play.
Different approaches to ensuring inventory management and stock safety might be used depending on the industry in which one works.
Levels of quantity
Between the lowest and highest levels is this level. It is there to ensure enough product in-store to handle both typical and unusual consumption conditions before the material purchased is delivered to the godown. It is, to put it simply, the point at which new orders should be issued to refill stock.
Management of just-in-time (JIT) inventories
JIT is a method of managing inventory that aims to have no inventory in shops. This method suggests that the material should only be bought when it is necessary for manufacturing. JIT is founded on two tenets:
1. Only make what is required.
2. Purchases should only be delivered when the customer requests them.
The “Demand pull” or “Pull through” systems of production are other names for it. In this method, the product manufacturing process begins as soon as the product order is received. The manufacturing process begins based on the demand, and the buying department is notified of the need for raw materials.
Control of Inventory Using Relative Classification
ABC Analysis
Depending on the investment, this system distributes power over various inventory items. According to the elements’ relative significance, they are often divided into three groups. These include their cost and how often they are replenished throughout time.
1. A Category
Due to their high pricing, strong demand, or both, this category, which makes up just around 10% of the total products handled by the retailers, requires a significant investment of roughly 70% of inventory value.
Items in this category may be efficiently regulated by following a routine approach that prevents overstocking and a lack of production-related supplies. Such a system creates budgets to plan its overall material needs. The maximum, minimum, and reorder levels are set in order to regulate the supply of supplies.
2. B Category
The things in this category are comparatively less important. They might make up 20% of all the materials that retailers handle. 20% of the total investment in inventory is the amount of investment that is necessary.
3. C Category
Although this group of goods only accounts for about 10% of the value of the store’s entire inventory, it accounts for almost 70% of all items handled by the establishment. There is no need to exercise continual control over these kinds of products.
Orders for products in this category may be made either every six months or once a year once consumption needs have been determined. In this instance, reducing ordering and processing expenses is the main goal.
Using Ratio Analysis
Input-Output Ratio
Analysis of the input-output ratio may be used to exercise inventory management. The ratio of materials used in production to their standard material content is known as the input-output ratio. By comparing actual consumption to standard consumption, this ratio analysis can determine whether the material is used favorably or unfavorably.
Inventory Turnover Ratio
Calculating inventory turnover ratios for various material items and comparing the turnover rates offers helpful advice for gauging inventory performance. A high inventory turnover ratio suggests that the product in question moves quickly. An insufficient turnover ratio indicates excessive investment and the locking up of working capital in inventories.
Physical Regulations
1. Two-Bin System
According to this system, each bin is divided into two sections:
a. The quantity equal to the required minimum stock or even the level for reordering, and
b. The second step is to preserve the remaining quantity.
From the bigger portion, materials are distributed. A new order is placed when a quantity from the smaller part of the bin becomes necessary.
2. Budgeting system establishment
To prevent overinvestment in inventories, one must know the number of lists needed at any given time. By closely examining production plans and the production cycle, it is possible to determine the precise number of different types of inventories that will be needed and when.
Based on this, the budget for the required inventories can be created. Such a budget will deter pointless inventory investment.
3. Continuous Stock Verification
Physical inventory verification is a crucial component of any reliable material control system. Physically examining each item in the inventory is part of the continuous stock-taking system. Though independent from the store and production staff, the internal audit department may perform the stock verification.
Without warning, stock verification is completed at the proper interval. For the system to be controlled effectively, the surprise is crucial.
Conclusion
Inventory management’s determination of safety stocks is essential. It will assist in lowering the possibility of stock-outs, resulting in inefficiency and disgruntled customers. We are still determining the actual future demand.
As a result, estimating future sales figures with accuracy is difficult. To reach the same conclusion, we employ various tools and techniques. To obtain the most accurate safety stock, modifications and adjustments to the actual results can be made based on one’s experience and understanding.
