In many practical situations, in most of the cases neither the demand is fixed nor is the lead time, that is, the time interval between placing an order and final replenishment. In other words, the demand for the store item and lead time seldom remains constant from month to month over a year’s duration. To face these uncertainties, an extra stock is maintained to meet the demand as and when they arise.
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The extra stock so maintained is termed as buffer or safety stock. Hence, production inventory consists of two things: Working inventory and safety stock. Safety stock has little or no turnover. It is, thus, in the nature of fixed assets as the investment tied up in it is committed for a long period of time.
ADVERTISEMENTS:
The need of safety stock arises because of the combination of two factors resulting in uncertainty about consumption rate and delivery time which may lead to exhaustation of stock before a replenishment stock arrives.
Hence, the only way out to avoid such stock outs is to keep, in some cases additional stock in hand which can be drawn up in cases of emergency. Safety stocks should not be counted in determining when to place an order for replenishment.
In case if the rate of consumption remain constant, the suppliers delivery time do not vary, there are no rejection during inspection, it would have been a simple matter to place order whenever stock on hand reaches the quantity equal to lead time usage.
A hundred percent efficient service level can be easily attained in such circumstances, when there will be no occasion for stock-outs as new supplies will always be arriving before the existing stock runs out.
ADVERTISEMENTS:
The fig. 6.1 illustrates an ideal inventory situation in which the usage rate for a given material is constant. Further, it has been assumed that material is always ordered at the proper order time and that the shipment or delivery arrives consistently in the same length of time.
In practice, however, the two factors of usage and lead time seldom remain constant from month to month over a year’s duration. A safety stock of material is, therefore, maintained as insurance against stock depletion when increased usage on unusually long delivery time causes the low point to fall below the minimum. Fig.6.2 show inventory position as against normal consumption, normal delivery, excess consumption and delayed delivery.
NC = Normal Consumption.
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ND = Normal Delivery.
EC = Excess Consumption.
DD = Delayed Delivery.
The shaded area in the diagram shows the situation of shortage and stock-outs and consequently had there been no safety stock, production would have stopped.
So, the proper inventory control system should pay adequate attention to the provision of safety stock so as to avoid:
(i) Shortages and stock-outs which are both costly and embarrassing.
(ii) Excesses to tie up unnecessary capital.
(iii) Problem of shortage and handling costs.
(iv) Obsolescence losses.
(v) Overstocking leads to higher consumption, partly unconscious and partly even conscious.
Factor to be Considered While Determining Safety Stock:
The management should take into consideration the following factors while fixing safety stock levels in an organisation:
1. Nature of the store items
2. Stock out costs
3. Lead time
4. Number of suppliers
5. Determination of safety stock.
1. Nature of the stores items:
Whether the stores meant for manufacturing purposes are indigenously or locally procured or likely to be imported, will affect the fixation of safety stocks in an organisation. Again the possibilities of changes in materials’ demand and their effect on manufacturing activity will also be considered while determining safety stock level.
2. Stock out costs:
Stock out costs exercise considerable influence on the holding of stock in an organisation. These include loss of sales if there were no stock of finished goods, cost of production, stoppage of material and work-in-progress, stocks and costs associated with placing urgent orders for replenishment.
3. Lead time:
The emergency reserve stock level depends on the procurement time of stores. It is to be taken into account as to how much time will be taken from placing an order upto the receiving of delivery of the materials. If the lead time is zero, there is no need of any buffer stock. If the lead time is low, then a small safety stock is required but if the lead time is significant then the concern will have to maintain higher buffer level to avoid stock out.
4. Number of suppliers:
The choice of the right source of supplier is very important from the point of view of getting the materials in time and of desired quality and required quantity at a right price. Trusted and tested supplies should be searched out. A list of tried suppliers should be in hand so as to avoid non-availability of stores timely. So, the various sources of availability of substitutes should be pinpointed and it will certainly lead to regularization of manufacturing activity in the concern.
5. Determination of safety stock:
Uncertainty in demand is also one of the factor which affects. The determination of safety stocks.