Safety stock

What it means

Safety stock is a reserve of goods or materials above normal consumption that protects a company from running out while it waits for a delivery. It covers two uncertainties: the supplier may be late, and customers may buy more than expected.

The calculation starts from average consumption, how much it fluctuates and the length and reliability of the lead time. The more demand varies and the less reliable the supplier, the larger the buffer needed. The company also chooses what service level it wants, for example having the item in stock 95 % of the time.

Safety stock plus expected consumption during the lead time gives the reorder point, the stock level at which the next delivery must be ordered. Together with the economic order quantity it determines how inventory moves over time.

How it works in practice

There is no point holding the same safety stock for every item. ABC analysis and XYZ analysis show which items are important and steady, where a small buffer is enough, and which are unpredictable, where a buffer is expensive and it is better to produce or order to demand.

Financially, safety stock is tied-up working capital: money sitting in the warehouse instead of the bank, plus the cost of storage, insurance and obsolescence risk. When suppliers change or after experiencing disruptions we therefore recommend recalculating it rather than simply increasing it by eye.

In the accounts safety stock is not a separate line; it is part of inventory in the balance sheet. It does, however, show up in the inventory turnover ratio and at stocktaking, where items that have not moved for a long time are assessed for an impairment allowance.

What to watch out for

A common mistake is setting safety stock once and never updating it. When a product’s sales fall, the original buffer turns into slow-moving stock that the company eventually sells at a discount or writes off.

The opposite mistake is removing the buffer altogether to cut inventory and moving to just in time without reliable suppliers. The first late delivery then halts sales or production, and the storage savings are quickly spent on express freight and lost customers.