Stock is based on an estimation of demand. In order to absorb the error of the estimation we use “Safety Stock”. Its actual use is to protect the company from an unexpected and unwanted stock out. In its simplest form, safety stock is calculated as a percentage of the Base Stock. A small example is given bellow:
Demand per day= 100 units
Projected Lead Time= 10 working days
Demand During Lead Time = 10 x 100 = 1000 units
Thus the Base Stock should be at least 1000 units.
Now consider a variation in our estimation of 30%. This means that the demand per day could rise up to 130 or more. In order to protect us from a stock out we add a Safety Stock of 30%,
thus 1000 x 30% = 300 units.
Stock = Base Stock + Safety Stock = 1000 + 300 = 1300 units
Now remember that this is the old and conventional approach of safety stock. Newer methods take under account the service level and also employ statistics to calculate the variation of the demand and the variation of the lead time.
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