A company’s on-hand inventory stock generally consists of both safety stock and cycle stock inventory. The cycle stock is the inventory expected to be sold based on demand forecasts, while safety stock is extra or buffer stock to meet excess demand, to protect against delayed shipments from your suppliers, or guard against unforeseen problems such as natural disasters.
Safety stock explained
Safety stock is typically used when the actual demand exceeds a sales forecast, or if production output is less than planned. In manufacturing, it is important to have raw materials and work-in-progress components on hand to reduce lost labour time. In retail, safety stock is primarily held to avoid the risk of stock-outs and the potential for lost sales and customer dissatisfaction.
Seasonal supply and demand fluctuations may require companies to hold safety stock at certain times throughout their business cycles. Likewise, any geographic remoteness or the distance of a business from its suppliers could reduce the frequency of deliveries or necessitate longer lead times. Safety stock levels should be driven by analytical data that incorporates such variables as lead times, service levels and fluctuations in supply and/or demand.
Why is Safety Stock Important?
The principal goal of safety stock is to ensure that there is sufficient product available to the customer.
Safety stock is necessary because in most industries it is impossible to predict with 100% certainty the amount of stock that will be needed, and the amount of stock available, to supply customers over a given period of time. Demand is variable to at least some degree, affected by seasonal effects, one-off ‘shock’ events, new customers being engaged, or old customers leaving. The best that a business can do is to make forecasts that are as accurate as possible, but ultimately these are just predictions. It is also impossible to fully guarantee an expected level of supply, as suppliers have their own problems in meeting demand requirements, and thus may not always deliver what is needed on time. Due to this uncertainty, having an amount of inventory in reserve can allow a business to weather any difficulties with demand or supply, and keep the customer satisfied.
Despite the clear need for some degree of safety, it must be emphasised that safety stock comes at a cost. There are many costs to holding inventory, and the more safety stock a business has, the larger these costs will be. Some examples of these costs are the cost of renting storage space, warehouse staff wages, security costs, and the costs of stock becoming dated or obsolete. When added up these costs are significant: the general consensus is that the total cost of holding inventory is between 20-40% of the cost of the stocked merchandise. This is not a one-off outlay, but something that a business must pay every year. Because of this high cost of holding inventory, a business faces a trade-off between safety against demand and supply changes, and minimising inventory costs.
Faced with this balancing of cost and safety, there are several points a business should consider in determining safety stock levels, regardless of the method used to do this. Firstly, customer satisfaction, while hard to quantify, has a large impact on the success of a business. In the modern world, one unhappy customer for a retail business can mean a large reduction in potential customers, especially if that customer spreads their dissatisfaction through social media.
In non-retail businesses that only supply a few key clients, relationships are everything, and one or two instances of failure to supply could cost a business a client that may make up a large fraction of their revenue. Second, different industries will face different levels of fluctuation in both demand and supply, and any method of determining safety stock should reflect these differences: the greater the potential fluctuation, the greater the level of safety stock should be.
Finally, businesses should be aware that specialised inventory software, which can track and calculate safety stock levels, is now available at a fraction of the cost that it used to be. This software can accommodate the various factors involved with supply and demand variability when calculating safety stock levels, and can provide constantly updated data without owners having to take the time to do this manually. Given the difficult trade-off that has to be made, this software is often a worthwhile investment.
Cycle stock inventory explained
Cycle stock inventory, also referred to as working stock, is the portion of inventory available to meet normal demand during a given period. It is one of the more important chunks of overall inventory because it is the amount of inventory needed to meet customer needs. Your cycle stock inventory is the first place a customer’s order will be fulfilled from.
Cycle stock inventory is the level of inventory a retailer or manufacturer uses for their standard business cycle to satisfy regular sales orders or sales forecasts. Part of the business’s total on-hand inventory stock, cycle stock replaces older stock items as they are sold.
Companies can improve demand forecasts by implementing inventory software solutions that use historic data and consider factors such as product lifecycle, seasonality and projected trends, to determine accurate cycle stock levels.
Cycle stock inventory also serves an important role in a company’s accounting records. As a business sells and replenishes its cycle stock inventory, the stock creates cash flow from the revenue it generates and for the payments made. Cycle stock inventory also accounts for a company’s total assets on its balance sheet.
Calculating inventory stock
Cycle stock inventory is equal to the total amount of on-hand inventory minus any goods held as safety stock.
Calculating safety stock is more challenging than calculating adequate quantities of cycle stock. While cycle stock inventory is held to meet most of the projected sales, safety stock is held to cover demand fluctuations and it involves many variables, including unexpected changes in supply or delivery lead times.
In just-in-time manufacturing or for small businesses that don’t hold buffer stock, the cycle stock inventory is the available on-hand inventory, excluding inventory stock that has been paid for but not yet delivered.
Cycle stock inventory represents the quantity of inventory that a business can sell and replenish according to plan. It does not include safety stock which is held to maintain sales in times of sustained high demand. In comparison, safety stock is held to prevent stockouts that can become costly when they equate to lost sales and poor inventory management.
For optimum inventory control, both cycle stock and safety stock can be combined to determine accurate stock levels for each stock unit, based on current market factors.
Businesses should undertake regular inventory reviews and incorporate overall inventory control practices into the broader business, sales and operational planning. This will help to ensure organisational alignment and long-term sustainability.
Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.