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Inventory Management: Safety Stock vs. Cycle Stock

By Alexandra Palmer

Inventory management is complex, involving multiple parties, SKUs, suppliers and producers, and can sometimes be driven by factors beyond the control of the purchasing or planning departments. Deciding how much inventory to carry is by no means a simple task; however, it is critical to free up cash and mitigate possible customer service risks. You can start by understanding what components can make up inventory levels.

Inventory levels can include both cycle stock and safety stock. Both components should be calculated on a per-SKU basis, and adjusted over time to optimize the cost of carrying against other risk factors (such as stock-outs).

Cycle stock is the amount of inventory that is planned to be used during a given period. The period is often defined as the time between orders (for raw materials), or the time between production cycles (for work in process and finished goods).

Safety stock can be thought of as buffer inventory; inventory that is not planned to be consumed but is held in case of emergency. Safety stock is typically dipped into if actual demand exceeds forecast, or if production output is less than planned. In the first case, the planned cycle stock would not be enough to satisfy the excess demand. In the latter case, the planned cycle stock may have been sufficient to satisfy demand; however, the organization was unable to procure or produce to plan. In both cases, in the absence of sufficient safety stock, the SKU would go on backorder. Safety stock is especially important in industries where customer service is a key success factor.

The best way to determine cycle stock levels is based on the forecast. In the absence of the forecast, historical figures can be used as a proxy, being careful to take any seasonality, product lifecycle factors, or upcoming trends into consideration.

Safety stock levels should be driven by a statistical formula that incorporates lead time, demand and/or supply fluctuations, and a service level factor.

Both cycle stock and safety stock can then be added together to determine the optimal inventory level for each SKU, based on current factors. Any SKU with inventory volumes above optimal can possibly be paired back, whilst any SKUs with inventory volumes below optimal might need to be increased. Any significant increases or decreases should be agreed to by the appropriate parties, acknowledging any associated risks.

Inventory management opportunities go well beyond defining current-state cycle and safety stocks; however, understanding these factors is the first step towards improvement. Installing frequent inventory review practices and incorporating inventory management into a broader Sales & Operations Planning process further helps to ensure organizational alignment and sustainable benefits.