Inventory management balances two risks: (1) stockout (lost sales, unhappy customers) vs (2) overstock (cash tied up, obsolescence risk). Safety stock protects against demand variability and supply disruptions.
Safety Stock
Safety Stock = Z × σ_demand × √Lead Time
Z = service level factor (1.65 for 95%), σ = standard deviation of demand.
Reorder Point
Reorder Point = (Average Daily Demand × Lead Time) + Safety Stock
Key Takeaways
- Safety stock protects against demand/supply variability.
- Higher service level = more safety stock = more cash tied up.
- Long lead times require more safety stock.
- Reorder point triggers procurement before stockout.