Balancing Safety Stock to Maximize Cash Flow

By maintaining adequate safety stock, businesses can ensure that the supply chain runs smoothly despite stocking delays and temporary outages.

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In 2021, stockouts resulted in $82 billion in lost revenue for U.S. retailers in the CPG industry. For businesses across all industries, revenue loss from stockouts can also negatively impact customer relationships when they decide to shop elsewhere or never return. As businesses navigate fluctuations in consumer demand, volatile economic conditions, and supply chain disruptions, it’s important to consider safety stock as part of an inventory management strategy.

Safety stock is extra inventory that a business keeps on hand to protect against uncertainties such as unexpected demand, supplier delays, and financial constraints. While safety stock is a valuable tool to combat stockouts, too much excess stock can negatively impact cash flow because it ties up capital and resources.

Therefore, it’s important for businesses to carefully balance the need for safety stock with the costs and benefits of maintaining it. Here’s how:

Benefits of Safety Stock in Scenario Planning

Safety stock can be valuable in unpredictable circumstances. Supply chain challenges such as supplier issues, transportation delays, or even natural disasters can disrupt inventory. A sufficient level of safety stock helps protect against these disruptions and ensures inventory availability to meet customer demand. By maintaining adequate safety stock, businesses can ensure that the supply chain runs smoothly despite stocking delays and temporary outages.

Another scenario where safety stock can be beneficial is fluctuations in seasonal customer demands. Retailers may experience higher demand during the holiday season and while businesses often forecast for these seasonal surges, demand may still be higher than initially anticipated. Safety stock helps provide sufficient inventory during these periods to meet demand and avoid losing competitive sales due to stockouts.

Finally, safety stock can be an easy remedy to sudden changes in customer behavior. It can ensure inventory readiness if a business experiences an unexpected surge in demand due to factors such as sudden shifts in customer trends, panic buying or a competitor's departure. This helps provide businesses with breathing room to replenish stock while meeting increased demand.

Safety stock is also one of the best ways to preserve customer satisfaction and loyalty. When customers can rely on a business to always have what they need in stock, they will likely keep coming back and provide valuable word-of-mouth advertising that stimulates business growth.

Finding the Right Balance of Safety Stock

Safety stock planning is about more than just having a few extra units available. Inventory managers can leverage safety stock formulas to identify the amount of inventory needed to protect against different demand scenarios, while also considering the costs and benefits of holding different levels of inventory.

A basic safety stock calculation evaluates: (maximum daily usage multiplied by maximum lead time) minus (average daily usage multiplied by average lead time). Inventory managers can further optimize safety stock calculations by incorporating critical factors such as lead time, order frequency, and demand variability.

When calculating optimal safety stock levels, enterprise resource planning (ERP) systems can play a valuable role in providing centralized visibility into all aspects of the business including sales data, current inventory, production timelines and supply chain operations. Advanced ERP systems may also offer analytics capabilities to improve forecasting, optimize inventory management, and reduce the possibility of excess safety stock. By leveraging these solutions for greater control over inventory and supply chain management, businesses can maximize sales, minimize disruptions and drive profits.

Evaluating Cash Flow Risks

Maintaining a sufficient level of safety stock can help businesses minimize potential stockouts and improve its ability to meet customer demand, but it also requires overhead expenses. As inventory managers consider safety stock strategies, it’s important to prioritize positive cash flow and consider potential risks.

Businesses must evaluate the costs associated with shipping and storing safety stock supplies. Overstock can also lead to increased risk of inventory becoming obsolete or spoilage of perishable goods. Inventory managers should consider a variety of factors including the nature of its products or services, the level of demand uncertainty and the costs and benefits of maintaining different levels of safety stock.

However, it’s also important to recognize how a lack of inventory can impact business expenses. With stockouts and shortages, businesses may face unexpected costs including premium fees for expedited production and shipping in addition to human capital for added administrative and warehouse responsibilities for replenishment.

Safety stock is a powerful shield against stockouts, but it's not an antidote for inventory issues. To optimize cash flow and help ensure future growth, businesses must analyze demand patterns, lead times and other business and economic factors to determine where safety stock makes sense and the appropriate levels of investment.

A Successful Stocking Strategy is Not Static

Too often, safety stock levels go unchecked and forecasting formulas are no longer reflective of daily usage or demand figures. In some cases, inventory requirements change frequently. To solve for this, inventory managers should analyze sales trends, market conditions, and supply chain efficiency regularly and adjust safety stock orders as necessary. This will also help create a more accurate analysis of safety stock impacts on liquid cash flow.

By maintaining constant inventory and sales visibility, businesses can adjust safety stock strategies and ensure they don’t have too much backup inventory or too little of something that is selling rapidly. Running low on stock is sometimes unavoidable, but proper preparation can help avoid business disruption and customer dissatisfaction.