Uncertainty and Safety Stocks

Usually requirements may not be certain and thus the firm holds safety stock to safeguard stock out cases.The safety stock guards against delays in receiving orders.  Nonetheless, carrying a safety stock has costs or it increases the average stock.

Demonstration

Consider illustration one and suppose that management desires to hold a minimum stock of 10 units or this stock is in hand at the starting of the year.

Required

a) Find out the re-order level

b) Find out the total relevant costs

Suggested solution

a) R       =       (DL/360) + S

Whereas:     S is the safety stock

                   =       ((2,000/360)  * 7) + 10

                   =       49 units

 b) The average inventory = ½Q + S

          TC     =       (½Q + S)Cn + D/QCo

                   =       [½(100) + 10]20 +  (2,000/100) * 50

                   =       1,200 + 1,000

                   =       Shs.2,200