What are the safety stocks in terms of working capital management ?

Safety stock is a buffer to meet unanticipated increase in usage. The usage of inventory cannot be perfectly forecast. The demand for inventory may fluctuate and delivery of inventory may also be delayed. In such a situation, the firm can face a problem of stock out, the stock out can prove costly by affecting the smooth working of the concern. To protect against the stock out arising out of usage fluctuations, firms usually maintain some margin of safety stocks. The basic problem is to determine the level of quantity of safety stocks. Two costs are involved in the determination of the stock i.e.: Opportunity cost of stock outs Carrying costs. The stock outs of raw material cause production disruption resulting in higher costs of production. Similarly, the stock outs of finished goods may result in the failure of the firm in competition as the firm cannot provide proper customer service. If a firm maintains low level of safety stock, frequent stock outs will occur resulting in larger opportunity costs. On the other hand, the larger quantities of safety stocks involve higher carrying costs.