Question

Which of the following relationships hold correct for the safety stock of inventory?

• A. The greater the risk of running out of stock, the small the safety of stock
• B. The larger the opportunity cost of the funds invested inventory, the larger the safety stock
• C. The greater the uncertainty associated with forecasted demand, the higher the safety stock
• D. None of the options are correct

Hint:

Think of safety stock like an umbrella: the more erratic and unpredictable the weather forecast (high uncertainty), the larger the umbrella you need to carry (higher safety stock) to avoid getting wet (stockout)!

Answer 1

The Correct Option is C

Safety stock exists purely to absorb the unpredictable part of demand during the time it takes for a new order to arrive. If demand were always known exactly, no cushion would be needed at all. The less certain we are about how much will actually be sold during that lead time, the bigger a cushion we need to avoid running dry, so safety stock rises as forecast uncertainty rises, confirming option 3. The other statements do not hold up: a higher risk of stockout calls for more safety stock, not less as option 1 claims, and a higher opportunity cost of tied up capital pushes firms to hold less safety stock, not more as option 2 claims, since carrying extra stock now costs more in forgone returns.