Question

Why might a firm keep a safety stock? What effect is it likely to have on carrying cost of inventory?

Short answer

The safety stock helps an organization against the risk of loss of sales, and the increase in safety stock increases the carrying cost of inventory.

Step-by-step solution

Reason for keeping safety stock

An organization should maintain safety stock to ensure that they have enough stock at a given time which will protect it against the risk of losing prospective sales which will affect the organization’s income. The safety stock will ensure that the organization is able to meet all the deliveries even when there is an unforeseeable delay like equipment breakdown, production delay, etc.

Impact of safety stock on carrying cost

The safety stock will result in an increase in the carrying cost of inventory. If an organization keeps a large safety stock, then it will lead to high carrying costs, and even small safety stock will result in a small increase in the inventory carrying cost.