Safety Stock is the inventory held in a process as a buffer against demand and supply variations. Demand variations are generally the result of variation is actual customer demand, but can also be due to inefficiencies in the transmission of information within the company and batch operations. Supply variation can be driven by variation in lead time from outside vendors, or variation in production cycle time for internal processes.
Example: when do you fill up your gas tank in the car? When it's half full? A quarter full? Or when the low-fuel warning light turns on? You may not realize it, but you've "set" your safety stock policy based on a few key factors: your tolerance for risk (stock outs), the availability of replenishments (how far to the next gas station), and the size of your tank (the cycle time of your inventory).
Safety Stock sizing is very important, and is not something that can be set once and forgotten. Too little safety stock will result in frequent stock outages and damage to the customer, while too much safety stock will increase inventory holding and management costs, as well as increased risk of damage or obsolescence. The basic formula for sizing safety stocks is: Safety Stock = Service Level X Standard Deviation of Demand X SQRT(Lead Time of Replenishment) While this formula provides a reasonable starting sizing for safety stock, it is important to note that safety stock levels should be regularly monitored and adjusted based on the real-life performance of the process. Additional factors can also help manage and reduce safety stock levels, such as the availability of substitutes, the number of usage points in the company for the item, etc...
http://en.wikipedia.org/wiki/Safety_stock - Reasons, Formulae and Examples