What are Inventory Costs?


Costs associated with ordering too much (represented by carrying costs)

Costs associated with ordering too little (represented by ordering costs)

These costs are opposing costs, i.e., as one increases the other decreases

The sum of the two costs is the total stocking cost (TSC)

Carrying (or holding) costs: sum of all costs that are proportional to the amount of inventory physically on hand at any point in time

Cost of capital (opportunity cost)

Breakage, spoilage, deterioration, obsolescence, loss, insurance etc.

Physical storage, handling, book-keeping, refrigeration, utility etc.

Ordering cost: sum of all costs related to the amount of inventory that is ordered for replenishment

Fixed cost: incurred independently of the size of the order as long as it is not zero, e.g. book-keeping and paper work, mailing, etc., associated with the order

Variable cost: incurred on a per unit basis

Penalty cost (or stock out of shortage costs): cost of not having sufficient stock on hand to meet demand when it occurs

Loss of goodwill

Loss of profit

Extra costs of emergency measures

Delay cost (including book-keeping) in case of backorder

Set-up Costs –

When the part or component is being made in-house these may be called set-up costs which refer to the cost of preparing the production order, and any other costs associated with obtaining the materials, changing the production process or setting up equipment.

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