There are various costs associated with Inventory Management that affects the overall process of materials management. We can describe all these types or classifications of costs involved in inventory with suitable examples. Generally, we categorize it into three types – Purchase cost, Ordering cost and carrying costs.
Costs Associated with Inventory Management
1. Purchase Costs
2. Ordering costs
3. Carrying cost
A. Direct Costs
i. Capital Costs
ii. Storage space costs
iii. Service Costs
iv. Risk costs
B. Indirect Costs
i. Business Risk
ii. Opportunity Costs
iii. Incremental increases in Infrastructure costs
4. Stock out cost
5. Warehousing cost
6. Damage, Pilferage (Stealing) and obsolescence cost
7. Exchange rate differentials
Explanation of these costs and related terms is given as below.
1. Purchase Costs
Nominal cost of inventory
Purchase price of the items or raw materials or
The production cost if produced within the organization
It may be constant or may vary based on variations in quantity
2. Ordering costs/Set up costs
Also known as procurement cost
Costs associated with the processing and chasing of the purchase order, transportation, quality inspection etc.
Set up cost: for production within organization
Costs to develop production schedule, resources etc.
3. Carrying Cost
Storage and maintenance etc.
A. Direct costs
1. Capital costs
Includes the costs of investments, interest on working capital, taxes on inventory paid, insurance costs and other costs associate with legal liabilities.
depends upon and varies with the decision of the management to manage inventory in house or through outsourced vendors and third party service providers.
Storage and maintenance etc.
2. Storage space costs
Includes storage requirements for all categories of inventories
An excess of stocks requires additional capacity
Storage space and inventory level are interrelated
Storage and maintenance etc.
3. Service costs
Volume related
Inventory insurance
Storage & Maintenance etc.
4. Risk Costs
Vary with the nature of the business
Obsolescence, Damage & Shrinkage
Related to the overall role of inventory within a logistics system
B. Indirect costs
i. Business Risk
Situation 1: A company carrying insufficient inventory – unable to meet & satisfy demand
Situation 2: Reverse – Satisfies demand but increases direct costs by increasing capital cost, Service costs, storage costs and risk costs.
Related to the overall role of inventory within a logistics system
ii. Opportunity costs
Range of investment alternatives
Lack of capital availability to invest in alternatives
Related to the overall role of inventory within a logistics system
iii. Incremental Increases in Infrastructure costs
Excess inventory can increase cost
Facilities
Transportation
Service Companies
This is all about various Costs Associated with Inventory Management.
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