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Costs Associated with Inventory Management

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



Service Companies

This is all about various Costs Associated with Inventory Management.

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