Costs Associated with Inventory. Following are the four major costs associated with inventory:
1) Purchasing Cost:
This is the normal cost of inventory. It includes the purchase price of the product bought from outside and the production costs in case of the goods are produced in-house. This inventory may be valued in a variety of ways including variable pricing and constant pricing.
2) Ordering Cost/Set-up Cost:
Ordering costs are also known as procurement costs and are incurred every time a firm places an order to replenish the inventory. It includes processing costs, inspection costs, and transportation costs.
Set-up costs, on the other hand, are associated with the goods which are produced by the firm itself. It includes production schedule costs as well as the cost of the resources used for production.
3) Carrying Cost:
These costs are also known as storage costs or holding costs. These are the costs which are incurred for storing inventory. These are influenced by the quantity of inventory as well as by the length of time, e.g., heating and lighting. storeman’s salary and transportation costs, warehouse costs, insurance costs, etc. Carrying costs may be expressed in a variety of ways such as a percentage of the inventory value or as rate per unit.
4) Stock-Out Cost:
This is the implied cost incurred by a firm when it cannot serve a customer due to a shortage of goods. This occurs due to production delays, strikes, or natural calamities. The firm loses its goodwill when it is not able to serve an order. It may result in loss of sales or backorders which means that the sales are not completely lost but are delayed for some time.
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