4 types of inventory

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COST ASSOCIATED WITH INVENTORIES

The effective management of inventory involves a trade off between having too little and too much inventory. In achieving this trade off, the Finance Manager should realize that costs may be closely related. To examine inventory from the cost side, five categories of costs can be identified of which three are direct costs that are immediately connected to buying and holding goods and the last two are indirect costs which are losses of revenues that vary with differing inventory management decisions.

The five costs of holding inventories are:

1. Material Costs of Inventory:
These are the costs of purchasing the goods including transportation and handling costs.

2. Ordering Costs:
Any manufacturing organization has to purchase materials. In that event, the ordering costs refer to the costs associated with the preparation of purchase requisition by the user department, preparation of purchase order and follow-up measures taken by the purchase department, transportation of materials ordered for, inspection and handling at the warehouse for storing. At times even demurrage charges for not lifting the goods in time are included as part of ordering costs. Read more about ordering costs

3. Carrying Costs:
These are the expenses of storing goods. Once the goods have been accepted, they become part of the firm's inventories. These costs include insurance, rent/depreciation of warehouse, salaries of storekeeper, his assistants and security personnel, financing cost of money locked-up in inventories, obsolescence, spoilage and taxes.
Read more about carrying inventory costs

4. Cost of funds tied up with Inventory:
Whenever a firm commits its resources to inventory, it is using funds that otherwise might be available for other purposes. The firm has lost the use of funds for other profit making purposes. This is its opportunity cost. Whatever the source of funds inventory has a cost in terms of financial resources. Excess inventory represents an unnecessary cost.

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The Costs Associated with Inventories