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What is the Inventory cost structure

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Now we know that inventory has good reason to be held, we can look at the cost structure in order to understand the cost key triggers:

•    Inventory carrying costs
•    Inventory ordering costs
•    Inventory stockout costs


Inventory carrying costs encompass basically what is directly required to hold any inventory:

1.    You need to purchase inventory, so you may need to borrow money at a given rate that will not be used for other investments having a higher return rate. This is the investment costs.
2.    You need to store the inventory in a safe place, so you need to rent or own a facility or square meters, storage materials (shelves, signs, painting,..), energy (light, fridge…) and facility insurance.  This is the warehousing costs.
3.    You need bear cost as inventory value may change: you need inventory insurance obviously (fire, robbery, damage,…) but also bear obsolescence cost or spoilage cost (especially for fresh food). This is the holding costs.
But let’s note here that the carrying costs could be up to 30% inventory value, main cost factor is the investment cost associated.

Inventory ordering costs encompass the costs associated with procuring the inventory, not the purchase cost of materials:

1.    You need to place purchase orders, so salary of purchasing staff or replenishment staff that are preparing and sending orders to suppliers
2.    You need to send orders, so all communication cost (internet, fax, phone, emails) are also included
3.    You need to receive materials ordered, so receiving staff that receive, data entry, handling, unpacking and inspection is included as well
4.    You need to pay suppliers, so accounting staff related to payables are included indeed.

In the case the company is purchasing internally within the company from another manufacturing department, we can express the same:

1.    You need to launch an manufacturing order, so you need to include the manufacturing staff preparing orders
2.    You need to prepare tools, dies and raw material – move them to the line
3.    You need to set-up the equipments and post work order then complete the work order

Inventory stockout costs are the cost associated with having an insufficient inventory to match the demand:

•    Orders that cannot be fulfilled are loss so a cost
•    Express transportation costs
•    Additional cost to satisfy the demand such as overtime, subcontracting,…

Last modified on Friday, 11 May 2012 08:12
More in this category: « Impact of holding inventory
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