3. What are the various costs associated with inventory? Which are largest? How are they expressed?

Inventory typically represents the second largest component of logistics cost next to transportation.

Costs associated with Inventory are normally shipping and maybe storage costs. It depends on your method of keeping the books for your inventory.

1. Ordering Cost

Ordering costs is associated with costs of placing order and receiving goods; retail & distribution

Ordering Cost is based on two factors - The cost of ordering excess and the Cost of ordering too less. Both these factors move in opposite directions to each other. Ordering excess quantity will result in carrying cost of inventory. While ordering less will result in increase of replenishment cost and ordering costs.

This functional analysis and cost implications form the basis of determining the Inventory Procurement decision by answering the two basic fundamental questions - How Much to Order and When to Order.

How much to order is determined by arriving at the Economic Order Quantity or EOQ.

Examples of costs:

- Preparing purchase or production orders, receiving and preparing and processing related documents.

- Incremental costs of purchasing or transportation for frequent orders (Purchase in small lots is often costlier and transportation costs also increase)

- Out of pocket costs of postage, telephones, telegrams, cost of stationery, traveling etc.

- Extra costs of numerous small production runs, overtime, setups, training etc. In addition- fixed costs in form of salaries, wages of employees connected with this work in purchasing, receiving, inspection and Material handling Departments.

2. Carrying Cost (Holding costs) – the largest!

Holding costs - associated with holding or “carrying” inventory over time.

Inventory storage and maintenance involves various types of costs namely:

• Inventory Storage Cost

• Cost of Capital

Inventory carrying involves Inventory storage and management either using in house facilities or external warehouses owned and managed by third party vendors. In both cases, inventory management involves extensive use of Building, Material Handling Equipments, IT Software applications and Hardware Equipments coupled managed by Operations and Management Staff resources.

The carrying cost of inventory is the cost of maintaining your average inventory investment of inventory in your warehouse, storeroom, stockroom, or other location where you stock raw materials or finished goods. What costs do you incur in carrying inventory?

• Cost of putting away stock receipts and moving material within the warehouse. How much of your employees' time is spent in these activities?

• Rent and utilities for the portion of your warehouse used to store stock inventory.

• Insurance and taxes on inventory. If it's in your warehouse, you have to insure it, and it may be subject to tax.

• Physical inventory and cycle counting. The more material in your warehouse, the longer it takes to count.

• Inventory shrinkage and obsolescence. The more material in your warehouse, the higher the possibility of shrinkage and obsolescence. After all, it's hard to steal something that isn't there!

• Opportunity cost of the money invested in inventory. How much could you make if you were to take the money you're investing in inventory and invest it in a more traditional investment (such as treasury bills)? Or if you are financing your inventory, how much interest are you currently paying the bank?

The carrying cost percentage is calculated by dividing the sum of these expenses (along with the opportunity cost) by the average inventory value. It is the amount of money it takes to maintain one dollar's worth of inventory for an entire year.