Inventory Carrying Cost

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Inventory carrying costs refers to the costs associated with carrying a quantity of stored inventory. This is one of the vital costs that needs to be optimized in any logistics system. It is a well-known fact that the inventory carrying costs is a part of the total logistics costs of the firm. Aspects of these vital costs can be described and evaluated from a variety of perspectives. Knowledge of inventory carrying costs is likely to be important to the success of any business. In general, knowledge of inventory carrying costs constitutes a vital part of management information necessary to optimize the logistics system.  However, without specific and comparable measurement of inventory carrying costs relative to a target level, knowledge of inventory carrying costs alone may not be sufficient to contribute either to the optimization of the firm's logistic system or to its total costs.

The objective of a firm's logistics system usually is to minimize total costs given a specified level of customer service. The total costs include inventory carrying costs, transportation costs, warehouse throughput costs, order-processing costs, and lot quantity costs. These total costs are dependent upon the configuration of the logistics system. To optimize the system, the component costs must be known and must be comparable. The comparison of these costs is not a simple process. The lack of a specific methodology by which to measure inventory carrying costs and the lack of an established preferred target level of inventory carrying costs, makes things to look further complicated. From the above, it is clear that several important decisions are, or should be, predicated on knowledge of the firm's inventory carrying costs. Basic questions concerning inventory strategy can be properly made only after knowledge of the firm's costs of carrying inventory.  Certain important questions that one might want to answer would be: • How much inventory should we carry?

• Should the inventory be placed close to the point of purchase, close to the point of supply, or at some in--process mid-point? • Should we institute a system of just-in-time supply? • Should we build field warehouses?

• Should we divest ourselves of existing warehouses?
• Should we use a form of premium transportation for our distribution? • Should we require our suppliers to use a for   premium transportation for in supply? Inventory costs must be known to arrive at the level of customer service, which the firm chooses to offer. However, one cannot provide this without having a thorough understanding of the inventory carrying costs. Management must know how an increase in customer service will impact inventory-carrying costs. Similarly, they must know the cost interactions between lost sales and smaller levels of inventory. In general, knowledge of inventory carrying costs, those costs associated with carrying a quantity of stored inventory, constitutes a vital part of management information necessary to optimize the logistics system. For example, if a business manager knew the typical level of inventory carry costs according to firm size, type, industry and geographic region, the manager may be able to make better judgments about how efficient his business operations are. However, it is possible to develop specific and comparable measurements of inventory carrying costs according to industry, firm size, type, and region can be developed.  These estimates would provide a target level of inventory carrying costs. This would allow us to assess the efficiency of our operation relative to competitors.  

The basic function of inventory is to insulate the production process or the inbound supply process (in our case) from changes in the environment (or demand fluctuations).

Hence the inventory function will not only be applicable to a manufacturing firm, but also to other industries that have...
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