This is the cost a business incurs over a certain period of time, to hold and store its inventory. Businesses use this figure to help them determine how much profit can be made on current inventory. It also helps them find out if there is a need to produce more or less, in order to keep up with expenses or maintain the same income stream. Carrying cost of inventory is often described as a percentage of the inventory value. This percentage could include taxes, employee costs, depreciation, insurance, cost to keep items in storage, opportunity cost, cost of insuring and replacing items, and cost of capital that help produce income for a business. There are four main components to the carrying cost of inventory; capital cost, storage space cost, inventory service cost, and inventory risk cost. 1. Cost of Capital ( Opportunity cost )
Includes the cost of investments, interest on working capital, taxes on inventory paid, insurance costs and other costs associate with legal liabilities. The inventory storage costs as well as cost of capital is dependent upon and varies with the decision of the management to manage inventory in house or through outsource vendor and the third party service providers.
2. Ordering Cost
Cost of procurement and inbound logistics cost form a part of Ordering Cost is dependent and varies based on two factor – 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. Whereas ordering less will result in increase of replenishment cost and ordering costs These two above costs together are called Total Stocking Cost. If you plot the order quantity vs the TSC, you will see the graph declining gradually until a certain point after which with every increase in quantity the TSC will proportionately show an increase. This functional analysis and cost implications form the...