Introduction
Businesses, whether small enterprises or large corporations, will inevitably encounter the issue of inventory over time. Although businesses need to keep a certain level of inventory to ensure production and sales, they also need to manage their inventory investment efficiently because it can easily become a burden to the company’s bottom line. The business is then required to calculate what kind of costs and benefits should be attributed to the inventory it owns. Among these costs, the most important one is usually the inventory holding cost, which is the cost that is associated with storing a stock of goods.
Like most other aspects of business finance, inventory holding cost can be divided into different parts so that one can better understand the cost/ benefit analysis of a company’s inventory. This article will present a brief overview of inventory holding costs and some of the components associated with it.
Definition of Inventory Holding Cost
Inventory holding cost, also known as ‘carrying cost’ is the cost associated with keeping a stock of goods. It is mainly composed of the costs of ordering, carrying, finance and storage that are incurred during a period of time due to the stock of goods that are held by the firm.
Inventory ordering cost
Inventory ordering costs refer to the costs associated with ordering and replenishing inventory. They include the costs of preparing the documents for the order, the cost of goods purchased form the suppliers, and shipping and handling costs. These costs vary from business to business, depending on the factors such as the quantity of goods being purchased, the frequency of ordering, payment terms, delivery times and method of ordering.
Inventory carrying cost
Inventory carrying costs refer to the cost of storing and maintaining inventory. These costs include costs for storage and handling, storage of insurance, transportation and taxes. These costs tend to increase as the amount and variety of inventory increases, because more space and resources are needed to store and maintain them.
Inventory finance cost
Inventory finance costs refer to the costs associated with borrowing funds to purchase and hold inventory. These costs include interest costs, finance costs, and taxes associated with the borrowed funds. These costs are usually proportionately higher with higher borrowing costs, and vary from company to company.
Inventory storage cost
Inventory storage cost is the cost associated with the storage of inventory. This can include costs of building and maintaining inventory related facilities, insurance costs and other associated costs. The cost of storage is always going to be higher when the inventory needs more space to store and when the cost of climate control is higher.
Conclusion
Inventory holding cost is one of the most important elements of inventory management for businesses. It is composed of various components such as ordering cost, carrying cost, finance cost, and storage cost. These costs can vary greatly depending on various factors so it is important for managers to take all of them into account when making decisions about their inventory. Understanding the components of inventory holding costs can help businesses make decisions that will lead to increased profitability and better management of their stocks.
