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Inventory - Management - Ch1 - Lec4

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13 views12 pages

Inventory - Management - Ch1 - Lec4

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yousseftarekfathallah
Copyright
© © All Rights Reserved
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LEC 04

INVENTORY MANAGEMENT
INVENTORY COSTS

4 basic costs are associated with inventories:


1. purchase,
2. Holding,
3. Transaction (ordering),
4. Shortage costs.
INVENTORY COSTS

1. Purchase cost
is the amount paid to a vendor or supplier
to buy the inventory. It is typically the
largest of all inventory costs.
INVENTORY COSTS

2. Holding, or carrying, costs


relate to physically having items in storage.
Costs include interest, insurance, taxes (in some
states), depreciation, obsolescence, deterioration,
spoilage, pilferage, breakage, tracking, picking, &
warehousing costs (heat, light, rent, security).
They also include opportunity costs associated with
having funds that could be used elsewhere tied up in
inventory.
Note that it is the variable portion of these costs
that is pertinent.
INVENTORY COSTS

The significance of the various components of holding


cost depends on the type of item involved, although
taxes, interest, & insurance are generally based on
the cash value of an inventory.
Items that are easily concealed (e.g., pocket cameras,
transistor radios, calculators) or fairly expensive
(cars, TVs) are prone to theft. Fresh seafood, meats
& poultry, produce, & baked goods are subject to
rapid deterioration & spoilage. Dairy products, salad
dressings, medicines, batteries, & film also have
limited shelf lives.
INVENTORY COSTS

Holding costs are stated in either of 2 ways:


➢ as a percentage of unit price
➢ or as a dollar amount per unit.
Typical annual holding costs range from 20 percent to
40 percent or more of the value of an item.
In other words, to hold a $100 item in inventory for
one year could cost from $20 to $40.
INVENTORY COSTS

3. Ordering costs
are the costs of ordering & receiving inventory.
They are the costs that vary with the actual
placement of an order.
Besides shipping costs, they include determining how
much is needed, preparing invoices, inspecting goods
upon arrival for quality & quantity, & moving the
goods to temporary storage.
Ordering costs are generally expressed as a fixed
dollar amount per order, regardless of order size.
INVENTORY COSTS

When a firm produces its own inventory instead of


ordering it from a supplier, machine setup costs
(e.g., preparing equipment for the job by adjusting
the machine, changing cutting tools) are analogous to
ordering costs; that is, they are expressed as a
fixed charge per production run, regardless of the
size of the run.
INVENTORY COSTS

4. Shortage costs
result when demand exceeds the supply of inventory
on hand.
These costs can include the opportunity cost of not
making a sale, loss of customer goodwill, late
charges, backorder costs, & similar costs.
INVENTORY COSTS

Furthermore, if the shortage occurs in an item


carried for internal use (e.g., to supply an assembly
line), the cost of lost production or downtime is
considered a shortage cost.
Such costs can easily run into hundreds of dollars a
minute or more.
Shortage costs are sometimes difficult to measure,
& they may be subjectively estimated.
EXAMPLE PROBLEM
❖ Carrying Cost
A company carries an average annual inventory of
$2,000,000. If it estimates the cost of capital is
10%, storage cost are 7% & risk cost are 6%, what
does it cost per year to carry this inventory?
Answer:
Total cost of carrying inventory
= 10% + 7% + 6% = 23%
Annual cost of carrying inventory
= 0.23 X $2,000,000 = $460,000
EXAMPLE PROBLEM
❖ Ordering Cost
Given the following annual cost,calculate the average cost
of placing one order.
Production control salaries=$60,000
Supplies & operating expenses =$15,000
Cost of setting up work centers for an order=$120
Orders placed each year=2000
Answer: Average cost= fixed cost + variable cost
number of orders

= $60,000 + $ 15,000 +$120= $157.50


2000

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