Inventory holding costs
These are costs incurred while holding inventory or stock in storage or a warehouse. It is the most quantifiable cost and can be interpreted as the main or only cost of inventory without any regard for the other costs such as ordering and shortage costs. Some common inventory holding costs include :
-Warehousing and logistic costs
These costs are the regular warehousing costs incurred such as rent, labour, and utilities. Logistics costs incurred in managing inventory are organizing and running an inventory order management system including trucks or other modes of transport to ship goods to customers and from suppliers in some cases.These can be reduced by having a well planned warehousing system such as an ABC warehouse.
Insurance costs to insure the inventory or stock against theft, losses, and destruction. Depending on the industry and location these could be quite substantial.
Spoilage or breakage costs include the retail cost of having to write off inventory due to it being spoiled or broken and unable to be sold. Some products are more susceptible to being damaged the more they are moved from one place to another. Others have short shelf lives such as fruit and vegetables and can spoil easily. So these types of products may have an inventory carrying cost of about 5-10% of their value due to spoilage or breakage. Again this greatly depends on the product.
Obsolete inventory write offs
Obsolete inventory costs are common in technology based products and computer/computer chip businesses, build to stock inventory systems, and single orders inventory models. This is due to the industry moving very quickly in terms of product development and product lines could easily be out of date in 12 months or less and are forced to be sold at a discount resulting in a loss. If inventory cannot be sold it may have to be written off completely. Stock rotation and a FIFO system may help reduce these type costs.
Materials handling costs
Material handling costs refer to the costs of moving materials and products from one place to another either in the same warehouse, production plant, or across greater distances to customers. These costs can include buying/leasing materials handling equipment such as forklifts, pallet trucks, palletisers, small trucks or vehicles, and the labour to operate these machines.
This is not a cash cost for the business but nevertheless should still be taken in account as it will most likely be realized when the inventory is sold. The depreciation cost can also refer to the depreciation cost of large machinery and plant used in managing the inventory.
Opportunity cost of tied up capital
This cost category is also a non cash charge to the business but with an understanding on capital budgeting is easy to understand that capital is scarce and must be allocated to its most efficient use where it will achieve the best expected return and add value to the business. So the capital tied up in inventory could be invested elsewhere in the business and generate an equal or better return.
More on inventory management