Inventory management costs

Inventory costs are all costs associated with ordering, holding and managing the inventory or stock of an operation or business. These inventory costs include Ordering costs, holding costs, and shortage costs.
Managing Inventory costs is important as they can be a substantial cost of doing business, and may vary from 10% to 40% of the value of inventory. It is therefore important to understand and have the ability to manage these different inventory costs when making production/purchasing, logistics, or inventory holding size decisions including determining safety stock levels . Lean manufacturing principles can be used to manage inventory levels more efficiently and thus have a tighter control over inventory costs. Some inventory software packages allow to track certain inventory costs, this feature may be very useful to some businesses.

The different inventory costs are further explained below:

-Inventory ordering costs:
These include costs incurred in ordering a batch, production run, or purchase of externally made parts or products. Costs such as administration and order approval costs including the costs to run an inventory management and ordering system are included in this category.

-Inventory holding costs:
These are costs incurred while holding inventory or stock in storage or a warehouse and managing its delivery to customers. Most of these costs can be quantified easily. Some common inventory holding costs include :
Warehousing and logistic costs, Insurance, Spoilage/breakage losses, Obsolete inventory write offs, and opportunity cost of tied up capital. Obsolete inventory write off costs are usually higher in build to stock inventory/production systems where there may be limited stock rotation and single order inventory cases.

-Inventory Shortage costs:
Inventory shortage costs refer to the costs, some intangible, of running out of stock and not being able to supply customers with the goods they demand in a certain timeframe or lead time . Most of these costs are difficult to quantify. The effects of a stock shortage, and cost, mainly relate to lost sales and profits, lost customers, stock-out fines and contract disputes.