Inventory Control Guide Page 6
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402.3 Costs
When dealing with inventories, three different types of costs are taken into account.
× × × ×
1. Holding cost
H
money/(item
time)
The holding costs are all the cost incurred because you hold the goods:
storage, handling,
You need a warehouse for the goods and it costs money to store them in the warehouse and
to retrieve them.
taxes, insurance,
Of course, you want to insure these goods. You might also have to pay taxes for them.
spoilage, obsolescence,
Items could get damaged or just obsolete. In such cases you loose not only the value of the
items but you further need money for scrapping the items.
cost of opportunity of capital
Last, these stored goods represent a capital you could have used for other opportunities. You
could have invested that money in profitable operations.
The holding cost is a cost per item per period of time. For example,
H = 10 ECU's / (item year) or (holding rate × × × × value)
means that holding one item for one year costs 10 ECU's. The holding cost can also be
expressed as a percentage of the value of the item. For example, if the holding cost
represents 20 % per year and one item costs 50 ECU's,
Example:
value = 50 ECU's / item,
holding rate = 0.20 / year
× × × ×
then
H = 10 ECU's / (item
year)
then the holding cost amounts to (0.20/year ) (50 ECU's/item)=10 ECU's/(item ×year).
2. Order/Setup cost
O
( money )
The order cost or setup cost corresponds to the fixed cost incurred each time an order is
launched. By assumption, this cost is independent of the quantity ordered.
paper work, transport, reception, setup
For a purchasing order, it namely comprises the paper work, the transport of the goods and
their reception. For a production order, it includes the transport of the raw materials, the setup
of the machines and possibly the setup scraps.
3. Item cost:
I
( money / item )
The item cost corresponds to the price paid for the goods themselves.
4. Penalty cost
P
( money / item )
The penalty cost is the cost paid for each demand item which cannot be served directly from
the inventory. How much does it cost the baker if I want one bread and none are left ? In this
case, this cost is at least the profit which is missed on one bread.
lost sales
bookkeeping, lateness penalties
loss of goodwill
The loss of goodwill and/or the loss of a customer are much more difficult to quantify.
Prod 2100-2110
Inventory Control
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