In Inventory costs, ordering, holding, carrying, shortage and spoilage costs make up some of the basic types of inventory-related costs we often forget. These groupings broadly separate the many different inventory costs that exist, and below we will identify and describe some examples of the different types of cost in each category.
The inventory costs require a certain amount of calculation to understand the impact it has on your gross profit. Let’s look at types of costs,
Ordering Costs
Ordering costs include payroll taxes, benefits and the wages of the procurement department, labor costs etc. These costs are typically included in an overhead cost pool and allocated to the number of units produced in each period. For Example,
- Transportation costs
- Cost of finding suppliers and expediting orders
- Receiving costs
- Clerical costs of preparing purchase orders
- Cost of electronic data interchange
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Inventory Holding Costs
Inventory holding costs is simply the amount of rent a business pays for the storage area where they hold the inventory. Moreover, this can be either the direct rent the company pays for all the warehouses put together; or a percentage of the total rent of the office area utilized for storing inventory. Such as,
- Inventory services costs
- Inventory risk costs
- Opportunity cost – money invested in inventory
- Storage space costs
- Inventory financing costs
Shortage Costs
Shortage costs are the costs incurred by an organization when it has no inventory in stock. These costs include the loss of business from customers who go elsewhere to make purchases. The loss of the margin on sales that were not completed, and overnight shipping costs to acquire goods that are not in stock.
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Shortage costs, also known as stock-out costs, occurs when businesses become out of stock for various reasons. Some of the reasons might be as below,
- Emergency shipments costs
- Disrupted production costs
- Customer loyalty and reputation
Spoilage Costs
Perishable inventory stock can rot or spoil if not sold in time, so controlling inventory to prevent spoilage is essential. Products that expire are a concern for many industries. In particular, industries such as the food and beverage, pharmaceutical, healthcare and cosmetic industries; are affected by the expiration and use-by dates of their products.
Inventory Carrying Costs
Inventory carrying costs is one of the lesser-known aspect of inventory cost. Especially, this cost requires a certain amount of calculation to understand the extent of its impact on your P&L statement. Inventory carrying costs refers to the amount of interest a business loses out on the unsold stock value lying in the warehouses.
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Furthermore, business owners often miss out on understanding the impact of the above factors while calculating the impact inventory has on their business. The inventory holding costs does show up as part of rental expense in the Profit & Loss statement. However, the inventory carrying cost is seldom considered when calculating the gross profit. We usually take into account only the principle cost of the goods held in the warehouses.
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