Structure of inventory carrying cost
Inventory carrying cost is the cost of maintaining an average level of inventory in a warehouse, showroom, or other locations where raw materials, supplies, or finished goods are stored. In terms of value, it represents a significant item in the statement of total logistics costs. According to the approach presented in Fig. 1, the calculation of inventory carrying cost is based on the knowledge of four basic cost categories, which are:
1. capital costs
2. inventory service costs
3. storage space costs
4. inventory risk costs
Capital cost. This cost is often referred to as the opportunity cost, because it expresses the loss that an enterprise incurs in connection with cash being frozen in inventory and not invested in other ventures (hence it is also called: alternative cost). Most often, capital cost constitutes the largest part of inventory carrying costs. An enterprise usually expresses it as a percentage of the monetary value of the inventory held. For the procedure of determining inventory carrying costs, it is important which inventory valuation method is used. According to Stock and Lambert, the alternative cost of capital corresponds only to the actual expenditures incurred in connection with investing in inventory. It then constitutes a direct variable cost incurred until the inventory is placed in the warehouse (cf. example in Table 1). The value of the inventory is therefore determined by multiplying the number of units of each product by the direct (variable) cost associated with its production and shipment to the storage location.
In the case of wholesalers and retailers, the cost of capital invested in inventory is equivalent to the costs of acquiring goods (i.e., the sum of purchase and transport costs).
The article comes from the magazine “Logistyka” 1/2003.