Inventory costs are one of the most important costs incurred by any company or organization, which means the value of the inventory. There are many types of inventory costs, and each type has its own importance in arriving at the actual cost of inventory held by the company.
The importance of inventory costs lies in knowing how to take an inventory of your stores or warehouses, in addition to their importance in calculating the expenses incurred by the company for the inventory you own.
In this article, we will provide you with all the details about inventory costs and its most important types, as well as how to reduce inventory costs as much as possible in the most modern and effective way.
What is the Cost of Inventory?
Inventory costs are the costs related to holding and carrying the inventory itself, which includes costs related to the space used including rent, heat, maintenance, etc. This is in addition to the cost of funds associated with inventory, the cost of insurance, and the cost of obsolescence of inventory items.
5 Types of Inventory Costs
There are many types of inventory costs, and as we mentioned earlier, each type has its own importance in arriving at the effective cost incurred by the company for holding inventory.
Each type affects the company’s total profits. The five main types of inventory costs are as follows:
1. Inventory Holding Costs
These are the costs that are paid for the storage space a company uses to keep its inventory. And Inventory Holding Costs can be the rent the company pays for the space it uses in stores or logistics warehouses.
2. Ordering Costs
Arrangement costs are one of the most important types of inventory costs, which include costs for taxes, salaries, wages, and labor costs. These costs are included in a line item called overhead costs.
3. Inventory Carrying Costs
Another inventory cost is Inventory Carrying Costs, which refers to the cost to a company of keeping its inventory. It affects the profit and loss statement significantly.
4. Spoilage Costs
These are the costs incurred by the company in the event of the deterioration of its inventory. This happens if the company is late in selling the inventory it owns.
There is great importance in controlling Spoilage Costs and the companies which are engaged in food or pharmaceutical and cosmetic industries are the most affected type of companies by Spoilage Costs as compared to other inventory costs.
5. Shortage Costs
And shortage costs are important inventory costs that a company incurs if it is out of stock for various reasons. Examples of Shortage Costs are:
- Costs to maintain customer loyalty and company reputation.
- The costs of idle production.
- Emergency shipment costs.
How to calculate inventory costs
There is great importance in calculating inventory costs, as it is an important consideration for any company seeking to make as much profit as possible. Especially since rising inventory costs will directly negatively affect profitability.
There are many ways to calculate inventory costs, but here is a simple and easy way to calculate inventory costs.
This method of calculating inventory costs depends on determining the beginning and ending values of inventory, as well as the value of inventory purchased over a certain period of time.
Here is the step by step to calculate inventory costs:
- Determine the period of time you want to calculate your inventory costs.
- Determine the beginning inventory, the value of your inventory at the beginning of the month or the beginning of the time period for which you want inventory costs.
- To the beginning inventory you determined, add the cost of inventory purchases at the end of the period for which you want to calculate inventory costs.
- Calculate the Physical Inventory of the cost of the inventory at the end of the period for which you want to calculate the inventory costs.
- Use the following formula to calculate inventory costs to arrive at the final cost in terms of the given information:
- Inventory costs = Beginning Inventory + Inventory Purchases – Ending Inventory
Tips to reduce carrying costs
It is of great importance to reduce carrying costs in any enterprise, because it affects its profitability significantly.
Here are some effective tips that will help you avoid and reasonably reduce a lot of carrying costs:
1. Determine the minimum stock level
It is one of the most important tips to reduce inventory costs, with which you will be able to determine when you will completely run out of inventory.
Which will affect the fulfillment center of orders and therefore if you reach a level below it, you will need to immediately look for another source to get stock.
Thus avoiding the high costs that will result from running out of your inventory. The most important of which is the loss of customers and the reputation of your company or organization in the market.
2. Determine the reorder level
They are also important for reducing inventory costs, and with them you’ll be able to tell at what level you’ll need to reorder.
Any order to supply inventory, because during the period of arrival of your inventory, you have a stock reserve that can be controlled for a customer or others, which is the minimum level that we explained in the previous paragraph.
3. Determine the highest level of stock
Which you must do after determining both the minimum level of stock and the level of re-order.
The highest level of inventory is the quantity that if you exceed it, you will enter into a state of stockpiling, which will cost you the storage value, expiry date and other huge costs.
4. Try to get rid of your dead stock
And that is by making discounts on it before its expiry date or giving it as gifts to customers, thus gaining their trust instead of losing stock. Especially since the dead stock will cost you a lot, so try to make the best use of it.
5. Decrease supplier lead time
With which you will be able to reduce inventory carrying costs, with which you will be able to reduce the amount of inventory you have due to the new lead time.
6. Use inventory management software
It is one of the best innovative ways that will help you greatly and effectively in reducing inventory carrying costs.
It saves time and effort as well as more costs by doing many tasks completely automated.
Diggipacks’ solutions provide you with the best inventory management software that will help you avoid a large part of inventory carrying costs.
