Cost of inventory

Inventory cost is the cost of the assets, plant, machinery and all of it’s required materials to run your business. It’s also known as “rolling stock” or “stock-in-trade”. For example a grocery store might stock a variety of items (like milk cartons). This is called a fixed asset because it doesn’t change over time. The cost of this stock would need to be deducted from the gross profit before taxes are totaled and the net profit is figured. 

What is Inventory?

The term “inventory” refers to all of the raw materials and finished goods that you would expect to see sitting on a shelf or in an office drawership. It includes any goods that are part of your pipeline (that is, goods that you plan to sell but haven’t yet produced) or those parts of your raw materials inventory that aren’t actually used, such as steel scrapings and scrap iron.

What does Inventory Cost mean?

The cost of inventory is the direct cost of having an item in inventory, whether or not it is sold. For example, the cost to store a customer’s order at a warehouse, or in transit between the customer and warehouse, are part of the inventory cost. While depreciation expense does not directly measure inventory costs (the asset wears out over time), it does measure some of the related costs. This section examines these costs and explains why they are important to factor into an analysis of inventory and production process flow.

What are the types of Inventory Costs?

There are three main types of inventory costs: the cost to hold inventory, the cost of production to make an item and the cost to sell an item. These three categories are sometimes referred to as holding, processing and consuming costs.

Holding Costs

Holding costs consist of expenses for storing items in a warehouse, on a shelf, or in transit from the customer to your warehouse or plant. In addition to paying rent, heating and lighting costs may be incurred. Also included are materials handling expenses such as employee wages for repetitive movements of inventory items around the warehouse floor. Sometimes these holding costs also include transportation expenses for transferring items from one location that is close enough that it doesn’t need to be picked up (e.g. a store near the warehouse) to another place farther away (e.g. a nearby store).

Ordering Costs:

The cost to order inventory is the cost of the shelf time that you have lost while waiting for your order. It is equal to the value of the inventory that has passed its “sell by” date – that is, merchandise that would be sold today if you had it on hand. The “sell by” date, or similar expiration date, is usually provided with each item’s product description. Ordering costs do not include all ordering costs as “ordering costs” are a broader concept.

Shortage Costs:

Shortages are items that are out of stock or unavailable to be produced. Shortage costs include those fixed costs incurred while waiting for inventory to be received, such as storage and transportation expenses or delay in the production process.

Inventory Carrying Costs:

Inventory carrying costs consist of costs to store inventory in a warehouse, or in transit from the customer to your warehouse or plant. Inventory carrying costs are also referred to as “inventory carrying charges.”

Production Inventory Costs: Production inventory costs are the direct cost of producing an item — that is, the cost of materials, labour and other direct expenses related to creating a particular product. This category includes materials and labour expenses, but not indirect shop floor expenses such as depreciation expense and selling expense. These production-related costs are incurred whether or not any products are sold.

Conclusion:

Inventory is an important business concept that is likely to be examined in your company Accounts preparation. You should at least be familiar with the nature of inventory costs and their place in your company’s accounting system.