Question

Inventory holding cost are those associated with storing unsold inventory which may include storage costs, labour, equipment, and insurance incurred to manage the unsold goods and risk of loss due to obsolescence or pilferage. To manage inventory holding costs, questions on “What”, “Where”, “When”, “How much” and “How often” are often considered. Explain how these questions help manage inventory holding costs. You may cite an example to support your explanation.

Answer 1

Inventory holding cost is part of inventory cost which increases the cost per unit. It is important to manage the inventory cost because it affects the cost of goods sold and affects the gross margin of the firm.

· A firm should analyse the type of various holding costs incurred by it in holding and storing the inventory. Analysing each component of cost helps in controlling the same by eliminating the activity which incurs such cost. For example : a material handling cost can avoided when double handling of material is done in stores department

· A firm should see where the costs are getting incurred in order to control the same. For example: A cost getting incurred in external warehouse for material handling can be eliminated by moving the material storage to inside the plant to save the external storage cost.

· A firm should analyse the when component of cost. For example : A cost getting incurred at point the point of unloading , or during movement or during storage in order to analyse the cost activity wise and control the same

· The cost incurred on inventory holding should be analysed as percentage of total cost and 80:20 rule should be applied. The top 80% cost incurred by major components should be analysed to reduce the inventory holding cost. This helps management in cost benefit analysis of inventory holding cost.

· The cost incurred in holing inventory should be analysed based on recurring or non recurring nature. Recurring costs should be controlled by cost reduction programme. For example: A recurring manual handling cost is reduced by automating the handling of inventory.