What is inventory cost?
Inventory cost is everything a business spends on having stock, beyond the purchase price of the goods. It falls into three groups: ordering costs for buying and receiving, carrying costs for storing and financing, and shortage costs for the sales and goodwill lost when an item runs out.
Formula
Total inventory cost = ordering costs + carrying costs + shortage costs
Worked example
Ordering costs of 4,000.00, carrying costs of 9,000.00 and shortage costs of 1,500.00 give a total inventory cost of 14,500.00. Carrying makes up 62.07% of it.
How to use the inventory cost calculator
- Enter your figures: ordering costs and carrying costs. Shortage costs is optional and counts as zero when left empty.
- Read the result. It updates as you type, so there is no button to press.
- Try other numbers to compare scenarios. Reset brings back the example values.
Getting it right
- Ordering costs include purchasing staff time, delivery charges and inspection on receipt.
- Carrying costs include warehouse rent, insurance, damage, obsolescence and interest on the money tied up.
- The three pull against each other: fewer, larger orders cut ordering costs but raise carrying costs.
Frequently asked questions
What are the three types of inventory cost?
Ordering costs, carrying (or holding) costs and shortage (or stockout) costs. The purchase price itself is usually treated separately.
How do I estimate shortage costs?
Multiply the units you could not supply by the profit lost on each, and add any rush-freight or penalty charges you paid to recover.
How can I reduce total inventory cost?
Find the order size where ordering and carrying costs balance, which is what the economic order quantity formula does, and set reorder points that prevent shortages without overstocking.