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Subject: Operations Mangement
Just-in-case Inventory Management
Inventory management is concerned with managing inventory costs. Three types of inventory costscan be readily identified with inventory:(1) Cost of acquiring inventory (other than the cost of the good itself),(2) Cost of holding inventory, and(3) Cost of not having inventoried on hand when needed.If the inventory is a material or good acquired from an outside source, then these inventory-acquisition costs are known as ordering costs. Ordering costs are the costs of placing and receivingan order. Examples include the costs of processing an order (clerical costs and documents),insurance for shipment, and unloading costs.If the material or good is produced internally, then the acquisition costs are called setup costs.Setup costs are the costs of preparing equipment and facilities so they can be used to produce aparticular product or component. Examples are wages of idled production workers, the cost of idledproduction facilities (lost income), and the costs of test runs (labor, materials, and overhead).Ordering costs and setup costs are similar in nature
both represent costs that must be incurred toacquire inventory. They differ only in the nature of the prerequisite activity (filling out and placingan order versus configuring equipment and facilities). Thus, in the discussion that follows, any reference to ordering costs can be viewed as a reference to setup costs. Carrying costs are the costsof holding inventory. Examples include insurance, inventory taxes, obsolescence, and theopportunity cost of funds tied up in inventory, handling costs, and storage space.If demand is not known with certainty, a third category of inventory costs
called stock-out costs
exists. Stock-out costs are the costs of not having a product available when demanded by acustomer. Examples are lost sales (both current and future), the costs of expediting (increasedtransportation charges, overtime, and so on), and the costs of interrupted production.