Costs that Encourage having Larger Inventories The major costs that play a crucial role in having

larger inventories are explained as follows: Customer service Coating inventory can speed delivery and
on time delivery. Inventory reduces the potential for stock outs and backorders which are key concerms of
whole sellers and retailers.

Back order Back order is a customer order that can't be filled when promised or demanded but is filled
later. Customers may be willing to wait for a backorder but next time may take their business elsewhere.
Sometimes customers are given discounts for the inconvenience of waiting.

Setup or ordering costs In production process after each production run the organization has to incur the
expenditure in. starting the next production run i.e. process set up costs in adjusting machine tools or
machine in changing over an assembly line to a new item etc. This expenditure is independent of the size
of the production and is known as set up costs. This cost can be reduced by planning with fewer setups of
large size production run leading to an increase in the size of the inventory. Each time a firm places a new
order, it incurs an ordering cost or the cost of preparing, a purchase order for a supplier, or a production
order for the shop. For some item, the ordering cost is constant, regardless of the order size. The
purchasing agent must take the time to decide how much to order and perhaps select a supplier and
negotiate terms. Time is also spent on paperwork, follow up and receiving. The internet can help
streamline the order process and reduce the cost of placing orders.

Direct material and labor costs It is observed that items are likely to be scrapped during each setup or
trial of the equipment. This results in increased costs on material and labor. If the size of job in each
production run is increased then there will be fewer setups and loss on materials and labor costs due to
scrapping will be reduced.

Depreciation costs In every organization, the value of the capital invested decreases with time. Thus
there is a tendency among organization to reduce its capital investment on machines and other equipment.
The depreciation costs are thus reduced. Naturally, the desired amount of production with reduced
humber of machines can be obtained by running the machines in slack-period, thus increasing the size of
inventory.

1.2.2 Costs that Encourage Smaller Inventory the primary costs which play a crucial role in reducing
the inventory are listed as follows:

Holding or carrying costs holding costs are incurred for keeping stocks in the store. Interest or
opportunity cost for any Had Inventory is an investment, where the capital is tied up in the form of
material and goods. Had this capital been free, it could be utilized elsewhere e.g. developing a new
product or to buy new equipment i.e., an opportunity cost exists. Thus, by holding inventory the
organization forgoes the use of invested capital in some alternative way.

Sometimes the inventory investment is made by borrowing money on which interest is to be paid
furthermore, the inventories for tax purpose are considered to be fixed assets and the amount of tn
increases with the size of the inventory.

Storage costs Maintenance of inventory means storage costs. These include expenditure made on
inventory staff expenditure on providing various facilities like heating, lighting, freezing, floor space,
shapers racks. bins and contain material handling equipment and other provisions for safe and proper
storage of items.

Deterioration, obsolescence and pilferage Some items are likely to deteriorate in quality with time. If
such items are in store for considerable time, then the organization may decide to dispose them at a loss.
Sometime the item in stock go out of fashion and technically obsolete. Some product can be out of date.
Some goods are subjected theft and misappropriation, breakage or accidental losses, cost of insurance,
etc.