The inventory cost of purchasing an item – there’s more than meets the eye

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When running a company, it is imperative to understand every reason for outgoing revenue and to try and find methods to reduce these so that the bottom line does not suffer. One such area that can sometimes take people by surprise is all the hidden costs associated with purchasing stock. They are not so much hidden as simply overlooked. Let us consider at what these are.

Purchasing price

Of course, there is the purchase price of an item which is the amount of money the vendors are requiring to be paid for it. This is self-explanatory and there is usually no hidden cost associated with it, bar any GST owing which may not have been factored into the cost price.

Ordering costs

To arrive at the point of ordering an item, there is often a huge amount of behind-the-scenes work required. These are administrative costs (in time) to source the ideal vendor with the required product, formulate purchase orders and place the order. However, with big ticket items, there can often be several steps in the process which involve formulating a purchase plan (including obtaining and collating vendor quotes), presenting it to the whole Board of Directors to decide on the best vendor and then possibly getting signatures from key employees such as managers. Only then may an order be placed which, as you can appreciate, is quite a lengthy process. And as the saying goes, ‘time is money’.

Shipping costs

The next cost incurred are shipping costs. Ideally, if orders are placed well in advance, there is the luxury of time to select the cheapest, albeit the slowest, reliable shipping company. Sometimes this is a luxury the company cannot afford however, and in instances like these, expedited shipping can come at a premium.

Receipting, warehousing and storage costs

Once a product arrives, it must be receipted into stock through the formalized company process. This may involve a few key people in charge of receipting and warehousing which of course, takes time. Once receipted, the inventory must be stored. This storage incurs costs too including the lease of the warehouse, the building overheads including electricity, and the insurance premiums on stored inventory should any adverse event occur rendering it unsaleable. These can also add quite a bit to the overall purchase so should never be overlooked.

Inventory management and shortage costs

To arrive at the decision that more product is needed, a significant amount of inventory management needs to happen. This refers to counting the stock already held, analysing sales trends and the forecasting of future orders, and then calculating a sensible new stock order amount. This step in the process, though time-costly, is essential as without it, it is likely that the company could run into a situation where they do not hold sufficient stock to satisfy customer demand. To rectify this adverse occurrence, they must then either order stock and pay for expedited shipping, or they simply cannot meet the customer’s needs. Unfortunately, this can often result in the customer going elsewhere and the company stands to lose business and subsequent revenue.

Lost opportunity costs

Although inventory held in stock is counted as an asset on paper (despite the costs it incurs as mentioned above), it also represents a lost opportunity cost as long as the money used for its purchase is not received back through a sale. A lost opportunity cost refers to the opportunity the company would have had to invest that money for a greater return if they indeed had it in their bank account. This is rather than it being tied up in the purchase of a product that is being stored and remains unsold.

These are a few of the costs incurred in the purchase of stock which can often go unnoticed until they impact the bottom line. It is imperative to understand them so that they can be included in the final sale price of the stock, ensuring the company remains profitable.

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Melanie - Unleashed Software

Article by Melanie Chan in collaboration with our team of Unleashed Software inventory and business specialists. Melanie has been writing about inventory management for the past three years. When not writing about inventory management, you can find her eating her way through Auckland.

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