Ordering cost, or inventory ordering cost, is the cost company spends to acquire the inventory from supplier to warehouse. This cost does not include inventory purchase price, but refers to the cost spend to transport the material from supplier’s warehouse to our warehouse.
This cost will be changed due to the number of the company placing the order to the supplier, it also related to the type of material, quantity and the origin of suppliers.
Ordering costs are those incurred to obtain the inventory from the supplier. They include the costs of placing and receiving orders, as well as any other costs associated with acquiring the item, such as transportation costs. Ordering costs are initially incurred when an order is placed, and they continue to be incurred until the order is received. As a result, ordering costs are added to the total cost of an inventory item.
Ordering cost is a widely used accounting tool that helps businesses to determine the most efficient way to order and receive inventory items. By taking into account the ordering costs, businesses can make sure that they are not spending more than necessary on their inventory. In addition, ordering costs can also be used to evaluate different suppliers, as well as different methods of ordering and receiving inventory items. As a result, an ordering cost is a valuable tool for businesses of all sizes.
Ordering Cost Formula
The cost may be different as company buys material from oversea, while others purchase from their local with a free delivery option. We can calculate the inventory ordering cost by:
- Staff cost: refer to the purchasing department who select suppliers, prepare purchase order and so on.
- Tax: include custom duty, import tax and other tax
- Insurance: insurance paid duirng transportation.
- Payment fee: the bank’s charge and other fees.
- Other costs: include legal fees, advertisement for biding, and so on.
Annual ordering cost is the total of these cost during the year. It is more accurate to calculate it annually as it is hard to separate the staff cost (salary) and allocate to each order. We can get the staff cost per year and divided by the total number of orders to get the average cost per order.
Examples of Ordering Costs
Company ABC produces handbag for the US and European markets, however, most of the materials are imported from South East Asia. The company usually modified the composition of the material to reflect new fashion trending. Moreover, for every order makes, the company requires the purchase officer and designer to travel and check the sample to ensure that they meet the company criteria.
The company usually spend around $ 50,000 for staffs cost to work on material modification, travel to the supplier, and work on sample quality. They will responsible for transportation from the port of shipment (supplier uses FOB as their incoterm), it usually costs $ 40,000 plus the insurance $ 10,000. The company spends $ 30,000 per month to rent the warehouse to store the material, and it will take around 3 months before they are used.
Please calculate the inventory ordering cost. which cost is not part of inventory ordering costs?
Ordering Costs = staffs cost + transportation + insurance = 50,000 + 40,000 + 10,000 = $ 100,000
Factory rental is not part of ordering cost, it is the holding cost.
What are the Costs Associated with Ordering Inventory?
|Ordering Cost includes the following items:
|We need to find a quality supplier before making any purchase. It is not a problem for long-run businesses that already have a good connection with multiple suppliers. For the new company, it will be challenging, the purchasing department needs to spend time collecting information from the supplier and discussing with the specialist the material quality.
|Negotiate the price
|After the material quality meets a certain requirement from the team, the purchasing department needs to discuss the price and credit term. If the supplier is not willing to negotiate on price or credit terms, the team may decide to source the material from another supplier. The team will also consider other factors such as lead time, delivery charges, and minimum order quantity when making its decision.
|Prepare purchase order
|The purchase department needs to prepare a purchase order to order the material. The purchase department is responsible for ordering the materials needed to complete a project. In order to do this, they must prepare a purchase order. The purchase order includes all of the necessary information about the materials, including the quantity, price, and delivery date. Once the purchase order is submitted, the supplier will ship the materials to the project site.
|When the goods arrive, we need to check if the quality and quantity meet our order. Upon receipt of the goods, a visual inspection will be conducted to assess if there are any obvious signs of damage. If there is any damage, this will be noted on the delivery docket and photos will be taken as supporting evidence. A more thorough assessment of the goods will then be conducted to check if the quality and quantity meet our order. This will involve opening up the packaging, counting items, and checking for compliance with specifications.
|Payment processing to supplier
|After receiving goods, the finance department needs to prepare payment to the supplier. We may incur costs such as bank charges and other fees. However, prompt payment is important to maintain good relationships with suppliers. Therefore, it is essential that we make every effort to keep these costs to a minimum. One way to do this is to automate payments where possible. This can help to reduce administrative costs and ensure that payments are made on time. Another way to reduce costs is to negotiate payment terms with suppliers. This can help to get the best possible rate and avoid late payment fees. By taking these measures, we can help to keep our costs down and maintain good relations with our suppliers.
How to Reduce the Ordering Cost?
|Set the reorder point
|The production and warehouse manager should discuss and set the reorder level of inventory in order to prevent any shortage and reduce the order time.
|Clear the obsolete stock
|The obsolete stock still consumes our warehouse space so it will increase the number of orders. We should get rid of it and make more space for new material. And we will be able to store more stock and decrease the number of orders.
|Use JIT system
|Just in time is an inventory management system that aims to reduce inventory management costs.
|The production manager should work closely with the sales department in order to come up with proper planning. With this plan, the purchasing department will be able to set a schedule for purchase orders.