Need & Cost of Inventory

Need to Hold Inventories:

Holding of inventories involves tying up funds of the company and storage and handling costs.

There are three general motives for holding inventories:

1. The Transactions motive: It expresses the need to maintain inventories to facilitate production and sales operation smoothly.
2. The Precautionary motive: It necessitates holding of inventories to guard against the risk of unpredictable change in demand and supply forces.
3. The Speculative motive: It influences the decision to increase or reduce inventory levels to take advantages of price fluctuation.

Cost of Holding Inventory:

Object of inventory management is to maintain the optimum level of inventory.

This optimum level depends on the following costs:

1. Ordering/Acquisition/Set-up Costs: These are the variable costs of placing an order for the goods. Orders are placed by the firm with suppliers to replenish inventory of raw materials.
2. Carrying Costs: These are the expenses of storing goods, i.e., they are involved in carrying inventory.