In making any decision with respect to inventories, the following costs should be taken into consideration:
Holding or Carrying Costs Thi broad category i usually subdivided into three segments: storage costs. capital costs. and obsolescence/shrinkage cost. Storage costs include the cost of the storage facility in the form of rent or depreciation. insurance, taxes, utilities, security. and facility personnel.
Capital costs can vary, depending on the firm's financial situation. For example. if the firm has an excess of cash, then the capital co interest lost by putting the money into inventory instead of short-term notes. If the firm has an alternative project to invest in, then the capital cost is the opportunity cost of the anticipated return of that project. If the firm has to borrow funds to maintain an inventory, then the capital cost is the interest paid on these funds.
Obsolescence costs recognize that products tend to depreciate in value over time. This is especially true in high technology industries where newer and better (and often cheaper) products are constantly being introduced. In this ca ego. we also include spoilage costs associated witt: products that have a short shelf life. like pen'stable food products and some types of prescription drugs. Shrinkage costs track pilferage and breakage.