What Is The Relationship Between Carrying Cost And Ordering Coct?

If various items in stock are multiplied by their purchasing price, one is able to determine the “A” items, those few that account for the highest value, the “B” items, those that come next and account for less value, and the “C” items, the remaining large number of items that have a far smaller share of the total value of inventory. By concentrating on the “A” items and then the “B” items one can develop a strategy that rest on reducing the quantities of “A” and “B” items held in stock to the optimum level. An important element of  this strategy consist of placing several orders of smaller quantities for “A” and “B” items per year instead of placing one order for whole year and keeping these in stock. The smaller the size of the order the less are the carrying costs. But the same, if more orders are placed then an extra cost is incurred as this may entail hiring more personnel to place and process these orders, and increased paperwork.Therefore the greater number of order in smaller quantities. The lower will be the carrying costs, but the ordering costs may increase. The optimum solution would where the two curves intersect.

In developing in ordering strategy we need to take two decisions: How much to order of each item in the “A” and “B” categories or what is the economic order quantity (EOQ);  and when to order this quantity or the reorder point.

To determine EOQ, three figures are needed: The first two are the average inventory for the item, in monetary terms, and the ordering costs, taken as the incremental cost pear or the cost of each additional order. If an enterprise places more orders, there is an increased cost consisting mainly of the salaries of the extra staff that will be required, as well as extra stationery and supplies. The third figure that is needed is the carrying costs. Ordering costs for placing orders, expediting, inspection, and changing or setting up facilities to produce in-house.Carrying costs on invested capital, handing, storage, security, insurance, taxes, obsolescence, spoilage, and data-processing costs.