Purposes of Inventory:

Inventories kept by all firms are due to following reasons :

1. interdependence between operations.

2. variation in product demand.

3. flexibility in production scheduling.

4. variation in raw material delivery time.

Because of above reasons, all of the firms have more inclination towards inventory. There are several costs associated with inventory and are given as follows:

Holding Cost

This includes the cost for storage facilities, insurance, handling pilferage, breakage, obsolescence, taxes, depreciation and the opportunity cost of capital. It implies that high holding costs tend to favour low inventory levels and frequent replenishment.

Setup (or Production Change Cost)

Manufacturing of a product needs the essential materials, arranging specific equipment setups, appropriately changing time, filling out the required papers and materials and moving out previous stock of materials. This all contributes to the setup cost.

Ordering Cost

These costs refer to the administrative and managerial costs to prepare the purchase or production order, receiving, transportation cost, and inspection cost.