What Is Ordering Cost In Accounting?
Ordering cost is a fixed expense incurred when placing orders for new inventory. This cost includes transportation, shipping fees, inspection fees, and other expenditures necessary for conveying the order. It is a component of the economic order quantity (EOQ), which is used to determine the optimal quantity of inventory to order and store.
Tracking the cost of orders helps businesses stay within budget and meet consumer demand and sales objectives. EOQ calculation is a key factor in successful inventory management. The amount spent on ordering costs ought to be weighed against the cost of holding stock, as well as other associated costs.
There are various strategies that can be employed to reduce ordering costs while still ensuring adequate inventory levels. These include setting minimum and maximum order limits, using bulk orders, and utilizing a just-in-time inventory management system.
Understanding the concept of ordering cost is essential to managing inventory levels efficiently and cost-effectively.
Formula
The order cost formula is comprised of various cost factors, including tax, insurance premiums, staff cost, inspection cost, payment fee, and other incurred costs.
Tax refers to any import tax associated with the order and the insurance premiums are the insurance paid on the product.
The staff cost includes labor costs for handling and transporting the order.
Inspection cost is any inspection costs incurred during the process and payment fee refers to any fees incurred for payments.
Other incurred costs can include tool taxes, maintenance costs, and other associated costs.
Understanding the order cost formula is important for businesses to be able to accurately calculate the cost of orders.
It is also important to consider the various other cost factors associated with the order, such as payment fees and other incurred costs.
Items of ordering cost
Inventory management is an important element of ordering cost, as it can affect the amount of money spent on ordering. The various items of ordering costs include:
| Item | Description | Cost |
|---|---|---|
| Preparing purchase orders | Invoice processing, accounting, and communication costs | Variable |
| Transportation | Moving goods to the warehouse or store | Variable |
| Receiving | Unloading goods at the warehouse and inspecting for quality | Variable |
| Electronic Data Interchange (EDI) | Reducing ordering processing costs | Variable |
| Other | Processing payments, receiving and inspecting materials, machine setup, start-up costs, and reviewing inventory levels | Variable |
EDI systems are important, as they help reduce the cost of ordering and speed up the process. Other costs such as machine setup and start-up costs need to be considered when calculating the cost of ordering. Additionally, the cost of receiving and inspecting materials can be reduced through quality control measures. Finally, reviewing inventory levels regularly can help ensure that the right amount of stock is ordered at the right time.
Example
Maximizing efficiency and reducing costs are important aspects of inventory management and can be achieved through the implementation of an EDI system.
In the case of Imperial Hospital Limited, the ordering cost of 200,000 units of item – A annually is dependent on the number of orders made. For example, if one order is made annually, the ordering cost is $200. However, if four orders are made annually with 50,000 units each, the ordering cost increases to $800. This illustrates that the more orders made, the higher the ordering cost.
As such, the ordering cost can be minimized by reducing the number of orders. By implementing an EDI system, Imperial Hospital Limited would be able to streamline its ordering process and ensure that the ordering costs remain low. This would help the company save on costs and maximize efficiency, which is essential for successful inventory management.
Conclusion
Ordering cost is an important component of inventory management that must be carefully evaluated in order to ensure optimal inventory levels. It encompasses the costs associated with obtaining and processing inventory orders, such as supplier costs, transportation costs, and processing costs.
The ordering cost formula is comprised of fixed costs and variable costs, with each item of the cost being determined by the particular inventory management strategy in place.
Through the careful evaluation of ordering cost, businesses can ensure that inventory levels are kept at an optimal level, resulting in a more efficient and cost-effective operation.