Ordering cost

Ordering cost
See also
Optimization of the production run-length Cycle stock Fill rate ABC method Differential costing Economic batch size Variable overhead efficiency variance Batch cost Purchase price variance

Ordering cost is the type of cost that represents the expenses which are incurred for the supplier in the aim to make and adapt an order. Ordering costs are taken into account when determining the amount of an economic order for a warehouse element. Along with the amount of orders ordered the total ordering costs also are going to rise. This total cost can be toned down when we put the huge colevtive orders for long intervals, the next step is to put out an order for the collective orders.

The unit is able to accept the high total ordering cost unless the effect is an increase concerns the total cost of transporting stocks. It happens if the company places orders such as raw materials and goods only when required. In order to place more orders in a situation where there are not so many stocks within easy reach. To correctly equalize the volume of orders and thus minimalize overall costs the company is obligated to oversee the ordering costs and costs of running a warehouse incurred by the company.

"Examples of ordering costs are (S. Bragg, 2018):

• Cost to prepare a purchase requisition
• Cost to prepare a purchase order
• Cost of the labor required to inspect goods when they are received
• Cost to putaway goods once they have been received
• Cost to process the supplier invoice related to an order
• Cost to prepare and issue a payment to the supplier"

Economic order quantity(EOQ) inventory model

The EOQ model made his debute st the beginning of the 21st century and normally accepted in many trades so far. Many earlier deterministic inventory models are being prepared foreseeing demand being constant or depending on the inventory in the case of inferior items (M.Pattnaik 2013, p.58). "Economic order quantity (EOQ) is a decision tool used in cost accounting. It’s a formula that allows you to calculate the ideal quantity of inventory to order for a given product."(K. Boyd 2018). The aim of the calculations is to reduce orders and costs of carrying.

$Q={\sqrt {\frac {2DS}{H}}}$

where:

• Q represents EOQ
• D - demand
• S - ordering cost
• H - cost of carrying (per unit)

Moreover, the ordering costs are presented per order.

Examples of Ordering cost

1. Purchasing and Processing of Supplies: Purchasing and processing supplies from suppliers often involve significant ordering costs. These costs include the time and money spent negotiating with suppliers, researching and selecting products, preparing and submitting purchase orders, and verifying invoices.
2. Shipping and Handling: For many businesses, the cost of shipping and handling goods is a significant component of their ordering costs. Businesses may incur costs for boxing, crating, and palletizing products, as well as the cost of transporting goods from the supplier to the business.
3. Storage and Inventory: Many businesses also incur costs associated with storing and maintaining inventory. These costs include the cost of space and personnel to manage the inventory, as well as the cost of insurance and taxes associated with storing inventory.
4. Accounting and Record-Keeping: The cost of accounting and record-keeping is another component of ordering costs. Businesses must track purchase orders, invoices, and other financial documents associated with ordering supplies. This cost includes the time and money spent creating, processing, and maintaining records.

Advantages of Ordering cost

Ordering cost is the cost incurred for a supplier to make and adjust an order. Here are some of the advantages of ordering cost:

• It helps in determining the best economic order quantity for a warehouse item. This helps in reducing the total ordering cost by ordering large quantities at once.
• It helps in reducing the cost of material handling and storage, as fewer orders are placed.
• It also helps in reducing the number of times the same item has to be processed, thus saving time and effort.
• It also helps in maintaining the inventory level of a warehouse, as it ensures there is enough stock available to meet the demand.
• It also helps in avoiding stock-outs and reducing the risk of lost sales.
• It also helps in avoiding wastage of resources by ordering the right amount of stock.
• Finally, it helps in improving customer satisfaction by providing timely delivery of goods.

Limitations of Ordering cost

Ordering cost is an important consideration when managing inventory and supply chains. However, there are some limitations to be aware of when it comes to this type of cost. These include:

• Unpredictable costs: Ordering costs often come as a surprise and are difficult to predict, making it difficult to plan for them.
• Lack of visibility: Ordering costs can be hard to track and monitor, making it difficult to determine if the cost is in line with expectations.
• Risk of overspending: Without proper tracking, it is possible to overspend on ordering costs, leading to an inefficient use of resources.
• Potential for delays: Ordering costs can lead to delays in the delivery of goods, resulting in customer dissatisfaction.
• Costly mistakes: Mistakes in ordering can be costly and difficult to rectify, leading to further delays and additional costs.

Other approaches related to Ordering cost

Ordering cost is an important factor in inventory management and order fulfillment. There are several approaches to minimizing ordering costs and optimizing inventory management. These include:

• Just-In-Time (JIT) Inventory Management: JIT is a system of inventory and production management that reduces the amount of inventory on hand by ordering only what is needed, when it is needed. This allows the company to avoid costly overstocks and minimize ordering costs.
• Vendor Managed Inventory (VMI): VMI is a system where the supplier takes responsibility for managing and monitoring the inventory levels of the company. The supplier is able to anticipate future demands and order what is needed when it is needed, thus reducing the number of orders and the associated costs.
• Automated Reordering: Automated reordering systems use software programs and inventory data such as minimum and maximum levels to automate the ordering process. This helps to ensure that the right amount of inventory is ordered at the right time, thus reducing the cost of ordering.
• Quantity Discounts: Many suppliers offer discounts on orders of certain quantities. Taking advantage of these discounts can help to reduce ordering costs.

In summary, there are several approaches which can be employed to reduce ordering costs and optimize inventory management. These include Just-In-Time (JIT) Inventory Management, Vendor Managed Inventory (VMI), Automated Reordering, and Quantity Discounts.

References

• Boyd K. (2018). Cost Accounting: The Economic Order Quantity Formula, "Dummies"
• Bragg S. (2018). Ordering costs, "Accounting Tools"
• Gholami A., Mirzazadeh A. (2018). An inventory model with controllable lead time and ordering cost, log-normal-distributed demand, and gamma-distributed available capacity, "Cogent Business and Management", Vol. 5
• Goyal A. K., Chauhan A., Singh S. R. (2015). An EOQ inventory model with stock and selling price dependent demand rate, partial backlogging and variable ordering cost, "Int. J. Agricult. Stat. Sci.", Vol. 11, No. 2, pp. 441-447
• Pattnaik M. (2013). Optimization in an instantaneous economic order quantity (EOQ) model incorporated with promotional effort cost, variable ordering cost and units lost due to deterioration, "Growing Science", Vol. 1, pp. 57-66
• Rad R. H., Razmi J., Sangari M. S., Ebrahimi Z. F. (2014). Optimizing an integrated vendor-managed inventory system for a single-vendor two-buyer supply chain with determining weighting factor for vendor׳s ordering cost, "ScienceDirect", Vol. 153, pp. 295-308

Author: Karolina Korbut