Question

Which of the following costs μst a company track in order to determine the correct level of inventory to keep in stock? (Check all that apply.)

a) Holding Costs
b) Ordering Costs
c) Shortage Costs
d) Setup Costs

Answer 1

To determine correct inventory levels, a company must track holding, ordering, shortage, and setup costs, which are crucial for analyzing short-run costs, calculating average profit, and evaluating profit patterns.

Step-by-step explanation:

To determine the correct level of inventory to keep in stock, a company must track multiple costs that influence the optimal inventory decision. These include:

• Holding Costs: The expenses associated with storing inventory over a period. These can include rental fees for storage space, insurance, depreciation, and opportunity costs.
• Ordering Costs: The costs incurred every time an order is placed. This could encompass the cost of paperwork, payment processing, and receiving and inspecting the goods.
• Shortage Costs: Costs arising when inventory is insufficient to meet demand, potentially leading to lost sales or customer dissatisfaction.
• Setup Costs: Relevant in a manufacturing context, these are the costs associated with preparing equipment and facilities for production.

Understanding these costs helps businesses to analyze short-run costs in terms of total cost, fixed cost, variable cost, marginal cost, and average cost, and to calculate average profit and evaluate potential profit patterns. In turn, this understanding aids in achieving an efficient inventory level that minimizes total costs while meeting customer demand.