Ordering costs

Ordering costs are the expenses incurred to create and process an order to a supplier. These costs are included in the determination of the economic order quantity for an inventory item. Examples of ordering costs are:

  • 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

There will be an ordering cost of some size, no matter how small an order may be. The total amount of ordering costs that a business incurs will increase with the number of orders placed. This aggregate order cost can be mitigated by placing large blanket orders that cover long periods of time, and then issuing order releases against the blanket orders.

An entity may be willing to tolerate a high aggregate ordering cost if the result is a reduction in its total inventory carrying cost. This relationship occurs when a business orders raw materials and merchandise only as needed, so that more orders are placed but there is little inventory kept on hand. A firm must monitor its ordering costs and inventory carrying costs in order to properly balance order sizes and thereby minimize overall costs.

Related Courses

Inventory Management