Stockout cost is the lost income and expense associated with a shortage of inventory. This cost can arise in two ways, which are:
Sales-related. When a customer wants to place an order and there is no inventory available to sell to the customer, the company loses the gross margin related to the sale. In addition, the customer may be lost permanently, in which case the company also loses the margins associated with all future sales.
Internal process-related. When a company needs inventory for a production run and the inventory is not available, it must incur costs to acquire the needed inventory on short notice. For example, the firm may need to pay a rush fee and overnight delivery charges to obtain the inventory. In addition, the production planning staff must scramble to adjust the production plan, advancing some other job in the schedule to replace the job that cannot be run until the required inventory has been received.
It is not always easy to discern the stockout costs incurred by a business. This is because lost sales do not appear on its income statement, and the costs associated with rush purchases are usually buried in the cost of goods sold line item.
A business can avoid stockout issues by maintaining a high level of inventory record accuracy and a reasonable safety stock level that is adjusted to match ongoing changes in customer demand.