The second broad category of costs associated with inventory are the carrying costs. They are involved in maintaining or carrying inventory. The cost of holding inventory may be divided into two categories
1. Those that Arise Due to the Storing Of Inventory
The main components of this category of carrying costs are (i) storage cost, that is, tax, depreciation, insurance, maintenance of the building, utilities and janitorial services; (ii) insurance of inventory against fire and theft; (iii) deterioration in inventory because of pilferage, fire, technical obsolescence, style obsolescence and price decline; (iv) serving costs, such as, labour for handling inventory, clerical and accounting costs.
2. The Opportunity Cost of Funds
This consists of expenses in raising funds. (interest on capital) to finance the acquisition of inventory. If funds were not locked up in inventory, they would have earned a return. This is the opportunity cost of funds or the financial cost component of the cost.
The carrying costs and the inventory size are positively related and move in the same direction. If the level of inventory increases, the carrying costs also increase and vice-versa.
The sum of the order and carrying costs represents the total cost of inventory. This is compared with the benefits arising out of inventory to determine the optimum level of inventory.