Ordering Costs

Ordering costs are considered expenses related to placing orders for new inventory. Transportation, shipping fees, inspection fees, and other expenses for conveying the order come under it. These costs are generally fixed in nature.

These costs are a component in calculating the economic order quantity (EOQ). This metric tells a business the optimal inventory quantity to order and store. The metric calculation is important to meet consumer demand and fulfill sales objectives. Additionally, tracking the cost of orders can help businesses stay within budget.

• Ordering costs are costs that are incurred at the time of placing an order. Each time a company puts in an order, these expenses are incurred, regardless of the size of the order.
• Shipping fees, unforeseen transportation charges, inspection fees, and other costs associated with acquiring inventory items might all be included in these ordering expenses.
• The costs associated with holding inventories in hand are referred to as carrying costs. Both costs are part of calculating economic order quantity. The carrying costs of the inventory are inversely connected to the ordering costs.

Ordering costs are costs associated with ordering items to fill the inventory from the supplier. Each time a company puts in an order, certain expenses are incurred, regardless of the quantity of the order. The following are a few examples of items attributing to ordering expenses:

• The price of creating a purchase request.
• Cost of the inspection necessary to inspect the commodities when they are delivered and to transport or store them after delivery.
• Processing fees for a supplier invoice associated with an order.
• The price of preparing and sending a payment to the supplier.

The total ordering expenses incurred by a business will rise as more orders are placed. Conversely, if the business decreased the number of orders it placed each quarter, its ordering expenses would go down. The aggregate order expense can be reduced by providing order releases against blanket orders, which are placed in large amounts and cover long periods.

The number of orders can be estimated by dividing the orders demanded annually (D) by the volume per order (Q).

Annual ordering expenses are estimated by multiplying the number of orders by fixed costs independent of the number of units (S).

The formula is as follows:

Let us look at some examples of ordering costs examples:

Example #1

Michelle Food and Beverages has an annual demand of 30,000 units for its food and beverage products. Their volume per order quantity is 50. The ordering cost per order is $5. Their orders can be calculated by dividing total annual demand by the volume per order quantity. 

Applying values to the formula gives the following:

Number of orders = 30,000/50

=600

=600*$5

=$3,000

Example #2

Michel clothing company sells clothes; they manufacture baby clothes. They purchase 30,000 units of fabrics annually in a single order to meet the manufacturing requirement. The expense associated with ordering the fabric is $300.

Carrying expenses rise, but ordering expenses fall in the event of significant purchases. Contrarily, if products are bought in modest amounts, carrying expenses fall, but ordering expenses rise due to the increasing number of orders. Hence, the carrying expenses of the inventory are inversely connected to the ordering expenses; that is, the greater the ordering expenses are, the lower the carrying expenses, and vice versa. 

Efficiency in planning the inventory level and the number of orders influences the business operations and their improvement. For example, businesses can order more than what is necessary and can order less than what is necessary. These two elements move in opposite directions from one another. Obtaining a large quantity at once will raise the organization's inventory carrying expenses but limit the ordering expenses; on the other hand, ordering and replenishing expenses will increase if it places orders of smaller quantities multiple times.

The sum of ordering and carrying expenses contributes to the total stocking cost. This functional analysis and cost implications are the foundation for the business's inventory procurement decision. It addresses the fundamental questions of "how much to order" and "when to order." Determining the economic order quantity can help companies arrive at the exact amount that needs to be ordered.

This has been a guide to what are Ordering Costs. We explain it with its formula, examples, and comparison with carrying costs. You can learn more about financing from the following articles –

• Safety Stock
• Activity Based Costing
• Avoidable Cost