Exam 12: Managing Inventories

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1. Ordering costs or setup costs are incurred as a result of the work involved in placing orders with suppliers or configuring tools, equipment, and machines within a factory to produce an item. Order and setup costs do not depend on the number of items purchased or manufactured, but rather on the number of orders that are placed.
2. Inventory-holding or inventory-carrying costs are the expenses associated with carrying inventory. Holding costs are typically defined as a percentage of the dollar value of inventory per unit of time (generally one year). They include costs associated with maintaining storage facilities, such as gas and electricity, taxes, insurance, and labor and equipment necessary to handle, move, and retrieve an SKU.
3. Shortage or stockout costs are costs associated with a SKU being unavailable when needed to meet demand. These costs can reflect backorders, lost sales, or service interruptions for external customers, or costs associated with interruptions to manufacturing and assembly lines for internal customers.
4. Unit cost is the price paid for purchased goods or the internal cost of producing them. In most situations, the units cost is a "sunk cost" because the total purchase cost is not affected by the order quantity.