Cost of holding inventories, Financial Management

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Q. Cost of Holding Inventories?

The holding of inventories engages blocking of a firm's funds. The various risks as well as costs in holding inventories are as below:

(1) Capital Costs: - Maintaining of inventories consequence in blocking of the firm's financial resources. The firm has thus to arrange additional funds to meet the cost of inventories. The funds possibly arranged from own resources or from outsiders. However in both cases the firm acquires a cost. In the previous case there is an opportunity cost of investment while in the later case and the firm has to pay interest to outsiders.

(2) Storage and Handling Costs: - Holding of inventories as well involves costs on storage as well as handling of materials. The storage costs include:

(i) Rent of the Godown

(ii) Insurance charges and so on.

(3) Risk of Price Decline: - There is forever a risk of reduction in the prices of inventories by the suppliers on holding inventories. This may be because of increased market supplies and competition or general depression in the market.

(4) Risk of Obsolescence: - The inventories may become obsolete due to change in requirements, improved technology, change in customer's tastes etc.

(5) Risk Deterioration in Quality: - The quality of the materials may as well deteriorate while the inventories are kept in stores.


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