Definition of Ordering Costs
Ordering Costs also known as setup costs which is incurred at the time of placing an order. This costs are related with the preparation of supplier’s order, including the costs of placing an order, inspection costs, documentation costs and other costs associated with an order.
The formula of Ordering Costs are :
Ordering Costs = Number of orders per year x Ordering Costs per year
Items of Ordering Costs
Ordering costs can be segregated into several types which are described as follows:
- Cost of Preparation of Purchase Order:
There are many costs incurred for the preparation of purchase order, these are :
- Invoice Processing costs
- Accounting costs
- Communication costs
2. Transportation Costs:
Transportation costs is the costs of moving the goods to the warehouse or to the store. Transportation costs are highly variable across different industries and items.
3. Receiving Costs:
Receiving costs includes cost of unloading goods at the warehouse, and inspecting the goods to make sure quality is ensured as per the specification.
4. Costs of Electronic Data Interchange (EDI) :
These are systems used by large businesses and especially retailers, which allow ordering processing costs to be significantly reduced.
5. Other costs:
Other Ordering costs includes processing payments costs, receiving and inspecting the materials costs, machine set up costs, start up costs, costs of reviewing inventory levels etc.
Example of ordering costs
Imperial Hospital Limited requires 200,000 units of item – A annually. Each order ordering costs is $ 200 which includes staff costs and freight & handling costs . If the firm make one order annually, its ordering costs will be $ 200. But if the firm decides to make 4 order annually of 50,000 units each, then annual ordering costs will be ($ 200 x 4) = $ 800.
From the example it proves that the more the number of orders, the higher the ordering costs. Hence, ordering costs can be minimized by reducing the number of orders.