CPIM Practice Exam

How do you calculate the total carrying cost of an organization's average inventory?

1. By assessing only the risk costs

2. By summing capital, storage, and risk costs

3. By applying a flat percentage to inventory

4. Using only the storage and capital costs

The correct answer is: By summing capital, storage, and risk costs

Calculating the total carrying cost of an organization's average inventory involves considering all the various costs associated with holding that inventory. The correct choice emphasizes the need to sum capital costs, storage costs, and risk costs. Capital costs refer to the opportunity cost of the funds tied up in inventory, which could otherwise be used for investment elsewhere. This cost reflects the potential returns that are foregone when capital is allocated to inventory rather than other investments. Storage costs involve the expenses related to warehousing inventory, such as rent, utilities, insurance, and handling costs. These are the direct costs incurred for storing goods. Risk costs account for the potential losses related to inventory, such as obsolescence, damage, or spoilage, which can happen over time. Inventory is subject to various uncertainties, and these risks must also be factored into the total carrying cost. By summing these three elements—capital, storage, and risk costs—an organization can obtain a comprehensive understanding of the total carrying cost associated with its average inventory. This total is vital for effective inventory management and optimization strategies.