CPIM Practice Exam

What is the total inventory cost formula comprised of?

1. Annual ordering cost + annual carrying cost

2. Lot size quantity + order point

3. Replenishment lead time + safety stock

4. Order point + total stock on hand

The correct answer is: Annual ordering cost + annual carrying cost

The total inventory cost formula is fundamentally comprised of the annual ordering cost and the annual carrying cost, as these two elements represent the primary costs associated with holding inventory. Annual ordering cost refers to the costs incurred each time an order is placed, which can include order processing costs, shipping, and handling costs. As the frequency of orders changes—or the lot size ordered affects this cost—it is critical to account for these expenses in order to manage inventory effectively. Annual carrying cost, on the other hand, includes the costs associated with holding inventory over time. This encompasses expenses such as warehousing, insurance, depreciation, and the opportunity cost of capital tied up in unsold inventory. By summing these costs, businesses can ascertain the total cost of their inventory, allowing them to make more informed decisions about procurement, stocking levels, and inventory management strategies. In contrast, the other options focus on specific logistical aspects of inventory management, rather than capturing the broad financial implications of inventory holding. For instance, lot size quantity and order point relate to the mechanics of ordering but do not convey their cost impact. Replenishment lead time and safety stock involve timing and risk management, which are essential for ensuring inventory availability, but they do not constitute a measure of total inventory costs.