Question

What is an opportunity cost related to inventory carrying costs?

Answer 1

Opportunity cost is the cost of alternative forgone by not pursuing it. Inventory carrying cost is the cost incurred for carrying inventory. Inventory is part of working capital. Hence a firm to finance its working capital may borrow the funds from banks or may arrange it through any short term financing like notes payable, etc or can deploy internally generated funds also. If Inventory was not carried by firm the firm could have invested the money in short term investments to generate additional returns. Hence the opportunity cost related to inventory carrying cost is the returns the firms could have generated by investing the money in other alternative investment opportunities available. Alternatively the opportunity cost can also be the cost of borrowing which can be avoided by not carrying inventory and incurring carrying cost.