What Are Inventory Carrying Costs and How To Calculate Them

Table of Contents

• Inventory Carrying Costs Examples
• Types of Inventory Holding Costs
• How to Calculate Inventory Carrying Costs
• Management and Reduction of Inventory Carrying Costs

There are significant costs associated with carrying inventory and they have an insidious way of cutting into revenue. Inventory Carrying Costs, otherwise known as Holding Costs, vary among industries.

These costs include inventory storage, transportation, labour, shrinkage and insurance. If, for example, you have a complicated process of unloading inventory from delivery vehicles then transporting it to another warehouse, these excess costs will increase the Inventory Carrying Costs. 

Inventory management is a critical aspect of any business, and it's essential to recognize the various costs associated with carrying inventory. Inventory Carrying Costs, also referred to as Inventory Holding Costs, encompass a range of expenses that can significantly impact a company's revenue.

Inventory Carrying Costs Examples

These costs differ across industries and encompass elements, such as:

• Inventory storage
• Transportation
• Labor
• Insurance

For instance, if a company employs a complex process for unloading inventory from delivery vehicles and transferring it to another warehouse, these additional steps will increase the Inventory Carrying Costs.

On average, Inventory Carrying Costs account for 20-30% of the inventory's value, and they tend to rise the longer a product is held in stock. Consequently, it's crucial to pay attention to this key metric to gauge the overall efficiency of your operations.

Types of Inventory Holding Costs

To gain a more comprehensive understanding, Inventory Carrying Costs can be broadly categorized into four main groups:

1. Capital Costs: This includes expenses related to purchasing inventory and any associated fees. For instance, interest paid to finance the inventory falls under this category.

2. Inventory Risk Costs: Encompassing shrinkage, depreciation, and product obsolescence, these costs pose potential risks to a company's inventory.

3. Service Costs: This category includes taxes, insurance, and inventory management software expenses that contribute to the overall carrying costs.

4. Storage Costs: These costs can be either fixed or variable and encompass everything linked to storing inventory. Expenses such as the warehouse's mortgage, labor, utilities, and administrative costs fall under this category.

Opportunity costs also play a crucial role in determining the overall impact of Inventory Carrying Costs. If these costs are excessively high, it can lead to missed opportunities that may affect the company's profitability.

How to Calculate Inventory Carrying Costs

To determine the Inventory Carrying Costs, you'll need to divide the Total Carrying Costs by the Total Inventory Value. The formula for calculating Inventory Carrying Costs is as follows:

Inventory Carrying Costs = Total Carrying Costs / Total Inventory Value

For instance, if a company's total carrying costs amount to $25,000, and the total inventory value is $100,000, you would use the formula: $25,000 / $100,000 = 0.25 or 25%.

Therefore, the Inventory Carrying Costs for the company stand at 25% of the total inventory value.

Understanding and managing these costs are essential for optimizing business operations and maximizing profitability.

How to Calculate Annual Inventory Carrying Cost

Utilizing our example from above, the formula for calculating the Annual Inventory Carrying Cost is derived from the previously mentioned formula.

After obtaining the Total Carrying Costs, divide it by the holding period to calculate the Annual Carrying Cost using the formula:

Annual Carrying Cost = Total Carrying Costs / Holding Period

For instance, if a company's Total Carrying Costs are $25,000, and the holding period is 365 days, the Annual Carrying Cost would be determined as follows: $25,000 / 365 = $68.49 per day.

By applying this formula, businesses can assess their yearly expenses incurred for inventory holding, enabling them to make informed decisions and optimize their inventory management strategies effectively.

Management and Reduction of Inventory Carrying Costs

To tackle Inventory Carrying Costs effectively, a robust inventory control system should be implemented as part of an overarching supply chain management strategy. By calculating the holding costs for each product, businesses can begin to address important questions, such as:

• Are we spending too much on storing excess inventory?
• Are we over-ordering from suppliers?
• Can we free up capital by discontinuing certain product lines with high shrinkage rates or those that require constant discounting?

Subsequently, decisions can be made concerning key aspects like:

• Margins: Evaluating whether certain products' margins adequately cover the holding costs or if adjustments are needed.
• Scheduling / Production: Identifying opportunities to optimize production schedules for products with low holding costs and high demand.
• Storage: Analyzing fixed and variable storage costs to optimize the use of warehouse space and resources.

Regularly calculating both the carrying costs and the inventory turnover ratio on a quarterly basis provides valuable insights into inventory expenses and the effectiveness of the inventory management system. Armed with this data-driven approach, businesses gain a clear sense of their inventory's performance, leading to more informed operational decisions.

The first crucial step in this process is to obtain an accurate count of the inventory. At Zupan, we offer solutions to streamline your inventory management. Connect with us for a demo, and we'll demonstrate how to unlock your inventory's full potential.

Optimize Inventory Carrying Costs Now

Understanding and efficiently managing Inventory Carrying Costs is vital for optimizing business operations, maximizing profitability, and maintaining a competitive edge in the market. By incorporating these insights and calculations into your inventory management strategy, you can pave the way for sustainable growth and success.