What Are Carrying Costs of Inventory
Carrying inventory is a big part of every business that sells physical products.
There can be a lot of costs that come with carrying that inventory–and they’re often overlooked. Here’s how you can calculate the carrying costs for your products, why it’s important, and how to reduce your inventory carrying costs.
What are inventory carrying costs?
Inventory carrying cost, also known as holding cost, is the costs involved in holding inventory in a warehouse, storage facility, or distribution center before it’s sold. These costs include rent, utilities and salaries, as well as intangible expenses like opportunity cost.
Inventory carrying costs vary by industry, often adding up to 20%–30% of total inventory value. Carrying costs increase the longer you store an item before sending it to the customer.
Why is the cost of carrying inventory important?
The cost of holding can add up to 25% of all inventory spend, which can affect a business’ overall financial health.
Understanding what’s being spent on carrying inventory can help a business improve their inventory management and supply chain management. Carrying costs are often overlooked, even though they have a significant impact.
These costs also help companies see how profitable their current inventory is. Carrying costs are a significant inventory expense, so once it’s calculated and deducted, it’s easier to measure an item’s actual profit.
How to calculate carrying cost
Inventory carrying costs can be sorted into four categories: capital, storage, service, and inventory risk.
Capital is any additional money spent on buying the inventory, such as interest on a loan.
Storage is the rent, utilities, and personnel costs.
Service is the money spent on inventory management software or insurance.
Inventory risk is the risk of inventory depreciating in value, or being damaged while in storage.
Calculating carrying costs helps businesses determine when they need to improve their processes and practices.
To determine inventory carrying costs, first add up the expenses—capital, storage, labor, transportation, insurance, taxes, administrative, depreciation—over a 12-month period. Then, divide the total costs by inventory value and multiply the number by 100 for a percentage.
Inventory Carrying Costs = Cost of Storage / Total Annual Inventory Value x 100
Capital costs: $5,000
Storage costs: $25,500
Total Carrying Costs: $202,000
Total inventory Value: $5,000,000
Carrying Cost Percentage: 4.04%
This calculation tells us that if we kept a product in storage for a year, it would cost about 4% of the product value. If that’s a $100 product, it will cost us around $4 to store that item for 12 months, or $1 to store it for a quarter.
Why do companies hold inventory?
If carrying inventory is a big expense and cuts into profits, why do it?
The main reason why companies hold inventory is to avoid supply chain interruptions. Depending on the product, it can take weeks to manufacture and send to the customer if there isn’t inventory on hand.
It can also be more expensive to produce the goods and fulfill just-in-time orders. Shorter production runs tend to be more expensive per part. It’s less expensive to mass produce most things.
On the flip side, holding too much inventory can be just as expensive. If customer demand drops, the cost of holding inventory goes up.
Ideally, companies will find a good balance of having enough inventory on-hand to avoid delays, and keep costs low by not carrying too much inventory.
It’s essential for companies to invest in their inventory management and supply chain management solutions.
How to reduce inventory carrying cost
As we mentioned, there are four main components of carrying costs: capital, storage, service, and risk. Here are some ways that you can reduce these costs.
One way to reduce the cost of capital is to invest in forecasting that leads to smaller, more strategic purchases. You could also negotiate a lower purchase price with suppliers.
Carrying less inventory allows companies to consider moving to a smaller warehouse and reducing the space they use which reduces storage related costs.
Having too much inventory around can tie up money and other resources. This money could be better used for marketing, hiring new people, or other investments that likely have a better ROI than inventory sitting on a shelf.
Lastly, working with the right suppliers and investing in your supply chain management helps reduce costs. This will ensures that you don’t incur too much expense and risk before a customer buys your items.
Spex has served as a local manufacturer since 1946. If you want to learn more about how we can help optimize your supply chain, and provide a range of manufacturing service, reach out to one of our team members.
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Phone: (585) 467-0520
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Rochester, NY 14621