How To Calculate Inventory Holding Costs: Complete Guide

Virginia Miller

May 25, 2024

In this article

In this competitive market, companies must be careful regarding unnecessary expenses. Inventory holding costs are necessary for companies that store raw materials & other manufactured goods after purchasing. For any business, it is essential to maintain the balance between the holding inventories. If you have excessive inventories over time, the cost of holding inventory can be expended. The inventory carrying cost is the fee a business has to pay when they store inventory in the warehouse.

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In this article, we will briefly share the cost of holding inventory. Let's look at how to calculate the inventory carrying cost & tips to minimize the cost and its benefits.

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What Are Inventory Holding Costs?

Inventory holding costs refer to the expenses related to storing unsold inventory over a period of time. These costs include:

Warehouse rent and utilities
Insurance
Security
Equipment depreciation
Inventory financing
Risk of obsolescence, damage or spoilage

Holding costs can vary significantly across industries and business sizes. On average, holding costs range from 20-30% of the inventory value per year. For fast-moving consumer goods, costs tend to be on the lower end, while slow-moving spare parts can lead to very high carrying costs.

Where Inventory Holding Costs Apply

Businesses deal with inventory holding costs in facilities including:

Warehouses - Large storage facilities owned or leased by the company.
Fulfillment centers - External warehouses that handle order processing and shipping on behalf of ecommerce merchants.
Distribution centers - Facilities that store inventory and enable transportation to retail locations.
Storage units - External self-storage spaces used temporarily when warehouse capacity is exceeded.

Calculating Your Inventory Carrying Cost

You can estimate inventory carrying costs using the following formula:

Annual Holding Cost = Average Inventory Value x Carrying Cost Percentage

The carrying cost percentage represents the cost of holding inventory, expressed as a percentage of the average inventory value per year. A reasonable estimate is 25%.

Strategies to Reduce Inventory Holding Costs

Here are some proven methods to lower inventory carrying costs:

Implement inventory optimization models to align stock levels with demand.
Renegotiate warehouse leases and storage rates.
Reduce insurance costs by improving warehouse safety and security.
Leverage inventory management software to minimize excess stock.
Enter vendor agreements to improve purchasing terms and transportation rates.

The Benefits of Lower Inventory Holding Costs

Increased cash flow from reduced capital tied up in inventory
Flexibility to respond better to changes in customer demand
Improved organization and accessibility of stock items
Enhanced profit margins

By understanding and controlling inventory holding costs, businesses can operate more efficiently and boost their bottom line. With some effort, most companies can reduce their carrying costs by 10-20%.

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FAQs

What are the main components of inventory holding costs?

The main components are capital costs, storage space costs, inventory service costs, and inventory risk costs.

How do you calculate inventory holding costs?

Use the formula: Holding Costs = Sum of Holding Costs / Total Inventory Value x 100. Or take the total annual inventory value divided by 4.

What drives inventory holding costs up?

Factors like large storage spaces, high insurance premiums, slow inventory turnover, and inefficient warehouse operations increase holding costs.

What are some ways to reduce inventory holding costs?

Optimize inventory levels, upgrade warehousing, automate management, follow trends, and make long-term supplier agreements to reduce costs.

What are the benefits of lower inventory holding costs?

Benefits include reduced material handling, increased competitiveness, higher profits, easier organization, and flexibility.

Should I outsource my order fulfillment to cut inventory costs?

Yes, working with a 3PL order fulfillment provider can significantly reduce your inventory expenses and overhead.

How much money can I save by lowering my inventory carrying costs?

Savings vary by business, but cutting holding costs by even 5% can increase profits by thousands for medium-large companies.

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