How To Calculate Inventory Holding Costs: Complete Guide

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 are the costs of carrying inventory. These costs can include the cost of the inventory itself, as well as the cost of storage, insurance, and any other associated expenses.

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The amount of inventory holding varies based on the industries to industry. Even in some industries, a small-scale business might have low inventories than the larger ones! Overall the cost of inventories varies based on the company sizes & industries. The cost of inventory holding hugely affects the organization's health, and if the company cannot handle this situation, it might end up with a cash flow situation. Specific components affect the cost of inventory holding, and those are: 

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• Capital amount

• The service cost for inventory

• Cost of storage space

• Inventory risk cost

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Does your company invest vast amounts of money in inventory? Does the cost of inventory carrying affect the development of the business? If this is the situation, you must try the tips to minimize it with the inventory holding cost formula mentioned below.

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Where You'll Need to Calculate Inventory Holding Costs

Storing the inventories within the personal space like a home can keep the fee low. But is this a practical solution? So, this is not an economical solution for a business that desires to grow significantly. Generating the orders manually is the most tedious & time-consuming technique. 

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When your business grows, the cost of inventory carrying also increases! So, if you are looking for the best storage solution, consider the following examples that involve holding costs.

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Fulfillment Centers

This is the physical location that third-party logistic companies mostly run. Some logistic service providers also take responsibility for the fulfillment centers. These centers are known for processing order fulfillment on behalf of the eCommerce store or retail companies with which they have collaborated! These are on-demand short-term storage solutions and ideal options for the growing business. These centers store inventories and take orders, pack, and ship them.

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Related: What Is An Amazon Fulfillment Center?

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Warehouses

This large storage area was built purposely by the companies or taken in the lease for storing the inventories. The area is surrounded by 1,000 square feet & more than that. The warehousing process depends upon the inventory type the business handles and the type of products they sell. If your business deals with food and chemicals or medications, it is recommended to store them in special units.

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Storage Facilities

Once your business outgrows the storage space for inventories, the storage facilities option can be the most prominent example. This short-term solution is far smaller than the above 2 options and does not offer any order fulfillment & inventory auditing! 

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Related: How to Liquidate Amazon Inventory

How To Calculate Your Inventory Holding Cost

When calculating the inventory holding cost, you can evaluate the profits you can make. By calculating the price, you can avoid unnecessary costs & prevent your business from losses. Calculating the inventory carrying cost can be done in 2 methods. Let's take a look at the holding cost formula. 

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Method 1: This is the standard & rough way to estimate the cost of inventory carrying of a business.

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The cost of inventory holding = The overall value of annual inventory/4

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For example, if the yearly value of inventory is 100000, the cost of inventory holding will be 100,000/4= 25,000

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Method 2: This is the most precise method of inventory holding cost.

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Cost of inventory carrying = Sum of Inventory holding/ overall value of inventory carrying multiplied by 100.

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The value of inventory carrying cost depends upon the inventory cost, which consists of storage, capital, risk & services. Let's take a look at an example.

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Examples Of How To Apply Inventory Holding Cost Calculations

The inventory value of a company= 100, 000 

Capital value= 10,000

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Storage cost = 2,000

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Service = 4,500

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Costs of Inventory risk = 3,500

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The overall inventory holding sum= 10,000 + 2,000 + 4,500 + 3,500 = 20,000

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Cost of Inventory holding (Based on the formula) = 20,000/100,000 x 100 = 20%

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Based on this, the cost of inventory carrying is 20%

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Tips To Reduce Holding Costs

For the company's best growth, you need to keep the cost of inventory carrying low. Some common strategies a business can try are:

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Optimizing The Inventory

As an owner of the company, you need to make a balance between overstocking & lower stocking. The business shouldn't reach the point where they have inadequate stocks and overstocks. The inventory optimization depends upon the sales patterns. The inventory level varies based on the type of item. It depends upon the products which sell out quickly and take longer time. 

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Upgrading The Warehouse

It is recommended to choose an ideal option for the warehouse for more than just storage purposes. The warehouse should be well-organized, so it can be easy and quick to locate the items. When a business has the ideal option of the warehouse, you can save money by lowering the tax and insurance premiums & depreciation costs. 

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Inventory Management Automation

Managing the inventory is a tedious task when it is done manually. Using advanced level of technologies for the optimization and management of stock can make your task easy. Multiple software on the internet allows the business to review, update and use the inventory information in real-time value. The software helps the companies by giving a clear & straightforward picture of inventory. The inventory system's report helps simplify the inventory pattern, ultimately reducing costs.

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Related: eCommerce Inventory Management Tips & Tricks

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Evaluating The Emerging Trend

To avoid the excessive stock, the business should follow emerging trends. The business must have a deep understanding of trends in the industry. You can evaluate this by going through the collection, analysis & interpretation. The companies should track the micro & macro sales reports regularly.

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Subscribe The Long-Term Agreements

Small businesses should get into a partnership with companies for long-term agreements. It is necessary to develop a good relationship with suppliers and retailers. By doing so, you can minimize expenses.

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Related: eCommerce Inventory Management Tips & Tricks

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Benefits Of Reducing Inventory Holding Costs

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Reducing Material Maintenance

Excessive inventory holding leads to extra storage space and cost. You also have to pay for the space and resources when you hold more inventories. You are also paying the transportation cost & labor fee. The price you pay for the materials is reduced by reducing the inventory. 

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Competitive Cost

When you work where your business is dealing with cutthroat competition, reducing inventory costs can make your service more competitive in the market. You will get a more comprehensive amount of exposure in the market. It might make you the leading leader in the market.

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Increased Profit

The lower expenses in inventory holding generate better profit. It makes a business flexible in the market. It would help if you were flexible with the number of inventories you order because of the product life cycles. If you have too many products that will expire within 6 months, it might leave you to pay unnecessary costs and space consumption. This is how reduced inventory is the key to success.

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Easy To Organize

The reduced inventory holding cost also gives better access to the space. You can easily organize the products in the warehouse. It takes less time to collect the goods and retrieve them when necessary. This makes the inventory simple and efficient. This is helpful, especially for companies with high inventory turnover values and needing space to get new products on the shelf quickly.

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As a business owner, it is necessary to maximize the profits and growth of the business. The key to a successful inventory management system is to maximize profit & prevent loss. Calculating the cost of inventory carrying is the most overlooked section for any business. The business needs to follow the above-discussed information to make a successful balance.

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Related: How Amazon FBA Automation Saves Time and Money

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Inventory Holding Cost FAQs

What factors affect inventory holding costs?

Factors that affect inventory holding costs include the following:

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-The cost of the inventory itself (e.g., the price of the goods and materials, storage and handling fees, insurance premiums)

-The amount of money tied up in inventory (the more money a company has tied up in inventory, the higher its holding costs)

-The space used to store inventory (the more space a company has to store inventory, the higher its holding costs)

-The time it takes to order new stock and get it delivered (the longer it takes to get new stock, the higher its holding costs)

-The risk of spoilage or damage to stored items (the greater the risk of spoilage or damage,

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How can inventory holding cost be used as a competitive advantage?

The inventory holding cost can be used as a competitive advantage by decreasing the amount of stock a competitor needs.

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This can be done in a few ways. One way is to offer products that are not available to your competitor. This will force them to keep more inventory on hand, and eventually, they will need more space or money to continue doing so. Another way is to have better stock management practices, allowing you to sell products close to being out-of-date without taking too much of a loss. Either way, having lower inventory holding costs than your competitors gives you a competitive edge.

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What are some common mistakes made when trying to reduce inventory holding costs?

Some of the common mistakes are:

• Having too many storage points

• Disbalance in performance indicators

• Focusing on price instead of cost

• Inconsistency in employee training and many more!

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Are holding costs and carrying costs the same?

The terms "holding costs" and "carrying costs" are often used interchangeably, but they have different meanings. Holding costs are the costs of maintaining a good or property while not being used in production. Carrying costs, on the other hand, are the costs of holding a good or property until it can be sold.

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The most common holding costs include insurance, taxes, and storage fees. Carrying costs usually include interest payments (on any money borrowed to finance the purchase of the goods or property) and storage and insurance expenses.

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Related: What's the Difference Between Warehousing and Storage

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Conclusion

If you're looking to reduce your inventory holding costs or stay on top of what they are, follow the tips in this article. By understanding all the factors that go into calculating these costs, you can minimize them and optimize your operations for profitability. And if you ever need help with eCommerce order fulfillment, our team at Simpl is always here to lend a hand.

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Recommended: Don't Let This Happen to You: Inventory Discrepancy