Table of Contents
Inventory carrying cost is a term used in business to describe the average amount of money companies spend on buying inventory and holding it. Inventory carrying costs can vary by industry, but one thing’s for sure: inventories don’t always turn out to be profitable.
Enterprise organizations often carry far too many products they don’t sell because they’re afraid that if they stop selling something, their stock price will drop as well as their overall profit margin. So what are you waiting for? Let us show you how we can help reduce your inventory carrying cost!
Inventory holding cost is the amount of money that a business spends on materials and inventory to keep it in stock. The formula for inventory holding cost is: C = P x Q where C is the cost, P is the price per unit, and Q is the quantity. There are many ways to reduce inventory carrying costs such as reducing prices, increasing production rates, decreasing order sizes, or using less expensive materials. Read more in detail here: inventory holding cost formula.
The entire amount of charges a small firm must pay to retain and store unsold products is referred to as inventory carrying cost, also known as holding cost or carrying cost. This comprises both direct and indirect expenses such warehouse leasing, staff compensation, Insurance, electricity, and taxes, as well as Depreciation and Shrinkage.
How to Calculate the Cost of Keeping Inventory
Carrying expenses often account for 20%–30% of inventory value as a general rule of thumb. You may use the following formula to receive an estimate for your company:
Inventory carrying costs are calculated as follows: yearly inventory value / 4
However, the precise statistic is extremely dependant on your company’s data. So, if you want to figure out your own inventory carrying expenses, apply some more precise arithmetic and multiply by 100 to obtain your % value:
(storage charges / yearly inventory value) * 100 = inventory carrying costs
Here’s what you should include into your storage costs:
- Rent/lease/mortgage/loan for a warehouse
- Utilities
- Wages for employees
- Insurance
- Inventory costs
- Transport to and from the storehouse
- Taxes
- Fees for administration
- Fees for software and technology
- Interest
- Depreciation
- Obsolescence
- Shrinkage
- Cost of opportunity
Example of Inventory Carrying Costs
Let’s take a look at a hypothetical Example of Inventory Carrying Costs to see how it works in the real world.
Manifesto Mocktails provides mocktail cocktails that have already been blended. It’s curious about inventory measurements, particularly because its goods are perishable. Manifesto Mocktails wants to make sure it can sell its goods before it runs out, therefore it’s chosen to look at carrying expenses more thoroughly.
The beverage retailer rents a climate-controlled warehouse storage space for $1,000/month, averaging around $250/month in Utilities. This is where it keeps $5,000 worth of product. Warehouse labor expenses are approximately $2,000/month, Insurance is $500/month, and shipping is another $500/month. Manifesto Mocktails also calculates $300/month in Depreciation, Shrinkage, Obsolescence, and Cost of opportunity.
The following is the retailer’s inventory carrying costs calculation:
((1,000+250+2,000+500+500+300) / 5,000) * 100 = Inventory carrying cost
Carrying cost of inventory = (4,550 / 5,000) * 100
Carrying cost of inventory = 0.91 * 100
The carrying cost of inventory is 91 percent.
Manifesto Mocktails has a substantially higher than usual inventory carrying cost in this situation. Remember that average carrying costs are between 20% and 30% of inventory value. This implies that the corporation should seek methods to reduce its holding expenses.
How to Lower the Cost of Keeping Inventory
Your holding costs might be expensive for a variety of reasons:
- Stock on hand/safety stock is excessive.
- High rent and utility costs
- Marketing and advertising that is ineffective
- Inventory that moves slowly
- Inventory management and forecasting are inefficient.
- Inventory methods and technologies are lacking.
- Products that are costly
Fortunately, small firms may decrease holding expenses in a variety of ways.
Work up a deal with wholesalers.
First and foremost, you may reduce your inventory capital expenditure by obtaining better prices with your suppliers. Your strategy is influenced by elements such as order volume, order value, and account history, as well as your connection with the provider. You may negotiate for alternative savings, such as free or discounted freight, if the supplier is unwilling to bend on wholesale price.
Make a Deal With Your Warehouse
Warehouse space is expensive, but it is necessary. According to one estimate, the average cost of storage is $6.53 per square foot. If you rent a warehouse space, you may negotiate with your landlord. Your strategy and success rate, similar to bargaining with manufacturers and suppliers, is based on a range of distinct criteria.
Improve the Efficiency of Your Warehouse
Whether you have luck or not with your negotiations, there are other ways you can reduce warehousing expenses that are more in your control. To start, you’ll want to Improve the Efficiency of Your Warehouse layout. Are you getting the most out of your space? Is it easy and efficient for your staff to navigate and do their job? Your organizational efforts may even reveal an opportunity to downsize. Moving to a smaller warehouse can be especially helpful competitively, considering the average size of retailers’ warehouses is growing and 87% of businesses have warehouse expansion plans through 2024.
Consider purchasing inventory management software.
Poor planning is one of the leading causes of high holding costs, and you can counteract it using technology. Finding the finest inventory management software for your company will provide you with more accurate reporting, better forecasting, and a more complete view so you can prepare ahead of time. It’s no surprise that demand for inventory management software increased between 2015 and 2020, yet just 18% of small firms use it, giving those that do a competitive edge.
You may more easily acquire the proper quantity of goods, organize marketing and advertising campaigns accordingly, and put yourself up for long-term success by using excellent inventory management software. Inventory management software may also help you save money on administrative expenses and reduce the amount of insurance and taxes you have to pay by optimizing inventory levels.
Use these resources to identify the finest inventory management software for your company:
If you only need a quick solution, you can also download our free inventory management worksheet.
Invest in software for warehouse management.
Warehouse management software offers many of the same advantages as inventory management software, with the exception that these systems are solely focused on managing and improving your actual warehouse space. Inventory management software focuses on the inventory that takes up that area.
Because it helps you better utilize your space for cost-effectiveness, your warehouse management software plays a crucial part in minimizing holding costs. You’ll also learn more about your area, including how it’s arranged, how your team moves about it, and how your merchandise is kept. Effective warehouse management also aids the order fulfillment process, making it more efficient and straightforward for your employees to complete orders.
Finding warehouse management software that interfaces with your inventory management platform is a smart move.
Use the First In, First Out (FIFO) principle.
When you use the first in, first out (FIFO) method, the first item you place on your shelf is also the first thing you distribute when you make a sale. This is particularly beneficial for firms who offer perishable items, such as Manifesto Mocktails, since the danger of expiry is reduced. FIFO (first in, first out) is a method of reducing obsolescence holding costs.
What You Can Automate
The more human resources you require to do inventory-related activities, the more vulnerable your company becomes to human mistake and escalating labor expenses. While increasing efficiency and cost-effectiveness, automation may help remove some of the monotonous activities off your workers’ plates so they can concentrate on more demanding and gratifying jobs.
Defeat Shrink
Inventory Shrinkage is when stock goes inexplicably missing. Shrink happens under a number of circumstances, including external and internal theft, human error, and inaccurate data. There are many ways you can Defeat Shrink and simultaneously lower carrying costs.
Carry out frequent physical inventory counts and compare the results to the information given by your program. Look into any differences. Train and invest in your staff so that they are more interested in their employment and less prone to steal. Last but not least, combat client fraud.
Warehousing and fulfillment may be outsourced.
Outsourcing your warehouse and fulfillment might be less expensive than handling everything in-house for developing internet enterprises. Warehouse, personnel, and software expenditures will all be reduced. Check out our top selections for the finest fulfillment services and third-party logistics providers.
The Importance of Inventory Carrying Costs
Inventory carrying cost is an essential factor to consider if you intend to establish a retail firm. Inventory management is one of the most important components of operating a product-based business—inventory consumes a significant amount of cash, and stockouts are expensive. Carrying expenses, fortunately, are generally under the merchant’s control.
- Profit margins are impacted by high carrying costs: When you can cut costs in your firm, you’re boosting your profit margin. When it comes to carrying expenses, the same approach applies. When it comes to retail inventory management, today’s small companies have a plethora of analytics tools at their disposal to help them make educated, data-driven choices.
- Inventory ties up cash flow: Carrying expenses have a significant influence on cash flow in small businesses. Inventory binds up cash, and when such assets need continual investment, retailers lose much more money than the value of the inventory.
- Excess spending may be discovered by looking at carrying costs: Looking at your carrying expenses may offer you a fast indication of how healthy your firm is and where your cash flow is going. Warehouse workers start at $11.44 per hour, while managers start at $47,478. Have you taken this into account in your company metrics?
- High expenditures may suggest poor planning: for example, you may have too much goods on hand. Low expenses, on the other hand, may warrant further research into stockouts and meeting consumer demand.
Conclusion
Knowing your inventory carrying costs will help you save money in more ways than one. You gain a clearer perspective of your total company when you understand your holding expenses. This measure, along with other important retail metrics, is critical for analyzing, developing, and expanding your small retail company.
The “inventory carrying cost calculation excel” is a tool that calculates the inventory carrying cost. The formula is simple, but there are some tips on how to reduce it.
Related Tags
- inventory carrying cost calculator
- inventory carrying cost example
- carrying cost formula in eoq
- annual carrying cost formula
- holding cost vs carrying cost
