A good way to drive profits is to cut costs. Thankfully, inventory carrying costs can be an easy one to cut. Of all the costs you have, finding room to snip some of your inventory expenses is relatively easy, and relatively harmless.
But to cut it, you must know it. There’s a lot that goes into the cost of inventory as a process and as the products you purchase. On a base level, inventory is simple, but as you dig deeper you’ll find there is plenty to learn. Whether you sell online or you're in charge of warehouse organization, understanding inventory is vital.
So, what is inventory carrying cost? What makes it a valuable inventory KPI? And why is it such a big opportunity for virtually every business? When you write a business plan, inventory carrying cost is a necessary component to consider.
We’re gonna walk you through what inventory carrying cost is, what an average carrying cost is, and how to calculate yours. By the time we’ve reached the end of this article, you’ll be much more familiar with the in’s and out’s of inventory, carrying cost, and why it’s so important for you and your business.As a business owner, you'll be set up for success.
You should also check out the inventory definition (see inventory meaning) and average inventory formula. That background knowledge will help you as you move further into the world of inventory costs, and the importance of a solid understanding of inventory processes for any business.
Carrying Cost of Inventory Definition
Inventory carrying cost is every expense related to storing and holding unsold inventory. In other words, the inventory carrying cost is the cost it takes for a company to carry and manage the load of their inventory system and all their current products. A company’s total carrying costs are represented as a percentage of the total inventory over a specific period of time.
There are a few moving parts to it, though, so let’s look a little closer.
How to Define Inventory Carrying Cost
Like everything in inventory, inventory carrying cost is easier to understand if you break it down into parts. Inventory carrying cost, in its totality, includes four parts:
- Capital costs, i.e. the money invested in a warehousing and carrying operation, along with its interest
- Warehousing costs like rent, utilities, salaries, shipping, and handling
- Inventory costs like obsolescence, expiration, inventory shrinkage, and insurance
- Opportunity costs of holding aging inventory, focusing labor on handling, and being unable to invest the capital needed for carrying cost elsewhere
Like other inventory costing methods, inventory carrying cost provides context and clarity around total inventory numbers. That provides an accurate picture of how efficiently inventory is being managed—and how parts of it may be optimized for maximum profit. Basically, understanding your inventory carrying cost is essential to understanding where your money is going, what profit possibilities you have, and how you can streamline your inventory process to make it the most beneficial.
Why Do Companies Incur Inventory Carrying Cost?
Businesses incur inventory carrying cost because they need to hold onto inventory. Here’s why:
- Safety stock, buffer stock, and anticipation inventory. This is all the product kept on hand to account for fluctuations in supply and demand.
- In transit inventory. All the inventory that’s on its way from one part of the supply chain to the next.
- Dead stock. What is dead stock? Stock that’s lapsed into expiration, obsolescence, or any other prohibitive degradation in quality or demand. RIP.
- Cycle inventory. Inventory that’s kept around to fulfill regular sales orders.
While these sections of stock aren’t something a customer will ever see outright, they’re all vital to a business’s success, as inventory is a constant flow of products. All this costs a pretty penny. Just how pretty? Let’s look at the average carrying cost of inventory.
Average Carrying Cost of Inventory
The average carrying cost of inventory depends on the industry and the organization’s size. Inventory carrying cost by industry varies widely. But there are some ballpark averages we can report.
What’s a Good Annual Inventory Carrying Cost?
According to a 2018 APICS study, a commonly accepted ideal annual inventory carrying cost is 15–25%. Though annual inventory carrying cost ranges from 18% to 75% annually depending on the industry and the organization.
Inventory Carrying Cost Benchmarks
From that same 2018 APICS survey are some interesting estimations around different types of inventory carrying cost benchmarks:
| Carrying Cost Type | Carrying Cost Percentage of Total Inventory |
|---|---|
| Capital | 6–12% |
| Shrinkage | 3–6% |
| Expiration and Obsolescence | 6–12% |
| Warehousing | 2–5% |
| Handling | 2–5% |
| Inventory Management & Control | 3–6% |
| Taxes | 2–6% |
| Insurance | 1–3% |
Now let’s look into how to calculate inventory carrying cost.
Inventory Carrying Cost Formula
Here’s the inventory carrying cost formula:
Carrying Cost (%) = Inventory Holding Sum / Total Value of Inventory x 100
But to use the formula, you need the inventory holding sum.
Inventory Carrying Cost Calculation
The inventory holding sum is the total of the four parts that make up carrying cost:
Inventory Holding Sum = Capital Costs + Warehousing Costs + Inventory Costs + Opportunity Costs
This is what is divided by total inventory value and multiplied by 100 for an inventory carrying cost percentage.
Let’s look at how it all comes together with an inventory carrying cost example calculation.
Inventory Carrying Cost Example
Let’s imagine BlueCart Coffee Company, a roaster and wholesale supplier of coffee beans. Here’s a step-by-step inventory carrying cost example.
Step 1: Get Inventory Holding Sum Numbers
We check the ledger, and BlueCart Coffee’s numbers look like this:
- Annual average inventory cost: $1 million
- Capital costs: $15,000
- Warehousing costs: $100,000
- Inventory costs: $75,000
- Opportunity costs: $20,000
Step 2: Calculate Inventory Holding Sum
Inventory Holding Sum = Capital Costs + Warehousing Costs + Inventory Costs + Opportunity Costs
Inventory Holding Sum = $15,000 + $100,000 + $75,00 + $20,000
Inventory Holding Sum = $210,000
Step 3: Use Inventory Carrying Cost Formula
Carrying Cost (%) = Inventory Holding Sum / Total Value of Inventory x 100
Carrying Cost (%) = $210,000 / $1,000,000 x 100
Carrying Cost (%) = 21%
BlueCart Coffee’s total inventory carrying cost over the year was 21% of their total inventory cost. That’s good. But if it wasn’t good, there are ways to bring it down.
How to Reduce Inventory Carrying Cost
Reducing carrying cost increases profit. The two have an inverse relationship, and that makes carrying cost an attractive lever for the profit-minded entrepreneur. It can even get wound up in your eCommerce marketing strategy as you work to offset costs.
Here’s how a business can reduce its inventory carrying cost:
- Refocus on demand forecasting. Having too much inventory is obviously less than ideal. Redouble your efforts at accurate demand inventory forecasting so you can fulfill what you need to without paying for it on the other end. Demand planning can help you for years in the future.
- Adjust warehouse layout. Many warehouse layouts aren’t constructed with carrying cost in mind. Quickly finding the correct products is the name of the game. If your inventory carrying cost lags, look over how your warehouse is organized. It may be that some form of segmentation is in order, to help with order processing. An ABC analysis might help out in this regard.
- Consider long-term contracts with vendors. Committing to a supplier for the long-term may yield quicker delivery and lower rates. You may even want to look into a wholesale purchase agreement. Both do wonders for inventory carrying cost. This is especially true if your suppliers require an MOQ (what does MOQ mean?).
- Leverage historical data. An automated inventory management platform allows you to consider historical acquisition cost, inventory days, sales price, sell through rate, and inventory turnover, using the inventory turnover formula. Considering these together helps businesses determine the purchasing and sales strategies that minimum the time they hold on to unsold inventory.
- SKU Rationalization: By conducting SKU rationalization, companies can determine which products to prioritize, and how much stock they can eliminate. Both metrics will reduce carrying costs.
By streamlining wholesale purchasing and fulfillment, BlueCart is a DTC and online marketplace that helps businesses across the country combat rising inventory carrying costs. Book a demo and we’ll show you how.
Frequently Asked Questions About Inventory Carrying Cost
Like everything else in inventory, there is always more to learn about the inventory carrying cost definition and relation to the wider inventory management world. Our answers to these frequently asked questions will help you along as you continue to learn.
What Are Examples of Inventory Carrying Costs?
Examples of inventory carrying costs can include anything from the cost of maintaining a warehouse space to the cost of keeping items at the ideal temperature for storage before shipping. Any cost that shows up because you’re storing items and shipping them falls under the umbrella of inventory carrying costs.
Is Inventory Carrying Cost the Same as Holding Cost?
In many ways, carrying costs and holding costs are the same, but there is a key difference people often reference. That difference is that carrying costs refer to inventory that is actively moving through your system. Holding costs can be related to items that are sitting in your inventory for an indefinite period.
What Are the Four Inventory Costs?
The four inventory costs are ordering, holding, carrying, and shortage and spoilage costs. Under those umbrella cost terms there are a myriad of smaller costs and things to know. Those four main categories, however, are a good place to start with learning about the costs you’ll have with inventory management.
Inventory Carrying Cost: Helping You Carry the Load
The inventory carrying cost is just one small part of the overall inventory definition. As you run your business, you'll need to keep learning about inventory practices, definitions, and benefits. The BlueCart blog is always here to help.
Streamline order management, grow your bottom line, and get back hours of your time with BlueCart. Schedule a demo now:
