Inventory Carrying Cost as a Part of Inventory Value

No secret that profit is the core of any business and profit-making is the ultimate activity of each company. Business which is not making an effort to get profit, fails.

Understanding a company’s performance is a tool for profit-making. In retail business profit means sales, and sales come from accurate inventory management.

In retail business there are also plenty of indicators demonstrating company’s level of profitability, such as net income, customer engagement, sales data etc. However, retail business can not function properly without accurate inventory control and management. That is why each retail shall consider inventory flow performance indicators as the primary ones.

Inventory carrying cost is the money and resource spent on inventory storage in the warehouse(s) during a particular accounting period (a month, a quarter, a year).

Inventory Carrying Cost

Inventory carrying cost (or sometimes referred to as “inventory holding cost”) is one of the principal indicators because it constitutes a part of another important figure - inventory value.

This figure depends on the cost of human resources (for example, the salaries of warehouse managers and logistics specialists), storage facilities rent, outsource and/or upkeep etc. Inventory carrying cost also includes the costs associated with inventory insurance, replacement or utilization of damaged or spoiled goods. It also may include taxes and other financial obligations that can be different depending on the region of business operational activity. 

While inventory value indicator gives you a broader picture and understanding of the expenses spent on inventory, the carrying cost figure contributes to approximately 30% of inventory value.

To sum up, inventory carrying cost is made of:

  • Human resource expenditures;
  • Inventory purchase cost;
  • Inventory insurance costs;
  • Warehousing and storage rent, upkeep;
  • Storage and personnel outsourcing (if applicable);
  • Replacement and care of damaged/expired goods;
  • Taxes.

How to find and calculate inventory carrying cost?

Inventory carrying cost shall be calculated for each SKU in your inventory, in each storage location for a particular accounting period.

The above-mentioned seven components of the inventory carrying cost can be grouped into four categories for easier understanding:

  • Capital costs; 
  • Storage and warehousing;
  • Logistics;
  • Insurance and risks.

Capital costs is the largest retailer’s investment into inventory. These costs reflect the factual value of the inventory (or raw materials) at the moment of its purchase. Taxes and other financial payments are included into this group. 

Storage and warehousing costs include warehouse facilities rent, upkeep and maintenance. These costs are affected by the state of storage facilities, its operational effectiveness and, of course, volume of inventory stored. Warehouse professionals labour cost is being a part of this expenditures group.  

Logistics costs are simple to understand and transparent, these costs reflect the expenditures spent on shipping, transportation of goods from the supplier, as well as its delivery to customers, or moving goods across storage locations. Logistics personnel expenditures are included into this group.

Insurance and risk costs.
Sometimes inventory stored in warehousing facilities can be unintentionally damaged or spoiled. Inventory may be stolen or lost, which results in shrinkage, which is a difference between inventory supplied and inventory available. To mitigate the risks of such losses retailers use insurance.  Therefore, inventory carrying cost shall include both insurance payments and the costs of already damaged, expired or out-of-season (out-of-fashion) goods. 

How to minimize inventory carrying cost?

Evidently, the higher cost retailers have to pay for their inventory storage, insurance, transportation, delivery etc, the less amount of money they can spend on business growth, development and expansion. If retailer invests too much into inventory, which is not being sold, there is a risk of having operational capital “tied up” on the warehouse shelves. 

So, here comes the question - how to reduce inventory carrying cost? 

Keeping efficient and rational inventory level to satisfy sales needs, balancing demand and running a cost-effective supply chain is the answer. 

We recommend to use modern and freshly-designed storage spaces, built ergonomically to save you space and money. 

We also recommend getting an intelligent inventory management system that will keep record of sales and orders, effectively forecast the demand and make you use the warehouse for only those goods you need. 

Such systems also track your inventory in real-time, across all locations, which means lower logistics and transportation costs. And an extra benefit - modern systems can save money you spend on human resources by using automated innovative machine-based solutions. 

Find out what you need to do to properly organize your inventory

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