Inventory carrying cost, also known as holding cost or carrying cost, is the total amount of expenses a business pays to hold and manage unsold merchandise. This includes direct costs such as warehouse leasing, employee wages, insurance, utilities, and taxes, along with indirect costs like depreciation and shrinkage.
As a general rule of thumb, carrying costs typically represent 20%–30% of inventory value.
Calculate your holding cost using our inventory carrying cost calculator and read through our guide to learn how to calculate it yourself, possible reasons for high inventory costs, and tips on how to reduce them.
Inventory Carrying Cost Formula
To get an estimate for your business’ holding cost, you can use the following inventory carrying cost formula:
Inventory Carrying Cost = Capital costs + Service costs + Risk costs + Space costs
- Capital Costs: These are your necessary raw materials or inventory items, along with any related costs such as financing and loan maintenance fees (with or without interest). Capital costs make up the bulk of carrying costs.
- Service Costs: Service costs are the fees you pay to keep your inventory safe and organized in a warehouse. They include insurance premiums, taxes, hardware investments, and inventory management software fees.
- Risk Costs: Inventory risk refers to the chance that items in storage can lose value or become unsellable before they’re sold. This is usually because of depreciation, obsolescence or shrinkage.
- Space or storage costs: Space costs are the fees associated in managing a warehouse such as renting or purchasing warehouse space, climate control and utilities costs, physical security, and handling fees.
- If you own a warehouse, these costs are fixed.
- If you use a third-party logistics provider (3PL) for your warehousing and fulfillment logistics, prices vary based on usage and product volume.
To calculate your inventory carrying cost as a percentage of total inventory value, you simply divide the carrying/holding cost by your total inventory value and then multiply by 100.
What Is Inventory Carrying Cost?
Inventory carrying costs (or holding costs) are the expenses related to acquiring, storing, and managing unsold inventory. Understanding and effectively handling inventory carrying costs is essential for a business’ financial health, because it represents a large portion of its total inventory value.
An inventory carrying cost is made up of two main categories: tangible costs and intangible costs.
Tangible Inventory Carrying Costs
Tangible inventory carrying costs are the direct, measurable expenses involved in holding inventory. In the calculation above, capital costs, service costs, and storage costs represent a variety of smaller, tangible inventory carrying costs. Here’s a closer look at the main types of these cost components:
- Storage Costs: This includes the expenses related to the space required to handle inventory. It includes leasing or purchasing a warehouse, climate control equipment, utilities, and security systems.
- Labor Costs: These costs come from the amount you pay the workforce handling, stocking, and organizing your inventory including wages, benefits, payroll, and training.
- Transportation Costs: These include expenses incurred in transporting inventory to and from your warehouses or distribution centers, shipping, customs, and freight charges.
- Insurance: These are costs required to insure your inventory to protect against potential losses, which can come from damage, theft, or natural disasters.
- Taxes: This expense may include sales taxes, property taxes, or other taxes associated with your inventory and its related cost centers.
Intangible Inventory Carrying Costs
Intangible costs are not as easy to quantify as tangible costs, but equally significant to the total expense of carrying inventory. In our calculation from earlier, risk costs describe a variety of smaller, intangible holding costs. They consist of:
- Opportunity Costs: These account for the potential earnings that a company loses because its resources are tied up in inventory. By holding onto inventory for an unnecessary period of time, businesses may miss more profitable opportunities.
- Deterioration or Depreciation: This cost represents factors like age, decay, expiration, or wear and tear can cause the value of some inventory to decline over time.
- Obsolescence: This cost reflects inventory that has become outdated or obsolete due to changes in industry standards, shifts in market demand, or the release of newer models, creating unsellable inventory or the need for markdowns.
- Shrinkage: Inventory shrinkage is the difference between a product’s recorded stock count and the amount physically on hand, typically caused by theft or clerical error. This contributes to increased carrying costs and results in financial losses for many businesses.
Another important area to consider is your brand’s reputation, which is closely tied to profitability. If your inventory methods lead to frequent stockouts, delayed deliveries, or selling subpar goods, it could negatively impact your reputation and long-term revenue.
Inventory Carrying Cost Example
Here’s a look at a hypothetical inventory carrying cost example to see how it works in the real world:
Manifesto Mocktails sells premixed mocktail drinks. It’s interested in knowing inventory metrics, especially because its products are perishable. Manifesto Mocktails needs to make sure it can sell its inventory before it expires, so it’s decided to look more closely at carrying costs.
Manifesto Mocktails has the following expenses:
- Capital costs: $5,000 for raw materials and associated costs
- Inventory service costs: The beverage retailer rents a climate-controlled warehouse storage space for $1,000/month, averaging around $250/month in utilities
- Inventory risk costs: Manifesto Mocktails calculates $300/month in depreciation, shrinkage, obsolescence, and opportunity cost
- Inventory storage costs: The beverage retailer rents a climate-controlled warehouse storage space for $1,000/month, averaging around $250/month in utilities
That’s $7,800 worth of carrying costs. Now, let’s assume the total inventory value of their on-hand mocktail drinks is $20,000.
Inventory Carrying Cost (%) = Inventory Holding Cost ÷ Total Inventory Value x 100
Inventory Carrying Cost (%) = $7,800 ÷ $20,000 x 100
Inventory Carrying Cost (%) = 39%
In this scenario, Manifesto Mocktails has a significantly higher than average inventory carrying cost, considering average carry costs are 20% to 30% of inventory value. This means the company should make efforts and look for ways to reduce its holding costs.
How to Reduce Your Inventory Carrying Cost
There are several reasons your holding costs may be high:
- Too much stock on hand/safety stock
- High rent/utilities
- Poor inventory management and forecasting (inaccurate sales projections)
- Ineffective marketing and advertising
- Slow-moving inventory
- Lack of inventory systems and technology
- Expensive products
Luckily, there are many approaches small businesses can take to reduce holding costs.
Negotiate With Wholesale Suppliers
First things first: You can lower your capital investment in inventory by negotiating better deals with your suppliers. Your approach depends largely on your relationship with the supplier, but also on factors like order volume, order value, and account history.
The supplier may not be able to budge on the wholesale pricing, but you can ask for other discounts like free or reduced shipping.
- How to Find a Wholesale Supplier for Your Business
- Online Resources for Finding the Best Wholesale Suppliers
Negotiate Your Warehouse Lease
Warehouse space isn’t cheap, but it is important. One estimate puts the average cost per square foot of warehousing to be $8.22. If you lease a warehouse space, you can ask your landlord to cut you a deal. Much like negotiating with manufacturers and suppliers, your approach and success rate depends on a variety of unique factors, like lease length and local demand.
Optimize Your Warehouse Space
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 optimize 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 jobs? Your organizational efforts may even reveal an opportunity to downsize, reducing your carrying costs significantly.
Invest in Inventory Management Software
Poor planning is one of the biggest culprits when it comes to high holding costs—and you can use technology to combat it. Finding the best inventory management software for your business will give you more accurate reporting, better forecasting, and a more comprehensive picture so you can plan accordingly.
Using effective inventory management software allows you to purchase the right amount of stock, plan marketing and advertising campaigns accordingly, and set yourself up for sustainable success more easily. Inventory management software can also lower administrative costs and, by optimizing inventory levels, lower the amount you need to pay in insurance and taxes.
Learn how to organize your inventory and use these guides to help you find the best inventory management tool for your business:
- Best Inventory Management Software
- Best Free Inventory Management Software
- Best Restaurant Inventory Management Software
Alternatively, you can download our free inventory management workbook if you just need a simple solution.
Invest in Warehouse Management Software (WMS)
Warehouse management software is designed to streamline and optimize the operations within your physical warehouse space—unlike inventory management software, which is centered on tracking the goods themselves.
Your warehouse management software plays a key role in lowering holding costs because it helps you better optimize your space for cost-effectiveness. Plus, you’ll gain insight into how your warehouse is organized, how your staff maneuvers in it, and how your inventory is stored. Effective warehouse management also supports the order fulfillment process, making it more efficient and easier for your staff to get orders out.
Pro tip: Find a warehouse management software that integrates with your inventory management platform.
Apply First In, First Out Principles
In the first in, first out (FIFO) inventory approach, the first item you place on your shelves is also the first one sold, while newly stocked items are placed in the back. This is especially impactful for businesses that sell perishable goods, because you reduce the risk of expiration (making FIFO a good way to mitigate obsolescence holding costs).
Accelerate Inventory Turnover
Inventory turnover is a measure of the number of times inventory is sold and replaced in a time period. This can be calculated by dividing sales by inventory. The time period is often counted annually but can be shorter.
Increasing retail sales is a surefire way to lower carrying costs because items spend less time on your shelves. Review your product sales each month to check if items are selling at the expected rate. If inventory turnover is higher or lower than expected, adjust your restocking strategy accordingly.
The more human power you need to accomplish inventory-related tasks, the more you make your business susceptible to high labor costs and human error.
Automation can help take some of the tedious tasks off your employees’ plates so they can focus on more challenging and productive tasks while you boost efficiency and cost-effectiveness.
Inventory shrinkage is when stock goes inexplicably missing due to causes such as external theft, internal theft, human error, and inaccurate data.
There are many ways you can fight shrinkage and simultaneously lower carrying costs. Conduct regular physical inventory counts and compare the numbers to your software-provided data to investigate any discrepancies. Train and invest in your employees so they’re more engaged in their jobs and less likely to commit theft. And, finally, fight customer fraud:
- Chargeback Protection Tools for Merchants
- How to Prevent Chargebacks
- How to Detect Counterfeit Money
Outsource Warehousing & Fulfillment
For growing online businesses, outsourcing your warehousing and fulfillment can be cheaper (and easier) than managing everything in-house. You’ll save on warehouse, employee, and software costs. See our top picks for the best fulfillment services and 3PL companies.
Read our comparison of in-house vs outsourced fulfillment.
Why Inventory Carrying Cost Is Important
If you want to start a retail business, inventory carrying cost is a highly important metric to consider. Inventory management is one of the most vital aspects of running a product-based business; inventory ties up a lot of capital and stockouts are costly. Luckily, carrying costs are largely within the merchant’s control. Here’s why they matter:
- High carrying costs impacts profit margins: Any time you can reduce your expenses as a business, you’re increasing your profit margin. The same principle applies when it comes to carrying costs. And, today’s small businesses have a bevy of analytics tools to help make informed and data-backed decisions when it comes to retail inventory management.
- Inventory ties up cash flow: Carrying costs greatly impact small business cash flow. Inventory itself ties up capital, and when those assets demand ongoing investment, merchants lose even more capital than the inventory value itself.
- Examining carrying costs can reveal excess expenses: Looking at your carrying costs can give you a quick glimpse into overall business health and a look at where your cash flow is going. Warehouse staff start at $15.78/hour, and managers start at an annual salary of $55,057. Have you accounted for this in your business metrics?
- High costs could indicate poor planning: High carrying costs may signal that you’re keeping too much inventory on hand, suggesting a need for better planning. Conversely, low costs could warrant an investigation into whether you have enough stock to meet customer demand without frequent stockouts.
Challenges of Inventory Carry Costs
Inventory carrying costs require a fine balance between supply, demand, and your company’s operations—which all involve many moving parts. For this reason many companies struggle to maintain optimal holding costs.
Here are common reasons why companies fail to control or reduce their inventory carrying cost:
Overstocking is a common challenge when businesses purchase more inventory than they can sell. It’s especially problematic for small retail businesses. This mistake results in higher storage, insurance, and handling costs, as well as an increased risk of items becoming obsolete.
Inaccurate Demand Forecasting
Inaccurate demand forecasting can lead to issues with inventory levels— such as holding onto slow-moving, obsolete items or running into problematic stockouts.
Inefficient Inventory Management
Poor inventory management practices can lead to restocking and ordering errors. This often results in higher holding costs, including additional labor and handling expenses, and missed opportunities for cost savings.
Inadequate Inventory Turnover
Some businesses struggle to sell inventory quickly, causing items to remain in storage for too long. This results in higher holding costs, including increased depreciation and the risk of obsolescence. Marketing, sales, and other promotions are often necessary to avoid this pitfall.
Poor Supplier Relationships
Unreliable suppliers can cause issues such as delayed deliveries, poor communication, and inconsistent product quality. This may cause precautionary overstocks or accidental shortages, leading to higher holding costs.
Lack of Technology and Automation
Not investing in proper technology and automation for inventory control can result in manual errors and missed cost-saving opportunities. Real-time visibility into inventory levels is critical for effective inventory carrying cost management.
Inventory Carrying Cost Frequently Asked Questions (FAQ)
Inventory carrying costs include all expenses associated with the acquisition, storage, and management of inventory. These expenses are divided into tangible costs (which are direct and measurable) and intangible costs (which are less quantifiable).
Holding cost is a term that describes a range of expenses related to inventory (including storage space and capital costs of the products themselves), whereas storage cost specifically refers to the cost of the physical space needed to hold the inventory.
Examples of inventory carrying costs include labor costs, insurance premiums, taxes, transportation, and storage expenses like warehouse leasing. They also include less direct costs such as opportunity costs and deterioration.
Knowing your inventory carrying costs is beneficial for more than just cost savings. When you understand your holding costs, you get a better picture of your overall business. By regularly calculating your inventory carrying costs, you can easily identify and improve on inventory inefficiencies and have key performance indicators (KPIs) to guide future business decisions.
This metric—inventory carrying cost—combined with other key retail analytics, is key to understanding, improving, and growing your small retail business.