Inventory Carrying Cost: Calculator, Formula & Reduction Tips

Inventory carrying cost, also known as holding cost or carrying cost, refers to the total amount of expenses a small business must pay to hold and store 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.

In the News: Retailers Struggling with Excess Inventory Carrying Costs Heading into the 2022 Holiday Season

Retailers of all sizes, from independent shops to brands like Nike, are facing unsold, aging inventory.
This aging inventory ties up cash flow and prevents stores from being able to purchase and store in-demand products.
Determining your carrying costs can help provide the information you need to bring your store into the black this holiday season.

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 those 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 aren’t related to your stock inventory but are the costs necessary to hold them at a warehouse. These include insurance premiums, taxes, hardware investments, and inventory management software fees.
Risk costs: Inventory risk refers to the chance that items in storage can become unsaleable before they can be sold, and are usually because of shrinkage and obsolescence.
- Shrinkage (loss due to damage, theft, or errors in record keeping)
- Obsolescence (loss due to product expiration or retirement)
Space or storage costs: Space fees are the costs 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.

Inventory Carrying Cost Example

Let’s take 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. Average carrying costs, remember, are 20% to 30% of inventory value. This means the company should look for ways to lower its holding costs.

Graphical representation of inventory carrying cost

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.

Related:

Negotiate With Your Warehouse

Warehouse space isn’t cheap, but it is important. One estimate puts the average cost per square foot of warehousing to be $7.96. 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.

Optimize 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 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. 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.

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. It’s no surprise that demand for inventory management software doubled from 2015 to 2020, yet, still, only 18% of small businesses use it, opening the door for a competitive advantage to those that do.

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:

Alternatively, you can download our free inventory management workbook if you just need a simple solution.

Invest in Warehouse Management Software

Warehouse management software has similar benefits to inventory management software, except these platforms are specifically focused on managing and optimizing your physical warehouse space. Inventory management software specifically focuses on the inventory that occupies that space.

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 your space, how it’s organized, how your staff maneuvers in it, and how your inventory is stored in it. 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

The first in, first out (FIFO) inventory approach is exactly that: The first item you put on your shelves is also the first item you distribute when you make a sale. This is especially impactful for businesses that sell perishable goods, like Manifesto Mocktails, because you reduce the risk of expiration. FIFO is a 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 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 accordingly.

If you find your inventory is moving too slowly, promotions and bundling may help clear it out.

Automate What You Can

The more human power you need to accomplish inventory-related tasks, the more you make your business susceptible to human error and rising labor costs. Automation can help take some of the tedious tasks off your employees’ plates so they can focus on more challenging and rewarding tasks while you boost efficiency and cost-effectiveness.

Fight 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 fight shrink 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:

Outsource Warehousing & Fulfillment

For growing online businesses, outsourcing your warehousing and fulfillment can be cheaper 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.

Why Inventory Carrying Cost Is Important

If you want to start a retail business, inventory carrying cost is one 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.

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 $14.97/hour, and managers start with $52,800 salaries. Have you accounted for this in your business metrics?
High costs could indicate poor planning: Maybe you keep too much stock on hand, for instance. Low costs, on the other hand, may merit further investigation into stockouts and being able to meet customer demand.

Bottom Line

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.

Inventory Carrying Cost: Calculator, Formula & Reduction Tips