Calculating and Minimizing Inventory Holding Costs

In retail, manufacturing, or eCommerce, inventory is essential but can also be challenging. You need enough stock for operations and customer needs, yet excessive inventory can produce extra expenses.

This guide will show you how to calculate inventory holding costs. It will help you identify different types, and offer practical tips to lower these expenses and keep more of your company's profits.

Key takeaways

• Inventory holding costs cover expenses such as rent, staff, insurance, and depreciation linked to storing unsold items.

• Calculating these costs aids in smart inventory management and business choices.

• Better demand prediction and efficient methods like Just-in-Time (JIT) management can cut inventory holding costs.

• Get a grip on your inventory by streamlining your entire supply chain, from sourcing to final delivery.

Understanding Inventory Holding Costs

Inventory holding costs, also called inventory carrying costs, are the total expenses linked to storing goods that haven't been sold yet.

Let's break it down with an example.

Imagine a shoe makanufacturer. They made 1,000 pairs of shoes but only sold 500. The 500 unsold pairs become their inventory.

The cost to store these unsold shoes, maintain warehouse conditions, and protect them from damage or theft all contribute to the total inventory holding costs.

"Holding costs" and "carrying costs" mean the same thing. They both talk about the expenses of keeping, or "carrying," inventory for a certain time.

Varieties of Holding Costs

When you talk about holding costs, you're considering lots of things that add up to how much it costs a company to store its stuff. If you want to handle your inventory well and spend less money, the first thing to do is to know the different types of holding costs:

• Depreciation costs mean your inventory loses value over time. This is big for businesses selling stuff that goes bad or goes out of style fast. Like, if a clothing store has leftover summer clothes, they might have to lower the prices next summer because the styles change. That's depreciation.

  Insurance costs are a big deal for businesses because they need to protect their inventory. Whether it's to cover theft or damage from stuff like floods or fires, there are lots of different types of business insurance to think about.

• Obsolete inventory write-off costs appear when a company loses money because their stuff is outdated. For example, if a tech store has an old laptop model that nobody wants anymore because a new one came out, they might have to admit they won't sell it and take a loss.

• Personnel costs cover everything related to the people who handle the inventory. These could be things like their salaries, training, and benefits. If a company has a lot of inventory that needs a ton of management, personnel costs can really add up.

• Rental space cost: This is the money needed for the place where the inventory is kept. It could be direct costs, like paying property taxes for a warehouse, or indirect costs, like losing out on more profitable uses for the space.

• Security cost: Inventory needs to be protected from theft, both inside and outside the company, to prevent losses. Security stuff can be anything from cameras to hiring guards. For example, a jewelry store might have to spend extra on top-notch security to safeguard its valuable inventory.

Calculating Your Inventory Holding Costs

Knowing how much it costs to hold onto inventory is key for managing it well. When businesses can figure out these costs accurately, they can decide how much inventory to keep, what prices to set, and plan their strategy better. In this part, we'll walk you through how to calculate all your inventory costs.

Simple Formula for Inventory Holding Costs

Carrying cost (%) = (Inventory holding sum / Total value of inventory) x 100

The total inventory holding cost is made up of four main parts. These include the cost of having money tied up in unsold inventory (like interest or investments), the cost of services to manage the inventory (like rent), the cost of the physical space to store the inventory (also like rent), and the cost related to risks involved with inventory (like loss of value or shrinkage).

Example Calculation of Inventory Holding Costs

We can illustrate this calculation with an example. Let's say a business has the following annual inventory carrying costs:

1. Capital cost: $5,000

2. Inventory service cost: $2,000

3. Storage space cost: $3,000

4. Inventory risk cost: $1,000

Together, these total to an inventory holding sum of $11,000.

Now, if the total value of the company's inventory is $70,000, we can apply the inventory holding cost formula to determine the carrying cost as a percentage:

Carrying cost (%) = ($11,000 / $70,000) x 100 = 15.7%

Thus, the carrying cost equals roughly 15.7% of the total inventory value. This implies that the company spends 15.7% of the inventory's total value annually to store and manage inventory.

This percentage helps the company optimize stock levels, aiming to enhance profitability and cash flow.

Reducing Your Inventory Holding Expenses

Effectively handling your inventory holding expenses is essential for any inventory management plan.

Lowering inventory costs typically involves boosting inventory turnover rates, precise reorder point calculations, and enhancing forecasting accuracy. These efforts streamline supply chain management, making it more efficient and budget-friendly.

Keen to find practical ways to trim expenses eating into your profits? Check out these actionable tips.

Enhance Your Inventory Management

Smart inventory management is key to slashing holding expenses. By precisely calculating your reorder point, you ensure you maintain ideal inventory levels.

For e-commerce ventures, it's crucial to employ savvy inventory management strategies. These tactics strike a balance between satisfying consumer needs and minimizing capital invested in inventory. Approaches such as ABC Analysis and Economic Order Quantity (EOQ) aid in determining when and how much to reorder, thereby cutting holding and service expenses.

Optimize Your Supply Chain

Ensuring your supply chain runs smoothly is a fantastic method to reduce inventory holding expenses. The goal is to keep your inventory flowing through the supply chain rather than sitting idle in costly warehouses.

After all, stagnant goods don't generate any revenue. Unless, of course, you're leasing warehouse space to another business. In that scenario, the more inventory, the better!

Mastering supply chain management requires strong ties with suppliers. You also need to leverage technology for forecasting and planning. Yet, even once you've got it figured out, optimizing your supply chain remains an ongoing process.

Install Just-in-Time (JIT) Inventory Control

Using Just-in-Time (JIT) inventory management is a smart tactic. You match your inventory levels with what customers want, slashing the time products linger in storage. Ordering inventory based on expected sales can significantly reduce holding expenses while avoiding shortages.

For example, a bakery employing JIT delivery and inventory might order flour and sugar precisely for the number of cookies, cakes, and pastries projected to sell the next day. This approach prevents them from splurging on excess ingredients that might spoil.

Forecast demand 

Forecasting your business's future demand is akin to having a GPS for your inventory plan. Precise demand forecasting helps you expect how many products you'll sell. That enables you to maintain suitable stock levels and trim needless inventory expenses.

You can achieve this by studying past sales data, keeping an eye on market trends, and grasping your customers' purchasing patterns.

Maximize Storage Efficiency

Making the most out of warehouse space isn't just about tidying up. It's also about smartly arranging your inventory to use less space and save on rent and utilities.

Here's a tip: Keep the items that sell the most within easy reach to cut down on time spent searching. Also, make sure to check your inventory regularly. If something's not selling, consider getting rid of it or offering discounts to make space for more popular items.

Use cross-docking 

Cross-docking is like a fast-pass lane for your inventory. Instead of storing shipments in your warehouse, you send them straight to their next destination.

This saves you money on storage space and gets products to customers quicker, especially if you deal with items that need to move fast.

Cut operating costs and enhance delivery efficiency with eLogii

Keeping your inventory expenses in check and ensuring smooth deliveries are vital for maintaining top-notch inventory operations.

Strategies like refining demand forecasts, optimizing the supply chain, and maximizing storage space all aim to cut inventory costs.

Yet, it's not just about saving money. It's also about staying adaptable and prepared for market changes. Expert inventory management not only boosts profits but also enhances customer satisfaction, ensuring long-term business success.

Inventory management involves overseeing deliveries from the supply chain to your customer’s doorstep.

Seize command of your delivery operations and expenses with eLogii. You can see how it enhances your delivery efficiency while trimming expenses.