Inventory carrying cost

What is Inventory Carrying Cost?

By Team TranZact | Published on Mar 3, 2023

Often times inventory managers stumble upon the concept of what is inventory carrying cost. Inventory carrying cost is crucial when discussing more nominal business costs. Business leaders today tend to be fixated on increasing profitability by minimizing the most apparent costs of businesses. Such fixation is responsible for the rise of more minor costs that hamper business growth in the longer run.

Are you carrying inventory unnecessarily and do you have excess inventory you had to mark down just because it stayed in the warehouse for a long time? If so, you need to look at what is inventory carrying cost, what is inventory carrying cost formula, what carrying cost includes, and how you can reduce it to make your business more profitable. Let's find out:

TranZact - Best Inventory Management Software

Understanding Inventory Carrying Cost

Companies face an array of inventory management challenges, including carrying costs. These costs arise when products are stored at a distribution center or a warehouse and attract significant depreciation, taxes, transportation, storage, labor, and insurance expenses.

Plus, opportunity cost - the reduction in investment opportunities a company undertakes due to carrying a large inventory - is an essential factor to consider. Businesses must have a deeper look into what is inventory carrying cost to minimize the same and make their business more profitable.

In most cases, holding costs, also known as inventory carrying cost value increases as an item sits in storage for a more extended period before being sold. This percentage depends on various variables, such as the volume of items the company sells, the inventory turnover ratio, storage space required, and the warehouse location.

Inventory carrying costs may affect business profitability, such as stocking and handling costs before items are sold. Inventory expenses usually account for a quarter of a stock's value. Adding up your inventory carrying costs and dividing them by the total inventory value will give you a more precise result.

Following are some key factors to understand about:

Poor forecasting, poor order management, and safety stocks can increase the cost of holding inventory. You can reduce inventory carrying costs by reducing inventory holding costs, increasing inventory turnover, evaluating warehouse layouts, and using an efficient system for managing warehouses. There are four main categories of inventory costs: inventory risk costs, service costs, storage costs, and capital costs. Inventory risks consist of product depreciation, shrinkage, and obsolescence.

What Are Examples of Inventory Carrying Costs?

Now that we have learned what is inventory carrying cost let's look at some examples of the cost associated with inventory. Inventory carrying costs depend upon the business and the size of its stock. Common carrying cost examples include Cost of Goods Sold (COGS), inventory holding or storage costs, depreciation, opportunity costs, financing costs, and ordering and setup costs.

How Do I Calculate Inventory Carrying Cost?

To make your business profitable, it is essential to calculate the carrying cost of inventory. The carrying cost formula in cost accounting is:

Inventory Carrying Cost (%) = (Total Carrying Costs/Total Inventory Value) x 100

Reasons for High Inventory Carrying Costs

A fine line between inventory and demand needs to be struck. Most companies believe having too many items is better than running out and losing a sale. The following reasons lead to organizations holding onto too much stock:

Safety stock

It can be risky to stock just enough products to meet expectations. Therefore, almost every company carries some safety stock in case of unforeseen events like surges in demand, supplier delays, or damaged shipments. Safety stock is an excellent idea for popular items, but being reasonable will reduce unnecessary holding costs.

Cycle inventory

An organization purchases cycle inventory based on its sales forecasts. Inventory cycle count requires businesses to verify inventory in small portions. This is done to generate sales and keep up with customer demand.

In-transit inventory

Purchasing inventory that has yet to be received is known as in-transit inventory. Inventory can be in transit for a long time, depending on the location and product type of the supplier. Future purchases should take these goods in transit into account.

Dead inventory

"Dead inventory" refers to obsolete inventory that can no longer be sold. Products no longer deemed marketable by a company are written off as losses. This may be lying in the back room, quietly and continuously raising inventory carrying costs.

How to Reduce Inventory Carrying Expenses?

Supply chain visibility technology helps businesses better predict inventory needs and minimize inventory carrying costs. You can also reassess safety stocks or excess stock quantities. Further, companies can reduce inventory-carrying costs and safety stock-holding expenses by prioritizing and improving agility across the organization.

Following are the reasons how inventory carrying costs can be cut:

Monitor inventory levels closely

Analyze your inventory levels carefully and invest in analytics tools to determine how much inventory is necessary for daily operations versus what you currently hold. Once you have a reliable database that displays your company's inventory performance, you can adjust and streamline these processes accordingly.

Create an agile supply chain:

Real-time tracking eliminates half the guesswork and reduces reliance on safety stock. Anticipating inbound shipments and making adjustments ahead of time helps avoid delays.

Maximize Yard Operations:

Inventory storage and service costs can be drastically reduced by optimizing yard operations. To make the most of your resources, you need to accurately know the status of shipments in the yard and incoming shipments. With an effective yard management system in place, this becomes even easier.

Reduce Inventory Carrying Costs With TranZact

Maintaining inventory levels can be a challenge for businesses without an automated solution and structured data repositories. A business's ability to expand its offerings becomes more simplified when there are accurate data points to consider. TranZact is a cloud-based business automation software that allows you to keep track of the entire sales cycle from quotations, order management, inventory management, production, and manufacturing onward. By integrating all these diverse functions with inventory, TranZact helps to manage inventory costs better and reduce expenses.

FAQs on Inventory Carrying Cost

1. What is the carrying cost in inventory management?

A business's carrying costs refer to its expenditures on maintaining inventory throughout the year. Carrying cost means the cost of storing, maintaining, and owning the items.

2. What is the difference between ordering cost and carrying cost?

The ordering cost is the cost of ordering and purchasing inventory, while the carrying cost is the cost of holding inventory. A business needs to find the right balance between these costs to optimize its inventory management strategy.

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TranZact is a team of IIT & IIM graduates who have developed a GST compliant, cloud-based, inventory management software for SME manufacturers. It digitizes your entire business operations, right from customer inquiry to dispatch. This also streamlines your Inventory, Purchase, Sales & Quotation management processes in a hassle-free user-friendly manner. The software is free to signup and gets implemented within a week.