Carrying costs of inventory are all the expenses associated with holding inventory including maintenance, storage costs, warehouse costs, and scrap costs. Also called inventory costs, it is the cost incurred over a period of time by holding and storing inventory. This also includes insurance, opportunity costs, loss from theft and/or damage. An important profit measure for businesses is to determine the optimal inventory levels such the carrying or holding costs per unit of the inventory are being minimized.
Carrying costs are usually between 20% and 30% of a company’s inventory value, might go up to about 40% depending upon the item type. Calculating and reducing the carrying cost of inventory remains a critical component of any inventory management system.
Understanding Carrying Costs
Now you know the carrying costs definition and that its components may differ depending on nature or size of business, even may vary product to product. Here are some of the costs that carrying costs consist of for carrying costs calculation:
- Utility cost
- Obsolescence cost
- Recovery cost
- Warehouse cost
- Opportunity cost
- Material handling cost
- Innovation cost
- Cost of lead time
Primarily, carrying costs can be divided into four main categories:
- Working capital and opportunity capital costs: This involves the money that is tied up in the holding of inventory, also the plausible losses for not being able to utilize tied capital at any other opportunity.
- Space and storage costs: These are costs incurred due to holding or storing inventory. It may include rent, utility costs, insurance, taxes, depreciation costs etc.
- Handling costs: This comprises of the labor costs required to pick, pack, move and organize inventory and any other resources required to handle inventory. This also includes losses incurred as a result of workplace injuries and worker’s compensation.
- Obsolescence & damage costs: Obsolescence costs occur due to poor inventory management, damage or wastage due to overstocking issues or any other losses as a result of damage or criminal activities such as theft, fraud, collusion etc. Taxes and insurance costs also factor in the same category.
Ways to Bring Down Carrying Costs
There are a couple of ways in which you can reduce your carrying costs and save that much-needed cash for business requirements.
- Planning your storage and warehouse management
Warehouse organization and space management is one of the key ways to ensure retail success. A design modification in the storage space can transform the whole picking, packing and shipping stations like a well-oiled machine.
You can strategically place inventory in the warehouse; for example, fast-selling items near the picking, packing stations, keeping low-selling items or dead stock at the back so they don’t come in the way.
- The stock requirement should be based on the state of consumer demand
The amount of stock you need to carry should be based on consumer demand. In order to keep carrying costs in check, how much inventory to order should change according to the changing dynamics of the economy, the current state of the industry, and exchange rates of currency.
- Negotiating contracts with suppliers
If you have long-term contracts with suppliers, it’s a good thing as it gives you some form of security against inventory costs.
However, it is important to clearly define the terms of the contracts to make sure they cover a portion of the inventory costs.
Clauses like duration that inventory will be kept in the storage space, the return of unused goods, carrying costs if the storage duration is extended, can help you make a concrete and proper contract that helps you save those extra bucks.
- Control your inventory
For better inventory control and warehouse management, utilize an inventory management software that helps you keep track of your stock in real-time.
An inventory management system initiates accurate demand forecasting and purchase patterns, your negotiations with suppliers will be more solid, as you will be better informed while setting order frequency and replenishment levels.
A cloud inventory management system will minimize carrying costs, streamline consignment selling, dropshipping, backordering of products , helping you maintain tight inventory control and avoid over-stocking.
Your inventory is a big part of your business and probably the most valuable asset. Holding inventory can be an expensive affair if it is not managed properly. If you want to keep your carrying costs to a minimum, then having a precise idea about your inventory levels is essential in order to maintain just the right amount of stock.