Inventory carrying cost, or more simply referred to as “carrying cost,” is something just about everyone who sells a physical product has to deal with in some form or other. If you’re selling a physical product, then that product needs to be held as inventory at some point before it makes it to the final consumer. That act of storing a product as inventory has costs associated with it: from warehouse or storage space to transportation and distribution costs and much more.
Generally, inventory carrying costs can be broken down into one of four categories:
The main components of inventory carrying cost are:
Below are some of the most common carrying costs faced by merchants at all levels of the supply chain:
Insurance: Any fees and costs associated with insuring your inventory fall into this category, including the opportunity costs associated with securing coverage or filing a claim.
Opportunity Costs: Opportunity costs are all of the intangible prices or sacrifices associated with doing business or keeping inventory. Safety stock and insurance are two classic examples of opportunity costs, as both are required for doing business but both also require you to tie up funds in ways that are not as productive as they could be otherwise.
Salaries: This is your major human resource cost category, and includes salaries paid out to employees, benefit and severance packages, wages for hourly or contract workers, as well as any administrative tools, software or expenses associated with managing your inventory.
Shrinkage: Any loss in inventory that is not directly related to a sale falls under shrinkage. This is a broad category, and could include theft, spoilage, lost or misplaced inventory, or even obsolescence or depreciation in the value of goods over time, as is common within the fashion and technology industries.
Taxes: Nobody likes paying taxes, but they’re a universal part of doing business, and inventory management is no exception.
Transportation: This most commonly includes shipping. handling and drop-shipping fees for smaller organizations, but can also include transportation management, logistics and distribution costs for larger companies and enterprises.
Warehousing: One of the most obvious costs associated with managing inventory is the space needed to store it, as well as any associated expenses needed for lighting, electricity, refrigeration, security, personnel, administration, etc.
Though it varies, inventory carrying costs are typically between 15-30% percent of the total cost of the inventory itself. As a rule of thumb, inventory carrying cost can generally be represented as one-fourth of the total value of the inventory.
For example, suppose you have $10,000 worth of inventory currently on-hand. Your capital cost can be estimated as $2,500.
If you wanted to get more granular than that, follow these steps to calculate the carrying cost associated with your inventory:
Supply chain visibility technology can help businesses reduce inventory carrying costs by allowing them to more accurately predict their inventory needs and thus eliminate any unnecessary amounts of inventory they are keeping on hand, known as safety stock.
Most businesses can’t help but keep a certain amount of inventory on hand and readily available. There’s often no escaping that reality of the business. However, by prioritizing and enhancing agility throughout the organization, any company can reduce its reliance on safety stock and, by extension, reduce their inventory carrying costs along the way.
In other words, having lower inventory levels will likely mean you also save on insurance, storage costs, and other costs from all four sectors described at the beginning of this article.
Using the right tools, technologies and techniques, you can drastically reduce the amount of inventory you need to have on hand to meet customer expectations and ensure productivity throughout your organization. In doing so, you will reduce your carrying costs in all four areas without negatively impacting other areas of your business. Here are a few examples of ways you can reduce inventory carrying costs throughout your organization:
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Inventory is considered a company asset and is recorded on your company’s balance sheet. The better you can manage and track the movement of your goods, the more control you will have over your inventory. Real-time visibility is a key component of any sophisticated inventory management process.
To find out more about how real-time visibility can help you reduce costs throughout your operation, check out our Ultimate Guide to Maximizing ROI With Supply Chain Visibility.
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