Inventory Holding Cost
Also known as: Carrying Cost, Holding Cost, Inventory Carrying Cost
Definition
Inventory holding cost (or carrying cost) represents the total expense of keeping inventory in stock. It includes all costs associated with storing, insuring, and managing goods that haven’t yet been sold, plus the opportunity cost of capital invested in inventory.
Components of Holding Cost
| Component | Description | Typical % |
|---|---|---|
| Capital cost | Interest/opportunity cost | 8-15% |
| Storage cost | Rent, utilities, handling | 3-6% |
| Insurance | Coverage for inventory | 1-3% |
| Obsolescence | Spoilage, out-of-date | 2-5% |
| Shrinkage | Theft, damage, loss | 1-3% |
| Taxes | Property tax on inventory | 1-2% |
Total typical range: 15-35% of inventory value annually
Calculating Holding Cost
Annual Holding Cost = Average Inventory Value × Holding Cost Rate
Example:
- Average inventory: $500,000
- Holding cost rate: 25%
- Annual holding cost: $125,000
Per-Unit Holding Cost
Per-Unit Holding Cost = Unit Value × Holding Cost Rate
Example:
- Product cost: $50
- Holding rate: 25%
- Annual holding cost per unit: $12.50
Why Holding Costs Matter
Inventory Decisions
- Order quantity optimization (EOQ)
- Safety stock levels
- Reorder point timing
- SKU rationalization
Financial Impact
- Working capital efficiency
- Profitability analysis
- Cash flow management
- Investment priorities
Reducing Holding Costs
Inventory Management
- Improve turnover rates
- Reduce safety stock where possible
- Better demand forecasting
- Eliminate dead stock
Operations
- Negotiate storage rates
- Optimize warehouse space
- Improve inventory accuracy
- Faster receiving processes
Suppliers
- Smaller, more frequent orders
- Vendor-managed inventory
- Consignment arrangements
- Drop shipping
Holding Cost Trade-offs
| Lower Inventory | Higher Inventory |
|---|---|
| Lower holding costs | Higher holding costs |
| Higher stockout risk | Lower stockout risk |
| More frequent orders | Less frequent orders |
| Higher per-order costs | Lower per-order costs |
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