Inventory carrying costs is the expense of holding inventory in stock. It’s also how merchants determine how much profit they can make off their current inventory, which means you definitely want to get it right.
Fortunately, this article has everything you need to calculate, manage and reduce inventory costs so you can maximize profit.
What Are Inventory Carrying Costs
Inventory carrying costs is the expense of holding inventory (product, stock, etc.) in storage (typically a warehouse) to fulfill sales orders. As such, inventory carrying costs can be categorized into four components – capital, service, risk, and space.
Capital Costs
Capital costs are fixed, one-time expenses incurred on the purchase of inventory and/or the cost of the land, buildings, construction, and equipment used in the production of said inventory. In most cases, capital costs are the largest component of a merchant’s inventory carrying cost because it includes the interests added and the cost of money already invested in the inventory.
Service Costs
Inventory service costs are the expenses incurred on the type of goods kept in inventory and the level of inventory — the amount of inventory a merchant keeps in stock to fulfill sales orders — such as taxes, insurance and the cost of IT infrastructure. Though high inventory levels make it easier to meet customer demand, they also attract higher insurance premiums and taxes, which can raise the total inventory service cost.
Risk Costs
Risk is one of the biggest costs associated with carrying inventory with a wide variety of risks, the least of which is shrinkage (the loss of product due to factors other than a sale). Other risks include theft and human error, such as missed deliveries and damaged inventory.
Arguably, the biggest risk associated with carrying inventory is product value depreciation, which occurs when items are stored for so long in inventory that their value drops to a fraction of their original worth.
Storage Space Cost
Storage space cost includes all of the expenses incurred in the storage of inventory, including the rent paid to the warehouse, utilities, transportation, and any other costs associated with owning, operating, and/or renting physical warehouse space.
Unlike capital costs, storage space cost is both fixed and a variable component, since the cost of rent is fixed but the cost shipping, handling, and materials is likely to vary with demand and the number of products kept in stock.
How to Calculate Inventory Carrying Costs
Inventory carrying costs is expressed as a percentage number and typically accounts for 15% to 30% of the value of a merchant’s inventory. It’s a significant variable, since the same percentage is used to calculate the profit that can be made from the sale of inventory; how long inventory held before depreciation, as well as how much product to order and when to order it.
How high or low your inventory carrying costs are depends on your products and their storage requirements, your location, your total number of SKUs, your inventory turnover rate and whether you conduct fulfillment in-house or outsource to a 3PL. Fortunately, there is an easy equation you can use to determine your inventory carrying costs.
Inventory Holding Sum (x) / Total Value Of Your Inventory (y) x 100 = Inventory Carrying Cost (z).
To calculate inventory carrying costs, add up the value of each of your inventory cost components (depreciation, insurance, taxes, warehousing and fulfillment, shipping and delivery, salary & wages, etc.) to get your inventory holding sum (x). Then divide your inventory holding sum (x) by the total value of your inventory (y) and multiply by 100 to get your inventory carrying cost (z).
How to Reduce Inventory Carrying Costs
Now that you know how to calculate carrying costs you can figure out the best way to minimize them; reclaim the money you have tied up in inventory and maximize profit.
- Find the Perfect Reorder Point
Understanding when is the right time to reorder inventory and at what right volume is the best way to ensure that you are not holding more inventory than you can sell but also carrying enough inventory to meet demand.
Demand forecasting tools can help you determine to reorder points by analyzing sales data; factoring in seasonality and geography and determining what channels customers have the highest conversion rates.
If you don’t have the capital to invest in demand forecasting software, you can always mimic the reorder points of businesses with similar inventory, customers, sales models, and cycle to yours.
- Automate Inventory Control
Automating inventory control enables merchants to better forecast, track, and replenish inventory stock. It also provides a clear view of what is happening in your business, enabling you to see which inventory items are moving and what products are sitting on the shelf taking up valuable space and resources.
Automated inventory control typically includes inventory tracking to determine the number of SKUs present at a given location but, most importantly, also includes tools with built-in reorder point formulas to optimize the ideal stock levels needed to fulfill customer orders on time.
- Avoid Overstocking
Suppliers love to offer larger discounts for higher volume orders but that can lead to spending a sizable portion of your budget on replenishing your stock. if your products aren’t flying off the shelves, then you can be left with an abundance of deadstock (inventory you can’t sell).
- Eliminate Obsolete Inventory
To run a smarter business you need to not only order the right amount of stock, you need to eliminate any obsolete inventory from your shelves and usee thee freed-up capital to sell on new channels or diversify your inventory.
- Reduce Supplier Lead Time
One of the best ways to reduce inventory holding costs is to reduce supplier lead time, thereby reducing the amount of stock you have to keep on hand and minimizing the space you need to house higher inventory levels.
- Consider On-Demand Warehousing
The largest components of inventory carrying costs are the capital and service costs incurred from simply keeping inventory in stock. Therefore, one of the best ways to minimize inventory carrying costs is to minimize your capital and service costs.
On-demand warehousing is the innovative new warehousing and distribution model that connects available warehousing space with businesses that only need a small amount of space, for a short amount of time.
This enables retailers to dynamically deploy different inventory volumes to different warehouses across the country in little to no time, thus expanding your previous distribution network into a comprehensive and responsive supply chain that is ideally suited to the ever-changing eCommerce marketplace.
Reduce Inventory Costs With Flowspace
That’s where Flowspace comes in. Different from traditional 3PLs, Flowspace enables online retailers with the flexibility they need to maintain the optimal stock levels and minimize their inventory carrying cost. Contact us today to get started.
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