Inventory Carrying Cost: Definition, Formula & Cost Reduction ...

Inventory carrying cost, also known as holding cost or carrying cost, refers to the total amount of expenses a small business must pay to ... FitSmallBusinesscontentandreviewsareeditoriallyindependent.Wemaymakemoneywhenyouclickonlinkstoourpartners.LearnMore. WRITTENBY:MeaghanBrophyPublishedAugust25,2021Meaghanhasprovidedcontentandguidanceforindieretailersastheeditorforanumberofretailpublicationsandaspeakerattradeshows.SheisFitSmallBusiness’sauthorityonretailandecommerce. ThisarticleispartofalargerseriesonRetailManagement. TableofContents 1 HowtoCalculateInventoryCarryingCost 2 HowtoReduceYourInventoryCarryingCost 3 WhyInventoryCarryingCostIsImportant 4 BottomLine Inventorycarryingcost,alsoknownasholdingcostorcarryingcost,referstothetotalamountofexpensesasmallbusinessmustpaytoholdandstoreunsoldmerchandise.Thisincludesdirectcostssuchaswarehouseleasing,employeewages,insurance,utilities,andtaxes,aswellasindirectcostslikedepreciationandshrinkage. HowtoCalculateInventoryCarryingCost Asageneralruleofthumb,carryingcoststypicallyrepresent20%–30%ofinventoryvalue.Togetanestimateforyourbusiness,youcanusethefollowingformula: Estimatedinventorycarryingcosts=annualinventoryvalue/4 Buttheexactmetricishighlydependentonyourbusiness’sdata.Soifyouwanttoknowyourpersonalinventorycarryingcosts,you’llwanttodosomemoreexactmath,multiplyingby100togetyourpercentagevalue: Inventorycarryingcosts=(storageexpenses/annualinventoryvalue)*100 Here’swhattoincludeinyourstorageexpenses: Warehouserent/lease/mortgage/loan Utilities Employeewages Insurance Costofinventory Transportationto/fromwarehouse Taxes Administrativefees Softwareandtechnologyfees Interest Depreciation Obsolescence Shrinkage Opportunitycost InventoryCarryingCostExample Let’stakealookatahypotheticalinventorycarryingcostexampletoseehowitworksintherealworld. ManifestoMocktailssellspremixedmocktaildrinks.It’sinterestedinknowinginventorymetrics,especiallybecauseitsproductsareperishable.ManifestoMocktailsneedstomakesureitcansellitsinventorybeforeitexpires,soit’sdecidedtolookmorecloselyatcarryingcosts. Thebeverageretailerrentsaclimate-controlledwarehousestoragespacefor$1,000/month,averagingaround$250/monthinutilities.Thisiswhereitkeeps$5,000worthofproduct.Warehouselaborexpensesareapproximately$2,000/month,insuranceis$500/month,andshippingisanother$500/month.ManifestoMocktailsalsocalculates$300/monthindepreciation,shrinkage,obsolescence,andopportunitycost. Theretailer’sinventorycarryingcostscalculationlookslikethis: Inventorycarryingcost=((1,000+250+2,000+500+500+300)/5,000)*100 Inventorycarryingcost=(4,550/5,000)*100 Inventorycarryingcost=0.91*100 Inventorycarryingcost=91% Inthisscenario,ManifestoMocktailshasasignificantlyhigherthanaverageinventorycarryingcost.Averagecarryingcosts,remember,are20%-30%ofinventoryvalue.Thismeansthecompanyshouldlookforwaystoloweritsholdingcosts. HowtoReduceYourInventoryCarryingCost Thereareseveralreasonswhyyourholdingcostsmaybehigh: Toomuchstockonhand/safetystock Highrent/utilities Ineffectivemarketingandadvertising Slow-movinginventory Poorinventorymanagementandforecasting Lackofinventorysystemsandtechnology Expensiveproducts Luckily,therearemanyapproachessmallbusinessescantaketoreduceholdingcosts. NegotiateWithWholesaleSuppliersFirstthingsfirst:Youcanloweryourcapitalinvestmentininventorybynegotiatingbetterdealswithyoursuppliers.Yourapproachdependslargelyonyourrelationshipwiththesupplier,butalsoonfactorslikeordervolume,ordervalue,andaccounthistory.Thesuppliermaynotbeabletobudgeonthewholesalepricing,butyoucanaskforotherdiscountslikefreeorreducedshipping. NegotiateWithYourWarehouseWarehousespaceisn’tcheap,butitisimportant.Oneestimateputstheaveragecostpersquarefootofwarehousingtobe$6.53.Ifyouleaseawarehousespace,youcanaskyourlandlordtocutyouadeal.Muchlikenegotiatingwithmanufacturersandsuppliers,yourapproachandsuccessratedependsonavarietyofuniquefactors. Related:HowtoLeaseCommercialRealEstate:TheUltimateGuide OptimizeYourWarehouseWhetheryouhaveluckornotwithyournegotiations,thereareotherwaysyoucanreducewarehousingexpensesthataremoreinyourcontrol.Tostart,you’llwanttooptimizeyourwarehouselayout.Areyougettingthemostoutofyourspace?Isiteasyandefficientforyourstafftonavigateanddotheirjob?Yourorganizationaleffortsmayevenrevealanopportunitytodownsize.Movingtoasmallerwarehousecanbeespeciallyhelpfulcompetitively,consideringtheaveragesizeofretailers’warehousesisgrowingand87%ofbusinesseshavewarehouseexpansionplansthrough2024. InvestinInventoryManagementSoftwarePoorplanningisoneofthebiggestculpritswhenitcomestohighholdingcosts—andyoucanusetechnologytocombatit.Findingthebestinventorymanagementsoftwareforyourbusinesswillgiveyoumoreaccuratereporting,betterforecasting,andamorecomprehensivepicturesoyoucanplanaccordingly.It’snosurprisethatdemandforinventorymanagementsoftwaredoubledfrom2015to2020,yet,still,only18%ofsmallbusinessesuseit,openingthedoorforacompetitiveadvantagetothosethatdo. Usingeffectiveinventorymanagementsoftwareallowsyoutomoreeasilypurchasetherightamountofstock,planmarketingandadvertisingcampaignsaccordingly,andsetyourselfupforsustainablesuccess.Inventorymanagementsoftwarecanalsoloweradministrativecostsand,byoptimizinginventorylevels,lowertheamountyouneedtopayininsuranceandtaxes. Usetheseguidestohelpyoufindthebestinventorymanagementtoolforyourbusiness: BestInventoryManagementSoftware BestFreeInventoryManagementSoftware BestRestaurantInventoryManagementSoftware Alternatively,youcandownloadourfreeinventorymanagementworkbookifyoujustneedasimplesolution. InvestinWarehouseManagementSoftwareWarehousemanagementsoftwarehassimilarbenefitstoinventorymanagementsoftware,excepttheseplatformsarespecificallyfocusedonmanagingandoptimizingyourphysicalwarehousespace.Inventorymanagementsoftwarespecificallyfocusesontheinventorythatoccupiesthatspace. Yourwarehousemanagementsoftwareplaysakeyroleinloweringholdingcostsbecauseithelpsyoubetteroptimizeyourspaceforcost-effectiveness.Plus,you’llgaininsightintoyourspace,howit’sorganized,howyourstaffmaneuversinit,andhowyourinventoryisstoredinit.Effectivewarehousemanagementalsosupportstheorderfulfillmentprocess,makingitmoreefficientandeasierforyourstafftogetordersout. Protip:Findawarehousemanagementsoftwarethatintegrateswithyourinventorymanagementplatform. ApplyFirstIn,FirstOutPrinciplesThefirstin,firstout(FIFO)approachisexactlythat:Thefirstitemyouputonyourshelvesisalsothefirstitemyoudistributewhenyoumakeasale.Thisisespeciallyimpactfulforbusinessesthatsellperishablegoods,likeManifestoMocktails,becauseyoureducetheriskofexpiration.FIFOisawaytomitigateobsolescenceholdingcosts. Related:InventoryAgingReportandHowtoCalculate:TheUltimateGuide AutomateWhatYouCanThemorehumanpoweryouneedtoaccomplishinventory-relatedtasks,themoreyoumakeyourbusinesssusceptibletohumanerrorandrisinglaborcosts.Automationcanhelptakesomeofthetedioustasksoffyouremployees’platessotheycanfocusonmorechallengingandrewardingtaskswhileyouboostefficiencyandcost-effectiveness. FightShrinkInventoryshrinkageiswhenstockgoesinexplicablymissing.Shrinkhappensunderanumberofcircumstances,includingexternalandinternaltheft,humanerror,andinaccuratedata.Therearemanywaysyoucanfightshrinkandsimultaneouslylowercarryingcosts. Conductregularphysicalinventorycountsandcomparethenumberstoyoursoftware-provideddata—investigateanydiscrepancies.Trainandinvestinyouremployeessothey’remoreengagedintheirjobsandlesslikelytocommittheft.Andfinally,fightcustomerfraud. ChargebackProtectionToolsforMerchants HowtoPreventChargebacks HowtoDetectCounterfeitMoney OutsourceWarehousingandFulfillmentForgrowingonlinebusinesses,outsourcingyourwarehousingandfulfillmentcanbecheaperthanmanagingeverythingin-house.You’llsaveonwarehouse,employee,andsoftwarecosts.Seeourtoppicksforthebestfulfilmentservicesand3PLcompanies. WhyInventoryCarryingCostIsImportant Ifyouwanttostartaretailbusiness,inventorycarryingcostisoneimportantmetrictoconsider.Inventorymanagementisoneofthemostvitalaspectsofrunningaproduct-basedbusiness—inventorytiesupalotofcapitalandstockoutsarecostly.Luckily,carryingcostsarelargelywithinthemerchant’scontrol. Highcarryingcostsimpactsprofitmargins:Anytimeyoucanreduceyourexpensesasabusiness,you’reincreasingyourprofitmargin.Thesameprincipleapplieswhenitcomestocarryingcosts.Andtoday’ssmallbusinesseshaveabevyofanalyticstoolstohelpmakeinformedanddata-backeddecisionswhenitcomestoretailinventorymanagement. Inventorytiesupcashflow:Carryingcostsgreatlyimpactsmallbusinesscashflow.Inventoryitselftiesupcapital,andwhenthoseassetsdemandongoinginvestment,merchantsloseevenmorecapitalthantheinventoryvalueitself. Examiningcarryingcostscanrevealexcessexpenses:Lookingatyourcarryingcostscangiveyouaquickglimpseintooverallbusinesshealthandalookatwhereyourcashflowisgoing.Warehousestaffstartat$11.44/hour,andmanagersstartwith$47,478salaries.Haveyouaccountedforthisinyourbusinessmetrics? Highcostscouldindicatepoorplanning:Maybeyoukeeptoomuchstockonhand,forinstance.Lowcosts,ontheotherhand,maymeritfurtherinvestigationintostockoutsandbeingabletomeetcustomerdemand. BottomLine Knowingyourinventorycarryingcostsisbeneficialformorethanjustcostsavings.Whenyouunderstandyourholdingcosts,yougetabetterpictureofyouroverallbusiness.Thismetric,combinedwithotherkeyretailanalytics,iskeytounderstanding,improving,andgrowingyoursmallretailbusiness. AbouttheAuthorFindMeaghanOnLinkedInTwitterMeaghanBrophyMeaghanBrophyistheRetailExpertatFitSmallBusinessfocusingonsmallbusinessretailandecommercecontent.Meaghan’s10+yearsofretailexperienceincludesworkingatlocalbookanddancesupplystores,handcraftinggiftsataneco-friendlymanufacturer,developingprivatelabelbrands,andmanagingateamofmorethan40salesandserviceprofessionalsatalocalspa. SignUpForOurRetailNewsletter! Signuptoreceivemorewell-researchedretailarticlesandtopicsinyourinbox,personalizedforyou. Thisemailaddressisinvalid. Email JoinTheList SignUpForOurRetailNewsletter! Thisemailaddressisinvalid. Email JoinTheList