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Inventory Holding Costs: What They Are and How To Calculate Them

April 7, 2021 Published by

money inside a cardboard box

Inventory holding costs are normal for any business that decides to store stock in a warehouse or other storage solution. However, if a business does not know how to optimize its inventory, these costs can add up.

Here we’ll be explaining what inventory costs are, why they’re important and how to calculate them.

What Are Inventory Holding Costs?

An inventory holding cost is the sum of all costs associated with storing unsold inventory. These costs include:

  • Warehousing
  • Insurance
  • Labor
  • Depreciation
  • Shrinkage
  • Obsolescence
  • And opportunity costs

Why Holding Costs Are Important

Reducing holding costs is an important part of any supply-chain management strategy. Inventory may require significant funds to hold and will result in less money available to focus on other important business efforts. This is also what’s known as an opportunity cost or the potential benefits a business will miss out on when choosing one option over the other.

How To Calculate Inventory Holding Cost

If you know your storage, employee, opportunity, and depreciation costs, calculating inventory holding costs is pretty simple. Below are brief descriptions about each cost so you know what to look for:

  • Storage costs: All costs associated with physically storing inventory like warehousing or storage rent, insurance, and utilities.

 

  • Employee costs: The salaries or wages for warehouse employees who manage and audit inventory, fulfill orders, and maintain the facility.

 

  • Opportunity costs: An intangible figure that represents the business opportunities missed due to spending on the storage of unused stock.

 

  • Depreciation costs: Another intangible figure that represents the costs incurred when an inventory’s value naturally depreciates over time.

To find your holding cost, calculate these subtotals, add them together, and then divide the sum by the total value of annual inventory (The combined average value of all inventory that is moved in a year.)

The holding formula looks like this:

Inventory Holding Cost = (Storage Costs + Employee Salaries + Opportunity Costs + Depreciation Costs) / Total Value of Annual Inventory

The Average Holding Cost

Holding costs vary depending on several factors, including:

  • The size of the products being stored. Heavier items may be more expensive to store compared to smaller items.
  • The number of SKUs The more products sold, the more storage is needed and the higher the holding cost will go.
  • The number of units that must be stored.
  • The warehouse location, such as whether it is in an urban or rural area.
  • The speed at which inventory turns over.
  • The types of orders a business has. DTC tends to have fewer units per order while B2B often needs a higher pallet storage solution.

Due to the fact holding costs can vary so widely, it’s hard to calculate an average holding cost. In general, holding costs tend to make up 20% to 30% of a company’s total cost of inventory.

Know Your Holding Costs To Save Money

Businesses that don’t understand what holding costs are or don’t know their own holding costs could be missing out on opportunities to save money. Failing to optimize your inventory can lead to added costs as you continue to pay for space to hold unsold inventory and the depreciation of those items as they get older.

Inventory management can be overwhelming. If you need help with optimizing your inventory and other aspects of fulfillment, think about enlisting the help of a 3PL like Fulfillment Works. We can help with every step of the fulfillment process from packing to inventory management and shipping.