Inventory Carrying Cost: How to Calculate, Reduce & Control It
This lost potential, known as opportunity cost, can significantly impact a manufacturer’s profitability. They include taxes, insurance, storage costs, employee costs and opportunity costs. Reducing inventory carrying costs is essential for maintaining profitability and operational efficiency. Effective inventory management reduces costs and improves financial performance. Understanding carrying cost components enables businesses to cut unnecessary expenses. Using an Inventory Management System helps in tracking and managing these costs effectively.
Inventory storage and warehousing costs
An Inventory Management System supports this agility by providing accurate demand forecasts and automating the replenishment process. Another important aspect of inventory carrying costs is their impact on cash flow. For example, companies that efficiently manage their inventory carrying costs can quickly inventory carrying cost formula examples tips to lower it adapt to shifts in consumer demand without incurring excessive expenses. This agility is particularly valuable in Singapore’s dynamic market, where consumer preferences can change rapidly. Understanding and managing these components can help you control and reduce carrying costs. This article will show you how to calculate inventory carrying costs to help you meet stock demand and supply for your business.
The company rents warehouse space to store its inventory of electronic items. Inventory turnover (which measures how quickly inventory is sold and replaced within a specific period) is closely related to inventory carrying costs. Higher inventory turnover rates generally result in lower carrying costs as inventory is held for shorter periods, reducing your storage and holding expenses.
Storage Expenses
Below are two examples of software applications that companies can employ to aid in their inventory management. Demand Management is a manipulating method used to shift the demand for a product or service. A company can use promotions or pricing to stimulate demand, thereby increasing sales volumes and speeding up inventory turnover. It can also use aggregation techniques to reduce the demand for its products if there are supply shortages. There are several internal and external factors that can influence inventory carrying costs. There are five main components that make up inventory carrying costs, with each being influenced and affected by different variables and factors.
- Multi-location Management enables businesses to track inventory across warehouses, retail locations, and distribution centers.
- The system provides real-time data on inventory levels, ensuring that businesses can make informed decisions about stock replenishment, storage, and sales strategies.
- They include the cost of lost sales, filling backorders and expedited shipping to dissatisfied customers.
Inventory Carrying Costs: Analysis, Calculation, and Reduction
When you understand the perfect reorder point for each product, you can order just the right amount at just the right time. Opt for consignment stock or vendor-managed inventory (VMI) agreements to reduce your burden. Implementing Just-in-Time inventory can align procurement with demand to reduce storage needs.
The inventory carrying cost formula typically includes various cost components and can be customized based on the specific requirements of the business. This system provides instant visibility into inventory across warehouses. Automated alerts ensure stock levels stay within optimal ranges, triggering replenishment only when needed. This approach can cut operational expenses by up to 22% by improving resource efficiency 1. For many midmarket and enterprise retailers, inventory represents one of the largest expenses, directly affecting cash flow, profitability, and operational efficiency.
How does tied-up capital affect inventory carrying costs, and what can manufacturers do to reduce it?
This level of insight is essential for keeping your costs in check and your margins healthy. Contact our inventory management experts for a free assessment of your current processes and customized recommendations for optimization. We’ll help you implement proven strategies that reduce costs, improve customer satisfaction, and support sustainable business growth. Carrying Cost Percentage represents the total cost of holding inventory as a percentage of average inventory value. Target ranges vary by industry but typically fall between 15-35% of inventory value annually. By maintaining appropriate stock levels rather than excess inventory, businesses free up working capital for other investments.
Ways to reduce inventory carrying costs
- The item went out of trend two years ago, and NYSC has been holding those 10,000 units for two years.
- Reducing inventory frees up cash and time for more revenue-generating activities.
- By carefully analyzing both direct and indirect costs, businesses can identify areas for cost reduction, improve profitability, and maintain a competitive edge in the market.
- This formula shows your carrying cost as a percentage of your total inventory value.
For this reason, the JIT method would only be suitable if you have a really good level of coordination and cooperation with your suppliers. Inventory risk costs make up between 5% to 10% of the total inventory carrying cost. These costs include any potential losses of inventory, whether due to fire, theft, spoilage, or obsolescence. Inventory risk costs can vary according to the shelf life or value of the inventory, as more valuable inventory requires more security. Inventory risk costs can be calculated by multiplying the risk cost per unit of inventory by the number of units. The risk cost per unit of inventory can be estimated by using historical data, the expected loss rate, or the insurance rate.
Inventory costs vary significantly depending on factors such as industry, product type, and operational efficiency. The average retailer spends between 20% and 30% of their inventory’s valuation on carrying costs. Economic Order Quantity (EOQ) is an essential concept that helps determine the optimal number of units to order, striking a balance between ordering costs and holding costs. This inventory management procedure allows retailers to efficiently manage their current inventory while keeping unnecessary spending under control. Obviously, an unstable supply chain is vulnerable to disruption, which can lead to increased inventory costs, lost sales, and damage to the brand’s reputation. Inconsistent suppliers may force businesses to hold more safety stock to guard against delays, increasing holding costs.
By implementing an advanced Inventory Management System, businesses can significantly reduce storage costs while optimizing their overall inventory management. A well-managed inventory carrying cost can lead to more efficient use of capital and resources, ultimately contributing to the business’s bottom line. Moreover, controlling these costs allows businesses to be more flexible and responsive to market changes. If your holding costs are high, the EOQ formula will produce a lower order quantity as the carrying costs will be a larger portion of the total cost. This means you’ll need to order inventory more frequently which can cause cash flow problems.
In a logistics hub like Singapore, where real estate costs are high, these expenses can be significant. Costs include rent, utilities, and maintenance of the storage facilities. Inventory risk cost covers potential losses from obsolete, damaged, or stolen goods. As inventory sits in storage, its value may decrease due to market changes, technological advancements, or physical degradation. Managing these risks effectively is crucial to minimizing unnecessary expenses. To reduce the cost of your inventory, try to negotiate better prices with your suppliers.
Businesses can’t easily track fast-moving items or respond quickly to demand changes. The lack of continuous monitoring also makes it challenging to optimize reorder points or identify slow-moving inventory. The periodic inventory control system involves counting inventory at regular intervals—typically monthly, quarterly, or annually. Between these counts, businesses don’t maintain continuous records of inventory levels, relying instead on periodic physical counts to determine stock positions. This formula expresses carrying costs as a percentage of the total annual inventory value. Raw materials and work-in-progress contribute a major portion of your total carrying costs, sometimes even more than the carrying costs of finished products.
Consider long-term contracts and ordering in bulk, which will likely get you better rates on goods and save you money over time. They include the cost of lost sales, filling backorders and expedited shipping to dissatisfied customers. This retailer’s carrying cost is 38%, much higher than the industry average of 20-30%. Adopt lean practices – Lean inventory management principles like reducing batch sizes and pull-based production can decrease inventory needs. Renegotiate supplier terms – Negotiate for lower purchase costs, minimum order quantities, or extended payment terms to reduce capital costs. Warehouse Layout can affect the productivity of a warehouse, as it influences the accessibility and utilization of the space.