Business inventory costs have increased by 2.4% over the past year. While this may sound like a great figure, keeping inventory holding costs low during peak seasons is essential. You don’t want a surplus stock that uses vital storage costs, right?

One way to manage a holding cost is to calculate your total inventory. Some businesses do this every month, depending on their sales.

If you want to know more about calculating inventory costs, you’ve come to the right place. We explain what inventory carrying costs are, including five steps on how you could calculate your inventory.

What Are Inventory Holding Costs?

An inventory carrying cost, also known as holding, refers to the cost of unsold stock. Businesses often calculate these costs to encourage better inventory management. It’s a pivotal part of being a business owner, especially if you’re new to the eCommerce industry.

Inventory carrying costs also comprise damaged goods, shortage, warehousing, capital, and insurance. Stored inventory is responsible for profit margins and operating costs during high customer demand.

Why Are Inventory Holding Costs Important?

Keeping track of your inventory costs determines how many products you need to buy and sell. A business must note lost profit on unsalable items, which can disrupt inventory levels and financial gain from sales.

While calculating total inventory value might seem tedious, it’s the only way to achieve a growing business. You can see what stock will lose money and how to prevent high holding costs in the future. Some months do well in terms of sales, and other months could increase inventory holding fees.

Determining carrying costs is also essential for:

• Warehouse space
• Employee salaries
• Transportation and handling
• Income tax/payroll taxes
• Insurance
• Depreciation costs
• Inventory shrinkage
• Product value depletion
• Labour costs

As you can see, many factors contribute to inventory carrying costs. You don’t want to lose cash flow on dead stock or products that slowly deplete over time. Just once a month or week, you can calculate inventory costs using a simple step-by-step formula.

How to Calculate Your Inventory Costs

There are several ways you can calculate inventory carrying costs. For a new business owner, it’s easier to use one method each month. That way, you know exactly what to do when determining total inventory costs and storage space after extended periods.

Below, you’ll find five steps to calculating inventory carrying costs:

Determine your time period

Firstly, you must choose a time when counting inventory holding costs. The typical period is one month, as you give the products plenty of time to sell. It may be worth calculating your inventory once every week if you want to stay on top of holding costs.

Example:

Let’s say you want to calculate the inventory holding cost at the end of each month.

Calculate beginning inventory costs

To get the ball rolling, you have to determine your beginning inventory at the start of every time period. This starting point allows you to compare financial figures throughout the year. You might notice a decline in inventory holding costs, which shows you’re doing everything right.

Example:

Starting in January, your beginning inventory is valued at $40,000.

Add up inventory purchases

You might make new purchases during your chosen time period to keep up with demand and encourage more sales. It’s essential to include these costs when preventing high inventory risk costs. Since holding inventory counts for all products, you need to compensate for every inventory-related purchase.

Example:

You purchased $20,000 worth of inventory in the past month.

Count your current inventory costs

Now, it’s time to calculate the inventory holding cost at the end of the time period. This step is key to comparing figures and determining your average inventory turnover ratio. The only way to optimise inventory levels is by looking at the fees incurred for storing goods in the last and present month.

Example:

The inventory holding cost for the end of the month is $10,000.

Use the inventory carrying cost formula

After these steps, you can finally calculate your holding inventory cost. Robust inventory management comes from using the simple formula below:

The Cost of Inventory = Beginning Inventory + Inventory Purchases – Final Inventory Cost.

So for the example, your calculation would be: $40,000 + $20,000 – $10,000 = $50,000.

If this cost is higher than the month before, you need to reduce your company’s inventory cost. Of course, more inventory means higher risks that could disrupt future sales. However, a few quick tips to consider when improving inventory management.

3 Ways to Prevent High Inventory Holding Costs

There are always ways to prevent high inventory fees in your business. A sound inventory management system can keep everything on track, especially when you can’t physically monitor inventory constantly.

To minimise those frustrating storage costs, follow these simple tips:

1. Organise your warehouse

As simple as it might sound, organisation is key to decreasing the inventory’s total cost. Not having this type of management can lead to breakages and misplaced items. The more shrinkage costs you have, the more money you spend on maintaining your inventory.

You should place fast-moving items at the front of your warehouse to avoid slow deliveries. We can secure your inventory at eCommerce Shipping on our warehouse sites. This means you don’t have to worry about unsold inventory items taking up business expenses.

2. Eliminate obsolete stock

There’s no point in keeping stock if you can’t sell it, right? The interest lost on older items will increase your inventory carrying cost, so try not to hold onto worthless products. Some businesses even promote bundles or package deals to eliminate inventory while still gaining profit.

For example, if you have skincare products that were trending two months ago, you might bundle them for a discounted price. Customers often gravitate towards total sales in trustworthy businesses.

Not all business owners can sell inventory this way. Instead, opt for clearance sales, donations, gifts to customers or returns to suppliers. You might not gain money, but it’s better than losing money due to high inventory fees.

3. Identify potential risks

Sometimes it’s almost impossible to avoid risks in eCommerce, but there are steps you can take to minimise human errors and administrative flaws.

You could increase storage space to prevent warehouse employees from accidentally damaging inventory. Mistakes happen when packing items, but giving employees enough room will help lower common shrinkage costs.

Other risks may be shelf life, theft and unreliable suppliers. Making changes to inventory security and relationships with suppliers can prevent a high inventory value. All it takes is some planning and dedication to keep that carrying cost as low as possible.

Summary

So, now you know how to calculate inventory holding costs, it’s essential to stay consistent with this monthly evaluation. You don’t want to increase inventory risk costs by storing unsold inventory throughout the year. Just remember to calculate the costs incurred to store low-demand products.

Of course, this process won’t always be straightforward. If you need extra guidance when finalising inventory holding costs, contact us. E-commerce Shipping has control systems to give the quickest inventory turnaround.

Improving warehouse storage and inventory management is the best way to scale your business. All you need to do is contact us to get things started.

FAQs

Here are some frequently asked questions about inventory costs:

How can you reduce inventory carrying cost?

Reducing costs in the business can improve financial statements and boost how much profit you gain from sales. The more you save, the more likely you’ll improve warehouse space and avoid administrative errors. Some ways to reduce carrying costs and inventory risk are:

• Avoid overstocking
• Remove deadstock in the warehouse
• Invest in inventory management software
• Negotiate on minimum order quantities
• Reorder products at the right time
• Reduce supplier lead time

What are the four inventory costs?

Four main components of carrying costs comprise capital cost, storage space, inventory service cost and inventory risk costs. Calculating everything that contributes to unsold inventory and the money invested in high-quality products is essential. These costs will also help you to understand what changes to make when reducing carrying costs.

What are examples of holding costs?

Storing inventory that doesn’t get sold will rack up fees for your business. Some examples include shrinkage due to human errors, material handling, insurance on valuable assets, obsolete inventory that has expired and employee costs from fulfilling orders. All of these components are typically included in your total inventory value.

Does inventory mean costs of goods sold?

Inventory holding represents the raw materials and finished goods in a warehouse or typical storage space. Costs of goods sold are the financial income of sales in your business. Measuring inventory levels is vital for preventing dead stock and low customer demand in a supply chain.