Inventory is the lifeblood of any retail, e-commerce, or wholesale business. But it can also be its most expensive asset. Holding, transportation, and insurance costs add up fast and can make inventory that’s not moving a significant drain on your overhead.
While certain holding costs are an inevitable part of running a business, keeping them at a minimum is crucial to maintaining profitability. To accomplish this, merchants must find the proper balance between having enough inventory to meet customer demand and fulfill orders and having excess stock that ties up cash flow and eats away at margins.
But in a constantly shifting industry with complex market forces, it’s nearly impossible to maintain optimal inventory levels for every SKU, product type, warehouse, and sales channel without using capable inventory planning software. In this article, we’ll explore inventory holding costs, how to calculate them, and the best practices for keeping them as low as possible.
What is inventory holding cost?
Inventory holding costs, also called inventory carrying costs, are the sum of all expenses that go into storing unsold inventory, such as warehousing, labor, administrative costs, insurance, transportation, handling, depreciation, taxes, inventory shrinkage, damaged or spoiled inventory, obsolescence, and opportunity costs.
Generally, inventory is an asset that requires huge cash outlays for businesses to maximize profit, thereby reducing the money available for business operations. The cost of holding inventory is calculated as a percentage of the total inventory value. The formula for calculating inventory holding costs is the sum of all inventory expenses, including storage costs, labor expenses, opportunity costs, depreciation, shrinkage, and obsolescence.
The average inventory holding cost depends on the industry and type of products in stock, but typically, retail brands want inventory holding costs to be around 15–30% of their total inventory value.
Minimizing inventory costs is an important supply-chain management strategy, and strategies to avoid holding costs include quick payment collection and calculating accurate reorder points.
How to calculate inventory holding costs
You don’t have to be a statistician to know how to calculate inventory holding costs. Here’s how:
- Identify the direct costs. The first step in calculating the direct costs of inventory holding is to identify the costs involved. These costs include storage, employee wages, inventory depreciation, and opportunity costs.
- Calculate the total value of your annual inventory. To calculate the total value of your annual inventory, add up the value of all the products in your inventory.
- Add up the indirect costs. Indirect costs include warehousing, insurance, labor, transportation, depreciation, inventory shrinkage, damaged or spoiled inventory, obsolescence, and opportunity costs.
- Use the cost of inventory formula. A more detailed way of calculating inventory holding costs is through the inventory holding cost formula, which factors in storage, employee, opportunity, and depreciation costs.
Inventory Holding Cost = Total of Inventory Holding/Overall Value of Inventory x 100.
- Evaluate profits. When calculating the inventory holding cost, you can evaluate the profits you can make. Calculating the price can help you avoid unnecessary costs and protect your business from losses.
Here is an example of how to calculate inventory holding costs using the annual inventory holding cost formula:
Let’s say that a direct-to-consumer jewelry business that sells minimalistic jewelry pieces is looking to update its inventory and needs to calculate its carrying cost. The retailer calculates storage costs of $20,000, opportunity costs of $20,000, $4,000 for labor expenses, $6,000 for shipping, $4,000 for insurance, and $2,000 for shrinkage and depreciation. That puts total inventory carrying costs at $56,000. The inventory has a cost of goods of $150,000.
After collecting the necessary data, the jewelry business can calculate its inventory holding cost for the past year using the annual inventory holding cost formula:
Inventory holding cost = ($20,000 + $20,000 + $4,000 + $6,000 + $4,000 + 2,000) / $150,000 x 100
Inventory holding cost: 37%
In this case, the jewelry store’s inventory holding cost is higher than it should be. Typically, inventory holding costs should only equal about 15–30% of your inventory’s annual value. So, let’s explore a few strategies for reducing inventory holding costs.
How Can You Reduce Inventory Holding Costs?
Determining your inventory holding costs is easy, but figuring out how to lower them can be difficult without the right tools. Here are a few strategies you can employ to help reduce inventory holding costs without decreasing your ability to fulfill orders and meet customer demand.
Accurate Demand Forecasting
Forecasting demand accurately is the best way to reduce inventory holding costs. When forecasts are reliable, it allows businesses to order just the right amount of inventory to meet customer demand while avoiding overstocking. Overstocking can lead to increased holding costs, as businesses are forced to store larger amounts of unsold goods for longer periods of time.
On the other hand, understocking can result in stockouts, which leaves businesses unable to meet demand, resulting in lost sales and revenue. Accurate demand forecasting helps businesses find the right balance between these two scenarios and order the right amount of inventory at the right time.
Accurate demand forecasting starts with the right inventory planning solution. Inventory Planner is the best forecasting software for businesses because it calculates exactly how much stock to order to meet demand based on numerous relevant data points and proper analysis. The software uses advanced algorithms to accurately predict future sales, identify trends, and make recommendations for optimizing stock levels, from individual SKUs to your entire inventory.
Automating Inventory Management and Planning
Businesses should lean into the power of technology to automate their inventory management and planning processes. Ditch the manual calculations and Excel sheets and instead use inventory planning software that can automatically provide accurate data about demand forecasting, reorder points, safety stock, and optimal inventory levels.
Eliminate Dead Stock
Dead stock is unsold goods that are unlikely to sell in the future. It can be a major problem for businesses, as it takes up valuable warehouse space and represents a bad investment. Here are some ways businesses can get rid of dead stock to reduce holding costs:
- Bundling. Businesses can bundle dead stock items with high-demand products for free or at a discounted price, which can help move them out of the store while still recouping some value.
- Return to the supplier. Depending on their relationship, businesses can sometimes return dead stock to the manufacturer or supplier, which can help recover some of the initial investment.
- Donations. Businesses can donate dead stock to charities and other non-profit organizations, which can help reduce waste and provide a tax write-off.
- Sales promotions. Offering sales and discounts on deadstock can help stimulate cash flow and free up valuable storage space for more profitable items.
- Liquidation. Businesses can also sell dead stock to liquidators, who will purchase the inventory at a severely discounted price.
Storage space management
Organization is crucial when it comes to warehouse and inventory management. It can help your business keep track of stock, move product efficiently, and prioritize storage. A cluttered warehouse is the home of high holding costs. You can cut costs by reorganizing your warehouse layout for maximum spatial efficiency, especially if you rent by square meters. Organizing your warehouse layout can also help you record inventory numbers more accurately and avoid lost or damaged stock.
Reduce Inventory Holding Costs with Inventory Planner
Using Inventory Planner to provide accurate forecasting, reliable ordering recommendations, and dependable data regarding your inventory health is the best way for businesses to reduce inventory holding costs.
With Inventory Planner, you can access real-time data on inventory levels, customer demand trends and shifts, and sales history, allowing you to make informed decisions about what to order and when. The software provides detailed demand forecasting for every SKU, variant, product type, sales channel, and location in your business and uses advanced algorithms to help you avoid overstocking or understocking products. This helps you maintain optimal stock levels, use storage space efficiently, and reduce inventory holding costs by ensuring you’re only storing the inventory you need.
Inventory Planner’s automation features save time and eliminate errors, helping businesses spend less time manually tracking and calculating inventory so they can focus on other important aspects of their business. Additionally, Inventory Planner provides insights that businesses won’t get anywhere else, like the last sold date, overstock units, and overstock costs. This information can help businesses identify inventory that is not selling and other inefficiencies so adjustments can be made and profitability maximized.
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