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Inventory Carrying Cost Formula and Calculation | 2020 Guide

By
Scott
on
Monday, November 9, 2020
Table of Contents

A good way to drive profits is to cut cost. Thankfully, inventory carrying costs can be an easy one to cut.

But to cut it, you must know it.

So, what is inventory carrying cost? And why is it such a big opportunity for virtually every business?

We’re gonna walk you through what inventory carrying cost is, what an average carrying cost is, and how to calculate yours.

Know thy inventory.

Carrying Cost of Inventory Definition

Inventory carrying cost is every expense related to storing and holding unsold inventory. A company’s total carrying costs are represented as a percentage of the total inventory over a specific period of time. 

There are a few moving parts to it, though, so let’s look a little closer. 

How to Define Inventory Carrying Cost

Inventory carrying cost, in its totality, includes four parts:

  • Capital costs, i.e. the money invested in a warehousing and carrying operation, along with its interest
  • Warehousing costs like rent, utilities, salaries, shipping, and handling
  • Inventory costs like obsolescence, expiration, shrinkage, and insurance
  • Opportunity costs of holding aging inventory, focusing labor on handling, and being unable to invest the capital needed for carrying cost elsewhere

Like other inventory costing methods, inventory carrying cost provides context and clarity around total inventory numbers. That provides an accurate picture of how efficiently inventory is being managed—and how parts of it may be optimized for maximum profit.

Why Do Companies Incur Inventory Carrying Cost?

Businesses incur inventory carrying cost because they need to hold onto inventory. Here’s why:

  • Safety stock, buffer stock, and anticipation inventory. This is all the product kept on hand to account for fluctuations in supply and demand.
  • Pipeline inventory. All the inventory that’s on its way from one part of the supply chain to the next.
  • Dead stock. Stock that’s lapsed into expiration, obsolescence, or any other prohibitive degradation in quality or demand. RIP.
  • Cycle inventory. Inventory that’s kept around to fulfill regular sales orders.

All this costs a pretty penny. Just how pretty? Let’s look at the average carrying cost of inventory.

Average Carrying Cost of Inventory

The average carrying cost of inventory depends on the industry and the organization’s size. Inventory carrying cost by industry varies widely. But there are some ballpark averages we can report.

What’s a Good Annual Inventory Carrying Cost?

According to a 2018 APICS study, a commonly accepted ideal annual inventory carrying cost is 15–25%. Though annual inventory carrying cost ranges from 18% to 75% annually depending on the industry and the organization.

Inventory Carrying Cost Benchmarks

From that same 2018 APICS survey are some interesting estimations around different types of inventory carrying cost benchmarks:

Carrying Cost Type Carrying Cost Percentage of Total Inventory
Capital 6–12%
Shrinkage 3–6%
Expiration and Obsolescence 6–12%
Warehousing 2–5%
Handling 2–5%
Inventory Management & Control 3–6%
Taxes 2–6%
Insurance 1–3%


Now let’s look into how to calculate inventory carrying cost.

Inventory Carrying Cost Formula

Here’s the inventory carrying cost formula:

Carrying Cost (%) = Inventory Holding Sum / Total Value of Inventory x 100

But to use the formula, you need the inventory holding sum.

Inventory Carrying Cost Calculation

The inventory holding sum is the total of the four parts that make up carrying cost:

Inventory Holding Sum = Capital Costs + Warehousing Costs + Inventory Costs + Opportunity Costs

This is what is divided by total inventory value and multiplied by 100 for an inventory carrying cost percentage.

Let’s look at how it all comes together with an inventory carrying cost example calculation.

Inventory Carrying Cost Example

Let’s imagine BlueCart Coffee Company, a roaster and wholesale supplier of coffee beans. Here’s a step-by-step inventory carrying cost example.

Step 1: Get Inventory Holding Sum Numbers

We check the ledger, and BlueCart Coffee’s numbers look like this:

  • Capital costs: $15,000
  • Warehousing costs: $100,000
  • Inventory costs: $75,000
  • Opportunity costs: $20,000

Step 2: Calculate Inventory Holding Sum

Inventory Holding Sum = Capital Costs + Warehousing Costs + Inventory Costs + Opportunity Costs
Inventory Holding Sum = $15,000 + $100,000 + $75,00 + $20,000
Inventory Holding Sum = $210,000

Step 3: Use Inventory Carrying Cost Formula

Carrying Cost (%) = Inventory Holding Sum / Total Value of Inventory x 100
Carrying Cost (%) = $210,000 / $1,000,000 x 100
Carrying Cost (%) = 21%

BlueCart Coffee’s total inventory carrying cost over the year was 21% of their total inventory cost. That’s good. But if it wasn’t good, there are ways to bring it down.

How to Reduce Inventory Carrying Cost

Reducing carrying cost increases profit. The two have an inverse relationship, and that makes carrying cost an attractive lever for the profit-minded entrepreneur. As if there is another kind.

Here’s how a business can reduce its inventory carrying cost:

  • Refocus on demand forecasting. Having too much inventory is obviously less than ideal. Redouble your efforts at accurate demand forecasting so you can fulfill what you need to without paying for it on the other end.
  • Adjust warehouse layout. Many warehouse layouts aren’t constructed with carrying cost in mind. Quickly finding the correct products is the name of the game. If your inventory carrying cost lags, look over how your warehouse is organized. It may be that some form of segmentation is in order.
  • Consider long-term contracts with vendors. Committing to a supplier for the long-term may yield quicker delivery and lower rates. Both do wonders for inventory carrying cost.
  • Leverage historical data. An automated inventory management platform allows you to consider historical acquisition cost, inventory days, sales price, sell through rate, and inventory turnover. Considering these together helps businesses determine the purchasing and sales strategies that minimum the time they hold on to unsold inventory.

By streamlining wholesale purchasing and fulfillment, BlueCart helps businesses across the country combat rising inventory carrying costs. Book a demo and we’ll show you how.