What is carrying cost? 

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Carrying cost is the amount that a business spends on holding inventory over a period of time. It is the cost of owning, storing, and keeping the items in stock.

Significance of carrying cost

Carrying cost includes the cost of renting the warehouse where the stock is kept, operating the warehouse, paying the salaries of the employees working at the warehouse, any loss of inventory due to theft and damage, and insuring the inventory. Carrying costs are usually 15% to 30% of the value of a company’s inventory. This is a significant figure as it tells the company how long they can keep their inventory before they start losing money over unsalable items. Additionally, it shows how much they need to sell and buy in order to maintain appropriate inventory levels. Calculating carrying cost and knowing how to minimize it can help a company reclaim money tied up in inventory and increase its profits.

Components of carrying cost

The four main components of carrying cost are:

1. Capital cost

2. Inventory service cost

3. Inventory risk cost

4. Storage space cost

 Capital cost

Capital cost is the largest component of carrying cost incurred by businesses. It includes the interests added and the cost of money invested in the inventory. Capital cost is always expressed as a percentage of the total value of the inventory being held. For example, if a company reports that its capital cost is 30% of its total inventory costs, and the total inventory is worth $8,000, then the company’s capital cost is $2,400.

Inventory service cost

Inventory service cost includes IT hardware, applications, tax, and insurance. The company’s insurance costs are dependent on the type of goods in inventory and the level of inventory. The level of inventory is the amount of inventory the company keeps on hand to fulfill its orders—a high level of inventory makes it easier to meet the customer demand. High levels of inventory attract higher insurance premiums and taxes, raising the total inventory service cost.

 Inventory risk cost

Carrying inventory comes with risk. Inventory risk costs include the shrinkage of inventory (which refers to the loss of products because of factors other than sale), theft, and administrative errors (such as misplaced goods, errors in shipping, or late system updates). Another risk factor is product value depletion: if items are stored for too long in the inventory, their value can drop to a fraction of what they were originally worth.

Storage space cost

Storage space cost includes the rent paid to warehouse your products, air conditioning and heating, lighting, transportation, and other costs associated with the physical warehouse. This cost has a fixed component and a variable component. The rent is a fixed cost, whereas the costs of handling the materials will vary constantly based on demand and the number of products stocked.

How to calculate carrying cost

Calculating your carrying cost percentage is important for calculating the profit you’re making on your inventory.Carrying costs are always expressed as a percentage of the total value of inventory. Carrying costs are always expressed as a percentage of the total value of inventory. They’re equal to the inventory holding sum divided by the total value of inventory, then multiplied by 100.

Carrying cost (%) = Inventory holding sum / Total value of inventory x 100

The inventory holding sum is simply the total of all four components of carrying cost.

Inventory holding sum = Inventory service cost + Inventory risk cost + Capital cost + Storage cost

To calculate your carrying cost:

1. Calculate the value of each of your inventory cost components (inventory service cost, inventory risk cost, capital cost, and storage cost).

2. Add the inventory cost components to get the inventory holding sum.

3. Determine the total value of your inventory.

4. Divide the inventory holding sum by the total value of inventory and multiply by 100.

For example, let’s look at the carrying cost for a

Motorcycle retailer who carries inventory for all his bike models. The total value of his inventory is $50,000. His inventory holding sum is $10,000 (which includes the inventory service cost, risk cost, capital cost and storage cost). His inventory carrying cost, expressed as a percentage, is:

Carrying cost (%) = Inventory holding sum / Total value of inventory x 100

                                = 10,000 / 50,000 x 100 

                                = 0.2 x 100 

                                = 20%

The carrying cost incurred by the motorcycle retailer is 20% of his total inventory value.

Therefore, carrying costs enables you to find out your profit against incurred against the inventory you are holding. This cost ensures that you do not run into grave losses by holding inventory over a long period of time. Always the carrying cost should only be in limits of 20% – 30% of your total inventory value.

 

 

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