Inventory Carrying Cost

What Is Inventory Carrying Cost?

Inventory carrying cost, or carrying costs, is an accounting term that identifies all business expenses related to holding and storing unsold goods. The total figure would include the related costs of warehousing, salaries, transportation and handling, taxes, and insurance as well as depreciation, shrinkage, and opportunity costs.

Total carrying costs are often shown as a percentage of a business' total inventory in a particular time period. The figure is used by businesses to determine how much income can be earned based on current inventory levels. It also helps a business determine if there is a need to produce more or less to maintain a favorable income stream.

Understanding Inventory Carrying Cost

Inventory carrying costs are often referred to simply as holding costs. Accountants are responsible for recording all of the related costs but there's also a carrying cost formula for estimating the total: Take the total value of the inventory and divide by four to get a reasonable guess at inventory carrying costs.

For retailers in particular, inventory and its associated costs represent a substantial percentage of current assets on the balance sheet. As such, the management of inventory flows can greatly influence the costs of carrying that inventory.

Carrying costs also can have a direct impact on the cost of capital and future cash flows generated by the company.

The Intangibles

The tangible costs of storing inventory such as storage, handling, and insuring goods are obvious. Less obvious are the intangibles such as the opportunity cost of the money that was used to purchase the inventory, and the cost of deterioration and obsolescence of goods in storage.

Important

A carrying cost formula: divide the total value of the stored inventory by four to get a rough estimate.

Opportunity cost is generally defined as the price of foregoing other, possibly more advantageous uses for money that is being tied up in stored goods.

The cost of obsolescence will be recorded as a write-off. Perishable or trendy inventory has a higher cost of obsolescence than non-perishable or staple items.

Example of Inventory Carrying Cost

A company might have an inventory carrying cost of 20%. Its average annual value of inventory is $1 million. The annual inventory carrying cost would be $200,000, or 20% of $1 million.

Carrying costs generally run between 20 percent and 30 percent of the total cost of inventory, although it varies depending on the industry and the business size.

When the company is public, analysts monitor its inventory carrying costs over time for big changes and also compare its inventory carrying costs against those of others in its peer group.