Having finished goods on hand to meet fluctuating customer demands is great — if you’re adequately calculating holding costs.
Without this knowledge, you risk accumulating excess stock or facing stock outs, both of which can stifle profitability. Instead, learn how to calculate (and reduce) holding costs to gain more control over stock levels, minimize surplus inventory, and align financial strategies with market dynamics.
What are holding costs?
Holding costs represent the total expenses incurred from storing inventory. Storing goods involves various expenses, including warehousing fees, utilities, insurance, and stock protection security. Goods also risk depreciating in value and becoming obsolete over time, further increasing expenses.
While it’s sometimes necessary to hold inventory, knowing how much it costs to keep that stock on hand for extended periods is crucial. If you stock up for a holiday sale, for instance, calculating holding costs lets you gauge the impact of storing extra stock. And if costs are high, you might shift your strategy toward ordering closer to the sale date and opting for expedited shipping to your warehouse instead.
Many use the terms holding costs or holding fees interchangeably with carrying costs. While the core concept remains the same — expenses incurred to store unsold goods — the scope of these costs can vary between businesses. Beyond storage fees, some companies also factor in planning, ordering, and handling costs. To ensure accurate inventory and financial planning, it’s important to make sure everyone agrees on what constitutes holding costs.
Understanding the inventory holding cost formula
To accurately calculate holding costs, you must assess four critical components:
- Capital costs represent the funds invested in acquiring stock. This is a major component of holding costs because these items immobilize capital that could serve other operational needs.
- Inventory service costs cover expenses related to inventory insurance and taxes. These costs are essential for safeguarding your investment against potential losses or damages, ensuring financial protection throughout the inventory lifecycle.
- Storage space costs encompass the total expenses for warehousing your goods, including rent, utilities, and related overheads. The more goods you store, the higher the fees.
- Inventory risk costs account for the financial risks associated with maintaining stock, such as value depreciation, obsolescence, or, for perishable goods, expiration.
How to calculate inventory holding cost
The formula for holding cost is the total of your inventory costs divided by the overall value of your stock, multiplied by 100. Here’s a step-by-step guide that breaks down the process.
1. Identify the value of inventory components
Start by calculating your capital, inventory service, risk, and storage costs. Here’s an example:
- Capital cost: $50,000 to purchase your inventory.
- Inventory service cost: $2,000 for insurance and taxes.
- Risk cost: $3,000 for stock obsolescence and loss insurance.
- Storage cost: $5,000 for warehouse rent and utilities.
2. Sum up the costs
Add up the identified numbers to find your total inventory holding cost. The formula is:
Inventory holding sum = capital cost + inventory service cost + risk cost + storage cost
Following the above example, the costs would be:
$50,000 (capital) + $2,000 (service) + $3,000 (risk) + $5,000 (storage) = $60,000
3. Calculate the total value of your inventory
Now, determine your unsold inventory’s value. If you’re using a modern inventory management system like Fishbowl, you can find this number with a few clicks.
For illustrative purposes, let’s say your unsold inventory’s value is $200,000.
4. Determine the holding cost percentage
Divide the inventory holding sum by the total inventory value and multiply by 100 to find your holding cost percentage.
Holding cost percentage = (inventory holding sum / total value of inventory) x 100
Following our example, if your total inventory value is $200,000 and your combined costs for risk, storage, capital, and services are $60,000, your holding cost calculation would be:
Inventory holding sum = capital cost + storage space cost + inventory risk cost + service costs
Inventory holding sum = $60,000
Holding cost percentage = (inventory holding sum / total value of inventory) x 100
Holding cost percentage = ($60,000 / $200,000) x 100
Holding cost percentage = 30%
In this example, your holding cost percentage is 30%, indicating that the expenses to hold your inventory represent 30% of its total value.
Where will you encounter holding costs?
When you’re running a small outfit from your garage, holding costs will be negligible. But as your business outgrows this space, holding costs will ramp up in scale.
If you’re looking for a new storage solution, here are a few prevalent options, each with unique holding fee implications:
- Warehouses: Leasing warehouse space is often the most cost-effective option for storing large inventory volumes, offering economies of scale that lower the per-unit storage cost. And they provide specialized features such as climate control and security, essential for maintaining the quality and safety of your goods.
- Storage units: Ideal for short-term or transitional needs, storage units offer quick lease initiation and easy termination without long-term commitments.
- Fulfillment centers: Managed by third-party logistics providers, fulfillment centers handle storage and the entire order fulfillment process, including packing and shipping. Their efficiency and scalability make them a viable option for businesses looking to outsource warehouse logistics. But their comprehensive services also come with a higher price tag.
5 tips for reducing holding costs
Revisiting your inventory management strategies is key to keeping costs in check and boosting your bottom line. Here are five actionable tips to effectively reduce your holding costs.
1. Streamline inventory levels
Balancing stock levels to match demand without overstocking is key to reducing holding costs. While it’s wise to maintain safety stock for unexpected supply chain interruptions, avoid excess stock that unnecessarily ties up space and capital. This is especially important when managing inventory across multiple locations, where poor overall stock visibility can lead to inefficiencies and increased costs.
2. Eliminate dead stock
Dead stock, or items that are obsolete, expired, and unsellable, represents sunk costs. Actively disposing these goods through discounting and repurposing helps mitigate your financial losses and frees up valuable warehousing space.
Proactively adopting strategies such as consignment inventory models and using analytics for demand forecasting can help you minimize dead stock accumulation and further reduce your holding costs.
3. Increase inventory turnover
Enhancing your inventory turnover frequency — selling through your entire stock within a given period — reduces holding costs by quickly moving goods out. Focusing on high-turnover items and scaling back on slower-moving stock keeps your inventory flow dynamic, diminishing holding costs and preventing stock obsolescence.
4. Enhance warehouse efficiency
Reworking your warehouse’s layout can turn wasted space into efficient storage, ensuring smooth inventory flow and reduced holding costs. By maximizing storage and streamlining the picking process, effective space management also speeds up order fulfillment, directly reducing holding fees while enhancing overall operational productivity.
5. Automate warehouse and inventory management
Manual inventory processes are prone to human errors and inefficiencies, leading to overstock and underutilized warehouse space. By providing real-time insights into stock levels, automation empowers you to make more data-driven decisions, ensuring you stock efficiently and respond quickly to demand changes.
Implementing an automated warehouse and inventory management system like Fishbowl not only reduces your holding costs but also enhances operational efficiency, lowering labor costs associated with manual inventory checks.
Enjoy efficient inventory management with Fishbowl
Calculating holding costs offers insight into your stock levels, but integrating Fishbowl Inventory elevates this advantage by offering unparalleled visibility and control over your stock.
Whether your business leverages centralized or decentralized manufacturing strategies, this all-in-one platform enhances operational efficiency by providing real-time updates and ensuring accuracy across all order fulfillment stages. And Fishbowl’s QuickBooks integration further simplifies inventory and financial data management, letting you seamlessly track costs and orders across every sales channel.
Book a demo today and discover how this tool streamlines inventory management.