What is Holding Cost and How to Calculate It – Guide 2022

Man calculating holding costs

Calculating Holding Cost: Everything You Need To Know

If your eCommerce or retail business stores inventory in a warehouse or a special storage facility, the holding cost is something you should definitely plan for to avoid financial issues in the future. 

Today, we will be looking at what holding costs really are, how to calculate and optimise them, as well as the storage solutions available and how to choose the right one.

What Are Holding Costs?

The holding costs, also known as inventory carrying costs, are defined as the amount of money you spend on storing inventory that remains unsold.  

They cover several things, including:

  • The total inventory cost (including shortage and ordering costs)
  • The storage space
  • The labour cost
  • The Insurance 
  • The price of goods that become spoiled or damaged 

Reducing inventory holding costs is important as it allows you to optimise your supply chain management for better profitability and cash flow.  Knowing the extent of your carrying costs also gives you the chance to make realistic growth projections based on your current inventory capabilities.

Calculating Inventory Holding Cost

Calculating the inventory holding cost is a very straightforward process, as long as you have worked out the price of the following four elements: storage, opportunity, employee and depreciation, 

Storage Costs

Storage costs typically include every outlay involved with the physical storage of inventory, including rental of warehouse/storage floor space, insurance and utilities.

Opportunity Costs

These are intangible and demonstrate the costs of holding dead stock.

Depreciation Costs

Another intangible cost, these concern the progressive costs that are incurred as the value of your inventory depreciates as the products become undesirable or obsolete.

Employee costs

This cost concerns the salary/wages of the warehouse staff who contribute to the maintenance of the warehouse building and processes within, such as inventory auditing and order fulfilment.

The Holding Costs Formula

So, once you have worked out the above, it’s  time to calculate your holding costs using the formula below:

Holding Cost = (Storage Costs + Opportunity Costs + Depreciation Costs + Employee Costs) / Total Value of Annual Inventory

Whether you are talking about inventory carrying costs or holding costs, the formula is the same. The resulting number, which should be a percentage, represents your inventory holding cost.

Holding Costs: Where You’ll Encounter Them

Although storing your inventory within your home or connected annexes will keep your holding cost low, this isn’t a practical solution for businesses that wish to grow substantially and significantly, as fulfilling orders manually can be an arduous and time-consuming task.

Subject to your objectives, your business will begin to outgrow such a limited amount of space and so too will your inventory. As a result, you should expect the holding costs to increase as your business grows. When looking at your next storage solution, consider the following three examples, all of which involve holding costs.

Fulfilment Centres

These are physical locations – typically run by third-party logistics (3PL) companies or logistics services providers – that often undertake the process of order fulfilment for the eCommerce/retail company they have partnerships with.

Built from the bottom up to efficiently fulfil orders, they are not merely limited to being a remote storage location. However, they are different to on-demand warehousing or short-term storage solutions.

Fulfilment centres are great solutions for growing businesses as they will not only store inventory but pick, pack and ship orders to the buying customer, also simplifying the last-mile delivery process.

Warehouses

Warehouses are typically large storage spaces purposely built by a company, or leased, to store inventory: they are usually at least 1,000 square feet in floor space.

The processes and tools available within a warehouse will often depend on the type of inventory you handle and sell, as you may require special features, such as refrigeration units if you handle food, chemicals or special medication.

Storage Facilities

Once your inventory outgrows humble storage spaces (such as the living room or garage), storage facilities may be a practical short-term solution to hold stock.

They are commonly far smaller than warehouses and do not typically offer any type of order fulfilment or inventory auditing, therefore they may have limited potential for companies with significant order numbers.

Reducing Holding Costs

Making a conscious effort to reduce your inventory holding costs frees up cash assets to direct into other aspects of your business. A surefire way to do that is to sell your inventory and quickly collect customer payments. Higher liquidity through collecting customer payments more quickly means that more cash is available to continue conducting business.

Companies can analyse and revise the efficiency of their cash collection management by utilising the inventory turnover ratio, calculated by dividing the cost of goods sold by average inventory.

Another practical way to lower holding costs is to accurately calculate reorder points or revise the automated requisite level of inventory that triggers new orders from suppliers. It allows you to avoid significantly overestimating the demand and overspending on inventory or storage, as well as underordering products, potentially losing sales.

A precise reorder point can also aid businesses to work out the ideal order amount from a supplier and discover the precise economic order quantity (EOQ), which can be calculated using modern inventory software.

FAQ

Why is calculating the cost of carrying inventory important?

Knowing the inventory holding cost allows your business to discover areas for optimisation and potentially optimise your practices to improve your cash flow.

Are holding costs and carrying costs the same?

Yes, inventory carrying costs and holding costs both cover the total costs related to storing unsold inventory and they are calculated the same way. 

How do I work out my inventory holding costs?

Calculating your inventory holding costs requires you to know the cost of your storage solution, how much staff wages cost, as well as the inventory depreciation cost and the opportunity costs. The combined cost of these four divided by the total value of your yearly inventory is your holding costs percentage.

Looking to reduce your holding costs? Here at Breakwells, we are haulage and storage experts located in the West Midlands with over 50 years of experience in the distribution and warehousing industry. At our modern storage facility in Kidderminster, you can benefit from 24/7 CCTV monitoring and experienced warehouse staff. Whether you are looking to store individual items or full container load, get in touch today.

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