How to Calculate Inventory Carrying Cost (With Examples)
By Indeed Editorial Team
Published 29 June 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Many businesses perform calculations to help them evaluate how to improve their operations. A common procedure involves determining what percentage of the company's assets go towards storage expenses for its goods. If you're interested in pursuing a business or finance-related career, learning how to calculate inventory carrying cost may be beneficial. In this article, we define what inventory carrying cost is, show how to calculate it, list its components and provide two examples to help you better understand the concept.
What is inventory carrying cost?
Inventory carrying cost, or carrying cost, refers to the total cost of holding inventory. Typically, it's used to refer to all the expenses a business incurs in storing unsold goods. These expenses might include the rental for a storage facility, utilities bills, labour wages and insurance for the products. An accountant may calculate it as a percentage of a company's total current inventory as it allows them to evaluate the production process for efficiency. This calculation can help a company determine whether to increase or decrease its production rate.
Here's the formula for calculating the inventory carrying cost as a percentage of a company's total current inventory value:
Carrying cost percentage = (Total inventory holding cost / Total inventory value) × 100
How to calculate inventory carrying cost
Follow these steps to learn how to calculate inventory carrying cost:
1. Ascertain the cost of each inventory element
The first step in performing an inventory carry cost calculation is to find out how much a company spends on each aspect of its inventory. These costs relate to inventory but don't include the inventory itself. Here are some examples of elements that contribute to inventory carry cost:
storage facility costs
storage facility employee wages
opportunity costs for alternate uses of the funds
2. Determine the total inventory holding cost
Next, calculate the first part of the formula, which is the total inventory holding cost. To do this, add all the costs of storing the goods. This includes any warehouse costs, wages for employees to operate the warehouse and insurance costs to protect the stored goods from any accidents that may occur, such as fires or floods.
3. Calculate the total inventory value
After determining the total inventory holding cost, calculate the total inventory value. Generally, you can attain this figure by multiplying the total number of goods available by the unit price of a single item. For example, if a book publishing company has 1,000 books with a value of $10 each, the calculation for determining the total inventory value looks like this:
Total inventory value = 1,000 × $10
4. Apply the inventory carrying cost formula
Now that you have the necessary values, you can incorporate them into the inventory carrying cost formula. First, divide the total inventory holding cost by the total inventory value. Next, multiply the result by 100 to attain the carrying cost figure as a percentage. For example, if the book publishing company has a total inventory holding cost of $2,500 and a total inventory valued at $10,000, here's how it looks when incorporated into the formula:
Inventory carrying cost = (Total inventory holding cots / Total inventory value) × 100
Inventory carrying cost = ($2,500 / $10,000) × 100
= (0.25) × 100
The components of inventory carrying cost
Here are the four main expenses that typically constitute a company's total inventory carrying cost:
Capital cost: Capital cost includes fixed price, one-time payments for resources such as land, buildings, materials, equipment and construction. Essentially, the prerequisites for operating a business feature in this cost.
Inventory service cost: This cost involves expenses for ordering and storing goods, including any cost for mandatory paperwork during this process. These costs don't relate directly to the goods themselves but rather the gathering and holding of them.
Inventory risk cost: Inventory risk cost covers any losses that may occur to products before they're sold. This can include theft, obsolescence, late shipping and mishandling.
Storage cost: This cost includes rent, utility bills and employee wages for a storage space to hold inventory. It may also include costs for moving goods in and out of the storage facility.
The benefits of calculating inventory carrying cost
Here are some of the main benefits of calculating inventory carry cost:
It aids with planning production schedules. Performing this calculation allows a company to be financially prudent by adjusting its production processes. For example, a product with a low carrying cost that sells well may warrant a faster production schedule.
It helps produce accurate financial statements. Many businesses spend a large part of their assets on inventory. Performing this calculation can provide a company with insight on how to minimise its spending in this area.
It shows how profitable the current inventory is. Determining the net value of inventory involves finding out the inventory carrying cost. As such, knowing this value can enable a company to forecast its future profits.
Examples of inventory carrying cost calculations
Here are two examples that demonstrate how companies calculate their inventory carrying cost:
Review this example to learn how to perform the necessary calculations:
Ishmael Boat Company has an inventory of 1,000 model ships. Each ship has an estimated value of $400. The business wants to determine its inventory carrying cost to see how it might adjust its production schedule as the product is selling quite well. First, the company's accountants consolidate a list of inventory holding costs that includes:
capital cost of $75,000
inventory service cost of $15,000
inventory risk cost of $20,000
storage cost of $30,000
Next, they add these values together to find out the company's total inventory holding cost, which is the first half of the carrying cost formula. After attaining this value, they proceed to find the second half of the carrying cost equation, which is the total inventory value. They do this by multiplying the value of a single model ship by 1,000, which is the total number of model ships. Here are the calculations:
Total inventory holding cost = $75,000 + $15,000 + $20,000 + $30,000
Total inventory holding cost = $140,000
Total inventory value = $400 × 1,000
Total inventory value = $400,000
Now that the accountants have both parts of the formula, they can incorporate these figures into the carrying cost formula and multiply it by 100. With this result, the accountants advise the company to wait a little longer before increasing its production schedule. This is because the accountants know from their experience in the field that a carrying cost within a range of 15% to 30% is preferable. Here are the calculations:
Carrying cost percentage = (Total inventory holding cost / Total inventory value) × 100
Carrying cost percentage = (140,000 / 400,000) × 100
Carrying cost percentage = 35%
Learn how to calculate inventory carrying cost from this example:
Sweet Child Music Store has 15 custom-made electric guitars in its current inventory. It estimates each guitar to be worth $1,000. The company tasks its accountant with finding out the carrying cost of its inventory. First, the accountant compiles the inventory holding costs. The collected data includes:
capital cost of $2,000
inventory service cost of $500 for transporting the guitars from the manufacturer
inventory risk cost of $500, including insurance for the instruments
storage cost of $1,000 for renting the location of the music store where the instruments currently are
Next, the accountant combines these costs to determine the total inventory holding costs. With this figure, the accountant proceeds to find out the total inventory value. They multiply the estimated value of a single guitar by the total number of instruments. Finally, the accountant puts these values into the equation to determine the carrying cost. Here are the calculations:
Total inventory holding costs = $2,000 + $500 + $500 + $1,000
Total inventory holding costs = $4,000
Total inventory value = $1,000 × 15
Total inventory value = $15,000
Inventory carrying cost = (Total inventory holding cost / Total inventory cost) × 100
Inventory carrying cost = ($4,000 / $15,000) × 100
Inventory carrying cost = 0.266 × 100
Inventory carrying cost = 26%
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