Inventory carrying cost

How inventory carrying cost is worked out

Add five components for a year, then divide by the average stock value over that year and turn it into a percentage.

Capital. What the money tied up in stock costs you, at whatever your own cost of capital currently is. Not a notional rate from a textbook.

Space. Rent, rates, heating, lighting, racking depreciation, the share attributable to storage rather than to the packing hall.

Insurance and taxes on the stock itself.

Handling that exists because the stock exists. Put-away, replenishment, counting, moving pallets to get at other pallets. Not the picking, which exists because of the order rather than the stock.

Obsolescence, write-off and shrinkage. This is the component people leave out, and in fashion, food and electronics it is frequently the largest of the five. A carrying cost built from rent and interest alone looks reassuring and is wrong by a wide margin.

There is a pallet storage cost calculator on this site for the space component.

There is no good number

A figure for a cold store and a figure for a steel stockholder have almost nothing in common. Published ranges exist and are not worth chasing; the point of this metric is not to match somebody else but to have your own number, because without it every stock decision is being made with no price attached.

What it is for is putting a cost on choices. An extra month of cover, a bulk buy at a discount, a higher service level on the long tail: each of those is a stock increase, and each one costs the carrying percentage per year, every year, until the stock leaves.

In practice

Average stock over the year is £800,000. The five components come out as: £56,000 of capital at seven per cent, £38,000 of space, £4,000 of insurance, £22,000 of write-off and obsolescence, and £14,000 of handling attributable to holding.

That totals £134,000, which against £800,000 of average stock is 16.75 per cent, so call it 17 per cent a year.

Now the figure does some work. Holding an extra £100,000 of stock costs about £17,000 a year. A supplier offering a five per cent discount for a buy that would add six months of cover to a slow line is offering five per cent once against roughly eight per cent of carrying cost over those six months, which makes it a worse deal than it looks. The numbers here are an illustration.

What moves the figure

• Your cost of capital. The largest controllable line after write-off, and the one most often left at a figure somebody chose years ago.
• Obsolescence risk by category. A single percentage across a range that mixes staples and seasonal lines will overstate one and understate the other badly.
• Space cost and how well the space is used. The same stock in a building at 52 per cent cubic fill costs nearly twice the rent per pound of stock. See space utilisation.
• How much stock you hold at all. The percentage is a rate; the bill is the rate times the stock, and the stock is the part you can change fastest. See days of inventory.
• Dead stock sitting in the average. It carries full cost and generates no margin. See dead stock.
• Whether handling is counted at all. Including it roughly doubles the handling-sensitive part of the figure, and excluding it is defensible as long as the report says so.