Holding Costs

What are 'Holding Costs'

Holding costs are the costs associated with storing inventory or assets that remain unsold. Holding costs are a major component of supply chain management, since businesses must determine how much of a product to keep in stock. With limited storage space, storing one product creates an opportunity cost because the business cannot store as much of other products.

BREAKING DOWN 'Holding Costs'

Holding costs of inventory contain hidden fees, such as the cost of purchasing items, housing, handling and accounting for depreciation if those items do not sell quickly. Such costs may represent as much as 25% of inventory value on hand.

Holding costs are typically computed for one year, then expressed as a percentage of the cost of the inventory items. For example, a company with $300,000 in inventory cost paying $60,000 per year for carrying the inventory has holding costs of 20%. Not accounting for holding costs may lead to excess, wasted, lost or damaged inventory, creating a loss for a business through a write-down or write-off.

Write-Downs and Write-Offs

A write-down occurs when goods have not sold and their market value has dropped below the purchase price. The difference between the purchase price and the current, lower price is the write-down amount. Any inventory write-down is recorded as an expense on an income statement. For example, the rebranding attempt by J.C. Penney Co. Inc. in 2013 cost the company $1 billion and caused a long-term negative effect on the business. Inventory liquidation and significant write-downs as low as 95% off occurred on some clothing items.

A write-off is the formal recognition of a portion of inventory no longer having value. This is more damaging to a company’s bottom line than a write-down. Many companies completing a manual inventory assessment discover a large portion of their inventory is missing. Because absent products have no value, the business must write them off. For example, Amarillo National Bank, headquartered in Amarillo, Texas, was manually tracking inventory. Because the bank had issues accounting for its entire inventory, unnecessary purchases were made and inaccurate billing was performed. As a result, the actual inventory did not match the numbers in the books. After the bank implemented a dedicated inventory management system, their inventory write-offs were reduced from tens of thousands of dollars each year to a few hundred dollars annually.

Types of Holding Costs

Inventory capital costs involve purchasing inventory and tying up liquid cash until recouping the money by selling the items. The process takes vital capital from company operations. Because inventory capital costs include the money spent on inventory, interest paid on the purchases and interest lost when the cash becomes inventory, this is typically the greatest portion of the total holding cost.

Storage space costs involve keeping inventory securely organized in one place and in proper condition. Costs include rent, utilities, security and upkeep.

Inventory service costs involve protection against theft, workplace accidents and other issues. Insurance, taxes and inventory management systems are included in these costs.

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