Understanding Carrying Costs: Types, Examples, and Impact on Business

What Are Carrying Costs?

Carrying costs, or holding costs, are the expenses a business incurs for storing and maintaining inventory, including storage, insurance, depreciation, and opportunity costs. These costs play an important role in evaluating profitability and managing inventory efficiently.

Understanding and calculating carrying costs helps businesses make informed financial decisions and identify ways to minimize expenses through effective inventory management systems.

Deep Dive Into Inventory Carrying Costs

Carrying costs are also sometimes referred to as the carrying costs of inventory. A company pays various costs over time for holding and storing inventory before it is sold and shipped to customers. Businesses calculate these costs to evaluate the level of profit they can reasonably expect on their current inventory. It is also useful in determining whether a company should increase or decrease the production of goods. By knowing its carrying costs, a business can stay on top of expenses and continue to generate a steady income stream.

Opportunity costs are another kind of carrying cost. These costs represent what a business owner sacrifices when choosing one option over another. Although opportunity costs are unseen and intangible, they can have a significant impact on a company's profitability.

Strategies to Minimize Carrying Costs

There are options business owners can implement to decrease the amount spent on carrying costs. For example, they can limit the volume of inventory they store. They can also limit the amount of time the inventory spends in storage. For businesses that utilize refrigerated warehouse space, this tactic is of specific importance. Improvement of warehouse or storage space may also be an option when trying to lower carrying costs. Having an efficient and cost-effective warehouse design and utilizing correct storage techniques can help keep carrying costs down.

Inventory tracking is also an option to help businesses cut down on carrying costs. In many cases, computerized inventory management systems are employed to keep track of inventory levels, as well as the business’ supplies and materials. These systems can alert owners or management when more or less inventory is needed.

The advantage of cyber stores over brick-and-mortar stores is the overriding lack of carrying costs. Most online stores stock inventory as it is needed, or simply have it shipped from one centralized location instead of keeping inventory in multiple physical locations.

Calculating and Understanding Carrying Costs: A Practical Example

Carrying costs are calculated by dividing the total inventory value by the cost of storing the goods over a given time. It is usually expressed as a percentage.

For example, a company that sells sporting goods might carry many items in inventory, such as sports equipment, apparel, footwear, and fitness trackers. To figure its inventory carrying costs, the company adds every cost it pays to store these items over one year. Let's say the total is $150,000. If the company has a total inventory value of $600,000, the company's inventory carrying cost is 25%. This means the company pays 25 cents per dollar of inventory it holds over the year.

The Bottom Line

Carrying costs represent the financial burden of maintaining inventory, including expenses like storage, insurance, taxes, labor, and opportunity costs. By calculating these costs, businesses can evaluate profitability and adjust inventory levels strategically.

Reducing carrying costs through efficient warehouse management and digital inventory systems helps improve profit margins and sustain a competitive edge.