Carrying Cost Of Inventory

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What is 'Carrying Cost Of Inventory'

Carrying cost of inventory, or carry cost, is often described as a percentage of the inventory value. This percentage could include taxes, employee costs, depreciation, insurance, cost to keep items in storage, opportunity cost, cost of insuring and replacing items and the overall cost of capital for the company as a whole.

BREAKING DOWN 'Carrying Cost Of Inventory'

Also referred to as carry cost of inventory, the carrying cost of inventory is the cost a business incurs over a certain period of time to hold and store its inventory. Businesses use this figure to determine how much profit can be made on current inventory. It also helps businesses find out if there is a need to produce more or less to keep up with expenses or maintain the same income stream.

Total Cost of Ownership

The way in which a company manages assets can tell a great deal about its future performance as well as management's efficiency. This is why analysts look at ratios such as return on assets (ROA) and inventory turnover. Inventory generally represents the largest portion of current assets. As such, the management of inventory flows can greatly influence the cost of carrying that inventory. Additionally, the cost of inventory can have a direct impact on the cost of capital and future cash flows.

The cost of inventory includes all costs associated with holding or storing inventory for sale. These costs include the opportunity cost of the money used to purchase the inventory, the space in which the inventory is stored, the cost of transportation or handling, and the cost of deterioration and obsolescence.

The opportunity cost of the money used depends on the source of funds used. The cost of funds obtained via internally generated activates is going to be lower than the cost of obtaining funds by issuing equity. The space used to store inventory includes expenses such as rent, depreciation, insurance and other charges associated with maintenance and operational controls such as security, workplace accidents and permits. The cost of obsolescence can be seen in the average amount of write-offs a company has. Perishable or trendy inventory may have a higher cost of obsolescence than non-perishable or staple items.

Inventory Carrying Cost Example

Inventory carrying cost is the cost of owning inventory and is generally expressed in percentage terms. For example, if a company has an inventory carrying cost of 10% and the average annual value of inventory is $1 million, the annual cost of inventory is $100,000. Inventory cost is generally between 20% and 30% of the cost to purchase inventory, but the average rate varies based on the industry and size of business. As such, analysts like to compare the rate against other companies in the same peer group and market capitalization.