How do you calculate the cost of carrying inventory?

Definition of Cost of Carrying Inventory
The cost of carrying inventory (or cost of holding inventory) is the sum of the following:

  • Cost of money tied up in inventory, such as the cost of capital or the opportunity cost of the money.
  • Cost of the physical space occupied by the inventory including rent, depreciation, utility costs, insurance, taxes, etc.
  • Cost of handling the items.
  • Cost of deterioration and obsolescence.

Often the costs are computed for a year and then expressed as a percentage of the cost of the inventory items. Others may focus on the incremental costs of carrying or holding inventory.

The cost of carrying inventory will vary from company to company. For instance, if a company has a large cash balance with no attractive investment options, has excess space for storage, and its products have a low probability for deterioration or obsolescence, the company's holding or carrying costs are very low. A company with enormous debt, little space, and products subject to deterioration will have very high holding costs.

Example of Calculating the Cost of Carrying Inventory
Based on the above items, let's assume that a company's holding costs add up to 20% per year. If the company's inventory has a cost of $300,000 the cost of carrying or holding the inventory is approximately $60,000 per year.