Definition of Cost to Store Inventory
The cost to store, hold or carry inventory is the total of the following:
- Cost of the space used for storing inventory, such as rent, heat, insurance, maintenance, etc.
- Cost of the money tied up in inventory
- Cost of insuring the inventory
- Cost of deterioration and obsolescence of the inventory items
Some of the costs listed are a function of the cost or value of the inventory, while some are based on the physical size of the items being stored. The annual costs to store or hold inventory are typically stated as an annual amount per unit or as a percentage of an item's cost.
The calculation of the cost to store inventory should be the incremental annual costs or the company's opportunity costs. In other words, if a business has a large amount of idle cash, no debt, and a warehouse that is half empty, its costs to store inventory will be relatively low. Another company with little cash, much debt, and little available storage space will have relatively high costs of storing inventory.
The costs to store inventory are part of the economic order quantity (EOQ) formula or model that calculates the optimum order quantity. The economic order quantity is the number of units that will minimize the total annual costs of both ordering and storing inventory.
Example of Cost to Store Inventory
A company estimated its annual cost to carry an additional increment of inventory to be 15% of the item's cost. This estimate was based on four components listed in the above definition. The cost of each of the components will likely be different for each company and the cost will likely vary over time.
Some of the costs are not easy to compute, but can be substantial. For example, the cost of holding items can be significant if the items become obsolete due to breakthroughs in technology.
If the company cuts back on the quantity of goods it orders or the quantity of goods it produces in order to reduce its holding costs, the company will incur additional ordering costs or production set up costs.