Calculating the Carrying

Cost of Inventory

Mary Lu Harding, C.P.M., CPIM, CIRM

Harding & Associates
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What is Carrying Cost ?

The cost of overhead required to
support the inventory
Expressed as a percent
Calculated per year

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Variable Costs
Change as the dollar level of
inventory changes in a direct ratio
Most widely accepted carrying cost
factors fall into this category

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Fixed Costs
Do not change directly as the
dollar level of inventory changes
Can change, but more slowly
Changes occur when certain
inventory levels are reached
These factors are too often ignored
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Variable Cost Factors

1.
2.
3.
4.

The cost of money

Taxes
Insurance
Obsolescence (reserve)

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The Cost of Money

Interest rate your organization
pays for borrowed money
or
Interest rate your money would be
earning if invested elsewhere
Calculated in percent
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Taxes
Tax on inventory by any political
jurisdiction for any inventory
storage point(s)
Calculated in percent

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Insurance
Covers the replacement value of
the inventory in the event of a
catastrophic loss
Premiums can vary with the value
of the assets (inventory)
Self-insured organizations typically
establish a reserve to cover losses
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Obsolescence Reserve
A financial reserve set aside to
cover forecasted inventory losses:
Shrinkage
Write-offs

Typically calculated in percent

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Variable Cost Example

Cost of money
Taxes
Insurance
Obsolescence
Total

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6%
2%
3%
6%
17%

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Fixed Cost Factors

1. Storage space
2. Personnel
3. Capital equipment

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Space
Overhead cost to operate a facility
Often calculated as cost / sq ft
Particularly significant for warehouses
Changes when significant space is
vacated

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Capital Equipment
The investment in support equipment
Automated material handling systems
Fork-lift trucks
Racks, scales, bins, etc

As long as equipment has value on

the books, that value is part of the
support cost of the inventory
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Capital Equipment Factor

To calculate the carrying cost factor for capital
equipment investments, determine:
1. Current capital equipment investment value
2. Average total inventory dollars
The factor is:
Capital Equipment Value X 100
Avg Tot Inventory Value
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= Carrying Cost
Factor (%)
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Personnel
Includes those people whose job
description is the management &
handling of inventory:

Warehouse managers
Inventory controllers
Material handlers
Stockkeepers
Cycle counters

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Personnel Factor
To calculate the carrying cost factor for personnel,
determine:
1. Total budget cost for the administrative area
2. Average total inventory dollars
The factor is:
Total Budget Value

100

= Carrying Cost

Avg Tot Inv Value

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Factor (%)
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Fixed Cost Example

Variable Carrying Cost
+
Storage space

17%

Personnel

12%

Capital equipment
Total

6%
40%

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5%

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Other Factors
In certain types of businesses,
other factors may apply:
Secondary quality costs
Computation costs

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Quality Costs
Quality costs that can properly be
added to carrying cost are those
secondary inspections related to
storage. For example:
Short-shelf-life items
Frequent revision-level changes
Damage from improper storage
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Computation Costs
Inventory is the largest data base
and the most active in many
organizations. If your organization
has purchased or maintains
software or hardware to track
inventory, then that is part of the
capital expenses allocated to the
inventory.
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Total Carrying Cost Example

Variable cost factors
Fixed cost factors
Secondary inspections
Computation costs
Total Carrying Cost

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17%
23%
6%
5%
51%

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Consequences
1. Decision-making at every level
2. Dollars of inventory on hand
3. Emphasis on inventory reduction
(or not!)
4. Behavior within the organization

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Case Study #1
A large multi-national corporation
making consumer products
Inventory carrying cost = single digits
Level of inventory = $1 Billion

The primary product takes only

minutes to produce
They just built additional warehouses
for finished goods
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Case Study #2
British Petroleum (Alaska) analyzed
the cost of supporting maintenance
inventory for the Alaska pipeline
Total inventory support costs = 72%

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Summary
Inventory carrying cost affects
decisions within the organization
A low number says that inventory
is a cheap alternative
The higher the number, the less
attractive inventory becomes as a
solution to problems
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Remember .....
If inventory is cheap,
you will have a lot of it.

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