Carrying Cost of Inventory - Explained
What is the Carrying Cost of Inventory?
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Table of ContentsWhat is the Carrying Costs of Inventory?How is the Carrying Costs for Inventory Used?
What is the Carrying Costs of Inventory?
The cost incurred by a company to hold and store its inventory for a certain period of time is called the carrying cost. In marketing, it is also known as the holding cost or carrying cost of inventory. It is often expressed as a percentage of the inventory value and helps in understanding how long the inventory could be put on hold before suffering a loss. Typically, the carrying cost includes taxes, the cost of keeping the products in the warehouse, salary and wages of the employees, depreciation, insurance, the cost of insuring and replacing items and others.
How is the Carrying Costs for Inventory Used?
Generally, the manufacturing companies store a certain amount of inventory in stock for fulfilling the sellers orders. The carrying cost of inventory includes four components: (i) Capital cost (ii) Cost of the storage space (iii) Service cost (iv) Risk cost Capital cost: It is a cost expanded by a company for carrying inventory. It is the major portion of the total costs of carrying inventory. It is expressed as a percentage of the total inventory. This percentage can be an exact figure calculated by the company or a subjective figure based on the experience and industry norms. Cost of the storage space: Costs are involved in operating and maintaining the storage space. It includes the rent or mortgage of the warehouse, costs of the power supply and other requirements, wages of the employees, handling the cost of moving the products in and out of the warehouse. While the rent or mortgage cost is fixed the other parts vary from time to time. Service cost: The inventory service cost includes local tax and insurance premiums. The amount of the insurance premium is determined by the nature and volume of the product. Local authorities may ask for taxes for maintaining the inventory. It depends on the rate of the tax charged by the respective authority. Risk cost: Storing the products in the warehouse involve a certain amount of risk. The product can become obsolete with the advent of new technology. The products that come with an expiry date may expire in the warehouse if stored for a long time. The expired products need to be scrapped and the company faces a loss. The products can also get damaged due to several reasons. Theft and pilferage are also included in such risk factors. All these should be included in the inventory risk cost. The carrying costs can be calculated as - (C + T + I + W + (S - R1) + (O - R2))/ Average annual inventory costs Here the C is the Capital cost, T is the taxes, I stands for the insurance premiums, W is the cost of the warehouse, S is the costs of scraping, O is the obsolescence costs and R is the recovery cost. It is important for a business to calculate its carrying costs for estimating the profit that can be made from the current inventory. It also helps them to determine whether to increase or decrease production in order to maintain the desired level of profit. The carrying cost constitutes for a major percentage of inventory value and is an essential cost factor.
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