Inventory Carrying cost

It is important to know your cost of carrying inventory. It is a critical factor in deciding what products to stock and when to reorder them, as well as the best quantity to order. Too often companies and organizations use an imprecise "rule of thumb" to estimate their cost of carrying inventory. The result: Bad inventory management decisions.

In a previous article, "The Mysterious Cost of Carrying Inventory," we gave you some direction for calculating an overall cost of carrying inventory for your entire company or an individual warehouse. The calculation considers these expenses and alternative opportunities for revenue:

* Moving material from the receiving dock to the proper bin location and shifting it to other warehouse locations as necessary.
* Rent and utilities for the portion of your warehouse used to store material.
* Inventory shrinkage and obsolescence.
* Physical inventory and cycle counting.
* Insurance and taxes on the inventory.
* Opportunity cost of the money invested in inventory – that is, how much could you make if the money tied up in inventory was invested in a relatively safe, income-producing investment. Or, if you finance your inventory purchases, the amount of interest that you pay the bank.

The sum of these factors is divided by the average inventory value to determine an overall carrying cost percentage – that is, what it costs to maintain a dollar's worth of inventory in your warehouse for an entire year.

But some companies find that it costs more to stock some items. Maybe they take up more space or are more susceptible to shrinkage and obsolescence. If the carrying cost percentage is used in so many critical inventory-related decisions, doesn't it make sense to calculate as accurate a carrying cost as possible for each product? If you believe that your cost of carrying inventory may vary for different segments of your inventory, consider calculating a cost of carrying inventory for each item.

Inventory carrying cost

Company's inventory carrying cost percentage – that is, what it costs to maintain a dollar's worth of stocked inventory in your warehouse for an entire year. The carrying cost is used in many inventory analysis and planning formulas including the economic order quantity formula, the calculation that is designed to determine your "best buy" replenishment quantity.
* It is fairly easy to calculate a distributor's or manufacturer's inventory carrying cost.
* There is no single accurate default value for the inventory carrying cost.
Replenishing inventory with quantities other than this "best buy" quantity will cause your company to experience higher costs and/or excess inventory.
There is no way to determine which order quantity represents the "best buy" without accurately calculating your company's specific carrying cost percentage and cost of ordering stock. The cost of ordering stock is the cost of issuing and processing a line item on replenishment order. I have read many articles stating that, as with the inventory carrying cost, this number is also too hard to calculate. Many analysts suggest that you should just pick a value between $5.00 and $6.00. As with using rules of thumb for the inventory carrying cost, if you just guess at your company's cost of ordering stock, the resulting economic order quantity will not represent your company's best buy quantity.