July 3, 2016      3 min read

With a growing amount of innovation and automation in inventory management, it can seem as though all that’s needed is cutting edge management software, a dedicated staff and a willing client base. While new techniques and tools are bringing more and more intuition and control to a business’s inventory management, the core fundamentals are still as important as ever before. One fundamental that’s essential for small businesses to understand and use are inventory carrying costs. Let’s take a closer look at what they are and how they work.

What are inventory carrying costs?

In a nutshell, inventory carrying costs are the cost of owning and storing inventory. Represented by a ratio, which reflects how a business’ inventory costs interact with inventory value, these costs will usually falls between 20% to 30% of inventory value on hand.

Why do these costs matter for small businesses?

Carrying costs matter because they are one of the main metrics that shows how viable and cost effective your business is. If your costs are too high, then your business may struggle to be competitive.

Survive to thrive

Survival is often the name of the game for small businesses starting out. Some months, just breaking even is a success. But what if the costs of operating far exceed profit? This is one of the main reasons that many small businesses fold within five years. One of the key ways that businesses can guard against this is to work from an accurate ratio of carrying costs.

Carrying costs as a guide

For small or start-up businesses, getting the fundamentals of inventory management right from the start goes a long way towards having the best chance to succeed. If carrying costs are higher than 30% of on-hand inventory, then there’s an imbalance in a business’s inventory. Working out carrying costs is a key way that you can ensure your business is on the right track.

How do I work out carrying costs?

As a general rule, inventory carrying costs will include the cost of the space used to store the inventory, the amount of capital tied up in stock, handling, obsolescence and depreciation costs, and the cost of insurance and utilities. These costs are then added together and expressed as a percentage against the overall inventory value.

An easy way to work this out is carrying costs / inventory value x 100. For example, if your carrying costs are 60,000 and your inventory value is 500,000 then your inventory carrying costs are expressed as 12%.

There are of course other variables in relation to specific industries, but this formula helps show the basic idea.

Inventory optimization

Working from accurate carrying costs plays a significant role in utilizing inventory optimization techniques. Without this baseline knowledge, attempts to optimize and streamline your inventory processes may be unsuccessful.

Even small amounts of carrying cost inaccuracies, especially when widespread, can greatly damage a business’s attempts to streamline and save costs.