Understanding Inventory Costs
One of the critical impacts on profitability often overlooked and misunderstood is the cost of holding inventory. There are some cost drivers in carrying inventory and sometimes, even more, important, the cost of not having enough inventory on hand. Below we have put together the facts around this important business cost calculation.Inventory Assumptions
Each company is different but on average your inventory holding cost will be somewhere between 25% and 40% of the inventory value on hand. In this example, we will make the following assumptions.
- Assuming you have $500,000 of yearly inventory your cost will range from $125,000 - $200,000
- Most companies are comfortable using a range of 30% - 35% a year
- Typically companies will apply a standard 3% “monthly” holding cost
Below is a case of the yearly inventory cost with a starting inventory value of $500,000. In this example, the annual cost of holding inventory comes to $190,000.
Remember we are using average costs in our calculations. It is important that you track your actual inventory costs. Monitoring inventory cost is where most companies fail to follow through in calculating their real costs.
Tracking actual costs (see below) is time-consuming, requires all levels of a management buy-in and is often not the most glamorous task. However, every company should attempt at completing these costs.
We hear feedback from customers on how eye opening the process is because they had no idea they were spending substantial money on a single expense. We suggest you hire an intern and start immediately to document your cost of holding inventory.
Actual Inventory Cost Categories
Here is the list of costs that go into figuring out your Inventory Costs.
1. Cost of Capital: 5%
|Monthly Value of Inventory||$500,000.00|
|Inventory Holding Costs||% Cost||Total|
|Cost of Capital||5%||$25,000|
|Obsolete & Outdated Inventory||3%||$15,000|
|Total Yearly Inventory Holding Costs||38%||$190,000|
This example will be different for your company no doubt. The point is we want to help you to start thinking about these real costs. The benefit of investing in this exercise can be significant cost savings that will drop to your bottom line. Everyone has a cost of inventory – do you know what yours is?
Also, see more on the benefits of the Cheever Customer Hold Inventory Program.