Inventory holding costs can soak up working capital. When mismanaged, it can lead to significant loss and missed opportunities. While we know your intention is to learn more, and that’s why you are here, we want to start by pointing out that holding costs and inventory costs are complex. While we can provide an overview of things to be mindful of and help you understand inventory management, it’s important to stay close to your own business and have a clear understanding. Things that can impact a business are like a domino effect so it’s important to know where they are stemming from.
Keep reading as we explain inventory holding costs, how to calculate them, and why they are important to understand.
What are inventory holding costs?
Inventory holding costs are the costs associated with storing (or holding) inventory until it is sold. Inventory that remains unsold can tie up cash flow in several ways. Additionally, some products are more expensive to hold than others. Hence why it’s encouraged to stock just the right amount of inventory, not too little and not too much. Holding costs can include storage space, insurance, labor, damaged or expired goods, and so forth. While holding costs are unavoidable, there are things you can do to minimize the expense. Understanding holding costs associated with your business is a good place to break down the equation. While we are unable to analyze your business, we can help guide you in the right direction. Let’s take a look at how to calculate the costs of inventory and why it’s important.
Why is calculating the cost of carrying inventory important?
In business, revenue is one thing and profit is another. To clearly understand the difference between the two and continually drive the bottom line, you’ll need to know where your money is going. By calculating the cost of carrying inventory, you can be one step closer to accurately calculating profit margins. Even businesses that are operating with healthy profit margins can experience cash flow issues. Inventory financing is often used to overcome cash flow challenges that can prevent businesses from stocking enough inventory. Leveraging inventory financing can also help businesses have more cash to invest in other areas of growth.
How to calculate inventory holding costs
As you aim to calculate inventory holding costs, note that it should be within the 20% to 30% range of your total inventory value. If you pursue inventory financing, backers or lenders will likely want a full financial picture of where money is going to justify the need for cash. To accurately calculate inventory holding costs here are some components/calculations you’ll need to understand.
- Storage costs: To calculate storage costs, include all costs associated with physically storing inventory. This could include rent for the space, utilities, insurance, and more.
- Depreciation: Depreciation, much like opportunity cost, is intangible. Naturally, over time the value of inventory decreases, which is known as inventory. To calculate depreciation you can use the following formula:
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- Depreciation = (cost to make goods – salvageable value) / inventory lifespan
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- Opportunity costs: To calculate opportunity costs take the potential return from the unchosen scenario and subtract it from the return from the scenario chosen. Opportunity costs in relation to inventory represent the cost of holding dead inventory as opposed to other, potentially more profitable products.
- Employee costs: Labor adds up, and while it’s an operating cost, you should be able to calculate labor that pertains to holding inventory.
The formula to calculate holding costs
- Inventory holding costs = (storage costs + employee salaries + opportunity costs + depreciation costs) / total value of inventory
Where do you typically encounter holding costs?
Inventory holding costs can impact financials. As you calculate profit margins, balance sheets, and other important financial documents, you’ll likely encounter holding costs. Even if you operate a lean and efficient business that executes efficient inventory management, there will be holding costs. Regardless though, you should work to minimize holding costs. Holding too much inventory is not a good thing. You want to hold enough inventory to ensure you do not miss sales, but you do not want to waste resources overstocking inventory. Utilizing effective inventory management is critical to ensure you meet the demands of customers while protecting your bottom line.
How Kickfurther can help
Kickfurther funds up to 100% of your inventory costs on flexible payment terms that you customize and control. With Kickfurther, you can fund your entire order(s) each time you need more inventory and put your existing capital to work growing your business without adding debt or giving up equity.
Why Kickfurther?
- No immediate repayments: You don’t pay back until your new inventory order begins selling. You set your repayment schedule based on what works best for your cash flow.
- Non-dilutive: Kickfurther doesn’t take equity in exchange for funding.
- Not a debt: Kickfurther is not a loan, so it does not put debt on your books. Debt financing options can sometimes further constrain your working capital and access to capital, or even lower your business’s valuation if you are looking at venture capital or a sale.
- Quick access: You need capital when your supplier payments are due. Kickfurther can fund your entire order(s) each time you need more inventory.
Kickfurther puts you in control of your business while delivering the costliest asset for most CPG brands. By funding your largest expense (inventory), you can free up existing capital to grow your business wherever you need it – product development, advertising, adding headcount, etc.
Closing thoughts
Inventory plays a pivotal role for CPG brands. Understocking and overstocking inventory can both lead to problems and or missed opportunities. As you try to navigate the perfect balance of effective inventory management and efficient operation, you may encounter cash flow challenges. With delays in accounts receivable and high operating costs (no matter how you try to minimize them), you will need plenty of cash to hold inventory and keep operations going. While there’s no one-size-fits-all solution, inventory financing may be an effective solution for your business. CPG brands may struggle to obtain inventory financing that works. As a team of entrepreneurs, we truly understand the challenges you may be going through. At Kickfurther we aim to keep business owners in control while allowing them to access funding for up to 100% of inventory with no immediate repayments. To get started, create a free business profile at Kickfurther. It’s fun and easy, and can really pay off in the end. So, what are you waiting for?
