Businesses often become hyper fixated on the cost of inventory itself, overlooking the high costs associated with storing and handling the inventory, also known as inventory carrying costs. These costs often grow due to insufficient or inadequate inventory levels, such as overstocking. Another root cause of inventory issues is the strain of cash flow. As businesses allocate most of their cash to holding inventory, other areas of operations suffer such as inventory tracking systems.
Failure to properly manage carrying costs can greatly impact profitability and unnecessarily tie up existing cash flow. As you can see here, it’s critical to understand all the costs associated with inventory and operations while maintaining healthy cash flow. One way to overcome challenges is to access more working capital or inventory financing, which may sound like an impossible and costly activity, until you discover Kickfurther.
What are inventory carrying costs?
Inventory carrying costs, also known as holding costs, are the expenses associated with storing and handling inventory before it sells. Storing inventory isn’t cheap and costs vary depending on the size of the business and inventory levels, but typically come out to about 20-30% of total inventory value. This can greatly impact your businesses profitability and increases the longer inventory is stored. Beyond the monetary cost your business can see from inventory carrying, it can also have opportunity cost and force you to turn down growth opportunities due to tying up your companies resources in inventory.
Why inventory carrying costs are important for businesses
Understanding and managing inventory costs is crucial for businesses to maintain financial health. In order to project accurate profit margins, operating costs, and other figures that impact the financial health of your business, you’ll need to understand inventory carrying costs. If costs are high it can lead to reduced profitability and cause cash flow pinches, having the potential to impact your bottom line. If you can recognize costs are high, you can take measures to improve efficiency and reduce costs.
By determining just how much you spend on storing and handling inventory, you can then adjust your operations accordingly to mitigate the costs. While we’re sure you already see the importance, here are a few more reasons why inventory carrying costs are so important for businesses to understand:
- Production planning: Knowing how much you spend on storing inventory can lead to changes in production schedule. If a product can be manufactured quickly, you can keep less inventory on hand and restock as the orders come in. You can also determine those top selling products with lower carrying costs and may decide to keep more inventory on hand.
- Inventory accounting: As inventory is often a businesses largest expense, having a clear depiction of carrying costs will lead to more accurate accounting.
- Profitability of existing inventory: With carrying costs being such a high percentage of overall inventory costs, tracking the value of holding costs per product can help you better determine the profitability of each product.
Benefits of managing inventory carrying costs effectively
Managing inventory carrying costs effectively offers several benefits for businesses. As inventory carrying comes with a variety of expenses, if managed correctly, businesses can reduce overall expenses and improve profitability. As fellow business professionals, we know this is always the mission. Beyond that though, here are some of the benefits that can result from managing inventory carrying costs effectively:
- Improved accuracy
- Accurate financial statements
- Proper pricing adjustments
- Ability to identify opportunities of improvement
- Free up working capital or identify the need for more
Tracking costs can be a complicated task as there are many moving parts and expenses. Regardless of how sophisticated internal systems are or are not, always be sure to give the level of effort tracking expenses deserves. Shortcutting this as it relates to inventory or operations can negatively impact business.
Components of Inventory Carrying Costs
In order to understand how to effectively manage inventory costs, it is crucial to understand the components of inventory carrying costs. Here are some common inventory carrying costs:
- Storage costs: Storage costs are as they sound. Think of expenses related to rent or lease payments for warehousing or storage facilities, utility bills, property taxes, insurance, and maintenance costs.
- Capital costs: Also referred to as opportunity costs, these are the expenses related to tying up capital in inventory. It includes the cost of financing inventory, such as interest on loans or the opportunity cost of using that capital for other investment purposes.
- Obsolescence costs: When inventory becomes outdated, obsolete, or spoiled, businesses face costs associated with disposing of or writing off the value of such inventory. This can occur due to changes in technology, market trends, or product expiration.
- Insurance costs: Inventory may be covered by insurance against potential losses, theft, or damage. Insurance premiums form a part of the carrying costs.
- Handling and labor costs: Expenses related to labor, equipment, and utilities used for handling, moving, and managing inventory within a warehouse or storage facility. This includes wages, benefits, equipment maintenance, and utilities required for inventory handling.
- Depreciation: If inventory items are subject to depreciation, such as goods that may lose value over time, the decline in value is considered as a carrying cost. Depreciation can be tracked on the income statement and can be tax-deductible – even more of a reason to track it closely and accurately.
- Risk of shrinkage: Inventory shrinkage refers to losses due to theft, damage, spoilage, or errors. The cost of such losses is included in the carrying costs.
- Taxes: Businesses may be subject to certain taxes, such as property taxes or inventory taxes, based on the value of the inventory held.
How to calculate inventory carrying costs
To calculate inventory carrying costs, you will need to consider the various factors that contribute to the overall cost of holding inventory that are identified above. Once you add up the expenses for a particular product over a specific period of time (typically monthly or yearly), you can then divide those carrying costs by the total inventory value. You can then multiply that number to get a percentage, using the equation below:
Inventory carrying costs = Costs of storage / Total inventory value (over specific time frame) x 100
This calculation will help you determine which products have a higher percentage of associated carrying costs and identify those products that are more profitable. It will also help you reevaluate certain processes and practices to ensure you are maximizing profitability. If you have inventory management systems in place, they should be able to generate reports and track expenses as needed. If you don’t find manual methods to bridge the gap until you have funds available to improve efficiency.
Need more working capital? Visit Kickfurther today.
Tips for Managing Inventory Carrying Costs
Is your business feeling the impacts of high inventory carrying costs? First and foremost, these costs can be reduced by maintaining optimal inventory levels and minimizing inventory on hand. Avoid excessive stock that ties up capital with storing inventory, but make sure you still keep enough inventory on hand to meet customer demand.Here are some tips that can help you manage inventory carrying costs:
#1. Slow down: Slowing down to invest time into accounting for expenses, analyzing efforts, and identifying areas of improvement can help manage carrying costs as well as improving the bottom line.
#2. Use demand forecasting: Knowing exactly how much inventory to stock and when can help make inventory costs more manageable. Avoiding overstocking inventory can also make inventory management more feasible.
#3. Access more working capital: A lack of working capital can stretch business owners thin causing them to overlook important activities. While you should understand costs and have efficient inventory management in place before securing funding, there’s always room for improvement. For affordable working capital that allows you to maintain equity and avoid taking on debt, turn to Kickfurther. A solution created by entrepreneurs for entrepreneurs.
Benefits of Effective Inventory Carrying Cost Management
Effective management of inventory carrying costs comes with a wide range of benefits that can improve your business. When done right, it can reduce overall expenses and improve profitability, freeing up additional working capital. With better cash flow, your business can take advantage of growth opportunities and improve operations. By effectively managing holding costs you can also minimize the risk of stockouts and improve order fulfillment rates, which can lead to higher customer satisfaction. A business that manages inventory carrying costs can gain a competitive edge, achieve better financial stability, and are better positioned for growth and success.
Conclusion
When effectively managed, businesses who reduce or can properly account for inventory carrying costs can see financial health improve. Plus, the ability to identify areas of improvement can directly impact the bottom line. . . success feels so good doesn’t it? As you navigate the land of business ownership, you may find you need more access to working capital. Inventory can tie up a lot of cash, thus leaving finances too tight to invest in inventory management systems, labor, and other important activities. While you may stray away from funding at first due to past experiences or beliefs, Kickfurther offers a solution that truly works to help grow your business. Our platform connects business owners to a community of backers that can fund up to 100% of inventory. Business owners can maintain control and devise repayment plans that work for them.
- No immediate repayments. You control repayment. Don’t pay until your product sells.
- Non-dilutive. Maintain equity in your business, we know how hard you worked for it. We are here to work with you, not against you.
- Not a debt. Because you have enough financial strain, this is not a loan.
- Upfront capital. Pay suppliers faster with upfront capital, there when you need it.
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