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Calculating the CarryingCost of Inventory
Mary Lu Harding, C.P.M., CPIM, CIRMHarding & Associates
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© Harding & Associates, 2004 2
What is Carrying Cost ?• The cost of overhead required to
support the inventory• Expressed as a percent• Calculated per year
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Variable Costs• Change as the dollar level of
inventory changes in a direct ratio
• Most widely accepted carrying costfactors fall into this category
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Fixed Costs• Do not change directly as the
dollar level of inventory changes
• Can change, but more slowly
• Changes occur when certain
inventory levels are reached• These factors are too often ignored
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The Cost of Money• Interest rate your organization
pays for borrowed moneyor
• Interest rate your money would beearning if invested elsewhere
• Calculated in percent
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Taxes• Tax on inventory by any political
jurisdiction for any inventorystorage point(s)
• Calculated in percent
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Insurance• Covers the replacement value of
the inventory in the event of a
catastrophic loss• Premiums can vary with the value
of the assets (inventory)
• Self-insured organizations typicallyestablish a reserve to cover losses
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Variable Cost ExampleCost of money 6%Taxes 2%Insurance 3%Obsolescence 6%Total 17%
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Fixed Cost Factors1. Storage space
2. Personnel3. Capital equipment
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Space• Overhead cost to operate a facility
• Often calculated as cost / sq ft• Particularly significant for warehouses
• Changes when significant space isvacated
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Capital Equipment Factor To calculate the carrying cost factor for capitalequipment investments, determine:
1. Current capital equipment investment value
2. Average total inventory dollars
The factor is:
Capital Equipment Value X 100 = Carrying CostAvg Tot Inventory Value Factor (%)
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Personnel• Includes those people whose job
description is the management &
handling of inventory:• Warehouse managers• Inventory controllers• Material handlers• Stockkeepers• Cycle counters
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Personnel Factor To calculate the carrying cost factor for personnel,
determine:
1. Total budget cost for the administrative area2. Average total inventory dollars
The factor is:
Total Budget Value X 100 = Carrying Cost
Avg Tot Inv Value Factor (%)
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Fixed Cost ExampleVariable Carrying Cost 17%
+Storage space 5%
Personnel 12%
Capital equipment 6%Total 40%
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Other Factors• In certain types of businesses,
other factors may apply: – Secondary quality costs
– Computation costs
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Quality Costs• Quality costs that can properly be
added to carrying cost are thosesecondary inspections related tostorage. For example: – Short-shelf-life items
– Frequent revision-level changes – Damage from improper storage
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Computation Costs• Inventory is the largest data base
and the most active in manyorganizations. If your organizationhas purchased or maintainssoftware or hardware to track
inventory, then that is part of thecapital expenses allocated to theinventory.
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Total Carrying Cost ExampleVariable cost factors 17%Fixed cost factors 23%Secondary inspections 6%Computation costs 5%Total Carrying Cost 51%
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Consequences1. Decision-making at every level2. Dollars of inventory on hand3. Emphasis on inventory reduction
(or not!)4. Behavior within the organization
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Case Study #1• A large multi-national corporation
making consumer products – Inventory carrying cost = single digits – Level of inventory = $1 Billion
• The primary product takes onlyminutes to produce
• They just built additional warehousesfor finished goods
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Case Study #2• British Petroleum (Alaska) analyzed
the cost of supporting maintenanceinventory for the Alaska pipeline
• Total inventory support costs = 72%
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Summary• Inventory carrying cost affects
decisions within the organization• A low number says that inventory
is a cheap alternative• The higher the number, the less
attractive inventory becomes as asolution to problems
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Remember .....
If inventory is cheap,you will have a lot of it.
