A Guide to Manage Inventory Carrying Cost (+ Formula Included!)

Published: June 21, 2024

The Nitty Gritty

  • Inventory Carrying Costs can cover up to a quarter of your inventory value
  • Knowing these factors is necessary to manage and improve your inventory management
  • Learn the inventory carrying cost formula and get insight into your costs
A man in a warehouse looking at a tablet

Supply chain interruptions present plenty of challenges for businesses worldwide, and as the aftereffects take their time cooling off, any field service business will want to assess all costs surrounding inventory. Getting the inventory is one thing; storing it is another.

Receiving the inventory isn’t the end of considerations and business logistics, but it presents a key cost that can affect your bottom line: inventory carrying costs.

Defining Inventory Carrying Costs and Their Importance

So, what is an inventory carrying cost? How can you calculate them, and how do they affect your profits?

An inventory carrying cost is the sum of all expenses incurred to stock and store unsold goods. These include the obvious costs, such as stock and storage expenses, but there are plenty of significant factors that make up the total inventory carrying cost.

At first glance, it might seem as if these costs are simply a given, and there’s not much to do about them. Still, there are many steps and strategies businesses can utilize to reduce overall expenses and increase the efficiency of their budget. When inventory carrying cost can account for a quarter of the total budget for inventory, reducing this cost and making carrying costs more efficient is a must.

How inventory costs affect overall financial health and efficiency

Inventory carrying costs often fly under the radar, and that can make them an unaccounted risk in your budget and financial health. Any cost that isn’t planned for or considered can be a nasty shock to your budget.

The financial health of your business relies on consistency and clarity. Understanding every part of your inventory is necessary to clarify your expenses and documentation. Consistency means you can prepare for trends, assign capital effectively and mitigate risks. Transparency in work processes facilitates this.

Relevant inventory carrying costs for field service teams

Why is inventory carrying cost such a large percentage of the budget, and what are all the factors to this overall cost? We’ve mentioned how these factors can eat into your bottom line, but what kind of inventory-carrying costs are we looking at for field service businesses?

Let’s break down these costs and what can cause that less-than-expected return on investment.

Storage Costs

Space is expensive, and depending on the inventory/supplies your field service business requires, it can be a decent chunk of your operating costs to store inventory safely and effectively. This is particularly true of field service businesses that use expensive or hazardous chemicals and equipment.

So, what goes into these storage costs?

Storage facilities

The inventory carrying cost for storage facilities is one of the clearest expenses after the purchase of physical goods. Warehouses and facilities can be expensive, so it’s important to make the most of your space. Businesses can rent or buy their own warehouses or utilize third-party services that take care of the logistics.

Utilities (electricity, water, and others)

Keeping the lights on in your storage facility is an additional inventory-carrying cost often overlooked when estimating the overall budget. Electricity and water are also necessary for security measures to protect your inventory and for labor hires.

You also may need a solid internet connection to utilize automated work and efficient handling of stock.

Regular maintenance

The storage facility and its utilities will need maintenance: the last thing you need is to spend that kind of money on storage facilities just to have poor lighting slowing down your inventory team. Regular maintenance also ensures job safety and reduces labor risks.

Capital costs

This is often the largest portion of the inventory carrying cost and represents the product's price and the additional costs to cover the purchase, such as loans and fees.

The price to stock inventory is usually one of the most obvious costs and the first cost that comes to mind, but the associated capital costs can also take up a considerable portion.

Opportunity cost of capital

Being able to cover the cost in your budget is one part of capital; the other is the opportunity cost. What is opportunity cost?

Opportunity cost is essentially the trade-off you make when you allocate your available funds and set your budget. There’s only so much capital to go around, so spending in one section affects the potential budget of another section. Decisions about an inventory carrying cost are difficult to make, and it’s up to you and your business performance.

You’ve already been making decisions that affect opportunity costs: your field service area, accepting one job over another, and the size of your fleet. Trust the numbers and your own assessment, and remember that every choice presents an opportunity.

Interest payment on loans

To buy storage facilities outright or make sizeable inventory orders will require loans, and these payment requirements contribute to the overall carrying cost. Consider the interest amount on top of other costs when preparing to take out loans. The interest on top can bite if your budget hasn’t accounted for it.

Service costs

These are the additional inventory costs required to manage your goods effectively, and these soft costs can greatly fluctuate depending on your needs.

Insurance against loss, damage, or theft

This is an essential inventory carrying cost; should the worst happen, your business is protected and can recoup costs. Insurance costs fluctuate depending on the amount of inventory and the kind of stock you own. The basic guide is more inventory = higher cost.

Hopefully, your business won’t need it, but if it does, it can be a lifesaver.

Labor (wages and benefits)

Managing an effective storage facility and handling goods requires skilled staff. These inventory carrying costs include staff wages, insurance and benefits.

Inventory management software to track and optimize inventory

Clarifying inventory carrying costs used to be the domain of pen and paper checklists and excel spreadsheets. Now, we have the power of digital services that can streamline tracking and auditing inventory to reduce carrying costs.

Inventory management software can make your work processes more efficient, keep all necessary documentation and updates in one place and provide your field service business with a wealth of insights on the real-time state of your inventory and costs.

Risk costs

Risk is built into many steps of field service businesses, and it’s the same for inventory carrying costs. Working with any amount of stock incurs a number of risks that must be factored into the overall budget.

There are methods to reduce these risks and recoup some loss so your business can proactively tackle these inventory carrying costs!

Shrinkage

Shrinkage is when stock is bought but can’t be sold or is lost. This means it could be damaged at some point in transit or storage, defective, or misplaced. This also accounts for stolen goods, whether due to staff or others.

Shrinkage is part of inventory carrying costs and will happen, but it can be mitigated with efficient stocktaking and audits. If goods are defective or damaged, you might be able to recoup the loss from the manufacturer or delivery service. Theft is possible (and happens to most inventory at some point), but robust security and a transparent and honest work culture can prevent most thefts.

Obsolescence

Obsolescence is an unfortunate part of life as technology develops, and it stands for stock that has reached the end of its life cycle.

This is especially true in field service areas such as HVAC installation and solar and electrical tech. Technology and innovation attract new and returning customers who want upgrades or want to enhance their lives, but they also bring the downside of obsolescence.

Any industry with built-in trends experiences these fluctuations. This is another reason why having as much data as possible about your stock and sales is vital, as it can assist your business in efficient stocking and purchasing to reduce inventory carrying costs.

Depreciation and spoilage

This ties into the inventory carrying cost of storage; unfortunately, no matter how effective your storage and maintenance process, inventory can degrade and spoil.

There is also the matter of depreciation. Over time, inventory will lose value. Trends might fall out of favor, or new developments in the industry may supersede equipment. Seasonal fluctuations also greatly affect many field service businesses and represent opportunities to gain a competitive edge.

Operational costs

These costs might fly under the radar, especially for newer field service businesses, but they can be particularly painful if not considered. Operational costs are part of doing business effectively and up to standard.

Compliance with regulation standards

As technology develops and trade processes evolve, regulation standards and laws do as well. Regulation standards for every trade adapt and change, and these changes can have a significant effect on your field service business and inventory carrying cost.

An excellent example of this is the changes made to HVAC system standards in 2023: the reassessment of SEER standards and introduction of SEER2 meant a huge overhaul for inventory. Manufacturers, distributors and contractors had equipment and systems that would soon be non-compliant to install and sell, presenting a large potential loss.

It’s vital to keep abreast of industry changes and the regulatory landscape.

Inventory audits

Audits are another vital step in effective logistics and another inventory-carrying cost. Your business will have records of purchases, sales and deliveries, but it’s one thing to have them on paper compared to the reality of your inventory.

There are vital questions you must ask:

  • Is the purchased inventory in the right condition?
  • Has it been delivered to the correct warehouse?
  • Are there damages?
  • Has inventory been stored correctly?
  • Is inventory missing/stolen?
  • Is the inventory compliant?

Audits might present an additional cost, but it’s better to know where your stock stands to manage inventory carrying costs most effectively. Transparency, clarity and a paper trail will ultimately help your bottom line.

Handling and processing (packaging of inventory for shipment or use)

Another operational cost is handling and processing stock. Field service businesses may focus less on picking and packing goods than retail businesses, but your team will still be handling necessary goods and equipment.

Opportunity costs

We covered this above regarding capital flow and budget, but there are other opportunity costs in physical space and inventory.

Warehouse utilization for storage

We covered the costs of physical storage locations and maintenance, but it can be easy to miss the quiet opportunity cost of using your storage facilities.

It’s simple: if something takes up space, it means that space is no longer usable for something else. Inventory is preparation and investment at every stage, and you need to consider the workable storage space available for your inventory.

Cash Flow

Similar to capital opportunity costs, interruptions or changes to cash flow can have a knock-on effect to other parts of your budget. It’s important to anticipate the opportunity cost of reduced cash flow when your business purchases inventory.

How to Calculate Inventory Carrying Cost

Now that we’ve covered the factors of inventory carrying costs and what kind of risks are present in inventory management, let’s get into the meat and potatoes.

Getting Your Total Costs

Before we approach the formula to calculate your inventory carrying costs, we need the details!

In order to effectively calculate the true cost, you need to account for all the factors that we’ve covered. If it’s relevant to your business’ inventory carrying cost, add it up.

This includes:

  • Storage
  • Capital Costs
  • Service Costs
  • Risks
  • Operational Costs

Some of these will fluctuate, so if you need to, work with an average cost over a period of time.

For our example, we’ll say the total costs are $32,000.

Total Inventory Value

Next, you’ll need the annual value of your inventory.

Total Inventory Value = Price per Unit x Number of Units

The price per unit is the amount you would receive for the sale of that good. The total number of units gives you the general overlook of projected revenue if all stock is sold.

For our example, we’ll say that you have 1000 units and each is priced at $125.

Price per Unit x Number of Units = 1000 x 125 = 125,000

Therefore, the total inventory value is $125,000.

General Formula

Inventory carrying cost is a percentage of your overall inventory value, as it can only exist alongside inventory. In this way, you can see the direct effects of costs on the profitability of stock.

Inventory Carrying Cost = Cost Totals / Total Inventory Value x 100

Using the example numbers:

Cost Totals / Total Inventory Value = 32,000 / 125,000 = 0.26

0.26 multiplied by 100

= 26%

Therefore:

Inventory Carrying Cost = 26%

Common Inventory Issues

The formula is a great tool to break down your inventory carrying costs and reflect on the percentage you spend covering and managing your stock. Around 25% is standard, but there’s always room for insight and improvement. If your management is up to par, this could even suggest you need to adjust your markup to make the most of your inventory.

To demonstrate some common pitfalls for inventory carrying costs, we’ll look at a few industries and their relevant risks.

Material holding for electrical contracting

Electrical contracting is a precision business, and the same is true for inventory management. Electrical field service businesses deal with a combination of evolving technology combined with many parts and materials required to operate effectively.

Many materials for electrical work are either highly-specialized and require excellent organization to store and utilize, or are valuable items that present a risk for theft.

Field service businesses need to be precise and careful with electrical inventory and equipment to ensure timely and accurate work.

Seasonal demand fluctuations for HVAC

HVAC businesses have a greater need for effective inventory management than other trades. The combination of stocking particular units/parts combined with seasonal demand means that effective logistics are necessary for a healthy bottom line.

This is where data of previous sales/installs will be your guide. Gearing up for summer or winter? Look at previous trends and the kind of stock you’ve needed previously and plan accordingly.

Inventory risks for security system installations

Security installation and maintenance businesses have seen a boom as systems become accessible for all levels of consumers and budgets. However, this comes with the downside of rapid development and adoption. Updates and new systems can quickly depreciate unsold inventory and risk obsolescence.

In addition, some security systems are quite small and valuable and can present a high theft risk. (You need good security for that security system!)

Inventory carrying cost to anticipate changes

Inventory carrying cost is a combination of many factors and with the right information, your field service business can effectively manage logistics and keep costs consistent. The right job management software, such as Simpro, provides all the tools your business needs to streamline work processes and improve your inventory insights.

With these insights, you can accurately anticipate inventory fluctuations to make the best decisions for your business. Book a demo today!