In this article, we will explore what the inventory holding cost formula is and its importance. We will also cover how to apply the formula using an example. Read on to learn more.
The inventory holding cost formula calculates the total cost associated with storing and maintaining an inventory over a certain period. It helps companies understand the total cost incurred for holding stock and aids in making informed decisions about inventory levels.
The formula for calculating inventory holding cost is:
Where:
In instances where the holding cost is expressed as a percentage of the total value of inventory, an additional formula is applied:
Where:
Here are our steps to apply the inventory holding cost formula:
Collect necessary data including the Average Inventory, Holding Cost per Unit, and the Total Number of Units Held.
The formula for inventory holding cost is given as:
Inventory Holding Cost = Average Inventory × Holding Cost per Unit
or it can be expressed as a percentage of the total value of the inventory:
Inventory Holding Cost Percentage = [ (Inventory Holding Cost / Total Value of Inventory ) × 100 ]
For instance,
Plug these values into the formula:
Inventory Holding Cost = 500 units x $5/unit
Inventory Holding Cost = $2500
To calculate the holding cost as a percentage of the total value of the inventory:
Inventory Holding Cost Percentage = ($2500/$25000) x 100
Inventory Holding Cost Percentage = 10%
With a holding cost of $2500 or 10% of the total inventory value, analyze how these costs impact the overall profitability and efficiency of the inventory management system. Evaluate whether reducing holding costs or optimizing inventory levels would be beneficial.
GreenThumb Landscaping wants to optimize inventory levels and reduce its holding costs. Here’s how the company calculated its inventory holding cost:
The collected data of the company includes:
We use the inventory holding cost formula:
Inventory Holding Cost = Average Inventory × Holding Cost per Unit
Using the data,
Plugging these values into the formula:
Inventory Holding Cost = 2,000 units x $10/unit
Inventory Holding Cost = $20,000
To calculate the holding cost as a percentage of the total value of the inventory:
Inventory Holding Cost Percentage = ($20,000/ $100,000) x 100
Inventory Holding Cost Percentage = 20%
GreenThumb Landscaping incurred a holding cost of $20,000, which is 20% of the total inventory value. The management needs to analyze whether this cost is within an acceptable range. They should assess if there are opportunities to reduce the holding cost, perhaps by optimizing storage solutions or improving inventory turnover.
Calculating the inventory holding cost is important for a number of reasons, some of the most common reasons include:
Calculating inventory holding costs helps businesses allocate resources efficiently to ensure that excess capital is not tied up in stored goods. This aids in optimizing storage, handling, and insurance costs to free up funds for operational enhancements and investments.
Assessing holding costs aids in fine-tuning demand forecasting and inventory planning. It ensures that companies maintain optimal inventory levels to meet customer demand without incurring excessive storage costs.
Knowing the inventory holding costs enables a more accurate profitability analysis. Companies can price their products to not only cover the cost of goods sold but also the expenses associated with storing, handling, and insuring the inventory.
Calculating holding costs helps in identifying and mitigating risks associated with inventory obsolescence, damage, and theft. Companies can develop strategies to minimize these risks to ensure that inventory retains its value over time.
We hope that you now have a better understanding of what the inventory holding cost formula is and how to calculate it.
If you enjoyed this article, you might also like our article on the cost of inventory formula or our article on the inventory accuracy formula.
