Inventory carrying costs: what they are, how to calculate, and ways to reduce them
Inventory carrying costs can quietly drain cash from your business. The more stock you hold, the more money is tied up in working capital, warehouse space, insurance, handling, and the risk of products losing value before they’re sold. For manufacturers, wholesalers, distributors, and retailers, the challenge is striking a balance between maintaining availability and avoiding excess or obsolete stock that eats into margins.
What are carrying costs in inventory management?
In simple terms, inventory carrying costs are the total cost of holding inventory before it’s sold. They often account for 20% to 30% of inventory value each year, making them a major factor in cash flow, profitability, and warehouse efficiency.
Inventory carrying costs (or inventory holding costs) is an umbrella term used to cover these four specific costs:
1. Capital costs
2. Storage space costs
3. Inventory service costs
4. Inventory risk costs
These costs can erode margins if they’re not managed properly. To see where that happens it helps to break down carrying costs into four areas that usually have the biggest impact on inventory performance, so you can understand their real impact on your bottom line.
How to calculate inventory carrying costs
Once you understand what drives carrying costs, the next step is to calculate what they add up to in your business. A simple way to calculate inventory carrying costs is to compare your total annual holding costs with your average inventory value.
For example, if your average inventory value is $500,000 and your annual storage, service risk, and capital costs total $125,000, your carrying cost is 25%. In other words, a quarter of your inventory value is being spent each year just to hold stock. With that in mind, let’s look at where those costs typically arise.
Once you’ve calculated the carrying cost, it makes sense to review your inventory turnover. This shows how quick the stock you buy moves through your business.
1. Capital costs
Capital costs are usually the biggest aspect of inventory carrying costs because they reflect all the money tied up in inventory. They include everything related to buying stock, such as the money spent, the interest or the return missed when working capital is tied up in stock, and the opportunity cost of not being able to use the money invested elsewhere in the business, assets or business projects.
This is why purchasing teams need to ensure they buy the right products, in the right volumes, at the right time, and at the right cost. Over ordering seasonal lines or committing to slow-moving stock can lead to excess stock, tying up capital in over-priced, unnecessary goods. At the expense of losing interest on money in the bank and the opportunity to invest in other areas of the business.
Capital costs are also affected by external factors, such as the supply and demand of raw materials which can cause prices to rise and fall, something that purchasing teams will have little control over.
2. Storage space costs
Storage space costs are the cost of keeping your inventory safe, accessible, in top condition, and ready for sale. They can be split into fixed and variable costs. Fixed costs include warehouse rent or mortgage, while; variable costs include lighting, heating, air conditioning, and the costs of physically handling the inventory.
Storage costs will vary depending on your storage setup. For example if you own your warehouse, you may have more control over your costs than if you use a Third Party Logistics (3PL) provider. In both cases it makes sense to ensure you’re holding the right products in the right volumes to meet demand without taking up valuable warehouse space with slow-moving items. ABC analysis or more sophisticated inventory classification techniques can help identify which items you should hold more of and which you should carry in smaller amounts or not at all.
Automating your inventory handling will also help improve productivity and reduce day-to-day operational costs.
3. Inventory service costs
Holding stock doesn’t just take up money and space. It requires systems, people, and processes to keep everything under control. Inventory service costs cover insurance, IT hardware and, in some countries, taxation. They also include the time and effort needed to manage inventory accurately. Increasing inventory levels and product complexity will have a knock-on effect on these costs.
The more inventory you carry, the higher your insurance premium is likely to be. This is one reason why maintaining, a healthy inventory turnover rate is so important for keeping these costs low.
Automating inventory handling and replenishment can also improve productivity, reduce manual effort, and lower the operation costs of day-to-day stock management.
If teams rely on manual planning or disconnected systems, service costs can rise quickly as more time is spent firefighting, expediting orders, and correcting avoidable errors. The right inventory optimization software helps reduce that burden by improving forecasting, replenishment, and a stock control, which can lower inventory levels without putting service at risk.
While the right solution is used, it should deliver a good return oninvestment. Inventory optimization software such as EazyStock will deliver an ROI within months of implementation, reducing stock levels by up to 30% and therefore dramatically cutting carrying costs.
4. Inventory risk costs
Even if you have the right stock in the right place, there’s still risk attached to holding it. This includes the risk of shrinkage, which means stock is lost while in storage rather than through sales. This might be due to administrative errors (shipping errors, misplaced goods, systems not updated etc.), theft (including employee theft) or damage in transit.
Inventory risk costs also include the chance that the inventory might lose value storage. Products might deteriorate, expire, or become obsolete and need to be discounted due to changes in customer demand. The longer excess stock is held, the greater the risk that it will erode margins before it’s finally sold.
Inventory holding costs and profitability
Taken together, these costs directly impact profitability. Inventory holding costs are typically between 20-30% of your stock value, making them too significant to ignore. When too much cash is tied up in stock, businesses have less flexibility to invest elsewhere, less room to protect margins, and greater exposure to waste, obsolescence, and inefficiency.
How to reduce inventory carrying costs
The good news is that carrying costs can be reduced without simply slashing stock across the board. Reducing inventory by 10% to 30% in a controlled way can have a substantial impact. It frees up working capital, lowers storage and insurance costs, and reduces the risk of stock becoming obsolete or needing to be discounted. It can also create more room for the products that matter most. The key is to do it intelligently, with better demand forecasting, replenishment, and stock policies, so cash flow and profitability improve without putting service levels under pressure.
Reviewing safety stock settings, using inventory classification to focus on the right items, reducing obsolete and slow-moving stock, and automating replenishment can keep inventory levels aligned with actual demand.
When profit margins are tight, getting your carrying costs as low as possible can significantly improve overall profitability. EazyStock can help by improving demand forecasting, automating replenishment, and giving teams better visibility into stock performance. This helps businesses reduce excess inventory, free up working capital, and maintain high service levels. instead of relying on manual planning or instinct, teams can make faster, data-driven decisions to match stock levels with true demand.
If your carry costs are higher than they should be, contact our team of inventory optimization experts and consultants who will analyze your current inventory data to help you identify how to improve your demand forecasting, supplier management, inventory optimization and procurement planning processes.
Originally published Oct 2015; updated Nov 2020.
Frequently asked questions about inventory carrying costs
Inventory carrying costs usually include four areas: capital costs, storage costs, service costs, and risk costs. Together, they represent the total cost of holding stock before it’s sold.
For many businesses, carrying costs range from 20% to 30% of annual inventory value. The right benchmark depends on your products, margins, supply chain complexity, and service-level targets.
Carrying cost is the cost of holding stock over time. Ordering cost is the cost of placing and receiving replenishment orders. Businesses need to balance both to avoid overstocking or ordering too little too often.
You can reduce inventory holding costs by improving demand forecasting, reviewing safety stock levels, reducing obsolete and slow-moving items, segmenting inventory more effectively, and automating replenishment to ensure stock levels more closely reflect actual demand.
They affect cash flow, profitability, warehouse efficiency, and working capital. If they are too high, too much cash ends up tied up in inventory, leaving the business with less flexibility to respond or invest.
