Inventory carrying costs: what they are, how to calculate them, and how 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 are 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 stock before it is 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. 

Carrying costs (or inventory holding costs) is an umbrella term used to cover 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 are not managed properly. To see where that happens, it helps to break down carrying costs into the 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 cost 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 quickly the stock you buy moves through your business. You can read more about this in our article, ‘How to calculate inventory turnover ratio’. 

1. Capital costs

Capital costs are usually the biggest  aspect of inventory carrying costs because they reflect the money tied up in stock. They include everything related to buying stock, such as the money spent, the interest or 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 (e.g., 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. Overordering seasonal lines or committing to slow-moving stock can lead to excess stock, which ties up capital in overpriced, unnecessary goods. This reduces the funds available for other business investment opportunities.   

External factors, such as fluctuations in raw material supply and demand, can also push capital costs up or down. While teams cannot control those shifts, they can respond faster with better visibility and planning. 

2. Storage space costs

Storage space costs are the expenses 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 the warehouse rent or mortgage, while variable costs include lighting, heating, air conditioning and the costs of physically handling the stock. 

Storage costs will vary depending on your 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 stock. ABC inventory 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 does not 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 stock 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 operational cost 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 optimisation software helps reduce that burden by improving forecasting, replenishment, and stock control, which can lower inventory levels without putting service at risk.  

When the right solution is used effectively, it should deliver a good return on investment. Inventory optimisation software, such as EazyStock, will deliver an ROI within months of implementation, reducing stock levels by up to 30% and dramatically cutting carrying costs. 

4. Inventory risk costs

Even if you have the right stock in the right place, there is 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 stock might lose value in 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 is finally sold.

Carrying costs and profitability

Taken together, these costs directly impact profitability. Inventory carrying costs are typically between 20% and 30% of 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 margin, 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, keeping carrying costs as low as possible can significantly improve overall profitability. This is where EazyStock can help. By improving demand forecasting, automating replenishment, and giving teams better visibility into stock performance, EazyStock 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 carrying costs are higher than they should be, contact our team of inventory optimisation experts, who will analyse your current inventory data to help you identify how to improve your demand forecasting, supplier management and inventory planning processes.