Enter any two values (average inventory value, carrying cost rate, or annual carrying cost) into the calculator to determine the missing variable.
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Carrying Cost Formula
The following formula is used to calculate the carrying cost (carrying cost percentage) of inventory for a given period (commonly one year):
CC = (IHS / TVI) * 100
- Where CC(%) is the carrying cost percentage of the inventory
- IHS is the inventory holding sum (total holding/carrying costs for the period, $)
- TVI is the total value of inventory (typically the average inventory value for the same period, $)
Further, the inventory holding sum can be calculated using the following formula (all costs should be for the same time period):
IHS = inventory service cost + inventory risk cost + capital cost + storage cost.
Carrying Cost Definition
A carrying cost is defined as the monetary cost it takes for a business to hold inventory over a given period of time. This value is often expressed as a percentage of the total value of the inventory.
In general, a business will want to keep its carrying cost to the lowest possible percentage.
Example Problem
How to calculate a carrying cost?
The first step in determining a carrying cost percentage is to calculate the total value of the inventory the business is holding (often the average inventory value over the period). In this example, we are analyzing a warehouse that has $40,000 in inventory value.
Next, determine the inventory service cost. This cost can include insurance, taxes, and administrative costs (for example, inventory management systems). For this problem, the inventory service cost is calculated to be $4,000.
Next, determine the inventory risk cost. Inventory risk cost is any cost associated with losing product that sits in inventory too long due to degradation, clerical errors, or theft. In this case, the inventory risk cost is small at $500.00.
Next, determine the capital cost. This is the opportunity cost (cost of capital) of money tied up in inventory, often estimated as an annual required return or interest rate times the inventory value. For this problem, assume a 12.5% annual cost of capital, so the capital cost is 0.125 × $40,000 = $5,000.
Next, determine the storage cost. The cost to store the inventory including the rent for the warehouse was $5,000.00.
Finally, calculate the carrying cost. Using the formula above, the carrying cost is calculated as:
CC (%) = (IHS / TVI) * 100
= ( 4,000 + 500 + 5,000 + 5,000 )/ 40,000 * 100
= 36.25%.
