What is Holding Cost?

Holding cost, also known as the carrying cost of inventory, refers to the cost that an entity incurs for handling and storing its unsold inventory during the accounting period (monthly, quarterly, annual) and is calculated as the total of storage cost, finance cost, insurance, and taxes as well as obsolescence and shrinkage cost.

Components of Holding Cost

It has the following key components:

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#1 – Storage Cost

It refers to the cost attributable to storing the unsold inventory. it includes:

  • Warehouse rent or lease paymentsLease PaymentsLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration.read more,Cost of personnel employed at the warehouse,Maintainance Cost,Material handling equipment cost,DepreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year.
  • read moreUtility charges etc.

As per the CSCMP’s 30th Annual State Logistics Report, the total storage cost of US businesses was the US $ 153.10 billion in 2018.

#2 – Cost of Capital or Finance Cost

It refers to the average cost of investments or financing the warehouse facility and include the following:

  • Cost of InvestmentsWorking Capital RequirementsFinancing Cost: This is the cost of financingCost Of FinancingFinancing costs refer to interest payments and other expenses incurred by the company for the operations and working management. An enterprise often borrows money from different financing sources to run their operations in return for interest payments and capital gains.read more the storage premises. Often, the entities avail warehouse financing facilities to cover the cost of premises and pay interest payments to the lending institution.Opportunity Cost: Opportunity costOpportunity CostThe difference between the chosen plan of action and the next best plan is known as the opportunity cost. It’s essentially the cost of the next best alternative that has been forgiven.read more generally refers to the loss of other alternatives due to the chosen alternative. The unsold inventory represents the cash blocked which, if not invested in buying inventories, then could have generated a return at the rate of the cost of capitalCost Of CapitalThe cost of capital formula calculates the weighted average costs of raising funds from the debt and equity holders and is the total of three separate calculations – weightage of debt multiplied by the cost of debt, weightage of preference shares multiplied by the cost of preference shares, and weightage of equity multiplied by the cost of equity.read more of the company. This implied loss is an opportunity cost for the businesses and, thus, added to the holding cost of the entity.

As per the CSCMP’s 30th Annual State Logistics Report, the total finance cost of US businesses was the US $ 192.50 billion in 2018

#3 – Insurance and Taxes

It refers to the cost of insurance of inventory and premises as well as the cost of taxes.

#4 – Obsolescence & Shrinkage Cost

In the case of holding inventory, specifically technology or software inventory, there is always a chance of inventory becoming obsolete. It may not sell for an extended period due to technological advancements. Thus, Shrinkage cost is the cost incurredIncurredIncurred Cost refers to an expense that a Company needs to pay in exchange for the usage of a service, product, or asset. This might include direct, indirect, production, operating, & distribution charges incurred for business operations. read more due to damage of inventory, or spoilage of inventory in case of perishable products, or loss incurred due to theft.

As per the CSCMP’s 30th Annual State Logistics Report, the total insurance and incurs the cost of US businesses were the US $ 148.10 billion in 2018.

Holding Cost Formula

The inventory holding cost can be calculated as:

Examples of Holding Cost

Let’s discuss some examples.

Example #1

ABC Inc is holding inventory worth US 400,000 and has a total carrying cost of 25%. Thus, the inventory holding cost for ABC Inc. will be $ 400,000 * 25% i.e. US $ 100,000.

Example #2

XYZ Inc. has taken a warehouse facility to store its inventories. The handling and storage cost is US $ 20,000, and the insurance cost is US $ 3,500. The total inventory of the entity for the years is US $ 200,000. In addition, the entity is paying interest of $ 7,500 as the cost of warehouse financing.

In this scenario, the inventory holding cost of XYZ Inc will be –

Inventory Holding Cost = Storage Cost + Cost of Capital + Insurance Cost = $ 20,000 + $ 7,500 + $ 3,500.

= $ 31,000.

Conclusion

The cost incurred to handle and store the inventory generally ranges between 15%-40% of total inventory cost, which further includes the costs attributable to storage and material handling charges, the financing cost, the opportunity cost of holding inventories, and insurance, taxes, and obsolescence cost. Inventory holding costs may vary from business to business as it depends on many factors such as inventory holding days, buying the premises vs. financing warehouse facilities, the average cost of capital, etc.

This article has been a guide to what holding cost is and its definition. Here we discuss components and formulas to calculate inventory holding costs with the help of some examples. You can learn more from the following articles –

  • Perpetual Inventory SystemRaw Material Inventory MeaningWIP Inventory DefinitionWhat is Write-Down of Inventory?