Operations teams usually notice inventory problems when stockouts happen, but the financial damage from excess inventory is harder to spot. It builds up quietly over time through storage fees, shrinkage and spoilage, and aging stock. Plus, it ties up capital that could be used elsewhere.
In this guide, we’ll explain inventory carrying cost, how to calculate it, and practical ways to reduce your carrying costs without disrupting operations.
What is Inventory Carrying Cost?
Whether you call it Inventory carrying cost, holding cost, or inventory holding cost, it includes all of the expenses for storing your unsold inventory over time. Unlike COGS, which reflects the direct cost of purchasing or producing goods, carrying costs of inventory measure what it costs you to keep stock on hand.
Inventory carrying costs are easy to underestimate. Companies typically focus more on the value of inventory and what they’ll net when products sell. But they forget there’s a cost to have it sitting on a shelf or in their warehouse. Yet, these costs add up over time across different categories and can cut into your margins.
Why Carrying Costs Matter to Inventory Performance
Getting a handle on your inventory carrying costs helps you identify operational inefficiencies that don’t always show up when you’re doing inventory counts or cycle counts. The inventory carrying cost calculation surfaces insights that go beyond just the numbers, including:
- Improving cash flow visibility: Excess inventory ties up working capital that could be allocated elsewhere in the business.
- Highlighting overstock exposure: High carrying costs often signal imbalances between replenishment cycles and actual demand.
- Supporting better purchasing decisions: Carrying cost analysis helps teams adjust reorder quantities and supplier timing.
- Strengthening profitability analysis: Inventory overhead directly affects margin performance, especially for slow-moving SKUs.
- Helping monitor inventory KPIs: Carrying cost trends provide insight into inventory efficiency alongside turnover and days of supply.
The Types of Costs for Holding Inventory
Figuring out the inventory carrying cost formula depends on several categories of operational and financial expenses.
Capital Costs
Capital costs represent the financial impact of money tied up in inventory instead of being used elsewhere. This includes opportunity cost, interest expense, working capital constraints, and inventory financing. For example, a manufacturer carrying excess buffer stock may delay investments in equipment upgrades or production expansion because cash remains locked in inventory.
Storage Costs
Storage costs include warehousing costs, utilities, equipment usage, labor, and facility overhead tied to storing inventory. These expenses increase as inventory levels grow or warehouse layout inefficiencies reduce usable space. For example, slow-moving and obsolete stock (SLOB) occupying high-access picking areas can inflate both handling and storage expenses.
Service Costs
Service costs include insurance, taxes, software systems, security, and administrative expenses associated with inventory management. These costs increase as inventory volume and SKU counts expand. For example, businesses with large inventories may pay higher insurance premiums or invest more heavily in systems used to monitor inventory KPIs across multiple facilities.
Risk Costs
Risk costs reflect inventory depreciation, shrinkage, damage, spoilage, and out-of-date inventory you can no longer sell. When inventory sits on shelves for long periods, your risk rises. This is especially concerning for perishable items, seasonal goods, or technology, which can lose value rapidly if excess stock sticks around too long.
The Inventory Carrying Cost Formula and Example
The standard inventory carrying cost formula is:
Carrying cost % = (Total carrying costs / Total inventory value) x 100
Follow these steps to fill it out.
- Add together all carrying costs, including capital, storage, service, and risk expenses.
- Determine the average inventory value over the same period.
- Divide total carrying costs by inventory value.
- Multiply the result by 100 to calculate the percentage.
You should compare your inventory carrying cost percentage against others in your industry as what’s a good number changes based on your sector. For consumer-packaged goods (CPGs), 20% to 25% is a solid number, while tech items and perishable goods might be closer to 25% to 30%.
Take a company that spends $250,000 annually on inventory overhead and maintains an average inventory value of $1 million; the inventory carrying cost percentage would equal 25%. That means the business spends roughly one-quarter of its inventory value each year simply to hold stock.
Strategies to Reduce Inventory Carrying Costs
The less inventory you carry, the lower your inventory carrying costs. But that only works if the stock you hold matches demand. If you don’t have any inventory and safety stock on your shelves, you risk missing sales targets.
Put these strategies in place to reduce your inventory holding costs:
- Improve demand forecasting: Your demand forecasting and planning should tie replenishment cycles to consumption patterns rather than static reorder points.
- Implement a just-in-time inventory system: Structuring supplier agreements around shorter replenishment windows reduces the amount of cycle stock sitting idle between production runs.
- Adopt analytics to identify high-cost SKUs: Analytics platforms can pinpoint which products generate the highest inventory holding cost based on days of supply, storage requirements, and low SKU velocity. Adopting AI for forecast accuracy can surface patterns across inventory data that you might miss otherwise.
- Implement real-time inventory visibility: Knowing exactly what inventory is on hand, where it is located, and how long it has been sitting helps operations teams catch aging inventory before costs escalate. IoT-enabled systems improve inventory position visibility for better stockout prevention and overstock cycles management.
- Reduce excess inventory on hand: Tightening your reorder quantities, adjusting reorder point assumptions, and reducing unnecessary buffer stock lowers carrying cost exposure.
- Optimize layout and slotting: An inefficient warehouse layout increases handling time and often hides slow-moving inventory. Organizing products by velocity, demand patterns, and Inventory turnover rate helps reduce handling costs.
Teams should also regularly evaluate their inventory methods, like FIFO and LIFO. FIFO (First In, First Out) and LIFO (Last In, First Out) vary depending on the type of products you have.
Take Control of Your Inventory Carrying Costs with Technology
Calculating inventory carrying cost is only your first step, however. Reducing your costs relies on consistent visibility into how inventory moves across your facilities. Surgere’s IoT-enabled tracking solutions and agentic AI capabilities help you identify overstock, shrinkage, aging inventory, and inefficient storage patterns before they become they hurt your bottom line.
To learn how we can help you improve inventory visibility and reduce inventory carrying costs, contact Surgere today or schedule a demo.
