Holding Cost

Key Highlights

• Holding Cost, or carrying cost, is the sum of money a company spends to hold and keep unsold inventory for a certain duration of time.

• Holding Cost = (Average Inventory × Holding Rate)

What is Holding Cost?

Holding Cost, or carrying cost, is the sum of money a company spends to hold and keep unsold inventory for a certain duration of time. It comprises warehousing, insurance, depreciation, and opportunity cost.

Purpose

The theory of holding cost assists companies in the following ways:

• To realize the actual cost of holding inventory

• To maximize inventory levels to save waste and increase efficiency

• To match supply with demand without excess stock

Key Components

1. Storage Costs: Warehouse rent, utility bills, and maintenance

2. Insurance: Expense of insuring the inventory on hand

3. Depreciation & Obsolescence: Reduction in value resulting from aging or expiration

4. Opportunity Cost: Capital invested in inventory that would otherwise be utilized

5. Handling Costs: Equipment and labor utilized in managing inventory

Formula

Holding Cost = (Average Inventory × Holding Rate)

For instance, if average inventory is ₹10,00,000 and the holding rate each year is 20%, the holding cost is ₹2,00,000 annually.

Why It Matters?

• High holding costs erode profits

• Promotes just-in-time (JIT) inventory systems

• Assists in determining the optimal order quantity and frequency

Advantages of Monitoring Holding Costs

1. Improved inventory planning

2. Cost reduction and enhanced efficiency

3. Enhanced cash flow management

Disadvantages if Overlooked

1. Excess inventory resulting in wastage or obsolescence

2. High storage costs

3. Working capital tied up