Inventory how-to

How to calculate carrying cost

Carrying cost is what it costs you to hold inventory for a period of time, usually shown as a percentage of inventory value per year.

Short answer: Carrying cost is what it costs you to hold inventory for a period of time, usually shown as a percentage of inventory value per year. Add up storage, capital, insurance, shrinkage, and obsolescence costs, divide by average inventory value, and multiply by 100.

What counts as carrying cost

Carrying cost has four main parts. Capital cost is the money tied up in stock that could have been used elsewhere, usually estimated with an interest rate or your cost of borrowing. Storage cost covers rent, utilities, and labor for the space the stock sits in. Risk cost covers shrinkage, damage, and markdowns on stock that goes stale or out of season. Service cost covers insurance and taxes on the inventory.

If you run a small store, you do not need exact accounting figures for each part. A reasonable estimate for each category is enough to make better ordering decisions.

The formula

Carrying cost rate = (total carrying costs for the year / average inventory value for the year) x 100.

Total carrying costs is the sum of capital cost, storage cost, risk cost, and service cost in dollars. Average inventory value is usually (beginning inventory value + ending inventory value) / 2, taken at cost, not retail price.

Why it matters for ordering

A high carrying cost rate means holding extra stock is expensive, so you want tighter reorder points and smaller safety buffers. A low rate means carrying some extra stock as a cushion against stockouts is cheaper and safer. This number should influence how many days of cover you target when you set reorder quantities, not just how you report inventory value.

Step by step

  1. List your inventory at cost for the start and end of the year, then average the two numbers.
  2. Estimate capital cost by multiplying average inventory value by your cost of capital or loan interest rate.
  3. Add up actual storage costs: rent, utilities, and labor tied to holding stock.
  4. Add estimated risk cost: shrinkage, damage, and markdowns from unsold or expired stock.
  5. Add service cost: insurance premiums and any taxes on inventory.
  6. Sum all four costs, divide by average inventory value, and multiply by 100 to get your carrying cost rate.
  7. Review the rate once or twice a year and use it to decide how much safety stock is worth carrying per SKU.

Worked example

Say a store has average inventory value of $50,000 at cost. Capital cost at 8 percent interest is $4,000. Storage cost (a share of rent and labor) is $3,000. Risk cost from markdowns and shrinkage is $2,500. Service cost (insurance) is $500. Total carrying cost is $4,000 + $3,000 + $2,500 + $500 = $10,000. Carrying cost rate is $10,000 / $50,000 x 100 = 20 percent per year.

How SteadyShelf helps

SteadyShelf does not calculate carrying cost or track landed cost, storage, or insurance expenses. It focuses on forecasting demand and timing purchase orders, so you would work out carrying cost separately, then use it to decide how many days of cover to set per supplier or SKU inside SteadyShelf.

$29/month flat, unlimited products and suppliers, 30-day free trial. Run the numbers now with the free reorder point calculator.

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FAQ

Does carrying cost include the purchase price of the goods?

No. Carrying cost is the cost of holding inventory you already own, not the cost of buying it. The purchase price is used to value the inventory, but the carrying cost itself is capital, storage, risk, and service costs on top of that value.

How often should I recalculate my carrying cost rate?

Once or twice a year is usually enough for a small store, unless rent, interest rates, or shrinkage change significantly. It does not need to be exact, just consistent enough to compare year over year.

Let SteadyShelf do this math for every SKU

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