Inventory holding costs

Everything you need to know about inventory holding costs.

What are warehousing costs?
Calculating warehousing costs
How can warehousing costs be reduced?
Reducing logistics and warehousing costs by improving supply chain processes
Measures to reduce storage time
Conclusion

Inventory costs

Inventory costs are an important aspect of operational financial planning and include all expenses associated with the administration and storage of goods. From rental costs and personnel expenses to the optimisation of warehouse processes – efficiency in warehousing plays a crucial role in the economic success of a company. In this article, we would like to explain the definition of warehousing costs, their influencing factors and the importance of key figures for effective cost management.

What are warehousing costs?

Warehousing costs include all expenses associated with storing goods or raw materials in a warehouse. These include rental costs for storage space, wages for warehouse personnel, depreciation of equipment and financing costs for the capital tied up in the warehouse. Accurately identifying all expenses and managing them efficiently is crucial for companies to control total operating costs and maximise profitability. Through targeted strategies such as just-in-time inventory management and advanced warehouse management systems, companies can not only optimise their warehousing costs but also strengthen their competitiveness.

Definition: What are fixed and variable warehousing costs?

Storage costs can be roughly categorised into fixed and variable costs of warehousing. Fixed costs remain unchanged regardless of the amount of goods stored. These include rental costs for storage space, insurance and salaries of permanent warehouse staff. In contrast, variable costs vary depending on warehouse utilisation and activities. Costs for transport or packaging are typical variable costs that are related to the actual inventory and associated processes.

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Why do warehousing costs arise?

Warehousing costs arise from the need to store goods or raw materials for a period of time between their production or procurement and their sale or use. In addition, warehousing performs various tasks, the organisational perception of which makes costs unavoidable:

Inventory management: Warehousing enables the management and control of the physical inventory. This includes the organisation, storage and updating of goods to ensure a smooth supply chain.
Risk reduction: By holding safety stock, companies can minimise the risk of supply shortages due to unexpected events such as delayed deliveries or production stoppages.
Service level: A well-organised warehouse helps to reduce delivery times and better meet customer requirements.

For companies, warehousing plays a central role in the supply chain, as the warehouse helps to keep products available in sufficient quantities to meet demand.

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The different types of warehousing costs

What warehousing costs are there and how are they calculated? Companies that are in the process of setting up a warehouse should consider the following main components:

Warehouse space rental costs: This includes the expenses for renting warehouse space, warehouses or storage racks for storing goods.
Personnel: This includes the salaries and wages of employees responsible for warehouse activities such as picking, packing, inventory management and shipping.
Transport costs: This refers to the costs of transporting goods to and from the warehouse, including freight and shipping costs
Insurance costs: These costs cover the insurance of stock and warehouse space to protect against risks such as theft, fire or damage.
Technology and systems: Investments in warehouse management systems (WMS), barcode scanners, RFID technology and other automated systems that help to manage warehouses efficiently.
Depreciation: The costs of depreciation of warehouse infrastructure, equipment and technologies used in warehouse operations.
Safety stock and excess inventory costs: These costs can arise from holding safety stock to avoid delivery bottlenecks, as well as from holding excess inventory that carries the risk of spoilage or obsolescence.
Financing costs: These include the interest or capital costs associated with financing the inventory if the company borrows to finance the inventory.

What are the costs of warehousing?

Typical storage costs at a glance:

Rental costs
Personnel costs
Insurance costs
Energy costs
Maintenance costs
Packaging material
Transport costs
Cost of capital

What is the difference between storage costs and inventory costs?

Storage costs is a broader term that includes all costs associated with keeping goods in a warehouse. The definition of inventory holding costs refers specifically to the costs directly associated with the physical storage of goods. Here is an example: employees in the accounting department use their time and resources for inventory accounting, among other things. Part of their salary can therefore be considered as warehousing costs, as it is directly related to the administration and accounting of warehousing activities. Expenses for pallets, containers, shelving systems, etc., which are necessary for the safe storage of goods, can be clearly identified as costs for physical storage and thus as warehousing costs.

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Calculating inventory carrying costs

Calculating inventory carrying costs requires a careful analysis of various types of costs. Here are the essential steps for a simple calculation of inventory carrying costs:

Identify the cost categories: Determine the various cost categories associated with inventory, such as warehouse rental costs, personnel costs, transport costs, insurance costs, technology investments, depreciation and other relevant expenses.
Data collection: For each cost category, collect relevant data, including lease agreements, payroll records, insurance policies, warehouse management system invoices and other documents.
Calculating total costs: To calculate annual carrying costs, add up the costs from each category identified.
Calculating average inventory levels: Determine the average value of inventory by adding up the beginning and ending inventory levels for a given period and dividing by 2.
Calculate the per-unit inventory carrying cost: Divide the total cost by the number of units in inventory. The units can be in different units of measure, such as items, pallets, or cubic metres, depending on what makes sense in your business.
Analyse and optimise: Analyse the results, compare with industry standards, and identify areas for cost reduction or process improvement.

Formula for calculating storage costs per item:

Here is a generic formula that can be used to determine the storage costs per item (unit):

Storage costs per item = total costs / number of units stored

In addition, other storage components can be calculated, such as the monthly storage costs for pallets of goods. We also have a generic calculation formula for this, which can be adapted to the operational circumstances:

Storage costs per pallet per month = (rental costs per m² x required storage space per pallet) + other storage costs per m²

The formula states: rental costs per m² = the monthly rental costs for the total storage area, divided by the number of square metres. Storage space required per pallet = The space required in the warehouse for a pallet. This could vary depending on the sizes of the pallets and the warehouse organisation. Other storage costs per m² = This component includes other relevant storage costs such as personnel costs, insurance costs, energy costs, maintenance costs and similar expenses that are incurred per square metre of storage space.

Calculate interest costs of inventory

The interest costs of inventory indicate how much it costs the company to use capital to store goods instead of investing it elsewhere. Efficient inventory management aims to minimise these interest costs by optimising inventory levels and reducing the amount of capital tied up. Formula for calculating interest costs:

Inventory carrying cost = Average inventory x Cost of capital per unit

To calculate the interest cost: Average inventory = The average value of goods held in inventory during a given period. Cost of capital per unit = The interest rate or the average cost of capital per unit of inventory. This represents the cost of the capital tied up.

Calculating the Inventory Interest Rate

While the interest cost pertains to the tangible financial expenses of capital tied up by inventory on hand, the inventory interest rate puts a percentage figure on it. It represents the cost of carrying inventory in relation to the average inventory on hand.
Inventory Interest Rate Formula:

Inventory interest rate = (cost of capital / average inventory) x 100

How to calculate storage capacity?

Calculating storage capacity depends on various factors, including the type of warehouse and the products being stored. Here are basic steps for calculating storage capacity:

Measure the length, width and height of the warehouse in metres to determine the total warehouse space.
Determine how the pallets are to be placed in the warehouse, including the type of racking systems, the aisles between the racks and the stacking height of the pallets.
Note the specific requirements of the stored products, such as pallet sizes or the type of storage (e.g. high-bay storage, block storage).
Take into account safety margins and free aisles between storage racks to ensure the mobility of goods and accessibility for employees
If necessary, you can convert the calculated storage capacity into the desired unit of measurement (e.g. cubic metres into cubic feet).

Definition: What is the inventory cost ratio?

The inventory cost ratio is a key figure that relates inventory holding costs to average inventory levels. Whether in industry, trade or manufacturing – as soon as warehousing is considered an integral part of business strategy and supply chain management, the inventory cost ratio is an important tool for effectively controlling inventory costs. A lower inventory cost ratio typically indicates a more efficient use of inventory and cost-effective warehousing, while a higher inventory cost ratio may indicate inefficient warehousing practices or excessive inventory levels. Inventory costs, and thus the inventory cost ratio, also influence product pricing by directly affecting total costs, thus affecting profitability and competitiveness.
To determine the carrying cost rate, you must first identify the total cost of carrying inventory and the average inventory balance for a given period. Then use the formula below with the appropriate values. Formula for calculating the carrying cost rate:

Carrying cost rate in percent = (Carrying cost / Average inventory balance) x 100

The following definitions apply to the formula: Warehousing costs = the total costs of warehousing. Average warehouse stocks = represent the average value of the warehouse stocks over a specific period of time.

Example of calculating the warehousing cost rate:
Let's assume that the total annual warehousing costs amount to 38,000 euros. At the same time, the average stock level during that year is 200,000 euros. The calculation of the inventory cost rate is therefore: Inventory cost rate = (38,000 / 200,000) x 100 = 19%

The inventory cost rate is 19%. This means that the storage costs over the course of a year account for about 19% of the average inventory. The company can now use this percentage to evaluate inventory management efficiency over a longer period of time and identify potential areas for improvement.
Likewise, the storage costs for a specific stock item can now be calculated. For this example, we will use the fictitious stock item no. 1123, with an inventory value of 250 euros. The calculation is as follows:
Storage costs for item no. 1123 = inventory value x (storage costs in % / 100) = 250 x (19 / 100) = 47.50 euros
The storage costs for item no. 1123 are 47.50 euros.

Definition: What is inventory intensity?

Inventory intensity is a business ratio that measures the relationship between inventory and other operational variables. It indicates how much of a company's sales or production is tied up in the warehouse on average. Inventory intensity is usually expressed as a percentage and can be calculated in different ways, depending on which operational sizes are put in relation.
A common formula for calculating inventory intensity is:

Inventory intensity = (Average inventory / Sales or Production) x 100

This ratio indicates how efficiently a company manages its inventory levels. A high inventory intensity can indicate inefficient inventory management, while a low inventory intensity tends to indicate efficient inventory management and faster turnover of goods.

Example of calculating inventory intensity:
Let's assume that a company has an average inventory of €50,000 and generates an annual turnover of €500,000. The calculation of the inventory intensity would be as follows:
Inventory Turnover = (500,000 – 50,000) x 100 = 200
In this example, the inventory turnover is 200. This means that the company turns over 200% of its annual sales on average. A low inventory intensity, as in this example, indicates that the company is relatively efficient with its inventory and only holds a comparatively small portion of its sales in inventory. The company could now analyse this value to assess its inventory management efficiency and possibly optimise inventory levels to reduce inventory intensity and free up capital.

How do inventory methods affect carrying costs?

The selection of different warehousing methods can have a significant impact on a company's storage costs. For example, implementing an efficient warehouse management system that enables automated processes and accurate inventory tracking can reduce labour costs and improve the accuracy of inventory data. This results in lower losses due to excess or lost stock, which can reduce the total cost of warehousing. Storage bin utilisation also significantly affects costs. Choosing between different storage racking systems and deciding whether to favour high-bay storage or block storage can affect space requirements. Optimised space management leads to better utilisation of storage space and can significantly reduce storage costs. On the other hand, inefficient warehousing methods could cause storage space to be wasted, which in turn leads to higher costs.

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How can warehousing costs be reduced?

Every company strives to identify and implement measures to reduce warehousing costs and thus optimise the efficiency of its warehousing. Here are some examples and measures:

Use advanced inventory management technology to monitor stock levels in real time. Avoid overstocking and ensure a balanced safety stock to prevent shortages.
Categorise products by value and focus more intently on manage high-value items, while low-value items can be stored more efficiently.
Conduct regular inventories to keep track of current stock levels and minimise stock discrepancies.
Work with suppliers to just-in-time deliveries and reduce the need for large inventory levels, which in turn lowers your storage costs. For example, Express currently stocks around 100,000 products from a wide range of brand manufacturers in a large warehouse with 4000 m² of storage space. Our customers benefit from our warehousing!
Structure the warehouse layout efficiently to enable quick access to frequently requested products and to shorten picking times.
Implement automated warehouse management systems such as barcode scanners or RFID technologies to accelerate the flow of inventory and human error.
Use cross-docking practices to move products directly from receiving to shipping without storing them in the warehouse. This minimises storage time and costs.
Analyse supplier ratings for reliability and delivery speed, as reliable suppliers can help to reduce inventory levels.
Take seasonal demand variations into account when planning your inventory to avoid overstocking and to make optimal use of resources.
Involve your warehouse staff in designing efficient warehouse processes, use their experience and rely on training and communication to minimise errors.

Reducing fixed storage costs

To reduce fixed storage costs, companies can apply various strategies. One approach is to make optimal use of storage space. Careful planning of the warehouse layout and the use of efficient racking systems can effectively utilise the available space, resulting in lower rental costs per square metre. Adopting technologies such as automated warehouse management systems, robotics and conveyor belts can increase efficiency while reducing the need for manual labour. In addition, reviewing and optimising warehousing contracts plays an important role. Flexible warehousing contracts that can be adapted to changing requirements enable better control over fixed warehousing costs. The option of outsourcing warehousing services offers companies the opportunity to benefit from the economies of scale and efficient processes of external service providers in order to reduce fixed costs.

Reduce storage costs by reducing inventory

Reducing storage costs by lowering inventory levels and introducing just-in-time deliveries is a proven strategy for increasing efficiency in warehouse management. This method involves delivering goods only when they are actually needed, rather than keeping large quantities in stock. Implementing this approach involves working closely with suppliers to enable fast and accurate delivery. Through improved communication and logistics, businesses can minimise their stock levels and reduce the costs associated with storage, space and the risks of overstocking.

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Reduce logistics and warehousing costs by improving supply chain processes

Improving supply chain processes can significantly reduce warehousing and logistics costs. Here are some ways to achieve these benefits.

Automation of ordering processes: Automated ordering processes can speed up the ordering process and minimise human error. This leads to more efficient supply chain operations and lower storage costs.
Reduction of delivery times: Shorter delivery times through more efficient transport and logistics processes can reduce inventory costs by decreasing the need for large inventory levels.
Optimisation of transport routes: Optimisation of transport routes not only results in faster deliveries, but can also reduce transport costs and environmental impacts.
Traceability of goods: Improved traceability of goods enables faster identification and handling of delivery issues, which can result in lower storage and returns costs.

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Measures to reduce storage time

A shorter storage period can also help to reduce storage costs. Companies can take various measures to achieve this, such as just-in-time inventory management. Goods are only delivered when they are needed. Close cooperation with suppliers also ensures efficient procurement in order to reduce storage time, minimise stock levels and lower storage costs.

Reducing storage costs through outsourcing

Outsourcing storage functions to external service providers usually leads to a reduction in storage costs and ensures even more advantages. These include the fact that external storage service providers often specialise in warehouse management and logistics. By working with experts who focus exclusively on these tasks, companies can benefit from their expertise and experience. This leads to more efficient processes and optimised warehouse management, which in turn results in cost savings. Outsourcing also makes it possible to reduce fixed costs. Instead of investing in their own warehouse infrastructure, personnel and equipment, external service providers can provide these resources. Companies then often only pay for the actual storage capacity used and the services provided. This measure reduces fixed costs and improves cost flexibility. Another advantage is that companies can once again focus more effectively on their core competencies. While external warehousing service providers take on the specific challenges of warehouse management, the company can focus on product development, sales and other key aspects of the business. The consequences are a more effective use of resources and improved overall efficiency for the company.

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Conclusion

Storage costs, as a significant part of operating expenses, include all costs associated with the storage of goods. This includes not only the physical storage, but also aspects such as inventory management, safety stocks and process optimisation. It is crucial for companies to keep an eye on storage costs and to optimise them continuously. Key figures such as the inventory cost rate or inventory intensity are crucial for evaluating the efficiency of warehousing. They provide companies with insights into how well resources are utilised, help control costs and enable targeted optimisations to increase the overall efficiency of the supply chain. Other ways to improve overall efficiency include minimising inventory levels and using external expertise.

Despite careful editing and checking of the contents, Stecker Express does not guarantee the timeliness, correctness, completeness and quality of the information provided.