The cost to store inventory

The cost to store inventory includes the costs associated with holding assets, storage, and the cost of money. The resulting aggregate cost should be considered when deciding how much inventory to keep on hand. The cost to store inventory includes the following items:

  • Facility cost. This is the cost of the warehouse, which includes depreciation on the building and interior racks, utilities, building insurance, and warehouse staff. There are also utility costs, such as electricity and heating fuel for the building. This is largely a fixed cost, and so can only be allocated to the inventory stored within the warehouse; there is no way to directly associate this cost with an individual unit of inventory.
  • Cost of funds. This is the interest cost of any funds that a company borrows in order to purchase inventory (or, conversely, the foregone interest income). This can be tied to a specific unit of inventory, since selling a single unit immediately frees up funds which can then be used to pay down debt. This cost of funds varies with the market interest rate.
  • Risk mitigation. This is not only the cost of insuring inventory, but also of installing any risk-management items needed to protect the inventory, such as fire suppression systems, flood mitigation planning, burglar alarms, and security guards. As was the case with facility costs, this is largely a fixed cost.
  • Taxes. The business district in which the inventory is stored may charge some form of property tax on the inventory. This cost can be reduced by selling off inventory just prior to the date on which inventory is measured for tax purposes.
  • Obsolescence. Inventory may become unusable over time (especially for perishable items), or it may be superseded by technological advances. In either case, it may only be disposed of at a large discount, or have no value at all. This tends to be an incremental cost that is more likely to be associated with low-turnover goods.

As noted in many of these points, a large proportion of inventory storage costs are fixed; thus, a company with an empty warehouse will find that the incremental cost associated with one extra unit of inventory in quite small, whereas a company operating a filled warehouse must deal with large step costs to accommodate the storage of additional units of inventory. To reduce these fixed costs to any great extent requires that a business eliminate a large proportion of its inventory.

Given the large number of inventory storage costs, it is no surprise that many inventory management experts consider inventory to be a liability, rather than an asset. Their focus is to reduce overall storage costs by eliminating inventory to the greatest extent possible.

The cost to store inventory is incorporated into the economic order quantity calculation, which (as the name implies) is used to determine the most appropriate number of units to purchase.

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Inventory Management