What is Holding Cost? – Definition

If you’re involved in the manufacturing industry, chances are you’ve heard of holding cost. But what exactly is it and why is it so important? Holding cost is a term used to describe the costs associated with storing and managing inventory. This includes costs like storage fees, insurance, taxes, depreciation and more. As a manufacturer, understanding your holding cost can be key to reducing overhead and increasing efficiency. In this blog article we’ll discuss the definition of holding cost in detail, explore why it’s important for manufacturers to understand their holding cost and provide tips on how to reduce it.

What is holding cost?

The holding cost, also known as the inventory carrying cost, is the cost of keeping a inventory item in stock. This cost includes the costs of storage, insurance, and opportunity cost. The holding cost is usually expressed as a percentage of the item’s purchase price.

For example, if it costs $100 to keep one widget in stock for one year, and the widgets sell for $200 each, then the holding cost would be 50% ($100/$200).

Examples of holding costs

There are many examples of holding costs. They can include the cost of money tied up in inventory, the cost of storage space, the cost of insurance, the cost of obsolescence, and more.

Inventory carrying costs are one of the most common examples of holding costs. These costs can include the interest paid on money borrowed to finance inventory, the opportunity cost of funds invested in inventory, storage costs, and shrinkage (product loss due to damage or theft).

Other examples of holding costs can include warehousing and distribution expenses, advertising and marketing expenses to maintain product awareness, and regulatory compliance expenses. Investment analysts often use a company’s operating cash flow divided by its total assets to calculate a holdco ratio which is used to assess a company’s financial health and its ability to generate returns on invested capital.

How to calculate holding cost

There are a few different ways to calculate holding costs. One way is to use the average inventory method, which averages the beginning and ending inventory levels during a period of time and multiplies that number by the holding or carrying cost percentage.
Another way to calculate holding costs is to use the specific identification method. This approach identifies each unit of inventory individually and uses its own unique cost. This information is then used to calculate a weighted average cost per unit of inventory.
The last method for calculating holding costs is the first-in, first-out (FIFO) method. The FIFO method assumes that the first units of inventory that were purchased are also the first units that are sold.
To calculate holding costs using the FIFO method, you will need to know the following information:
• The cost of each unit of inventory that was purchased
• The number of units in each purchase
• The selling price of each unit

The benefits of reducing holding cost

When it comes to inventory, the cost of holding or carrying inventory is one of the most important factors to consider. After all, if you have too much inventory on hand, you tie up valuable resources that could be better used elsewhere. Not to mention, the longer you keep inventory on hand, the more risk there is of obsolescence or damage.

There are a number of reasons why reducing your holding costs is a good idea:

1. Free up cash flow: Carrying too much inventory can tie up a lot of working capital. By reducing your inventory levels, you can free up cash flow which can be used for other purposes such as investing in new products or expanding your business.

2. Improve efficiency: Too much inventory can lead to inefficiencies in your operations. For example, if you have too much stock on hand, it can lead to higher storage and handling costs. Reducing your inventory levels can help improve your overall efficiency and bottom line.

3. Reduce risk: As mentioned earlier, the longer you keep inventory on hand, the greater the risk of obsolescence or damage. Reducing your inventories helps reduce these risks and improve your bottom line.

The impact of inventory on holding cost

The holding cost of inventory is the cost associated with storing inventory. It is a function of the opportunity cost of money, the cost of storage, and the costs associated with inventory obsolescence or deterioration.

The opportunity cost of money is the interest that could have been earned if the money was invested elsewhere. The storage cost is the expense incurred to maintain inventory in a suitable location and in proper condition. These costs can include rent, utilities, insurance, and salaries for staff members who manage the inventory. The costs associated with inventory obsolescence or deterioration are those incurred when inventory becomes unusable or unsaleable due to changes in technology or fashion trends.

Conclusion

In conclusion, holding cost is an important yet often overlooked part of the supply chain. Holding costs can be a large expense and have a significant impact on your bottom line. By understanding how to calculate it and optimizing processes like inventory management, you can reduce or eliminate these costs in order to maximize profitability. Understanding what factors go into calculating holding cost is the first step in taking control of this hidden business expense that can make all the difference for your financial health.