Holding Costs

The expenses incurred by keeping unsold items in storage are known as holding charges Along with ordering and shortage fees, these costs make up a portion of the overall cost of the inventory. The cost of damaged or spoiled goods, as well as that of storage space, labor, and insurance, are all included in a company's holding expenses.

Components Of Holding Costs

Depreciation Cost

All storage areas, racks, and equipment that the company owns to keep and manage goods are depreciated by the company each quarter. If the business has made significant investments in automated storage and retrieval technologies, this fee may be significant.

Insurance Cost

The business's inventory asset should be covered by insurance. If so, the price of the insurance that goes along with this coverage is a holding expense.

Obsolete Inventory Write-Off Cost

If inventory is held around for too long, it may lose its ability to be sold. Upon being deemed outdated, if applicable, it is written off. This can be quite expensive for companies that frequently introduce new items.

Personnel Cost

A holding cost is the wage paid to the warehouse worker responsible for storage. Payroll taxes and employee benefits are included in this expense.

Rental Space Cost

A holding expense, the cost of renting warehouse space can be high if the facility's cubic volume is not fully utilized by the storage systems in place.

Security Cost

It makes sense to have security guards, fencing, and monitoring systems in place if the merchandise is valuable; all of these are holding expenses.

Holding Costs Example

Suppose ABC Manufacturing creates furniture that is sent to retailers after being kept in a warehouse. In addition to paying for utilities, insurance, and security for the facility, ABC must either rent or buy warehouse space.

Also, the business needs to pay employees to transfer inventory into the warehouse and load the sold goods onto trucks for transportation. When moving furniture into and out of the warehouse, the company runs a small risk of damage.

Holding Cost Reduction Methods

Selling products and obtaining payments swiftly are two ways to make sure a business has enough cash to maintain its operations. The more quickly clients pay, the less cash overall the business needs to raise to keep running. The inventory turnover ratio, which is computed as the cost of goods sold (COGS) divided by average inventory, is used by businesses to gauge how frequently cash is collected.

For instance, a business with a cost of goods sold of $1 million and an inventory balance of $200,000 has a turnover ratio of 5. The objective is to boost sales while lowering the amount of inventory that must be kept on hand, increasing the turnover ratio.

Key Takeaways

  • Holding fees are incurred when unsold inventory is kept in storage.
  • The price of ruined or damaged items is included in a company's holding expenses, along with labor, insurance, and storage charges.
  • Reduced inventory costs are an essential supply-chain management strategy.
  • Quick payment collection and accurate reorder point calculation are two tactics to reduce holding costs.
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