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Cost of Carrying Inventory – Yes it costs money

by Blair Williams CFPIM, CSCP, CLTD, Jonah – Princeton South Jersey Chapter. Industry Professor – NYU (retd)

Inventory is often the single largest asset owned by a business. It directly affects the income reported. The Japanese considered inventory as “evil”. In spite of many protestations to the contrary and many good resolutions, we in the USA do not really have Inventory Control as a priority and in many cases do not even measure it or are even aware of how to measure it

Studies of industries about inventory carrying costs reveal the following . . .

  • Over 65% of most companies do not compute inventory carrying costs, they use rough estimates
  • Leading logistics experts place the cost of carrying inventory between 18% per year and 75% per year depending on the type of products and business
  • The standard “rule of thumb” for inventory carrying cost is 15% to 25% of inventory value on hand
  • The cost of capital is the leading factor in determining the percentage of carrying cost

Inventory carrying costs are made up of the following

  • Capital Costs – Investment Cost (cost that money would be earning if not tied up in inventory)
  • Inventory Service Costs – Insurance; Physical Handling, Taxes
  • Storage Space Costs – Warehouses – Public, Private, Rented, Company-owned
  • Inventory Risk Costs – Obsolescence, Damage, Shrinkage, Relocation

Total inventory carrying costs can be estimated at . . . .

  • Cost of Money 6% - 12%
  • Taxes 2% - 6%
  • Insurance 1% - 3%
  • Warehouse Expenses 2% - 5%
  • Physical Handling 2% - 5%
  • Clerical & Inventory Control 3% - 6%
  • Obsolescence 6% - 12%
  • Deterioration & Pilferage 3% - 6%

Carrying Costs Total 25% to 55%

Statistics

Here are some statistics from US Census Bureau – Annual Survey of Manufacturing 2006 (numbers in thousands)

NAICS Description Cost of Sales Average Inventory ($) Turns (COGS/Avg Inv)
  All US Mfg 2,247,845 433,195 5.12
33611 Automotive 174,410 4,195 41.58
311 Food 288,360 21,678 13.3
3254 Pharmaceutical / Biotech 38,615 19,603 1.96
3364 Aerospace 56,030 32,518 1.72

 

Global Benchmarks (PRTM 2005 survey)       –         Median            5.41                                                     

For all US Mfg, half an inventory turn is equivalent to $ 216.595 million

 It is estimated that over half of the working capital of a Supply Chain is in Inventory!

 Questions: Contact Blair Williams blairrw@att.net

 

 

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