One of the most common costs for businesses dealing with physical goods, holding costs are often understated when it comes to handling expenses. They’re generally associated with storing inventory, all its related costs being put within the broader term, “holding cost.”
Cost Components
Put simply, holding costs are all the costs, fees, payments, and money associated with keeping your unsold inventory held within a warehouse or another storage location. These costs are divided into four major components:
1. Storage
2. Employee
3. Depreciation
4. Taxes/Opportunity
Storage and employee costs are the two tangible components associated with holding inventory – storage costs cover the physical expenses, such as warehouse rent, storage rent, utilities, and insurance, while employee costs are made up of your cut of salaries and wages for warehouse employees.
The intangible costs (depreciation, taxes, and opportunity) are costs incurred further down the road. Depreciation, for example, represents the costs brought about by slowly depreciating product value. Another cost, taxes, comes in the form of valuing remaining, unsold inventory, becoming another property tax. Lastly, there are opportunity costs, the potential gap in revenue from holding dead inventory instead of replacing it for sellable product.
Example
Although many find holding costs to be overwhelming, they’re much more digestible with an example. When predicting your holding costs, it’s important to keep in mind that they’re variable costs and likely to change as your inventory’s conditions change. Nonetheless, here’s a brief example:
Let’s say your company is planning on storing ten thousand cubic feet of your product. The warehouse you’re looking at offers storage payments per cubic foot. At one dollar per cubic foot, that’s $10,000 in storage costs. This $1 per cubic foot covers the lighting, air conditioning, physical storage, heating, coverage, and everything else that involves your product’s location. Additionally, they charge ten cents per cubic foot for employee and management costs – that’s another $1,000.
Next comes insurance, which you negotiate out to be $1,500.
Lastly, you’re left with the depreciation and tax/opportunity costs. These aren’t upfront costs, but rather come from a depreciation over time. Your product will likely decrease in value while being stored, so if your inventory was originally worth $400,000, it might be worth just $200,000 by the time you plan on selling.
As for opportunity, you could have sold $350,000 in the meantime with the same dimensions, meaning $150,000 in opportunity costs too. In all, that’s $162,500 in holding costs for your inventory during the time it’s being held, built up from storage, employee, depreciation, tax, and opportunity costs on your original inventory’s value.