What Are Holding Costs? (With How-to Steps and Examples)

By Indeed Editorial Team

Published June 25, 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Holding costs are the expenses a business incurs to maintain a product in storage. To assess holding costs, finance professionals assess the opportunity costs associated with the space and the literal expenses of holding. Understanding how to calculate holding costs can help you optimize logistics solutions in the workplace. In this article, we answer the question, "What are holding costs?", detail their various components, explain how to calculate them, and provide examples you can use for reference.

What are holding costs?

Holding costs represent the amount of money that a company pays to store the inventory that remains unsold. Many professionals call this figure carrying costs, and it represents an expense that companies usually average as a percentage of inventory over a period. The appropriate holding cost as a percentage depends on the industry and surrounding economic conditions. On average, the cost ranges from 20% to 30% of the total inventory value of a business.

Companies assess holding costs to determine the actual profit the inventory earns. It also assists in calculating how long a company can store a piece of inventory before incurring a loss. Businesses use carrying costs to determine sales quotas and order quantities it requires to maintain appropriate levels of inventory. It also serves as a metric of how steadily a business earns income and how that impacts the company's logistics.

Read more: Inventory Management Techniques (With Best Practices)

Components of carrying costs

Carrying costs comprise anything that associates with what a company pays to store goods. It includes the tangible price associated with the cubic footage, relative to rent and utilities. The metric also includes intangible values, such as opportunity costs. Here are some other notable components of holding costs:

Inventory service

Inventory cost refers to expenses that the company incurs due to tax. It also covers hardware costs associated with maintaining the inventory. Inventory service expenses also include any insurance that covers the products that the warehouse stores. To mitigate risk and maintain proper licenses, almost all companies have some type of insurance to protect their services or products.

Read more: How to Calculate Manufacturing Overhead (With 6 Steps)

Storage space

The cost of storing items refers to the lease payment or rent that a company pays to keep its inventory in a warehouse. Specific agreements depend on the business and the types of goods, where most use cubic footage to determine the percentage of the whole that the business pays for the space. This component includes the fees associated with transportation and utility expenses, such as the cost of cooling for refrigerated products.

Read more: Outbound Logistics (What Is It, How It Works, and Tips)

Risk cost

The risk expense related to inventory relates to both theft and damage. Companies can mitigate the risk of theft through security measures and responsible storage practices. Damage is less predictable because it relates to the unexpected, such as fire or flood. While insurance usually covers this expense, it can damage customer relationships. The risk expense is an average of loss figures over a set period, relative to the overall inventory. Professionals use this figure to determine the actual expense of keeping products in inventory.

Read more: Risk Management Tools to Use in Project Management

Capital expense

The capital cost usually appears as a percentage. It refers to the amount that the company invests into the inventory that remains in holding. For example, if a company paid $500,000 for merchandise and $95,000 remains unsold, its capital expense is the value of the remaining goods. The capital expense percentage is 19%. The expense loss of the investor who pays for the inventory is that $95,000. Ideally, the capital expense that contributes to holding cost is low, but it usually represents the most significant component.

How to calculate holding costs

The following steps outline how to calculate the holding, or carrying costs, your company incurs to maintain its inventory:

1. Assess inventory cost components

The first step in determining the holding expense of your company's products is to total each component. Take the sum of each aspect of the inventory expenses. These include:

  • Capital expenses: The amount the company directly invests in the goods currently in storage

  • Storage costs: The rental expense associated with the cubit footage of the inventory in the warehouse

  • Inventory service: Includes utility surcharges from the warehouse, such as the expense for refrigeration

  • Risk pricing: The insurance expenses that protect the business against the cost of damage to the products during its holding period

Read more: Inventory Management Techniques (With Best Practices)

2. Determine the holding sum and value

The holding, or carrying, sum totals all the components of the inventory holding expense. This total represents the amount that the company pays for unused inventory. The resulting figure can inform the quantities of future orders and help businesses determine the most affordable storage solutions.

3. Identify the inventory value

Even if the company incurs storage costs for its products, it can still earn a profit. Identifying carrying costs helps companies determine when to change an item's price or find a different storage solution. The value of the inventory involves your calculating the sales value of the remaining inventory. This is a way of assessing potential earnings. The longer it takes the company to sell that inventory, the less profit it earns. Additionally, the longer it takes, the more vulnerable to changing markets and consumer interests it becomes.

Read more: Inventory Write-Down: Definition, Causes, Tips, and Examples

4. Divide the sum by the inventory value

Holding costs are usually a ratio between the cost it takes the organization to store the inventory versus the potential sales value. The value of each item can remain the same, but by calculating it against the holding costs, a company can identify the point at which they incur a loss due to carrying expenses. To express the holding cost as a percentage, you can use this formula:

Holding cost = (Inventory holding sum / Total value of inventory) x 100

Examples of holding cost situations

The following examples represent situations where companies of different sizes use holding costs to make important business decisions:

Small company

Bob and Martha's cookbook store keeps its unsold inventory in a warehousing facility. The total value of that inventory amounts to a value of $200,000. Costs associated with the inventory holding, including service expenses, insurance costs, and capital expenses, total $96,000. Relying on this information, the company can determine its holding costs by using the following calculations:

Inventory holding totals = Inventory service expenses + Capital cost + Storage space price + Inventory risk in dollars
Inventory holding sum = $96,000
Percentage of holding costs = Sum of inventory holding expenses / Total potential sales value of inventory) x 100
Percentage of holding costs = ($96,000 / $200,000) x 100
Percentage of holding costs = 48%

Using these calculations, you can see that the holding costs for this company amount to 48%.

Read more: Frequently Asked Questions: Can Inventory Be a Current Asset?

Medium-sized company

An art company that retails prints carries a diverse inventory for its broad supply of artwork. The total value of its inventory is $75,000. After the company totals the expenses related to holding the products, it realizes a holding sum of $12,000. It uses this data to determine the holding costs of the inventory:

Total value of inventory = $75,000
Inventory holding sum = $12,000
Holding costs as a percentage = (Inventory holding sum / Total dollar value of inventory) x 100
Holding cost as a percentage = ($12,000 / $75,000) x 100
Holding costs as a percentage = 16%

This shows that the art store has a 16% holding cost for its inventory.

Read more: What Is the Inventory to Sales Ratio? (With Examples)

Large company

A major superstore carries inventory for its varied array of products. The total sales value of its inventory is holding is $500,000. After factoring in all the expenses that relate to the storage of the inventory remaining unsold, the company calculates a holding total of $325,000. It uses the following calculation to assess the holding expenses:

Total value of inventory = $500,000
Inventory holding sum = $325,000
Holding costs in percentage = (Sum of inventory holding expenses / Total potential value of inventory sales) x 100
Holding costs in percentage = ($325,000 / $500,000) x 100
Holding costs = 65%

The superstore has a holding cost percentage of 65%.

Explore more articles