What is the hidden cost of holding inventory?

To accurately assess the true expense of inventory management, it’s essential to consider the Inventory Carrying Cost (ICC) or Holding Cost Factor (HCF). The HCF encapsulates the financial commitment involved in maintaining and storing inventory before its actual need arises. This factor is quantified as a percentage of the total inventory value, derived by summing several costs: capital cost, handling, insurance, labor, obsolescence, shrinkage, and storage space cost.

Industry observations reveal that annual inventory holding costs generally fall within 15-40%, with a common range of 20-25% of the inventory’s value. For instance, an organization with a 22% HCF and a $10,000,000 inventory value incurs an annual expense of $2,200,000 to manage its inventory.

Real savings can be made

The introduction of a robust process for identifying maintenance-required spares, as opposed to those suggested by Original Equipment Manufacturers, can significantly enhance an organization’s cash position. Assuming a 25% reduction in inventory purchases leads to a $550,000 decrease in holding costs, alongside a $2,500,000 direct savings from reduced purchases.

For businesses like manufacturing or asset-intensive companies operating at a 5% profit margin, a $50,000 operational savings equates to the revenue generated from $1 million in sales.