Managing inventory is one of the most challenging aspects of business management. No matter how large the organization or experienced the management team, inventory control problems continue to be an issue and therefore a constant risk to the business if not controlled properly. This is because the cost to carry inventory goes on the balance sheet and is considered an asset (though short-term) until sold. The cost of carrying inventory is referred to as carrying costs and determining the exact costs depends on the nature of the inventory.
Determine the costs associated with inventory. These can include storage, handling, obsolescence, administrative and loss (internal).
Sum these costs together. These are the costs associated with annual inventory costs.
Divide the inventory costs by the average inventory value. Calculate average inventory value by adding beginning inventory to ending inventory (monthly, quarterly or annually) and dividing by 2. For instance, if average inventory is $50,000 and inventory costs are $5,000, then the answer is 10 percent.
Determine your opportunity costs of capital (the return you could make if you invested your money elsewhere). This is generally around 9 or 10 percent.
Add the cost of insurance and a charge for taxes on the inventory. This is generally 4 percent and 6 percent, respectively.
Sum all costs for the total cost of carry, which is a percentage of sales. For this example, the answer is 10 percent + 9.5 percent + 4 percent + 6 percent = 29.5 percent.
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