Holding Costs
What Are Holding Costs?
Holding costs are those associated with putting away inventory that stays unsold. These costs are one part of total inventory costs, along with ordering and shortage costs.
A firm's holding costs incorporate the price of goods harmed or ruined, as well as that of storage space, labor, and insurance.
Grasping Holding Costs
Limiting inventory costs is an important supply-chain management strategy. Inventory is a asset account that requires a large amount of cash outlay, and choices about inventory spending can reduce the amount of cash accessible for different purposes.
For instance, expanding the inventory balance by $10,000 means that less cash is accessible to operate the business every month. This situation is viewed as a opportunity cost.
Holding Costs Example
Expect that ABC Manufacturing produces furniture that is stored in a warehouse and afterward sent to retailers. ABC must either lease or purchase warehouse space and pay for utilities, insurance, and security for the location.
The company must likewise pay staff to move inventory into the warehouse and afterward load the sold merchandise onto trucks for transportation. The firm brings about some risk that the furniture might be harmed as it is moved into and out of the warehouse.
Holding Cost Reduction Methods
One method for guaranteeing a company has adequate cash to run its operations is to quickly sell inventory and collect payments. The sooner cash is collected from customers, and the less total cash the firm must think of to proceed with operations. Businesses measure the frequency of cash collections utilizing the inventory turnover ratio, which is calculated as the cost of goods sold (COGS) partitioned by average inventory.
For instance, a company with $1 million in cost of goods sold and an inventory balance of $200,000 has a turnover ratio of five. The goal is to increase sales and reduce the required amount of inventory so the turnover ratio increases.
One more important strategy to limit holding costs and other inventory spending is to compute a reorder point, or the level of inventory that makes the company aware of order additional inventory from a provider. An accurate reorder point allows the firm to fill customer orders without overspending on putting away inventory. Companies that utilization a reorder point keep away from shortage costs, which is the risk of losing a customer order due to low inventory levels.
The reorder point thinks about what amount of time it requires to receive an order from a provider, as well as the week after week or month to month level of product sales. A reorder point likewise assists the business with processing the economic order quantity (EOQ), or the ideal amount of inventory that ought to be ordered from a provider. EOQ can be calculated utilizing inventory software.
Features
- Limiting inventory costs is an important supply-chain management strategy.
- A firm's holding costs incorporate storage space, labor, and insurance, as well as the price of harmed or ruined goods.
- Holding costs are costs associated with putting away unsold inventory.
- Strategies to try not to hold costs incorporate quick payment collection and ascertaining accurate reorder points.
