The Costs to Carry Inventory for a Small Business

As a small business owner, passion for your business and doing right by your customers’ trumps most everything else related to your business. One area that seems to get overlooked and is probably one of the most challenging is a thorough understanding of inventory management.   

For a small business owner, how they handle inventory management can make or break their business. Successful inventory management involves the balancing act of keeping inventory costs low with the benefits of having the inventory in stock.inventory inside warehouse

How long a business holds and stores an item determines the carrying cost of inventory. A business’s carrying cost of inventory is the average dollar value of inventory over a fixed period of time. The longer the inventory is kept, the more costly its upkeep. This number is expressed as a percentage of a business’s average inventory investment.

Carrying costs include storage of inventory, inventory insurance, risk of inventory becoming obsolete, taxes on the inventory, possible damage to inventory and opportunity costs.  

Storage of Inventory

One of the biggest costs associated with inventory is that of storing merchandise prior to selling it. Whether it is kept in a storage room or offsite at a warehouse, the more inventory you keep will increase your costs to rent, maintain and manage it. 

Insurance

This cost covers the cost to replace inventory in the event of a major loss. The premiums paid vary based on the inventory kept.

Risk of Being Obsolete

Unfortunately there is a possibility that some inventory may become unusable over time. This can occur due to a new model coming out, technology changes or the item being perishable. The probability of this affecting a small business increases with any increase in inventory.

Inventory Taxes

Although many states have moved away from charging property taxes on business inventory there are still several that do so. According to a September 2012 report from the Tax Foundation, there are still thirteen states that either fully or partially charge property taxes on business inventory.

Damage

The longer inventory is held, the more likely it is to get damaged. Once a piece of inventory is damaged an attempt can be made to sell it at a lower price. If that can’t be done, it becomes a total write-off to the business.

Opportunity Costs

This cost is based on what alternatives investments could be made for your business if the money was not tired up in inventory.  The difference between the value of the inventory and an alternative investment is the opportunity cost.

Understanding the full costs of inventory is very important for any small business. By examining these costs, a business can determine where they can make changes that will result in cost savings for their business. 

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Barbara Goldberg

Business Operations Strategist at Back On Track Solutions
With over 15 years of corporate experience within Fortune 500 companies, Barbara Goldberg now brings world-class customer service to the small business community. An avid sports fan, Barbara likens her passion, focus and strategy to a crew chief guiding a race car driver to the finish line. Barbara will analyze, evaluate, distill and then solve the problems challenging business owners, allowing them to get back on track to servicing customers.

With over 15 years of corporate experience within Fortune 500 companies, Barbara Goldberg now brings world-class customer service to the small business community. An avid sports fan, Barbara likens her passion, focus and strategy to a crew chief guiding a race car driver to the finish line. Barbara will analyze, evaluate, distill and then solve the problems challenging business owners, allowing them to get back on track to servicing customers.

Posted in Business Expenses, Small Business, Small Business Toolkit Tagged with: , , , , , , , ,
  • Barbara Goldberg: As an experienced purchaser and cost analyst I know about the challenges about inventory management. You want to have enough material in stock, but not too much! 😉 Personally, I am not so sure about the so-called “Opportunity Costs” that you learn about at school and in business literature, but I would say that the Pareto Principle is applicable to what to have in stock and what not to have on the shelves.

  • Barbara Goldberg

    LyceumMartin, thanks for your comments. I included “Opportunity Cost” because like you mentioned it’s something that we’ve either learned or heard about. When it comes to small business I believe that because they don’t have unlimited funds they pick and choose what they believe is best for their business.
    I’m curious, could you explain more on how you would apply the Pareto Principle to inventory.

  • Barbara Goldberg LyceumBarbara: I agree that we always have limited funds (that is a valid concept in economics) and that you have pick between alternatives. The problem I have is that you put a cost on the alternative that you don’t pick! 😉
    I worked for a company that applied the 80/20 rule throughout the whole organization. Regarding the inventory you could find that 20 percent of the products were generating 80 percent of the revenue. Less than 20 percent of the products were “shelf warmers” and could have much more impact on the binding of capital of what it should have, rejection and return to the vendors of not sellable material with a long overdue due date, etc.

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