There are many nuances to managing a growing ecommerce business. Inventory management requires resources and experience—to properly track, store, and manage products across the supply chain is no small task. Any discrepancies or issues upstream can result in problems downstream (i.e. for the customer).
A common metric that high-growth ecommerce brands track regularly is their inventory carrying cost. Knowing how much their goods are costing to store and hold is important. The longer items are kept in storage, the more capital is tied up that can’t be spent on marketing, product development, or internal business processes.
What Are Inventory Carrying Costs?
Inventory carrying costs, also known as inventory holding costs, are the sum of many costs it takes to store goods or products, these may include warehousing and storage space costs, insurance, labor, depreciation or damage, and shrinkage.
The total carrying cost includes total inventory costs, plus the cost of renting the warehouse, operating the space, paying and training employees who work there, as well as any inventory attrition or shrinkage due to theft or damage.
Inventory Carrying Cost Formula
Calculating the overall cost of inventory will help you determine an appropriate retail cost, cost of goods sold (COGS), and it will give you insight into your total inventory value at any given time.
To calculate inventory carrying costs per unit, follow the following formula:
Inventory carrying cost per unit = (Total inventory carrying cost / Average inventory level) / Number of units
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How to Improve Overall Inventory Carrying Costs
Knowing your inventory carrying costs is important for all ecommerce businesses, to free up working capital, maximize profitability, and maintain optimal inventory management.
When inventory carrying costs get too high, you may find your profit margins go down unless you increase your retail prices.
Here are some suggestions to help lower overall inventory carrying costs.
Calculate EOQ (Economic Order Quantity)
One of the most important metrics to monitor to reduce high carrying costs is EOQ. Any strong inventory management program will formulate EOQ on a regular basis to help decrease unnecessary costs. The EOQ formula is used to identify the greatest number of units needed (per order) to reduce buying.
Monitor Inventory Service Costs
While it’s obvious to include total warehouse space and the cost of your actual inventory items in your carrying costs calculation, many brands forget to include service costs like warehouse management system (WMS) software, inventory management system, IT services, taxes, or other one-time capital costs. These should be included in your formula too.
Limit Your Inventory Levels by Lowering SKU Count
If you’ve not succumbed to SKU proliferation, stop before you do. While adding more items to your product mix is important to reach more customers and increase revenue, it can also lead to increased storage costs and tie up your cash flow. Be mindful about adding product variations and new SKUs to your product line as it often leaves you with excess inventory.
Process Returns More Efficiently
The faster you can process returned merchandise the quicker it can be resold. The first step to efficient returns management is creating a process to streamline and categorize incoming returns. It is crucial to immediately classify and document the condition of the items upon receipt. Work with your 3PL to create business rules to ensure they can put resealable items back into inventory.
Do More Than Just Dispose
If you find you have a lot of unmoving inventory and it’s increasing your carrying cost, work with your 3PL to find solutions to get rid of some of it. There may be a big opportunity cost in getting rid of old, unmoving, or unsold items; obsolescence is a critical aspect of any annual inventory audit or analysis.
Beyond just disposal, you can choose to rework it (sell used or refurbished goods), or donate it to create a charitable marketing campaign. An experienced 3PL will have lots of options to help you remove unmoving inventory.
Get a Better at Forecasting and Demand Forecasting
If you find that you are not able to sell the amount of inventory you have on hand, it may mean you need to adjust your approach to forecasting. First analyze your current stock levels, lead times, reorder points, and a strategy to sync your promotional cycle with your operations.
If a new forecast doesn’t help adjust your inventory carrying costs, you may need to look into demand forecasting (real-time ordering to meet customer demand) or just-in-time inventory which allows your company’s inventory to match more closely the orders coming in.
Bottom Line
The level of inventory you keep in storage is directly correlated to your cash flow. You can make big improvements to your inventory carrying costs by tracking and monitoring the right aspects of your inventory management. Don’t get caught with too much capital tied up from storing inventory that isn’t selling. Rely on trusted partners to help you make informed decisions about your inventory storage strategy, the correct amount of safety stock, and manage your inventory velocity.
This post was written by Maureen Walsh, Marketing Manager at DCL Logistics. A writer and blogging specialist for over 15 years, she helps create quality resources for ecommerce brands looking to optimize their business.
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Tags: Calculators & Formulas, warehouse management
