2018F SUP-3043-1 Supply Chain Operations Management

Assignment #1: Group Research Project

 Total Marks - 15
 Marks Weightage – 15%
 Complete the assignment, print and submit 1 copy in class per group (APA
format).
 Upload 1 copy on Moodle per group.
 You are expected to present key points of your report in class.

DATE: October 15, 2018

INSTRUCTOR: Lal Jose

CLASS: SUP-3043

GROUP: 1

STUDENT FIRST NAME STUDENT LAST NAME STUDENT NUMBER

(IN CAPITAL) (IN CAPITAL)
1 JUAN GONZALEZ C0712484

2 SALMAN YASSIN C0720930

3 BRENO DUARTE TIRADO C0723202

4 ALEKSANDRS IGNATOVS C0714032

5 LIBIN AUGUSTINE C0719205

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 2018F SUP-3043_1 Supply Chain
Operations Management

Inventory Carrying Cost

When trying to reduce cost, companies tend to ignore the cost of carrying the inventory that is
already sitting in their warehouses. It is crucial for companies to pay attention to any and all cost
of carrying this inventory and carefully analyze where can changes be made to reduce said cost
and in return boost their bottom line.
To truly optimize their supply chain, a company needs recognize the total cost of its supply chain
and, most importantly, realize that inventory carrying cost makes up for a large portion of that
total cost. Carrying cost can turn out to be a substantial portion of the expenses when purchasing
and storing goods.

This is why it is so important, especially for new businesses to take into consideration all cost
involved in carrying inventory and not focusing only on the price paid for goods. The purpose of
this document is to highlight the importance Inventory Carrying Cost, offer a an explanation of
what Inventory Carrying Cost means, its impact on a the company’s finance, how can companies
measure its Inventory Carrying Cost as well as a sample calculation of this very important KPI.

© 2014 LAMBTON COLLEGE IN TORONTO

 2018F SUP-3043_1 Supply Chain
Operations Management

What does Inventory Carrying Cost mean?

Inventory Carrying Cost is best described as the cost that, over a period of time, a business will
incur to hold on to and store its inventory. Inventory Carrying Cost is described often as a
percentage of the value of a company’s inventory.
Said percentage can include capital, taxes, employee cost, obsolescence costs, warehousing
costs, insurance and the cost of insuring, scraping and replacing items. These components can be
categorized in four mayor categories to better understand them:

1. Capital costs
2. Storage costs
3. Service costs
4. Inventory risk costs

Capital Costs
When speaking of capital costs, we usually mean the costs incurred for carrying inventory, such
as the amount paid for purchasing goods, the amount paid on interest for the purchase of said
goods, the loss of interest when we give up cash to turn it into inventory and even the
opportunity cost of buying inventory. Capital cost continues to be the largest percentage of the
total inventory carrying cost. Although Inventory carrying cost is expressed as a percentage of
the dollar value of the total inventory a company is holding, this percentage can be the result of
calculation or be an independent figure, resulting from either experience or industry standards.

Storage Cost
Storage costs are the cost of holding inventory in a facility such as a warehouse of a distribution
centre. This cost it the result of combination of related expenses, such as the facility’s rent or
mortgage, its utilities, in addition to the cost of transporting goods in and out of the facility.
These costs can be fixed as in the case of mortgage or variable, like utilities, but if the company
is using 3PLs, then all cost can be rolled into a single monthly expense.

© 2014 LAMBTON COLLEGE IN TORONTO

 2018F SUP-3043_1 Supply Chain
Operations Management

Inventory Service Costs

The cost to protect inventory from theft or workplace accidents is known as Inventory Service
Costs. But Inventory Service Cost are not limited only to insurance, they also include payment of
taxes on inventory and software licenses to manage said inventory. Insurance is usually paid
depending on the types of goods stored and the amount of inventory, where higher valued items
will pay higher premiums as higher levels of inventory will do so as well.

Inventory Risk Costs

Holding inventory inheritably carries some degree of risk, which may come from several factors.
One of these factors can be shrinkage, the loss of inventory that happens after the purchasing of
goods but before it finally sold to customers. This can happen due to in transit damages,
administrative errors or pilferage and theft by employees.
Secondly, risk can come from the loss of value of inventory while stored and waiting to be sold,
as in the case of the launching of a new product, or by obsolescence if goods held in storage go
beyond their expiration date. Ultimately, items can may become damaged, by water, heat, or by
due to incorrect storage.

Why is Inventory Carrying cost important for firms and what is its impact a firm’s
finance?

Inventory carrying cost indicates a particular percentage of the inventory cost, which serves as
the expenses a business have over a certain period of time to carry that inventory. This
percentage may consist of depreciation, taxes, salaries, insurance, storage, opportunity cost and
the overall cost of capital for the company as a whole.
Management and analysts use this KPI metrics to find out the possible profit can be made based
on current inventory. It also helps businesses to determine if there is a need to produce more
products. Inventory KPIs can assist with maintaining the current level of productivity and it can
help to boost up the business.

© 2014 LAMBTON COLLEGE IN TORONTO

 2018F SUP-3043_1 Supply Chain
Operations Management

Inventory is typically shown as the largest share of current assets on the balance sheet.
Therefore, managing the movement of inventory can significantly ‘impact the cost of carrying it.
Moreover, the cost of inventory can straightly influence the cost of capital and all forthcoming
cash flows linked with the company.
The cost of inventory consists of total costs related with the inventory handling operations. These
costs include:
• Opportunity cost of the money tied up in the purchased inventory
• Storage space for inventory
• Transportation or handling expenses
• Depreciation and obsolescence

How can companies measure and monitor Inventory carrying cost?

Commonly, the expenses are processed for a year and after that is expressed as a percentage of
the cost of the inventory items. For instance, a company may express their inventory holding cost
as 10%. Let’s assume that a company has $200,000 of inventory cost, the cost of carrying and
holding inventory would be estimated to be $20,000 per year.

Below is the formula of calculating the carrying cost inventory:

Inventory carrying rate * Average inventory value/100

The expense of carrying cost will differ from organization to another. For example, if an
organization has an expansive money offset with no alluring venture choices, has overabundance
space for capacity, and its items have a low probability for deterioration or obsolescence, the
organization's holding or conveying costs are low. An organization with tremendous obligation,
little space, and items subject to crumbling will have very high holding costs.
Carrying cost has a variety of holding costs in any inventory warehouses, below are some of
these costs:
· Labor
· Rent
© 2014 LAMBTON COLLEGE IN TORONTO
 2018F SUP-3043_1 Supply Chain
Operations Management

· Utilities
· Storage
· Security
· Theft
· Equipment
· Etc.

A warehouse manager needs to measure the majority of the particular expenses in their facility
into solid dollar sums with the end goal to make a precise stock KPI for conveying costs.
Once that stock KPI is made, you can create techniques for improving or optimizing your
carrying costs. For example,
Improvement of the warehouse layout to better utilize space.
Improvement of labor productivity
 Improvement of databases for accurate prediction of demand
 Inventory reduction
 Just in time (JIT)
 Consider utilizing dispatch stock
 Figure a proper measure of security cost
 Use an accurate reorder point formula
 Rent space for high demand season instead owning a bigger warehouse year round

© 2014 LAMBTON COLLEGE IN TORONTO

 2018F SUP-3043_1 Supply Chain
Operations Management

Sample Inventory Carrying Cost Calculation

© 2014 LAMBTON COLLEGE IN TORONTO

 2018F SUP-3043_1 Supply Chain
Operations Management

Bibliography
Dear Systems. (2017, Septembre 17). Retrieved from Inventory KPI: What It Is and the
Most Important KPIs to Measure: https://dearsystems.com/inventory-
software/blog/inventory-kpi/
Investopedia. (n.d.). Retrieved from Carrying cost of inventory:
https://www.investopedia.com/terms/c/carryingcostofinventory.asp#ixzz5TxtsPP
bB
Junior. (2017, February 19). Unleashed Software. Retrieved from Three reasons to
understand your inventory carrying costs:
https://www.unleashedsoftware.com/blog/three-reasons-understand-inventory-
carrying-costs
Maha Muzumdar, A. Z. (2015, July 2015). Supply Chain 24/7. Retrieved from Secrets to
Successful Order Fulfillment:
https://www.supplychain247.com/article/secrets_to_successful_order_fulfillment
Mbaskool.com. (n.d.). Retrieved from Invetory Carrying Cost:
https://www.mbaskool.com/business-concepts/operations-logistics-supply-chain-
terms/15270-inventory-carrying-cost.html
Murray, M. (2018, July 14). The Balances MB. Retrieved from Suppy Chain Specifics:
https://www.thebalancesmb.com/inventory-carrying-costs-2221373
Tradegecko. (n.d.). Retrieved from Introduction to carrying costs:
https://www.tradegecko.com/learning-center/introduction-to-carrying-costs

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