Inventory carrying cost (ICC) annualizes the cost of carrying (or holding) the average inventory value. The annualization is important because it allows inventory carrying cost to be placed alongside and optimized with lost sales cost, transportation cost, and warehousing cost in the computation of total supply chain costs. Inventory carrying cost (ICC) is the annual cost of carrying (or holding) the average inventory value. It is computed by multiplying the average inventory value (AIV) by the inventory carrying rate (ICR).
ICC = AIV x ICR
For example, if the average inventory value in a warehouse is $10,000,000 and the inventory carrying rate is 30% per year, then the inventory carrying cost in the warehouse is
ICC = $10,000,000 x 30%/year = $3,000,000 per year.
Expected inventory carrying costs associated with target unit fill rates ranging from 50% to 99.95% for a medium moving SKU in a large food and beverage company were presented below. Note that inventory carrying costs grow from a low of $12,739 per year at a target fill rate of 50% to a high of $15,444 per year at a target unit fill rate of 99.97%.
The inventory carrying rate is an annual percentage applied to the average inventory value to estimate inventory carrying charges. The rate includes the opportunity cost of capital (every dollar invested in inventory could theoretically be earning the opportunity interest rate), insurance, taxes, loss, and obsolescence. With this definition, the ICR typically ranges between 10% and 30% per year. In addition, storage and warehousing costs may also be included if they are not already being considered as a part of total logistics cost. If warehouse operating costs are included, the inventory carrying rate typically ranges between 15% and 40%. In most cases corporations underestimate their inventory investment and associated carrying charges. In many cases corporations do not even have a standard inventory carrying rate.
The average inventory value (AIV) for an item, i, should be estimated as the product of the average inventory level (AIL) in units and the unit inventory value (UIV). The unit inventory value is the investment in or cost of creating each unit of inventory at its current status (raw material, work in process, or finished goods). The unit inventory value is typically the selling price less the margin.
AIVi = AILi * UIVi