How to Calculate and Reduce Inventory Costs

Where Inventory Costs Add Up

Inventory costs can accumulate throughout the supply chain, from purchasing and receiving to storage and ongoing management. Understanding where these expenses arise helps organizations identify opportunities to control costs, improve inventory decisions, and protect margins.

The initial purchase of inventory brings additional expenses, including shipping, handling, and taxes. Once goods are received, storage introduces costs associated with warehouse space, utilities, security, and insurance.

Carrying inventory also ties up capital that could otherwise support growth or other business priorities, particularly when stock remains unsold for extended periods. Administrative expenses, including inventory management and accounting, can also add to the overall cost of maintaining inventory.

These expenses generally fall into four main categories:

1. Ordering Costs
2. Carrying Costs
3. Stockout Costs
4. Inventory Management Costs

The 4 Main Types of Inventory Costs

Ordering Costs

Ordering costs represent the expenses associated with replenishing stock. In addition to the purchase price, secondary costs can include:

• Shipping fees
• Payment processing
• Handling labor
• Administrative costs
• Management of supplier relationships

Think of it like this: Every time your business places an order with the supplier, a series of actions unfold, starting from generating purchase orders to receiving and inspecting the goods upon arrival.

From there, the goods are received and put away in the warehouse.

Some fees are more obvious, like shipping charges. Others are less visible, such as the cost of administrative tasks for procurement and order management.

Recognizing and understanding these costs can help you improve inventory management and reduce overhead.

To gain even more order efficiency, technologies like mobile barcoding can help automate manual tasks. The efficiencies gained by eliminating extra steps and human error directly improve the costs of inventory management.

Carrying Costs

Carrying costs, or the cost of holding inventory, remain a constant concern in the warehouse.

Holding onto inventory incurs multiple indirect expenses, from rent or mortgage payments for storage space to utilities, insurance, and personnel.

These costs accumulate over time, affecting the financial health of a business.

Inefficient inventory control often leads to a buildup of excessive overstock. Whether your business is attempting to stockpile “just in case” materials to avoid a shortage or your operation doesn’t have the visibility it needs to streamline stock levels, overstocking detracts from profits.

If you’re in an industry like food and beverage or electronics manufacturing, perishable goods add another layer of complexity. Spoilage or obsolescence create losses. Therefore, these products must be managed with meticulous care.

Balance must be maintained between minimizing the resources tied up in inventory and reducing the risk of stock obsolescence.

Different types of inventory also create different storage and handling requirements, making it important to understand where carrying costs are concentrated.

One way to reduce carrying costs is through a mobile warehouse solution. By leveraging real-time barcode scanning connected to the ERP system, transactions are instantly recorded, enhancing visibility, traceability, and throughput. All of these factors help reduce carrying costs.

In addition, mobile technology plays an important role in enabling accurate demand forecasting, thus allowing for more precise inventory control and lower carrying costs.

Stockout Costs

Stockout costs emerge when businesses fail to meet demand due to inadequate inventory levels. Warehouse managers dread stockouts.

Stockouts cause disruptions or delays in customer orders and production lines, and lead to missed sales opportunities.

Ultimately, these issues can have a long-term impact on customer satisfaction—or dissatisfaction, as the case may be. Loss of customer loyalty and brand reputation are difficult to calculate, but real nonetheless.

Not only do dissatisfied customers tend to stop buying, they often go to competitors, damaging your bottom line twofold.

To avoid stockouts and overstocking, your organization should take a proactive approach to inventory management. Accurate inventory data and consistent replenishment processes help maintain stock availability without carrying unnecessary inventory.

In this case, mobile inventory solutions can help optimize stock levels, automate re-order points and replenishment, and boost the accuracy of demand forecasting.

Embracing technology for real-time inventory tracking and analytics equips businesses with the insights they need to maintain resilience in the face of demand fluctuations and the unexpected.

Inventory Management Costs

Lastly, the handling of items themselves affects inventory costs. For the warehouses using manual processes or limited automation, these costs can be significant.

Not only is inventory frequently misplaced, but it can also be re-ordered (and overstocked) due to lack of visibility or timely information in the ERP system.

Labor expenses factor heavily into inventory costs as well. Consider the following:

• Accuracy of inventory, picking, and orders
• Speed of task completion
• Time spent searching for inventory
• Error corrections and re-work
• Training time for new or seasonal workers

Again, mobile technology provides transformative benefits. By automating manual processes and replacing dated practices with real-time digital inventory, your warehouse can significantly improve accuracy, speed, and training time.

Other Factors That Increase Inventory Costs

Operational Efficiency

As with inventory management, operational efficiency ultimately influences total inventory costs as well.

In short, operational efficiency determines how well your business can manage its inventory to meet demand without incurring unnecessary expenses.

This means warehouse management procedures affect the bottom line. Ideally, a company will want to make its warehouse as efficient as possible.

There are several important areas to look at:

• Time spent on each inventory stage (receiving, cycle counting, picking, etc.)
• Labor productivity
• Ability to effectively forecast demand
• Amount of waste
• Level of automation
• Hidden bottlenecks

Technological advancements in warehouse automation are helping businesses to streamline inventory activities and lower overhead costs.

Implementing a mobile inventory management solution is one possibility. By connecting an enterprise mobility solution to your ERP system, you can accelerate operations into real time with reliable data, visibility, and analytics capable of driving more effective decision-making.

Mobile workflows with intuitive interfaces can help teams follow standard processes with less training and fewer manual steps, allowing for more consistent handling and better inventory practices.

External Factors

Although harder to predict, external factors play a role in inventory costs, too. External factors can be anything from market trends, seasonal or fluctuating demand, global economic conditions, localized disruptions from natural disasters, and so on.

Depending on your business, these factors may impact your inventory costs.

For instance, an unexpected surge in demand can lead to rapid stock depletion, necessitating urgent restocking at potentially higher costs.

In another example, a sudden market downturn might result in overstock, increasing carrying costs.

Additionally, supply chain disruptions from natural disasters, political instability, or pandemics can lead to delays and inflated costs.

For these reasons, businesses must rely on technology and operational health to stay agile. Having reliable data that’s always up to date is key. Only then can decisions be made quickly and effectively to pivot when faced with uncertainty or changing conditions.

Strategies to Reduce Inventory Costs

Inventory Optimization Techniques

The most important thing you can do to reduce inventory costs is to optimize your inventory control. This way, you can align your stock levels as closely as possible with customer demand.

Many techniques abound. Some strategies include:

• ABC analysis, which categorizes inventory based on its importance, prioritizes faster moving inventory and resources.
• Economic Order Quantity (EOQ) is a model that determines the optimal order size to minimize both ordering and carrying costs.
• Just-in-time (JIT) inventory system reduces inventory levels by arranging for goods to arrive only as they are needed.

Implementing any of these techniques requires precise monitoring and forecasting. The only way to do that in today’s fast-moving supply chain is through the use of technologies like mobile data collection.

Using Technology to Reduce Inventory Costs

Accurate inventory data helps organizations manage costs across receiving, storage, picking, and replenishment. Mobile data capture connected to an ERP system can reduce manual entry and improve the visibility needed to make better inventory decisions.

A mobile solution like RFgen transforms obsolete inventory control practices. With built-in manufacturing traceability solutions, asset tracking, offline inventory management, and more, every area of inventory can be optimized, from stock levels to turnover rates and costs.

Investing in RFID tags and barcode scanners can also improve throughput and reduce errors, further improving cost control.

More accurate transaction data and consistent mobile workflows can help reduce the labor, rework, and inventory discrepancies that contribute to higher operating costs.

Calculating Inventory Costs and Cost of Goods Sold

One way to evaluate inventory-related costs is to calculate the cost of goods sold (COGS) for a given period. For a business using a periodic inventory method, the basic formula is:

Cost of Goods Sold Inventory Cost = Beginning Inventory + Net Inventory Purchases – Ending Inventory

This calculation measures the cost of inventory sold during the period. It does not include every expense associated with managing inventory. Carrying costs, stockout costs, and other operating expenses should be evaluated separately to understand their broader impact on profitability.

If you want a more accurate result, include cost modifications from the four pillars mentioned above as well as the impact of operational efficiency and external factors.

Because the calculations can get pretty complicated, you may wish to turn to a free online inventory cost calculator that can automate some of the manual work.

In larger organizations, calculating inventory costs can be especially complex. When evaluating new inventory technologies, consider reaching out to potential technology vendors who can help you calculate the cost savings associated with implementing the new solution.

Improving Inventory Performance and Cost Control

Controlling inventory costs starts with understanding where expenses accumulate and how everyday inventory decisions affect your organization. Purchasing, storage, handling, and stock availability all influence cost performance, making accurate information essential to managing those expenses.

For supply chain and warehouse leaders, improving inventory accuracy and workflow consistency can create opportunities to reduce unnecessary stock, limit manual work, and protect service levels. With a clearer view of inventory movement and costs, organizations can make more informed decisions about where to improve operations and how to maintain those improvements over time.

Frequently Asked Questions

What is inventory cost?

Inventory cost includes the expenses associated with acquiring, holding, and managing stock. These can include purchasing, ordering, storage, handling, labor, insurance, and losses related to excess or unavailable inventory. Understanding these costs helps businesses evaluate inventory performance and identify opportunities to reduce operating expenses.

How do you calculate inventory cost?

The formula Beginning Inventory + Net Inventory Purchases − Ending Inventory calculates cost of goods sold under a periodic inventory method. To assess broader inventory costs, organizations must also evaluate expenses such as carrying, ordering, and inventory management costs. The appropriate calculation depends on which cost is being measured.

What is inventory carrying cost?

Inventory carrying cost is the expense of holding unsold stock over time. It can include warehouse space, utilities, insurance, handling, capital tied up in inventory, and losses from damage or obsolescence. Carrying costs increase when businesses maintain more inventory than their operations require.

What is the difference between ordering costs and carrying costs?

Ordering costs arise when a business replenishes inventory, including purchasing administration, shipping, and receiving activities. Carrying costs accumulate while inventory is stored, including space, insurance, and capital costs. Balancing ordering frequency and stock levels helps organizations manage both expenses without compromising availability.

Does inventory cost include labor and warehouse overhead?

Yes. Labor and warehouse overhead can contribute to inventory-related operating costs through receiving, storage, handling, counting, and order fulfillment. Their accounting treatment varies depending on the activity and costing method. Organizations should distinguish inventory acquisition costs from ongoing operating expenses when evaluating total cost performance.

How can you reduce inventory costs without increasing stockout risk?

Businesses can reduce inventory costs by improving inventory accuracy, reviewing reorder points, monitoring demand patterns, and identifying excess stock. Regular cycle counting and timely transaction updates help maintain visibility into available inventory, allowing teams to control carrying costs while protecting the stock needed for production and customer orders.