Also referred to as a carrying cost, a holding cost is any expense that is incurred while maintaining an inventory of goods. The warehoused inventory may be raw materials awaiting use in production, or finished goods that are awaiting sale and shipment. There are several different types of holding costs that are likely to apply with the maintenance of any type of inventory.
Some forms of holding costs relate directly to the physical facilities where the goods are housed. For businesses that do not own their own warehouses, the resources expended for rental of warehouse space qualifies as holding cost. When the owner of the inventory does own warehouse facilities, expenses like taxes, utilities, insurance on the building and the inventory, and the wages and salaries paid to employees working in the warehouse can each be rightly classified as a holding cost.
In order to increase the profitability of the business, there are some strategies that can help minimize holding costs in general, and thus increase the net income earned by the company within any given period. One of the most effective ways is to maintain as low an inventory as possible. Carrying a smaller inventory means that it is possible to rent a smaller, and therefore less expensive, warehouse. Fewer employees are needed to oversee a smaller inventory. There is also a chance of reducing the amount of utilities necessary to keep the climate of the storage area within acceptable limits.
One of the greatest benefits in terms of reducing holding cost has to do with taxes. In many countries, businesses pay taxes on finished goods held in inventory based on the total value of every unit current being held in a warehouse. By employing production methods that make it possible to produce goods only a short time before they are to be shipped to a buyer, the inventory is kept to a minimum, thus making it possible to have fewer items that are subject to taxes.
The same approach can be used with a raw materials inventory. By employing a method that is known as cycle ordering, it is possible to establish re-order points for each of the required materials. Essentially, this approach allows the producer to continually maintain just enough materials on hand to keep production going until the next order of raw materials is received. By avoiding the accumulation of a large inventory of materials that may set for months before being used in production, the business is subject to a smaller tax burden, allowing it to keep more of the revenue generated from the sales of the finished goods.