Definition: A carrying cost is the expense associated with holding inventory over a period of time. In other words, it’s the cost of owning, storing, and keeping inventory to be sold to customers.
What Does Carrying Cost Mean?
In managerial accounting, there are many different costs associated with inventory beyond its actual cost. That is one of the biggest reasons why retailers want to sell their inventory within 90 days of buying it. It costs money to store and maintain goods before they are sold to customers.
Example
Let’s take a look at a typical retail store for example. After the retailer orders the goods, it arrives at the store and an employee must receive, unpack, and check all of the items. The goods must then be moved to storage and cataloged. As the product is sold, it is pulled from storage and placed in the main retail store. So what are the carrying costs in this example?
First, the retailer has to pay rent for the storage area. The more inventory it has, the more space is required. More space means more rental payments.
Second, the goods can’t simply stay back there unchecked and unattended. The retailer has to periodically count the units and put safeguards in place to make sure employees don’t ruin or steal any of it.
Third, if the products seasonal or time sensitive, spoilage could occur. For example, a clothing store can’t sit on its winter inventory all summer. It has to sell all of it during the winter season or it is worthless.
Forth, the last and final cost of carrying inventory is an opportunity cost. Unlike the other expenses we mentioned, this isn’t an actual dollar payout. Instead, it’s a cost associated with not being able to take advantage of another opportunity. All of cash sitting in inventory and paying for storage could have been used for something else productive.
All of these expenses combined make up carrying costs.
