Question

What is a common rule of thumb used to calculate inventory carrying costs? Give an example of its use

Answer 1

Out of the overall inventory value on hand, the common rule of thumb used to calculate the inventory carrying costs is 25% of the same. For example:

An entity has an average inventory value of $ 20M. Here, before proceeding with the carrying costs, there first needs to be the summation of the noncapital costs. Let the addition of the noncapital cost represent the total of 3.9M USD that may include costs such as Inventory services or inventory risks. If the same is converted into the percentage terms to that of the inventory value then 3.9M USD / 20M USD = 19.5%. With the assumption that the capital costs are say 10% in our case, hence the total inventory cost would be 2.9M+1M=3.9M. Therefore, for an average inventory of $20M, the inventory cost is 3.9M and the inventory carrying cost is 19.5%+10%=29.5%.